71126 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Parts 240, 242, and 249

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

RIN 3235–AJ33

Fair Administration and Governance of 

Self-Regulatory Organizations; 

Disclosure and Regulatory Reporting 

by Self-Regulatory Organizations; 

Recordkeeping Requirements for SelfRegulatory Organizations; Ownership 

and Voting Limitations for Members of 

Self-Regulatory Organizations; 

Ownership Reporting Requirements 

for Members of Self-Regulatory 

Organizations; Listing and Trading of 

Affiliated Securities by a SelfRegulatory Organization

AGENCY: Securities and Exchange 

Commission.

ACTION: Proposed rule.

SUMMARY: The Securities and Exchange 

Commission (‘‘Commission’’) is 

proposing to adopt new rules and 

amend existing rules and forms under 

the Securities Exchange Act of 1934 

(‘‘Exchange Act’’). The proposals pertain 

to the governance, administration, 

transparency and ownership of selfregulatory organizations (‘‘SROs’’) that 

are national securities exchanges or 

registered securities associations and 

the periodic reporting of information by 

these SROs regarding their regulatory 

programs. The proposals also relate to 

the listing and trading by SROs of their 

own or affiliated securities. 

First, the proposals would impose 

new governance standards on national 

securities exchanges and registered 

securities associations by requiring a 

majority of the members of the 

exchange’s or association’s board of 

directors to be independent. In addition, 

key committees of the board would be 

required to be composed solely of 

independent directors. The proposals 

would define the term ‘‘independent 

director.’’ The proposals also would 

require exchanges and associations to 

establish policies and procedures to 

maintain a separation between their 

regulatory functions and their market 

operations and other commercial 

interests, and require that funds 

received from regulatory fines, fees, and 

penalties be used for regulatory 

purposes.

Further, the proposals would require 

national securities exchanges and 

registered securities associations to 

prohibit any member that is a broker or 

dealer from owning and voting more 

than 20% of the ownership interest in 

the exchange or the association, or a 

facility of the exchange or association. 

To supplement these ownership and 

voting provisions, the proposals also 

would require each member of an 

exchange or association that is a broker 

or dealer to file a report with the 

Commission when the member acquires 

ownership of more than 5% of any 

interest in the exchange or association, 

or any facility thereof. Also, the 

Commission proposes to require 

national securities exchanges and 

national securities associations to 

maintain their books and records in the 

United States. Together, these proposals 

are designed to strengthen the 

governance and administration of SROs 

and address the possible concentration 

of ownership by member firms. 

In addition, the Commission proposes 

to amend its forms for registration as a 

national securities exchange or 

registered securities association to 

require that these SROs file with the 

Commission and publicly disclose 

enhanced information relating to their 

governance, regulatory programs, 

finances, ownership structure, and other 

matters. Further, the Commission’s rules 

governing the procedures for filing 

amendments to these registration forms 

would be revised to require more 

frequent updating of the required 

information and the posting of the 

required information on the SROs’ 

Internet Web sites. These proposals are 

designed to provide greater 

transparency to key aspects of the 

governance, ownership structure, and 

regulatory operations of national 

securities exchanges and registered 

securities associations. 

The Commission also proposes to 

require national securities exchanges 

and registered securities associations to 

file with the Commission, in an 

electronic format, quarterly and annual 

reports on particular aspects of their 

regulatory programs. This proposal is 

intended to enhance the Commission’s 

oversight and surveillance of exchanges 

and associations by requiring them to 

provide the Commission with detailed 

regulatory information on a regular 

basis, thereby assisting the Commission 

to oversee more effectively the SROs’ 

regulatory programs and better identify 

any trends or issues that may arise. 

Finally, the Commission proposes to 

impose requirements on a national 

securities exchange or registered 

securities association that chooses to list 

or trade its own security, the security of 

any trading facility, or the security of an 

affiliate of itself or a facility. The 

proposed requirements are designed to 

assure that these SROs are able to 

enforce effectively their listing 

standards with respect to, and supervise 

trading in, their own or a facility’s 

securities, or the securities of affiliates 

of the SRO or a facility.

DATES: Comments should be submitted 

on or before January 24, 2005.

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/

rules/proposed.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number S7–39–04 on the subject line; 

or 

• Use the Federal eRulemaking Portal 

(http://www.regulations.gov). Follow the 

instructions for submitting comments. 

Paper Comments 

• Send paper comments in triplicate 

to Jonathan G. Katz, Secretary, 

Securities and Exchange Commission, 

450 Fifth Street, NW., Washington, DC 

20549–0609. 

All submissions should refer to File 

Number S7–39–04. This file number 

should be included on the subject line 

if e-mail is used. To help us process and 

review your comments more efficiently, 

please use only one method. The 

Commission will post all comments on 

the Commission’s Internet Web site 

(http://www.sec.gov/rules/

proposed.shtml). Comments are also 

available for public inspection and 

copying in the Commission’s Public 

Reference Room, 450 Fifth Street, NW., 

Washington, DC 20549. All comments 

received will be posted without change; 

we do not edit personal identifying 

information from submissions. You 

should submit only information that 

you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: SRO 

Governance and Disclosure: Nancy J. 

Sanow, Assistant Director, at (202) 942–

0796, Susie Cho, Special Counsel, at 

(202) 942–0748, Leah Mesfin, Special 

Counsel, at (202) 942–0196, Geraldine 

Idrizi, Attorney, at (202) 942–7317, and 

A. Michael Pierson, Attorney, at (202) 

942–0192; Reporting Requirements for 

SROs: Nancy J. Sanow, Assistant 

Director, at (202) 942–0796, and Richard 

Holley III, Attorney, at (202) 942–8086; 

and SRO Ownership and Voting 

Restrictions, SRO Self-Listing, and 

Reporting Requirements for Members:

Heather Seidel, Attorney Fellow, at 

(202) 942–0788, Sonia Trocchio, Special 

Counsel, at (202) 942–0753, David Hsu, 

Special Counsel, at (202) 942–0731, and 

Jennifer Dodd, Attorney, at (202) 824–

5471; all of whom are in the Division of 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71127

Market Regulation, Securities and 

Exchange Commission, 450 Fifth Street 

NW, Washington DC 20549–1001.

SUPPLEMENTARY INFORMATION: We are 

proposing to add new Rules 3b–19, 6a–

5, 17a–26, 17a–27, and Regulation AL 

under the Exchange Act; amend Rules 

6a–2, 15Aa–1, and 17a–1 under the 

Exchange Act; redesignate Rule 15Aj–1 

under the Exchange Act as Rule 15Aa–

2 and amend redesignated Rule 15Aa–

2; amend Form 1 under the Exchange 

Act; redesignate Form X–15AA–1 under 

the Exchange Act as Form 2 and amend 

redesignated Form 2; and remove Forms 

X–15AJ–1 and X–15AJ–2 under the 

Exchange Act.

Table of Contents 

I. Background 

A. Self-Regulation under the Exchange Act 

B. Overview of Recent Developments 

1. Governance Concerns 

2. Concerns Relating to Weaknesses of SRO 

Regulatory Programs 

3. Competitive Concerns 

4. Concerns Relating to New Ownership 

Structures 

II. Fair Administration and Governance of 

National Securities Exchanges and 

Registered Securities Associations 

A. Background and Need for Proposed 

Rules 6a–5 and 15Aa–3

B. Description of Proposed Rules 6a–5 and 

15Aa–3

1. Scope of Proposed Rules 6a–5 and 

15Aa–3

2. Board Consisting of a Majority of 

Independent Directors 

a. Determination of Independence 

b. Independent Board Requirements 

c. Fair Representation 

3. Standing Committees 

4. Other Committees of the Board 

5. Other Requirements Applicable to 

Directors and Officers 

6. Executive Sessions of the Board 

7. Separation of Chairman of the Board and 

CEO Positions

8. Separation of Regulatory and Market 

Operations 

a. Independence of Regulatory Program 

b. Use of Regulatory Fees, Fines, and 

Penalties 

c. Confidentiality of Regulatory and 

Trading Information 

9. Member Voting and Ownership 

Limitations 

a. Members’ Interests Aggregated with 

Their Related Persons 

b. Solicitation of Revocable Proxies 

c. Requirement to Divest Ownership 

Interest and Restrict Voting 

d. Ability to Obtain Information 

10. Code of Conduct and Ethics and 

Governance Guidelines 

11. Exemption Provision 

12. Implementation 

C. Request for Comment 

III. Proposed Regulation AL—National 

Securities Exchanges and Registered 

Securities Associations Listing Affiliated 

Securities 

A. Background and Need for Proposed 

Regulation AL 

B. Description of Proposed Regulation AL 

1. Definition of Affiliated Security 

2. Initial Listing 

3. Continued Listing and Trading 

4. Parity in Application of Listing and 

Trading Rules 

5. Exemption Provision 

C. Request for Comment 

IV. Disclosure by Eros 

A. Overview of Proposed Amendments to 

Registration Forms for Exchanges and 

Associations 

B. Description of Registration Processes 

1. Registration as a National Securities 

Exchange or Exemption from Such 

Registration Based on Limited Volume 

2. Registration as a Registered Securities 

Association or Affiliated Securities 

Association 

C. Proposed Revisions to Form 1 and New 

Form 2

1. Scope of Disclosures Required by 

Revised Form 1 and New Form 2

2. Composition, Structure, and 

Responsibilities of the Board 

3. Composition, Structure, and 

Responsibilities of Committees and 

Executive Boards 

4. Governance 

a. Governance Guidelines 

b. Code of Conduct and Ethics 

5. Organizational Charts 

6. Regulatory Program 

7. Audited Financial Statements and Other 

Financial Information 

a. Budget and Revenues Devoted to 

Regulatory Activities 

b. Revenues and Expenses 

c. Other Financial Disclosures 

8. Relationship between SROs, Facilities, 

and Their Affiliates 

9. Ownership 

10. Listing and Trading of Affiliated 

Securities 

11. Location of Books and Records 

12. Miscellaneous Matters Specific to New 

Form 2

13. Current Disclosures to be Retained in 

Revised Form 1 and Added to New Form 

2

a. Constitution, Articles of Incorporation, 

Bylaws, and Rules 

b. Rulings and Interpretations 

c. Officers 

d. Financial Statements of Affiliates 

e. General Information Relating to 

Affiliates and SRO Trading Facilities 

f. Operation of SRO Trading Facilities 

g. Membership Forms 

h. Financial Responsibility and Minimum 

Capital Requirements of Members 

i. Listing Applications 

j. Criteria for Membership 

k. List of Members 

l. Securities Listed and Traded 

D. Timing and Format of Revised Form 1 

and New Form 2

E. Proposed Changes to Rule 15Aa–1

F. Proposed Repeal of Forms X–15AJ–1 

and X–15AJ–2

G. Request for Comment 

V. Periodic Reporting Obligations of 

Exchanges and Associations 

A. Background and Need for Proposed Rule 

17a–26

B. Scope and Timing of Reports Required 

by Proposed Rule 17a–26

1. Quarterly Reports 

2. Annual Reports 

C. Format of Reports 

D. Quarterly Reporting of Regulatory 

Information 

1. Information on the SRO’s Surveillance 

Program 

2. Information on Complaints Received 

3. Investigations, Examinations, and 

Enforcement Actions 

4. Information on Listings Programs 

5. Copies of Board and Committee Meeting 

Agenda 

E. Annual Reporting of Regulatory 

Information 

1. Cumulative Summary of Quarterly 

Information 

2. Processes for Carrying Out Regulatory 

Responsibilities 

3. Evaluation of the Regulatory Program 

4. Internal Controls 

5. Employment Arrangements with 

Regulatory Personnel 

6. Copies of Standing Committee 

Evaluations 

7. Compliance with Regulatory Plans 

F. Audit Report of Electronic SRO Trading 

Facilities 

G. Certifications 

H. Interim Changes 

I. Confidentiality of Reports 

J. Compliance Date 

K. Exemptions and Extensions of Time for 

Filing Reports

L. Filing of Reports 

M. Request for Comment 

VI. Proposed Rule 17a–27

A. Background and Need for Proposed Rule 

17a–27

B. Description of Proposed Rule 17a–27

1. Brokers and Dealers Subject to the Rule 

2. Information Required to be Filed 

3. Timing of Filing 

4. Filings with the Exchange or Association 

5. Exemptions 

C. Request for Comment 

VII. Implementation 

VIII. General Request for Comment 

IX. Paperwork Reduction Act Analysis 

A. Proposed Rule 3b–19

B. Proposed Amendments to Rule 6a–2, 

Revised Form 1, Rule 15Aa–2, and New 

Form 2

1. Summary of Collections of Information 

2. Proposed Use of Information 

3. Respondents 

4. Reporting and Recordkeeping Burden 

5. Collections of Information are 

Mandatory 

6. Record Retention Period 

C. Proposed Rules 6a–5 and 15Aa–3

1. Summary of Collection of Information 

2. Proposed Use of Information 

3. Respondents 

4. Reporting and Recordkeeping Burden 

5. Collection of Information is Mandatory 

6. Record Retention Period 

D. Proposed Regulation AL 

1. Summary of Collection of Information 

2. Proposed Use of Information 

3. Respondents 

4. Reporting and Recordkeeping Burden 

5. Collection of Information is Mandatory 

6. Record Retention Period 

E. Proposed Amendments to Rule 17a–1

F. Proposed Rule 17a–26

71128 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

1 15 U.S.C. 78a, et seq.

2Securities Acts Amendments of 1975, Pub. L. 

94–29, 89 Stat. 97 (1975).

3S. Rep. No. 75, 94th Cong., 1st Sess. (1975) at 

201.

4Section 3(a)(26) of the Exchange Act, 15 U.S.C. 

78c(a)(26), defines a self-regulatory organization as 

any national securities exchange, registered 

securities association, or registered clearing agency, 

or (solely for purposes of Sections 19(b), 19(c), and 

23(b) of the Exchange Act, 15 U.S.C. 78s(b), 78s(c), 

and 78w(b)), the Municipal Securities Rulemaking 

Board. The proposed rulemaking would apply only 

to those SROs that are national securities exchanges 

registered under Section 6(a) of the Exchange Act, 

15 U.S.C. 78f(a), and securities associations 

registered under Section 15A(a) of the Exchange 

Act, 15 U.S.C. 78o–3(a).

5See supra note 2.

6Section 19(b)(1) of the Exchange Act, 15 U.S.C. 

78s(b)(1), requires an SRO to file with the 

Commission copies of any proposed rule or any 

proposed change in, addition to, or deletion from 

the rules of such SRO, accompanied by a concise 

general statement of the basis and purpose of such 

proposed rule change, for Commission approval. 

This filing requirement is supplemented by Rule 

19b–4 under the Exchange Act, 17 CFR 240.19b–4.

7Section 19(c) of the Exchange Act, 15 U.S.C. 

78s(c), permits the Commission, by rule, to 

abrogate, add to, or delete from the rules of an SRO 

as the Commission deems necessary or appropriate 

to insure the fair administration of the SRO, to 

conform its rules to requirements of the Exchange 

Act and the rules and regulations thereunder 

applicable, or otherwise in furtherance of the 

purposes of the Exchange Act.

8Section 19(d)(2) of the Exchange Act, 15 U.S.C. 

78s(d)(2), states that notice of any final disciplinary 

sanction, denial of membership or participation, or 

limitation of access to services to a person, member, 

or person associated with a member shall be subject 

to review by the appropriate regulatory agency for 

such member, participant, applicant, or other 

person. Section 3(a)(34)(E) of the Exchange Act, 15 

U.S.C. 78c(a)(34)(E), states that when used with 

respect to a member of a national securities 

exchange or registered securities association, the 

appropriate regulatory authority is the Commission. 9Section 17(a)(1) of the Exchange Act, 15 U.S.C. 

78q(a)(1), states that exchanges and associations, 

among others, are required to make, keep and 

furnish any records, and make and disseminate any 

reports, that the Commission, by rule, prescribes as 

necessary or appropriate in the public interest, for 

the protection of investors, or otherwise in 

furtherance of the purposes of the Exchange Act.

10Section 17(b) of the Exchange Act, 15 U.S.C. 

78q(b), states that all records of a national securities 

exchange or registered securities association, among 

others, are subject at any time, or from time to time, 

to such reasonable periodic, special, or other 

examinations by representatives of the Commission, 

as the Commission deems necessary or appropriate 

in the public interest, for the protection of 

investors, or otherwise in furtherance of the 

purposes of the Exchange Act.

11Section 19(h)(1) of the Exchange Act, 15 U.S.C. 

78s(h)(1).

12 Id.

13Section 19(h)(4) of the Exchange Act, 15 U.S.C. 

78s(h)(4).

14Sections 6(b)(1) and 15A(b)(2) of the Exchange 

Act, 15 U.S.C. 78f(b)(1) and 78o–3(b)(2).

15Sections 6(b)(3) and 15A(b)(4) of the Exchange 

Act, 15 U.S.C. 78f(b)(3) and 78o–3(b)(4).

1. Summary of Collection of Information 

2. Proposed Use of Information 

3. Respondents 

4. Reporting and Recordkeeping Burden 

5. Collection of Information is Mandatory 

6. Record Retention Period 

G. Proposed Rule 17a–27

1. Summary of Collection of Information 

2. Proposed Use of Information 

3. Respondents 

4. Reporting and Recordkeeping Burden 

5. Collection of Information is Mandatory 

6. Record Retention Period 

H. Request for Comment 

X. Consideration of Costs and Benefits 

A. Costs and Benefits of Proposed Rules 

6a–5 and 15Aa–3

1. Benefits 

2. Costs 

3. Request for Comment 

B. Costs and Benefits of Proposed 

Regulation AL 

1. Benefits 

2. Costs 

3. Request for Comment 

C. Costs and Benefits of Proposed Rule 6a–

2 and Revised Form 1, and Rule 15Aa–

2 and New Form 2

1. Benefits 

2. Costs

3. Request for Comment 

D. Costs and Benefits of Proposed 

Amendments to Rule 17a–1

1. Benefits 

2. Costs 

3. Request for Comment 

E. Costs and Benefits of Proposed Rule 

17a–26

1. Benefits 

2. Costs 

3. Request for Comment 

F. Costs and Benefits of Proposed Rule 

17a–27

1. Benefits 

2. Costs 

3. Request for Comment 

XI. Consideration of Burden on Competition, 

and Promotion of Efficiency, 

Competition, and Capital Formation 

XII. Consideration of Impact on the Economy 

XIII. Regulatory Flexibility Act Certification 

XIV. Statutory Authority and Text of 

Proposed Rules

I. Background 

A. Self-Regulation Under the Exchange 

Act 

The system of regulation for our 

Nation’s securities markets and market 

participants is grounded on the 

principle of self-regulation. Thus, the 

Exchange Act 1 sets forth a regulatory 

model that combines both industry and 

government responsibility, based on the 

notion that regulation is most effective 

when it is done as closely as possible to 

the regulated activity. Congress 

enhanced this framework for the 

regulation of securities markets and 

market participants since the adoption 

of the Exchange Act, most notably in the 

Securities Acts Amendments of 1975.2

While Congress at that time again 

weighed the risks of permitting the 

securities industry to regulate itself 

against the burdens of attempting to 

assure regulation directly through the 

government on a wide scale,3 it 

refrained from changing the underlying 

principle of self-regulation. Thus, 

although the Commission has ultimate 

responsibility for oversight of the U.S. 

securities markets and their 

participants, the SROs continue to have 

‘‘front-line’’ responsibility for 

overseeing trading on their markets and 

their members’ compliance with 

applicable statutory and regulatory 

provisions.4

Congress, however, gave the 

Commission a wide range of tools to 

oversee this self-regulatory system and 

to compel SROs to act when they fail to 

provide adequate protection to 

investors.5 For example, the 

Commission is empowered to approve 

SRO rules 6 and to abrogate, add to, or 

delete from SRO rules.7 The 

Commission also is authorized to review 

disciplinary actions taken by SROs 

against their members.8 In addition, the 

Commission has the authority to require 

exchanges and associations to keep 

records and to file reports with the 

Commission.9 All records of exchanges 

and associations are subject, at any time, 

or from time to time, to reasonable 

periodic, special, or other examinations 

by the Commission.10 If the Commission 

identifies deficiencies, it will bring 

them to the attention of the SRO and 

can inspect the SRO to ascertain 

whether corrective action has been 

taken. Moreover, the Commission has 

the authority to impose limitations on 

the operations of an SRO if it finds that 

the SRO has violated or is unable to 

comply with any provisions of the 

Exchange Act or rules or regulations 

thereunder, or with any of the SRO’s 

own rules, or has failed to enforce 

compliance with any such provision by 

its members.11 Further, the Commission 

has the authority to suspend or revoke 

the registration of an SRO,12 and remove 

from office or censure any officer or 

director of an SRO.13

As part of its duties, an SRO must 

conduct surveillance of trading in its 

markets and examine the operations of 

its members. In addition, an exchange or 

association may not be registered with 

the Commission unless it is so 

organized and has the capacity to carry 

out the purposes of the Exchange Act 

and to comply with, and enforce its 

members’ compliance with, the federal 

securities laws and rules thereunder, as 

well as its own rules.14 An exchange or 

association also may not be registered 

unless the rules of the exchange or 

association, among other things: (1) 

Provide for a fair representation of its 

members on the board of directors; 15 (2) 

provide for an equitable allocation of 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71129

16Sections 6(b)(4) and 15A(b)(5) of the Exchange 

Act, 15 U.S.C. 78f(b)(4) and 78o–3(b)(5).

17Sections 6(b)(5) and 15A(b)(6) of the Exchange 

Act, 15 U.S.C. 78f(b)(5) and 78o–3(b)(6).

18 Id.

19 Id.

20 Id.

21Sections 6(b)(7) and 15A(b)(7) of the Exchange 

Act, 15 U.S.C. 78f(b)(7) and 78o–(b)(7).

22See Sections 6(b)(5) and 15A(b)(6) of the 

Exchange Act, 15 U.S.C. 78f(b)(5) and 78o–3(b)(6).

23See, e.g., John Waggoner and Thomas A. 

Fogarty, Scandals Shred Investors’ Faith: Because 

of Enron, Andersen, and Rising Gas Prices, the 

Public Is More Wary Than Ever of Corporate 

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

Aguilar, Scandals Jolting Faith of Investors, Denver 

Post, June 27, 2002.

24Nasdaq is a facility of the National Association 

of Securities Dealers, Inc. (‘‘NASD’’). Pursuant to 

proposed Rule 15Aa–3(b)(11), which would define 

the term ‘‘facility’’ with regard to a registered 

securities association, Nasdaq would continue to be 

a facility of the NASD.

25Sarbanes-Oxley Act of 2002, Pub. L. 107–204, 

116 Stat. 745 (2002).

26H.R. Conf. Rep. No. 610, 107th Cong., 2nd Sess. 

(2002).

27See Securities Exchange Act Release Nos. 

47672 (April 11, 2003), 68 FR 19051 (April 17, 

2003) (publishing for comment File No. SR–NYSE–

2002–23); 48137 (July 8, 2003), 68 FR 42152 (July 

16, 2003) (publishing for comment File No. SR–

NASD–2002–80); 48123 (July 2, 2003), 68 FR 41191 

(July 10, 2003) (publishing for comment File No. 

SR–NASD–2002–77); 48124 (July 2, 2003), 68 FR 

41193 (July 10, 2003) (publishing for comment File 

No. SR–NASD–2002–138); 48125 (July 2, 2003), 68 

FR 41194 (July 10, 2003) (publishing for comment 

File No. SR–NASD–2002–139); and 47516 (March 

17, 2003), 68 FR 14451 (March 25, 2003) 

(publishing for comment File No. SR–NASD–2002–

141).

28See Securities Exchange Act Release No. 48745 

(November 4, 2003), 68 FR 64154 (November 12, 

2003) (order approving File Nos. SR–NYSE–2002–

33, SR–NASD–2002–77, SR–NASD–2002–80, SR–

NASD–2002–138, SR–NASD–2002–139, and SR–

NASD–2002–141).

29See id.

30See Letters from William H. Donaldson, 

Chairman, Commission, to Salvatore F. Sodano, 

Chairman & CEO, American Stock Exchange LLC 

(‘‘Amex’’); Kenneth R. Leibler, Chairman & CEO, 

Boston Stock Exchange, Inc. (‘‘BSE’’); William J. 

Brodsky, Chairman & CEO, Chicago Board Options 

Exchange, Inc. (‘‘CBOE’’); David A. Herron, CEO, 

Chicago Stock Exchange, Inc. (‘‘CHX’’); David 

Colker, President & CEO, Cincinnati Stock 

Exchange, Inc. (‘‘CSE’’); David Krell, CEO, 

International Securities Exchange, Inc. (‘‘ISE’’); 

Philip D. DeFeo, Chairman & CEO, Pacific 

Exchange, Inc. (‘‘PCX’’); Meyer S. Frucher, 

Chairman & CEO, Philadelphia Stock Exchange, Inc. 

(‘‘Phlx’’); Robert R. Glauber, Chairman & CEO, 

NASD; Richard G. Ketchum, President & Deputy 

Chairman, Nasdaq; and Richard A. Grasso, 

Chairman & CEO, NYSE (March 26, 2003). Copies 

of these letters are available in the Commission’s 

Public Reference Room under File No. S7–39–04.

31See id.

32See id.

33See Letter from William H. Donaldson, 

Chairman, Commission, to The Honorable H. Carl 

McCall, Chairman, Human Resources and 

Compensation Committee, Chairman, Special 

Committee on Governance of the NYSE, NYSE, 

dated September 2, 2003. A copy of this letter is 

available in the Commission’s Public Reference 

Room under File No. S7–39–04.

34See Letters from William H. Donaldson, 

Chairman, Commission, to Salvatore F. Sodano, 

Chairman & CEO, Amex; Kenneth R. Leibler, 

Chairman & CEO, BSE; William J. Brodsky, 

Chairman & CEO, CBOE; Robert; David A. Herron, 

CEO, CHX; David Colker, President & CEO, CSE; 

David Krell, President & CEO, ISE; Philip D. DeFeo, 

Chairman & CEO, PCX; Meyer S. Frucher, Chairman 

& CEO, Phlx; Robert R. Glauber, Chairman & CEO, 

NASD; and Robert Greifeld, President & CEO, 

Nasdaq (September 23, 2003). Copies of these letters 

are available in the Commission’s Public Reference 

Room under File No. S7–39–04.

35See Securities Exchange Act Release No. 48764 

(November 7, 2003), 68 FR 64380 (November 13, 

2003).

dues, fees, and charges among its 

members; 16 (3) are designed to prevent 

fraudulent and manipulative acts and 

practices; 17 (4) are designed to promote 

just and equitable principles of trade; 18

(5) are designed to perfect the 

mechanism of a free and open market 

and a national market system; 19 (6) 

protect investors and the public 

interest; 20 and (7) provide a process for 

disciplining its members.21

Accordingly, the Exchange Act makes 

clear that SROs are charged with an 

important public trust to carry out their 

self-regulatory responsibilities 

effectively and fairly, while fostering 

free and open markets, protecting 

investors, and promoting the public 

trust.22

B. Overview of Recent Developments 

Recent developments have prompted 

the Commission to review aspects of its 

oversight and regulation of national 

securities exchanges and registered 

securities associations and to consider 

whether changes are necessary to 

respond to those developments. 

1. Governance Concerns 

In the wake of corporate scandals that 

threatened investor confidence in the 

securities markets,23 the governance of 

companies listed on securities 

exchanges and The Nasdaq Stock 

Market (‘‘Nasdaq’’) became the focus of 

attention.24 After allegations of 

improprieties by several issuers and 

their executives, Congress enacted the 

Sarbanes-Oxley Act of 2002 (‘‘SarbanesOxley Act’’) 25 to improve the accuracy 

and reliability of corporate disclosures 

and the effective oversight of the 

financial reporting process.26 During 

this period, the New York Stock 

Exchange, Inc. (‘‘NYSE’’) and Nasdaq 

each undertook a review of its own 

corporate governance listing standards 

and proposed changes to strengthen 

those standards.27 The new NYSE and 

Nasdaq corporate governance listing 

rules, which were approved by the 

Commission in November 2003, 

establish a more comprehensive 

definition of ‘‘independence’’ for 

directors and require the majority of 

members on listed companies’ boards to 

satisfy the new independence 

standard.28 In addition, the new NYSE 

and Nasdaq rules include a number of 

provisions that mandate and facilitate 

independent director oversight of 

functions relating to corporate 

governance, auditing, director 

nominations, and compensation.29

In light of the governance changes 

proposed by the NYSE and Nasdaq for 

their listed issuers, in March 2003, the 

Commission’s Chairman requested that 

the SROs review the adequacy of their 

own governance practices.30 In his letter 

to each SRO, the Chairman noted that 

the SROs play a critical role in our 

securities markets as standard setters for 

listed companies, operators of trading 

markets, and front-line regulators of 

securities firms.31 Further, the 

Chairman referred to the enhanced 

corporate governance listing standards 

proposed by the NYSE and Nasdaq as a 

high standard that the SROs should 

demand not only of listed issuers, but 

also of themselves.32

Several months later, while the NYSE 

was reviewing its own governance 

practices, the media published reports 

of the proposed extension of the 

employment agreement of its then 

Chairman and Chief Executive Officer 

(‘‘CEO’’), as well as an anticipated 

substantial payout of his accrued 

compensation. In response, the 

Commission’s Chairman sent a letter to 

the Chairman of the NYSE’s 

Compensation and Human Resources 

Committee and Special Governance 

Committee requesting information 

regarding the compensation of the NYSE 

Chairman and CEO and the decisionmaking processes at the NYSE that led 

to the pay package.33 Shortly thereafter, 

the Commission’s Chairman sent letters 

to the other SROs requesting that they 

provide details about the extent of 

public representation on their boards 

and key committees (including the 

Compensation Committee); the 

decision-making processes with respect 

to the nomination of directors, their 

assignment to committees, and the 

compensation of executives; and the 

SROs’ past practices and current plans 

for public disclosure of these processes 

and the compensation arrangements of 

key executives.34

During this period, the NYSE 

announced the resignation of its 

Chairman and CEO and shortly 

thereafter named an interim Chairman. 

In November 2003, the NYSE filed with 

the Commission a proposal to amend 

the NYSE Constitution to implement a 

series of governance changes at the 

NYSE.35 The proposal called for the 

71130 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

36See Securities Exchange Act Release No. 48946 

(December 17, 2003), 68 FR 74678 (December 24, 

2003).

37See In the Matter of Chicago Stock Exchange,

Securities Exchange Act Release No. 48566 

(September 30, 2003) (‘‘CHX Order’’).

38See CHX Article XX, Rule 7.01; see also

Exchange Act Rule 11Ac1–1, 17 CFR 240.11Ac1–1.

39See CHX Article XXX, Rule 2.

40See CHX Article XX, Rule 7.05; see also

Exchange Act Rule 11Ac1–4, 15 CFR 240.11Ac1–4.

41The CHX’s regulatory oversight committee 

must advise the CHX’s board of governors about 

regulatory, compliance, and enforcement matters 

and assist the board in monitoring the design, 

implementation, and effectiveness of the CHX’s 

compliance program. See CHX Order, supra note 

37.

42See In the Matter of Bear Wagner Specialists 

LLC, Securities Exchange Act Release No. 49498 

(March 30, 2004); In the Matter of Fleet Specialist, 

Inc., Securities Exchange Act Release No. 49499 

(March 30, 2004); In the Matter of LaBranche & Co. 

LLC, Securities Exchange Act Release No. 49500 

(March 30, 2004); In the Matter of Spear, Leeds & 

Kellogg Specialists LLC, Securities Exchange Act 

Release No. 49501 (March 30, 2004); and In the 

Matter of Van der Moolen Specialists USA, LLC, 

Securities Exchange Act Release No. 49502 (March 

30, 2004). These five firms agreed to pay a total of 

$241.8 million in penalties and disgorgement, and 

agreed to implement steps to improve their 

compliance procedures and systems. In July 2004, 

the Commission and the NYSE settled enforcement 

actions against two other NYSE specialist firms. See 

In the Matter of SIG Specialists, Inc., Securities 

Exchange Act Release No. 50076 (July 26, 2004); 

and In the Matter of Performance Specialist Group 

LLC, Securities Exchange Act Release No. 50075 

(July 26, 2004). These firms agreed to pay a total 

of $5.2 million in penalties and disgorgement, 

consisting of $1.7 million in civil money penalties 

and $3.5 million in disgorgement, and agreed to 

implement steps to improve their compliance 

procedures and systems.

43See, e.g., CHX Order, supra note 37; In the 

Matter of Certain Activities of Options Exchanges,

Securities Exchange Act Release No. 43268 

(September 11, 2000) (proceeding against Amex, 

CBOE, PCX, and Phlx for engaging in 

anticompetitive activities and for failing adequately 

to enforce compliance with their own rules); and In 

the Matter of NYSE, Inc., Securities Exchange Act 

Release No. 41574 (June 29, 1999) (proceeding 

against NYSE for failure to enforce compliance with 

federal securities laws and NYSE rules prohibiting 

proprietary and on-floor trading by NYSE floor 

broker members in violation of Section 19(g) of the 

Exchange Act, 15 U.S.C. 78s(g)).

44Alternative trading systems include electronic 

communications networks (‘‘ECNs’’) such as INET 

ATS (‘‘INET’’), a subsidiary of Instinet Group, Inc. 

An ECN is an electronic system that widely 

disseminates to third parties orders entered therein 

by an exchange market maker or over-the-counter 

(‘‘OTC’’) market maker, and permits such orders to 

be executed against in whole or in part. The term 

specifically excludes internal broker-dealer order 

routing systems and crossing systems, i.e., systems 

that cross multiple orders at one or more specified 

times at a single price set by the ECN and do not 

allow orders to be crossed or executed against 

directly by participants outside of such times. 17 

CFR 240.11Ac1–1(a)(8).

45See Regulation ATS, 17 CFR 242.300, et seq.

46 15 U.S.C. 78o(b) and 78o–5.

47See Regulation ATS, 17 CFR 242.300, et seq.

establishment of a new board of 

directors composed wholly of 

independent directors; an advisory 

board of executives that would be 

representative of the exchange’s various 

constituencies; independent board 

committees with specific oversight 

authority for compensation, audit 

functions, the nominations process and 

regulatory matters; and an autonomous 

regulatory unit that would report 

directly to the regulatory oversight 

committee. The Commission approved 

the NYSE’s governance revisions in 

December 2003.36

2. Concerns Relating to Weaknesses of 

SRO Regulatory Programs 

In addition to the enhanced focus on 

SRO governance, recent Commission 

enforcement actions involving SROs 

have highlighted weaknesses in the 

effectiveness of certain SRO regulatory 

programs. In September 2003, for 

example, the Commission settled an 

administrative enforcement action 

against the CHX for failure to enforce its 

trading rules.37 The Commission’s 

order, among other things, included 

findings that the CHX’s surveillance 

program failed adequately to detect 

violations by its members of the firm 

quote rule,38 trading ahead 

prohibitions,39 and the limit order 

display rule 40 from 1998 through 2001. 

As part of the undertakings imposed by 

the settlement, the CHX was required, 

among other things, to create a 

regulatory oversight committee 

comprised almost exclusively of 

individuals with no material business 

relationship with the exchange.41 In 

addition, the CHX was required to file 

with the Commission various 

certifications by its officials confirming 

its ongoing compliance with its 

statutory obligations.

Also, recent Commission enforcement 

actions involving SRO members have 

pointed to weaknesses in the 

effectiveness of SROs’ regulatory 

programs. In 2004, for example, the 

Commission settled enforcement actions 

against the seven NYSE specialist firms. 

The Commission found that, between 

1999 and 2003, these specialist firms 

violated federal securities laws and 

NYSE rules by executing orders for their 

dealer accounts ahead of executable 

public customer orders.42 As part of the 

settlement, the firms agreed to pay a 

total of more than $247 million in 

penalties and disgorgement, and agreed 

to implement steps to improve their 

compliance procedures and systems.

Moreover, the Commission’s staff 

recently has conducted inspections of 

SROs that have raised questions 

regarding whether, in certain 

circumstances, SROs have governance 

structures that are sufficiently 

independent, or whether SROs have 

maintained regulatory programs that are 

sufficiently rigorous to detect, deter, and 

discipline for members’ violations of the 

federal securities laws and rules and 

SRO rules. 

Taken together, developments 

involving SRO governance, as well as 

the concerns raised by recent 

enforcement actions 43 and inspections 

involving SROs, have prompted the 

Commission to consider new regulatory 

measures with respect to SROs. The 

Commission therefore has determined to 

propose rules that would strengthen the 

governance of national securities 

exchanges and registered securities 

associations and the independence of 

their regulatory programs. Moreover, the 

Commission is proposing to enhance the 

level of information that would be 

publicly available about SROs, 

including with respect to their 

governance structures, finances, 

regulatory programs, and significant 

owners. Finally, the Commission 

believes that oversight of SROs would 

be enhanced, and inspections could be 

better targeted to problematic areas, if 

the Commission were to receive more 

extensive and frequent data about SRO 

regulatory programs in a systematic 

fashion. Therefore, the Commission is 

proposing a new SRO reporting rule that 

is intended to facilitate more effective 

Commission monitoring of SROs’

regulatory programs. While the 

Commission is proposing other 

measures that would increase the 

transparency of SROs’ operations, the 

information submitted under this 

proposed rule is intended to be used as 

part of the Commission’s examination 

program and thus may not be publicly 

available.

3. Competitive Concerns 

More broadly, the Commission’s 

review of SROs also was prompted by 

marketplace developments and the 

increasingly competitive environment 

faced by SROs that operate trading 

facilities. For example, in recent years, 

market participants have developed a 

variety of alternative trading systems 

(‘‘ATSs’’) that furnish execution services 

historically provided by exchanges.44

Under Regulation ATS,45 ATSs may 

choose whether (a) to register as 

national securities exchanges, and thus 

assume the responsibilities of SROs; or 

(b) to register as broker-dealers under 

Sections 15(b) or 15C of the Exchange 

Act,46 subject to certain additional 

reporting and conduct requirements.47

Regulation ATS was designed to impose 

essential elements of market-oriented 

regulation on ATSs, while maintaining 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71131

48See Securities Exchange Act Release No. 40760 

(December 8, 1998), 63 FR 70844 (December 22, 

1998) (adopting Regulation ATS).

49See Securities Exchange Act Release No. 44983 

(October 25, 2001), 66 FR 55225 (November 1, 2001) 

(establishing Arca-Ex as the equities trading facility 

of PCX Equities).

50For example, INET has arranged to execute and 

report its trades through the National Stock 

Exchange, Inc. (‘‘NSX’’) (formerly known as CSE).

51The figure is based on Nasdaq/UTP Plan market 

data (as of September 2004). Copies of this data are 

available in the Commission’s Public Reference 

Room under File No. S7–39–04.

52The figure is based on Network B, CTS Activity 

market data (as of September 2004). Copies of this 

data are available in the Commission’s Public 

Reference Room under File No. S7–39–04.

53The figure is based on Network A, CTS Activity 

market data (as of September 2004). Copies of this 

data are available in the Commission’s Public 

Reference Room under File No. S7–39–04.

54See Securities Exchange Act Release Nos. 

50173 (August 10, 2004), 69 FR 50407 (August 16, 

2004) (notice of proposed rule change proposing 

improvements to NYSE’s existing automatic 

execution facility, NYSE Direct+) and 49921 (June 

25, 2004), 69 FR 40690 (July 6, 2004) (approval of 

proposed rule change by Amex to enhance its AutoEx technology for exchange-traded funds and 

Nasdaq stocks traded on the exchange).

55See Securities Exchange Act Release No. 26870 

(May 26, 1989), 54 FR 23963 (June 5, 1989).

56See Securities Exchange Act Release No. 43268, 

supra note 43. See also U.S. v. American Stock 

Exchange LLC, et al., 2000 WL 33400154 (D.D.C. 

2000).

57See Securities Exchange Act Release No. 41439 

(May 24, 1999), 64 FR 29367 (June 1, 1999). The 

Commission approved the ISE’s registration 

application in 2000. See Securities Exchange Act 

Release No. 42455 (February 24, 2000), 65 FR 11388 

(March 2, 2000).

58 In August 1999, 32% of equity options were 

traded on more than one exchange. By September 

2000, that number had risen to 45%. Securities 

Exchange Act Release No. 43085 (July 28, 2000), 65 

FR 47918 (August 4, 2000) (proposing to extend 

Exchange Act Rule 11Ac1–1 to options). Over the 

same period, the percentage of aggregate option 

volume traded on only one exchange fell from 60% 

to 15%. Id. According to the Options Clearing 

Corporation, by September 2003, 98.3% of equity 

options classes traded on more than one exchange. 

Id.

59For example, the Boston Options Exchange 

(‘‘BOX’’), a facility of the BSE, commenced trading 

in 2004. See Securities Exchange Act Release No. 

49067 (January 14, 2004), 64 FR 2761 (January 21, 

2004) (order approving the operating agreement of 

BOX).

60See Sections 6(b)(1) and 15A(b)(2) of the 

Exchange Act, 15 U.S.C. 78f(b)(1) and 78o–3(b)(2).

sufficient regulatory flexibility to foster 

market innovation.48

The highly-competitive environment 

of recent years also has induced 

alliances among particular SROs and 

ATSs to combine the regulatory status of 

the SRO with the market share of the 

ATS. In 2001, for example, the 

Commission approved a proposal by 

PCX to establish the Archipelago 

Exchange (‘‘Arca-Ex’’) as a facility of its 

subsidiary, PCX Equities, Inc. (‘‘PCX 

Equities’’).49 In addition, several ECNs 

have made arrangements to execute and 

report trades through a particular 

exchange, and to share the market data 

revenues generated thereby.50

Moreover, the SROs face increased 

competition from foreign trading 

markets that operate under regulatory 

regimes that differ from the U.S. 

regulatory model. These foreign markets 

may not be subject to the same kind of 

regulatory requirements that markets 

operated by U.S. SROs must satisfy. For 

example, issuers listed on U.S. 

exchanges or Nasdaq generally are 

subject to different disclosure standards 

than issuers whose securities are listed 

and traded solely on foreign markets. 

These differences in the U.S. reporting 

regime may deter some foreign issuers 

from U.S. registration, with the result 

that their securities cannot be traded on 

U.S. exchanges or Nasdaq, but can be 

traded on foreign markets or on U.S. 

trading systems (such as ECNs) that are 

not operated by SROs.

The effect of these developments is 

that markets operated by SROs have 

faced increased competition from 

foreign trading markets and from 

electronic trading systems, such as 

ECNs, that have made substantial 

inroads into the market share of the 

traditional SRO markets, especially with 

respect to Nasdaq securities. 

Furthermore, historic differences in the 

securities traded by particular SROs are 

disappearing. For example, the NYSE 

and Amex historically dominated 

trading in their listed securities, and 

market makers dominated trading in 

Nasdaq stocks. Today, however, for 

Nasdaq stocks, automated order-driven 

market centers (such as Nasdaq’s 

SuperMontage, Arca-Ex, and INET) have 

captured more than 50% of share 

volume.51 For Amex-listed stocks (for 

which approximately 39% of share 

volume now is represented by two 

extremely active exchange-traded funds 

(‘‘ETFs’’)—the QQQ and SPDR), Amex 

now handles approximately 21% of the 

volume, with the remaining balance 

split among Arca-Ex, INET, and 

others.52 The NYSE has retained 

approximately 80% of the volume in its 

listed stocks, but other market centers 

are attempting to raise the level of 

competition and increase their share of 

trading.53 Moreover, the NYSE and 

Amex have sought to add automated 

facilities that are integrated with and 

complement their traditional exchange 

floors.54

The historic differences between 

SROs that operate options trading 

markets have also eroded. From 1977 

until 1999, most actively traded options 

were traded on only one exchange. In 

1989, the Commission adopted Rule 

19c–5 under the Exchange Act, 

prohibiting exchanges from having rules 

that limit their ability to list any stock 

options class because that options class 

is listed on another options exchange.55

The options exchanges, however, did 

not widely implement multiple listing 

of options until 1999. By that time, the 

U.S. Department of Justice (‘‘DOJ’’) and 

the Commission had begun to 

investigate the four floor-based options 

exchanges (Amex, CBOE, PCX, and 

Phlx) for engaging in anticompetitive 

activities—in particular, for refraining 

from listing options listed on another 

exchange—and for failing to enforce 

adequately compliance with their own 

rules.56 In addition, during that period 

the ISE had filed an application with the 

Commission to register as a national 

securities exchange that would trade 

options.57

As part of their settlement with the 

Commission, the floor-based options 

exchanges were ordered to collectively 

spend $77 million on surveillance and 

enforcement. The settlement of the 

Commission’s enforcement action and 

the entry of a consent decree in the DOJ 

case, along with the proposed entry of 

the ISE as a national securities exchange 

that intended to trade options, were the 

catalysts for the expansion of multiple 

listing of equity options. Today, 

virtually all actively traded equity 

options trade on multiple markets, a 

development that has enhanced 

competition among the options 

exchanges.58 The entry of electronic 

options trading markets has further 

raised the level of competition.59

The recent developments outlined 

above have led the Commission to 

consider whether the increasing 

competitive pressures placed on SROs 

that operate trading facilities warrant 

additional measures that are designed to 

focus the SROs on their statutorilymandated responsibilities as market 

regulators. Pursuant to the Exchange 

Act, SROs are charged with a public 

trust to implement and enforce the 

federal securities laws and rules, as well 

as their own rules with respect to their 

members.60 Yet, as membership 

organizations, and in some cases as 

shareholder-owned organizations, SROs 

are expected to promote the economic 

interests of their members and their 

owners. In addition, SROs, as operators 

of trading markets, are critical to the 

success and viability of our capital 

markets. In this capacity, SROs play a 

key role in the price discovery process, 

are innovators of new products, and, 

through the listing mechanism, provide 

71132 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

61See Securities Exchange Act Release Nos. 

45803 (April 23, 2002), 67 FR 21306 (April 30, 

2002) (order approving the restructuring of ISE from 

a limited liability company to a corporation); 49718 

(May 17, 2004), 69 FR 29611 (May 24, 2004) (order 

approving the demutualization of PCX); and 49098 

(January 16, 2004), 69 FR 3974 (January 27, 2004) 

(order approving the demutualization of Phlx).

62See supra note 48 (citing to the adopting 

release for Regulation ATS).

63See Securities Exchange Act Release Nos. 

49451 (March 19, 2004), 69 FR 16305 (March 29, 

2004) (PCX stating that by ‘‘restructuring its 

business as a stock corporation with business 

control and management vested in a Board of 

Directors, the entity will have greater flexibility to 

develop and execute strategies designed to improve 

its competitive position than it has under the 

current membership-cooperative structure’’ and that 

it anticipates that ‘‘by restructuring as a stock 

corporation, PCX management will be better able to 

respond quickly to competitive pressures and to 

make changes to its operations as market conditions 

warrant, without diminishing the integrity of its 

regulatory programs.’’) and 49098, supra note 61 

(stating that Phlx proposed to effect a 

demutualization for a number of reasons, including 

to ‘‘expand its sources of capital and revenue; to 

facilitate its ability to enter into relationships with 

strategic or financial partners who may be crucial 

for the Exchange’s future development, capital 

formation and viability; to facilitate the 

introduction of new products and thus potentially 

increase transaction volume and Exchange 

revenues; and to better position itself to react to 

new opportunities and challenges’’).

64See Securities Exchange Act Release Nos. 

44983, supra note 49 and 49067, supra note 59.

65See Securities Exchange Act Release No. 50170 

(August 9, 2004), 69 FR 50419 (August 16, 2004) 

(order approving PCX rule filing relating to the 

Certificate of Incorporation and Bylaws of 

Archipelago Holdings) and ISE Registration 

Statement on Form S–1, File No. 333–117145.

66See Securities Exchange Act Release No. 50700 

(November 18, 2004).

67See id.

68See supra Section I.B.

69Congress was aware of the conflicting roles 

faced by exchanges when it designed the regulatory 

scheme for U.S. securities markets. See, e.g., S. Rep. 

No. 73–792, at 4–5 (1934); H.R. Rep. No. 73–1383, 

at 14–16 (1934); and S. Rep. No. 73–1455, at 80–

81 (1934).

issuers with an opportunity to access 

capital. This business model 

understandably would prompt SROs to 

be concerned with preserving and 

enhancing their competitive positions. 

As competition increases among 

marketplaces and SROs actively pursue 

strategies to increase their market share, 

there is a possibility that SROs could 

face increasing pressure from members 

and owners with respect to the degree 

of emphasis placed on their regulatory 

obligations. In the Commission’s view, 

this factor underscores the need to 

consider measures that foster and 

enhance the independence of SROs’

governance, the transparency of their 

processes, and the effectiveness of their 

regulatory programs.

4. Concerns Relating to New Ownership 

Structures 

Finally, SROs have been challenged 

by the recent trend to demutualize and 

reorganize as shareholder-owned 

entities.61 SROs historically have been 

structured as mutual, not-for-profit 

organizations owned, for the most part, 

by members that are registered brokerdealers. In 1998, the Commission 

expressed the view that exchanges 

could be organized as for-profit 

entities.62 Since that time, and 

especially over the past few years, a 

number of SROs have demutualized and 

explicitly separated the right to trade in 

their markets from the economic 

ownership rights in those SROs. SROs 

have put forth various reasons for 

demutualizing, but common themes are 

an increased ability to more quickly 

respond to competitive pressures and 

additional potential sources of capital.63

In addition, some SROs have trading 

facilities that are owned and operated 

by persons other than the SRO itself or 

its members. For example, Archipelago 

Holdings, Inc. (‘‘Archipelago Holdings’’) 

operates Arca-Ex, the equities trading 

facility of PCX Equities, and BOX, an 

options trading facility of the BSE, is 

operated by the Boston Options 

Exchange Group, LLC.64 Demutualized 

SROs, and separate facilities of SROs, 

also may choose to become publicly 

traded companies. For instance, 

Archipelago Holdings, the parent 

company of Arca-Ex, recently 

completed an initial public offering, and 

ISE has filed a registration statement 

under the Securities Act of 1933 

(‘‘Securities Act’’) with regard to its 

intended initial public offering.65 In 

addition, Nasdaq’s common stock is 

publicly traded in the OTC market.

The impact of demutualization is the 

creation of another SRO constituency—

a dispersed group of public 

shareholders—with a natural tendency 

to promote business interests. To the 

extent that a well-regulated market is 

considered by an SRO’s owners to be in 

their commercial interest, 

demutualization could better align the 

goals of SRO owners with their statutory 

obligations. On the other hand, it could 

also exacerbate the concern, discussed 

above, that SROs may put their 

commercial interests ahead of their 

responsibilities as regulators. The trend 

toward demutualization of SROs is yet 

another reason why the Commission is 

proposing regulatory changes to better 

assure the ability of SROs to carry out 

effectively their regulatory obligations. 

The Commission believes that the 

proposals—summarized above and 

discussed in detail below—to enhance 

the governance, administration, 

transparency and oversight of all SROs 

would effectively address many of the 

concerns raised by the demutualization 

of SROs. In addition, the Commission 

believes that it is appropriate to 

consider limits on member ownership of 

an exchange, association or facility, and 

heightened procedures in the case of 

SRO ‘‘self-listing.’’

Finally, while the Commission 

believes that the proposals contained 

herein would significantly enhance the 

governance, administration, 

transparency, and oversight of SROs, 

legitimate questions remain as to 

whether more radical structural changes 

are warranted. Indeed, in addition to the 

proposals contained in this release, the 

Commission is today issuing a Concept 

Release that discusses in detail the 

strengths and weaknesses of the selfregulatory model and seeks 

commenters’ views on a wide range of 

issues relating to self-regulation.66 The 

Concept Release examines the attributes 

of the current self-regulatory system, 

explores additional changes that could 

be made to the existing system to 

address the weaknesses of selfregulation, and discusses other models 

that, if implemented, would require a 

more extensive restructuring—or 

elimination—of the current system of 

self-regulation.67

II. Fair Administration and Governance 

of National Securities Exchanges and 

Registered Securities Associations 

A. Background and Need for Proposed 

Rules 6a–5 and 15Aa–3

As operators of trading markets, frontline regulators of securities firms, and 

standard-setters for listed issuers, 

national securities exchanges and 

registered securities associations are 

critical to the integrity of the U.S. 

securities markets. Recent events have 

highlighted, however, that the securities 

industry’s system of self-regulation has 

not always worked as effectively or 

fairly as it should.68 In addition, the 

dual roles of exchanges and associations 

as both market overseers and market 

operators, the increased competition 

among markets, and the growing trend 

of exchanges to demutualize have raised 

concerns about their ability and efforts 

to fulfill their regulatory duties 

vigorously and impartially.69 As 

exchanges and associations continue to 

face these and other new challenges, the 

Commission is proposing to address 

issues of SRO governance and 

administration, and to explore changes 

that could foster robust fulfillment of 

SROs’ self-regulatory duties.

Accordingly, the Commission is 

proposing new Rule 6a–5 under the 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71133

70Proposed Rules 6a–5 and 15Aa–3 are 

substantially similar. Rule 15Aa–3(b)(11), however, 

proposes to define the term ‘‘facility’’ for purposes 

of associations. Currently, the only securities 

association registered under Section 15A(a) of the 

Exchange Act, 15 U.S.C. 78o–3(a), is the NASD.

71See Sections 6(b)(1) and 15A(b)(2) of the 

Exchange Act, 15 U.S.C. 78f(b)(1) and 78o–3(b)(2).

72 15 U.S.C. 78f(b) and 78o–3(b).

73 15 U.S.C. 78f(b)(3) and 78o–3(b)(4).

74See proposed Rules 6a–5(a) and 15Aa–3(a).

75 15 U.S.C. 78f(g)(1).

76 15 U.S.C. 78o–3(k)(1).

77See proposed Rules 6a–5(s)(1) and 15Aa–

3(s)(1). The Commission does not have primary 

responsibility for regulating exchanges registered 

under Section 6(g)(1) of the Exchange Act and 

national securities associations registered under 

Section 15A(k)(1) of the Exchange Act (‘‘limited 

purpose national securities associations’’). See 15 

U.S.C. 78f(g)(1) and 78o–3(k)(1). This responsibility 

instead lies with the Commodity Futures Trading 

Commission (‘‘CFTC’’). For this reason, such 

exchanges and associations are exempt from the 

requirements to file with the Commission proposed 

rule changes, except for certain specified types of 

rules. Importantly, exchanges registered under 

Section 6(g)(1) of the Exchange Act and limited 

purpose national securities associations are not 

required to file with the Commission proposed 

changes to rules related to their governance, 

ownership, or fulfillment of their self-regulatory 

responsibilities. Because the Commission does not 

have primary responsibility for the regulation of 

these exchanges and associations, the Commission 

is proposing to exempt such exchanges and 

associations from proposed Rules 6a–5 and 15Aa–

3.

78Under paragraph (a) of proposed Rules 6a–5 

and 15Aa–3, paragraphs (c), (d), (e), (f), (g), (h), (i), 

(j), (k), (l), (m), (n), (p), and (q) of the proposed rules 

would apply to regulatory subsidiaries.

79Regulatory services are intended to cover any 

of those activities that generally would fall within 

the scope of the SRO’s regulatory obligations.

80See, e.g., Securities Exchange Act Release Nos. 

42759 (May 5, 2000), 65 FR 30654 (May 12, 2000) 

(order approving creation of PCX Equities, a 

wholly-owned subsidiary of PCX) and 49065 

Continued

Exchange Act, which pertains to the fair 

administration and governance of 

national securities exchanges, and new 

Rule 15Aa–3 under the Exchange Act, 

which pertains to the fair administration 

and governance of registered securities 

associations.70 The proposals would 

apply to exchanges and associations 

minimum governance standards that are 

commensurate with standards required 

of listed issuers. Among other 

provisions, the proposed rules would 

require an exchange’s or association’s 

governing board to be composed of a 

majority of independent directors, with 

key board committees to be composed 

solely of independent directors. The 

Commission believes that the proposed 

rules would promote a structure that 

would facilitate the ability of SROs to 

perform their responsibilities under the 

Exchange Act with objectivity and vigor. 

In the Commission’s view, proposed 

Rules 6a–5 and 15Aa–3 would further 

the goals of the Exchange Act, which, 

among other things, requires national 

securities exchanges and registered 

securities associations to be so 

organized and have the capacity to carry 

out the purposes of the Exchange Act.71

The Commission also believes that by 

mandating a governance structure that is 

less susceptible to competing internal 

interests, proposed Rules 6a–5 and 

15Aa–3 would help promote investor 

confidence in the way in which our 

securities markets are administered.

The proposed governance rules also 

would require each exchange and 

association to separate its regulatory 

function from its market operations and 

other commercial interests, whether 

through functional or organizational 

separation. Although a premise 

underlying self-regulation is that 

regulation works best when it is carried 

out in proximity to the regulated 

activity, it is equally important that 

there be sufficient independence within 

the self-regulatory process to adequately 

check undue interference or influence 

from the persons or entities being 

regulated. In the Commission’s view, 

the proposed rules would help insulate 

the regulatory activities of an exchange 

or association from the conflicts of 

interest that otherwise may arise by 

virtue of its market operations.

In addition, the proposed rules would 

require an exchange or association to 

establish ownership and voting 

limitations on the interest of its 

members that are brokers or dealers in 

the exchange, association, or a facility of 

the exchange or association through 

which the member is permitted to effect 

transactions. Members who trade on an 

exchange or through a facility of an 

exchange or association have 

traditionally had ownership interests in 

such exchange or facility. Recent 

developments, including the trend 

towards demutualization, have raised 

the concern that a member’s interest 

could become so large as to cast doubt 

on whether the exchange or association 

could fairly and objectively exercise its 

self-regulatory responsibilities with 

respect to that member. For example, an 

exchange may hesitate to diligently 

monitor and surveil the trading conduct 

of a member that is a controlling 

shareholder of the exchange or a facility 

of the exchange, or to diligently enforce 

its rules and the federal securities laws 

with regard to conduct by such member 

that violates these provisions. The 

Commission believes that the proposed 

rules would help mitigate the conflicts 

of interest that could occur if a member 

were to control a significant stake in its 

regulator, and are necessary and 

appropriate to help ensure that an 

exchange or association can effectively 

carry out its statutory obligations under 

Section 6(b) or 15A(b) of the Exchange 

Act, respectively.72

Finally, the Commission believes that 

the proposed rules are consistent with, 

and should enhance, the ‘‘fair 

representation’’ requirements applicable 

to exchanges and associations. As more 

fully discussed below, the proposals are 

designed to reinforce the Exchange Act 

requirement that the rules of an 

exchange or association ‘‘assure a fair 

representation of its members in the 

selection of its directors and 

administration of its affairs and provide 

that one or more directors shall be 

representative of issuers and investors 

and not be associated with a member of 

the exchange [or association], broker, or 

dealer.’’ 73

B. Description of Proposed Rules 6a–5 

and 15Aa–3

1. Scope of Proposed Rules 6a–5 and 

15Aa–3

Under proposed Rules 6a–5 and 

15Aa–3, each national securities 

exchange and registered securities 

association, respectively, would be 

required to comply with, have rules that 

comply with, and have the capacity to 

carry out the purposes of, the provisions 

of the applicable governance rule.74 A 

national securities exchange registered 

pursuant to Section 6(g)(1) of the 

Exchange Act,75 and a limited purpose 

national securities association registered 

pursuant to Section 15A(k)(1) of the 

Exchange Act,76 would not be subject to 

these requirements.77 While the 

proposed rules would establish 

minimum standards for the governance 

and administration of an exchange or 

association, an exchange or association, 

of course, could determine to establish 

more rigorous standards.

Certain provisions of the proposed 

rules would be applied to any 

‘‘regulatory subsidiary’’ of the exchange 

or association in the same manner as 

they would apply to the exchange or 

association.78 The term ‘‘regulatory 

subsidiary’’ would be defined in 

proposed Rules 6a–5(b)(18) and 15Aa–

3(b)(19) as any person that, directly or 

indirectly, is controlled by the exchange 

or association and that provides, 

whether pursuant to contract, agreement 

or rule, regulatory services 79 to or on 

behalf of the exchange or association. In 

recent years, several exchanges, as well 

as the NASD, have formed subsidiaries 

and have delegated, pursuant to rules 

approved by the Commission, to those 

subsidiaries certain regulatory functions 

historically conducted by the exchange 

or the NASD directly.80 These 

71134 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

(January 13, 2004), 69 FR 2768 (January 20, 2004) 

(order approving creation of Boston Options 

Exchange Regulation, LLC (‘‘BOXR’’), a whollyowned subsidiary of the BSE). 

For example, NASD Regulation, Inc. is 

responsible for carrying out most regulatory 

functions otherwise within the jurisdiction of the 

NASD; and the NASD’s subsidiary, Nasdaq, 

pursuant to a plan of delegation, carries out certain 

regulatory functions on behalf of the NASD. Nasdaq 

would be subject to proposed Rule 15Aa–3 on two 

bases: It is both a facility of an association and it 

is an affiliate that provides regulatory services to or 

on behalf of the NASD. In addition, the BSE’s 

subsidiary, BOXR, carries out certain regulatory 

functions on behalf of the BSE; and PCX’s 

subsidiary, PCX Equities, carries out certain 

regulatory functions on behalf of PCX.

81To date, the Commission has permitted an SRO 

to delegate its regulatory responsibilities only to a 

subsidiary of the SRO or to another SRO. The SRO 

that delegates such responsibilities, however, 

retains primary responsibility for ensuring 

compliance with the Exchange Act, and rules 

thereunder, and the rules of the SRO.

82 15 U.S.C. 78s(b).

83 Id.

84 17 CFR 240.19b–4(b)(1).

85 Id.

86The term ‘‘facility’’ is defined in Section 3(a)(2) 

of the Exchange Act and, when used with respect 

to an exchange, includes its premises, tangible or 

intangible property whether on the premises or not, 

any right to the use of such premises or property 

or any service thereof for the purpose of effecting 

or reporting a transaction on an exchange 

(including, among other things, any system of 

communication to or from the exchange, by ticker 

or otherwise, maintained by or with the consent of 

the exchange), and any right of the exchange to the 

use of any property or service. See 15 U.S.C. 

78c(a)(2). In many cases, a facility of the exchange 

is within the same legal entity as the exchange itself 

and thus only the exchange would need to meet the 

proposed governance rule’s requirements. 

The term ‘‘facility,’’ when used with respect to an 

association, would be defined in new Rule 15Aa–

3(b)(11) as its premises, tangible or intangible 

property whether on the premises or not, any right 

to the use of such premises or property or any 

service thereof for the purpose of effecting or 

reporting a transaction (including, among other 

things, any system of communication to or from the 

association, by ticker or otherwise, maintained by 

or with the consent of the association), and any 

right of the association to the use of any property 

or service. If a facility of the association is within 

the same legal entity as the association itself, only 

the association would need to meet the proposed 

governance rule’s requirements. 87For instance, as discussed below in Section 

II.B.9., an exchange or association would be 

required to limit its members’ interest in a facility 

of the exchange or association, as well as the 

exchange or association itself, which may involve 

changes to the rules of the SRO, including any of 

the governing documents of the exchange or 

association, or a facility of the exchange or 

association. 88The term ‘‘board’’ would be defined in the 

proposed rules as the Board of Directors or Board 

of Governors of the exchange or association, or any 

equivalent body. See proposed Rules 6a–5(b)(5) and 

15Aa–3(b)(6). 89See proposed Rules 6a–5(c)(1) and 15Aa–

3(c)(1). The term ‘‘director’’ would be defined in 

proposed Rules 6a–5(b)(8) and 15Aa–3(b)(9) as any 

member of the board. 90See Sections 6(b)(1) and 15A(b)(2) of the 

Exchange Act, 15 U.S.C. 78f(b)(1) and 78o–3(b)(2).

91See, e.g., James H. Cheek III, et al., Report of 

the American Bar Association Task Force on 

Corporate Responsibility (2003) (‘‘ABA Task Force 

Report’’); Derek Higgs, Review of the Role and 

Effectiveness of Non-Executive Directors (2003) 

(‘‘Higgs Report’’); and The Business Roundtable, 

Principals of Corporate Governance (May 2002) 

(‘‘Business Roundtable Report’’).

92See, e.g., Securities Exchange Act Release No. 

48745, supra note 28; NYSE Listed Company 

Manual Section 303A.01; and NASD Rule 

4350(c)(1).

93Because of the unique role played by the SROs 

and the related conflicts, and in the context of the 

package of proposals in this release, the 

Commission at this time has determined to propose 

a majority independent director requirement for 

SROs. We are soliciting comment on this proposal. 

See also infra note 191.

94The NYSE Constitution, for example, requires 

that the NYSE’s board of directors be entirely 

independent of the management of the exchange, 

the membership of the exchange, and issuers of 

securities listed on the exchange. See NYSE 

Constitution, Article IV, Sec. 2.

95See infra Section II.B.3. for a discussion on the 

Standing Committees of the board.

96See, e.g., ABA Task Force Report, supra note 

91, at 31.

subsidiaries remain subject to the selfregulatory authority of the SRO and the 

SRO ultimately retains responsibility for 

fulfilling the self-regulatory duties 

imposed on it by the Exchange Act. To 

account for the fact that some SROs 

have delegated regulatory 

responsibilities under specified 

conditions to their subsidiaries, 

exchanges and associations would be 

required to apply various provisions of 

the proposed rules to any such 

subsidiaries, but only to the extent that 

the subsidiary has a separate governing 

board and key board committees. 

Accordingly, this proposal recognizes 

that a regulatory subsidiary of an 

exchange or association is an integral 

part of the SRO, and by carrying out 

certain self-regulatory duties on behalf 

of the exchange or association, it should 

be subject to the same governance 

standards applicable to the SRO itself.81

Each SRO subject to Rule 6a–5 or 

15Aa–3 would implement the 

applicable rule’s requirements through 

rule filings with the Commission 

pursuant to Section 19(b) of the 

Exchange Act.82 SROs are required to 

file any proposed change in, addition to, 

or deletion from its rules.83 A ‘‘stated 

policy, practice, or interpretation,’’ as 

defined in Rule 19b–4(b)(1) under the 

Exchange Act,84 is deemed a proposed 

rule change, and includes ‘‘any material 

aspect of the operation of the facilities 

of the [SRO].’’ 85 The Commission 

believes that any changes made by an 

SRO to its or any facility’s 86 articles of 

incorporation, constitution, bylaws, and 

rules, or any instrument corresponding 

to the foregoing, that relate to or are 

made to comply with proposed Rules 

6a–5 or 15Aa–3 would relate to a 

material aspect of the operation of the 

facilities of the exchange or association 

and therefore would be required to be 

filed under Section 19(b).87

2. Board Consisting of a Majority of 

Independent Directors 

Rules 6a–5 and 15Aa–3 would impose 

a series of substantive requirements 

with respect to the composition of the 

exchange’s and association’s board 88

that are designed to assure the 

independence of the board and the fair 

administration and governance of the 

exchange or association. To this end, the 

Commission proposes that the board of 

each exchange and association be 

composed of a majority of independent 

directors.89 This provision would 

further the statutory goals that an 

exchange and association be so 

organized and have the capacity to carry 

out the Exchange Act’s purposes and to 

comply, and enforce compliance by 

members and their associated persons, 

with the Exchange Act and rules 

thereunder and the SRO’s own rules.90

We note that this proposal is consistent 

with accepted corporate governance 

‘‘best practices’’ regarding board 

independence.91 The requirement to 

have a majority of independent directors 

also comports with exchange and 

association rules applicable to listed 

companies that recently were approved 

by the Commission to address similar 

governance concerns and the conflicts 

of interest that can arise between a 

company’s management and its public 

shareholders.92

The Commission’s proposed approach 

to SRO governance is multi-faceted and 

multi-pronged. It combines public 

disclosure of important governance 

information with guidelines for 

independent board representation and 

reliance on totally independent board 

committees for oversight of critical SRO 

functions and responsibilities.93 The 

proposed rules are designed to enhance 

the governance of exchanges and 

associations, while at the same time 

providing them with a measure of 

flexibility in determining their own 

governance models, so long as the 

minimum requirements are satisfied. 

SROs, of course, can elect to implement 

a greater proportion of independent 

directors.94

The Commission believes that 

requiring SRO boards to have a majority 

of independent directors, in 

combination with the other proposed 

requirements ‘‘for example, the 

proposed requirement mandating 

completely independent Standing 

Committees (as defined below) of the 

board 95 ‘‘should help address the 

conflicts of interest that otherwise might 

arise when persons with a nexus to the 

SRO are involved in key decisions.96

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71135

97See Sections 6(b) and 15A(b) of the Exchange 

Act, 15 U.S.C. 78f(b) and 78o–3(b).

98An ‘‘industry’’ director is generally an 

individual who is an officer, director or employee 

of a broker or dealer or an affiliate of a broker or 

dealer, a consultant or employee of the exchange 

itself, or an exchange permit holder. See, e.g., 

NASD Bylaws, Articles I(n) and I(o) and Phlx 

Bylaws, Article I, Section 1–1(m).

99A ‘‘non-industry’’ director may be an 

individual who has some relationship with the SRO 

or the financial services industry; thus, a nonindustry director could not be considered truly 

‘‘public.’’ For example, officers and employees of 

issuers listed on the exchange are considered nonindustry directors. See, e.g., Phlx Bylaws, Article I, 

Section 1–1(t) and CHX Bylaws, Article III, Section 

10(1).

100A ‘‘public’’ director is generally an individual 

who has no material business relationship with a 

broker or dealer or with the exchange or 

association. See, e.g., NASD Bylaws, Articles I(ee) 

and I(ff); Phlx Bylaws, Article I, Section 1–1(y); and 

CHX Bylaws, Article III, Section 10(2).

101For example, the BSE’s board is composed of 

the Chairman, the Vice-Chairman and twenty other 

directors, ten of whom must represent the securities 

industry and ten of whom must represent the 

public. See BSE Constitution, Article II, Section 1. 

At least 50% of the directors on PCX’s board are 

required to be persons from the public and cannot 

be affiliated with a broker or dealer or employed by, 

or involved in any material business relationship 

with, PCX or its affiliates. See PCX Bylaws, Article 

III, Section 3.02(a).

102See Securities Exchange Act Release No. 

48745, supra note 28; NYSE Listed Company 

Manual Section 303A.02(b); and NASD Rules 4350, 

4200(a)(15), and IM–4200.

103See proposed Rules 6a–5(b)(12) and 15Aa–

3(b)(13).

104See Sections 6(b) and 15A(b) of the Exchange 

Act, 15 U.S.C. 78f(b) and 78o–3(b).

105See proposed Rules 6a–5(c)(2) and 15Aa–

3(c)(2).

106See proposed Rules 6a–5(b)(13) and 15Aa–

3(b)(14).

107See proposed Rules 6a–5(c)(2) and 15Aa–

3(c)(2).

108Moreover, pursuant to proposed changes to 

exchange and association registration forms, this 

determination would be required to be disclosed, 

thereby fostering greater transparency of the SROs’

governance processes. See proposed revised Form 

1 and proposed new Form 2, infra Section IV.

109For purposes of the proposed governance 

rules, the term ‘‘member’’ has the same meaning as 

set forth in Section 3(a)(3) of the Exchange Act, 15 

U.S.C. 78c(a)(3). See proposed Rules 6a–5(b)(14) 

and 15Aa–3(b)(15).

110See proposed Rules 6a–5(b)(12) and 15Aa–

3(b)(13). See also infra note 230 (for a definition of 

‘‘affiliate’’).

111 15 U.S.C. 78f(b)(1) and 78o–3(b)(2). See 

generally Sections 6(b) and 15A(b) of the Exchange 

Act, 15 U.S.C. 78f(b) and 78o–3(b).

112See proposed Rules 6a–5(b)(12) and 15Aa–

3(b)(13).

113The term ‘‘immediate family member’’ would 

be defined in the proposed rules as a person’s 

spouse, parents, children, and siblings, whether by 

blood, marriage, or adoption, or anyone residing in 

such person’s house. See proposed Rules 6a–

5(b)(11) and 15Aa–3(b)(12).

114See proposed Rules 6a–5(b)(12)(i) and 15Aa–

3(b)(13)(i).

115See proposed Rules 6a–5(b)(12)(ii) and 15Aa–

3(b)(13)(ii).

116See proposed Rules 6a–5(b)(6) and 15Aa–

3(b)(7) for the definition of the term 

‘‘compensation.’’

These proposals together also should 

increase the likelihood that exchange 

and association boards will act in 

accordance with the mandates of the 

Exchange Act and in the best interests 

not only of the SRO and its members or 

shareholders, but also of the investing 

public. The Exchange Act sets broad 

parameters regarding the composition of 

an exchange’s or association’s governing 

body.97 The proposed rules are intended 

to provide greater clarity to those 

statutory provisions.

The exchanges, the NASD, and 

Nasdaq generally divide their boards 

between industry 98 and non-industry 99

(including public) 100 directors, with a 

number of exchanges requiring that at 

least 50% of the board be composed of 

public or non-industry directors.101 The 

proposed governance rules’ definition of 

independence is based largely on the 

current notion of a ‘‘public’’ director. 

Like the recently-adopted NYSE and 

NASD rules for listed issuers,102 the 

proposed governance rules also would 

include specific circumstances that 

preclude a director from being 

considered an independent director.103

The Commission believes that requiring 

exchanges and associations to adhere to 

the high standards set forth in the 

proposed rules should help foster a 

greater degree of independent decisionmaking by the exchanges’ and 

associations’ governing bodies. In the 

Commission’s view, the proposed rules 

should promote the goals of the 

Exchange Act that SROs be so organized 

and have the capacity to carry out their 

purposes.104

a. Determination of Independence. 

The proposals would specify that no 

director may qualify as an independent 

director unless the board affirmatively 

determines that the director has no 

material relationship with the exchange 

or association.105 The term ‘‘material 

relationship’’ would be defined as a 

relationship, whether compensatory or 

otherwise, that reasonably could affect 

the independent judgment or decisionmaking of the director.106 The proposals 

would require the board to make this 

independence determination upon the 

director’s nomination and thereafter no 

less frequently than annually and as 

often as necessary in light of the 

director’s circumstances (e.g., a job 

change or marriage that would 

disqualify the director from being 

considered independent).107 The 

Commission believes that requiring an 

exchange’s or association’s board to 

make an affirmative determination of 

independence, and to reevaluate that 

decision at least annually, would 

increase the accountability of such 

board and would further the proposals’

goal of requiring the board to be 

composed of a majority of truly 

independent directors.108 The proposed 

rules would define the term 

‘‘independent director’’ as a director 

who has no material relationship with 

the exchange or association or any 

affiliate of the exchange or association, 

any member 109 of the exchange or 

association or any affiliate of such 

member, or any issuer of securities that 

are listed or traded on the exchange or 

a facility of the exchange or 

association.110 The Commission 

believes that the rigorous proposed 

definitions of ‘‘independent director’’

and ‘‘material relationship’’ should help 

assure that SRO boards are controlled by 

persons not subject to potential conflicts 

of interest, and thereby further the goals 

of Sections 6(b)(1) and 15A(b)(2) of the 

Exchange Act.111

In addition to the general criteria of 

no material relationship, the proposed 

rules would identify certain specific 

circumstances when a director would 

not be considered independent.112 A 

director would not be considered 

independent if any of the following 

circumstances existed:

• The director, or an immediate 

family member,113 is, or within the past 

three years was, employed by or 

otherwise has or had a material 

relationship with the exchange or 

association or any affiliate of the 

exchange or association;114

• The director is, or within the past 

three years was, a member or employed 

by or affiliated with a member or any 

affiliate of a member, or the director has 

an immediate family member that is, or 

within the past three years was, an 

executive officer of a member or any 

affiliate of a member;115

• The director, or an immediate 

family member, has received during any 

twelve month period within the past 

three years more than $60,000 in 

payments from the exchange or 

association, any affiliate of the exchange 

or association or from a member or any 

affiliate of a member; however, 

payments received in the form of 

compensation 116 for board or board 

committee services, compensation to an 

immediate family member who is not an 

executive officer of the exchange or 

association, any affiliate of the exchange 

or association or of a member or any 

affiliate of a member, and pension and 

other forms of deferred compensation 

for prior services, not contingent on 

71136 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

117See proposed Rules 6a–5(b)(12)(iii) and 15Aa–

3(b)(13)(iii). The Commission believes that 

compensation received as deferred compensation 

for prior service should not by itself exclude a 

director from being considered independent. 

However, the director would still need to satisfy the 

core definition of independence contained in the 

proposed rules.

118See proposed Rules 6a–5(b)(7) and 15Aa–

3(b)(8) for the definition of the term ‘‘control.’’

119See proposed Rules 6a–5(b)(12)(iv) and 15Aa–

3(b)(13)(iv).

120See proposed Rules 6a–5(b)(12)(v) and 15Aa–

3(b)(13)(v).

121See proposed Rules 6a–5(b)(12)(vi) and 15Aa–

3(b)(13)(vi).

122See proposed Rules 6a–5(b)(12)(vii) and 15Aa–

3(b)(13)(vii).

123See infra Section II.B.3. for a discussion of the 

Audit Committee.

124See proposed Rules 6a–5(b)(12)(viii) and 

15Aa–3(b)(13)(viii). This requirement is 

commensurate with an independence requirement 

for non-investment company issuers contained in 

Rule 10A–3(b)(1)(ii) under the Exchange Act, 17 

CFR 240.10A–3(b)(1)(ii), which pertains to listing 

standards relating to audit committees. The 

proposed requirement is designed to help assure 

that there are no fee arrangements between the 

exchange or association or any of its affiliates and 

the Audit Committee member that would impair the 

independence of the Audit Committee member.

125See Sections 6(b)(1) and 15A(b)(2) of the 

Exchange Act, 15 U.S.C. 78f(b)(1) and 78o–3(b)(2).

126See, e.g., Securities Exchange Act Release Nos. 

48745, supra note 28 and 48863 (December 1, 

2003), 68 FR 68432 (December 8, 2003) (order 

approving governance standards for issuers of 

securities listed on Amex).

127See proposed Rules 6a–5(b)(12)(i) through (vii) 

and 15Aa–3(b)(13)(i) through (vii).

128See NYSE Listed Company Manual Section 

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

4200; and Amex Company Guide, Part I, Section 

121A.

129See proposed Rules 6a–5(b)(12)(iii) and (iv) 

and 15Aa–3(b)(13)(iii) and (iv).

130See NASD Rules 4350, 4200(a)(15), and IM–

4200 and Amex Company Guide, Part I, Section 

121A.

131See proposed Rules 6a–5(b)(11) and 15Aa–

3(b)(12).

132See NASD Rule 4200(a)(14).

133For example, the proposed governance rules 

state that a director would not be considered 

independent in the circumstance where a director 

is, or within the past three years was, a member or 

employed by or affiliated with a member, or the 

director has an immediate family member that is, 

or within the past three years was, an executive 

officer of a member or any affiliate of a member. 

Similarly, a director would not be considered 

independent in the circumstance where a director, 

or an immediate family member, is or within the 

past three years was an executive officer of an 

issuer of securities listed or primarily traded on the 

exchange or a facility of the association. See

proposed Rules 6a–5(b)(12)(ii) and (iv) and 15Aa–

3(b)(13)(ii) and (iv).

134See, e.g., Higgs Report, supra note 91, at 37 

and Richard C. Breeden, Restoring Trust: Report on 

Corporate Governance for the Future of MCI, Inc.

(August 2002) (‘‘Breeden Report’’), at 61.

continued service, would not disqualify 

a director as independent;117

• The director, or an immediate 

family member, is a partner in, or 

controlling 118 shareholder or executive 

officer of, any organization to which, or 

from which, the exchange or association 

or any affiliate of the exchange or 

association made or received payments 

for property or services in the current or 

any of the past three full fiscal years that 

exceed 2% of the recipient’s 

consolidated gross revenues for that 

year, or $200,000, whichever is more, 

other than certain payments arising 

solely from investments in the securities 

of the exchange or association or any 

facility or affiliate of the exchange or 

association or payments under nondiscretionary charitable contribution 

matching programs;119

• The director, or an immediate 

family member, is, or within the past 

three years was, an executive officer of 

an issuer of securities listed or primarily 

traded on the exchange or a facility of 

the exchange or association;120

• The director, or an immediate 

family member, is, or within the past 

three years was, employed as an 

executive officer of another entity where 

any of the exchange’s or association’s 

executive officers serve on that entity’s 

compensation committee;121

• The director, or an immediate 

family member, is a current partner of 

the outside auditor of the exchange or 

association or any affiliate of the 

exchange or association, or was a 

partner or employee of the outside 

auditor of the exchange or association or 

any affiliate of the exchange or 

association who worked on the audit of 

the exchange or association or any 

affiliate of the exchange or association, 

at any time within the past three 

years; 122 or

• In the case of a director that is a 

member of the Audit Committee,123

such director (other than in his or her 

capacity as a member of the Audit 

Committee, the board, or any other 

board committee), accepts, directly or 

indirectly, any consulting, advisory, or 

other compensatory fee from the 

exchange or association, any affiliate of 

the exchange or association, or a 

member or any affiliate of a member, 

other than fixed amounts of pension and 

other forms of deferred compensation 

for prior service, provided such 

compensation is not contingent in any 

way on continued service.124

The Commission believes that the 

proposed circumstances that would 

preclude a determination of a director’s 

independence—in effect, concluding 

that a ‘‘material relationship’’ exists 

under certain circumstances—should 

better assure that a majority of an SRO’s 

board is truly independent, and thus 

should promote the statutory 

requirement that SROs be so organized 

and have the capacity to carry out the 

Exchange Act’s purposes.125 The 

proposed circumstances that would 

preclude a director from being 

considered independent are similar to 

criteria that are contained in SRO listing 

standards, which recently were 

approved by the Commission and are 

designed to address similar governance 

concerns and the conflicts of interest 

that can arise between a company’s 

management and its public 

shareholders.126 For example, the threeyear look-back provision 127 is a feature 

of NYSE, NASD, and Amex rules for 

listed issuers;128 the $60,000 restriction 

on payments received and the 2%/

$200,000 threshold for payments 

received or made for property or 

services 129 are similar to factors 

contained in NASD and Amex listing 

rules;130 and the definition of 

‘‘immediate family member 131 is 

substantially the same as the definition 

of the term ‘‘family member’’ in the 

NASD’s listing rules.132 The 

Commission further notes that because 

SROs are member organizations and 

operate markets with listing 

requirements, the proposed rules would 

take into account specific relationships 

between the director and a member or 

listed company that could challenge the 

impartiality of the director.133

In the Commission’s view, the 

proposed relationship tests that would 

preclude a determination that a director 

is independent strike an appropriate 

balance and promote the goal of 

providing clear standards regarding the 

determination of independence.134 The 

Commission believes that these criteria 

are indicative of whether directors can 

reach independent decisions that affect 

the SRO without competing pressures or 

conflicts of interest. For example, the 

fact that a director was an executive 

officer of a listed issuer more than three 

years prior to his or her nomination to 

the board is unlikely to have an 

influence on his or her decisions as a 

board member. On the other hand, a 

director’s recent employment with a 

member does raise such concerns and 

would preclude a finding that he or she 

is independent. The Commission 

believes that these specific 

circumstances appropriately identify 

those relationships, such as recent 

employment, a business or financial 

relationship, or family ties, that are 

likely to impair the independence of a 

director. Further, there are practical 

reasons for relying on criteria that are 

similar to factors currently in place at 

the SROs for their listed issuers, as the 

SROs already are experienced in 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71137

135See proposed Rules 6a–5(c)(3) and 15Aa–

3(c)(3).

136See proposed Rules 6a–5(c)(9) and 15Aa–

3(c)(9).

137See proposed Rules 6a–5(c)(4) and 15Aa–

3(c)(4). See infra Section II.B.2.c. for a discussion 

of the statutory ‘‘fair representation’’ requirement.

138See proposed Rules 6a–5(c)(5) and 15Aa–

3(c)(5).

139See infra Section II.B.2.c.

140See proposed Rules 6a–5(c)(6) and 15Aa–

3(c)(6). See infra Section II.B.3. for a discussion of 

the Standing Committees of the board.

141Each SRO with non-independent directors 

would have to establish procedures for determining 

which non-independent directors would vote under 

such circumstances, consistent with the ‘‘fair 

representation’’ requirements discussed below.

142See proposed Rules 6a–5(c)(8) and 15Aa–

3(c)(8).

143 15 U.S.C. 78f(b)(3).

144 15 U.S.C. 78o–3(b)(4).

145See infra Section II.B.3. for a discussion of the 

fully-independent Nominating Committee.

146See supra note 109 for the definition of the 

term ‘‘member.’’

147See proposed Rules 6a–5(f)(3) and 15Aa–

3(f)(3). 148See Securities Exchange Act Release Nos. 

48946, supra note 36 and 49718, supra note 61. The 

Commission notes that it previously has taken the 

position that the fair representation requirement 

could be satisfied if the exchange’s or association’s 

rules provided that members constitute at least 20% 

of the individuals serving on the Nominating 

Committee. See, e.g., Securities Exchange Act 

Release Nos. 49098 and 49718, supra note 61. 

Because the proposed governance rules would 

mandate that the Nominating Committee consist 

solely of independent directors, an exchange or 

association no longer would have the option of 

satisfying the fair representation requirement by 

having at least 20% member representation on its 

Nominating Committee. Although the Commission 

previously approved SRO proposals that allowed 

members to constitute at least 20% of the 

exchange’s or association’s Nominating Committee, 

the Commission now believes that the governance 

of exchanges and associations would be 

strengthened by requiring a fully independent 

Nominating Committee.

interpreting and applying those 

standards. The Commission emphasizes 

that the absence of any of the proposed 

relationship tests, of course, would not 

necessarily result in a determination of 

independence, as the board must still 

affirmatively determine that the director 

has no material relationship with the 

SRO.

b. Independent Board Requirements. 

The proposed governance rules would 

require exchanges and associations to 

establish policies and procedures to 

require each director, on his or her own 

initiative and upon request of the 

exchange or association, to inform the 

exchange or association of the existence 

or establishment of any relationship or 

interest that may reasonably be 

considered to bear on whether such 

director is an independent director.135

Exchanges and associations also would 

be required to establish procedures for 

interested persons to communicate their 

concerns relating to any matter within 

the authority or jurisdiction of a 

Standing Committee directly to the 

independent directors.136

The proposed governance rules also 

would require that at least 20% of the 

total number of directors be selected by 

members.137 In addition, the proposed 

governance rules would require that at 

least one director be representative of 

issuers and at least one director be 

representative of investors and, in each 

case, such director must not be 

associated with a member or broker or 

dealer.138 The Commission believes that 

these provisions are consistent with the 

‘‘fair representation’’ and ‘‘issuer and 

investor representation’’ requirements of 

the Exchange Act, which are discussed 

below.139

Further, the proposed governance 

rules would require that when the board 

of an exchange or association considers 

any matter that is recommended by or 

otherwise is within the authority or 

jurisdiction of a Standing Committee, a 

majority of the directors who vote on 

the matter must be independent 

directors.140 For example, assume an 

exchange has a board composed of nine 

independent directors and eight nonindependent directors. If two 

independent directors do not participate 

in a board meeting but all the nonindependent directors participate in 

such meeting, the matter could be voted 

upon only by the seven independent 

directors present and six of the eight 

non-independent directors present.141

This proposal is intended to preserve 

and bolster the requirement that the 

majority of the board be independent, 

and is designed to assure that matters 

before the board that are within the 

authority or jurisdiction of the fullyindependent Standing Committees are 

considered by and voted on by a 

majority of independent directors.

In addition, the proposed governance 

rules would require that if the exchange 

or association fails to comply with the 

requirement that the board be composed 

of a majority of independent directors 

because there is a vacancy on the board 

or a director ceases to be independent, 

the exchange or association must 

remedy such non-compliance by the 

earlier of the exchange’s or association’s 

next annual meeting or one year from 

the date of the occurrence of the event 

that caused the non-compliance.142 This 

provision is consistent with the 

standard imposed on listed issuers and, 

in our view, should assure prompt 

remediation, yet provide exchanges and 

associations with a reasonable period of 

time, consistent with their governance 

procedures, to cure any failure to satisfy 

the majority independence requirement.

c. Fair Representation. Section 6(b)(3) 

of the Exchange Act requires that the 

rules of an exchange assure a fair 

representation of its members in the 

selection of its directors and 

administration of its affairs (‘‘fair 

representation requirement’’), and must 

provide that one or more directors be 

representative of issuers and investors 

and not be associated with a member of 

the exchange, broker or dealer (‘‘issuer 

and investor representation 

requirements’’).143 Section 15A(b)(4) of 

the Exchange Act contains an identical 

requirement with respect to the rules of 

an association.144

Consistent with the fair representation 

requirement, the proposed governance 

rules would require that the Nominating 

Committee 145 administer a fair process 

that provides members 146 with the 

opportunity to select at least 20% of the 

total number of directors (‘‘member 

candidates’’).147 This requirement is not 

intended to prohibit exchanges and 

associations from having boards 

composed solely of independent 

directors. If an exchange’s or 

association’s board is composed wholly 

of independent directors, the candidate 

or candidates selected by members 

would have to be independent. This 

‘‘20% standard’’ for member candidates 

comports with previously-approved 

SRO rule changes that raised the issue 

of fair representation.148 The 

Commission preliminarily believes that 

the proposed 20% requirement strikes a 

proper balance by giving members a 

practical voice in the governance of the 

exchange or association and the 

administration of its affairs, without 

jeopardizing the overall independence 

of the board.

An exchange or association would 

have some leeway in implementing the 

fair process for members to select board 

candidates. For example, the 

Commission believes that the exchange 

or association would have a fair process 

if it established an advisory panel of 

members that reports to the Nominating 

Committee, and that is directly 

responsible for nominating member 

candidates for the board. Another type 

of fair process would be for the member 

advisory panel to make 

recommendations to the Nominating 

Committee, with the Nominating 

Committee required to nominate the 

member candidates identified by the 

member advisory panel. The member 

candidates, of course, would be required 

to satisfy all relevant eligibility criteria 

for directors (including independence 

requirements, if applicable). The fair 

process must also ensure that the 

member candidates actually are 

provided seats on the board. 

71138 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

149See proposed Rules 6a–5(c)(7) and 15Aa–

3(c)(7). SROs currently have rules that permit 

members to engage in a petition process to 

nominate candidates. For example, pursuant to 

Phlx rules, members representing not less than 50 

votes may, by written petition, independently 

nominate an individual for the position of on-floor 

governor, and members representing not less than 

75 votes may propose an entire ticket, or any 

portion thereof, for on-floor governor positions 

which are vacant. See Phlx Bylaws, Article III, 

Section 3–7. A similar process is employed at the 

NYSE where members may propose by written 

petition potential nominees for positions to be filled 

at elections. Any such nominee must be endorsed 

by not less than 40 members, and not less than 100 

members may petition for an entire ticket, or any 

portion thereof. See NYSE Constitution, Article III, 

Section 1. 150See proposed Rules 6a–5(f)(3) and 15Aa–

3(f)(3). 151See proposed Rules 6a–5(f)(4) and 15Aa–

3(f)(4). For example, the Nominating and 

Governance Committee of the NYSE currently is 

required to recommend to the board at least one 

individual who is representative of issuers and at 

least one individual who is representative of 

investors. See NYSE Constitution, Article IV, 

Sections 2 and 12. 152 15 U.S.C. 78f(b)(3) and 78o–3(b)(4).

153See Securities Exchange Act Release No. 

48946, supra note 36.

154See supra Section I.B.

155See proposed Rules 6a–5(b)(21) and (e)(1) and 

15Aa–3(b)(22) and (e)(1). An SRO would not be 

precluded from allowing a single committee to 

carry out the functions of two Standing Committees 

as long as the committee consisted solely of 

independent directors, e.g., the functions of the 

Nominating Committee and the Governance 

Committee could be carried out by a single 

committee. Also, to the extent that a Standing 

Committee of the exchange or association carries 

out responsibilities on behalf of a regulatory 

subsidiary, the regulatory subsidiary would not be 

required to have a Standing Committee that 

performs the same functions. See proposed Rules 

6a–5(a) and 15Aa–3(a).

156See proposed Rules 6a–5(f)(1), (g)(1), (h)(1), 

(i)(1), and (j)(1) and 15Aa–3(f)(1), (g)(1), (h)(1), (i)(1), 

and (j)(1). This provision is consistent with the 

recommendations in the Higgs Report, ABA Task 

Force Report and the Breeden Report. See Higgs 

Report, supra note 91, at 60–61; ABA Task Force 

Report, supra note 91, at 63–67; and Breeden 

Report, supra note 134, at 103.

157See Sections 6(b)(1) and 15A(b)(2) of the 

Exchange Act, 15 U.S.C. 78f(b)(1) and 78o–3(b)(2).

158See proposed Rules 6a–5(e)(2) and 15Aa–

3(e)(2). The Business Roundtable Report noted that 

it may be appropriate for boards and committees to 

seek advice from outside advisors and that board 

and committee access to outside advisors is an 

important element of corporate governance. See

Business Roundtable Report, supra note 91, at 27–

28.

159See proposed Rules 6a–5(f)(5), (h)(3), (i)(3) and 

(j)(6) and 15Aa–3(f)(5), (h)(3), (i)(3) and (j)(6). The 

proposed rules would require each exchange and 

association to provide sufficient funding and other 

resources, as determined by each Standing 

Committee, to permit the Standing Committees to 

fulfill their responsibilities and to retain 

independent legal counsel and other advisors. See

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

160See proposed Rules 6a–5(g)(3) and 15Aa–

3(g)(3).

To further address the fair 

representation requirement, proposed 

Rules 6a–5(c)(7) and 15Aa–3(c)(7) 

would require exchanges and 

associations to adopt rules to establish 

a fair process for the nomination of 

alternative candidates by members 

through a petition process. This 

requirement would provide members 

with the means to nominate one or more 

alternative candidates representative of 

members. The percentage of members 

that is necessary to put forth such 

alternative member candidate or 

candidates would be required to be 

specified in the exchange’s or 

association’s rules, and could not 

exceed 10% of the total number of 

members.149 The Commission believes 

that this 10% requirement strikes an 

appropriate balance in that it provides 

members a practical mechanism to put 

forth alternative candidates, without 

jeopardizing the overall integrity of the 

nominating process. The Nominating 

Committee would be required to 

administer the petition process 

established by the exchange’s or 

association’s rules.150

To address the issuer and investor 

representation requirement, the 

Nominating Committee would be 

required to nominate at least one 

director who is representative of issuers 

and at least one director who is 

representative of investors and who, in 

each case, is not associated with a 

member or broker or dealer.151 This 

provision simply would codify in 

Commission rules the requirements set 

forth in Sections 6(b)(3) and 15A(b)(4) of 

the Exchange Act.152

The Commission notes that it recently 

approved the NYSE’s proposal to 

establish a fully independent board, 

finding that such a board could be 

consistent with the Exchange Act and 

the fair representation and issuer and 

investor representation requirements.153

As discussed above, the Commission 

only is proposing to require exchanges 

and associations to elect majorityindependent boards, although an SRO 

may elect to impose a more rigorous 

requirement. The Commission believes 

that an exchange’s or association’s board 

could be wholly-independent based on 

the independence criteria contained in 

the proposed governance rules, 

provided that its rules satisfy the fair 

representation requirement and issuer 

and investor representation 

requirements (i.e., by requiring that at 

least 20% of the independent directors 

are selected by members, that at least 

one independent director is 

representative of issuers, and at least 

one independent director is 

representative of investors).

3. Standing Committees 

Recent developments have 

highlighted the critical role that board 

committees play in the governance of 

exchanges and associations and the 

importance of having key committees 

function independently of the pressures 

that otherwise could be exerted on them 

by management, members or other 

interested parties.154 The Commission is 

proposing that each exchange and 

association, at a minimum, have the 

following standing committees, or their 

equivalent: Nominating Committee; 

Governance Committee; Compensation 

Committee; Audit Committee; and 

Regulatory Oversight Committee 

(collectively, ‘‘Standing 

Committees’’).155 The proposed 

governance rules also would require 

that each Standing Committee be 

composed solely of independent 

directors.156 The Commission 

preliminarily believes that the functions 

to be performed by these committees are 

important to the effective administration 

of an exchange or association. Moreover, 

these are the committees that generally 

are charged with overseeing the SRO’s 

regulatory responsibilities, including 

the SRO’s commitment of financial 

resources to fund those responsibilities. 

Thus, the Commission believes that 

requiring all of the members of these 

Standing Committees to be independent 

would result in a greater degree of 

objective decision-making with respect 

to the exchange’s or association’s core 

responsibilities and would further the 

Exchange Act’s goal that SROs be so 

organized and have the capacity to carry 

out their self-regulatory obligations.157

The proposed governance rules would 

require each Standing Committee to 

have the authority to direct and 

supervise inquiries into any matter 

brought to its attention within the scope 

of its duties and to obtain advice and 

assistance from independent legal 

counsel and other advisors as it 

determines necessary to carry out its 

duties.158 In addition, each Standing 

Committee, other than the Governance 

Committee, would be required to 

conduct an annual performance selfevaluation.159 Rather than conduct an 

annual self-evaluation of the 

committee’s performance, the 

Governance Committee would be 

required to conduct an annual 

performance evaluation of the 

governance of the exchange or 

association as a whole, including the 

effectiveness of the board and its 

committees.160 The Commission 

believes that these self-evaluations 

should assist the exchange or 

association in identifying strengths and 

deficiencies in the governance, 

administration, regulatory programs, 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71139

161The ABA Task Force Report recommended 

periodic evaluations by the directors of the 

effectiveness and adequacy of meetings of the board 

and its committees. See ABA Task Force Report, 

supra note 91, at 72. The Business Roundtable 

Report similarly recommended that the 

‘‘performance of the full board should be evaluated 

annually, as should the performance of its 

committees,’’ to allow the board to determine 

whether it and its committees were following the 

procedures necessary to function effectively. See

Business Roundtable Report, supra note 91, at 28.

162See proposed Rules 6a–5(f)(2) and 15Aa–

3(f)(2).

163See proposed Rules 6a–5(g)(2) and 15Aa–

3(g)(2).

164See proposed Rules 6a–5(h)(2) and 15Aa–

3(h)(2).

165See proposed Rules 6a–5(i)(2) and 15Aa–

3(i)(2). The complaint procedures for the Audit 

Committee are commensurate with the complaint 

procedures contained in Rule 10A–3(b)(3) under the 

Exchange Act, 17 CFR 240.10A–3(b)(3), which 

pertain to audit committees of listed issuers.

166See proposed Rules 6a–5(n)(3) and 15Aa–

3(n)(3), which would require exchanges and 

associations to appoint a Chief Regulatory Officer. 

See also infra Section II.B.8.a.

167 ‘‘Senior regulatory personnel’’ means those 

individuals, including the proposed Chief 

Regulatory Officer, who are the senior managers of 

the SRO’s regulatory program.

168The term ‘‘affiliated security’’ is proposed to 

be defined as any security issued by an affiliated 

issuer, except that it would not include any option 

exempt from the Securities Act pursuant to Rule 

238 thereunder, 17 CFR 230.238, and any security 

futures product exempt from the Securities Act 

pursuant to Section 3(a)(14) thereof, 15 U.S.C. 

77c(a)(14). See proposed Rules 6a–5(b)(3) and 

15Aa–3(b)(3). An ‘‘affiliated issuer’’ is proposed to 

be defined to mean an exchange, an association, an 

SRO trading facility of the exchange or association, 

an affiliate of the exchange or association, or an 

affiliate of an SRO trading facility of the exchange 

or association. See proposed Rules 6a–5(b)(2) and 

15Aa–3(b)(2). ‘‘SRO trading facility’’ is proposed to 

be defined in proposed Rules 6a–5(b)(20) and 

15Aa–3(b)(21) as any facility of a national securities 

exchange or registered securities association, 

respectively, that executes orders in securities.

169See proposed Rules 6a–5(j)(2) and 15Aa–

3(j)(2). See infra Section III. for a discussion of 

proposed Regulation AL.

170See proposed Rules 6a–5(j)(4) and 15Aa–

3(j)(4).

171See proposed Rules 6a–5(j)(1) and 15Aa–

3(j)(1).

172See proposed Rules 6a–5(j)(3) and 15Aa–

3(j)(3).

173See id.

174See Sections 6(b)(3) and 15A(b)(4) of the 

Exchange Act, 15 U.S.C. 78f(b)(3) and 78o–3(b)(4).

and financial matters of the exchange or 

association.161

In order to function effectively, each 

Standing Committee would need to be 

clear as to its role. Accordingly, the 

proposed rules would require that each 

Standing Committee have a written 

charter that addresses such committee’s 

purpose and responsibilities, which, at 

a minimum, must be as follows:

• Nominating Committee: to identify 

individuals qualified to become board 

members, consistent with criteria 

approved by the board and administer a 

process for the nomination of 

individuals to the board.162

• Governance Committee: to develop 

and recommend to the board a set of 

governance principles applicable to the 

exchange or association and to oversee 

the evaluation of the board and 

management.163

• Compensation Committee: to have 

direct responsibility to review and 

approve corporate goals and objectives 

relevant to the compensation of the 

executive officers of the exchange or 

association; evaluate the performance of 

the executive officers in light of those 

goals and objectives; and consider and 

approve recommendations with respect 

to the compensation level of the 

executive officers, based on this 

evaluation.164

• Audit Committee: to assist the 

board in oversight of the integrity of the 

exchange’s or association’s financial 

statements; the exchange’s or 

association’s compliance with related 

legal and regulatory requirements; the 

qualifications and independence of the 

exchange’s or association’s auditor, 

including direct responsibility for the 

hiring, firing, and compensation of the 

auditor, overseeing the auditor’s 

engagement, meeting regularly in 

executive session with the auditor, 

reviewing the auditor’s reports with 

respect to the exchange’s or 

association’s internal controls, and preapproving all audit and non-audit 

services performed by the auditor; 

determining the budget and staffing of 

the exchange’s or association’s internal 

audit department; and establishing 

procedures for the receipt of complaints 

regarding accounting, internal 

accounting controls, or auditing matters 

of the exchange or association and the 

confidential submission by employees 

of the exchange or association of 

concerns regarding questionable 

accounting or auditing matters.165

• Regulatory Oversight Committee: to 

assure the adequacy and effectiveness of 

the exchange’s or association’s 

regulatory program; assess the 

exchange’s or association’s regulatory 

performance; determine the regulatory 

plan, programs, budget, and staffing for 

the regulatory functions of the exchange 

or association; assess the performance 

of, and recommend compensation and 

personnel actions involving, the Chief 

Regulatory Officer 166 and other senior 

regulatory personnel 167 to the 

Compensation Committee; monitor and 

review regularly with the Chief 

Regulatory Officer matters relating to 

the exchange’s or association’s 

surveillance, examination, and 

enforcement units; assure that the 

exchange’s or association’s disciplinary 

and arbitration proceedings are 

conducted in accordance with the 

exchange’s or association’s rules and 

policies and any other applicable laws 

or rules, including those of the 

Commission; prior to the exchange’s or 

association’s approval of an affiliated 

security 168 for listing, certify that such 

security meets the exchange’s or 

association’s rules for listing; and 

approve any reports filed with the 

Commission as required by proposed 

Regulation AL (§ 242.800).169

The Commission believes that the 

foregoing proposed responsibilities of 

the Standing Committees would foster 

the effectiveness of such committees 

and further the objective of good 

governance on the part of SROs. 

Exchanges and associations, of course, 

could elect to assign additional 

responsibilities to the Standing 

Committees, as long as they were 

otherwise consistent with the proposed 

governance rules. 

In addition, any committee, 

subcommittee, or panel that is 

responsible for conducting hearings, 

rendering decisions, and imposing 

sanctions with respect to disciplinary 

matters would be subject to the 

jurisdiction of the Regulatory Oversight 

Committee.170 Although the Regulatory 

Oversight Committee would be required 

to be composed solely of independent 

directors,171 the Commission believes 

that, to satisfy the fair representation 

requirement, the exchange or 

association must provide for member 

participation on any committee, 

subcommittee, or panel that is 

responsible for conducting hearings, 

rendering decisions, and imposing 

sanctions with respect to member 

disciplinary matters.172 In order to 

satisfy this requirement, the proposal 

would require that at least 20% of the 

members of any such committee, 

subcommittee, or panel be members of 

the exchange or association.173 The 

Commission believes that this provision 

furthers the requirement of the 

Exchange Act that an exchange or 

association assure a fair representation 

of members in the administration of its 

affairs.174 By proposing to require 

members to be represented on bodies 

that consider disciplinary matters 

relating to members, members would be 

assured input into a key aspect of SRO 

administration that is of critical 

importance to them. The Commission 

believes that the proposed 20% 

requirement would provide members 

with a practical voice in disciplinary 

matters without compromising the 

overall independence of the disciplinary 

process, which would be overseen by 

71140 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

175See, e.g., Securities Exchange Act Release Nos. 

50057 (July 22, 2004), 69 FR 45091 (July 28, 2004) 

(notice of filing of proposed rule change including 

to require that the Amex Adjudicatory Council, 

which has the authority to act for the Amex Board 

of Governors with respect to, among other things, 

any appeal or review of a disciplinary proceeding, 

be composed of three industry governors and three 

independent governors) and 49718, supra note 61 

(order approving the proposed rules pertaining to 

the demutualization of PCX and finding that permit 

holders would retain a voice in the administration 

of the affairs of the reorganized PCX, including the 

rulemaking and the disciplinary process, through 

participation on various committees).

176See proposed Rules 6a–5(j)(5) and 15Aa–

3(j)(5); proposed Rule 17a–26. See infra Section V. 

for a discussion of proposed Rule 17a–26.

177See proposed Rules 6a–5(k)(1) and 15Aa–

3(k)(1).

178See id.

179See proposed Rules 6a–5(k)(2) and 15Aa–

3(k)(2).

180See, e.g., Securities Exchange Act Release No. 

49718, supra note 61 (order approving the PCX 

Options Trading Permit Advisory Committee, 

which among other things, acts in an advisory 

capacity regarding rule changes related to 

disciplinary matters and trading rules and which 

must be made up entirely of options trading permit 

holders).

181See Sections 6(b)(5) and 15A(b)(6) of the 

Exchange Act, 15 U.S.C. 78f(b)(5) and 78o–3(b)(6).

182See Sections 6(b)(6)–(7) and 15A(b)(7)–(8) of 

the Exchange Act, 15 U.S.C. 78f(b)(6)–(7) and 78o–

3(b)(7)–(8).

183 15 U.S.C. 78c(a)(39). 184See proposed Rules 6a–5(l)(1) and 15Aa–

3(l)(1). 185See proposed Rules 6a–5(l)(2) and 15Aa–

3(l)(2). 186See, e.g., 15 U.S.C. 78f(b) and 78o–3(b). 187See ABA Task Force Report, supra note 91, at 

63; Breeden Report, supra note 134, at 52; and 

Higgs Report, supra note 91, at 34. 188See proposed Rules 6a–5(d)(1) and 15Aa–

3(d)(1). The proposed governance rules would 

define ‘‘executive session’’ as a meeting of 

independent directors of the board, without the 

presence of either management of the exchange or 

association or directors who are not independent 

directors. See proposed Rules 6a–5(b)(9) and 15Aa–

3(b)(10).

the fully independent Regulatory 

Oversight Committee, or the ability of 

the exchange or association to carry out 

its obligations under the Exchange Act. 

The Commission notes that this 20% 

standard is consistent with prior SRO 

proposals that were approved by the 

Commission and that provided members 

with a voice in the exchange’s or 

association’s disciplinary process.175

The Commission notes, however, that 

unlike previously-approved structures, 

the proposal would require any 

committee, subcommittee, or panel 

containing members to report to the 

fully-independent Regulatory Oversight 

Committee. This requirement would be 

necessary because the Regulatory 

Oversight Committee, which is 

proposed to be fully independent, is 

intended to be the committee 

responsible for oversight of regulatory 

matters, including disciplinary matters.

The Regulatory Oversight Committee 

also would be required to oversee the 

preparation of the exchange’s or 

association’s annual regulatory report, 

as required by proposed Rule 17a–26 of 

the Exchange Act.176

4. Other Committees of the Board 

The proposed governance rules would 

permit an exchange or association to 

establish such other committees of the 

board as it determines to be appropriate; 

however, if such committee has the 

authority to act on behalf of the board, 

that committee would be required to be 

composed of a majority of independent 

directors.177 For example, if the 

exchange or association has established 

an Executive Committee that is 

empowered to act on the board’s behalf, 

such committee would be required to be 

composed of a majority of independent 

directors. Further, the exchange or 

association could not delegate to any 

committee not consisting solely of 

independent directors the authority to 

act on matters that otherwise are within 

the jurisdiction of a Standing 

Committee.178

In addition, the Commission is 

proposing that at least 20% of the 

persons serving on any committee that 

is not a Standing Committee and any 

committee, subcommittee, or panel that 

is subject to the jurisdiction of a 

Standing Committee, and that is 

responsible for providing advice with 

respect to trading rules or disciplinary 

rules, be members of the exchange or 

association.179 The Commission 

believes that, consistent with the 

Exchange Act’s fair representation 

requirement, members should be 

provided with the opportunity to 

formally provide input on the 

development of, or changes to, trading 

and disciplinary rules. Rulemaking in 

this area is a key aspect of SRO 

administration and can have a 

significant impact on members. The 

Commission preliminarily believes that, 

as in prior contexts, the 20% 

requirement affords members a practical 

voice in the formulation of rules 

important to them. The Commission 

notes that it has previously approved 

SRO proposed rule changes that provide 

members with a role in developing rules 

relating to trading and disciplinary 

matters.180

5. Other Requirements Applicable to 

Directors and Officers 

The duties and responsibilities 

imposed by the Exchange Act on 

exchanges and associations make clear 

that these SROs are charged with an 

important public trust and play an 

integral role in, among other things, 

maintaining securities markets that are 

free from fraudulent or manipulative 

acts or practices and that promote just 

and equitable principles of trade.181

Exchanges and associations also are 

charged with appropriately disciplining 

their members pursuant to fair 

procedures.182 To further these and 

other statutorily-imposed requirements 

applicable to exchanges and 

associations, the proposed governance 

rules would require that the rules of the 

exchange or association prohibit a 

person subject to any statutory 

disqualification, within the meaning of 

Section 3(a)(39) of the Exchange Act,183

from being a director or officer of the 

exchange or association.184 The 

Commission believes that the integrity 

of the exchange or association—as well 

as its ability to perform its statutorily 

required functions—could be seriously 

undermined if individuals subject to 

these serious regulatory or legal 

sanctions were permitted to serve on the 

board or as an officer of the exchange or 

association.

In addition, the proposed rules would 

require exchanges and associations to 

explicitly mandate that each director, in 

discharging his or her responsibilities as 

a member of the board, reasonably 

consider all requirements applicable to 

the exchange or association under the 

Exchange Act.185 Exchanges and 

associations, as regulated entities, have 

certain obligations under the Exchange 

Act,186 and their directors must take 

these obligations into account when 

discharging their responsibilities. We 

note that directors have fiduciary 

obligations under state law. The 

Commission believes, however, that 

expressly requiring directors to take into 

account the exchange’s or association’s 

obligations under the Exchange Act 

should help promote greater awareness 

and accountability on the part of 

directors, thus furthering the objectives 

of the Exchange Act.

6. Executive Sessions of the Board 

The Commission believes that 

independent directors must be provided 

with the opportunity to discuss any 

important matters regarding the 

exchange or association in a frank and 

open manner, free from the presence of 

management.187 Therefore, the 

Commission proposes that the 

independent directors of the exchange’s 

or association’s board meet regularly in 

executive session.188 The Commission, 

however, is not proposing a minimum 

frequency for the independent directors 

to meet regularly in executive session; 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71141

189See proposed Rules 6a–5(d)(2) and 15Aa–

3(d)(2). See also supra note 158 (noting the 

Business Roundtable Report’s support of board and 

committee access to outside advisors). 190See proposed Rules 6a–5(d)(3) and 15Aa–

3(d)(3). 191The Commission seeks to mitigate the conflict 

between an SRO’s regulatory functions on the one 

hand, and its business operations on the other, 

among other conflicts. We note in this connection 

that, in light of the distinct statutory scheme and 

historical experience relevant to mutual funds and 

investment advisers, and in the context of different 

and potentially more serious conflicts, involving 

activities expressly prohibited by Congress, the 

Commission (Commissioners Glassman and Atkins 

dissenting) determined to require an independent 

chairman. See Investment Company Act Release 

No. 26520 (July 27, 2004), 69 FR 46377 (August 2, 

2004); see also supra note 93. In the context of 

SROs, the Commission may require a different 

regulatory response. In any event, we are soliciting 

comment on whether this approach is appropriate 

in this context.

192See proposed Rules 6a–5(m)(1) and 15Aa–

3(m)(1).

193See NYSE Constitution, Article IV, Section 2 

and BSE Constitution, Article II, Section 1.

194See proposed Rules 6a–5(m)(2) and (4) and 

15Aa–3(m)(2) and (4).

195See proposed Rules 6a–5(m)(3) and 15Aa–

3(m)(3). With regard to SROs, the Commission 

believes at this time that, in combination with the 

other proposed safeguards, a lead independent 

director would adequately address its concerns. We 

are soliciting comment on these proposals.

196 In testimony before Congress, the 

Commission’s Chairman identified the inherent 

tension between an SRO’s role as a regulator and 

as the operator of a market, and between its role as 

a regulator and as a membership organization, as a 

possible explanation for why self-regulation has not 

always worked as effectively and fairly as it should. 

See Testimony of William H. Donaldson, Chairman, 

Commission, Concerning Improving the 

Governance of the NYSE, before the Senate 

Committee on Banking, Housing and Urban Affairs 

(November 20, 2003).

197See supra note 80. Although the NYSE has not 

separated its regulatory functions and market 

operations into distinct legal entities, the NYSE’s 

Regulatory Oversight and Regulatory Budget 

Committee is responsible for, among other things, 

assuring the effectiveness, vigor, and 

professionalism of the NYSE’s regulatory program; 

overseeing the NYSE’s Regulation, Enforcement & 

Listing Standards Committee and the Regulatory 

Quality Review Unit; determining the NYSE’s 

regulatory plan, budget and staffing proposals 

annually; and assessing the NYSE’s regulatory 

performance and recommending compensation and 

personnel actions involving senior regulatory 

personnel to the board’s Human Resources & 

Compensation Committee for action. See NYSE 

Constitution, Article IV, Section 12(a)(4).

198See proposed Rules 6a–5(n) and 15Aa–3(n).

199See proposed Rules 6a–5(n)(1) and 15Aa–

3(n)(1).

rather, it is leaving this decision to the 

board, to be based on the facts and 

circumstances of the particular 

exchange or association.

The proposed governance rules also 

would require that independent 

directors have the authority to direct 

and supervise inquiries into any matter 

brought to their attention within the 

scope of their duties, and to obtain 

advice and assistance from independent 

legal counsel and other advisors, as they 

determine necessary to carry out their 

duties.189 Accordingly, the proposed 

governance rules would require that the 

exchange or association provide 

sufficient funding and other resources, 

as determined by the independent 

directors, to permit the independent 

directors to fulfill their responsibilities 

and to retain independent legal counsel 

and other advisors.190 The Commission 

believes that the proposed governance 

rules should provide independent 

directors with the ability to serve 

effectively, including assuring that they 

have adequate resources and funding to 

perform their duties. In addition, 

authorizing independent directors to 

utilize independent legal counsel and 

other advisors is important to permit 

them to have access to advice from 

independent sources before acting on 

significant matters affecting the 

exchange or association.

7. Separation of Chairman of the Board 

and CEO Positions 

The Commission is not proposing to 

require that an exchange’s or 

association’s Chairman of the board be 

an independent director in all 

circumstances.191 However, if the 

exchange’s or association’s CEO is not 

also the Chairman, we are proposing 

that the Chairman must be an 

independent director.192

The proposed rules, including the 

provisions related to the Chairman and 

CEO, are designed to foster a greater 

degree of independent decision-making 

by the governing body of an exchange or 

association. However, while recognizing 

the benefits of independence, the 

Commission understands that some 

SROs may perceive efficiencies in 

having one person serve as Chairman 

and CEO, and therefore the Commission 

is not proposing to prohibit this 

arrangement. In this regard, the 

Commission notes that both the NYSE 

and BSE currently have separate 

individuals serving as the Chairman and 

as the CEO of the exchange, although 

the exchanges’ governing documents do 

not expressly require this separation.193

Nevertheless, in the event that an 

exchange or association elects to have a 

single individual serve as Chairman and 

CEO, the proposed governance rules 

would prohibit that person—who, as the 

CEO, would not be ‘‘independent’’—

from participating in any executive 

sessions of the board and from serving 

on the Nominating, Governance, 

Compensation, Audit, or Regulatory 

Oversight Committees.194

The Commission also proposes that if 

the Chairman and CEO were the same 

individual, the board would be required 

to designate an independent director as 

a ‘‘lead director’’ to preside over 

executive sessions of the board, and the 

board would be required to publicly 

disclose the lead director’s name and a 

means by which interested parties may 

communicate with the lead director.195

This requirement should benefit 

exchanges and associations by 

providing that an independent director 

would head executive sessions, and 

thereby encourage an open climate of 

decision-making.

8. Separation of Regulatory and Market 

Operations 

There is an inherent tension between 

an exchange’s or association’s role as a 

regulator and as the operator of a 

market, and between its role as a 

regulator and as a membership 

organization.196 The existence of a 

shareholder class separate from 

membership adds yet another 

constituency with interests potentially 

in conflict with the regulatory 

responsibilities of the SRO. In recent 

years, some exchanges, as well as the 

NASD, have attempted to address this 

tension by separating, to varying 

degrees, their regulatory functions from 

their market operations.197

As discussed below, the Commission 

is proposing to require exchanges and 

associations, among other things, to 

effectively separate their regulatory 

function from their market operations 

and other commercial interests, to use 

regulatory funds only to fund regulatory 

obligations, and to establish procedures 

to prevent the dissemination of 

regulatory information other than to 

persons carrying out the exchange’s or 

association’s regulations obligations.198

The Commission believes that these 

requirements should allow SROs to 

better manage the conflicts of interest 

inherent in any self-regulatory structure. 

In addition, the Commission believes 

that these provisions, along with other 

features of the proposed governance 

rules, would help promote greater 

accountability on the part of exchanges 

and associations with respect to their 

regulatory programs and strengthen 

their ability to meet their statutory 

obligations.

a. Independence of Regulatory 

Program. The proposed rules would 

require exchanges and associations to 

establish policies and procedures that 

provide for the independence of their 

regulatory programs from the operation 

or administration of their trading 

facilities and other businesses.199

Specifically, the proposals would 

require that the exchange’s or 

association’s regulatory program be 

71142 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

200See proposed Rules 6a–5(n)(2) and 15Aa–

3(n)(2).

201See proposed Rules 6a–5(n)(3) and 15Aa–

3(n)(3). To the extent that the Chief Regulatory 

Officer of the exchange or association performs the 

same responsibilities for any regulatory subsidiary, 

the regulatory subsidiary would not need to appoint 

a Chief Regulatory Officer. See proposed Rules 6a–

5(a) and 15Aa–3(a).

202 15 U.S.C. 78f(b)(1) and 78o–3(b)(2).

203See proposed Rules 6a–5(n)(4) and 15Aa–

3(n)(4).

204See also proposed Exhibit I to revised Form 

1 and new Form 2.

205See 15 U.S.C. 78f(b)(1) and 78o–3(b)(2).

206See 15 U.S.C. 78f(b)(4) and 78o–3(b)(5). 207See 15 U.S.C. 78f(b)(6) and 78o–3(b)(7). 208The term ‘‘regulatory information’’ is proposed 

to be defined to mean any information collected by 

an exchange or association in the course of 

performing its regulatory obligations under the 

Exchange Act. See proposed Rules 6a–5(b)(17) and 

15Aa–3(b)(18). Examples of such regulatory 

information would include, for instance, 

information relating to an on-going disciplinary 

investigation or action against a member, the 

amount of a fine imposed on a member, financial 

information, or information regarding proprietary 

trading systems gained in the course of examining 

a member.

209See proposed Rules 6a–5(n)(5)(i)(B) and 15Aa–

3(n)(5)(i)(B).

either: (1) Structurally separated from 

the exchange’s or association’s market 

operations and other commercial 

interests, by means of separate legal 

entities; or (2) functionally separated 

within the same legal entity from the 

exchange’s or association’s market 

operations and other commercial 

interests.200 In the Commission’s view, 

such separation must be designed to 

permit the regulatory program to 

function independently from the market 

operations and other commercial 

interests of the exchange or association. 

In either case, the proposed governance 

rules would require that the board 

appoint a Chief Regulatory Officer to 

administer the regulatory program and 

that the Chief Regulatory Officer report 

directly to the proposed independent 

Regulatory Oversight Committee.201

The Commission believes that its 

proposal to require the structural or 

functional separation of the regulatory 

functions and the market operations and 

other commercial interests of the 

exchange or association, together with 

the creation of a fully independent 

Regulatory Oversight Committee and the 

appointment of a Chief Regulatory 

Officer who would administer the 

regulatory program and report directly 

to the Regulatory Oversight Committee, 

are designed to manage more effectively 

the inherent conflicts of interest in our 

self-regulatory system and bolster the 

effectiveness of exchanges’ and 

associations’ regulatory programs. By 

not mandating a particular structure for 

this separation—focusing on the ends 

rather than the means—the proposed 

rules would provide exchanges and 

associations with a measure of 

flexibility in determining how best to 

achieve the result of functional 

independence of the regulatory 

program.

In addition, the proposed requirement 

that each exchange and association 

appoint a Chief Regulatory Officer is 

designed to assure that all regulatory 

matters are subject to oversight by a 

person independent of the SRO’s 

commercial interests. Further, the 

proposal to require the Chief Regulatory 

Officer to report directly to a committee 

composed solely of independent 

directors is intended to fortify the 

independence of the Chief Regulatory 

Officer. In the Commission’s view, these 

requirements to enhance the 

independence of the regulatory function 

further the objectives of Sections 6(b)(1) 

and 15A(b)(2) of the Exchange Act,202

which require exchanges and 

associations, respectively, to be so 

organized and have the capacity to carry 

out the purposes of the Exchange Act, 

and comply, and enforce compliance by 

their members, and persons associated 

with their members, with the Exchange 

Act and rules thereunder and the rules 

of the exchange or association.

b. Use of Regulatory Fees, Fines, and 

Penalties. The proposed governance 

rules also would require an exchange or 

association to direct monies collected 

from regulatory fees, fines or penalties 

(‘‘regulatory funds’’) exclusively to fund 

the regulatory operations and other 

programs of the exchange or association 

related to its regulatory responsibilities, 

and to keep such books and records as 

are necessary to evidence compliance 

with this requirement.203 Consistent 

with the proposed rules, an exchange or 

association could not use such 

regulatory funds to pay dividends or 

make distributions to its shareholders. 

The scope of the categories of regulatory 

funds included in this requirement, as 

well as the limitation on use of such 

funds, is intended to be broad. As 

discussed in Section IV.C. below, 

regulatory fees would include all 

member fees, dues and assessments 

charged and collected by an exchange or 

association that are assessed for the 

purpose of funding the operation of the 

exchange’s or association’s regulatory 

program.204 Regulatory fines or 

penalties also would include any 

revenue received from fines or penalties 

resulting from disciplinary or 

enforcement actions.

This proposed restriction on the use 

of regulatory funds is intended to 

preclude an SRO from using its 

authority to raise regulatory funds for 

the purpose of benefiting its 

shareholders, or for other non-regulatory 

purposes, such as to fund executive 

compensation. SROs have an obligation 

to be so organized and have the capacity 

to be able to carry out the purposes of 

the Exchange Act, and to enforce 

compliance by their members with the 

Exchange Act and their rules.205 SRO 

rules must provide for the equitable 

allocation of reasonable dues, fees, and 

other charges among its members and 

issuers and other persons using its 

facilities.206 SRO rules also must 

provide that their members and persons 

associated with their members are 

appropriately disciplined for violations 

of the Exchange Act or SRO rules.207

SROs collect various fees, dues and 

assessments from their members on the 

basis that they need to fund a program 

to carry out these statutory obligations. 

The Commission believes that these 

proposed requirements to use regulatory 

funds only to fund regulatory activities 

would further advance the SROs’ ability 

to effectively comply with these 

statutory requirements, by helping to 

ensure that an SRO’s regulatory 

activities are properly funded and that 

the SRO is not abusing its regulatory 

authority.

c. Confidentiality of Regulatory and 

Trading Information. Proposed Rules 

6a–5(n)(5)(i)(A) and 15Aa–3(n)(5)(i)(A) 

would require exchanges and 

associations to establish policies and 

procedures reasonably designed to 

prevent the dissemination of regulatory 

information 208 to any person other than 

those officers, directors, employees, and 

agents of the exchange or association 

directly involved in carrying out the 

exchange’s or association’s regulatory 

obligations under the Exchange Act. 

This means that an exchange’s or 

association’s policies and procedures 

would be required to establish that 

regulatory information could only be 

available to officers and employees that 

are responsible for regulatory functions, 

directors that are involved in regulatory 

functions, such as an appeal of a 

disciplinary matter, or agents to the 

extent necessary to perform the 

regulatory function for which they have 

been hired. In addition, the proposed 

rules would require that an exchange’s 

or association’s policies and procedures 

be reasonably designed to prevent the 

use of regulatory information for any 

purpose other than for carrying out the 

exchange’s or association’s regulatory 

obligations.209 The Commission also is 

proposing that an exchange’s or 

association’s policies and procedures 

would have to require that its officers, 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71143

210See proposed Rules 6a–5(n)(5)(ii) and 15Aa–

3(n)(5)(ii).

211For example, this information could include 

the name of the member, or the member’s customer, 

submitting the order for execution, and the terms 

of the order.

212See proposed Rules 6a–5(n)(5)(i)(C) and 15Aa–

3(n)(5)(i)(C).

213See proposed Rules 6a–5(n)(5)(ii) and 15Aa–

3(n)(5)(ii). The Commission notes that, of course, 

nothing in the proposed rules would limit in any 

way the Commission’s authority to access SRO 

information or the ability of any SRO and its 

officers, directors, employees, and agents to provide 

any information to the Commission.

214See Sections 6(b)(8) and 15A(b)(9) of the 

Exchange Act, 15 U.S.C. 78f(b)(8) and 78o–3(b)(9).

215 15 U.S.C. 78f(b) and 78o–3(b).

216See proposed Rules 6a–5(o) and 15Aa–3(o).

217See, e.g., Securities Exchange Act Release Nos. 

49718 and 49098, supra note 61.

218See Securities Exchange Act Release Nos. 

50170, supra note 65 and 49067, supra note 59.

219 15 U.S.C. 78s(b) and 17 CFR 240.19b–4.

220See Securities Exchange Act Release No. 

50170, supra note 65.

221See Securities Exchange Act Release Nos. 

49718 and 49098, supra note 61.

222 In each of these instances, members’

ownership interest was limited to 20%, with no 

process for members to exceed that limitation.

223When the Commission approved the 

demutualization of PCX and the operation of BOX 

as a facility of the BSE, there were shareholders that 

owned more than 20%. In each case, the rules of 

the exchange required the controlling shareholder 

to consent to the Commission’s jurisdiction; to 

provide that the books and records of the 

shareholder shall be deemed to be the books and 

records of the SRO (to the extent they are related 

to the exchange’s or facility’s activities); to agree 

and consent (on behalf of its officers and directors) 

that its officers and directors would be deemed to 

be officers and directors of the SRO (to the extent 

they are related to the exchange’s or facility’s 

activities); and to agree (on its own behalf and that 

of its officers and directors) to cooperate with the 

Commission and the SRO in the performance of 

their regulatory oversight responsibilities. See

Securities Exchange Act Release Nos. 49718, supra

note 61 and 49067, supra note 59. The Commission 

is not at this time proposing such requirements for 

controlling shareholders of an SRO or a facility.

224The definition of ‘‘related person’’ also would 

include all members that are natural persons, either 

because they are registered brokers or dealers, or 

because they are ‘‘related persons’’ of the broker or 

dealer with which they are associated. See infra

Section II.B.9.a.

directors, employees and agents agree to 

comply with these requirements.210

In addition, proposed Rules 6a–

5(n)(5)(i)(c) and 15Aa–3(n)(5)(i)(c) 

would require exchanges and 

associations to have policies and 

procedures reasonably designed to 

maintain the confidentiality of 

information that must be submitted to 

the exchange or association to effect a 

transaction on or through the exchange, 

association or a facility.211 The 

proposed rules would, however, allow 

an exchange or association to make 

available such information in an 

aggregated form, if the information is 

aggregated to such an extent that the 

recipient is unable to identify (such as 

by reverse engineering) any person 

whose data is included in the aggregate 

information, or if the person 

consents.212 Exchanges’ and 

associations’ policies and procedures 

also would have to require exchange 

and association officers, directors, 

employees and agents to agree to 

maintain the confidentiality of this 

information consistent with the 

proposed rules.213

The Commission believes that the 

requirement that exchanges and 

associations keep regulatory and certain 

other information confidential, and not 

use information collected in the course 

of performing regulatory obligations for 

business or other non-regulatory 

purposes would help to assure an 

independent and effective regulatory 

function and is implicit in the 

exchange’s or association’s 

responsibilities under the Exchange 

Act.214 As competitive pressures on 

SROs increase, however, and the 

tensions between their regulatory 

obligations and commercial interests 

increase, the Commission believes that 

an explicit prohibition on this conduct 

may be necessary and appropriate.

9. Member Voting and Ownership 

Limitations

As discussed above in Section II.A., to 

further the ability of an exchange or 

association to effectively carry out its 

statutory obligations under Sections 6(b) 

and 15A(b) of the Exchange Act,215 the 

Commission is proposing to require an 

exchange or association to limit the 

ability of its members that are brokers or 

dealers to own or vote a significant 

interest in the exchange, association or 

any separate facility.216

Several exchanges that have 

converted to shareholder-owned 

structures have limited the ability of any 

person, including their members, to 

directly or indirectly own or vote more 

than a certain percentage of the interest 

in the exchange.217 Similar limits have 

been approved for separate SRO 

facilities.218 The Commission approved 

these limits on a case-by-case basis 

under the rule filing process of Section 

19(b) of the Exchange Act and Rule 19b–

4 thereunder.219

For example, in the case of the public 

offering of Archipelago Holdings (the 

parent company of Arca-Ex, the equities 

trading facility of PCX Equities), the 

Commission approved a PCX rule 

prohibiting any person and its related 

persons from directly or indirectly 

owning more than 40% and voting more 

than 20% of the securities of 

Archipelago Holdings.220 If a person 

wanted to exceed these limits, the rules 

require PCX to file a proposed rule 

change with the Commission and the 

Commission would need to approve 

such action. Similarly, in connection 

with the demutualizations of Phlx and 

PCX, the Commission approved a 

comparable prohibition under the 

exchanges’ rules on any person and its 

related persons directly or indirectly 

owning more than 40% or voting more 

than 20% of the applicable securities 

without first receiving Commission 

approval of a proposed rule change.221

In each of these three instances, the 

limitations applied not only to 

members,222 but to any person owning 

securities of the applicable SRO or a 

facility.223

By proposing to require SROs only to 

limit the ownership and voting of their 

members, the Commission today is 

proposing a less restrictive approach 

than the rules adopted by the exchanges 

discussed above. The proposal is 

designed only to address the specific 

conflict of interest that could exist if a 

member were to own a significant 

interest in the exchange or association 

of which it was a member or a facility 

through which the member is permitted 

to effect transactions, by requiring an 

exchange or association to impose 

ownership and voting limits on 

members that are brokers or dealers.224

The Commission believes that the 

conflict with respect to members creates 

a risk that a member could use its 

controlling interest in its regulator to 

influence the regulatory process to its 

benefit. Accordingly, because of the risk 

presented by the prospect of member 

control of its regulator, and the 

significant incentives for a member to 

attempt to exercise undue influence in 

such a case, the Commission is 

proposing to require an SRO to impose 

ownership and voting restrictions on 

members that are brokers or dealers.

The Commission recognizes that there 

is also the potential for any person that 

controls an exchange or association or 

facility of an exchange or association to 

direct its operation so as to cause the 

SRO to neglect its regulatory obligations 

under the Exchange Act. In light of the 

substantive governance and other 

standards being proposed today to 

strengthen the independence of SROs 

and their regulatory functions, the 

Commission is not at this time 

proposing to require an exchange or 

association to impose ownership and 

voting restrictions on persons other than 

members. For the time being, however, 

the Commission intends to maintain its 

current policies in this area while it 

considers whether to adopt ownership 

and voting restrictions that apply only 

to members. 

71144 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

225The Commission notes that PCX had a 

limitation on the number of seats that any person, 

associated person, or group of associated persons 

could own. See Securities Exchange Act Release 

No. 46098 (June 20, 2002), 67 FR 43693 (June 28, 

2002) (order approving PCX rule filing to limit to 

15% the number of exchange memberships that any 

person, associated person, or group of associated 

persons could, directly or indirectly, beneficially 

own or control the voting rights of). In connection 

with the demutualization of PCX, PCX replaced the 

limitation on the number of seats that any person, 

associated person, or group of associated persons 

could own with limitations on the amount of 

ownership interests and voting power that a person 

and its related persons could possess. See Securities 

Exchange Act Release No. 49718, supra note 61. 

The Commission also notes that the CHX has a 

rule that states that the exchange will not approve 

a transfer or sale of a membership if the transferee 

(or lessor), together with any person who directly 

or indirectly controls, is controlled by, or under 

common control with, the transferee (or lessor), 

owns or has the voting power of 10% or more of 

the outstanding memberships of the exchange, 

unless the requirement is waived by the exchange’s 

board for good cause shown. See CHX Article I, 

Rule 10.

226 ‘‘Beneficial ownership’’ would be defined to 

have the meaning set forth in Rule 13d–3, 17 CFR 

240.13d–3. See proposed Rules 6a–5(b)(4) and 

15Aa–3(b)(5). The concept of beneficial ownership 

in Rule 13d–3 is designed to encompass any person 

or group of persons that may be able to act to 

influence or control an issuer. The Commission is 

proposing to use the same definition of beneficial 

ownership in this rule because it also would 

describe those persons or groups of persons that 

may be able to act to influence or control an 

exchange or association. However, to the extent any 

person beneficially owns any security or other 

ownership interest solely because such person is a 

member of a group within the meaning of Section 

13(d)(3) of the Exchange Act, such person would 

not be deemed to beneficially own such security or 

other ownership interest for purposes of this 

section, unless such person had the power to direct 

the vote of such security or other ownership 

interest. See proposed Rules 6a–5(b)(4) and 15Aa–

3(b)(5). The Commission is proposing to exclude 

beneficial ownership that results solely from being 

a member of a group to provide more certainty to 

members that would be required to comply with the 

limitations, in light of the impact of exceeding the 

ownership limit—i.e., that the member will be 

divested of the excess interest. If a person has the 

right to vote the interest, however, it is important 

to continue to include such interest.

227Specifically, this requirement would prohibit 

a member that is a broker or dealer from directly 

or indirectly voting, causing the voting of, or giving 

any consent or proxy with respect to the voting of, 

any interest in the exchange, association, or facility 

that exceeds 20% of the voting power of any class 

of securities or other ownership interest of such 

exchange, association, or facility. See proposed 

Rules 6a–5(o)(1)(ii) and 15Aa–3(o)(1)(ii).

228See, e.g., Rule 19h–1(f)(2) under the Exchange 

Act, 17 CFR 240.19h–1(f)(2) (defining a 

presumption of ‘‘control’’ to include a person that 

directly or indirectly has the right to vote 10% or 

more of the voting securities of a company) and 

Rule 10A–3(e) under the Exchange Act, 17 CFR 

240.10A–3(e) (deeming a person not to be in control 

of a specified person if the person is not the 

beneficial owner, directly or indirectly, of more 

than 10% of any class of voting security of the 

specified person).

229See infra Section II.C.

230 ‘‘Affiliate’’ would be defined to mean any 

person that, directly or indirectly, controls, is 

controlled by, or is under common control with, the 

exchange or association. See proposed Rules 6a–

5(b)(1) and 15Aa–3(b)(1). ‘‘Control’’ would be 

defined to mean the possession, direct or indirect, 

of the power to direct or cause the direction of the 

management and policies of a person, whether 

through the ownership of voting securities, by 

contract, or otherwise. Any person that (i) is a 

director, general partner, or officer exercising 

executive responsibility (or having similar status or 

function); (ii) directly or indirectly has the right to 

vote 25% or more of a class of voting securities or 

has the power to sell or direct the sale of 25% or 

more of a class of voting securities; or (iii) in the 

case of partnership, has the right to receive, upon 

dissolution, or has contributed, 25% or more of the 

capital, is presumed to control that person. See

proposed Rules 6a–5(b)(7) and 15A–3(b)(8).

231 ‘‘Person associated with a member’’ would be 

defined to have the same meaning as in Section 

3(a)(21) of the Exchange Act, 15 U.S.C. 78c(a)(21). 

See proposed Rules 6a–5(b)(16) and 15Aa–3(b)(17).

The proposed rules would apply to all 

exchanges and associations, not just 

demutualized ones. Although the 

proliferation of demutualized exchanges 

and shareholder-owned facilities has 

highlighted the concern with member 

control of an SRO, the Commission 

believes these concerns are equally 

applicable to SROs that continue to be 

mutual organizations.225

Specifically, proposed Rules 6a–

5(o)(1) and 15Aa–3(o)(1) would require 

the rules of a national securities 

exchange and a registered securities 

association to prohibit any member that 

is a broker or dealer, alone or together 

with its related persons, from either: 

• Directly or indirectly beneficially 

owning 226 any interest in the exchange 

or association, or a facility of the 

exchange or association through which 

the member is permitted to effect 

transactions, that exceeds 20% of any 

class of securities or other ownership 

interest of the exchange, association or 

facility; or

• Voting any interest in such 

exchange, association or facility of the 

exchange or association through which 

the member is permitted to effect 

transactions, that exceeds 20% of the 

voting power of any class of securities 

or other ownership interest of such 

exchange, association or facility.227

Thus, a member that is a broker or 

dealer would not be able to, alone or 

together with its related persons, own 

more than 20% of the exchange or 

association of which it is a member or 

a facility through which the member is 

permitted to effect transactions. A 

member that is a broker or dealer, and 

its related persons, also would not be 

able to vote or cause the voting of more 

than 20%. The rules of the SRO would 

be required to prohibit both; they would 

not be able to prohibit only one or the 

other. 

The Commission preliminarily 

believes that a member ownership and 

voting limit of 20% is an appropriate 

threshold because it precludes 

situations where a member would have 

a realistic probability of being able to 

exert undue influence over its SRO, yet 

refrains from interfering in an SRO’s 

organizational processes or the desire by 

members to acquire equity interests in 

their markets. In some Commission 

rules, a 10% ownership threshold is 

used to determine ‘‘control.’’ 228

Accordingly, the Commission 

considered whether 10% would be a 

more appropriate threshold to propose 

for member ownership and voting 

limitations, given the concerns 

regarding the conflict of interest if a 

member were to control its regulator. 

The Commission recognizes, however, 

that generally the existing standard that 

exchanges have in place with respect to 

limits on their member’s ownership in 

and voting of interests in the exchange 

or a facility is 20%, and that members 

that currently own more than 10% 

would have to divest themselves of any 

excess interest. The Commission 

therefore is proposing 20% as the 

ownership and voting threshold. The 

Commission requests specific comment 

on whether the threshold should be 

lower than 20%, given the concern that 

a member with a lesser interest may be 

able to influence or control the 

exchange or association.229

a. Members’ Interests Aggregated With 

Their Related Persons. For purposes of 

calculating a member’s ownership and 

voting interests, the proposed rules 

would aggregate a member’s ownership 

and voting interests with those of its 

‘‘related persons.’’ An exchange or 

association has members over which the 

exchange or association has regulatory 

authority, and these members 

participate in the governance and 

disciplinary process of the exchange or 

association. The Commission therefore 

believes that it is important to aggregate 

the members’ ownership and voting 

interests with the interest of any person 

with whom the member may be able to 

act together to influence or control the 

exchange, association or facility. As 

such, the proposed rules would define 

‘‘related person’’ to mean, with respect 

to a member that is a broker or dealer: 

(i) Any affiliate of the member;230 (ii) 

any person(s) associated with the 

member;231 (iii) any immediate family 

member of the member, or any 

immediate family member of the 

member’s spouse, who, in each case, has 

the same home as the member or who 

is a director or officer of the exchange, 

association or facility or any of its 

parents or subsidiaries; and (iv) any 

immediate family member of a person 

associated with the member or any 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71145

232See proposed Rules 6a–5(b)(19) and 15Aa–

3(b)(20).

233See 17 CFR 240.14a–1 through 240.14a–15. 

See also proposed Rules 6a–5(o)(2) and 15Aa–

3(o)(2).

234See Securities Exchange Act Release No. 

39538 (January 12, 1998), 63 FR 2854, at 2858 

(Section II.G.) (January 16, 1998).

235Rule 14a–2(b)(2) under the Exchange Act, 17 

CFR 240.14a–2(b)(2), exempts from Rules 14a–3 to 

14a–6 (other than Rule 14a–6(g)), 14a–8, and 14a–

10 to 14a–15 any solicitation made otherwise than 

on behalf of the registrant where the total number 

of persons solicited is 10 or fewer. See 17 CFR 

240.14a–3 through 240.14a–6; 240.14a–8; and 

240.14a–10 through 240.14a–15.

236See proposed Rules 6a–5(o)(2) and 15Aa–

3(o)(2).

237 17 CFR 240.14a–4.

238See Rules 14a–4(a)(3), 14a–4(c)–(d), and 14a–

4(d)(2)–(3) under the Exchange Act, 17 CFR 

240.14a–4(a)(3), 14a–4(c)–(d), and 14a–4(d)(2)–(3).

immediate family member of such 

person’s spouse, who, in each case, has 

the same home as the person associated 

with the member or who is a director or 

officer of the exchange, association or 

facility or any of its parents or 

subsidiaries.232

For example, the parent company of 

a member would be considered a 

‘‘related person’’ of the member. A sister 

affiliated company of the member also 

would be a ‘‘related person’’ of the 

member. The definition of ‘‘related 

person’’ also would include all members 

that are natural persons, either because 

they are registered brokers or dealers, or 

because they are ‘‘related persons’’ of 

the broker or dealer with which they are 

associated. 

It is important to note that the 

proposed rules would require an 

exchange or association to restrict the 

indirect ownership and voting interests 

of a member that is a broker or dealer 

in an exchange, association or facility. 

The Commission believes that it is 

crucial to restrict the indirect ownership 

and voting interests of these members 

because if the Commission were to 

require an exchange or association to 

establish requirements only for direct—

but not indirect—ownership and voting 

rights, the limitations could be easily 

circumvented. For example, if an 

exchange only prohibited a member 

from directly owning or voting shares, 

the member could hold its ownership 

interests in the exchange, association or 

facility through multiple subsidiaries of 

a holding company, thus easily 

circumventing the intent of the 

proposed rules. In addition, the 

ownership and voting limitations would 

apply to ownership and voting of 

interests in a parent company of the 

exchange or association. For example, if 

the exchange, association or facility was 

wholly-owned by a holding company, a 

member (alone or together with its 

related persons) would be prohibited 

from owning or voting more than 20% 

of the interest in the parent company 

because that would be an indirect 

ownership or voting interest in the 

exchange, association or facility. The 

proposed limitations also would apply 

to a member (either alone or together 

with its related persons) that 

beneficially owned more than 20% of an 

entity that itself owned more than 20% 

of an exchange, association or facility, if 

the person (and the entity) had the 

ability to vote or cause the vote, or 

dispose of, or cause the disposition of, 

the interest in the exchange, association, 

or facility.

b. Solicitation of Revocable Proxies. 

The Commission is proposing to make 

clear in the proposed rules that the 20% 

voting limitation—which includes 

‘‘causing the vote’’ of more than 20% of 

the interests in an exchange, association 

or facility—would not apply to any 

solicitation or receipt of revocable 

proxies by a member, if conducted 

pursuant to Regulation 14A under the 

Exchange Act.233 Thus, an exchange or 

association would be required to 

preserve the ability of a member to 

solicit and receive revocable proxies 

from other shareholders on such issues 

as alternative nominees for the board of 

directors, or a particular shareholder 

proposal. The solicitation or receipt of 

a revocable proxy does not transfer 

voting (or investment) power—i.e.

beneficial ownership—to the person 

soliciting or receiving the proxy.234

Therefore, the act of soliciting or 

receiving a revocable proxy should not 

undermine the purpose of the voting 

limitation because it would not 

constitute an agreement or other 

arrangement between the shareholder 

soliciting the proxy and a shareholder 

being solicited to vote a particular way. 

In particular, any shareholder so 

solicited would remain free to choose 

whether or not to grant a proxy, and the 

proxy would remain revocable up until 

the vote that is the subject of the proxy. 

The Commission notes, however, that if 

a member and one or more persons 

banded together to solicit proxies, and 

in addition that group agreed to vote a 

particular way, the agreement to vote 

would go beyond the soliciting or 

receipt of proxies and be considered to 

be causing the vote, or giving a consent 

or proxy with respect to voting, that 

would be in violation of the proposed 

voting limitation, if the aggregate 

amount of ownership or voting interests 

controlled by the group of persons so 

agreeing exceeded 20%.

The Commission is concerned, 

however, that allowing a member to 

solicit an ‘‘open-ended’’ proxy—one 

with no end date and one not for a 

particular purpose or meeting—from 

one or more shareholders would allow 

a member to obtain the ability to vote 

more than 20%. As such, the proposed 

rules would require an exchange or 

association to prohibit a member subject 

to the voting limitation from soliciting 

a proxy pursuant to an exemption 

contained in Rule 14a–2(b)(2) under the 

Exchange Act 235 with regard to a person 

or persons whose interest, together with 

the member and its related person’s 

interests, would exceed the 20% voting 

limit.236 The purpose of not allowing 

solicitations by members pursuant to 

this exemption in excess of the voting 

limitation is to prevent a member from 

soliciting proxies that are not subject to 

the requirements of Rule 14a–4 under 

the Exchange Act,237 which requires, 

among other things, a form of proxy to 

clearly identify each matter to be acted 

upon, limits the authority that a proxy 

may confer, and limits the length of 

time for which a proxy is valid.238 Thus, 

disallowing this exemption for members 

would close a potential loophole to the 

proposed voting limitation.

c. Requirement To Divest Ownership 

Interest and Restrict Voting. Proposed 

Rules 6a–5(o)(3) and 15Aa–3(o)(3) also 

would require an exchange or 

association to provide in its rules an 

effective mechanism to divest any 

member and its related persons of any 

interest owned in excess of the 20% 

limitation discussed above. The 

Commission believes that to be an 

effective mechanism, the rule would 

have to require the exchange or 

association to take action to reduce the 

member’s and its related persons’

ownership interest that exceeded the 

proposed ownership limit. In addition, 

proposed Rules 6a–5(o)(4) and 15Aa–

3(o)(4) would require the rules of an 

exchange or association to be reasonably 

designed to not give effect to the portion 

of a vote by a member and its related 

persons that is in excess of the proposed 

voting limitation. 

The Commission is not proposing to 

specify how an exchange or association 

would effectuate these requirements. 

Instead, the Commission is proposing to 

provide exchanges and associations 

flexibility to determine the best 

approach under relevant state law. Any 

mechanism adopted by an exchange or 

association, however, would need to be 

sufficient to assure that the exchange or 

association has a viable, enforceable 

mechanism to divest a member and its 

related persons of any interest owned in 

excess of, and to not give effect to the 

71146 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

239The Commission notes that any mechanism 

would need to be valid, binding, and enforceable 

under state law. 240See, e.g., Securities Exchange Act Release No. 

50170, supra note 65. The Commission notes that 

any redemption mechanism that reduces the 

number of outstanding shares of stock or other 

ownership interest, to be effective, would have to 

take into account such reduction in determining 

what amount would need to be redeemed to bring 

the member and its related persons below the 20% 

threshold, and to cover a situation where a 

reduction in the number of outstanding shares 

causes another owner to exceed the 20% threshold.

241The SRO’s procedures also could provide that 

even a member that exceeds the ownership 

limitation through its own (or its related person’s) 

actions would have the ability to sell out its excess 

shares prior to the SRO repurchasing them. The 

Commission emphasizes, however, that this ‘‘grace 

period’’ should be of short duration.

242See, e.g., Securities Exchange Act Release No. 

49718, supra note 61. The Commission notes that 

any such rule changes would be required to be filed 

pursuant to Section 19(b) of the Exchange Act and 

would be subject to the Commission’s review and 

approval.

243See infra Section IV.C.9.

244See proposed Rules 6a–5(p)(1) and 15Aa–

3(p)(1). This proposal is consonant with the 

Business Roundtable Report which recommended 

that, as part of good governance, ‘‘corporations 

should have a code of conduct with effective 

reporting and enforcement mechanisms.’’ See

Business Roundtable Report, supra note 91, at 10.

245See proposed Rules 6a–5(p)(2) and 15Aa–

3(p)(2).

246See Breeden Report, supra note 134.

247See proposed Rules 6a–5(q) and 15Aa–3(q).

248See Sections 6(b)(1) and 15A(b)(2) of the 

Exchange Act, 15 U.S.C. 78s(b)(1) and 78o–3(b)(2).

249See proposed Rules 6a–5(s) and 15Aa–3(s).

portion of a vote in excess of, the 20% 

limitation. This mechanism would need 

to impose a requirement, not a choice, 

on the exchange or association to take 

such action to reduce the member’s 

interest or voting power.239 For 

example, an exchange could adopt 

rules—perhaps as part of its 

organizational documents—to provide 

that, if a member that is a broker or 

dealer exceeded the 20% ownership 

limitation, the exchange would be 

required to redeem that number of 

shares owned in excess of the 20% 

ownership limitation at par value.240

Because the par value of the shares of 

stock is likely to be substantially less 

than the fair market value of the shares 

of stock, such a provision may act as a 

strong disincentive to members to 

exceed the limit, and cause them to 

more closely monitor their 

accumulation of ownership or voting 

power in an exchange, association or 

facility.241 This requirement would not 

preclude an exchange or association 

from having a separate mechanism to 

divest a broker-dealer member whose 

ownership goes above 20% solely 

because of an issuer repurchase of its 

own shares. For example, an SRO could 

adopt rules that permit a grace period to 

divest shares under such circumstances. 

An exchange or association also could 

amend its rules to provide that, if a 

broker-dealer member were to vote, or 

attempt to vote, more than 20%, the 

exchange or association would not 

honor any portion of the vote in excess 

of 20%.242

d. Ability To Obtain Information. 

Finally, proposed Rules 6a–5(o)(5) and 

15Aa–3(o)(5) would require an 

exchange’s or association’s rules to 

provide a mechanism for the exchange 

or association to obtain information 

relating to ownership and voting 

interests in the exchange, association or 

separate facility from any owner of any 

interest. The Commission believes this 

requirement would help an exchange or 

association to more closely monitor 

ownership and voting by its members in 

relation to the proposed 20% limits. For 

example, an exchange could amend its 

governing documents to require owners 

to provide information relating to their 

ownership and voting interests to the 

exchange upon request. Alternatively, 

the exchange could require owners to 

provide such information at specified 

times, such as monthly or quarterly. In 

addition, this requirement would 

provide a mechanism for an exchange or 

association to obtain the ownership 

information that the exchange or 

association would be required to 

disclose to the Commission pursuant to 

proposed Exhibit Q to revised Form 1 

and new Form 2.243

10. Code of Conduct and Ethics and 

Governance Guidelines 

The proposed governance rules would 

require that the rules of each exchange 

and association provide for a code of 

conduct and ethics for directors, officers 

and employees, and provide that any 

waiver of the code of conduct and ethics 

must be approved by the board, or the 

appropriate board committee.244 The 

proposed rules also would require that 

the exchange or association prohibit any 

of its employees or officers from being 

a member of the board of directors of a 

listed issuer or member firm.245

Although the exchange or association 

could determine the details of its own 

policies, the Commission proposes that 

the code of conduct and ethics, at a 

minimum, establish policies and 

procedures regarding: conflicts of 

interest; corporate opportunities; 

confidentiality; fair dealing; protection 

and proper use of the exchange’s or 

association’s assets; compliance with 

laws, rules, and regulations by directors, 

officers and employees; and the 

reporting of illegal or unethical 

behavior. Formulation and adoption of 

a code of conduct and ethics would 

present an exchange or association with 

an opportunity to express its values, as 

well as the standards of behavior that 

the exchange or association wishes to 

set for itself.246 The Commission 

believes that requiring exchanges and 

associations to adopt a code of conduct 

and ethics should help foster the ethical 

behavior of directors, officers and 

employees, because these individuals 

would be informed of the standards of 

conduct expected of them in fulfilling 

the responsibilities of their positions. 

The Commission further believes that 

the specific provision prohibiting 

employees or officers of an exchange or 

association from being a board member 

of a listed issuer or member firm is 

desirable to avoid the inherent conflict 

of interest of such a relationship.

The proposed governance rules also 

would require that each exchange and 

association adopt governance guidelines 

that, at a minimum, establish policies 

regarding: director qualification 

standards; director responsibilities; 

director access to management and 

independent advisors; director 

compensation; director orientation and 

continuing education; management 

succession; and annual performance 

evaluations of the board.247 Requiring 

exchanges and associations to adopt 

governance guidelines should help 

promote greater awareness of the 

principles that are intended to guide the 

exchange or association in 

implementing good governance.

In our view, these proposals would 

assist exchanges and associations in 

fulfilling the statutory mandate that they 

be so organized and have the capacity 

to carry out the Exchange Act’s 

purposes.248

11. Exemption Provision 

The proposed governance rules would 

establish procedures for the 

Commission, upon written request or its 

own motion, to grant an exemption from 

the rules’ provisions, either 

unconditionally or on specified terms 

and conditions, if the Commission 

determines that such exemption is 

necessary or appropriate in the public 

interest and is consistent with the 

protection of investors.249 Pursuant to 

this provision, the Commission would 

consider and act upon appropriate 

requests for relief from the proposed 

rules’ provisions and would consider 

the particular facts and circumstances 

relevant to each such request, the 

potential ramifications of granting any 

exemption, and any appropriate 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71147

250See proposed Rules 6a–5(r) and 15Aa–3(r). As 

SROs, exchanges and associations currently are 

required by the Exchange Act to file with the 

Commission any proposed new rules or rule 

amendments, accompanied by a concise general 

statement of the basis for, and purpose of, the 

proposed rule change. Once an exchange or 

association files a proposed rule change, the 

Commission must publish notice of it and provide 

an opportunity for public comment. See Section 

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

and Rule 19b–4 under the Exchange Act, 17 CFR 

240.19b–4. The proposed rule change may not take 

effect unless the Commission approves it pursuant 

to Section 19(b)(2) of the Exchange Act, or it is 

otherwise permitted to become effective under 

Section 19(b)(3)(A) or Section 19(b)(7) of the 

Exchange Act. 15 U.S.C. 78s(b)(2), (b)(3)(A) and 

(b)(7). 

The requirements that the exchanges and 

associations file a proposed rule change that 

complies with the applicable proposed rule by a 

specified date, and that final rules be operative by 

a specified date, are consistent with the 

Commission’s approach when it adopted Rule 10A–

3 under the Exchange Act. See Rule 10A–3 under 

the Exchange Act, 17 CFR 240.10A–3.

conditions to be imposed as part of the 

exemption.

12. Implementation 

Because exchanges and associations 

in all likelihood would have to revise 

their governing documents to comply 

with the applicable rule, each exchange 

and association would be required to 

submit to the Commission proposed 

rule changes reflecting new rules or rule 

amendments no later than four months 

following the date of publication of final 

rules in the Federal Register (‘‘final 

rules’ publication date’’), and those 

rules or rule amendments would have to 

be approved by the Commission no later 

than ten months following the final 

rules’ publication date and operative no 

later than one year following the final 

rules’ publication date.250 By amending 

its existing rules, each exchange or 

association could tailor its governance 

rules to its own particular structure, as 

long as such rules were consistent with 

the Exchange Act and the proposed 

governance rules, if those rules 

ultimately are adopted by the 

Commission.

C. Request for Comment 

The Commission seeks comments on 

proposed Rules 6a–5 and 15Aa–3. Also, 

the Commission requests that interested 

persons respond to the following 

specific questions: 

Question 1. Do the proposed 

governance rules strike an appropriate 

balance? Are there provisions of the 

proposed rules that are unnecessary or 

are there other provisions that should be 

added? Are there aspects of the 

proposed rules that would be difficult 

for exchanges or associations to 

implement and, if so, why would that be 

the case? 

Question 2. Is it appropriate to extend 

the proposed rules to regulatory 

subsidiaries?

Question 3. Is the proposal that the 

board of each exchange and association 

be composed of a majority of 

independent directors appropriate? 

Should the proposal require a different 

threshold, e.g., a wholly independent 

board or independent directors 

constituting 75% or 66% of the board? 

Question 4. Is the proposed definition 

of ‘‘independent director,’’ i.e., that the 

director have no material relationship 

with the exchange or association or any 

affiliate of the exchange or association, 

or any member of the exchange or 

association or any affiliate of such 

member, appropriate? Is there another 

definition of independent director that 

would be preferable? Is the proposed 

definition of ‘‘material relationship’’

appropriate? Is an annual determination 

of independence appropriate, or should 

such determination be made more or 

less frequently? Have we provided 

enough guidance for boards to make the 

required independence determination? 

If not, what additional guidance is 

needed? 

Question 5. Are the relationship tests 

set forth in the proposed rules that 

indicate when a director would not be 

considered independent appropriate? 

Are there aspects of these relationship 

tests that should be modified or clarified 

and, if so, why would that be the case? 

Is the three-year look-back period 

appropriate? Should the look-back 

period be longer or shorter? Is the scope 

of the proposed relationship tests 

appropriate? Are there other 

relationships that should be expressly 

covered so that the director could not be 

considered independent, e.g., the 

Chairman of the board of a member firm 

or listed issuer? Is the $60,000 limit on 

payments received by the director, or an 

immediate family member, from the 

exchange or association appropriate? 

Should this amount be higher or lower? 

Is the proposed definition of 

‘‘immediate family member’’

appropriate? Is the proposed definition 

of ‘‘compensation’’ appropriate? Is the 

2% of recipient’s yearly gross revenues 

or $200,000 limit on payments made to 

or from an exchange or association to an 

organization in which the director, or an 

immediate family member, is a partner, 

controlling shareholder or executive 

officer appropriate? Is the exclusion 

from the 2% gross revenues/$200,000 

payments test for non-discretionary 

charitable contribution matching 

programs appropriate? Should these 

percentage and dollar amounts be 

higher or lower? Is the proposed 

definition of ‘‘control’’ appropriate? Is it 

appropriate to include in the 

relationship tests immediate family 

members and affiliates? Is the limitation 

on prior or current relationships with 

the exchange’s or association’s auditor 

appropriate? 

Question 6. Many exchanges define a 

‘‘public director’’ to include a person 

who has no material relationship with a 

broker or dealer. The proposed rules’

definition of independent director 

would not expressly preclude an 

independent director from being 

associated with a non-member broker or 

dealer or affiliate of a non-member 

broker or dealer, unless such nonmember broker or dealer or affiliate has 

a material relationship with the 

exchange or association. Should the 

proposed definition of independent 

director preclude a director associated 

with a broker or dealer or any affiliate 

of such broker or dealer from being 

considered an independent director? 

Question 7. Should an executive 

officer of an issuer whose securities are 

‘‘primarily traded’’ on an exchange or a 

facility of an association be precluded 

from being an independent director? 

Should this limitation cover an 

executive officer of any issuer of 

securities that are traded on the 

exchange or a facility of an association 

pursuant to unlisted trading privileges 

without regard to the extent of the 

volume of trading in those securities? 

Question 8. Is the proposed 

requirement to remedy non-compliance 

with the majority independence 

requirement by the earlier of the next 

annual meeting or one year from the 

date of non-compliance appropriate? Is 

another time frame more appropriate? 

Question 9. Is the proposed definition 

of ‘‘Standing Committee’’ appropriate? 

Should we require fewer or additional 

Standing Committees? If so, what 

should be eliminated or added? Is the 

proposed requirement that each 

Standing Committee be composed 

entirely of independent directors 

appropriate? Are there circumstances 

when this requirement would not be 

necessary? Are the duties of each of the 

Standing Committees, as proposed to be 

set forth in their charters, appropriate or 

are there duties that should be added or 

deleted? If so, what should be added or 

deleted? Are the requirements that the 

Standing Committees be composed 

solely of independent directors and 

report directly to the board likely to 

foster a greater degree of independent 

decision-making by the exchange’s or 

association’s governing body? If not, 

what would accomplish this goal? 

Should each Standing Committee be 

required to conduct an annual 

performance evaluation? 

71148 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

Question 10. Some SROs currently 

require that members of their audit 

committee be financially literate and/or 

that at least one member have 

accounting related financial 

management expertise. See, e.g., PCX 

Rule 3.3(d) and the NYSE Audit 

Committee Charter. Also, Section 407 of 

the Sarbanes-Oxley Act and Item 401 

under Regulation S-K require that listed 

companies disclose whether or not the 

Audit Committee contains at least one 

financial expert. Should the proposed 

governance rules contain a similar 

requirement for exchanges’ and 

associations’ Audit Committees? Are the 

proposed responsibilities of the Audit 

Committee appropriate? Should the 

proposed rules require the Audit 

Committee to prepare and publicly 

disclose an annual report? Are there 

other responsibilities that should be 

added? If so, which? Should any of the 

proposed Audit Committee 

responsibilities be eliminated? If so, 

which?

Question 11. Are the provisions 

relating to the fair representation 

requirement appropriate? Is the 

requirement that at least 20% of the 

directors be selected by members and 

that members be given the opportunity 

to select candidates who compose at 

least 20% of the total number of 

directors appropriate? Should the 20% 

threshold be higher or lower? 

Question 12. Given the proposed fair 

representation requirement that at least 

20% of directors be selected by 

members, could this factor impair the 

independence of those directors 

selected by members? 

Question 13. Is the provision 

pertaining to the petition process 

appropriate? Is the requirement limiting 

to 10% the percentage of members 

necessary to put forth an alternative 

member candidate or candidates 

appropriate? Should the 10% threshold 

be higher or lower? Should the 

percentage limitation differ depending 

on whether members petition to 

nominate a single candidate or more 

than one candidate? Are there other 

ways to obtain the fair representation of 

members through a petition process 

rather than by imposing a limitation on 

the percentage of members necessary to 

put forth an alternative candidate? 

Question 14. Are the other provisions 

relating to the proposed fair 

representation requirement appropriate? 

Specifically, is the proposed 

requirement that at least 20% of the 

members of any committee, 

subcommittee, or panel that is subject to 

the jurisdiction of the Regulatory 

Oversight Committee and that is 

responsible for disciplinary matters be 

composed of members of the exchange 

or association, appropriate? Is the 

proposed requirement that at least 20% 

of the members of any committee, 

subcommittee, or panel that is subject to 

the jurisdiction of a Standing Committee 

and that is responsible for providing 

advice with respect to trading rules or 

disciplinary rules be members of the 

exchange or association appropriate? Is 

the proposed minimum threshold 

adequate member representation to 

achieve the goal of fair representation? 

Should the proposed threshold be 

higher or lower than 20%? 

Question 15. Is it appropriate to 

require that when the board considers 

any matter that is recommended by or 

otherwise is within the authority or 

jurisdiction of a Standing Committee, a 

majority of the directors who vote on 

the matter must be independent 

directors? Are there circumstances 

when this provision would be 

unnecessary? 

Question 16. Is it appropriate to 

require that if any committee has the 

authority to act on behalf of the board, 

it must be composed of a majority of 

independent directors and that the 

board may not delegate to any 

committee not consisting solely of 

independent directors the authority to 

act on matters that otherwise are within 

the jurisdiction of a Standing 

Committee? 

Question 17. Should the proposed 

rules give greater guidance on the 

matters that should be considered with 

respect to the annual performance selfevaluations and annual performance 

evaluation of the governance of the 

exchange or association by the Standing 

Committees? 

Question 18. Is there a reason to deny 

SROs the flexibility of having a nonexecutive Chairman who is not an 

independent director? Do other 

provisions of the proposed governance 

rules make it unnecessary to require the 

Chairman to be an independent director 

if two individuals serve as Chairman 

and CEO? Should the proposed 

governance rules instead require that if 

the Chairman is not an independent 

director and two individuals serve as 

Chairman and CEO, a lead director 

should preside over executive sessions 

and over any Standing Committee 

meetings?

Question 19. Should the proposed 

governance rules require a complete 

separation of the positions of Chairman 

and CEO? Is the provision requiring the 

exchange or association to appoint a 

lead director to preside over executive 

sessions when a single individual serves 

as Chairman and CEO sufficient? Is it 

appropriate to require that the Chairman 

be prohibited from serving on a 

Standing Committee, unless the 

Chairman is an independent director? 

Question 20. Are the provisions 

relating to the separation of regulatory 

functions from any market operations 

and other commercial interests of the 

exchange or association appropriate? 

Should the proposed governance rules 

require the regulatory function and 

market operations and other commercial 

interests of an exchange or association 

to be conducted in separate legal 

entities? What would be the 

consequences of any such requirement? 

Would such a requirement mitigate 

conflicts of interest? If so, how? Are 

there other requirements relating to the 

independence of the regulatory function 

that should be implemented? 

Question 21. Is the proposal requiring 

each exchange and association to have 

a Chief Regulatory Officer appropriate? 

Are there other duties that a Chief 

Regulatory Officer should be required to 

perform? Are there other provisions that 

should be imposed to require his or her 

independence? 

Question 22. Should the proposed 

governance rules be applied to other 

SROs, such as clearing agencies? Why? 

Question 23. Is the requirement that 

officers and directors of an exchange or 

association not be subject to a statutory 

disqualification, as defined in Section 

3(a)(39) of the Exchange Act, 

appropriate? Is there some other 

definition of statutory disqualification 

that is more appropriate? Should the 

definition be broader or narrower? 

Question 24. Is the requirement that 

an exchange or association explicitly 

mandate that each director, in 

discharging his or her obligations as a 

director, reasonably consider all 

requirements applicable to the exchange 

or association under the Exchange Act 

broad enough? 

Question 25. Should the proposed 

rules require that the exchange or 

association provide sufficient funding 

and other resources to permit the 

independent directors and the Standing 

Committees to retain independent legal 

counsel and other advisors in order to 

fulfill their responsibilities? 

Question 26. Is the requirement that 

an exchange or association apply funds 

received from regulatory fees, fines or 

penalties only to fund programs and 

operations directly related to such 

exchange’s or association’s regulatory 

responsibilities appropriate? Is the 

scope of which funds would be 

included in the requirement clear? Is it 

broad enough, or are there other sources 

of remuneration that should be 

included? For instance, should issuer 

fees be considered regulatory fees? 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71149

Should the Commission define the term 

‘‘regulatory fees’’? 

Question 27. Should regulatory fees, 

fines, or penalties be allowed to be used 

to fund non-regulatory activities? If so, 

should there be any restrictions on 

activities for which such funds could be 

used? 

Question 28. Instead of requiring 

exchanges and associations to use 

regulatory funds only to fund 

regulation, should the Commission 

permit an exchange or association to use 

regulatory funds for purposes other than 

to fund regulation if the exchange’s or 

association’s Regulatory Oversight 

Committee approves the use of the 

funds and the exchange or association 

submits to the Commission, pursuant to 

section 19(b)(2) and Rule 19b–4, both its 

stated policy, practice, or interpretation 

regarding committee approval and each 

proposed use of regulatory funds for 

other than regulatory purposes? 

Question 29. Should the Commission 

enumerate in the proposed rules certain 

types of regulatory fees, fines or 

penalties that would fall within the 

prohibition? If so, what items should be 

included? 

Question 30. Is the proposed 

requirement that an exchange or 

association implement policies and 

procedures to maintain the 

confidentiality of regulatory and certain 

other information appropriate? 

Question 31. Is there any other type 

of information other than regulatory 

information and information required to 

be submitted to effectuate a transaction 

that an exchange or association should 

be required to keep confidential? 

Should such information include 

information gained in the course of 

applications for listing on the exchange? 

Question 32. Should an exchange or 

association be allowed to disseminate 

such information (other than regulatory 

information), including order and trade 

data, in an aggregated form, as 

proposed? If so, are there any 

restrictions, in addition to those 

proposed, that should be required so 

that the information is truly aggregated? 

Question 33. Is the proposed 

definition of ‘‘regulatory information’’

appropriate? Is it too broad? Or, should 

the prohibition on use of regulatory 

information for other than a regulatory 

purpose include information other than 

information gained in the course of 

carrying out regulatory obligations? If 

so, what information?

Question 34. Would the proposed 

limitations on disseminating regulatory 

information and information required to 

be submitted to effectuate a transaction 

restrict an exchange or association from 

being able to disseminate information 

that currently is disseminated by 

exchanges or associations? If so, how 

so? 

Question 35. Should an exchange or 

association be allowed to disseminate 

order and trade data, or regulatory 

information, which is otherwise made 

public by a person other than the 

exchange, association, or an officer, 

director, employee, or agent of the 

exchange or association? 

Question 36. Do commenters believe 

that it is necessary to have any 

ownership and voting limits? 

Question 37. Should the proposed 

ownership and voting limitations in 

relation to interests in an exchange, 

association or a facility of an exchange 

or association apply to all other persons, 

besides members that are brokers or 

dealers? What specific concerns exist 

that imposing ownership and voting 

limits on other persons, not just 

members that are brokers or dealers, 

would serve to mitigate? If the 

Commission were to impose restrictions 

on other persons, should the limit be the 

same as for members that are brokers or 

dealers—20%—or should it be higher or 

lower? Upon which other persons 

should these restrictions be imposed? 

Question 38. Should the Commission 

require that SROs impose ownership 

and voting limits on persons that are not 

statutory ‘‘members’’ but that own one 

or more memberships, or ‘‘seats,’’ in an 

exchange, but are not registered brokers 

or dealers and do not trade on or 

through the facilities of the exchange, 

but lease the trading right to a brokerdealer? If so, should it depend upon 

whether the person retains the voting 

rights associated with such 

membership? 

Question 39. If the Commission were 

to impose ownership and voting 

restrictions on all persons, should the 

SRO and the Commission be able to 

permit persons to exceed the limit? If so, 

should the Commission impose 

requirements on any person that was 

permitted to exceed the limit? If so, 

what types of requirements? Should the 

person be required to agree to provide 

the Commission access to its books and 

records, and agree to cooperate with the 

Commission and the relevant SRO in 

the performance of their regulatory 

oversight responsibilities? Are there any 

other requirements that should be 

imposed? 

Question 40. Is a 20% ownership and 

voting threshold the appropriate level? 

Are these thresholds too high? For 

instance, should the Commission 

prohibit ownership and voting over 

10% (the level used in the definition of 

‘‘associate’’ in Rule 12b–2)? Or 5% (the 

reporting threshold for Regulation 13D)? 

Or should these thresholds be higher 

than 20%? 

Question 41. The Commission is 

proposing to limit a member’s beneficial 

ownership in an SRO or facility of an 

SRO. The beneficiaries of an irrevocable 

trust are not generally deemed to 

beneficially own the securities in the 

trust, because the voting and investment 

power over those securities is typically 

held exclusively by a third party trustee. 

Should the Commission explicitly 

prohibit members from owning 

securities subject to the proposed 

prohibition through such an irrevocable 

trust? Are there any other forms of 

ownership that the Commission should 

require an SRO to prohibit, other than 

beneficial ownership? 

Question 42. The Commission is 

proposing ownership and voting limits 

on members’ ownership, and voting of 

interests, both in ‘‘traditional’’

mutually-owned SROs and in 

demutualized SROs. Is this appropriate? 

Should the Commission not limit 

ownership of seats, or memberships, in 

a mutually-owned SRO? If so, why 

should the Commission treat these SROs 

differently than demutualized SROs? 

Question 43. Is there any special 

consideration that should be taken into 

account with respect to requiring a 

mutually-owned SRO to impose 

ownership and voting limits on its 

members’ ownership in or voting of 

interests in the SRO and its facilities? 

For instance, if a member is entitled to 

only one vote even if it owns more than 

one seat or membership, would a limit 

on ownership be necessary? If so, how 

should such a limit be structured? 

Question 44. Are there practical 

implementation issues that would be 

faced by exchanges and associations in 

devising rules to divest members that 

are brokers or dealers and their related 

persons of any interest in excess of that 

proposed to be permitted? What about 

rules reasonably designed to not give 

effect to the portion of a vote by a 

member that is a broker or dealer that 

is in excess of the proposed limits? If so, 

how could these issues be addressed? 

Question 45. Are the proposed 

requirements that an exchange and 

association impose ownership and 

voting limits on its members that are 

brokers or dealers consistent with state 

law under which the SROs are 

governed? If not, please explain why 

that is the case. 

Question 46. Should the Commission 

prohibit direct, but not indirect, 

ownership and voting over the proposed 

limits? Could a limit on direct 

ownership and voting—without a limit 

on indirect—easily be circumvented? 

71150 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

251See supra Section I.B.4. and note 61.

252See supra note 65.

Question 47. The ownership and 

voting limitations as proposed would 

apply to ownership in or voting of 

interests in any facility of an exchange 

or association. Is this appropriate, or is 

it too broad? If too broad, what types of 

facilities should be included within the 

scope of the member ownership and 

voting limitations? How would the 

Commission achieve its goals by 

narrowing the ownership and voting 

limitations? 

Question 48. The Commission 

requests comment on whether any 

broker-dealer members and their 

‘‘related persons’’ currently own more 

than 20% of the interest in an exchange, 

association or a facility of an exchange 

or association. If so, the Commission 

requests comment on the length of time 

that an exchange or association should 

be given to allow such members to 

divest themselves of such interest. 

Question 49. As proposed, a brokerdealer member of an exchange or 

association would be prohibited from 

owning and voting more than 20% of 

the securities of an exchange, 

association, or facility, which could 

include agreements not to vote. The 

Commission has not proposed any 

requirements on what would constitute 

a quorum for purposes of a shareholder 

vote, in part because broker-dealer 

members and other persons would be 

able to vote all the shares of stock they 

are entitled to own (i.e., members can 

own and vote up to 20%), so there 

would not be a percentage of stock that 

is owned but not voted. The 

Commission recognizes, however, that a 

broker-dealer member theoretically 

could accumulate undetected 

ownership in violation of the 20% limit. 

If the member’s interest was large 

enough, the member could, by not being 

present at a shareholder vote, keep a 

quorum from being present at a 

shareholder meeting. The Commission 

requests comment on whether it is 

necessary to require the exchange or 

association to amend its rules to 

prohibit such a scenario. 

Question 50. Are the proposed 

definitions of ‘‘affiliated,’’ ‘‘affiliated 

issuer,’’ and ‘‘affiliated security’’

appropriate? Should the definitions be 

broader? Should they be narrower? 

Question 51. Is the proposed 

definition of ‘‘related persons’’ too 

narrow? Or too broad? Is there any other 

relationship that should be included 

within the definition that is not? For 

instance, should the Commission 

include ownership that is acquired 

solely by being a member of a group? 

Question 52. Is the proposed part of 

the definition of ‘‘related person’’ that 

includes any person associated with a 

member too broad? For example, should 

it be limited to those associated persons 

that possess, directly or indirectly, the 

power to direct or cause the direction of 

management and policies of the 

member, whether through the 

ownership of voting securities, by 

contract, or otherwise? 

Question 53. The proposed ownership 

and voting limits would apply to 

members that are natural persons 

directly, if they are broker-dealers, or 

indirectly, through the member’s 

associated broker or dealer. Should the 

Commission require that an SRO impose 

the ownership and voting limits directly 

on all members, or would it be sufficient 

to capture natural persons that are not 

brokers or dealers as ‘‘related persons’’

of their associated broker-dealer? 

Question 54. Is the proposed 

definition of ‘‘beneficial ownership’’

appropriate for purposes of the 

proposed ownership limitation? Is it too 

narrow? Or is it too broad? What other 

definition would be appropriate? 

Should the Commission instead only 

require information to be filed with 

respect to record ownership rather than 

beneficial ownership? If so, how would 

that impact securities positions of a 

customer of the member for which the 

member holds in street name? 

Question 55. How difficult would it 

be for an SRO to monitor ownership by 

broker-dealer members and their related 

persons under the proposed definition 

of related person? Would the proposed 

rule (Rule 17a–27) that would require 

broker-dealer members to report to the 

Commission and the relevant SRO 

ownership by the member and its 

related persons in excess of 5% help the 

SRO monitor the ownership and voting 

limits? To what extent would the 

proposed requirement that an SRO 

adopt rules permitting it to request 

information from its owners help SROs 

obtain the information they need? 

Question 56. Should the Commission 

require exchanges and associations to 

allow members subject to the ownership 

and voting limits to solicit and receive 

revocable proxies under Regulation 14A 

of the Exchange Act, as the Commission 

has proposed? Or, would doing so 

undermine the purpose of the 20% 

voting limitation? Or, is not allowing 

‘‘open-ended proxies’’ sufficient to 

mitigate any concern that the act of 

soliciting and receiving proxies would 

in and of itself provide a member the 

opportunity to exceed the 20% 

threshold? If so, would disallowing the 

exemption contained in Rule 14a–

2(b)(2) under the Exchange Act be 

sufficient? Are there other situations 

that should be explicitly excluded from 

the proposed limitation? 

Question 57. Should the Commission 

specify the manner in which an SRO 

must assure that if a member that is a 

broker or dealer violated the ownership 

and voting limits the exchange or 

association has an effective mechanism 

to divest a member and its related 

persons of any interest owned in excess 

of, or to not give effect to the portion of 

a vote in excess of, the 20% limitation? 

If so, what should the requirement be? 

Question 58. Should the Commission 

require an exchange or association to 

have an independent party tabulate any 

shareholder vote, to help ensure 

compliance by the exchange or 

association and its broker-dealer 

members with the proposed voting 

limit? How should the Commission 

define ‘‘independent party’’ in this 

context?

Question 59. Are there other issues 

that an exchange’s or association’s code 

of conduct and ethics and governance 

guidelines should be required to address 

in addition to those identified in 

proposed Rules 6a–5(p) and (q) and 

15Aa–3(p) and (q)? 

Question 60. Are the proposed dates 

by which the exchange or association 

must file a rule change proposing the 

governance standards and by which the 

proposed rule change must be adopted 

by the Commission and operative by the 

SRO appropriate? 

III. Proposed Regulation AL—National 

Securities Exchanges and Registered 

Securities Associations Listing 

Affiliated Securities 

A. Background and Need for Proposed 

Regulation AL 

As discussed above, competition 

among markets has increased 

dramatically over the past few years, 

and several SROs have demutualized or 

entered into arrangements with separate 

trading facilities.251 As a demutualized 

entity, an SRO may become a publicly 

traded company and choose to list its 

securities on its own market. In 

addition, a facility of an SRO that has 

a separate legal existence and that is 

publicly traded currently may choose to 

list on its affiliated SRO. The owner of 

one facility of an SRO already has 

completed an initial public offering, and 

another SRO has filed a registration 

statement under the Securities Act with 

regard to its intended initial public 

offering.252 The listing of securities 

issued by an SRO, the facility of an 

SRO, or an affiliate of either on the SRO 

would create a new conflict of interest 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71151

253See Sections 6(b) and 15A(b) of the Exchange 

Act, 15 U.S.C. 78f(b) and 78o–3(b).

254 15 U.S.C. 78s(b).

255See Securities Exchange Act Release No. 

50171 (August 9, 2004), 69 FR 50427 (August 16, 

2004) (approving SR–PCX–2004–76, which places 

additional reporting requirements on the exchange 

if any affiliate of the exchange or any entity that 

operates and/or owns a trading system or facility of 

the exchange lists any security on the exchange). 

The Commission notes that the NASD did not 

impose additional requirements when the securities 

of Nasdaq, a facility of the NASD, began trading in 

the OTC Bulletin Board, a service operated by the 

NASD.

256See id.

257See id.

258See proposed Rule 800(a)(4).

259 17 CFR 230.238.

260 15 U.S.C. 77c(a)(14). See proposed Rule 

800(a)(4). Standardized options and security futures 

products are issued and guaranteed by a clearing 

agency. Currently, all standardized options and 

security futures products are issued by the Options 

Clearing Corporation (‘‘OCC’’). The Commission 

proposes to exempt standardized options and 

security futures products from the definition of 

‘‘affiliated security’’ because the value of these 

instruments is not related to the value of its issuer—

i.e., the OCC. Instead, their value is based on the 

value of the security underlying the option or 

security futures product. Accordingly, the 

Commission does not believe the same conflicts 

exist when an SRO lists and trades standardized 

options and security futures products issued by an 

affiliate as when an SRO lists and trades other 

securities issued by an affiliate.

261See proposed Rule 800(a)(3). ‘‘Affiliate’’ would 

be defined to mean, with respect to any person, any 

other person that directly or indirectly controls, is 

controlled by, or is under common control with, the 

person. See proposed Rule 800(a)(2). ‘‘Control’’

would be defined to mean the possession, direct or 

indirect, of the power to direct or cause the 

direction of the management and policies of a 

person, whether through ownership of voting 

securities, by contract, or otherwise. A person is 

presumed to control another person if the person 

(i) is a director, general partner or officer exercising 

executive responsibility (or having similar status or 

functions); (ii) directly or indirectly has the right to 

vote 25% or more of a class of voting securities or 

has the power to sell or direct the sale of 25% or 

more of a class of voting securities; or (iii) in the 

case of a partnership, has the right to receive, upon 

dissolution, or has contributed, 25% or more of the 

Continued

with the SRO’s statutory obligations as 

a regulator.

In particular, such ‘‘self-listing’’ raises 

questions as to an SRO’s ability to 

independently and effectively enforce 

its own or the Commission’s rules 

against itself or an affiliated entity, and 

thus comply with its statutory 

obligations under the Exchange Act.253

For instance, the SRO might be reluctant 

to vigorously monitor for compliance 

with its initial and continued listing 

rules by the securities of an affiliated 

issuer or its own securities, and may be 

tempted to allow its own securities, or 

the securities of an affiliate, to be listed 

(and continue to be listed) on its market 

even if the security is not in full 

compliance with the SRO’s listing rules. 

In addition, self-listing may exacerbate 

conflicts with the SRO overseeing 

competitors that also may be listed on, 

and thus regulated by, the SRO. For 

example, an SRO might choose to more 

strictly construe and apply its listing 

rules to the securities of a competitor 

that is listed on, or that seeks to list on, 

the SRO than it would for its own or an 

affiliate’s securities. Or, an SRO might 

be reluctant to allow additional time for 

the securities of an unaffiliated issuer to 

regain compliance with a listing rule, or 

may allow more time for its own 

securities that are self-listed.

Trading of its own securities or the 

securities of an affiliated issuer on the 

SRO also raises similar potential 

conflict concerns, in that the SRO might 

choose to selectively enforce (or not 

enforce) its trading rules with respect to 

trading in its own stock or that of an 

affiliate so as to benefit itself. For 

example, the SRO may determine to 

look the other way with respect to 

improper trading in an affiliated 

security that creates the appearance of 

increased volume, such as through wash 

sales, or trading that artificially inflates 

or sustains the price of the stock, such 

as marking the close. In addition, the 

SRO may improperly pressure the 

specialist to stabilize the price of the 

stock. The SRO also may improperly 

discourage legal short sales or other 

types of legitimate trading practices that 

the SRO believed may negatively impact 

the value of the stock.

To date, the Commission has 

approved, through the rule filing 

process of Section 19(b) of the Exchange 

Act,254 heightened reporting 

requirements in a particular instance in 

which an SRO ‘‘self-listed’’ securities 

issued by an affiliate.255 Specifically, in 

anticipation of the listing of Archipelago 

Holdings (the parent company of ArcaEx) on PCX, PCX amended its rules to 

require it to periodically report to the 

Commission regarding its oversight of 

the listing on PCX and trading on ArcaEx of Archipelago Holdings’ stock. PCX 

also amended its rules to require an 

annual independent audit of 

Archipelago Holdings’ compliance with 

PCX’s listing standards, a copy of which 

the exchange must provide to the 

Commission.256 The Commission 

approved PCX’s proposed rule change 

as consistent with the Exchange Act, 

stating that it would help protect against 

concern that PCX would not effectively 

enforce its rules with respect to the 

listing and trading of securities of an 

affiliate of the exchange or any entity 

that operates or owns a facility of the 

exchange.257

SROs currently have listing rules that 

would permit them to list and trade 

their own or ‘‘affiliated’’ securities 

without any additional requirements 

such as those adopted by PCX. Because 

of the conflict of interest raised by selflisting, which could result in an SRO 

being less vigilant in its obligations to 

enforce the securities laws and its own 

rules, the Commission is proposing 

additional requirements when an SRO 

lists and trades its own, or an affiliate’s, 

securities. Proposed Regulation AL is 

designed to provide further assurance 

that SROs will carry out their regulatory 

responsibilities under the Exchange Act 

with respect to surveillance of affiliated 

securities and to provide the 

Commission a greater ability to monitor 

SROs’ efforts in this regard. The 

Commission believes that the proposed 

rule would establish safeguards that 

would better ensure that the listing and 

trading of an affiliated security on an 

SRO complies with applicable rules of 

the SRO and the Commission. In 

addition, the Commission believes that 

the proposed rules would serve to 

mitigate the inherent conflict of interest 

between the SRO’s responsibility to 

vigorously oversee the listing and 

trading of an affiliated security on its 

market and its own commercial and 

economic interests by providing the 

Commission with enhanced information 

and increased ability to monitor the 

SRO’s surveillance of the affiliated 

security. 

B. Description of Proposed Regulation 

AL 

1. Definition of Affiliated Security 

Proposed Regulation AL would define 

the term ‘‘affiliated security’’ 258 to mean 

any security issued by an affiliated 

issuer, except any option exempt from 

the Securities Act pursuant to Rule 238 

under the Securities Act 259 and any 

security futures product exempt from 

the Securities Act under Section 3(a)(14) 

of the Securities Act.260 The term 

‘‘affiliated issuer’’ would be defined to 

mean: (i) With respect to a national 

securities exchange, the national 

securities exchange, an SRO trading 

facility of the national securities 

exchange, an affiliate of the national 

securities exchange, or an affiliate of an 

SRO trading facility of the national 

securities exchange, and (ii) with 

respect to a registered securities 

association, the registered securities 

association, an SRO trading facility of 

the registered securities association, an 

affiliate of the registered securities 

association, or an affiliate of an SRO 

trading facility of the registered 

securities association.261 The term ‘‘SRO 

71152 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

capital. See proposed Rule 800(a)(5). The 

Commission proposes to define the term ‘‘affiliate’’

consistent with its existing definitions of such 

terms under the securities laws, including Rules 

12b–2 and 10A–3 under the Exchange Act and Rule 

144 under the Securities Act, and to define 

‘‘control’’ consistent with its existing definitions of 

such terms under the securities laws, including 

Form 1, Form BD and Rule 300 of Regulation ATS. 

These definitions are intended to include any 

person that would have the potential ability to 

influence the operation of the person specified. 262See proposed Rule 800(a)(6). The term 

‘‘facility’’ would have the meaning in Section 

3(a)(2) of the Exchange Act and proposed Rule 

15Aa–3 under the Exchange Act. See proposed Rule 

800(a)(7). 263Securities issued by Nasdaq currently trade on 

the OTC Bulletin Board pursuant to rules of the 

NASD, and would be covered by proposed 

Regulation AL. If securities issued by Nasdaq were 

to trade on Nasdaq, they also would be covered as 

they would be approved for trading on, and would 

trade pursuant to the rules of, the NASD. 264See proposed Rule 800(b)(1). 265 15 U.S.C. 78f and 78o–3.

266See proposed Rule 800(b)(2)(i)(A). The 

exchange or association would be required to file 

the report not more than 30 calendar days after the 

end of each calendar quarter.

267The Commission understands, however, that 

most, if not all, SROs review compliance with 

listing rules on at least a quarterly basis.

268See proposed Rule 800(b)(2)(i)(B).

269See proposed Rule 800(c)(i).

270See proposed Rule 800(b)(2)(ii).

271See proposed Rule 800(c)(ii).

272See proposed Rule 800(b)(2)(ii).

273See proposed Rules 6a–2(b) and 15Aa–2(b).

274See proposed Rule 800(b)(2)(iii).

trading facility’’ would be defined to 

mean any facility of a national securities 

exchange or registered securities 

association that executes orders in 

securities 262 and would capture 

Nasdaq’s SuperMontage system, ArcaEx and the NYSE floor. It would not, 

however, include the NASD’s 

Alternative Display Facility (‘‘ADF’’) 

because the ADF does not execute 

orders. Thus, Nasdaq would be 

considered an affiliated issuer of the 

NASD because it would be an SRO 

trading facility of the NASD, and 

Archipelago Holdings would be an 

affiliated issuer of PCX because it would 

be an affiliate of an SRO trading facility 

of PCX.263 The proposed definitions of 

affiliated security, affiliated issuer, and 

SRO trading facility are intended to 

include the securities of any entity 

whose interests may be so closely 

aligned with the SRO’s interests that the 

same concerns are raised about the 

ability of the SRO to oversee such 

security’s listing and trading as are 

raised by the listing and trading of the 

SRO’s own securities.

2. Initial Listing 

Proposed Regulation AL would 

prohibit a national securities exchange 

or registered securities association from 

approving for listing an affiliated 

security unless such exchange’s or 

association’s Regulatory Oversight 

Committee certified that such security 

satisfies the exchange’s or association’s 

rules for listing.264 This requirement is 

intended to provide for review by an 

independent body of a listing process 

that contains a conflict of interest so as 

to help ensure that the exchange or 

association effectively carries out its 

obligations under Section 6 or 15A of 

the Exchange Act,265 as applicable. The 

Commission notes that only an 

exchange or association, as an SRO, is 

permitted to establish listing rules. For 

instance, the listing rules for securities 

traded on Nasdaq are rules of the NASD. 

Accordingly, the NASD, not Nasdaq, 

would be required to comply with 

proposed Regulation AL.

3. Continued Listing and Trading 

In addition, if an affiliated security is 

listed on, approved for trading on, or 

trades pursuant to the rules of, an 

exchange or association, proposed 

Regulation AL would impose specific 

reporting and notice obligations on the 

exchange or association. The proposal 

would require the exchange or 

association to file a quarterly report 

with the Commission summarizing its 

monitoring of the affiliated security’s 

compliance with its listing rules.266

This proposed requirement could 

require an exchange or association to 

evaluate an affiliated security’s 

compliance with applicable listing rules 

more frequently than other securities 

listed on the exchange or association to 

comply with the quarterly filing 

requirement.267 The Commission 

believes that requiring this report to be 

filed quarterly would help ensure that 

the SRO monitors and reports its 

monitoring of compliance by the 

affiliated security with listing rules on 

a frequent enough basis so as to bring 

to light possible concerns, without being 

unduly burdensome. Pursuant to the 

proposed rule, the exchange would be 

required to provide in the report factual 

information regarding the affiliated 

security’s compliance with each 

applicable rule, both for quantitative 

listing standards (e.g. market 

capitalization) and qualitative standards 

(e.g. that the majority of the board of 

directors be independent).

In addition, the exchange or 

association would be required to 

include in the quarterly report a 

summary of its surveillance of the 

trading of affiliated securities by its 

members.268 Each SRO may employ 

different tools and methods in carrying 

out its statutory obligations under the 

Exchange Act to monitor trading in its 

market by its members. The 

Commission therefore is not proposing 

to delineate each item or type of factual 

information that must be included in 

the summary of surveillance of trading. 

The Commission believes, however, that 

this report should include factual 

information regarding surveillance 

alerts, exception reports, complaints 

and regulatory referrals, including the 

steps taken by the SRO with respect to 

problems identified in surveillance 

alerts, exception reports or complaints, 

in relation to trading in the affiliated 

security.

Finally, the Commission proposes to 

require the exchange’s or association’s 

Regulatory Oversight Committee to 

approve the report before it is filed with 

the Commission.269 This requirement is 

intended to provide an independent 

level of review of the report prior to 

submission, and would ensure that the 

Regulatory Oversight Committee is 

made aware of potential concerns 

regarding the listing and trading of an 

affiliated security.

In addition to the quarterly report 

described above, the exchange or 

association would be required to file 

with the Commission annually a report 

prepared by a third party analyzing 

compliance by the affiliated security 

with applicable listing rules of the 

exchange or association.270 This 

requirement is intended to provide a 

second level of review by an entity other 

than the SRO of an affiliated security’s 

compliance with the SRO’s listing rules. 

The exchange or association also would 

be required to provide its Regulatory 

Oversight Committee a copy of this 

report within five business days of its 

receipt so that this committee is made 

aware of any potential concerns 

regarding affiliated securities’

compliance with SRO listing rules.271

This report would be required to be 

filed within 60 calendar days of the end 

of the exchange’s or association’s fiscal 

year.272 The Commission has proposed 

that a copy of this report be provided to 

the Commission within 60 days of the 

end of the exchange’s or association’s 

fiscal year to coincide with the 

proposed requirement for annually 

updating Form 1 and new Form 2.273

Pursuant to its existing rules, an 

exchange or association would review 

an affiliated security’s compliance with 

applicable listing rules. If the exchange 

or association were to believe that the 

affiliated security is not in compliance 

with any applicable listing rule, the 

proposal would require the SRO to 

notify the affiliated issuer promptly.274

This proposed requirement likely would 

require exchanges and associations to 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71153

275See proposed Rule 800(b)(2)(iv).

276See proposed Rule 800(c)(i).

277See proposed Rule 800(b)(2)(v) and (c)(ii).

278 15 U.S.C. 78q(a), 78r(a), and 78ff(a). Section 

17(a) of the Exchange Act imposes recordkeeping 

requirements on national securities exchanges and 

registered securities associations; Section 18(a) of 

the Exchange Act imposes liability for false or 

misleading statements with respect to a material 

fact in applications, reports, or documents filed 

pursuant to the Exchange Act or any rule or 

regulation thereunder; and Section 32(a) of the 

Exchange Act provides for penalties against any 

person that willfully violates any provision of, or 

that willfully and knowingly makes, or causes to be 

made, any false or misleading statements with 

respect to a material fact in any application, report, 

or document required to be filed under the 

Exchange Act or any rule or regulation thereunder.

279See proposed Rule 800(e)(ii).

280See proposed Rule 800(d)(i) and (ii).

281Of course, any such amendment would have 

to be filed with the Commission pursuant to Section 

19(b) of the Exchange Act and the rules thereunder. 

15 U.S.C. 78(s) and 17 CFR 240.19b–4.

282See proposed Rule 800(d)(iii).

amend their current rules setting forth 

the process for reviewing continued 

listing to require prompt notification to 

affiliated issuers of any alleged noncompliance found during routine 

reviews.

The proposal also would require the 

exchange or association, within five 

business days of providing such notice 

to the affiliated issuer, to file a report 

with the Commission identifying the 

date the SRO alleged that the affiliated 

security was not in compliance, the 

listing rule at issue, the action the 

exchange or association proposes to take 

with respect to the affiliated security, 

and any other material information 

conveyed to the affiliated issuer in the 

notice of non-compliance (a ‘‘noncompliance report’’).275 The exchange’s 

or association’s Regulatory Oversight 

Committee would be required to 

approve this non-compliance report 

prior to filing with the Commission.276

Finally, the exchange or association also 

would be required to provide the 

Commission and the exchange’s or 

association’s Regulatory Oversight 

Committee with a copy of any response 

received from the affiliated issuer 

regarding its alleged noncompliance 

within five business days of receipt of 

the response.277

The Commission believes that 

requiring the exchange or association to 

provide to the Commission a noncompliance report and a copy of any 

response from an affected affiliated 

issuer within five business days of 

receipt would provide the Commission 

with timely information but still 

provide sufficient time for the exchange 

or association to prepare and file the 

report and to file the response. The 

Commission believes that requiring the 

Regulatory Oversight Committee to 

approve the non-compliance report 

before it is filed with the Commission, 

and requiring the Regulatory Oversight 

Committee to receive a copy of any 

response from the affiliated issuer, 

would make this committee aware of 

any compliance concerns regarding an 

affiliated security in a timely manner. 

Pursuant to proposed Rule 800(e)(i), 

each report required to be filed under 

proposed Regulation AL would 

constitute a ‘‘report’’ within the 

meaning of Sections 17(a), 18(a), and 

32(a) of the Exchange Act, and any other 

applicable provisions of the Exchange 

Act.278 In addition, each report or 

response required to be filed pursuant to 

Regulation AL would be considered 

filed upon receipt by the Division of 

Market Regulation at the Commission’s 

principal office in Washington, DC.279

4. Parity in Application of Listing and 

Trading Rules 

Proposed Regulation AL also would 

require that, except as otherwise 

required by proposed Regulation AL, (i) 

any action taken by the exchange or 

association with regard to the listing of 

an affiliated security, including the time 

period granted to the affiliated issuer to 

come into compliance with any listing 

standard, be in compliance with the 

existing rules of the exchange or 

association and (ii) the exchange or 

association must not apply the same 

listing rules to affiliated securities in a 

manner materially different than the 

treatment afforded to other securities 

listed on the exchange or association.280

This requirement would not preclude an 

exchange or association from amending 

its rules to apply stricter initial and 

continued listing standards to affiliated 

securities.281 Additionally, any action 

taken by the exchange or association 

with respect to the trading of an 

affiliated security by the exchange’s or 

association’s members must be in 

compliance with the rules of the 

exchange or association and with 

federal securities laws, and must not be 

materially different than action taken 

with respect to the trading of other 

securities traded on the exchange or 

association.282 These requirements are 

intended to help ensure that an 

exchange or association does not give 

preferential treatment to affiliated 

securities.

5. Exemption Provision 

Proposed Rule 800(f) would establish 

procedures for the Commission to grant 

an exemption, upon written request or 

on its own motion, from the provisions 

of proposed Regulation AL, either 

unconditionally or on specified terms 

and conditions, if the Commission 

determines that such exemption is 

necessary or appropriate in the public 

interest and is consistent with the 

protection of investors. Pursuant to this 

provision, the Commission would 

consider and act upon appropriate 

requests for relief from the rule’s 

provisions and consider the particular 

facts and circumstances relevant to each 

such request, the potential ramifications 

of granting any exemption, and any 

appropriate conditions to be imposed as 

part of the exemption. 

C. Request for Comment 

The Commission seeks general 

comments on all aspects of proposed 

Regulation AL as described above. In 

addition, the Commission requests that 

interested persons respond to the 

following specific questions: 

Question 61. Proposed Regulation AL 

would place reporting and notice 

obligations on an exchange or 

association with respect to an affiliated 

security listed on, approved for trading 

on, or traded pursuant to the rules of, 

the exchange or association. As noted 

above, this would include the trading of 

securities issued by Nasdaq on the OTC 

Bulletin Board or Nasdaq, as well as the 

trading of an exchange’s securities on 

the exchange or a facility of the 

exchange. Is the scope of the proposed 

rule broad enough? Is it too broad? 

Question 62. How frequently should 

an SRO be required to file reports 

summarizing its monitoring of the 

affiliated security’s compliance with the 

SRO’s listing rules and surveillance of 

the trading of the affiliated securities by 

such SRO’s members? Is quarterly 

reporting appropriate, or should it be 

more often? Or less frequent? Is this 

proposed reporting requirement 

appropriate at all? 

Question 63. Should the Commission 

specify in the proposed rule the type of 

information an SRO should include in 

the quarterly report summarizing the 

SRO’s surveillance of trading of 

affiliated securities by exchange 

members? For instance, should the 

Commission explicitly require the SRO 

to provide factual information on all 

exception reports, surveillance alerts, 

complaints, or regulatory referrals 

related to trading in the affiliated 

security? Is there any other particular 

information that should be specified? 

Question 64. Under the proposal, an 

SRO has 60 calendar days after the end 

of its fiscal year to file with the 

Commission a report prepared by a third 

party analyzing compliance by the 

affiliated security with the SRO’s listing 

rules. If an SRO found that an affiliated 

71154 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

283See infra Section V.

284See supra Section I.A.

285Sections 6, 15A, and 19 of the Exchange Act, 

15 U.S.C. 78f, 78o–3, and 78s, among others, 

establish a statutory scheme with respect to the 

responsibilities imposed on and Commission 

oversight of SROs. The statutory scheme vests SROs 

that are national securities exchanges and registered 

securities associations with nearly identical 

responsibilities and imposes upon the Commission 

virtually the same oversight requirements with 

respect to such exchanges and associations.

286 15 U.S.C. 78f(a).

security were not in compliance with 

any applicable listing rule of the SRO, 

the SRO would be required to file a 

report notifying the Commission within 

five business days of notifying the 

affiliated issuer of its noncompliance. In 

addition, the SRO would be required to 

provide the Commission with a copy 

any response from the affiliated issuer 

within five business days of receipt. 

Finally, the SRO would be required to 

provide its Regulatory Oversight 

Committee with a copy of the annual 

report and the response from an 

affiliated issuer within five business 

days. Are these time periods 

appropriate? Should they be shorter? 

Should they be longer? 

Question 65. Should the third party 

preparing the annual report regarding 

compliance by the affiliated security 

with applicable listing rules of the SRO 

be required to be independent of the 

SRO? If so, how should independence 

be defined? Or should the SRO be 

allowed to have its regular auditor 

conduct the analysis and prepare the 

report, as proposed? 

Question 66. Should the Commission 

require a third party to periodically 

audit an SRO’s surveillance of trading in 

the affiliated security as well as 

compliance with listing rules? If so, 

should the Commission require that 

entity to be independent of the 

exchange or association? If so, how 

should independence be defined? If so, 

what type of entity would be qualified 

to undertake this analysis? What would 

be the cost to the SRO of hiring a thirdparty to conduct the audit? 

Question 67. Should the Commission 

itself have primary responsibility for 

assessing compliance by the affiliated 

security with the exchange’s or 

association’s listing rules? If so, should 

the Commission determine initial 

compliance, as well as continued 

compliance? If both, how often should 

the Commission conduct a review? 

Question 68. Are the definitions of 

‘‘affiliated issuer,’’ ‘‘affiliated security’’

and ‘‘SRO trading facility’’ appropriate? 

Are they broad enough? For instance, 

should any entity be included that is not 

included within the proposed definition 

of ‘‘affiliated issuer?’’ Are they too 

broad? 

Question 69. Should the definition of 

‘‘affiliated security’’ include options and 

security futures products? If so, why? 

Question 70. Should the Commission 

exclude from the definition of 

‘‘affiliated security’’ any security issued 

by an investment company that tracks 

an index, such as an ETF? If so, why? 

Question 71. Is the proposed 

definition of ‘‘control’’ appropriate? 

Should it be broader? Or more narrow?

Question 72. Should the Commission 

impose additional requirements beyond 

those proposed here on SROs that wish 

to list or trade an affiliated security? Or 

should the Commission prohibit 

outright the listing and trading on the 

SRO of an affiliated security? What 

impact would doing so have on 

competition, if the issuer was forced to 

list the security on a competing market? 

Question 73. Should ‘‘self listing’’ be 

allowed only if the securities also are 

listed on another market and such other 

market has made an independent initial 

listing determination? If so, should the 

self-listing SRO be required to abide by 

the actions of the other market with 

regard to continuing compliance with 

listing rules and decisions to delist? 

Would the listing rules of the two 

markets need to be comparable? 

Question 74. Should the Commission 

require an SRO that lists or trades an 

affiliated security to contract with 

another SRO to monitor an affiliated 

security’s compliance with the affiliated 

SRO’s listing rules, and to monitor 

trading in the affiliated security by the 

affiliated SRO’s members? 

Question 75. Are there other 

requirements that the Commission 

should impose to address the conflicts 

of interest? 

IV. Disclosure by SROs 

A. Overview of Proposed Amendments 

to Registration Forms for Exchanges and 

Associations 

The Commission proposes to amend 

the procedures for the registration of 

exchanges and associations and the 

filing of amendments and supplements 

to the registration application. These 

proposals are intended to bring greater 

transparency to the governance 

structure of SROs and to their regulatory 

programs and processes, and to provide 

the mechanism for more timely 

disclosure of the specified information. 

The enhanced disclosure requirements 

are designed to assure that users of 

exchange or association facilities, 

investors, and others have access to 

current and relevant information about 

SROs, including their administration, 

regulatory programs and ownership 

structure. Moreover, improving the 

transparency of SROs would enable 

their members, market participants, 

investors and regulators to more readily 

monitor the effectiveness and 

performance of SROs and promote 

greater accountability by SROs with 

respect to their Exchange Act 

obligations. 

In addition, the proposals should 

assist the Commission in its oversight of 

exchanges and associations and help 

make its oversight programs more 

effective by requiring better and more 

frequent disclosure of important SRO 

information, particularly with respect to 

the governance of SROs, their regulatory 

programs and expenditures on those 

programs, and the ownership of SROs 

and their facilities. Along with proposed 

Rule 17a–26 under the Exchange Act,283

which would require SROs to provide 

the Commission with periodic 

information about specific aspects of 

their regulatory programs, the proposals 

to improve SRO transparency should 

help the Commission better identify and 

respond to regulatory issues and 

concerns promptly and effectively.

Further, the proposals would provide 

for greater uniformity in the regulatory 

treatment of exchanges and associations 

by mandating similar disclosure for both 

exchanges and associations. Under the 

current disclosure framework, 

exchanges are required to provide more 

detailed information on Form 1 than 

associations are required to submit on 

applicable registration forms. In the 

Commission’s view, there does not 

appear to be a sound reason today for 

maintaining differing disclosure 

requirements. National securities 

exchanges and registered securities 

associations are charged with nearly 

identical obligations under the 

Exchange Act.284 Among other 

requirements, both exchanges and 

associations must be so organized and 

have the capacity to carry out the 

purposes of the Exchange Act and 

comply with, and enforce their 

members’ compliance with, the federal 

securities laws and rules thereunder and 

SRO rules.285 The proposal therefore 

seeks to more closely align the 

regulatory disclosure framework for 

exchanges and associations.

B. Description of Registration Processes 

1. Registration as a National Securities 

Exchange or Exemption From Such 

Registration Based on Limited Volume 

Section 6(a) of the Exchange Act 286

generally provides that an exchange 

may be registered as a national 

securities exchange by filing with the 

Commission an application for 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71155

287 Id.

288See Rule 6a–1 under the Exchange Act, 17 

CFR 240.6a–1, and Form 1, 17 CFR 249.1.

289Currently, Form 1 requires the following 

material to be included as exhibits: (1) a copy of the 

constitution, articles of incorporation or 

association, and by-laws (Exhibit A); (2) a copy of 

all written rulings, settled practices having the 

effect of rules, and interpretations of any governing 

board or committee of the exchange (Exhibit B); (3) 

information regarding all affiliates and subsidiaries 

(Exhibit C); (4) unconsolidated financial statements 

for each subsidiary or affiliate of the exchange for 

the latest fiscal year (Exhibit D); (5) a description 

of the manner of operation of the electronic trading 

system to be used to effect transactions on the 

exchange (Exhibit E); (6) complete set of 

applications for membership, participation or 

subscription to the exchange or for a person 

associated with a member, participant, or subscriber 

of the exchange (Exhibit F); (7) financial statements, 

reports or questionnaires required of members, 

participants, subscribers, or other users (Exhibit G); 

(8) listing applications, any agreements required to 

be executed in connection with listing and a 

schedule of listing fees (Exhibit H); (9) audited 

consolidated financial statements for the last fiscal 

years of the exchange prepared in accordance with, 

or reconciled to, United States generally accepted 

accounting principles (Exhibit I); (10) information 

with respect to officers, governors, members of all 

standing committees, or persons performing similar 

functions, who presently hold or have held their 

offices or positions during the previous year 

(Exhibit J); (11) information with respect to persons 

with 5% direct ownership for non-member owned 

exchanged (Exhibit K); (12) description of the 

exchange’s criteria for membership (Exhibit L); (13) 

information with respect to any members, 

participants, subscribers or other users and the 

information pertaining thereto (Exhibit M); and (14) 

a schedule of securities listed on the exchange, 

securities admitted to unlisted trading privileges, 

securities admitted to trading on the exchange 

which are exempt from registration under Section 

12(a) of the Exchange Act, 15 U.S.C. 78l, and other 

securities traded on the exchange (Exhibit N).

290 17 CFR 240.6a–1 and 240.6a–2.

291See infra Section IV.D. for a description of the 

requirements of Rule 6a–2 under the Exchange Act.

292 15 U.S.C. 78o–3.

293Section 15A(d) of the Exchange Act, 15 U.S.C. 

78o–3(d), generally provides that an association 

shall not be registered as an affiliated securities 

association unless it appears to the Commission 

that: (1) such association will be affiliated with an 

association registered as a registered securities 

association and (2) such association and its rules 

satisfy the requirements of Section 15A(b)(2)–(10) 

and (12). To date, no entity has registered with the 

Commission as an affiliated securities association.

294Section 15A(a) of the Exchange Act, 15 U.S.C. 

78o–3(a).

295 17 CFR 240.15Aa–1 and 240.15Aj–1.

296See Rule 15Aa–1 under the Exchange Act, 17 

CFR 240.15Aa–1, and Form X–15AA–1, 17 CFR 

249.801.

297The exhibits to Form X–15AA–1, 17 CFR 

249.801, require the following information: (1) 

copies of the association’s constitution, charter, 

articles of incorporation or association, with all 

amendments thereto, and of its existing by-laws and 

of any rules or instruments corresponding to the 

foregoing (Exhibit A); (2) a balance sheet of the 

association together with an income and expense 

statement (Exhibit B); and (3) an alphabetical list of 

all members of the association and the member’s 

principal place of business (Exhibit C).

298 17 CFR 240.15Aj–1. See infra Section IV.D. for 

a description of Rule 15Aj–1 under the Exchange 

Act.

299See Section 5 of the Exchange Act, 15 U.S.C. 

78e.

300For clarity, we use the term ‘‘revised Form 1’’

to refer to the Form 1, as proposed to be amended 

by this rulemaking. Currently, securities 

associations are required to register on Form X–

15AA–1 and to file amendments and supplements 

on Forms X–15–AJ–1 and X–15–AJ–2. The 

Commission proposes to redesignate Form X–

15AA–1 as Form 2 and to amend Form 2 consistent 

with the proposals contained in this release. For 

clarity, we refer to the registration form for 

registered securities associations, as proposed to be 

amended, as ‘‘new Form 2.’’

registration in such form as the 

Commission, by rule, may prescribe. 

The application must contain the rules 

of the exchange and such other 

information and documents as the 

Commission, by rule, may prescribe as 

necessary or appropriate in the public 

interest or for the protection of 

investors.287

Currently, under Rule 6a–1 under the 

Exchange Act, an exchange applying for 

registration as a national securities 

exchange, or for an exemption from 

such registration based on limited 

volume, is required to file its 

application with the Commission on 

Form 1.288 Form 1 requires applicants to 

provide general identifying information 

(e.g., name, address, telephone, and 

legal status), as well as more specific 

information, as set forth in exhibits 

attached to the Form.289 In addition, 

Rules 6a–1 and 6a–2 under the 

Exchange Act 290 set forth the 

application procedures and timing 

requirements for registration as a 

national securities exchange, or for an 

exemption from registration as an 

exchange based on limited volume, and 

the procedures and timing requirements 

for amending the application.291

2. Registration as a Registered Securities 

Association or Affiliated Securities 

Association 

Section 15A of the Exchange Act 292

generally provides that an association of 

brokers and dealers may be registered as 

a registered securities association or as 

an affiliated securities association 293 by 

filing with the Commission an 

application for registration in such form 

as the Commission, by rule, may 

prescribe. The application must contain 

the rules of the association and such 

other information and documents as the 

Commission, by rule, may prescribe as 

necessary or appropriate in the public 

interest or for the protection of 

investors.294

Rules 15Aa–1 and 15Aj–1 under the 

Exchange Act 295 set forth the 

application process and timing 

requirements for registration as a 

registered securities association or an 

affiliated securities association, and the 

process for amending or supplementing 

such application. Rule 15Aa–1 under 

the Exchange Act requires an 

association applying for registration as a 

registered securities association or an 

affiliated securities association to file its 

application for registration on Form X–

15AA–1.296 Currently, Form X–15AA–1 

requires an applicant to provide general 

organizational information (e.g., name 

and addresses of applicant and 

information about the applicant’s 

officers, directors, and committee chairs 

and members). An applicant also is 

required to identify its rules that pertain 

to (1) admission to association 

membership; (2) fair representation of 

membership; (3) dues and expenses; (4) 

business conduct; (5) protection of 

members; (6) disciplining of members; 

(7) affiliated associations; (8) dealings 

with nonmembers; and (9) enforcement 

of association rules. An applicant is 

required to provide additional 

information to the Commission as set 

forth in Exhibits A, B, and C to Form X–

15AA–1.297 Rule 15Aj–1 currently 

requires a registered securities 

association or affiliated securities 

association to update its registration 

statement promptly after the discovery 

of any inaccuracy in the statement or in 

any amendment or supplement thereto, 

either on Form X–15AJ–1 or on Form X–

15AJ–2, depending on the 

circumstances.298

C. Proposed Revisions to Form 1 and 

New Form 2

We propose to harmonize the 

procedures for application as a national 

securities exchange and as a registered 

securities association and for the 

submission of amendments to such 

applications. Under the proposals, an 

applicant for registration as a national 

securities exchange or for an exemption 

from exchange registration based on 

limited volume,299 would be required to 

file revised Form 1, and an applicant for 

registration as a registered securities 

association or an affiliated securities 

association would be required to file 

new Form 2.300 The revised Form 1 and 

new Form 2 also would be used by an 

exchange or association, respectively, 

for submitting all amendments. Because 

new Form 2 would serve as the form for 

both initial registration of registered 

securities associations and for all 

amendments, the Commission proposes 

to repeal Forms X–15AJ–1 and X–15AJ–

2. In addition, the proposals would 

require exchanges and associations to 

disclose more detailed information than 

currently is required about their 

governance, regulatory functions, and 

ownership in the registration 

71156 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

301See infra Sections IV.D. through IV.F., 

inclusive. 302The proposals would not require the posting 

of an applicant’s initial Form 1 or Form 2 on the 

applicant’s Web site, because the Commission 

generally files the initial application on its own 

Web site when it publishes the applicant’s 

proposed rules for public comment.

303See supra Section II., relating to proposed new 

Rules 6a–5 and 15Aa–3 under the Exchange Act, 

and Section V., relating to proposed new Rule 17a–

26.

304For purposes of revised Form 1, the term 

‘‘facility’’ would have the same meaning as in 

Section 3(a)(2) of the Exchange Act, 15 U.S.C. 

78c(a)(2). For purposes of new Form 2, the term 

‘‘facility’’ would have the same meaning as in 

proposed Rule 15Aa–3(b)(11). See proposed 

Instructions to revised Form 1 and new Form 2.

305The term ‘‘SRO trading facility’’ would mean 

any facility of a national securities exchange or 

registered securities association that executes orders 

in securities. See proposed Instructions to revised 

Form 1 and new Form 2.

306The term ‘‘regulatory subsidiary’’ would be 

defined as any person that, directly or indirectly, 

is controlled by the exchange or association and 

provides, whether pursuant to contract, agreement 

or rule, regulatory services to or on behalf of the 

exchange or association. See proposed Instructions 

to revised Form 1 and new Form 2. For example, 

several SROs have delegated to one or more 

subsidiaries the responsibility to carry out certain 

functions arising out of the SRO’s obligations under 

the Exchange Act. Examples include BOXR, which 

is a wholly-owned options regulatory subsidiary of 

the BSE, and PCX Equities, a wholly-owned 

subsidiary of PCX. See, e.g., Securities Exchange 

Act Release Nos. 49065, supra note 80 and 44983, 

supra note 49.

307Therefore, the exchange or association must 

file as part of revised Form 1 or new Form 2 the 

information specified in various Exhibits with 

respect to any facility that is a separate legal entity 

and any regulatory subsidiary of the exchange or 

association. These Exhibits are Exhibits A, B, C, D, 

E, F, G, H, and I, which are discussed below.

308See supra note 64 and accompanying text.

309For a discussion of proposed Exhibits A and 

B to revised Form 1 and new Form 2, see Section 

IV.C.13.

310See Section II.B.2.a.

311See supra note 106 and accompanying text for 

the definition of ‘‘material relationship.’’

312See proposed Rules 6a–5 and 15Aa–3.

application and subsequent 

amendments thereto.

The Commission also proposes to 

amend Rules 6a–2, 15Aa–1, and 15Aj–

1 under the Exchange Act (and to 

redesignate Rule 15Aj–1 as Rule 15Aa–

2), as discussed below.301 Among other 

things, the proposed changes to these 

rules would require exchanges and 

associations to submit any amendments 

to revised Form 1 or new Form 2 on a 

more timely basis. Further, the 

proposals would mandate the posting of 

amendments to revised Form 1 and new 

Form 2 on the Internet Web site of the 

exchange or association.302

The following subsections will set 

forth the scope of the proposed 

disclosures required by revised Form 1 

and Form 2; describe those Exhibits to 

revised Form 1 and new Form 2 that 

would require enhanced disclosures; 

and discuss the current Exhibits to Form 

1 that the Commission proposed to 

retain in revised Form 1 (in the same or 

substantially the same for mat) and to 

incorporate into new Form 2.

1. Scope of Disclosures Required by 

Revised Form 1 and New Form 2

We propose to require more detailed 

information, and, in some cases, new 

information from exchanges and 

associations on revised Form 1 and new 

Form 2. These disclosures would 

supplement the Commission’s proposals 

to impose new substantive standards 

with respect to SRO governance, 

administration and ownership, and SRO 

reporting requirements.303

Further, the revisions to the 

registration forms for exchanges and 

associations also are intended to update 

and modernize the forms by taking into 

account new ways in which SROs are 

organized. Thus, the requirements of 

revised Form 1 and new Form 2 would 

be applicable to exchanges and 

associations, respectively, and also any 

‘‘facility’304 (including an ‘‘SRO trading 

facility’’) 305 of an exchange or 

association that is a separate legal 

entity, and any ‘‘regulatory 

subsidiary’’ 306 of an exchange or 

association.307 By expressly referring to 

a facility and regulatory subsidiary, the 

forms are intended to elicit complete 

information about the exchange or 

association. In our view, the trend in 

recent years of SROs to delegate to 

separate legal entities functions arising 

out of their obligations under the 

Exchange Act necessitates enhanced 

disclosure about those regulatory 

subsidiaries that perform the duties on 

behalf of an SRO. Moreover, an SRO 

trading facility may be contained in a 

separate entity and may be owned or 

operated by the SRO or another 

entity.308 The Commission notes that 

even if an SRO enters into an agreement 

or arrangement to delegate certain selfregulatory duties to a subsidiary, the 

SRO itself, and not the regulatory 

subsidiary, retains the ultimate 

responsibility and primary liability 

under the Exchange Act for selfregulatory failures. The SRO’s 

obligations under the Exchange Act 

extend to the operation and 

administration of any regulatory 

subsidiary.

Therefore, revised Form 1 and new 

Form 2 expressly would require 

exchanges and associations to provide 

information about any facility and 

regulatory subsidiary in various 

Exhibits. This disclosure should more 

fully inform market participants and the 

public of the structure and governance 

of exchanges and associations in today’s 

market environment and thus should 

help promote investor confidence in the 

administration of U.S. securities 

markets. 

2. Composition, Structure, and 

Responsibilities of the Board 

Proposed Exhibit C of revised Form 1 

and new Form 2 would require each 

exchange and association, respectively, 

to describe the composition, structure, 

and responsibilities of its board.309 This 

description would include a list of all 

directors who presently hold or have 

held their positions during the previous 

year, indicating each director’s name, 

title, dates of commencement and 

termination of term or position, and 

type of business in which the director 

is primarily engaged. This information 

currently is required by Exhibit J to 

Form 1 and would be incorporated into 

revised Form 1 and new Form 2.

The Forms also would require the 

identification of any board member who 

is an independent director and the basis 

for the affirmative determination that 

such board member is independent. The 

determination of whether a director is 

an ‘‘independent director’’ would be 

made according to the criteria set forth 

in proposed new Rules 6a–5(b)(12) and 

15Aa–3(b)(13).310 Exchanges and 

associations also would be required to 

provide a description of any affiliations 

or relationships that reasonably could 

affect the director’s judgment or 

decision-making as a director, i.e., 

whether the director has a material 

relationship 311 that would render the 

director ineligible to be considered an 

‘‘independent’’ director. The 

Commission notes that the proposed 

disclosures are intended to bolster the 

requirements of proposed Rules 6a–5 

and 15Aa–3 under the Exchange Act.312

The Commission further believes that 

such disclosures would aid market 

participants, investors, and the 

Commission in determining whether 

exchanges and associations are 

complying with the proposed 

requirement that their boards be 

composed of a majority of independent 

directors and in ascertaining any 

affiliations and relationships that would 

preclude directors from being 

considered independent.

In addition, if the board’s Chairman 

and CEO are the same person, the 

exchange or association would be 

required to indicate the director that is 

designated as the lead independent 

director. These disclosure items would 

correspond with the requirement in 

proposed Rules 6a–5(m)(3) and 15Aa–

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71157

313See supra Section II.B.7.

314See supra Section II.B.2.b.

315See supra Section II.B.7.

316See Sections 6(b)(1) and 15A(b)(2) of the 

Exchange Act, 15 U.S.C. 78f(b)(1) and 78o–3(b)(2).

317For example, the NYSE maintains a Board of 

Executives composed of representatives of 

members, significant investors, and listed 

companies. See NYSE Constitution, Article V, 

Section 2.

318See supra Section II.B.3. For purposes of 

proposed Rules 6a–5 and 15Aa–3, the term 

‘‘Standing Committees’ means the following 

committees of the board: Nominating Committee, 

Governance Committee, Compensation Committee, 

Audit Committee, and Regulatory Oversight 

Committee, or their equivalent.

319See 15 U.S.C. 78f (b) and 78o–3(b).

320 15 U.S.C. 78f and 78o–3.

321See supra Section II.B.10.

3(m)(3) that if a single individual serves 

as both Chairman and CEO, the board 

must designate an independent director 

as a lead director to preside over 

executive sessions of the board.313

Exhibit C also would require a 

discussion of the authority of the board, 

including any powers of the board to 

delegate its authority to management or 

any executive board or committee. 

Further, the exchange or association 

would have to describe the lines of 

authority between the Chairman and 

CEO (or between any lead independent 

director and the CEO, when the CEO is 

the Chairman). The Commission 

believes that such disclosure should 

provide market participants, investors, 

and the Commission with a better 

understanding of the administration of 

the exchange or association. 

Finally, Exhibit C of revised Form 1 

and new Form 2 would obligate the 

exchange or association to state the 

method for interested persons to 

communicate their concerns regarding 

any matter within the authority or 

jurisdiction of a Standing Committee 

directly to the independent directors. 

These disclosure items would 

correspond with the requirement in 

proposed Rules 6a–5(c)(9) and 15Aa–

3(c)(9) that the board establish a method 

for interested persons to communicate 

their concerns regarding any matter 

within the authority or jurisdiction of a 

Standing Committee directly to the 

independent directors.314 The proposed 

disclosure also would aid in 

implementing proposed Rules 6a–

5(m)(3) and 15Aa–3(m)(3), which would 

require that the board publicly disclose 

the lead director’s name and a means by 

which interested parties may 

communicate with the lead director.315

The Commission believes that requiring 

the disclosure of such processes would 

make more evident to market 

participants, investors, and the public 

the opportunity to communicate with 

independent directors and increase their 

understanding of the governance and 

administration of exchanges and 

associations.316

3. Composition, Structure, and 

Responsibilities of Committees and 

Executive Boards 

Proposed Exhibit E of revised Form 1 

and new Form 2 would require a 

description of the structure, 

composition, and responsibilities of any 

executive board or committee of the 

exchange or association (including 

board, non-board, and mixed board/

non-board committees and executive 

board committees).317 The description 

would include a list of members of any 

executive board and each committee, 

with identifying information that 

includes each member’s name, title, 

dates of term of office or position, and 

primary business, which is information 

currently required by Form 1 and would 

be incorporated into revised Form 1 and 

new Form 2. Exhibit E also would 

require disclosure of any affiliations or 

relationships that reasonably could 

affect the committee member’s 

independent judgment or decisionmaking. Further, this Exhibit to the 

Forms would require the submission of 

a chart illustrating the complete 

governance structure of the exchange or 

association and any facility or 

regulatory subsidiary of the applicant.

The Commission believes that 

requiring greater information about the 

governance structure of exchanges and 

associations would aid market 

participants, investors, and the public 

with greater insight into the manner in 

which the exchange or association is 

organized. Moreover, requiring 

identifying information about executive 

board directors and members of the 

committees of an exchange or 

association should aid market 

participants, investors, and the 

Commission in determining whether the 

executive board and committee 

members of exchanges and associations 

have any affiliations or relationships 

that could influence their judgment. 

Further, the Commission believes that 

requiring disclosure of the SRO’s 

complete governance structure in a 

chart would present important 

information in a clear format and thus 

assist investors and market participants 

in their understanding of the SRO’s 

organization from a governance 

perspective. 

In addition, the exchange or 

association would be required to 

provide a copy of the written charter of 

each Standing Committee of the 

exchange’s or association’s board. Under 

proposed Rules 6a–5 and 15Aa–3, each 

Standing Committee must have a 

written charter that sets forth the 

Committee’s purpose and 

responsibilities. In our view, requiring 

the disclosure of Standing Committee 

charters would prove useful to market 

participants, investors, and the public, 

because they could gain an 

understanding of the duties of key 

committees of exchanges and 

associations. The Commission further 

notes that this requirement would 

supplement the provisions of proposed 

Rules 6a–5 and 15Aa–3, which would 

require the Standing Committees of the 

boards of exchanges and associations to 

have written charters.318

In the Commission’s view, the 

disclosure requirements of Exhibit E 

would further the Exchange Act’s 

requirements for registration that 

exchanges and associations be so 

organized and have the capacity to carry 

out their statutory obligations.319

4. Governance 

a. Governance Guidelines. Exchanges 

and associations would have to provide 

as part of proposed Exhibit F to revised 

Form 1 and new Form 2 a copy of their 

governance guidelines and the 

governance guidelines of any regulatory 

subsidiary. We believe that requiring 

exchanges and associations to disclose 

their governance guidelines would 

further heighten SRO awareness of the 

need for good governance and help 

foster SROs’ compliance with their 

obligations under Sections 6 and 15A of 

the Exchange Act.320 Increased 

transparency also would aid market 

participants, investors and the public by 

providing them with greater knowledge 

of the governance guidelines of 

exchanges and associations. Further, the 

proposed disclosures would supplement 

the provisions under proposed Rules 6a5(q) and 15Aa-3(q), which would 

require exchanges and associations, 

respectively, to adopt governance 

guidelines and would set forth the 

minimum criteria that the governance 

guidelines would address.321

b. Code of Conduct and Ethics. 

Proposed Exhibit F to revised Form 1 

and new Form 2 would require 

exchanges and associations to file a 

copy of the code of conduct and ethics 

for directors, officers, and employees of 

the exchange or association. In addition, 

the exchange and association would be 

required to disclose any waivers of the 

code of conduct and ethics for directors, 

officers, or employees. The Commission 

believes that requiring disclosure of 

exchanges’ and associations’ codes of 

conduct and ethics should provide 

71158 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

322See supra Section II.B.10. 323See supra Section II.B.8.

324See, e.g., 15 U.S.C. 78f, 78o–3, and 78s.

325This requirement is part of Exhibit I to current 

Form 1.

326Exhibit B to current Form X–15AA–1 requires 

a securities association to provide a balance sheet 

within 30 days of the filing of the Form, together 

with an income and expense statement. The 

Commission believes that the proposed financial 

disclosure requirements set forth in proposed 

Exhibit I to revised Form 1 and new Form 2 would 

provide a more comprehensive view of the finances 

of an association and better aid the public and the 

Commission in their understanding of how the 

association would meet its obligations under 

Sections 15A and 19 of the Exchange Act. 15 U.S.C. 

78o–3 and 78s. Therefore, Exhibit B to current Form 

X–15AA–1 would not be retained in new Form 2.

market participants, investors, and the 

public with useful information about 

the ethical standards that these SROs 

have set for their directors, officers, and 

employees. In addition, disclosure of 

waivers of the code of conduct and 

ethics should give market participants, 

investors, the public, as well as 

regulators, the opportunity to evaluate 

the board’s performance with respect to 

adherence to the code of conduct and 

ethics and the circumstances under 

which it has determined to grant 

waivers. Further, the proposal would 

complement the requirements of 

proposed Rules 6a–5(p) and 15Aa–3(p), 

which would require exchanges and 

associations to adopt a code of conduct 

and ethics for directors, officers, and 

employees, and also would require the 

board or appropriate board committee to 

approve any waiver of the code of 

conduct and ethics.322

5. Organizational Charts 

Proposed Exhibit G to revised Form 1 

and new Form 2 would require 

exchanges and associations to submit a 

chart or charts illustrating fully the 

internal organizational structure of the 

exchange and association (and of any 

facility or regulatory subsidiary). The 

charts would need to indicate the 

internal divisions or departments, the 

responsibilities of each such division or 

department, and the reporting structure 

of each division or department, 

including its oversight by board 

committees or their equivalent. The 

charts should be sufficiently detailed to 

permit the Commission and the public 

to gain a complete understanding of the 

manner in which the exchange or 

association is structured and, along with 

the proposed governance chart 

requirement of Exhibit E, should be able 

to provide the Commission and the 

public with an overview of the SRO’s 

organizational and governance 

structure. The Commission believes that 

disclosure of these organizational charts 

would be an important means by which 

to provide market participants, 

investors, and regulators with a better 

understanding of the governance 

structure of exchanges and associations. 

6. Regulatory Program

Proposed Exhibit H to revised Form 1 

and new Form 2 would require 

exchanges and associations to describe 

fully their regulatory programs. The 

description would include information 

such as member firm regulation, market 

surveillance, enforcement, listing 

qualifications, arbitration, rulemaking 

and interpretation, as well as the 

process for assessment and development 

of regulatory policy. Exchanges and 

associations would be required to 

submit a copy of any delegation plan or 

other contract or agreement relating to 

regulatory services that are provided to 

the exchange or association by a 

regulatory subsidiary of the exchange or 

association, another SRO, or a 

regulatory subsidiary of another SRO. 

The Commission believes that such 

enhanced transparency from an 

exchange or association would better 

inform market participants and 

investors about the exchange’s or 

association’s regulatory program. 

Moreover, such disclosure would aid 

the Commission in its oversight and 

evaluation of the exchange’s and 

association’s compliance with Exchange 

Act provisions. 

Further, Exhibit H would require a 

description of the independence of the 

regulatory program from the market 

operations or other commercial interests 

of the exchange or association. The 

proposed disclosure is intended to 

provide transparency in connection 

with substantive requirements set forth 

in proposed new Rules 6a–5(n) and 

15Aa–3(n), which would require 

exchanges and associations to establish 

standards and procedures to provide for 

the independence of their regulatory 

programs from their market operations 

or other commercial interests.323

In addition, each exchange and 

association would be required to discuss 

fully any new material regulatory issues 

that have arisen or any material events 

that have taken place in the past year, 

including any technology or trading 

issues, that relate to or otherwise may 

affect the exchange’s or association’s 

regulatory responsibilities or the 

operation of its regulatory program. The 

Commission believes that the discussion 

of such issues or events would be 

focused on those issues and events that 

would be considered by the exchange or 

association to be material to an 

assessment of the overall effectiveness 

of the regulatory program. Exhibit H 

would require exchanges and 

associations to discuss the effect these 

material issues or events may have on 

the mission, strategy, and future 

operations of the exchange’s or 

association’s regulatory program. 

Exchanges and associations also would 

be required to discuss generally any 

material changes that are planned for 

their regulatory programs. The 

Commission expects that the discussion 

would center on those changes that 

would impact the exchange’s or 

association’s regulatory program and its 

ability to fulfill its regulatory obligations 

under the Exchange Act. 

The Commission believes that 

mandating enhanced disclosure 

regarding exchanges’ and associations’

regulatory programs would substantially 

facilitate the ability of the Commission 

and the public to assess the strengths 

and vulnerabilities of these programs. 

The Commission further believes that 

requiring exchanges and associations to 

provide details concerning their 

regulatory programs would enable 

regulators to conduct more effective 

oversight of these SROs’ compliance 

with their obligations under the 

Exchange Act. In addition, requiring 

disclosure of an exchange’s or 

association’s regulatory program and its 

self-analysis of regulatory issues could 

help an exchange or association to focus 

on its capability to meet its statutory 

obligations under the Exchange Act 324

and to pursue necessary changes and 

improvements in its regulatory program.

7. Audited Financial Statements and 

Other Financial Information 

Proposed Exhibit I to revised Form 1 

would retain the current requirement 

that exchanges include audited financial 

statements for the applicant’s latest 

fiscal year, which are prepared in 

accordance with (or in the case of a 

foreign applicant, reconciled with) U.S. 

generally accepted accounting 

principles.325 We are proposing to 

incorporate this requirement in new 

Form 2.326 In the Commission’s view, 

the financial statement requirements 

currently imposed on exchanges should 

be applied to associations as well 

because, under the statutory framework, 

the obligations of exchanges and 

associations are nearly parallel. In 

addition, the exchange or association 

would be required to file audited 

financial statements for any facility of 

an exchange or association that is a 

separate legal entity and for any 

regulatory subsidiary.

Moreover, Exhibit I to these Forms 

would specify that the audited financial 

statements would need to be prepared 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71159

327The term ‘‘registered public accounting firm’’

would have the same meaning as under Section 

2(a)(12) of the Sarbanes-Oxley Act of 2002, 15 

U.S.C. 7201(a)(12). Currently, Exhibit I to Form 1 

contains the requirement that audited financial 

statements for an exchange be covered by a report 

prepared by an independent public accountant.

328See infra Section IV.C.13.d. for a discussion of 

Exhibit J to revised Form 1 relating to financial 

statements of affiliates.

329For example, Sections 6(b)(4) and 15A(b)(5) of 

the Exchange Act require that the rules of 

exchanges and associations provide for the 

equitable allocation of reasonable dues, fees, and 

other charges among its members and issuers and 

other persons using its facilities. 15 U.S.C. 78f(b)(4) 

and 78o–3(b)(5).

330See Sections 6(b)(1) and 15A(b)(2) of the 

Exchange Act, 15 U.S.C. 78f(b)(1) and 78o–3(b)(2).

by a registered public accounting 

firm.327 This requirement mirrors a 

standard recently imposed on reporting 

issuers, and conforms to existing Form 

1 by retaining the requirement that 

exchanges include audited financial 

statements for the applicant’s latest 

fiscal year.328 The Commission believes 

that disclosure of audited financial 

statements would permit market 

participants, investors, and the 

Commission to better understand the 

financial resources and decisions of 

exchanges and associations, so as to 

determine whether they continue to 

comply with their obligations under the 

Exchange Act.329

Exhibit I to revised Form 1 and new 

Form 2 also would require exchanges 

and associations to provide more 

detailed financial information as a 

means to supplement the financial 

information SROs currently are required 

to provide. Under the proposal, the 

following categories of financial 

information would be required for the 

current fiscal year, and would need to 

be compared to the same figures for the 

prior fiscal year and estimated figures 

for the next fiscal year. 

a. Budget and Revenues Devoted to 

Regulatory Activities. We propose to 

require exchanges and associations to 

disclose their regulatory expenses as a 

proportion of their total budget, and 

separately as a proportion of their total 

annual revenues. Pursuant to this 

provision, exchanges and associations 

would be required to disclose the 

aggregate amounts that they expend on 

regulatory activities, as well as the 

amounts that they expend on certain 

subcategories of regulatory activities, 

including supervisory activities (e.g.,

routine examinations and oversight of 

member activity conducted in the 

regular course of business), surveillance 

activities (e.g., manual and automated 

surveillance to ensure compliance with 

rules, such as trading rules and financial 

responsibility rules), and disciplinary 

activities (e.g., enforcement activities). 

We propose to require the disclosure of 

this financial data, in part, to allow the 

Commission and the public to assess 

more fully the adequacy of the resources 

devoted by exchanges and associations 

to their regulatory programs and how 

these financial determinations affect 

their capacity to be able to carry out the 

purposes of the Exchange Act.330

b. Revenues and Expenses. Proposed 

Exhibit I to revised Form 1 and new 

Form 2 would require exchanges and 

associations to disclose the dollar 

amount of their revenues and expenses 

of their regulatory programs, with 

detailed itemization within the 

following broad categories: revenues; 

direct expenses; and allocated expenses. 

Exchanges and associations should 

provide this information for each area of 

their regulatory programs, such as 

surveillance, supervision, and 

discipline, and provide aggregate data 

for all program areas. The Commission 

believes that these uniform categories 

would provide useful information to 

market participants, investors, and the 

Commission by relaying an overview of 

the finances of exchanges and 

associations that are related to 

regulatory programs. 

Each itemized category of revenue or 

expense should be accompanied by a 

description that permits an objective 

assessment of the nature of the revenues 

or expenses included within each 

category, annotated as appropriate. 

Proper descriptions of the itemized 

categories are especially important 

given the variation currently among the 

exchanges and the NASD in the way 

they report their itemized financial 

information. For example, an exchange 

or association should specify the 

underlying components or otherwise 

provide a description of the nature of an 

item labeled ‘‘member technology fees’’

to allow a complete understanding of 

the scope of that item.

Each of the three broad categories 

(revenues, direct expenses, and 

allocated costs) should be subdivided 

and itemized as specified in Exhibit I, 

and at a minimum, would have to 

include the items specified in Exhibit I 

to revised Form 1 and new Form 2. With 

respect to revenues, the Commission 

proposes to require exchanges and 

associations to provide general 

information on the main categories of 

revenues that are reported by exchanges 

and associations. To the extent that an 

exchange or association does not report 

a category of revenue that would be 

required by the Exhibit, the exchange or 

association should note this fact. 

In particular, Exhibit I would require 

exchanges and associations to disclose 

revenues by fee categories, including 

regulatory fees, transaction and 

transaction services fees, and market 

information fees. The Commission notes 

that the category of ‘‘regulatory fees’’

would include all fees charged and 

earned by an exchange or association, 

including all member dues and 

assessments, that are assessed for the 

purpose of funding the operation of the 

exchange’s or association’s regulatory 

program. Exchanges and associations 

would be required to itemize, by 

category, all such regulatory fees. 

Disclosure of this information should 

allow market participants, investors, 

and the Commission to better assess the 

adequacy of the funding sources 

supporting an exchange’s or 

association’s regulatory program. 

In addition, Exhibit I would require 

exchanges and associations to disclose 

other member dues and assessments not 

used for the purpose of funding 

regulation, as well as their transaction 

fees, transaction services fees, trading 

privileges fees, and similar fees. As with 

the regulatory fees, these member dues, 

transaction fees, and trading fees would 

need to be itemized by category. Exhibit 

I also would require exchanges and 

associations to disclose their revenues 

earned from market information fees, 

including market data fees, itemized by 

product. The proposed disclosure of this 

information would provide market 

participants, the public, and the 

Commission with an understanding of 

the other primary sources of revenue for 

exchanges and associations and, in 

particular, would permit the assessment 

of the relative adequacy of an 

exchange’s or association’s expenditures 

on its regulatory program as a 

proportion of its overall revenues. 

Exhibit I also would require the 

disclosure of other categories of 

revenue, along with a general catch-all 

category. In particular, exchanges and 

associations would need to detail their 

revenues from fines and penalties 

resulting from disciplinary and 

enforcement actions, fees paid by 

issuers, including listing fees and issuer 

services, and investments of the 

exchange or association, including 

dividend and interest income. With 

respect to the ‘‘other revenues’’ catch-all 

category, an exchange or association 

would be required to itemize and 

footnote the amount disclosed to allow 

market participants, investors, and the 

Commission to obtain an understanding 

of the nature of the categories that 

comprise the ‘‘other revenues’’ category. 

The disclosure of these additional 

categories of revenue would allow 

market participants, investors, users of 

the SRO’s facilities, the public and the 

71160 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

331The exhibit would not require exchanges and 

association to identify their senior regulatory 

personnel by name in the compensation schedule, 

though identification according to position would 

be necessary to complete the schedule. 332 15 U.S.C. 78f, 78o–3, and 78s.

Commission to obtain a more complete 

understanding of an exchange’s or 

association’s total annual revenues, 

thereby permitting them to assess the 

adequacy of the exchange or 

association’s resources devoted to 

fulfilling self-regulatory responsibilities. 

Exhibit I would require exchanges 

and associations to disclose direct and 

allocated expenses that are incurred in 

connection with their regulatory 

activities. Direct expenses refer to the 

amounts an exchange or association 

spends on its regulatory department or 

unit as well as amounts expended in the 

performance of its regulatory activities, 

while allocated expenses refer to the 

portion of expenses incurred by nonregulatory personnel and systems which 

are attributed by the exchange or 

association, in whole or in part, to the 

performance of regulatory activities. The 

disclosure of this information would 

allow market participants, investors, 

users of the SRO’s facilities, and the 

Commission to ascertain expenditures 

by an exchange or association on 

regulatory activities and compare those 

expenditures with the exchange’s or 

association’s revenues generally. The 

Commission stresses, however, that the 

amount spent by an exchange or 

association on its regulatory programs is 

not, by itself, an indication of the 

quality of the exchange’s or 

association’s regulatory program. 

Rather, an exchange’s or association’s 

expenditures relating to its regulatory 

program is only one factor that the 

Commission considers in assessing the 

overall adequacy of the SRO’s regulatory 

program. 

With respect to direct expenses, an 

exchange or association would be 

required to disclose the expenses it 

incurs in connection with its 

supervision of members, surveillance 

activities, and disciplinary activities. 

Specifically, Exhibit I would require 

exchanges and associations to disclose 

the aggregate personnel costs for their 

regulatory employees, including 

compensation and benefits, as well as 

provide compensation schedules for the 

Chief Regulatory Officer and all other 

senior regulatory personnel.331 The 

Commission expects that these 

compensation schedules would include 

all forms of compensation including 

base compensation, bonuses, and 

benefits. In addition, exchanges and 

associations would be required to 

disclose expenses associated with 

training programs relating to the 

regulatory function of the exchange or 

association. Market participants, 

investors, users of the SRO’s facilities, 

and the Commission could use this 

information to assess the level of 

compensation that is part of the SRO’s 

regulatory budget, as well as the 

resources devoted to training the 

exchange’s or association’s regulatory 

personnel.

In addition, exchanges and 

associations would be required to 

disclose certain expenses that they incur 

in connection with regulatory services, 

including all expenses in connection 

with routine and for-cause 

examinations, investigations, and 

enforcement actions, with each category 

reported separately. As the Commission 

proposes that the expense categories to 

be disclosed in Exhibit I would be 

mutually exclusive, for clarity’s sake, 

the Commission believes that this 

category should include expenses 

incurred that are not already reported 

under another category, such as 

personnel expenses. The reporting of 

this information would allow market 

participants, investors, users of the 

SRO’s facilities, and the Commission to 

assess the adequacy of resources 

devoted by an exchange or association 

to its examination, investigatory and 

disciplinary regulatory activity. 

Similarly, Exhibit I would require the 

disclosure of information technology 

expenses, broken down by categories 

including data center costs, systems 

hardware and software, systems 

consultant fees, and electronic 

surveillance systems. The information 

technology expenses to be disclosed 

under this provision would include 

automated surveillance and information 

technology support provided to 

regulatory personnel. To the extent an 

exchange or association has entered into 

a contract or agreement with a 

regulatory subsidiary or another SRO to 

provide regulatory services to or on 

behalf of the exchange or association, 

the Commission believes that the costs 

associated with the contract or 

agreement should be disclosed 

separately. Finally, with respect to 

direct expenses, Exhibit I would require 

an exchange or association to disclose 

its occupancy and other overhead 

expenses, all professional services, such 

as independent auditors or attorneys, 

any depreciation and amortization, and 

any other expenses itemized as 

appropriate. 

For allocated regulatory expenses 

incurred by non-regulatory departments 

that directly involve or relate to an 

exchange’s or association’s regulatory 

function, the Commission proposes to 

require exchanges and associations to 

disclose several basic categories in 

sufficient detail to allow market 

participants, investors, users of the 

SRO’s facilities, and the Commission to 

assess the nature and extent of 

regulatory activities performed by nonregulatory personnel or groups. 

Specifically, Exhibit I would require 

exchanges and associations to disclose 

personnel expenses, based on a stated 

percentage of employee hours devoted 

to regulation-related activities, as well 

as information technology expenses, 

occupancy and other overhead 

expenses, and other allocated costs 

including, but not limited to, legal fees 

related to regulatory activities and 

expenses of regulatory and business 

conduct committees. 

Exchanges and associations also 

would be required to provide an 

itemization of their non-regulatory 

expenditures, including, but not limited 

to, personnel expenses, program 

expenses, systems and other technology 

expenses, consultants and advisors, and 

overhead. The disclosure of nonregulatory expenditures would provide 

market participants, investors, users of 

the SRO’s facilities, and the 

Commission with a frame of reference 

against which they could consider an 

exchange’s or association’s regulatory 

expenditures as a portion of the 

exchange’s or association’s other 

expenses when using the information to 

assess the exchange’s or association’s 

regulatory expenditures devoted to 

fulfilling its self-regulatory 

responsibilities. 

The purpose of the proposed financial 

disclosure requirements relating to an 

exchange’s or association’s regulatory 

program is to provide enhanced 

transparency of the regulatory and nonregulatory revenues and expenses of 

exchanges and associations. 

Accordingly, market participants, 

investors, users of the SRO’s facilities, 

and the public generally, as well as the 

Commission, would be able to better 

assess, among other things, the 

adequacy of resources devoted by an 

SRO to its regulatory program and the 

way in which the exchange or 

association has utilized those resources. 

The assessment would be useful to the 

Commission and others in determining 

whether the exchange or association is 

meeting its obligations under Sections 6, 

15A, and 19 of the Exchange Act, among 

other statutory provisions, and the rules 

thereunder and enforcing compliance by 

its members with the Exchange Act and 

rules thereunder and the SRO’s own 

rules. 332 The proposed disclosures 

relating to regulatory revenue, in 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71161

333See, e.g., Sections 6(b)(1), 6(b)(5), 15A(b)(2) 

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

78f(b)(1), 78f(b)(5), 78o–3(b)(2) and 78o–3(b)(6).

334This requirement is similar to disclosure 

requirements imposed on registered companies 

pursuant to Item 303 of Regulation S–K, 17 CFR 

229.303; however, the Commission has tailored the 

proposed requirement to the operations of 

exchanges and associations. The Commission 

believes that requiring similar disclosure about an 

exchange’s or association’s financial condition 

would help the Commission and the public to 

determine whether the SRO has the capacity to be 

able to carry out the purposes of the Exchange Act. 

See Sections 6(b)(1) and 15A(b)(2) of the Exchange 

Act, 15 U.S.C. 78f(b)(1) and 78o–3(b)(2).

335See id.

336See id.

337The term ‘‘immediate family member’’ would 

mean a person’s spouse, parents, children, and 

siblings, whether by blood, marriage, or adoption, 

or anyone residing in such person’s home. See

proposed Instructions to revised Form 1 and new 

Form 2.

338See Item 404(a) of Regulation S–K, 17 CFR 

229.404(a). See also NASD Rule 4350(h) (defining 

‘‘related party transactions’’ as transactions required 

to be disclosed pursuant to Regulation S–K).

339See proposed Rules 6a–5(c)(i) and 15Aa–

3(c)(i).

340See supra note 334.

341See Item 402 of Regulation S–K, 17 CFR 

229.402.

particular those relating to regulatory 

fees, fines and penalties, and to 

regulatory expenses, should help the 

Commission review an exchange’s or 

association’s compliance with the 

requirements in proposed Rules 6a–

5(n)(4) and 15Aa–3(n)(4) that an 

exchange or association use monies 

received from regulatory fees, fines, or 

penalties only to fund the regulatory 

operations of the exchange or 

association.

c. Other Financial Disclosures. The 

Commission also proposes to require 

disclosure of a number of additional 

items relating to the financial condition 

of an exchange or association (and any 

separate facility or regulatory 

subsidiaries). In many cases, these 

disclosures are modeled on those 

disclosure requirements applicable to 

reporting issuers. The Commission 

believes that similar transparency with 

respect to exchanges and associations 

would provide market participants, 

investors, members of the public, and 

the Commission with greater knowledge 

to permit an assessment of how 

specified financially-related matters 

could impact an exchange’s or 

association’s performance of its 

statutory obligations to oversee its 

members and facilities. 333

First, proposed Exhibit I would 

require a discussion of information 

necessary to an understanding of the 

financial condition of the exchange or 

association and any material changes in 

its financial condition. 334 Exchanges 

and associations also would be required 

to disclose all charitable contributions 

of the applicant (whether made directly 

or indirectly) in excess of $1,000 to a 

charity in which an executive officer or 

director of the applicant, or any of their 

immediate family members, is an 

executive officer or director of the 

charity. This proposed requirement 

would enable market participants, users 

of the exchange’s or association’s 

facilities, the public, and the 

Commission to be apprised of larger 

charitable donations where there is a 

nexus between officers and directors of 

the exchange or association, and officers 

and directors of the charitable 

organization.

Further, under Exhibit I, the exchange 

or association would have to 

incorporate a discussion of any unusual 

or infrequent events or transactions or 

any significant economic changes that 

have had a material effect on the 

financial condition of the exchange or 

association, and any known demands, 

commitments, events or uncertainties 

that would result in or are reasonably 

likely to result in a material change in 

financial condition. 335 The discussion 

should focus on events and 

uncertainties known to management 

that would cause reported financial 

information not to be necessarily 

indicative of future financial condition.

The Commission also would require a 

description of any significant business 

development involving the exchange or 

association, including a reorganization, 

merger or consolidation, acquisition or 

disposition of significant assets, or any 

other material change in business or 

operations. 336

In addition, proposed Exhibit I would 

require exchanges and associations to 

describe all material contracts and all 

material related party transactions. In 

this context, material contracts and 

related party transactions would be 

those to which the exchange or 

association, and any facility or 

regulatory subsidiary is a party; any 

director, nominee for director, officer, 

member, lessee, or any immediate 

family member 337 of any of the 

foregoing persons is also a party; and 

either the amount involved exceeds 

$60,000 or it is not a contract made in 

the ordinary course of business of the 

exchange or association and any facility 

or regulatory subsidiary. The 

Commission notes that these proposals 

regarding material contracts and related 

party transactions, and the $60,000 

minimum amount triggering disclosure, 

is consistent with the requirement for 

listed companies in Item 404 of 

Regulation S–K. 338 The Commission 

believes that similar required 

disclosures for exchanges and 

associations should help the 

Commission and the public in assessing 

an exchange’s or association’s 

compliance with the proposed 

requirements in Rules 6a–5 and 15Aa–

3 that the board of an exchange or 

association be composed of a majority of 

independent directors.339 Such 

disclosures should aid the Commission 

and the public in the determination of 

whether a director is independent.

Further, Exhibit I would require a 

description of the material 

commitments of the exchange or 

association for expenditures as of the 

end of the latest fiscal period, and 

indicate the general purpose of such 

commitments and the anticipated 

source of funds needed to fulfill such 

commitments.340

Finally, Exhibit I would require the 

submission of a table detailing the 

compensation of the exchange’s or 

association’s top five most highly 

compensated executives, disclosed in a 

manner consistent with the table 

required of reporting companies.341 The 

mandated disclosure would include all 

compensation (including perquisites) 

and would be presented in a table 

comparable to that required of public 

companies. In addition, Exhibit I would 

require a description of the material 

terms of the employment agreements of 

the five most highly compensated 

executives of the applicant and would 

require the exchange or association to 

provide a description of the 

compensation provided to members of 

its board. In the Commission’s view, the 

information presented in the 

compensation table regarding the SRO’s 

five most highly compensated 

executives, the description of the 

material terms of their employment 

contracts, and the description of the 

compensation provided to members of 

the SRO’s board of directors would 

prove useful to the Commission and the 

public in determining whether the 

compensation accorded to directors and 

executives appears reasonable or 

presents conflicts of interest that may 

impact the SRO’s capacity to carry out 

the purposes of the Exchange Act and 

rules thereunder and the SRO’s own 

rules.

The Commission believes that all of 

the financial and other related 

disclosures proposed to be disclosed as 

part of proposed Exhibit I should assist 

the Commission and the public in 

assessing the vigor of the regulatory 

programs of exchanges and associations. 

As SROs, exchanges and associations 

have been accorded a public trust to 

oversee their members and, when they 

71162 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

342See Sections 6(b)(1), 6(b)(5), 15A(b)(2) and 

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

78f(b)(5), 78o–3(b)(2) and 78o–3(b)(6). 343See supra note 230 for the proposed definition 

of the terms ‘‘affiliate’’ and ‘‘control.’’ 344See Items 1, 2 and 3 of proposed Exhibit P to 

revised Form 1 and new Form 2. 345 15 U.S.C. 78l. 346See Items 4 and 5 of proposed Exhibit P to 

revised Form 1 and new Form 2. 347See Item 6 of proposed Exhibit P to revised 

Form 1 and new Form 2.

348See Item 7 of proposed Exhibit P to revised 

Form 1 and new Form 2.

349 15 U.S.C. 78f and 78o–3.

350Currently, Exhibit K to Form 1 requires certain 

disclosures from exchanges that have one or more 

owners, shareholders, or partners that are also not 

members of the exchange, including general 

information about persons owning 5% or more of 

the ownership interest in the exchange. Proposed 

Exhibit Q to revised Form 1 and new Form 2 is 

intended to solicit more detailed and relevant 

disclosure about significant owners from all 

exchanges and associations.

351 15 U.S.C. 78m(d) and (g).

352See Securities Exchange Act Release Nos. 

37403 (July 3, 1996), 61 FR 36521 (July 11, 1996) 

and 26598 (March 6, 1989), 54 FR 10552 (March 14, 

1989).

353See Item 1 of proposed Exhibit Q to revised 

Form 1 and new Form 2.

354The term ‘‘Related Persons’’ is proposed to be 

defined in the Instructions to revised Form 1 and 

new Form 2 to mean (1) with respect to any member 

of the exchange or association that is a broker or 

dealer, any related person as defined in Rules 6a–

5 or 15Aa–3 under the Exchange Act; or (2) with 

respect to any other person: (a) Any affiliate of such 

person and (b) in the case of a person that is a 

natural person, any immediate family member of 

such person, or any immediate family member of 

such person’s spouse, who, in each case, has the 

same home as such person or who is a director or 

officer of the Disclosure Entity or any of its parents 

or subsidiaries. See also supra Section II.B.9.

355Proposed Item 6 of Exhibit Q to revised Form 

1 and new Form 2 would require that for each 

Disclosure Entity that is a partnership, the exchange 

or association provide a list of all general partners 

operate markets, remove impediments 

to and perfect the mechanism of a free 

and open market and a national market 

system and protect investors and the 

public interest, among other 

requirements.342 Requiring greater 

disclosure of financial and other 

information about the regulatory 

programs of exchanges and associations 

should enable market participants, 

investors, and the Commission to more 

easily ascertain how well SROs abide by 

their statutory responsibilities. For these 

reasons, the Commission has 

determined to propose these enhanced 

disclosures of financial and other 

related information by exchanges and 

associations.

8. Relationship Between SROs, 

Facilities, and Their Affiliates 

Proposed Exhibit P to revised Form 1 

and new Form 2 would require 

exchanges and associations to provide 

an organizational chart showing the 

relationship between and among the 

exchange or association, any facility of 

the exchange or association, and any 

affiliate of the exchange, association, or 

facility of the exchange or 

association.343 Exhibit P to revised Form 

1 and new Form 2 also would require 

disclosure about the nature and 

organizational structure of the exchange, 

association, any facility, and any 

affiliate, including legal name, form of 

organization, and ownership 

structure.344

Exchanges and associations would be 

required to further disclose whether the 

exchange, association, facility or 

affiliate is a reporting issuer under 

Sections 12 of the Exchange Act,345 and 

whether it is registered with the 

Commission as a broker or dealer, 

investment adviser, or otherwise.346

Information also would be required 

concerning whether and how any 

facility or affiliate possesses the power, 

directly or indirectly, to direct or cause 

the direction of the management and 

policies of the exchange or association, 

whether through ownership of voting 

securities, by contract, or otherwise.347

In addition, Exhibit P would require 

that exchanges and associations provide 

a description concerning the ability of 

any facility or affiliate to exert any 

influence over the exchange’s or 

association’s regulatory 

responsibilities.348

In view of the trend toward 

demutualization of SROs, and the 

increased competitive pressures under 

which all SROs operate, the 

Commission believes that the 

disclosures required in Exhibit P should 

provide relevant information to the 

public and the Commission about the 

relationships among exchanges, 

associations, their facilities and their 

respective affiliates, so that the public 

and Commission might better evaluate 

how exchanges and associations fulfill 

their statutory responsibilities under 

Sections 6 and 15A of the Exchange 

Act.349 In today’s rapidly evolving 

marketplace, the disclosures proposed 

to be required in Exhibit P should 

provide greater transparency regarding 

the relationships among SROs, their 

facilities, and their affiliates, and 

whether those entities have the ability 

to control the SRO, thus enabling 

members, market participants, investors, 

and the Commission to more readily 

monitor the effectiveness and 

performance of SROs and promote 

greater accountability by SROs with 

respect to their Exchange Act 

obligations to comply with, and enforce 

compliance by their members with, 

their rules and the federal securities 

laws.

9. Ownership

Proposed Exhibit Q to revised Form 1 

and new Form 2 would require that 

exchanges and associations provide 

enhanced disclosures describing any 

class or series of outstanding securities 

or other ownership interest of the 

exchange, association, or a facility of the 

exchange or association (each would be 

defined as a ‘‘Disclosure Entity’’), and 

information on persons owning more 

than 5% of such class of securities or 

other ownership interest and the nature 

and extent of such ownership.350 The 

5% reporting threshold and the 

information proposed to be required to 

be disclosed about such ownership is 

modeled on the beneficial ownership 

reporting requirements of the Williams 

Act, embodied in Sections 13(d) and 

13(g) of the Exchange Act and the rules 

and regulations thereunder.351 These 

Exchange Act provisions are intended to 

provide information to the issuer and 

the marketplace about accumulations of 

securities that may have the potential to 

change or influence control of an 

issuer.352 Similarly, the intent of the 

proposed disclosure requirements in 

proposed Exhibit Q to revised Form 1 

and new Form 2 is to provide the 

Commission, members of an exchange 

or association, persons who trade on the 

facilities of an exchange or association, 

investors, and the SRO itself, more 

detailed information about which 

persons or certain groups of persons 

potentially could control or influence 

the SRO.

To begin, proposed Item 1 of Exhibit 

Q would require exchanges and 

associations to provide a description of 

each class or series of outstanding 

securities or other ownership interest 

(including debt) of each Disclosure 

Entity that includes: (1) The title of the 

class of securities or other ownership 

interest; (2) the total number of 

securities or other ownership interests 

issued and outstanding; (3) any 

restrictions on ownership, voting, 

transfers, or other disposition of such 

securities or other ownership interest; 

(4) if the securities are publicly traded, 

the market(s) where they trade; and (5) 

any other material information relating 

to ownership of the Disclosure Entity.353

Further, pursuant to proposed Item 2 

of Exhibit Q, exchanges and associations 

would be required to provide certain 

information with regard to any person 

(alone or together with its Related 

Persons 354) that directly or indirectly 

beneficially owns more than 5% of any 

class of securities or other ownership 

interest in a Disclosure Entity (‘‘5% 

Owner’’).355 Background details would 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71163

and those limited and special partners that have the 

right to receive upon dissolution, or have 

contributed, more than 5% of the partnership’s 

capital. 

The term ‘‘beneficially owns’’ is proposed to be 

defined to have the same meaning, with respect to 

any security or other ownership interest, as set forth 

in Rule 13d–3 under the Exchange Act, as if (and 

whether or not) such security or other onwership 

interest were a voting equity security registered 

under Section 12 of the Exchange Act; provided 

thatto the extent any person beneficially owns any 

security or other ownership interest solely because 

such person is a member of a group within the 

meaning of Section 13(d)(3) of the Exchange Act, 

such person shall not be deemed to beneficially 

own such security or other ownership interest for 

purposes of Form 1 or Form 2, unless such person 

has the power to direct the vote of such security or 

other ownership interest. See proposed Instructions 

to revised Form 1 and new Form 2 and supra note 

226.

356See Items 2.a. and 2.b. of proposed Exhibit Q 

to revised Form 1 and new Form 2.

357For purposes of making this percentage 

determination, a class of securities would be 

deemed to consist of the amount of the outstanding 

securities of such class, exclusive of any securities 

held by or for the Disclosure Entity (the issuer), or 

a subsidiary of the Disclosure Entity. See Item 4 of 

Exhibit Q to revised Form 1 and new Form 2.

358See Items 2.c.i. of proposed Exhibit Q to 

revised Form 1 and new Form 2.

359See Items 2.c.ii. of proposed Exhibit Q to 

revised Form 1 and new Form 2. A listing of the 

shareholders of an investment company registered 

under the Investment Company Act of 1940 or the 

beneficiaries of an employee benefit plan, pension 

fund or endowment fund would not be required.

360See Item 3.c. of proposed Exhibit Q to revised 

Form 1 and new Form 2.

361See Item 5 of proposed Exhibit Q to revised 

Form 1 and new Form 2.

362See Item 7 of proposed Exhibit Q of revised 

Form 1 and new Form 2.

363See id.

364See proposed Rules 6a–5(o)(5) and 15Aa–

3(o)(5) and discussion in Section II.B.9.

365 15 U.S.C. 78f(b)(1) and 78o–3(b)(2).

be required to be provided about any 

such person, including their name, 

address, place of organization (for 

corporations), principal business or 

occupation, and whether the person is 

an officer or director of the Disclosure 

Entity.356

Furthermore, for each person that is a 

5% Owner, proposed Item 2.c. of 

Exhibit Q would require the exchange or 

association to state the aggregate 

number and percentage of shares of a 

class of securities or ownership interest 

of such security that are beneficially 

owned.357 In addition, the exchange or 

association would be required to 

indicate the aggregate number of shares 

or ownership interest as to which there 

is sole power to vote or to direct the 

vote, shared power to vote or to direct 

the vote, sole power to dispose or to 

direct the disposition, or shared power 

to dispose or to direct the 

disposition.358 If any other person is 

known to have the right to receive or the 

power to direct the receipt of dividends 

from, or the proceeds from the sale of, 

such securities or other ownership 

interest, a statement to that effect would 

need to be included, and if such interest 

related to more than 5% of the class, 

such person would need to be 

identified.359 Pursuant to proposed Item 

3 of Exhibit Q, the exchange or 

association would be required to 

separately identify each Related Person 

whose ownership in the Disclosure 

Entity is included in the calculation of 

beneficial ownership required to be 

disclosed pursuant to proposed Item 2 

of Exhibit Q, and provide the same 

ownership information as for the 

original person as would be required by 

proposed Item 2.c. of Exhibit Q. The 

exchange or association also would be 

required to disclose if the Related 

Person is an officer or director of the 

Disclosure Entity.360

The Commission notes that the 

proposed disclosure relating to 

ownership in an exchange, association, 

or a facility of an exchange or 

association would cover both direct and 

indirect ownership. Thus, if the 

exchange or facility were owned by a 

holding company, the exchange or 

association would be required to 

provide ownership information with 

regard to any person, alone or together 

with its related persons, that owned 

more than 5% of the holding company. 

The Commission emphasizes that the 

exchange’s or association’s 

responsibility to provide any disclosure 

pursuant to proposed Exhibit Q to 

revised Form 1 or new Form 2 would be 

independent of the obligation of any 

person to file with the Commission, and 

provide to the issuer, a Schedule 13D or 

13G. Therefore, an exchange or 

association would be required to 

undertake its own due diligence to 

obtain and provide to the Commission 

the information that would be required 

by proposed Items 2 and 3 of Exhibit Q. 

An exchange or association also 

would be required to state whether and 

how the 5% Owner, alone or with any 

Related Persons, possesses the power, 

directly or indirectly, to direct or cause 

the direction of the management or 

policies of the Disclosure Entity, 

whether through ownership of voting 

securities, by contract, or otherwise (i.e.,

whether they have ‘‘control’’).361

Finally, exchanges and associations 

would be required to describe any 

contracts, arrangements, understandings 

or relationships (legal or otherwise) 

among the persons and Related Persons 

identified in Exhibit Q, and between 

such persons and any other person, with 

respect to any securities or other 

ownership interest of the Disclosure 

Entity, including but not limited to 

transfer or voting of any of the securities 

or other ownership interest, finder’s 

fees, joint ventures, loan or option 

arrangements, put or calls, guarantees of 

profits, division of profits or loss, or the 

giving or withholding of proxies, and to 

name the persons with whom such 

contracts, arrangements, understandings 

or relationships have been entered 

into.362 The description also would be 

required to include such information for 

any of the securities or other ownership 

interest that are pledged or otherwise 

subject to a contingency the occurrence 

of which would give another person 

voting power or investment power over 

such securities or other ownership 

interest. However, disclosure of 

standard default and similar provisions 

contained in loan agreements would not 

be necessary.363

In order to more easily obtain this 

information, proposed Rules 6a–5(o)(5) 

and 15Aa–3(o)(5) would require the 

rules of an exchange or association to 

provide a mechanism for the exchange 

or association to obtain information 

from any owner of the exchange, 

association, or a facility of the exchange 

or association relating to such owner’s 

ownership in and voting of such 

interest.364 The Commission requests 

comment on the ability of an exchange 

or association to obtain the information 

regarding its owners and its owners’

related persons necessary to calculate 

and report beneficial ownership interest 

in compliance with the proposed 

requirements of proposed Exhibit Q to 

revised Form 1 and new Form 2.

The Commission believes that each 

item of information proposed to be 

disclosed pursuant to Exhibit Q would 

be pertinent to providing a complete 

picture of which person or group of 

persons may control a significant stake 

in an SRO. The Commission believes 

that these disclosures proposed to be 

required by Exhibit Q relating to 

ownership of the exchange, association 

or a facility would provide the 

Commission, as well as members and 

users of the exchange or association (or 

the facilities of the exchange or 

association), with up-to-date 

information regarding a change or 

potential change in control of an 

exchange or association. In addition, 

requiring an SRO to gather and publicly 

disclose this information should 

provide greater accountability by the 

SRO with respect to the performance of 

its regulatory obligations and further its 

ability to operate in compliance with 

the requirements of Sections 6(b)(1) and 

15A(b)(2) of the Exchange Act 365 that it 

be so organized and have the capacity 

71164 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

366 15 U.S.C. 78f(b)(8) and 78o–3(b)(9).

367See infra Section IV.C.13.l. for a discussion of 

current Form 1 requirements regarding securities 

listed and traded on an exchange or association, 

and their facilities, which would be retained in 

revised Form 1 and added to new Form 2.

368See proposed Item 5 of Exhibit T to revised 

Form 1 and new Form 2. See also discussion of 

proposed Regulation AL in Section III.

369See supra Section III.

370 15 U.S.C. 78f(b)(1) and 78o–3(b)(2). 371See Rule 6a–2(d) under the Exchange Act, 17 

CFR 240.17a–1. 372 15 U.S.C. 78q. 373Currently, this information is required by 

Items 29 and 30 of Form X–15AA–1.

374This item would be included on the execution 

page of new Form 2.

375 15 U.S.C. 78o–3(d).

376Currently, this information is required by 

Items 7 through 28, inclusive, of Form X–15AA–1.

377See Sections 6(b)(5) and 15A(b)(6) of the 

Exchange Act, 15 U.S.C. 78f(b)(5) and 78o–3(b)(6).

378See Sections 6(b) and 15A(b) of the Exchange 

Act, 15 U.S.C. 78f(b) and 78o–3(b).

to be able to carry out the purposes of 

the Exchange Act and to comply with, 

and enforce compliance by its members 

and persons associated with members 

with, the Exchange Act and rules 

thereunder and with the rules of the 

exchange, and the requirements of 

Sections 6(b)(8) and 15A(b)(9) of the 

Exchange Act 366 that the rules of the 

exchange not impose any burden on 

competition not necessary or 

appropriate in furtherance of the 

purposes of the Exchange Act. Requiring 

the disclosure of this information also 

will allow the Commission and the 

public to more readily monitor the 

SROs’ performance of their obligations. 

In addition, the Commission expects 

that the disclosure of information 

concerning persons owning more than 

5% of an exchange, an association or a 

facility of an exchange or association 

should help the Commission more 

effectively oversee and regulate SROs 

and their facilities, especially if the SRO 

or facility is owned and controlled by 

persons who are not regulated by the 

Commission.

10. Listing and Trading of Affiliated 

Securities 

Proposed Exhibit T of revised Form 1 

and new Form 2 would require that 

exchanges and associations provide 

information with respect to securities 

listed and traded on the SRO or its 

facilities.367 Among other disclosures, 

an exchange or association would be 

required to provide an explanation of 

the process for monitoring initial and 

ongoing compliance with the listing 

rules of the exchange or association of 

a security issued by the SRO, or a 

trading facility, or an affiliate of the SRO 

or trading facility, if such security were 

listed on the exchange or association. In 

addition, the exchange or association 

would have to explain the process for 

monitoring trading of the security by the 

members of the exchange or association, 

as well as the process for enforcing the 

exchange’s or association’s listing rules, 

trading rules, and the federal securities 

laws with respect to the listing and 

trading of the securities.368 The 

Commission believes that, given the 

conflicts inherent in ‘‘self-listing,’’ 369

enhanced public transparency 

concerning the ‘‘self-listing’’ of an 

exchange or association (or listing by an 

SRO facility or affiliate of the exchange, 

association, or facility) should result in 

a greater degree of accountability by the 

SRO with respect to monitoring the 

listing by and trading of the ‘‘affiliated’’

security on the SRO or a facility of the 

SRO in compliance with its statutory 

obligations under Sections 6(b)(1) and 

15A(b)(2) of the Exchange Act.370 In 

addition, providing this information to 

the Commission should further the 

Commission’s ability to monitor the 

SRO’s regulation of such listing and 

trading of the affiliated security.

11. Location of Books and Records

Proposed Exhibit U to revised Form 1 

and new Form 2 would require 

exchanges and associations to provide 

the name and address of the location 

where their books and records are 

maintained. The Commission believes 

that requiring exchanges and 

associations to provide details 

concerning the location of their books 

and records should enable the 

Commission to conduct more effective 

and efficient oversight of these SROs. 

The proposed disclosure also is 

intended to reinforce a proposed change 

to Rule 17a–1 under the Exchange 

Act 371 that would require, for the 

existing five-year record retention 

period, exchanges and associations (and 

registered clearing agencies and the 

Municipal Securities Rulemaking 

Board) to maintain their books and 

records in the United States. This 

requirement is intended to assure that 

such books and records may be made 

easily available for inspection and 

examination by the Commission 

pursuant to Section 17 of the Exchange 

Act,372 particularly in an instance where 

an exchange or association is owned by 

a person or entity located outside the 

U.S.

12. Miscellaneous Matters Specific to 

New Form 2

Currently, applicants for registration 

as an affiliated securities association 

must provide the name of the registered 

securities association that the applicant 

association seeks affiliation with, and an 

estimation of the annual dollar volume 

of transactions effected by members of 

the applicant association.373 The 

Commission believes that this 

information, which is specifically asked 

of applicants for affiliated securities 

association status, should be included 

on new Form 2,374 because such 

identifying information is useful to the 

Commission in its determination of 

whether the association satisfies the 

requirements set forth in Section 15A(d) 

of the Exchange Act.375

In addition, applicants for registration 

as a registered securities association or 

an affiliated securities association are 

now asked to identify the rule or rules 

of the association that deal with 

membership; fair representation of 

members; dues and expenses; business 

conduct and protection of members; 

disciplining of members; and affiliated 

associations.376 Because new Form 2 

would require applicants to provide the 

Commission with a copy of the 

association’s rules, the Commission 

believes that separately requesting that 

applicants identify their rules by 

category would be unnecessary. 

Therefore, the Commission proposes to 

omit these inquiries from new Form 2.

13. Current Disclosures To Be Retained 

in Revised Form 1 and Added to New 

Form 2

The Commission is proposing to 

retain in revised Form 1 and add to new 

Form 2 several exhibits that currently 

are required by Form 1 and Form X–

15AA–1. In addition, the Commission 

proposes to incorporate in new Form 2 

several disclosures currently required 

by Form 1. The Commission believes 

that the information proposed to be 

disclosed in these exhibits should aid 

the Commission in its evaluation of an 

application for registration as an 

exchange (or for an exemption from 

exchange registration based on limited 

volume) or association. In addition, the 

information to be disclosed in these 

exhibits would be relevant to the 

Commission and to the public in their 

evaluation of whether the exchange or 

association has rules that comply with 

Sections 6(b)(5) and 15A(b)(6) of the 

Exchange Act.377 The disclosures 

should also guide the Commission (and 

the exchange or association) in 

determining whether the exchange or 

association meets the statutory 

standards for initial and continued 

registration as a national securities 

exchange or registered securities 

association.378

Further, the Commission in several 

instances proposes to align the 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71165

379See supra note 285.

380See Sections 6(b)(1) and 15A(b)(2) of the 

Exchange Act, 15 U.S.C. 78g(b)(1) and 78o–3(b)(2).

381Currently, this information is required by 

Exhibit J to Form 1.

382Currently, this information is required by 

Exhibit D to Form 1.

383 If any affiliate or subsidiary is required by 

another Commission rule to submit annual financial 

statements, a statement to that effect, with a citation 

to the other Commission rule, may be provided 

along with a copy of the financial statements 

prepared pursuant to such other Commission rule.

384The Commission notes that by proposing to 

require disclosure only of an affiliate of an 

exchange or association, there is no intent to 

propose a substantive change to the current 

requirement. The Commission believes that the 

definition of ‘‘affiliate’’ set forth in the Instructions 

to revised Form 1 and new Form 2 would include 

a ‘‘subsidiary,’’ and by proposing to eliminate the 

term ‘‘subsidiary’’ from proposed Exhibit J, the 

Commission seeks solely to clarify the requirement.

385See Regulation S–X, 17 CFR Part 210.

386Currently, this information is required by 

Exhibit C to Form 1.

387The Commission notes that by proposing to 

require disclosure only of an affiliate of an 

exchange or association, there is no intent to 

propose a substantive change to the current 

requirement. The Commission believes that the 

definition of ‘‘affiliate’’ set forth in the Instructions 

to revised Form 1 and new Form 2 would include 

a ‘‘subsidiary,’’ and by eliminating the term 

‘‘subsidiary’’ from proposed Exhibit K, the 

Commission, seeks solely to clarify the requirement.

regulatory treatment of exchanges and 

associations by mandating similar 

disclosure for both exchanges and 

associations. Under the current 

disclosure framework, exchanges are 

required to provide more detailed 

information on Form 1 than associations 

are required to submit on applicable 

registration forms. The Commission 

does not believe that in today’s 

environment the registration procedures 

for exchanges and associations under 

the Exchange Act should maintain 

differing disclosure requirements. 

National securities exchanges and 

registered securities associations are 

charged with nearly identical 

obligations under the Exchange Act.379

In addition, we are proposing to 

enhance the transparency of 

governance, administration, regulation, 

and ownership for both exchanges and 

associations. This is an opportune time 

to review all aspects of the registration 

procedures and forms for exchanges and 

associations and propose appropriate 

revisions. In our view, the proposed 

inclusion in new Form 2 of certain 

Exhibits currently contained in Form 1 

would align more closely the regulatory 

disclosure framework for exchanges and 

associations. Moreover, the Commission 

believes that the incorporation of 

current Form 1 requirements into new 

Form 2 would further the statutory goal 

of assuring that to be registered, and 

remain registered, an exchange and an 

association must be so organized and 

have the capacity to comply with, and 

enforce compliance by members with, 

the provisions of the Exchange Act, the 

rules thereunder, and the rules of the 

exchange or association.380

a. Constitution, Articles of 

Incorporation, By-Laws, and Rules. 

Exhibit A of current Form 1 and current 

Form X–15AA–1 both require that 

exchanges and associations provide to 

the Commission copies of their 

constitution or articles of incorporation 

or association, with all subsequent 

amendments, and of their existing bylaws or corresponding rules or 

instruments. This disclosure item would 

be retained as Exhibit A of revised Form 

1 and new Form 2. 

b. Rulings and Interpretations. Exhibit 

B of current Form 1 requires exchanges 

to provide a copy of all written rulings, 

settled practices having the effect of 

rules, and interpretations of the board or 

any committee of the exchange in 

respect of any provisions of the 

constitution, by-laws, rules, or trading 

practices of the exchange which were 

not otherwise provided as part of 

Exhibit A. This required disclosure item 

would be retained in revised Form 1, 

and added to new Form 2, as Exhibit B. 

c. Officers. Form 1 currently requires 

the disclosure of the officers of the 

exchange or association who presently 

hold their offices or positions, or have 

held them during the previous year, 

with identifying information that 

includes each officer’s name, title, dates 

of commencement and termination of 

term of office, and type of business.381

The Commission believes that 

mandating associations and exchanges 

to disclose this information should 

better inform market participants, 

investors, and regulators about exchange 

and association officers. Therefore, this 

required disclosure would be retained 

in revised Form 1 and added to new 

Form 2, as Exhibit D.

d. Financial Statements of Affiliates. 

Form 1 currently requires exchanges to 

provide to the Commission 

unconsolidated financial statements for 

each subsidiary or affiliate for the latest 

fiscal year.382 Such financial statements 

must consist, at a minimum, of a 

balance sheet and an income statement 

with such footnotes and other 

disclosure as are necessary to avoid 

rendering the financial statements 

misleading.383 We believe that the 

financial statements of affiliates would 

be relevant to the Commission and to 

market participants and the public 

generally with respect to associations, as 

well as exchanges. Therefore, this 

required disclosure would be retained 

in revised Form 1, and added to new 

Form 2, as Exhibit J.384 The required 

financial statements under proposed 

Exhibit J would consist of, at a 

minimum, a balance sheet and an 

income statement of cash flows, with 

such footnotes and other disclosure as 

are necessary to avoid rendering the 

financial statements misleading. The 

Commission proposes to clarify that the 

financial statement would include an 

income statement of cash flows, would 

clarify that separate financial statements 

are required for each affiliate, and 

would delete the reference to 

‘‘subsidiary’’, in each case to conform to 

current accounting terminology.385

e. General Information Relating to 

Affiliates and SRO Trading Facilities. 

Form 1 currently requires exchanges to 

provide to the Commission information 

regarding any of their affiliates, 

subsidiaries and any electronic trading 

system to be used to effect transactions 

on the exchange.386 The exchange is 

required to disclose identifying 

information about the organization of 

each such entity, such as name, address, 

form of organization, and state under 

which it is organized. The exchange also 

must describe the nature and extent of 

any affiliation, and the nature of the 

business or functions performed by the 

affiliate, subsidiary, or electronic 

trading system, including 

responsibilities with respect to the 

operation of an electronic trading 

system. In addition, the exchange must 

provide to the Commission a copy of the 

organizational documents of each such 

entity, including its constitution or 

articles of incorporation and by-laws, as 

well as a list of officers, governors, and 

members of standing committees. 

Finally, the exchange must indicate if 

such entity ceased to be associated with 

the exchange during the previous year. 

The exchange must provide a brief 

statement of the reasons for termination 

of the association with the entity. 

We believe that knowledge of 

identifying and organizational 

information with respect to affiliates 

and any unaffiliated entity that operates 

an SRO trading facility would be useful 

to the Commission and to the public. 

This would be the case with respect to 

associations as well as exchanges. 

Therefore this disclosure item would be 

retained in revised Form 1, and added 

to new Form 2, as proposed Exhibit 

K.387

f. Operation of SRO Trading Facilities. 

Under current Form 1 requirements, 

exchanges must describe the manner of 

operation of any electronic trading 

system to be used to effect transactions 

71166 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

388Currently, this information is required by 

Exhibit E to Form 1. 389Currently, this information is required by 

Exhibit F to Form 1. 390Currently, this information is required by 

Exhibit G to Form 1. The exchange also must 

provide a table of contents of the forms included 

in the exhibit.

391Currently, this information is required by 

Exhibit H to Form 1.

392Currently, this information is required by 

Exhibit L to Form 1.

393See Form X–15AA–1.

394Currently, this information is required by 

Exhibit M to Form 1.

395Current Exhibit M to Form 1 states that a 

person shall be ‘‘primarily engaged’’ in an activity 

or function when that activity or function is the one 

in which that person is engaged for the majority of 

their time.

396Currently, this information is required by 

Exhibit C to Form X–15AA–1.

397 15 U.S.C. 78 l.

398Currently, this information is required by 

Exhibit N to Form 1.

on the exchange.388 The description 

must include the means of access, 

procedures governing entry and display 

of quotations and orders, procedures 

governing the execution, reporting, 

clearance, and settlement of 

transactions, proposed fees, and 

procedures for ensuring compliance 

with usage guidelines. The exchange 

must also disclose the hours of 

operation of the electronic trading 

system, and the date on which the 

exchange intends to commence 

operation of the electronic trading 

system. If the exchange proposes to hold 

funds or securities on a regular basis, 

the exchange must provide a description 

of the controls that will be implemented 

to ensure safety of those funds or 

securities. Finally, the exchange is 

required to attach a copy of the users’

manual. The Commission believes that 

market participants, investors, and 

regulators would benefit from the 

disclosure of information about SRO 

trading facilities of associations, 

including electronic trading systems, in 

addition to SRO trading facilities of 

exchanges. This required disclosure 

would be retained in revised Form 1, 

and added to new Form 2, as proposed 

Exhibit L.

g. Membership Forms Form 1 

currently requires exchanges to provide 

a complete set of all forms pertaining to 

application for membership, 

participation or subscription to the 

exchange, application for approval as a 

person associated with a member, 

participant, or subscriber, and any other 

similar materials.389 The current Forms 

for associations requires the filing of a 

list of members, but does not require the 

filing with the Commission of the forms 

for membership. In our view, the 

information required to be disclosed 

with respect to membership would be 

beneficial in the context of associations, 

in addition to exchanges. Therefore this 

required disclosure item would be 

retained in revised Form 1, and added 

to new Form 2, as proposed Exhibit M.

h. Financial Responsibility and 

Minimum Capital Requirements of 

Members. Pursuant to Form 1, 

exchanges must provide a complete set 

of all forms of financial statements, 

reports or questionnaires required of 

members, participants, subscribers, or 

any other users relating to financial 

responsibility or minimum capital 

requirements for such members, 

participants, or any users.390 We believe 

that the information regarding member 

financial responsibility and minimum 

capital requirements, if any, would be 

relevant information to be disclosed by 

associations as well. Therefore, this 

disclosure item would be retained in 

revised Form 1, and added to new Form 

2, as proposed Exhibit N.

i. Listing Applications. Form 1 

currently requires exchanges to provide 

the Commission with a complete set of 

documents comprising its listing 

applications, including any agreements 

required to be executed in connection 

with listing, and a schedule of listing 

fees.391 If the exchange does not list 

securities, the exchange must provide a 

brief description of the criteria used to 

determine what securities may be traded 

on the exchange. The Commission 

believes that information about listing 

and trading of securities on facilities of 

an association also would be useful to 

the Commission and to the public 

generally. In this way, the Commission 

and the public would have access to the 

current listing applications used by 

issuers, along with other materials 

related to the listing of securities. We 

therefore propose to retain the required 

disclosure in revised Form 1, and add 

it to new Form 2, as proposed Exhibit 

O.

j. Criteria for Membership. Form 1 

currently requires exchanges to provide 

a description of the criteria for 

membership, the conditions under 

which members may be subject to 

suspension or termination with regard 

to access to the exchange, and any 

procedures that will be involved in the 

suspension or termination of a 

member.392 In contrast, Form X–15AA–

1 simply requires associations to state 

which of its rules deal with admissions 

to membership, restrictions on 

membership, and appeals procedures 

for brokers or dealers that have been 

denied membership.393 The 

Commission believes that the 

information about membership criteria 

is relevant to the Commission and to the 

public generally as a means to be 

informed about membership eligibility 

requirements and the conditions under 

which those members can have their 

access to the SRO’s facilities suspended 

or terminated. We propose that this 

required disclosure, in the format 

required by current Form 1, be retained 

in revised Form 1, and added to new 

Form 2, as proposed Exhibit R.

k. List of Members. Form 1 currently 

requires exchanges to provide a list of 

all members, participants, subscribers or 

other users.394 Exchanges must also note 

the name of the entity with which an 

individual is associated and 

relationship to the entity, the type of 

activities primarily engaged 395 in by the 

member, participant, subscriber, or 

other user (e.g., floor broker, specialist, 

odd lot dealer, other market maker, 

proprietary trade, non-broker dealer, 

inactive or other functions), and the 

class of membership, participation or 

subscription or other access. Form X–

15AA–1 simply requires associations to 

provide a list of all of its members and 

the principal place of business for each 

of them.396 The Commission believes 

that the broader Form 1 disclosure 

requirements should be applied to 

associations, as well, including 

information about members, 

participants, subscribers or other users 

of association facilities, if any. Thus, we 

propose that this disclosure be retained 

in revised Form 1, and added to new 

Form 2, as proposed Exhibit S.

l. Securities Listed and Traded. Under 

current Form 1 requirements, exchanges 

must provide a schedule of listed 

securities (including name of issuer and 

description of the security); securities 

admitted to unlisted trading privileges 

(including name of issuer and 

description of the security); securities 

admitted to trading on the exchange 

which are exempt from registration 

under Section 12(a) of the Exchange 

Act 397 (including the name of the 

issuer, a description of the security, and 

the statutory exemption claimed); and 

other securities traded on the exchange 

(including name of issuer and 

description of the security).398 The 

Commission believes that information 

with respect to securities listed and 

traded on the facilities of an association, 

if any, would be helpful to the 

Commission and to market participants 

in ascertaining the securities that are 

listed and traded on an SRO’s facilities. 

We therefore propose that this required 

disclosure be retained in revised Form 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71167

399 17 CFR 240.6a–2(a). 400Currently, these exhibits are Exhibits C, F, G, 

H, J, K and M to Form 1. See supra note 289 for 

a brief description of the subject matter of the 

exhibits to current Form 1.

401 17 CFR 240.6a–2(b).

402Currently, these exhibits are Exhibits D, I, K, 

M, and N to Form 1. See supra note 289 for a brief 

description of the subject matter of the exhibits to 

current Form 1.

403 17 CFR 240.6a–2(c).

404Currently, these exhibits are Exhibits A, B, C, 

and J to Form 1. See supra note 289 for a brief 

description of the subject matter of the exhibits to 

current Form 1.

405See supra note 289 for a description of the 

information required by Exhibits A, B, C, J, K, M, 

and N.

406 17 CFR 240.6a–2(d).

407 17 CFR 240.15Aj–1.

408 17 CFR 249.801. Rule 15Aa–1 under the 

Exchange Act requires the initial filing of the Form 

X–15AA–1 for registration as a registered securities 

association or an affiliated securities association. 

See 17 CFR 240.15Aa–1.

409 17 CFR 240.15Aj–1(a).

410 17 CFR 259.802.

411 17 CFR 240.15Aj–1(b).

412 17 CFR 259.803.

413 17 240.15Aj–1(c)(i)–(ii).

414 17 CFR 240.15Aj–1(c)(2).

415 17 CFR 240.15Aj–1(c)(1)(i)–(ii). This 

alternative to paper filing is available for annual 

supplements and the filing of a complete Exhibit A 

to current Form X–15AJ–2, which is required every 

three years.

416Whereas proposed Rule 6a–2 resembles the 

current Rule 6a–2, proposed redesignated Rule 

15Aa–2 would completely replace the text of the 

current Rule 15Aj–1 as a result of an effort to 

conform Rule 15Aa–2 more closely to Rule 6a–2 

and thereby harmonize the procedural and timing 

requirements for the filing of the revised Form 1 

and new Form 2 and any amendments.

417See proposed Rule 6a–2(a).

1, and added to new Form 2, as Exhibit 

T.

D. Timing and Format of Revised Form 

1 and New Form 2

In conjunction with its proposals to 

revise Form 1 and adopt new Form 2, 

the Commission also proposes to revise 

the rules governing the timing and 

format of the required disclosures by 

exchanges and associations. Currently, 

Rule 6a–2(a) under the Exchange Act 399

requires a national securities exchange, 

or an exchange exempted from such 

registration based on limited volume, to 

file with the Commission an 

amendment to its Form 1 within 10 days 

after any action is taken that renders 

inaccurate, or that causes to be 

incomplete: (1) Information filed on the 

Execution Page of Form 1 (or any 

amendment thereto); or (2) information 

filed as part of certain exhibits 400 to 

Form 1. In addition, Rule 6a–2(b) under 

the Exchange Act 401 requires an 

exchange to file an annual amendment 

to its Form 1 to update certain 

exhibits,402 while Rule 6a–2(c) under 

the Exchange Act 403 requires an 

exchange to file an amendment to its 

Form 1 every three years to update 

certain other exhibits.404 Finally, Rule 

6a–2 provides exchanges with several 

alternatives that they may utilize in lieu 

of the annual filing requirement for 

Exhibits K, M, and N and the three-year 

filing requirement for Exhibits A, B, C, 

and J.405 In lieu of paper filing of 

Exhibits A, B, C, J, K, M, and N, 

exchanges have the following options 

(‘‘paper filing alternatives’’):

(1) If the exchange publishes, or 

cooperates in the publication of the 

information required by these exhibits, 

on an annual or more frequent basis, the 

exchange may identify the publication 

in which such information is available, 

the name, address, and telephone 

number of the person from whom such 

publication may be obtained, and the 

price of such publication, so long as it 

certifies to the accuracy of the 

information as of its publication date; 

(2) If the exchange keeps the 

information required by these exhibits 

up-to-date, and makes it available to the 

Commission and the public upon 

request, the exchange may certify that 

the information is kept up-to-date and 

available to the Commission and public 

upon request; or 

(3) If the information required by 

these exhibits is available continuously 

on an Internet Web site controlled by 

the exchange, the exchange may 

indicate the location where such 

information may be found and certify 

that the information available at such 

location is accurate as of its date.406

Rule 15Aj–1 under the Exchange 

Act 407 is the companion rule for a 

registered securities association or an 

affiliated securities association and 

contains filing requirements similar to 

the provisions of Rule 6a–2. Rule 15Aj–

1 currently requires an association to 

update its Form X–15AA–1 408 promptly 

after the discovery of any inaccuracy in 

the registration statement or in any 

amendment or supplement thereto.409

Rule 15Aj–1 also requires an association 

to file a current supplement on Form X–

15AJ–1 410 following any change which 

renders the information contained or 

incorporated in the registration 

statement or any amendment thereto no 

longer accurate.411 In addition, an 

association is required to file a 

consolidated supplement to its 

registration statement on Form X–15AJ–

2 412 annually and a complete Exhibit A 

of the Form X–15AJ–2 every three 

years.413 Finally, an association must 

file with the Commission a supplement 

setting forth its balance sheet following 

the close of each fiscal year.414 As is the 

case for exchanges under Rule 6a–2, 

with respect to certain filings required 

under current Rule 15Aj–1, an 

association may, in lieu of filing in 

paper form, identify the publication in 

which such information is available, the 

name, address, and telephone number of 

the person from whom such information 

may be obtained, and the price of the 

publication, as long as it certifies that 

the information is accurate.415

For clarity, the Commission proposes 

to redesignate Rule 15Aj–1 as Rule 

15Aa–2 so that it will be located with 

Rule 15Aa–1, the rule for registration as 

a registered securities association or 

affiliated securities association. The 

Commission also proposes to revise 

Rule 6a–2 and the redesignated Rule 

15Aa–2 to enhance the frequency of 

disclosures by exchanges and 

associations, to harmonize filing and 

format requirements for exchanges and 

associations, and to streamline the 

disclosure process.416

The proposed amendments to Rule 

6a–2 would require a national securities 

exchange or an exchange exempted from 

such registration based on limited 

volume, to file an amendment to revise 

its Form 1 within 10 calendar days after 

any material event takes place that 

renders inaccurate, or that causes to be 

incomplete: 

(i) Any information filed on the 

Execution Page of revised Form 1, or an 

amendment thereto; 

(ii) Any information filed as part of 

proposed Exhibits C (board), D 

(officers), E (executive board and 

committees), H (regulatory program), I 

(financial statements and information), J 

(financial information about 

subsidiaries and affiliates), K (general 

information about subsidiaries, 

affiliates, and SRO trading facilities), M 

(membership forms), N (financial 

responsibility requirements), O (listing 

applications), P (relationship among the 

exchange or association, any facility of 

the exchange or association, and any 

affiliate of either), S (list of members 

and participants), or U (location of 

books and records), and as part of Item 

3 of Exhibit F (waivers of code of 

conduct and ethics) or Items 1, 5, 6 and 

7 of Exhibit Q (certain information 

about ownership in a Disclosure Entity) 

to revised Form 1, or any amendments 

thereto; or 

(iii) Any information filed as part of 

Items 2 and 3 of proposed Exhibit Q, or 

any amendment thereto, except that 

such information would not be required 

to be filed with respect to any 

ownership change that is less than 1% 

from the ownership interest last 

reported on Form 1, or any amendment 

thereto.417

71168 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

418As part of the Commission’s effort to simplify 

and streamline the disclosure process for registered 

securities associations and affiliated securities 

associations, new Form 2 would be used for all 

applications and amendments and would replace 

current Forms X–15AA–1, X–15AJ–1 and X–15AJ–

2. See supra Section IV.F.

419See proposed Rule 15Aa–2(a).

420See proposed Rules 6a–2(b) and 15Aa–2(b).

421See supra Section I.A.

422The proposed rules provide an exception to 

the paper filing requirement for annual 

amendments to proposed Exhibits A, B, M, N, S, 

and T to revised Form 1 and new Form 2, and Items 

1–7 of proposed Exhibit L to revised Form 1 and 

new Form 2. With respect to these Exhibits, an 

exchange or association, in lieu of filing such 

information in paper format, would only be 

required to identify the Internet web site it controls 

where such information is available continuously 

and to certify to the accuracy of such information 

as of its date. See proposed Rules 6a–2(d) and 

15Aa–2(d). 423The Commission is not proposing at this time 

to require that exchanges and associations file 

revised Form 1 and new Form 2 electronically. In 

the future, the Commission may consider the 

feasibility of requiring electronic filing of revised 

Form 1 and new Form 2. See, e.g., Securities 

Exchange Act Release No. 50486 (October 4, 2004), 

69 FR 60287 (October 8, 2004) (adopting rules 

requiring SRO proposed rule changes under Section 

19(b) of the Exchange Act, 15 U.S.C. 78s(b), to be 

filed electronically with the Commission). 424See proposed Rules 6a–2(e) and 15Aa–2(e).

The Commission is proposing to 

retain the 10-day filing deadline 

requirement from the current Form 1, 

because the Commission believes that 

10 days is a sufficient time period in 

which to file a Form 1 amendment. 

The proposed amendments to 

redesignated Rule 15Aa–2 similarly 

would require a registered securities 

association or an affiliated securities 

association to file an amendment to 

revise new Form 2 418 within 10 

calendar days after any material event 

takes place that renders inaccurate, or 

that causes to be incomplete: (i) Any 

information filed on the Execution Page 

of new Form 2, or an amendment 

thereto; (ii) any information filed as part 

of proposed Exhibits C (board), D 

(officers), E (executive board and 

committees), H (regulatory program), I 

(financial statements and information), J 

(financial information about 

subsidiaries and affiliates), K (general 

information about subsidiaries, 

affiliates, and SRO trading facilities), M 

(membership forms), N (financial 

responsibility requirements), O (listing 

applications), P (relationship among the 

exchange or association, any facility of 

the exchange or association, and any 

affiliates of either), S (list of members 

and participants), or U (location of 

books and records), and as part of Item 

3 of Exhibit F (waivers of code of 

conduct and ethics) or Items 1, 5, 6 and 

7 of Exhibit Q (certain information 

about ownership in a Disclosure Entity) 

to the new Form 2, or any amendment 

thereto; or (iii) any information filed as 

part of Items 2 and 3 of proposed 

Exhibit Q, or any amendment thereto, 

except that such information would not 

be required to be filed with respect to 

any ownership change that is less than 

1% from the ownership interest last 

reported on Form 1 or Form 2, or any 

amendment thereto.419

The 10-day filing deadline 

requirement for filing an amendment to 

revised Form 1 is based on the current 

Form 1 filing deadline. The Commission 

believes that the filing requirements for 

exchanges and association should be 

uniform. As with the requirement for 

exchanges, the Commission believes 

that 10 days is a sufficient time period 

in which to file a Form 2 amendment. 

Under proposed Rules 6a–2(b) and 

15Aa–2(b), an exchange or association 

would be required to file an annual 

amendment to update the proposed 

revised Form 1 or new Form 2, as 

applicable, in its entirety, within 60 

days of the end of its fiscal year. With 

respect to this annual amendment, the 

information would be required to be upto-date as of the end of the latest fiscal 

year of the exchange or association.420

The Commission believes that a 60-day 

filing deadline would give exchanges 

and associations sufficient time in 

which to file an annual amendment to 

Forms 1 and 2, while at the same time 

rendering the information contained in 

the annual amendment still timely and 

relevant.

The Commission believes that the 

proposed amendments to Rules 6a–2 

and 15Aa–2 would enhance investor 

confidence in the integrity of the 

markets by requiring exchanges and 

associations to provide more consistent 

and up-to-date disclosures about 

significant changes in their governance, 

administration, regulatory programs, 

and ownership. Furthermore, by 

standardizing the requirements for 

exchanges and associations and by 

replacing the current forms for 

associations with new Form 2, the 

Commission believes the proposed rules 

should simplify and streamline the 

disclosure process and provide more 

uniform treatment for exchanges and 

associations. The Commission does not 

believe that the registration procedures 

for exchanges and associations under 

the Exchange Act should maintain 

differing disclosure requirements, as 

national securities exchanges and 

registered securities associations are 

charged with nearly identical 

obligations under the Exchange Act.421

The Commission also is proposing 

changes to the current requirements 

with respect to the format in which 

registration applications and their 

amendments are submitted, with the 

aim of making such information more 

readily accessible to both the 

Commission and the public. Currently, 

exchanges and associations submit their 

registration forms and amendments to 

the Commission, through its Division of 

Market Regulation, in paper format. As 

noted above, there are paper filing 

alternatives to the filing of exhibits to 

existing Form 1 and Forms X–15AJ–1 

and X–15AJ–2. 

Under proposed Rules 6a–2(c) and 

15Aa–2(c), a national securities 

exchange, an exchange exempted from 

such registration based on limited 

volume, a registered securities 

association, or an affiliated securities 

association would be required to file the 

initial proposed revised Form 1 or new 

Form 2, and all subsequent amendments 

thereto (with a few exceptions),422 in 

paper format with the Commission.423

However, in addition to the paper filing, 

the Commission also proposes to require 

that each exchange and association 

continuously post its most recent 

annually amended registration form and 

any subsequent updating amendments 

on a publicly accessible Web site 

controlled by the exchange or 

association. In the Commission’s view, 

a publicly accessible Internet Web site 

is one that does not require a password 

in order to access information contained 

in Form 1 or Form 2.

In addition, Rules 6a–2(c) and 15Aa–

2(c) would require the exchange or 

association to indicate, in any 

amendments filed with the Commission, 

the location of the Internet Web site 

where the most recent Form 1 or Form 

2 and any subsequent updating 

amendments may be found, and to 

certify that the information available at 

such location is accurate as of its date. 

The Commission believes that posting 

the most recent version of Form 1 or 

Form 2 on an Internet Web site would 

significantly increase transparency with 

regard to each exchange and association, 

and would assist the Commission, 

market participants, and the public in 

their understanding and awareness of 

significant aspects of these SROs. 

Finally, the Commission proposes to 

add to Rules 6a–2 and 15Aa–2 a process 

for the Commission, upon written 

application or its own motion, to grant 

an exemption from the Form 1 or Form 

2 filing requirements, either 

unconditionally or on specified terms 

and conditions, if the Commission 

determines that such exemption is 

necessary or appropriate in the public 

interest and is consistent with the 

protection of investors.424 Currently, 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71169

425 17 CFR 240.15Aa–1.

426 17 CFR 259.802. See Rule 15Aj–1(a) and (b), 

17 CFR 240.15Aj–1(a) and (b).

427 17 CFR 259.803. See Rule 15Aj–1(c), 17 CFR 

240.15Aj–1(c).

Rule 6a–2 contains a provision 

providing procedures for the 

Commission, upon certain conditions, 

to exempt an exchange from filing an 

amendment required by the rule for any 

affiliate or subsidiary listed in Exhibit C 

to current Form 1. The Commission, 

however, proposes to include 

procedures for broader exemptive relief 

under Rules 6a–2 and 15Aa–2, 

particularly in light of the additional 

disclosure requirements that are 

proposed.

E. Proposed Changes to Rule 15Aa–1

Rule 15Aa–1 under the Exchange Act 

requires that an application for 

registration as a registered or an 

affiliated securities association shall be 

made on Form X–15AA–1.425 Because 

the Commission is proposing to revise 

Form X–15AA–1 and redesignate it as 

new Form 2, the Commission is also 

proposing corresponding changes to 

Rule 15Aa–1. The amendment to Rule 

15Aa–1 would clarify that an 

application for registration as a 

registered or an affiliated securities 

association shall be made on new Form 

2.

F. Proposed Repeal of Forms X–15AJ–1 

and X–15AJ–2

Currently, a registered securities 

association is required to file 

amendments or supplements to correct 

any statement that the association 

discovers is inaccurate or that is no 

longer accurate on Form X–15AJ–1.426

An association also is required to file an 

annual consolidated supplement to its 

registration statement, and an 

amendment every three years with the 

Commission on Form X–15AJ–2.427

Under the proposals, a registered 

securities association would be required 

to file all amendments to its registration 

application on new Form 2, rather than 

on Forms X–15AJ–1 or X–15AJ–2. 

Therefore, the Commission is proposing 

to repeal Forms X–15AJ–1 and X–15AJ–

2. The Commission believes that the 

repeal of these forms should make the 

process of registration as a registered 

securities association or affiliated 

securities association, as well as the 

process of filing amendments to new 

Form 2, more efficient to the extent that 

associations could use one form for both 

purposes.

G. Request for Comment 

The Commission seeks comments on 

the proposed changes to the forms for 

registration as a national securities 

exchange (or exemption from 

registration as a limited volume 

exchange) and as a registered securities 

association (or affiliated securities 

association), in addition to the 

companion rules governing the filing of 

the registration forms and amendments 

to those forms, as described above. In 

addition, the Commission requests that 

interested persons respond to the 

following specific questions: 

Question 76. Are the requested 

disclosure items contained in revised 

Form 1 and new Form 2 appropriate? 

Are there other disclosure items that 

should be added or are there proposed 

items that should be deleted? 

Question 77. Is the proposed 

definition of ‘‘control’’ in the proposed 

Instructions to revised Form 1 and new 

Form 2 appropriate? 

Question 78. Is the proposed 

definition of ‘‘disclosure entity’’ in the 

proposed Instructions to revised Form 1 

and new Form 2 appropriate? 

Question 79. Is the proposed 

definition of ‘‘immediate family 

member’’ in the proposed Instructions 

to revised Form 1 and new Form 2 

appropriate? 

Question 80. Is the proposed 

definition of ‘‘regulatory subsidiary’’ in 

the proposed Instructions to revised 

Form 1 and new Form 2 appropriate? 

Question 81. Is the proposed 

definition of ‘‘SRO trading facility’’ in 

the proposed Instructions to revised 

Form 1 and new Form 2 appropriate? 

Question 82. Currently, national 

securities exchanges are required to 

provide more detailed disclosure to the 

Commission than are registered 

securities associations. The 

Commission’s proposal aims to 

harmonize the filing requirements for 

exchanges and associations. Should 

registered securities associations be 

required to disclose the same items as 

national securities exchanges? Are any 

of the proposed disclosure items 

unnecessary for registered securities 

associations? Are there items that have 

not been proposed that should be added 

for registered securities associations? Is 

there any other information currently 

required by Form X–15AA–1 that 

should be retained in new Form 2? 

Question 83. Are there features of the 

proposed disclosure requirements that 

should be applied to other SROs, such 

as registered clearing agencies and the 

Municipal Securities Rulemaking 

Board? 

Question 84. Are the disclosure items 

contained in proposed Exhibit A 

(constitution, bylaws, rules) to revised 

Form 1 and new Form 2 appropriate? 

Are there other disclosure items that 

should be added or are there proposed 

items that should be deleted? 

Question 85. Are the disclosure items 

contained in proposed Exhibit B 

(written rulings and interpretations) to 

revised Form 1 and new Form 2 

appropriate? Are there other disclosure 

items that should be added or are there 

proposed items that should be deleted? 

Question 86. Are the disclosure items 

contained in proposed Exhibit C (board) 

to revised Form 1 and new Form 2 

appropriate? Are there other disclosure 

items that should be added or are there 

proposed items that should be deleted? 

Is it useful to require the disclosure of 

information relating to affiliations or 

relationships that reasonably could 

affect the director’s independent 

judgment or decision-making for all 

directors? 

Question 87. Are the disclosure items 

contained in proposed Exhibit D 

(officers) to revised Form 1 and new 

Form 2 appropriate? Are there other 

disclosure items that should be added or 

are there proposed items that should be 

deleted?

Question 88. Are the disclosure items 

contained in proposed Exhibit E 

(executive board and committees) to 

revised Form 1 and new Form 2 

appropriate? Are there other disclosure 

items that should be added or are there 

proposed items that should be deleted? 

Is it useful to require disclosure of 

information relating to affiliations or 

relationships that reasonably could 

affect each executive board or 

committee member’s independent 

judgment or decision-making? Is it 

useful to require the filing of the 

charters of each Standing Committee? 

Question 89. Are the disclosure items 

contained in proposed Exhibit F 

(governance guidelines and codes of 

conduct) to revised Form 1 and new 

Form 2 appropriate? Are there other 

disclosure items that should be added or 

are there proposed items that should be 

deleted? Is it useful to require the 

disclosure of governance guidelines and 

codes of conduct and any waiver of the 

code of conduct? 

Question 90. Are the disclosure items 

contained in proposed Exhibit G 

(organization charts) to revised Form 1 

and new Form 2 appropriate? Would the 

organization charts be helpful? Should 

the Commission require a minimum 

level of detail that exchanges and 

associations should provide in the 

charts? Are there other disclosure items 

that should be added to this Exhibit? 

Question 91. Are the disclosure items 

contained in proposed Exhibit H 

(regulatory program) to revised Form 1 

and new Form 2 appropriate? Are there 

other disclosure items that should be 

71170 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

added or are there proposed items that 

should be deleted? Is it useful for SROs 

to disclose information about their 

regulatory programs, including the 

independence of the regulatory program 

from market operations and other 

commercial interests, any significant 

planned changes, and any significant 

issues and events and their effect on the 

regulatory program? Should SROs be 

required to submit copies of their 

delegations plans or other agreements 

pertaining to regulatory services 

provided by another SRO or its 

regulatory subsidiary, or the regulatory 

subsidiary of the applicant? 

Question 92. Are the categories of 

financial disclosures contained in 

proposed Exhibit I (regulatory program 

financial and other information) 

appropriate? Are there any categories 

that need to be clarified, added, or 

deleted? 

Question 93. Are the items in 

proposed Exhibit I pertaining to 

percentage of total budget and 

percentage of total revenues devoted to 

regulatory activities appropriate? Are 

there other items that should be 

included? 

Question 94. Are the categories of 

revenues and expenditures and 

allocated costs in proposed Exhibit I 

that must be disclosed with respect to 

the regulatory program appropriate? Are 

there specific categories that should be 

added, deleted, or clarified? Do the 

specified items capture sufficiently the 

categories of revenue and expenses that 

exchanges and associations currently 

utilize? Would it be easy or difficult for 

SROs to provide the requested 

information? 

Question 95. Should disclosure of a 

discussion of unusual events or 

significant economic changes that have 

had a material effect on the SRO’s 

financial condition be required? 

Question 96. Should disclosure of 

significant business developments 

involving the SRO be required? 

Question 97. Should disclosure of 

material contracts and material related 

party transactions be required? Is the 

$60,000 threshold amount for material 

contracts and related party transactions, 

as set forth in proposed Exhibit I, 

appropriate? Should the threshold 

amount be set higher or lower?

Question 98. Should disclosure of 

material commitments for expenditures 

as of the end of the latest fiscal period 

and the purpose of those commitments 

and their anticipated source of funds be 

required? 

Question 99. Should disclosure of 

charitable contributions in excess of 

$1,000, whether made directly or 

indirectly, under specified 

circumstances be required? Should the 

disclosure threshold be $1,000 or a 

higher or lower amount? Should all 

charitable contributions be disclosed? 

Are there other kinds of contributions 

that should be disclosed? 

Question 100. Should disclosure of a 

table detailing the compensation of the 

five most highly compensated 

executives of the exchange or 

association, using Item 402(b) of 

Regulation S–K, be required? 

Question 101. Should proposed 

Exhibit I require the disclosure of an 

annual report of the exchange’s or 

association’s Audit Committee? 

Question 102. Are the disclosure 

items contained in proposed Exhibit J 

(subsidiary financial statements) to 

revised Form 1 and new Form 2 

appropriate? Are there other disclosure 

items that should be added or are there 

proposed items that should be deleted? 

Question 103. Are the disclosure 

items contained in proposed Exhibit K 

(SRO trading facility) to revised Form 1 

and new Form 2 appropriate? Are there 

other disclosure items that should be 

added or are there proposed items that 

should be deleted? 

Question 104. Are the disclosure 

items contained in proposed Exhibit L 

(SRO trading facility) to revised Form 1 

and new Form 2 appropriate? Are there 

other disclosure items that should be 

added or are there proposed items that 

should be deleted? 

Question 105. Are the disclosure 

items contained in proposed Exhibit M 

(membership forms) to revised Form 1 

and new Form 2 appropriate? Are there 

other disclosure items that should be 

added or are there proposed items that 

should be deleted? 

Question 106. Are the disclosure 

items contained in proposed Exhibit N 

(members’ financial forms) to revised 

Form 1 and new Form 2 appropriate? 

Are there other disclosure items that 

should be added or are there proposed 

items that should be deleted? 

Question 107. Are the disclosure 

items contained in proposed Exhibit O 

(listing forms) to revised Form 1 and 

new Form 2 appropriate? Are there 

other disclosure items that should be 

added or are there proposed items that 

should be deleted? 

Question 108. Is the information 

proposed to be required in proposed 

Exhibit P (organizational charts) relating 

to the relationship between an 

exchange, an association, a facility of an 

exchange or association, and their 

respective affiliates, and whether and 

how the facility or affiliate has the 

power to influence or control the 

management, policies and regulatory 

responsibilities of the exchange or 

association, appropriate? Should the 

Commission require the exchange or 

association to provide any other 

information? 

Question 109. Are the disclosure 

requirements contained in proposed 

Exhibit Q (ownership of an exchange or 

association or facility of an exchange or 

association) appropriate? Should the 

Commission require an exchange or 

association to disclose any additional 

information relating to such ownership? 

Question 110. Should the 

Commission require the exchange or 

association to disclose direct and 

indirect ownership in any entity other 

than the exchange, association, or a 

facility of the exchange or association? 

If so, what other category of entity?

Question 111. In relation to the 

proposed ownership disclosure in 

proposed Exhibit Q, is the proposed 

definition of ‘‘related persons’’

appropriate? Should it be broader? 

Narrower? 

Question 112. Will the exchange or 

association be able to obtain the 

information necessary to determine 

whether any person, alone or together 

with its related persons, exceeds the 5% 

reporting threshold? The Commission 

has proposed to require an exchange or 

association to have rules that would 

provide a mechanism for the exchange 

or association to obtain information 

from its owners or the owners of its 

facility regarding such ownership. 

Would this help? How difficult would it 

be for an exchange or association to 

implement such rules for owners that 

are not members, such as by amending 

its certificate of incorporation? 

Alternatively, should the Commission 

require an exchange or association to 

disclose ownership information only to 

the extent it is reasonably available to 

them, if they have made reasonable 

efforts to obtain such information and 

were unable to do so? 

Question 113. Are the disclosure 

items contained in proposed Exhibit R 

(membership criteria) to revised Form 1 

and new Form 2 appropriate? Are there 

other disclosure items that should be 

added or are there proposed items that 

should be deleted? 

Question 114. Are the disclosure 

items contained in proposed Exhibit S 

(list of members) to revised Form 1 and 

new Form 2 appropriate? Are there 

other disclosure items that should be 

added or are there proposed items that 

should be deleted? 

Question 115. Are the disclosure 

items contained in proposed Exhibit T 

(schedule of securities listed or 

admitted to trading) to revised Form 1 

and new Form 2 appropriate? Are there 

other disclosure items that should be 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71171

428The Commission has the authority to require 

exchanges and associations to make, keep, and file 

with the Commission any records, and make and 

disseminate any reports, that the Commission, by 

rule, prescribes as necessary or appropriate in the 

public interest, for the protection of investors, or 

otherwise in furtherance of the purposes of the 

Exchange Act. See Section 17(a)(1) of the Exchange 

Act, 15 U.S.C. 78q(a)(1). 

In addition, all records of exchanges and 

associations are subject to such reasonable, 

periodic, special, or other examinations by 

representatives of the Commission as the 

Commission deems necessary or appropriate in the 

public interest, for the protection of investors, or 

otherwise in furtherance of the purposes of the 

Exchange Act. See Section 17(b)(1) of the Exchange 

Act, 15 U.S.C. 78q(b)(1). 429See supra Section IV.

added or are there proposed items that 

should be deleted? 

Question 116. Is the requested 

disclosure item contained in proposed 

Exhibit U (location of books and 

records) of revised Form 1 and new 

Form 2 appropriate? 

Question 117. Is the proposed change 

to Rule 17a–1 to require, for the existing 

five-year record retention period, an 

exchange or association (and other 

SROs) to maintain its books and records 

in the United States appropriate? 

Question 118. In proposed Exhibit J to 

revised Form 1 and new Form 2, 

exchanges and associations would be 

required to provide separate annual 

financial statements for each affiliate. In 

proposed Exhibit K, exchanges and 

associations would be required to 

provide specified organizational 

information concerning each affiliate 

and for any unaffiliated entity that 

operates an SRO trading facility, 

including copies of organizational 

documents and lists of officers, 

governors, and Standing Committee 

members. Substantively, these 

requirements mirror those currently 

applicable to exchanges in Exhibits C 

and D of current Form 1. Given the 

trend toward SRO demutualization, and 

the prospect that an SRO could become 

part of a large conglomerate, should the 

SRO affiliates with respect to which 

information is required in proposed 

Exhibits J and K be narrowed (e.g. to 

those affiliates that are in the chain of 

control with the exchange or 

association, or to affiliates that are in the 

securities business)? If so, what specific 

information should be excluded with 

respect to these affiliates (e.g., separate 

financial statements, copies of 

organizational documents)? 

Question 119. Should the disclosure 

requirement contained in current 

Exhibit B to Form X–15AA–1 be 

retained in new Form 2 appropriate? 

Are there other disclosure items from 

Form X–15Aa–1 that should be added to 

revised Form 1?

Question 120. Are the revisions to 

proposed Rules 6a–2 and 15Aj–1 (to be 

redesignated as Rule 15Aa–2) 

appropriate? Is the 10-day filing 

deadline for periodic updates 

appropriate? Is it too long? Is it too 

short? Is the 60-day filing deadline for 

annual updates appropriate? Is it too 

long? Is it too short? 

Question 121. The Commission has 

proposed to permit exchanges and 

associations, in complying with the 

requirement of filing amendments to 

revised Form 1 and new Form 2, to 

make proposed Exhibits A, B, M, N, S, 

or T or Items 1–7 of proposed Exhibit 

L available continuously on a Web site 

controlled by the exchange or 

association, instead of filing the 

information in the Exhibits in paper 

form. Should this Web site posting 

alternative be available for the filing 

other proposed Exhibits to revised Form 

1 and new Form 2? 

Question 122. Should there be more 

alternatives to paper filing, e.g., simply 

relying on posting on the exchange’s or 

association’s Internet website? 

Question 123. Should revised Form 1 

and new Form 2 be integrated into a 

single form to be used both exchanges 

and associations? 

Question 124. Should the 

Commission consider electronic filing of 

revised Form 1 and new Form 2, such 

as on EDGAR? 

V. Periodic Reporting Obligations of 

Exchanges and Associations 

A. Background and Need for Proposed 

Rule 17a–26

A critical component of the selfregulatory system is the Commission’s 

authority to inspect and examine each 

SRO to ascertain whether it is properly 

complying with and enforcing federal 

statutory and regulatory provisions, as 

well as the SRO’s own rules.428 Among 

the mechanisms utilized by the 

Commission in its oversight efforts are 

cyclical inspections of SROs that 

concentrate on particular facets of their 

regulatory programs and targeted 

inspections of SROs that are conducted 

in response to particular developments. 

The periodic nature of the 

Commission’s inspections of SROs, 

coupled with the inherent limitations 

on the Commission’s ability to detect 

violations in a system based on selfregulation, creates a risk that the 

Commission could be unaware that an 

exchange or association may not be 

responding promptly and adequately to 

new regulatory issues, or may not be 

fully and promptly addressing the 

findings and recommendations of the 

Commission’s staff’s prior inspection. In 

addition, an issue uncovered during the 

course of an inspection of an exchange 

or association can foreshadow similar 

issues across several SROs in a 

particular regulatory program area. The 

Commission believes that its ability to 

identify such system-wide issues, given 

the time necessary for its staff to prepare 

for and conduct on-site inspections of 

one or more SROs, could be enhanced 

by its receiving regulatory program 

information from the SROs on a regular 

basis.

Accordingly, the Commission 

proposes to adopt new Rule 17a–26 

under the Exchange Act to establish a 

system of quarterly and annual 

reporting by national securities 

exchanges and registered securities 

associations with respect to key aspects 

of their regulatory programs. Along with 

the proposals to strengthen the public 

disclosure requirements applicable to 

exchanges and associations,429 proposed 

Rule 17a–26 is intended to enhance the 

Commission’s ability to monitor 

exchanges’ and associations’

compliance with their regulatory 

responsibilities.

The proposed rule would elicit 

specific information about exchanges’

and associations’ regulatory programs, 

including their surveillance and 

disciplinary operations. By requiring 

exchanges and associations to file with 

the Commission the information 

specified in proposed Rule 17a–26 on a 

periodic basis, the Commission believes 

that it should be able to better target its 

on-site inspection resources and 

monitor more closely SROs’ responses 

to critical issues affecting the securities 

markets, particularly during the period 

between Commission inspections of the 

exchange or association. Additionally, 

proposed Rule 17a–26 should assist the 

Commission in its efforts to stay abreast 

of new developments and challenges 

affecting SROs’ self-regulatory 

obligations and to monitor SROs’

performance of their statutory obligation 

to comply with, and enforce compliance 

with, the federal securities laws and the 

rules and regulations thereunder, in 

addition to the SROs’ own rules. We 

believe that the information to be 

provided by SROs would be valuable to 

the Commission because it would 

highlight potential problem areas and, 

in turn, could aid the Commission in 

crafting an appropriate response. 

Accordingly, the information filed 

pursuant to the proposed rule could 

enhance the Commission’s ability to 

oversee the SROs, their members, and 

the entities under their jurisdiction.

Furthermore, proposed Rule 17a–26 

should improve compliance practices by 

SROs. In particular, the proposed rule 

71172 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

430Proposed Rule 17a–26 would not apply to a 

national securities exchange registered pursuant to 

Section 6(g)(1) of the Exchange Act, 15 U.S.C. 

78f(g)(1), or to a national securities association 

registered pursuant to Section 15A(k)(1) of the 

Exchange Act, 15 U.S.C. 78o–3(k)(1). Because the 

Commission does not have primary responsibility 

for the regulation of entities under those provisions, 

including security futures product exchanges and 

limited purpose national securities associations, the 

Commission is proposing to exempt such exchanges 

and associations from Rule 17a–26. See supra note 

77 (discussing the division of regulatory 

responsibility between the Commission and the 

CFTC). 431See proposed Rule 17a–26(a)(1) (regarding 

quarterly and annual reports) and (d) (regarding 

interim changes). Although proposed Rule 17a–26 

would not expressly require exchanges or 

associations to maintain the records necessary to 

prepare the required reports, Rule 17a–1 under the 

Exchange Act, 17 CFR. 240–17a–1, would do so. 

Rule 17a–1(b) requires every exchange and 

association, among others, to keep and preserve all 

documents made or received by it in the course of 

its business for a period of not less than five years, 

the first two in an easily accessible place, subject 

to the destruction and disposition provisions of 

Rule 17a–6 under the Exchange Act, 17 CFR 

240.17a–6.

432See proposed Rule 17a–26(j)(5) for a definition 

of the term ‘‘regulatory subsidiary.’’

433See proposed Rule 17a–26(a)(1).

434See infra Section V.D.

435See proposed Rule 17a–26(b)(2)(i)–(vii). Given 

the proposed electronic nature of the quarterly 

reports, the Commission would expect that it would 

be a relatively simple task for an SRO to aggregate 

the quarterly information and incorporate the data 

into the annual report. The Commission believes 

that the aggregation of this material in the annual 

report would facilitate its review by the SRO’s 

management and governing board, including the 

Chief Regulatory Officer and the Regulatory 

Oversight Committee.

436See proposed Rule 17a–26(b)(3).

437Accordingly, at the end of a calendar year, the 

exchange or association would file the quarterly 

report for the fourth quarter within 20 business 

days after the end of the calendar year (which 

represents the end of the fourth quarter), and the 

annual report within 60 days after the calendar year 

end.

438See proposed Rule 17a–26(a)(1).

439See infra Sections V.E. and V.F.

440See proposed Rule 17a–26(a)(2).

441See proposed Rule 17a–26(b)(1)(ii). The term 

‘‘uniform’’ in this context means that there should 

be uniformity in presentation of the data on the 

SRO’s part for both quarterly and annual reports. 

See also Securities Act Release No. 8497 

(September 27, 2004), 69 FR 59111 (October 1, 

2004) (concept release regarding enhancing 

Commission filings through the use of tagged data). 

Data tagging uses standard definitions to translate 

text-based information into files that can be 

retrieved, searched, and analyzed through 

automated means.

442See proposed Rule 17a–26(b)(1)(ii).

would compel exchanges and 

associations to review, on a quarterly 

and annual basis, the operation and 

performance of their regulatory 

programs. In gathering the necessary 

information and preparing the required 

reports under the proposed rule, 

exchanges and associations would have 

the opportunity to review and assess the 

information that they compile and file 

with the Commission. The preparation 

of the reports required by proposed Rule 

17a–26 should be particularly useful to 

the SRO’s proposed Chief Regulatory 

Officer and the members of its proposed 

Regulatory Oversight Committee to 

inform them about the operations of the 

SRO’s regulatory program. The reporting 

requirements should help exchanges 

and associations to identify potential 

weaknesses in their compliance 

practices and surveillance programs, 

and help facilitate their ability to 

quickly revise and, as necessary, 

strengthen their regulatory programs. 

Finally, by helping to bolster the 

effectiveness of self-regulation, 

proposed Rule 17a–26 should benefit 

not only the SROs and their members, 

but also users of their facilities and 

other market participants, as well as the 

investing public. 

B. Scope and Timing of Reports 

Required by Proposed Rule 17a–26

Proposed Rule 17a–26 would require 

every exchange and association subject 

to the proposed rule 430 to file quarterly 

and annual reports with the 

Commission that contain specified 

information about their regulatory 

programs.431 The information required 

by the proposed rule would concern the 

regulatory programs of an exchange or 

association (which would include any 

regulatory subsidiary)432 and would 

encompass any surveillance, 

examination, and disciplinary programs. 

In the event that an exchange or 

association has entered into a 

contractual relationship with another 

SRO pursuant to which that SRO 

provides regulatory services to or on 

behalf of the exchange or association, 

the information required by the 

proposed rule also would need to 

account for the regulatory services 

provided on behalf of the exchange or 

association.

1. Quarterly Reports 

Every national securities exchange 

and registered securities association 

subject to the proposed rule would be 

required to file with the Commission the 

reports specified in paragraph (b)(2) of 

proposed Rule 17a–26 on a quarterly 

basis, within 20 business days after the 

end of each calendar quarter.433 The 

Commission believes that the 

requirement to file the quarterly reports 

within 20 business days after a quarter’s 

end would accommodate the 

Commission’s interest in receiving the 

reports as promptly as possible, while 

granting an exchange or association a 

sufficient amount of time to prepare and 

finalize the reports containing the 

information that it compiles during the 

course of the quarter. The scope of the 

information proposed to be required in 

the quarterly reports is discussed 

below.434

2. Annual Reports 

Under proposed Rule 17a–26, every 

national securities exchange and 

registered securities association subject 

to the proposed rule also would be 

required to prepare an annual report 

covering the following categories of 

information: (1) An aggregated year-end 

cumulative summary of the information 

specified in the first seven items of the 

quarterly report provisions of the 

proposed rule,435 (2) additional 

information on the SRO’s regulatory 

program that is not required to be set 

forth in the quarterly reports, and (3) the 

annual report of an independent third 

party designed to assess whether the 

operations of any electronic SRO trading 

facility of the exchange or association 

comply with the rules governing such 

facility.436 Together, these three 

categories, discussed below, would 

compose the annual report.437 The 

proposed rule would specify that the 

annual report would have to be filed 

with the Commission within 60 

calendar days after the calendar year 

end.438 The Commission believes that 

the proposed requirement to file the 

annual report within 60 calendar days 

after the year’s end satisfies the 

Commission’s interest in receiving the 

reports as promptly as possible, while 

granting an exchange or association a 

sufficient amount of time to prepare the 

report. The scope of the information 

proposed to be required in the annual 

report in addition to the aggregated 

quarterly information is discussed 

below.439

C. Format of Reports

Proposed Rule 17a–26 would require 

all quarterly and annual reports, as well 

as all audits of electronic SRO trading 

facilities,440 to be submitted 

electronically in a uniform, readilyaccessible, and useable format.441 To 

that end, the proposed rule would 

require every exchange and association 

subject to the proposed rule to establish 

procedures for the preparation of the 

quarterly and annual reports in a 

uniform, readily accessible, and usable 

electronic format, as well as to review 

those procedures from time to time to 

evaluate their efficacy, and to revise the 

procedures as necessary.442 The reports 

should be in a user-friendly format, with 

an emphasis on readable layouts, ability 

to manipulate and search the data 

(including cutting, pasting, and 

exporting text), and a common, 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71173

443See Securities Act Release No. 50486, supra

note 423.

444See proposed Rule 17a–26(b)(2)(i). Automated 

surveillance programs refer generally to computerbased programs that monitor activity for 

compliance with the SRO’s rules and the federal 

securities laws and regulations, and generate alerts 

and reports upon the occurrence of any conduct 

that does not comply with designated parameters. 

Manual surveillance programs refer generally to 

non-computer-based regulatory review of activity.

445Exception reports and alerts are produced in 

connection with the operation of an SRO’s manual 

and automated surveillance programs and generally 

highlight unusual activity that may be indicative of 

violations of the SRO’s trading rules or the federal 

securities laws and regulations.

446See proposed Rule 17a–26(b)(2)(ii).

447See id. The Financial and Operational 

Combined Uniform Single Report (‘‘FOCUS report’’) 

is filed by a broker or dealer on Form X–17A–5 

pursuant to Rule 17a–5(a), 17 CFR 240.17a–5(a). 

The FOCUS report is the basic financial and 

operations report required of brokers and dealers 

that are subject to minimum net capital 

requirements under Rule 15c3–1 of the Exchange 

Act, 17 CFR 240.15c3–15. An amended FOCUS 

report generally is filed when a broker or dealer 

becomes aware of a material inaccuracy in its 

previous filing.

448For example, Firm ABC could be identified 

according to the unique identifier ‘‘MF123.’’

Subsequent references to this member in the same 

or any subsequent reports would need to refer to the 

member as ‘‘MF123.’’ The unique identifier should 

be used consistently throughout a particular report, 

including across each category of information, as 

well as consistently in all reports over time.

449See proposed Rule 17a–26(b)(2)(iii).

compatible, and accessible program 

language. The proposed rule would not 

mandate a technology-specific format or 

a particular template for presenting the 

data, but it does contemplate that an 

exchange or association would select a 

commonly-acceptable standard that 

would emphasize presentation of the 

data in a simple layout with the ability 

to access and manipulate the data 

provided.

In proposing to require the exchanges 

and associations to establish procedures 

for preparing the data for quarterly and 

annual reports in an electronic format, 

the Commission hopes to minimize the 

costs incurred by exchanges and 

associations to generate the reports, and 

to foster a mutually acceptable format 

for the reports in a manner that 

facilitates historical comparisons and 

data tracking by each SRO and by the 

Commission. The Commission requests 

comment below on the nature of the 

proposed electronic format, as well as 

possible alternatives for a common 

format for all exchanges and 

associations that would be user-friendly 

and compatible with existing SRO and 

Commission computer systems. The 

Commission also seeks comment below 

concerning whether it should explore 

the feasibility of the filing of proposed 

quarterly and annual reports through a 

secure Web-based system.443

D. Quarterly Reporting of Regulatory 

Information 

The categories of information 

specified below would compose the 

quarterly report required by the 

proposed rule. The program areas 

covered by these categories are designed 

to address the primary operations and 

main features of an exchange’s or 

association’s regulatory program, and 

constitute those areas for which the 

Commission has an interest in receiving 

information on a regular basis. 

1. Information on the SRO’s 

Surveillance Program 

Proposed Rule 17a–26 would require 

exchanges and associations to report 

quarterly on the results of their 

surveillance programs, both manual and 

automated, during the reporting 

period.444 This reported information 

would include, but would not be 

limited to, information on the number of 

exception reports and alerts generated, 

sorted by applicable rule or category.445

An exchange or association also would 

be required to indicate the number of 

exception reports and alerts that were 

reviewed by the exchange or association 

and the number of exception reports 

and alerts that were referred for further 

investigation or for an enforcement 

proceeding.

The Commission believes that this 

information, as with the other categories 

of information required by the proposed 

rule, should better enable it to stay 

informed of novel and recurring issues 

that could present a challenge to an 

SRO’s regulatory programs, as well as 

facilitate the Commission’s ability to 

respond in a timely manner, as 

appropriate. The required information 

also should raise awareness of 

surveillance issues at the SROs, and 

allow the Commission and the SROs to 

take action when necessary to 

implement a coordinated response to 

any systemic concerns. Finally, the 

regular submission of this information 

should help focus the Commission’s 

inspection resources on those matters 

that need urgent attention and 

encourage further cooperation between 

the Commission and each SRO in 

seeking solutions to regulatory 

challenges. 

With respect to an exchange’s or 

association’s efforts to monitor for 

compliance with financial and 

operational requirements of its brokerdealer members, proposed Rule 17a–26 

would require exchanges and 

associations to maintain records of and 

report information regarding all 

members that had net capital 

computation errors exceeding 10% of 

excess net capital, including an 

objective description of any action taken 

by the exchange or association in 

response to such deficiency.446 An 

exchange or association also would be 

required to provide a list of members 

that were late in filing their FOCUS 

reports as well as a separate list of 

members that filed amended FOCUS 

reports, and provide an objective 

description of any response taken by the 

exchange or association in response to 

either of these situations.447 The 

Commission believes that this 

information should allow it to better 

monitor the effectiveness of an 

exchange’s or association’s surveillance 

for compliance with net capital and 

FOCUS reporting obligations, and 

should permit the Commission to 

respond on a contemporaneous basis to 

circumstances that may warrant further 

attention.

Rather than identify the member firms 

by name, however, the proposed rule 

would require the lists to be prepared 

using a unique identifier specific to 

each member firm reported. Various 

provisions throughout the proposed 

rule, including the provision regarding 

compliance with financial and 

operational requirements, would require 

an exchange or association to assign 

each member firm (or its associated 

persons) a unique identifier for the 

purpose of reporting the information 

required by the proposed rule.448

Although the exchange or association 

would not be required to include the 

identity of the member firm or its 

associated persons in the regularly-filed 

reports, a unique identifier would need 

to be used in a consistent manner in 

each quarterly and annual report in 

order to allow the Commission to spot 

trends involving a particular firm or 

individual. The protection afforded by a 

system of unique identifiers is intended 

to maintain the anonymity, with respect 

to the Commission, in information filed 

regularly with the Commission of the 

member firms or individuals subject to 

an investigation or regulatory action by 

an SRO. Commission staff could contact 

the SRO to follow-up if it saw a 

recurring pattern of a particular unique 

identifier being captured on the 

required reports.

2. Information on Complaints Received 

Proposed Rule 17a–26 would require 

an exchange or association to report 

quarterly on all complaints it received 

during the reporting period that relate to 

the exchange’s or association’s 

regulatory programs.449 An exchange or 

association would have to include 

objective summaries of the substance of 

71174 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

450See supra note 448 and accompanying text.

451See supra note 448 and accompanying text. To 

refer to an associated person of Firm ABC, an 

exchange or association could use a suffix system 

as follows: ‘‘MF123–1.’’ The unique identifier 

should be used consistently throughout a particular 

report, including across each category of 

information, as well as consistently in all reports 

over time.

452See proposed Rule 17a–26(b)(2)(iv).

453See supra note 448 and accompanying text. 

The unique identifier should be used consistently 

throughout a particular report, including across 

each category of information, as well as consistently 

in all reports over time. 454See proposed Rule 17a–26(b)(2)(iv). 455See proposed Rule 17a–26(b)(2)(v). 456See supra note 448 and accompanying text. 

The unique identifier should be used consistently 

throughout a particular report, including across 

each category of information, as well as consistently 

in all reports over time.

457See proposed Rule 17a–26(b)(2)(v).

458See id.

459See proposed Rule 17a–26(b)(2)(vi).

460See supra note 448 and accompanying text. 

The unique identifier should be used consistently 

throughout a particular report, including across 

each category of information, as well as consistently 

in all reports over time.

each complaint received. The 

summaries would be grouped by the 

subject matter of the complaint, and 

would use a unique identifier specific to 

the member and any associated persons 

involved.450 Similar to the requirements 

for financial and operational reporting, 

discussed above, the provision requiring 

information on complaints received 

would require an exchange or 

association to assign each member a 

unique identifier for the purpose of 

reporting the information required by 

the proposed rule.451

The summary also would need to 

include the type of source of the 

complaint (e.g., ‘‘member’’ or ‘‘public’’), 

the date the complaint was received by 

the exchange or association, and the 

disposition of the matter, including an 

objective description of any action taken 

or response by the exchange or 

association and the date of any such 

response. By requiring SROs to file with 

the Commission information on 

complaints they receive, the 

Commission should be able to better 

monitor potential problem areas and 

take steps designed to ensure that the 

exchanges and associations are taking 

appropriate, timely action in response to 

complaints. In addition, the requirement 

to compile and summarize information 

on complaints should help to focus an 

SRO’s attention on the complaints it 

receives and should facilitate its ability 

to assess any trends with respect to, and 

track the resolution of, such complaints. 

3. Investigations, Examinations, and 

Enforcement Actions 

The Commission proposes to require 

exchanges and associations to report on 

all investigations, examinations, and 

enforcement cases opened, closed, and 

pending during the reporting period. 

With respect to investigations, proposed 

Rule 17a–26 would require exchanges 

and associations to provide a summary 

of, including a count of the aggregate 

numbers of, open, closed, and pending 

investigations, as well as provide an 

objective summary of the facts and 

circumstances of each investigation.452

The summary information would 

include, but would not be limited to, the 

member firm and any associated 

person(s) under review using a unique 

identifier specific to the member and 

any associated person(s); 453 a factual 

description of any alleged rule 

violations; a general identification of the 

type of source that led to the 

investigation (e.g., ‘‘member complaint’’

or ‘‘automated surveillance alert’’); a 

factual description of the matter under 

investigation (i.e., without subjective 

commentary, explanation, or elaboration 

by the exchange or association) and the 

relevant security symbol or type of 

security involved; the date of the 

occurrence of the matter under 

investigation and the date the alleged 

violation was reported or detected; the 

date the exchange or association opened 

the investigation; and the length of time 

the investigation has been open. For 

closed investigations, the summary also 

would include the date the investigation 

was closed; the length of time the 

investigation was open; and an objective 

description of the recommendations and 

disposition of the investigation. In 

addition, the proposed rule would 

require a summary of the number of 

investigations conducted during the 

reporting period as well as the average 

elapsed time, in days, for investigations 

closed during the reporting period.454

This information should allow the 

Commission to better monitor the 

operations and effectiveness of the 

SROs’ investigation programs, as well as 

spot trends with respect to potentially 

violative conduct by member firms and 

their associated persons.

With respect to examinations, 

proposed Rule 17a–26 would require 

exchanges and associations to provide a 

summary of, including a count of the 

aggregate numbers of, open, closed, and 

pending examinations, as well as 

provide an objective summary of the 

facts and circumstances of each 

investigation.455 The summary 

information would include, but would 

not be limited to, the following: a list of 

the member firms examined, using a 

unique identifier specific to the member 

firm;456 the member’s examination cycle 

(i.e., the frequency with which the 

member is generally examined, such as 

a one-year or two-year cycle); whether 

the examination was a routine cycle 

examination or whether it was for-cause 

and an objective description of any 

reasons for a cause examination; 

whether the examination was of a new 

member of the exchange or association 

and, if so, the date the new member 

registered under the Exchange Act and 

the date the examination of the new 

member commenced; an objective 

description of the scope and subject 

matter of the examination and the areas 

and items reviewed during the 

examination; the date the examination 

was opened and, as applicable, closed; 

the length of time the examination has 

been or was open; an objective 

description of any potential violations 

(i.e., the rules allegedly violated); and a 

factual description of the 

recommendations and disposition of the 

examination.457 In addition, we propose 

to require exchanges and associations to 

provide data on the number of 

examinations conducted during the 

reporting period and the average 

elapsed time, in days, for all 

examinations that have been completed 

during the reporting period.458 As with 

the information proposed to be filed 

with the Commission regarding 

investigations, the Commission believes 

that its receipt of this information 

should permit it to better monitor each 

SRO’s reasons for opening, and progress 

in conducting, examinations, and to 

discern trends across SROs.

Finally, with respect to enforcement 

cases, the Commission proposes to 

require exchanges and associations to 

provide a summary of, including a 

count of the aggregate numbers of, open, 

closed, and pending enforcement cases, 

as well as provide a factual summary of 

the facts and circumstances of each 

case.459 The summaries would include 

a list of all enforcement cases, grouped 

by subject matter, and provide factual 

case information, including, but not 

limited to, the member firm and any 

associated person(s) under review, 

identified according to a unique 

identifier specific to the member firm 

and associated person; 460 the type of 

source that led to opening the case (e.g.,

tip, referral from another regulator, 

complaint, etc.); a factual description of 

any alleged violations and the relevant 

security symbol or specific type of 

security involved; the date of 

occurrence of any alleged violations and 

the date they were reported or detected; 

the date the enforcement case was 

opened; and the number of days the 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71175

461See proposed Rule 17a–26(b)(2)(vi).

462See id.

463The Commission anticipates that the provision 

of enforcement information under proposed Rule 

17a–26 also would assist in the Commission’s 

initiative to receive information pursuant to Rule 

19d–1 under the Exchange Act, 17 CFR 240.19d–

1, in electronic format.

464See proposed Rule 17a–26(b)(2)(vii). With 

respect to the proposed requirement to provide 

information on listing programs, for an exchange or 

association that has an affiliate that lists and trades 

securities, the exchange or association would be 

responsible for assuring that its affiliate provides it 

with the required information on its listings 

program, and the exchange or association would be 

responsible for including such information in its 

quarterly report.

465See supra note 448 and accompanying text. 

The unique identifier should be used consistently 

throughout a particular report, including across 

each category of information, as well as consistently 

in all reports over time.

466See proposed Rule 17a–26(b)(2)(vii).

467See id.

468See id.

469See proposed Rule 17a–26(b)(2)(viii).

470See proposed Rule 17a–26(b)(3).

471See id.

472See proposed Rule 17a–26(b)(2)(i)–(vii).

473See proposed Rule 17a–26(a)(1).

474See proposed Rule 17a–26(b)(2)(i)–(vii).

case has been open.461 For cases closed 

during the reporting period, the 

exchange or association also would be 

required to provide the date the case 

was closed; the number of days the case 

had remained opened; and an objective 

description of the disposition of the 

case, including whether the case was 

settled and the sanctions imposed, if 

any, including any fines and 

penalties.462 In addition, the report 

would include a summary of the 

number of enforcement cases conducted 

during the reporting period and the 

average elapsed time for all enforcement 

cases closed during the reporting 

period.463 The Commission believes that 

the required information on 

enforcement cases could assist it in 

monitoring, on a regular basis, each 

exchange’s and association’s vigilance 

with respect to, as well as its resolution 

of, enforcement matters. In addition, 

this information should assist the 

Commission in its efforts to monitor 

developing enforcement issues that 

potentially could impact SROs 

generally, as well as focus an SRO’s 

attention on trends in its enforcement 

program.

In the Commission’s view, the 

proposed requirement to compile and 

summarize information on 

investigations, examinations, and 

enforcement actions should help to 

focus an SRO’s attention on these 

regulatory activities and should 

facilitate the ability of its management, 

including its Chief Regulatory Officer 

and its Regulatory Oversight Committee, 

to monitor the SRO’s vigilance in 

pursuing and completing investigations, 

examinations, and enforcement activity.

4. Information on Listings Programs 

Under proposed Rule 17a–26, 

exchanges and associations would be 

required to provide quarterly 

information on their listings 

programs.464 Each exchange or 

association would be required to 

provide information including a list of 

all securities that were newly listed and 

delisted during the reporting period; a 

list of all issuers to whom the exchange 

or association, or a facility thereof, sent 

during the reporting period a notice 

alleging that such issuer does not satisfy 

a rule or standard for continued listing 

on the exchange or association, or a 

facility thereof, and, in the case of an 

exchange, a notice that the exchange has 

submitted an application under 

Exchange Act Rule 12d2–2 (17 CFR 

240.12d2–2) to the Commission to delist 

a class of the issuer’s securities, and, in 

the case of an association, a notice that 

the association has taken all necessary 

steps under its rules to delist the 

security from its facility; a list of all 

issuers, using unique identifiers,465

alleged to not satisfy a rule or standard 

for continued listing and any action 

taken with respect to any listed issuer 

that allegedly failed to satisfy any rule 

or standard for continued listing; and a 

list of any issuers, using unique 

identifiers, that are alleged to have 

failed to file timely quarterly or annual 

reports.466 Further, the proposed rule 

would require exchanges and 

associations to set forth the rule or 

standard for continued listing that the 

issuer is alleged to have failed to satisfy 

and the date when the issuer was 

alleged to have failed to satisfy such 

rule or standard for continued listing. 

The summary also would need to 

discuss the status of any compliance 

plan agreed upon between the issuer 

and the exchange or association, 

including any alleged failure on the part 

of the issuer to satisfy any of the 

provisions of such compliance plan.467

For listed options, the exchange or 

association would be required to 

provide information on any options 

classes or series that did not satisfy the 

applicable listing standards or rules 

when trading commenced.468 The 

Commission believes that this 

information should permit it to better 

monitor, among other things, listing and 

delisting trends and, in particular, the 

SROs’ handling of delisting 

proceedings.

5. Copies of Board and Committee 

Meeting Agenda 

Proposed Rule 17a–26 would require 

every exchange and association to 

provide, as part of their quarterly 

reports, the final agenda from any 

meeting of the board of directors or 

executive committee of the exchange or 

association, or any meeting of any 

committee of the board of directors or 

executive committee, that occurs during 

the reporting period.469 An exchange or 

association would not be required to 

resubmit this information as part of its 

annual report.470 The Commission 

believes that the quarterly filing of this 

information would assist it in its efforts 

to keep abreast of regulatory matters 

considered by an exchange’s or 

association’s board and its committees 

and would help to focus the 

Commission’s inspection efforts.

E. Annual Reporting of Regulatory 

Information 

In addition to filing quarterly reports 

for each calendar quarter, proposed Rule 

17a–26(b)(3) also would require an 

exchange or association to file an annual 

report with the Commission.471 The 

annual report would contain a 

cumulative year-end summary of the 

first seven categories of information 

filed as part of the quarterly reports,472

as well as an audit of any electronic 

SRO trading facility and a summary of 

several additional categories of 

regulatory information, and would be 

due within 60 calendar days after the 

year’s end.473 The additional categories 

of annual regulatory information are 

discussed below.

1. Cumulative Summary of Quarterly 

Information 

The annual report required by 

proposed Rule 17a–26(b)(3) would need 

to contain an aggregated year-end 

cumulative summary of the information 

specified in the first seven items of the 

quarterly report provisions of the 

proposed rule.474 Accordingly, the 

annual report would need to include a 

compilation of the following quarterly 

information: (1) The results of the 

surveillance programs; (2) the results of 

the surveillance programs for financial 

and operations requirements; (3) the 

summary of complaints relating to the 

exchange’s or association’s regulatory 

program; (4) the summary of 

investigations; (5) the summary of 

examinations; (6) the summary of 

enforcement cases; and (7) the summary 

of listings information. Exchanges and 

associations would not be required to 

re-file copies of their board and 

committee agenda. The Commission 

believes that the compilation and 

71176 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

475See proposed Rule 17a–26(b)(3)(i).

476See supra Section IV.C.6. (discussing 

proposed Exhibit H to revised Form 1 and new 

Form 2).

477Paragraph (d)(1) of proposed Rule 17a–26 

would require exchanges and associations to file 

with the Commission a supplement in the event 

that the exchange or association implements, 

revises, or discontinues any manual or automated 

surveillance programs in the period between 

quarterly reports. The annual report should 

highlight and summarize any material reported 

pursuant to the interim changes provision, which 

is discussed in Section V.H. below.

478See proposed Rule 17a–26(b)(3)(i).

479See supra Section IV.C.6. (discussing 

proposed Exhibit H to revised Form 1 and new 

Form 2).

480See proposed Rule 17a–26(b)(3)(ii).

481See proposed Rule 17a–26(b)(3)(iii).

482See id.

483See id.

aggregation of the quarterly report 

information into the annual report 

should facilitate review of the annual 

report by the exchange’s or association’s 

management and board, including the 

proposed Chief Regulatory Officer and 

the proposed Regulatory Oversight 

Committee. Given the electronic nature 

of the quarterly reports, the Commission 

expects that an exchange or association 

should be able to compile the data 

easily. The Commission solicits 

comment, below, on this provision, 

including the attendant burden of 

aggregating the quarterly information 

into the annual report.

2. Processes for Carrying Out Regulatory 

Responsibilities 

Proposed Rule 17a–26 would require 

exchanges and associations to report on 

their internal policies and procedures 

for carrying out their regulatory 

responsibilities on an annual basis.475

Under this provision, the Commission 

proposes to require each exchange and 

association to describe in detail its 

overall program of surveillance for 

member compliance with all applicable 

rules, laws, and regulations. The 

purpose of this requirement, among 

other things, is for the SRO to report on 

its designated examining authority 

responsibilities, as well as on its manual 

and automated surveillance programs, 

including the processes for ensuring 

compliance by its members with the 

SRO’s rules, as well as the federal 

securities laws and regulations. By 

requiring exchanges and associations to 

prepare and submit this information 

yearly, the Commission should be better 

apprised of each exchange’s or 

association’s regulatory programs and 

processes and how they contribute to 

the SRO’s fulfillment of its statutory and 

regulatory obligations. In addition, by 

preparing this report, exchanges and 

associations should have a better 

opportunity to focus on the 

effectiveness of their regulatory 

programs and to ascertain whether 

revisions to those programs are 

necessary. The Commission notes that 

the annual report is intended to provide 

a greater depth of information than 

would be provided in Exhibit H of 

revised Form 1 and new Form 2 476 with 

respect to the exchange’s or 

association’s regulatory programs. The 

annual report also would need to 

highlight and summarize any new, 

revised, or terminated surveillance 

programs and discuss the reasons for 

such change.477

Each exchange and association would 

be required to identify the staff 

responsible for carrying out the SRO’s 

regulatory and supervisory 

responsibilities by providing an 

organization chart detailing the various 

regulatory groups or divisions according 

to their areas of responsibility, and 

noting the names of staff and 

supervisors in each group or division.478

This information is intended to provide 

the Commission with information about 

the organizational structure, and the 

lines of authority and areas of 

responsibility, with respect to the SRO’s 

regulatory program.

3. Evaluation of the Regulatory Program 

To complement the information 

provided by exchanges and associations 

pursuant to proposed Exhibit H of 

revised Form 1 and new Form 2, which 

would require exchanges and 

associations to describe generally their 

regulatory program and publicly 

disclose this information,479 proposed 

Rule 17a–26 would require exchanges 

and associations to file with the 

Commission an evaluation of the 

effectiveness of their regulatory 

programs in effect during the reporting 

period.480 An exchange or association 

would provide a discussion of the 

particular strengths and weaknesses of 

its regulatory program, as well as a 

discussion of any planned revisions to 

the regulatory program in response to 

any weaknesses, including those 

weaknesses uncovered during the 

process of preparing the quarterly and 

annual reports. In this regard, exchanges 

and associations would need to provide 

candid discussions of the overall 

operation and effectiveness of their 

regulatory programs, and would need to 

highlight the areas in which their 

programs should be improved. The 

Commission believes that this 

information should allow it to better 

monitor the operations of an SRO’s 

regulatory program, with a particular 

emphasis on potential challenges to and 

weaknesses in an SRO’s regulatory 

program. In addition, by preparing this 

information, SROs would be required to 

assess regularly the adequacy of their 

self-regulatory procedures and systems, 

and their ability to monitor properly the 

activity on their markets. The 

Commission also would expect this 

requirement to encourage closer 

cooperation between the Commission 

and the SROs in seeking solutions to 

regulatory challenges that SROs 

encounter.

4. Internal Controls 

Under the proposed rule, an exchange 

or association would have to provide in 

the annual report a discussion of the 

internal controls implemented by the 

exchange or association that are 

designed to detect, prevent, and control 

any conflicts of interest between its 

market and other business interests and 

its self-regulatory responsibilities, and 

to assure that the exchange or 

association appropriately carries out its 

self-regulatory responsibilities.481 The 

discussion would need to address the 

controls that assure the exchange or 

association adequately supervises its 

members, surveils for misconduct, and 

otherwise carries out its self-regulatory 

responsibilities even when the market 

operations and other commercial 

interests of the exchange or association 

create conflicting incentives.482 The 

discussion also would need to address 

the controls that the exchange or 

association has in place that assures it 

carries out its self-regulatory obligations 

under the Exchange Act.483 This 

provision is intended to assure that the 

exchange or association has the 

mechanisms in place to effectively 

control conflicts of interest arising from 

its business functions. The Commission 

expects exchanges and associations to 

remain acutely sensitive to the conflicts 

of interest that may arise between their 

commercial interests, including their 

facilities for the trading of securities, 

and their regulatory responsibilities. 

The periodic submission of information 

on the internal controls that address 

these conflicts should allow the 

Commission to better assess an SRO’s 

ability to effectively carry out its 

regulatory obligations in the face of 

commercial pressures. Requiring an 

SRO to discuss its internal controls in 

the annual report also should help focus 

the SRO’s attention on its internal 

controls and the operation of those 

controls.

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71177

484See proposed Rule 17a–26(b)(3)(iv) and supra

note 167 for a discussion of the term ‘‘senior 

regulatory personnel.’’

485See proposed Rule 17a–26(b)(3)(v). See supra

Section II.B.3. for a discussion of proposed Rules 

6a–5(f)(5), (g)(3), (h)(3), (i)(3), and (j)(6) and 15Aa–

3, (f)(5), (g)(3), (h)(3), (i)(3), and (j)(6).

486See Rule 17a–26(b)(3)(vi).

487See proposed Rule 17a–26(a)(2).

488See proposed Rule 17a–26(j)(3).

489See proposed Rule 17a–26(c).

490See id.

491See proposed Rule 17a–26(d)(1).

492See Id.

493See proposed Rule 17a–26(d)(2).

5. Employment Arrangements With 

Regulatory Personnel 

Proposed Rule 17a–26 would require 

exchanges and associations to discuss 

the employment arrangements in effect 

between the exchange or association 

and its Chief Regulatory Officer and 

other senior regulatory program 

personnel.484 The exchange or 

association would need to provide 

information on all aspects of its 

employment arrangements with its 

Chief Regulatory Officer and other 

senior regulatory program personnel, 

including salary and bonus levels and 

benefits and other cash and non-cash 

compensation paid to these individuals. 

This information would aid the 

Commission in its understanding and 

knowledge of the compensation 

arrangements for the most senior 

personnel at an exchange or association 

who are charged with carrying out the 

SRO’s regulatory responsibilities.

6. Copies of Standing Committee 

Evaluations

Proposed Rule 17a–26 would require 

an exchange or association to file with 

the Commission copies of the most 

recent annual performance selfevaluation, as would be required by 

proposed Rules 6a–5 and 15Aa–3, of 

each Standing Committee of the board 

of a national securities exchange or 

registered securities association, as well 

as the proposed annual governance 

performance evaluation prepared by 

each exchange’s or association’s 

Governance Committee.485 This 

information would allow the 

Commission to review each Standing 

Committee’s assessment of its 

fulfillment of the responsibilities set 

forth in the committee’s charter and an 

assessment of the overall governance of 

the exchange or association by its 

Governance Committee. The proposed 

responsibilities of the Standing 

Committees, as set forth in proposed 

Rules 6a–5 and 15Aa–3, generally are 

related to the self-regulatory functions 

of an exchange or association.

7. Compliance With Regulatory Plans 

Under the proposed rule, exchanges 

and associations would be required to 

provide annual information on their 

efforts to comply with any 

recommendations resulting from any 

inspection or examination conducted by 

Commission staff.486 Requiring 

exchanges and associations to provide 

periodic information on the status of 

their compliance with inspection 

recommendations should allow the 

Commission to respond more effectively 

to identified concerns and to monitor 

the implementation of recommended 

changes to an exchange’s or 

association’s regulatory program. 

Additionally, the proposed requirement 

should further encourage regular 

communication between exchanges and 

associations and the Commission’s staff 

as a means to assist these SROs in 

tailoring and adjusting the 

implementation of the 

recommendations.

F. Audit Report of Electronic SRO 

Trading Facilities 

Proposed Rule 17a–26 would require 

every exchange and association subject 

to the proposed rule that owns, 

operates, or sponsors an electronic SRO 

trading facility to file with the 

Commission, on an annual basis as part 

of the annual report, an audit report of 

an independent third party that assesses 

whether the operations of the electronic 

SRO trading facility comply with the 

rules governing the facility.487 The 

purpose of the proposed requirement is 

to determine whether the facility’s 

design and implementation is consistent 

with the exchange’s or association’s 

rules relating to such system that have 

been filed with and approved by the 

Commission.

For purposes of the proposed rule, an 

electronic SRO trading facility would be 

defined as a facility of an exchange or 

association that executes orders in 

securities on an electronic basis.488 An 

independent third party would include 

a party not affiliated with the exchange 

or association that is qualified to render 

an opinion on such matters. We are not 

mandating the category of persons or 

entities that are qualified to perform 

such an audit and prepare the audit 

report with respect to an electronic SRO 

trading facility so that SROs would have 

flexibility in retaining an appropriate 

party to conduct their electronic SRO 

trading facility audit and prepare the 

audit report. At a minimum, however, 

the independent third party must have 

the capability to assess whether the 

system’s design and implementation 

complies with the rules governing the 

facility. The Commission believes that 

the proposed requirement is a 

reasonable means to determine whether 

the systems aspects of electronic SRO 

trading facilities align with the rules 

that govern those facilities (e.g., trading 

rules), particularly as electronic SRO 

trading facilities and their associated 

rules have become more complex over 

the years. This provision of the 

proposed rule is intended to evaluate 

the integrity of electronic SRO trading 

facilities with respect to compliance 

with applicable regulatory requirements 

and surveillance procedures.

G. Certifications 

All quarterly and annual reports filed 

with the Commission pursuant to 

proposed Rule 17a–26 would be 

required to be accompanied by a signed 

certification executed on behalf of the 

exchange or association by the CEO or 

an equivalent officer, representing that 

the information contained in the report 

is current, true, and complete as of the 

date filed with the Commission.489 Any 

supplemental filing submitted pursuant 

to proposed Rule 17a–26(d) also would 

need to be accompanied by a 

certification.490 The Commission 

intends for the certification requirement 

to reinforce to exchanges and 

associations the importance of 

informing and updating the Commission 

on the operation of their regulatory 

programs and to remain mindful of their 

obligations as self-regulatory 

organizations.

H. Interim Changes 

Proposed Rule 17a–26 would specify 

that any material changes to or material 

developments that effect an exchange’s 

or association’s regulatory program must 

be reported to the Commission in a 

supplemental filing within 10 business 

days after the occurrence of such event 

or change, along with a discussion of 

the event or change and the reasons for 

any change.491 Examples of material 

changes that would require an exchange 

or association to file a supplement 

would include changes to the 

parameters of an exchange’s or 

association’s surveillance programs and 

any new, revised, or discontinued 

manual or automated surveillance 

programs that occurred since the filing 

of the previous quarterly report.492 An 

exchange or association also would be 

required to report a material change to 

the organization or staffing of its 

regulatory or supervisory department or 

unit within 10 business days of such 

change.493 The Commission believes 

that a 10 business day requirement 

71178 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

494See proposed Rule 17a–26(e).

495See 5 U.S.C. 552.

496See 17 CFR 240.24b–2.

497 5 U.S.C. 552(b)(8).

498 17 CFR 200.80(b)(8).

499See Section 17(b)(1) of the Exchange Act, 15 

U.S.C. 78q(b)(1) (providing that all records of 

exchanges and associations are subject to such 

reasonable, periodic, special, or other examinations 

by representatives of the Commission as the 

Commission deems necessary or appropriate in the 

public interest, for the protection of investors, or 

otherwise in furtherance of the purposes of the 

Exchange Act).

500 5 U.S.C. 552(b)(4).

501 17 CFR 200.80(b)(4)(iii).

502See proposed Rule 17a–26(f).

503See proposed Rule 17a–26(g).

504See proposed Rule 17a–26(h)(1).

505See proposed Rule 17a–26(h)(2). See also 15 

U.S.C. 78f(g) (notice-registered exchanges) and 78o–

3(k)(1) (limited purpose securities associations).

506See proposed Rule 17a–26(i). See also 15 

U.S.C. 78q(a) (Section 17(a) under the Exchange Act 

requiring the maintenance of certain books and 

records); 78r(a) (Section 18(a) under the Exchange 

Act providing for liability for misleading 

statements); and 78ff(a) (Section 32(a) under the 

Exchange Act providing for penalties for willful 

violations and false and misleading statements).

strikes an appropriate balance between 

allowing the Commission to have 

prompt notice of material changes and 

giving an SRO adequate time to prepare 

and file a supplement with the 

Commission.

I. Confidentiality of Reports 

An exchange or association could 

request confidential treatment of any 

report or other information that the 

exchange or association provides to the 

Commission pursuant to proposed Rule 

17a–26. 494 The Commission would 

accord confidential treatment to the 

information to the extent permitted by 

law, including the Freedom of 

Information Act (‘‘FOIA’’). 495 An 

exchange or association would follow 

the procedures set forth in Rule 24b–2 

under the Exchange Act to request 

confidential treatment of information 

filed pursuant to proposed Rule 17a–

26.496 With respect to the basis for 

requesting confidential treatment under 

FOIA, there are two exemptions that 

likely would be relevant to a 

Commission determination whether to 

grant confidential treatment for 

information filed with the Commission 

under proposed Rule 17a–26. First, 

FOIA Exemption 8 provides an 

exemption for matters that are 

‘‘contained in or related to examination, 

operating, or condition reports prepared 

by, on behalf of, or for the use of an 

agency responsible for the regulation or 

supervision of financial 

institutions.’’ 497 Similarly, Commission 

Rule 80(b)(8), implementing FOIA 

Exemption 8, states that the 

Commission generally will not publish 

or make available to any person matters 

that are ‘‘[c]ontained in, or related to, 

any examination, operating, or 

condition report prepared by, on behalf 

of, or for the use of, the Commission, 

any other Federal, state, local, or foreign 

governmental authority or foreign 

securities authority, or any securities 

industry self-regulatory organization, 

responsible for the regulation or 

supervision of financial 

institutions.’’ 498 The information 

required by proposed Rule 17a–26 is 

material that would be submitted by 

SROs to their primary regulator in 

connection with and to facilitate the 

Commission’s periodic inspections of 

exchanges and associations, and would 

supplement the Commission’s 

examination and inspection program.499

Second, FOIA Exemption 4 provides 

an exemption for ‘‘trade secrets and 

commercial or financial information 

obtained from a person and privileged 

or confidential.’’ 500 Commission Rule 

80(b)(4)(iii), which implements FOIA 

Exemption 4, provides that this 

exemption is available for ‘‘information 

contained in reports, summaries, 

analyses * * * arising out of, in 

anticipation of or in connection with an 

examination or inspection of the books 

and records of any person or any other 

investigation.’’ 501 The information to be 

filed with the Commission pursuant to 

the proposed rule concerns regulatory 

and supervisory processes of SROs, and 

may contain trade secrets and 

commercial information, such as 

information involving the proprietary 

design of an exchange’s or association’s 

surveillance systems.

J. Compliance Date 

The first quarterly report required by 

proposed Rule 17a–26 would be due for 

the first full quarterly reporting period 

commencing six months after the 

publication of any final rule in the 

Federal Register.502 The Commission 

believes that this implementation period 

would allow exchanges and associations 

sufficient time to begin tracking, to the 

extent they are not currently doing so, 

all categories of information required by 

the proposed rule, as well as to develop 

an electronic format for filing the 

proposed reports.

K. Exemptions and Extensions of Time 

for Filing Reports 

Under Rule 17a–26 as proposed, the 

Commission would consider granting an 

extension of time for the filing of any 

reports or materials required by the 

proposed rule, upon the written request 

of an exchange or association or upon 

its own motion, if it determines that 

such extension is necessary or 

appropriate in the public interest and is 

consistent with the protection of 

investors.503 In addition, upon the 

written request of the exchange or 

association or on its own motion, the 

Commission would consider granting an 

exemption from any of the proposed 

rule’s requirements, either 

unconditionally or on specified terms 

and conditions, if it determines that 

such exemption is necessary or 

appropriate in the public interest and is 

consistent with the protection of 

investors.504 The proposed rule also 

would exempt from its reporting 

requirements all notice-registered 

exchanges and limited purpose 

securities associations.505

L. Filing of Reports 

Each report required by Proposed 

Rule 17a–26 shall constitute a ‘‘report’’

within the meaning of the Exchange 

Act, including the books and records 

provision of Sections 17(a) and the 

liability provisions of Sections 18(a) and 

32(a). 506 In proposing this provision of 

the proposed rule, the Commission 

intends to specify that the reports 

submitted pursuant to proposed Rule 

17a–26 would be subject to the general 

books and requirements of the Exchange 

Act and would be subject to the 

Exchange Act’s provisions governing 

liability for misleading statements in 

reports filed with the Commission.

M. Request for Comment 

The Commission invites interested 

persons to submit written comments on 

proposed Rule 17a–26. The Commission 

specifically requests comments on the 

following aspects of the proposed rule: 

Question 125. Is the proposed rule 

sufficiently clear regarding the 

information that is proposed to be 

required to be filed in the quarterly and 

annual reports? Are there any categories 

of information that should be added or 

deleted? 

Question 126. Are there provisions of 

the proposed rule that would be 

difficult for an exchange or association 

to satisfy and, if so, how could the 

provision in question be better tailored 

to assist in compliance? 

Question 127. Are the time frames for 

providing quarterly reports, i.e., within 

20 business days after the calendar 

quarter end, and annual reports, i.e., 

within 60 days after the year end, 

appropriate? Should they be shorter, 

e.g., 10 business days after the end of 

the calendar quarter end for the 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71179

quarterly report, or longer, e.g., 75 or 90 

days after the year’s end for the annual 

report? 

Question 128. Should the quarterly 

and annual reports required by the 

proposed rule be based on the SRO’s 

fiscal year, rather than on a calendar 

year basis? Are there reporting 

requirements in the proposed rule that 

should be filed on a fiscal year basis? 

Question 129. Should the 

Commission require a fourth quarter 

report to be filed 20 business days after 

the calendar year end, given the 

requirement to file an annual report 60 

days after the year end and the fact that 

the annual report would contain, in an 

aggregated form, information from the 

fourth quarter? If the Commission 

decides to require filing of only the first 

three quarterly reports, how could the 

information for the fourth quarter be 

separated in the annual report? Should 

it be separated in the annual report? 

Question 130. Are there issues 

presented by requiring the report of an 

annual independent audit to assess the 

operations of an exchange’s or 

association’s electronic SRO trading 

facility for compliance with all 

applicable SRO rules and with the 

federal securities laws and regulations? 

Are there other ways for the 

Commission to achieve the same result, 

i.e., to determine that the operation of 

any electronic SRO trading facility is 

conducted in accordance with all 

applicable statutory provisions and 

rules? Does the proposal provide 

sufficient time for the independent 

audit report to be prepared and 

incorporated into the annual report? If 

not, what time period would be 

sufficient? Should the audits be 

required more or less often? Should the 

Commission establish specific criteria to 

determine the entities qualified to 

conduct such an audit and prepare a 

report? Should the audit be required to 

be conducted by an independent 

auditor? Would independent public 

auditor be capable of conducting such 

audits? How much would such an audit 

cost? 

Question 131. Are any issues 

presented by the Commission’s 

proposed requirement that exchanges 

and associations establish procedures 

for the preparation of the quarterly and 

annual reports in a uniform, readily 

accessible, and usable electronic format? 

Should the Commission mandate the 

use of a particular format? Should the 

Commission require exchanges and 

associations to work together to develop 

a plan for filing the required reports in 

a standard electronic format? What role 

should the Commission play in such a 

process? 

Question 132. If the Commission were 

to adopt a technological standard for the 

format of the electronic quarterly and 

annual reports, what standard would be 

appropriate? The Commission’s primary 

concern in considering a technological 

standard is to minimize costs to the 

exchanges and associations, allow for 

easy manipulation and use of the data 

submitted, and not unduly restrict the 

development and adoption of new 

technological standards and formats. 

What standard or method would best 

serve to accomplish these goals? To 

what extent should the electronic 

reports be in a Microsoft Excel-type 

format versus a XML ‘‘data tagging’’

language format? If data tagging is the 

better approach, would XML, or a 

variation thereof, be an appropriate 

standard? To what extent does the 

appropriate electronic format depend 

upon the type and amount of data that 

would be required under the proposed 

rule?

Question 133. Should the 

Commission specify a method by which 

exchanges and associations file the 

proposed information, such as CDROM? Should the Commission explore 

the creation of a secure Web-based 

system for the filing of the required 

reports? 

Question 134. Would the requirement 

that the annual report contain an 

aggregation of the quarterly information 

for a given year be a relatively simple 

task, given the electronic nature of the 

reports? Would the inclusion of 

aggregated quarterly data in the annual 

report be helpful to an SRO’s 

management, including its Chief 

Regulatory Officer and the Regulatory 

Oversight Committee, in reviewing the 

operation of the SRO’s regulatory 

program on an annual basis? What 

arguments are there against requiring 

the annual report to contain the 

aggregated quarterly data? 

Question 135. Are there any items 

that should be added or deleted with 

respect to the results of surveillance 

programs, both manual and automated, 

and the results of surveillance for 

financial and operational requirements? 

Should the Commission require more or 

less detail on some or all of the items? 

Are there any alternatives to unique 

identifiers that could better accomplish 

the goals of tracking the information 

over time without including the identity 

of the member? Are there any issues 

presented by requiring the unique 

identifiers to be constant over time? 

Question 136. Are there any items 

that should be added or deleted in 

connection with the summaries of 

complaints, investigations, 

examinations, and enforcement cases? 

Should the Commission require more or 

less detail on any of the subcategories 

mentioned under any of those items? 

Should the Commission require 

information on other categories of 

complaints? Are there any alternatives 

to unique identifiers that could better 

accomplish the goals of tracking the 

information over time without including 

the identity of the member and 

associated person under review? Are 

there any issues presented by requiring 

the unique identifiers to be constant 

over time? 

Question 137. Is the provision 

requiring reporting of listings activity, 

including reporting of securities that 

were delisted or otherwise reprimanded 

for failure to satisfy listing standards, 

appropriate? Should the listings 

information in the proposed quarterly 

reports be expanded to include 

information on SRO delisting decisions 

that were appealed during the reporting 

period? Should the summary contain 

additional information on compliance 

plans? Is there any other information 

that should be added or deleted from 

this provision? 

Question 138. Is the provision 

requiring an exchange or association to 

file with the Commission, as part of the 

quarterly report, copies of agenda for 

board and committee meetings 

appropriate? Should the Commission 

require the filing of the complete 

minutes for board and committee 

meetings, or, as an alternative, some 

specified portion of the minutes? If a 

specified portion were required, what 

should that portion include? Should the 

provision extend to subject matter 

committees that are not composed of 

directors and are not part of the official 

board committee structure? 

Question 139. Is the requirement that 

the annual report contain a discussion 

of the internal policies and procedures 

an exchange or association uses to carry 

out its regulatory responsibilities 

appropriate? Are there any items under 

this category that should be deleted or 

added? 

Question 140. Is the requirement that 

the annual report contain an 

organizational chart of the regulatory 

department appropriate? Should the 

Commission require more or less detail 

to be reported on this chart? Should the 

Commission require contact information 

and employee titles to be reported in the 

chart? Should the Commission limit or 

expand the categories of staff that need 

to be specifically identified in the chart? 

Question 141. Is the provision 

requiring the SRO to evaluate the 

effectiveness of its regulatory program, 

including strengths and weaknesses, 

appropriate? Are there other 

71180 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

507See supra Sections II.B.9. and IV.C.9. for a 

detailed discussion of these proposed rules.

508 ‘‘Member’’ would be defined to have the 

meaning in Section 3(a)(3) of the Exchange Act, 15 

U.S.C. 78c(a)(3). See proposed Rule 17a–27(a)(9).

509 ‘‘Beneficial ownership’’ would be defined to 

have the meaning in Rule 13d–3 under the 

Exchange Act, 17 CFR 240.13d–3, as if (and 

whether or not) such security or other ownership 

interest were a voting equity security registered 

under Section 12 of the Act; provided that, to the 

extent any person beneficially owns any security or 

other ownership interest solely because such person 

is a member of a group within the meaning of 

Section 13(d)(3) of the Exchange Act, such person 

would not be deemed to beneficially own such 

security or other ownership interest for purposes of 

this section, unless such person had the power to 

direct the vote of such security or other ownership 

interest. See proposed Rule 17a–27(a)(3) and supra

note 226.

510See proposed Rule 17a–27(b)(1). Proposed 

Rule 17a–27(c) also would require the member to 

provide a copy of the statement to the exchange or 

association, as applicable.

511See proposed Rule 17a–27(a)(6). The term 

‘‘disclosure entity’’ would exclude exchanges 

registered under Section 6(g) of the Exchange Act, 

15 U.S.C. 78f(g), and national securities associations 

registered under Section 15A(k) of the Exchange 

Act, 15 U.S.C. 78o–3(k). Because the Commission 

does not have primary responsibility for regulating 

these exchanges and associations, members of such 

exchanges and associations would not be subject to 

proposed Rule 17a–27. See supra note 77.

512See proposed Rules 6a–5(b)(19) and 15Aa–

3(b)(20). ‘‘Person’’ would be defined to have the 

meaning in Section 3(a)(9) of the Exchange Act, 15 

U.S.C. 78c(a)(9). See proposed Rule 17a–27(a)(11). 

Members can be natural persons. If a member is a 

natural person, and a broker or dealer, it would be 

subject to the proposed Rule. If the member is not 

a broker or dealer, the member’s affiliated broker or 

dealer (which would be subject to the rule) would 

be required to aggregate the member’s interest with 

its own interest.

requirements that should be included in 

or deleted from this provision? 

Question 142. Is the requirement that 

the annual report contain a discussion 

of the internal controls regarding 

conflicts of interest appropriate? Are 

there items that should be added or 

deleted from this provision? 

Question 143. Is the requirement that 

the annual report discuss the 

employment arrangements with the 

Chief Regulatory Officer appropriate? Is 

requiring a discussion of employment 

arrangements with senior regulatory 

program personnel appropriate? Should 

the Commission limit the coverage of 

this provision to the five most highly 

compensated regulatory personnel? If 

so, is five the appropriate number or 

should the number be higher or lower? 

Question 144. Is the requirement that 

the annual report contain a copy of the 

annual performance self-evaluation 

prepared by a national securities 

exchange’s or registered securities 

association’s standing committees, 

including its Nominating, 

Compensation, Audit, and Regulatory 

Oversight Committees, appropriate? Is 

the requirement to provide a copy of the 

annual performance evaluation 

prepared by the Governance Committee 

appropriate? 

Question 145. Is the requirement to 

discuss efforts to comply with any 

recommendations or plan resulting from 

a Commission inspection or 

examination appropriate? 

Question 146. Is the certification 

requirement appropriate? Is the chief 

executive officer the appropriate official 

to certify the quarterly and annual 

reports on behalf of the exchange or 

association? In light of the provision of 

proposed Rules 6a–5 and 15Aa–3, 

which would require exchanges and 

associations to establish a Chief 

Regulatory Officer, would it be more 

appropriate for the Chief Regulatory 

Officer to certify the required reports, or 

for both officers to certify? 

Question 147. Under the 

Commission’s current rules, if an SRO 

wanted to request confidential treatment 

for information filed pursuant to 

proposed Rule 17a–26, the SRO would 

need to submit a request for confidential 

treatment pursuant to Rule 24b–2, and 

follow that Rule’s procedures. As 

discussed above, each SRO subject to 

proposed Rule 17a–26 would be 

required to submit quarterly and annual 

reports. In light of the regularity of filing 

of the proposed reports, should the 

Commission adopt a confidential 

treatment request procedure like Rule 

83? If the Commission adopts a 

procedure like Rule 83, are there ways 

that the Rule 83 procedure should be 

tailored in the context of Rule 17a–26? 

If so, how? 

Question 148. Are the provisions 

relating to the reporting of interim 

changes to the regulatory program and 

regulatory department or unit 

appropriate? Are there any other interim 

changes or developments, in addition to 

the changes to surveillance programs 

and changes to the exchange’s or 

association’s regulatory department 

cited in the rule, that should specifically 

be mentioned as triggering an obligation 

to file a supplement with the 

Commission? 

Question 149. Are the defined terms 

appropriate and sufficiently clear? Is the 

definition of the term ‘‘electronic SRO 

trading facility’’ and ‘‘regulatory 

subsidiary’’ appropriate? Should the 

Commission add to, delete, or modify 

any of the defined terms in the proposed 

rule?

VI. Proposed Rule 17a–27

A. Background and Need for Proposed 

Rule 17a–27

Proposed Rule 17a–27 would require 

a member of a national securities 

exchange or registered securities 

association that is a broker or dealer to 

provide notice to the Commission and 

the exchange or association of which it 

is a member when it acquires more than 

a 5% ownership interest in such 

exchange, association or in a facility of 

such exchange or association through 

which it is permitted to effect 

transactions. The proposed rule is 

designed to facilitate the ability of the 

Commission and each exchange and 

association to monitor the accumulation 

of significant ownership interests by 

members, so as to help ensure that 

exchanges and associations effectively 

perform their regulatory obligations to 

oversee the operations of their members 

and trading in their own markets, and 

to further the ability of the Commission 

to carry out its regulatory oversight of 

exchange and associations. This 

reporting requirement also is designed 

to complement proposed Rules 6a–5(o) 

and 15Aa–3(o), which would require 

exchanges and associations to have 

rules that prohibit their members that 

are brokers or dealers from owning and 

voting more than 20% of the exchange 

or association or a facility of the 

exchange or association, and proposed 

Items 2 and 3 of Exhibit Q to revised 

Form 1 and new Form 2, which would 

require an exchange or association to 

provide to the Commission information 

on all persons that own more than 5% 

of the exchange or a facility of the 

exchange or association.507

B. Description of Proposed Rule 17a–27

1. Brokers and Dealers Subject to the 

Rule 

Proposed Rule 17a–27 would require 

any member 508 of an exchange or 

association that is a broker or dealer to 

file a statement with the Commission if 

such member, alone or together with its 

related persons, acquires, directly or 

indirectly, beneficial ownership 509 of 

more than 5% of any class of securities 

or other ownership interest in a 

disclosure entity.510 For purposes of 

proposed Rule 17a–27, the term 

‘‘disclosure entity’’ would be defined to 

mean, with respect to a member, an 

exchange or association of which it is a 

member, or a facility of an exchange or 

association through which it is 

permitted to effect transactions.511 The 

term ‘‘related persons’’ would be 

defined in proposed Rule 17a–27(a)(13) 

to cover the same relationships as the 

term ‘‘related persons’’ in proposed 

Rules 6a–5 and 15Aa–3.512 As discussed 

above in Section II, the Commission 

believes it is important to capture all 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71181

513See supra Section II.B.9. for a discussion of 

the proposed definition of related persons.

514See proposed Rule 17a–27(b)(2).

515See proposed Rule 17a–27(b)(2)(i).

516See proposed Rule 17a–27(b)(2)(ii) and (iii).

517See proposed Rule 17a–27(b)(2)(iv).

518 15 U.S.C. 78l. See proposed Rule 17a–

27(b)(2)(v).

519See proposed Rule 17a–27(b)(2)(vi)(A). For 

purposes of making this percentage determination, 

a class of securities means the outstanding 

securities of such class, exclusive of any securities 

of such class held by or for the account of the 

disclosure entity (the issuer), or a subsidiary of the 

disclosure entity. See proposed Rule 17a–27(a)(4).

520See proposed Rule 17a–27(b)(2)(vi)(B). 521See proposed Rule 17a–27(b)(2)(vi)(C). A 

listing of the shareholders of an investment 

company registered under the Investment Company 

Act of 1940 or the beneficiaries of an employee 

benefit plan, pension fund or endowment fund 

would not be required. 522See proposed Rule 17a–27(b)(2)(vii) and supra

notes 519–521 and accompanying text. 523See supra Section IV.C.9. 524 15 U.S.C. 78m(d) and (g).

525See proposed Rules 17a–27(b)(2)(viii) and 

17a–27(b)(2)(ix).

526See proposed Rule 17a–27(b)(2)(x).

527 15 U.S.C. 78q(a), 78r(a), and 78ff(a). See

proposed Rule 17a–27(e)(i).

528See proposed Rule 17a–27(e)(ii).

529See proposed Rule 17a–27(b)(3).

530See proposed Rule 17a–27(b)(4).

potential relationships of a member 

with another person that could lead to 

the member having the ability to 

influence or control an exchange or 

association.513

2. Information Required To Be Filed 

Any statement required to be filed by 

a member pursuant to proposed Rule 

17a–27 would be required to include the 

following information: 514

• The title of the class of securities or 

other ownership interests for which the 

member is required to file the statement, 

and the identity and form of 

organization of the disclosure entity; 515

and

• Such member’s contact information, 

principal occupation (if the member is 

a natural person), and principal 

business (if the member is not a natural 

person).516

The member would be required to 

provide general information regarding 

the ownership interest that is the subject 

of the filing, including: (i) The total 

number of securities or other ownership 

interests of the disclosure entity issued 

and outstanding in each class or series; 

(ii) if the securities are publicly traded, 

the market(s) where they trade; (iii) any 

restrictions on ownership voting, 

transfers, or other disposition of such 

securities or other ownership interest of 

the disclosure entity; and (iv) any other 

material provisions relating to 

ownership of the disclosure entity.517 In 

addition, the member would be required 

to state whether the disclosure entity is 

a reporting issuer under Section 12 of 

the Exchange Act.518

The member also would be required 

to state the aggregate number and 

percentage of shares of a class of 

securities or other ownership interest of 

the disclosure entity that are 

beneficially owned by the member.519 In 

addition, the member would be required 

to indicate the aggregate number of 

shares or other ownership interest as to 

which the member has sole power to 

vote or to direct the vote, shared power 

to vote or to direct the vote, sole power 

to dispose or to direct the disposition, 

or shared power to dispose or to direct 

the disposition.520 Also, if any other 

person is known to have the right to 

receive or the power to direct the receipt 

of dividends from, or the proceeds from 

the sale of, such securities or other 

ownership interest, the member would 

be required to include a statement to 

that effect and, if such interest relates to 

more than 5% of the securities or 

ownership interest, to identify such 

person.521 Further, the member would 

be required to separately identify each 

related person whose ownership in a 

disclosure entity is included in the 

calculation of beneficial ownership 

required to be disclosed by the member, 

and provide the same ownership 

information for the related person as for 

the member.522 As noted above in 

Section IV, these requirements are 

modeled on the information required to 

be included in Schedule 13D or 13G 

under the Exchange Act.523 The 

Commission believes these 

requirements are appropriate because 

the intent of proposed Rule 17a–27—to 

provide the Commission with up-to-date 

information on the ability of members to 

control or influence the exchange—is 

similar to the purpose of the disclosure 

requirements of Sections 13(d) and 13(g) 

of the Exchange Act and the rules 

thereunder.524

The member also would be required 

to describe the power or ability of the 

member and its related persons to direct 

or cause the direction of the 

management and policies of the 

disclosure entity and any ability to 

exercise any influence or control over 

the regulatory responsibilities of the 

exchange or association.525 In addition, 

the member would be required to 

describe any contracts, arrangements, 

understandings or relationships (legal or 

otherwise) among the member and its 

related persons and between such 

persons and any other person with 

respect to any securities or other 

ownership interest of the disclosure 

entity, including but not limited to the 

transfer or voting of any of the securities 

or ownership interest, finder’s fees, joint 

ventures, loan or option arrangements, 

put or calls, guarantees of profits, 

division of profits or loss, or the giving 

or withholding of proxies. Such 

disclosure also would be required with 

respect to any of the securities or other 

ownership interests that are pledged or 

otherwise subject to a contingency the 

occurrence of which would give another 

person voting power or investment 

power over such securities or interest, 

except the statement would not need to 

disclose any standard default or similar 

provisions contained in loan 

agreements. The member would be 

required to provide the names of the 

other parties to these contracts, 

arrangements, understanding or 

relationships.526

Each statement filed by a member 

pursuant to this proposed rule would 

constitute a ‘‘report’’ within the 

meaning of Sections 17(a), 18(a), and 

32(a) of the Exchange Act, and any other 

applicable provisions of the Exchange 

Act.527 In addition, each statement 

required to be filed by a member 

pursuant to proposed Rule 17a–27 

would be considered filed upon receipt 

by the Division of Market Regulation at 

the Commission’s principal office in 

Washington, D.C.528

The disclosure requirements of 

proposed Rule 17a–27 are designed to 

provide information on members’

significant interests in their regulators 

or a facility thereof. The Commission 

believes that this information would 

further the ability of the exchange or 

association to carry out its regulatory 

responsibilities with respect to its 

members, and for the Commission to 

perform its statutory oversight of the 

exchange or association, by helping to 

reduce the potential for conflict between 

a member and its regulator. 

3. Timing of Filing 

A member would be required to make 

its initial filing of a statement under 

Rule 17a–27 within 10 calendar days of 

when it, together with its related 

persons, beneficially owns more than 

5% of any class of securities or other 

ownership interest, as set forth in 

paragraph (b)(1) of the proposed rule.529

In addition, a member would be 

required to file an amendment to the 

statement within ten calendar days of 

any change in the information required 

to be provided. However, a member 

would not be required to amend its 

statement if there is an increase or 

decrease of less than 1% of the 

ownership interest last reported on the 

statement or any amendment thereto.530

71182 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

531See proposed Rule 17a–27(c).

532See proposed Rule 17a–27(d).

The Commission believes the 10 day 

time period is reasonable in that it 

provides for timely disclosure by the 

member while still providing sufficient 

time to make and prepare the filing.

4. Filings With the Exchange or 

Association 

A member also would be required to 

provide a copy of the statement and all 

amendments to the applicable exchange 

or association,531 and the exchange or 

association would be required to post a 

copy of the statement on its publiclyaccessible Web site within 10 calendar 

days of receipt.532

5. Exemptions 

Finally, paragraph (f) of proposed 

Rule 17a–27 would provide a process 

for the Commission, upon written 

request or its own motion, to grant an 

exemption from the provisions of the 

proposed rule, either unconditionally or 

on specified terms and conditions, if the 

Commission determines that such 

exemption is necessary or appropriate 

in the public interest and is consistent 

with the protection of investors. 

Pursuant to this provision, the 

Commission would consider and act 

upon appropriate requests for relief 

from the rule’s provisions and consider 

the particular facts and circumstances 

relevant to each such request, the 

potential ramifications of granting any 

exemption, and any appropriate 

conditions to be imposed as part of the 

exemption. 

C. Request for Comment 

The Commission seeks general 

comments on all aspects of proposed 

Rule 17a–27 as described above. In 

addition, the Commission requests that 

interested persons respond to the 

following specific questions: 

Question 150. Would the information 

the Commission proposes to require 

members to provide to the Commission 

and the applicable SRO further SROs’

ability to carry out their regulatory 

obligations? Would the information be 

useful to investors? 

Question 151. Is the definition of 

beneficial ownership appropriate? Is it 

too narrow? Or is it too broad? 

Question 152. Is the proposed 

definition of ‘‘related persons’’ too 

narrow? Too broad? Is there any other 

relationship that should be included? 

Question 153. Should any person 

associated with a member be included 

in the proposed definition of ‘‘related 

person,’’ or should only those associated 

persons that possess, directly or 

indirectly, the power to direct or cause 

the direction of management and 

policies of the member, whether 

through the ownership of voting 

securities, by contract, or otherwise be 

included within the definition of 

‘‘related person’’? 

Question 154. Are the categories of 

information that would be required on 

the statement pursuant to proposed Rule 

17a–27 appropriate? Are there other 

categories that should be included, or 

some that should be deleted? 

Question 155. Should the 

Commission require members to 

provide any information in addition to 

what is proposed? If so, what additional 

information should be required? 

Question 156. Is 10 days sufficient 

time for members to make the initial 

filing, or do commenters think that less 

time is necessary? Or is more than 10 

days needed? 

Question 157. Is 10 days sufficient 

time for members to update information 

previously filed, or do commenters 

think that less time is necessary? Or is 

more than 10 days needed? 

Question 158. Is the proposed 

exclusion of members’ ownership in 

notice registered national securities 

exchanges and limited purpose national 

securities associations from the scope of 

proposed Rule 17a–27 appropriate? If 

not, why should they be included?

Question 159. The proposal would 

only require members that are brokerdealers to file statements under Rule 

17a–27; it would not require members 

that are natural persons and not 

registered as broker-dealers to file such 

statements. The Commission asks for 

comment on whether all members 

should be subject directly to the 

proposed reporting requirement. 

Question 160. Should the 

Commission require that members 

provide the required information in a 

particular form? For instance, should 

the Commission create a standardized 

form to be used to file the reports 

required by proposed Rule 17a–27? If 

so, please provide detail as to the 

structure of such a form. 

Question 161. Should the 

Commission apply the proposed rule to 

those persons that are not statutory 

‘‘members’’ but that own one or more 

memberships, or ‘‘seats,’’ in an 

exchange, but are not registered brokers 

or dealers and do not trade on or 

through the facilities of the exchange, 

but lease the trading right to a brokerdealer? If so, should it depend upon 

whether the person retains the voting 

rights associated with such 

membership? 

Question 162. Will members have 

access to, or the ability to obtain for 

each item, information that would be 

required to be filed pursuant to 

proposed Rule 17a–27? In particular, 

would a member be able to obtain the 

information required by paragraph 

(b)(2)(iv) on the total number of 

securities or other ownership interest 

issued and outstanding of a disclosure 

entity? Is there any information a 

member would not be able to easily 

obtain? 

VII. Implementation 

The Commission is proposing to 

implement the proposed rules and rule 

amendments and proposed revisions to 

forms as follows: 

Proposed Rules 6a–5 and 15Aa–3 

would require SROs to file proposed 

rule changes that comply with the 

applicable proposed rule’s requirements 

no later than four months following the 

date of publication in the Federal 

Register of any governance rules 

adopted by the Commission, and would 

require that SROs have final rules 

approved by the Commission no later 

than ten months following such 

publication date. The SROs’ rule 

changes would have to be operative no 

later than one year following the 

publication date of any governance rules 

adopted by the Commission. 

Regulation AL would be operative one 

year following the date of publication in 

the Federal Register of the adoption of 

proposed Regulation AL. 

Revised Form 1 and new Form 2 

would become effective 30 days 

following the date of publication in the 

Federal Register of the adoption of the 

proposed amendments to these forms in 

the case of those applicants whose 

registration forms have not yet been 

approved by the Commission as of such 

publication date. The proposed 

amendments to Rules 6a–2 and 15Aa–2 

also would become effective 30 days 

following the date of publication in the 

Federal Register of the adoption of 

these proposed amendments in the case 

of those applicants whose registration 

forms have not yet been approved by the 

Commission. 

Pursuant to proposed paragraph (g) of 

Rule 6a–2 and proposed paragraph (f) to 

Rule 15Aa–2, any exchange or 

association that is registered with the 

Commission as of the publication date 

of the adoption of proposed 

amendments to these Commission rules 

would be required to file a complete 

new statement together with all exhibits 

no later than six months following such 

publication date. Until such filing, 

currently-registered exchanges and 

associations could continue to rely on 

the requirements of the current 

registration forms and the related rules.

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71183

The amendment to Rule 17a–1 would 

become effective 30 days following the 

date of publication in the Federal 

Register of the adoption of proposed 

amendments to Rule 17a–1. 

Under proposed Rule 17a–26, the first 

quarterly report would be due for the 

first full quarterly reporting period 

commencing six months following the 

date of publication in the Federal 

Register of the adoption of proposed 

Rule 17a–26. 

Finally, proposed Rule 17a–27 would 

become effective 60 days following the 

date of publication in the Federal 

Register of the adoption of proposed 

Rule 17a–27. 

We request comment on these 

proposed implementation dates and 

whether they would provide sufficient 

time for SROs to comply with the 

proposed new rules and rule 

amendments and the proposed revisions 

to the forms. We request comment on 

whether more or less time is necessary 

for exchanges and associations to review 

their governance and regulatory 

structures in light of the proposed 

governance rules and whether the 

proposed implementation schedule 

would provide sufficient time for the 

SROs to prepare proposed rule changes, 

prepare for necessary governance 

changes, and conform to the 

requirements relating to the 

independence of the regulatory 

programs from market operations and 

other commercial interests. 

We also seek comment on the 

feasibility of existing exchanges and 

associations preparing a complete new 

registration statement within the 

proposed six month time frame. We 

further recognize that many of the 

proposals are interrelated and thus some 

requirements cannot be complied with 

until all rule and form revisions are 

fully implemented, e.g., certain revised 

Form 1 and new Form 2 Exhibits relate 

to items proposed in the governance 

rules. Accordingly, we request 

commenters’ views on an 

implementation schedule that would 

achieve the Commission’s goal of having 

any final rules become operative as soon 

as feasible, yet provide exchanges and 

associations with sufficient time to 

comply with any new requirements. 

VIII. General Request for Comment 

The Commission seeks comment on 

proposed Exchange Act Rules 3b–19, 

6a–5, 15Aa–3, 17a–26, and 17a–27; 

proposed amendments to current 

Exchange Act Rules 6a–2, 15Aa–1, 

15Aa–2 (redesignated Rule 15Aj–1), and 

17a–1; proposed Regulation AL; 

proposed amendments to Form 1 and to 

Form 2 (redesignated Form X–15AA–1); 

and the proposed removal of Forms X–

15AJ–1 and X–15AJ–2. 

We ask commenters to address 

whether the proposed rules are 

appropriately tailored to achieve the 

goal of furthering sound governance as 

well as the other applicable provisions 

of the Exchange Act by requiring SROs’

boards to be composed of a majority of 

independent directors and Standing 

Committees to be fully independent and 

by mandating the independence of the 

SROs’ regulatory functions from their 

market operations and other commercial 

interests. We also request comments on 

the need to, and appropriateness of, 

requiring exchanges and associations to 

limit the ability of their members that 

are brokers or dealers from owning or 

voting a significant stake in the 

exchange or association (or facility 

thereof), to reduce conflicts of interest 

and the potential for a member to 

influence or control its regulator in a 

manner detrimental to its competitors or 

in a manner favorable to such member. 

In addition, we seek commenters’ views 

regarding the proposal to enhance the 

transparency of SROs’ governance and 

ownership structures and regulatory 

activities and its potential impact on 

users of the SROs’ trading facilities, 

other market participants, and the 

public generally. Further, we seek 

comment on the proposed disclosure 

items of revised Form 1 and new Form 

2, and the timing and form of 

amendments to proposed Rules 6a–2, 

15Aa–1, and 15Aa–2. We specifically 

request comment on the ability of an 

exchange or association to obtain the 

ownership information necessary to 

comply with the ownership disclosure 

requirements of revised Form 1 and new 

Form 2.

We ask commenters to address Rule 

17a–26, including whether there are 

items of information that should be 

added or deleted in the quarterly and 

annual reports to the Commission. We 

also specifically request comment on 

the effectiveness of proposed Regulation 

AL to enhance an exchange’s or 

association’s monitoring of listing and 

trading of affiliated securities and thus 

to reduce the potential conflicts 

inherent in such oversight, and whether 

proposed Regulation AL would provide 

adequate guidance for preparing and 

filing the required quarterly and annual 

reports. We also seek comment on the 

usefulness of the disclosures required 

by proposed Rule 17a–27. We request 

comment on whether proposed Rule 

17a–27 is too broad or narrow in its 

reach and whether the Commission 

should prescribe a form for providing 

such disclosures. We also seek comment 

on the various proposed definitions and 

the proposed numerical criteria and 

threshold values that are contained in 

the proposed rules. We seek comments 

on the proposals as a whole, including 

their interaction with each other, and 

whether they would achieve their 

intended goals. 

Commenters should, when possible, 

provide us with empirical data to 

support their views. Commenters 

suggesting alternative approaches 

should provide comprehensive 

proposals, including any conditions or 

limitations that they believe should 

apply. The Commission also invites 

commenters to provide views and data 

concerning the costs and benefits 

associated with the proposed new rules 

and amendments to existing rules and 

forms. 

International Commenters 

The Commission shares the goal of 

the international regulatory community 

in seeking greater convergence of robust 

standards for oversight of the securities 

markets, and recognizes that the 

proposals described above would 

impact foreign exchanges seeking to 

conduct business directly in the U.S. 

market. Accordingly, we are interested 

in obtaining comment from foreign 

exchanges and market participants 

about these proposals. We are interested 

in general comments, and, specifically, 

the extent to which any of the proposals 

would cause conflicts with foreign law. 

In assessing the comments, the 

Commission will be mindful of the 

importance of its investor protection 

mandate and the need for a level 

playing field. 

We specifically request comment on 

the following topics: 

Question 163. With regard to the 

Governance Standards Proposal, are 

there any direct conflicts of law in your 

jurisdiction? Has your jurisdiction had 

recent experience with the issues raised 

by this proposal? If so, please describe 

the approach taken in your jurisdiction. 

Question 164. With regard to the 

Transparency Proposal, are there any 

direct conflicts of law in your 

jurisdiction? Has your jurisdiction had 

recent experience with the issues raised 

by this proposal? Please describe the 

types of reporting requirements to 

which exchanges in your jurisdiction 

are subject. 

Question 165. With regard to the SRO 

Reporting Proposal, are there any direct 

conflicts of law in your jurisdiction, in 

particular with regard to privacy laws? 

Has your jurisdiction had recent 

experience with the issues raised by this 

proposal? If so, please describe the 

approach taken in your jurisdiction. 

71184 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

533 44 U.S.C. 3501, et seq.

534 44 U.S.C. 3512.

535The Commission also proposes to amend Rule 

15Aa–1 under the Exchange Act, 17 CFR 240.15Aa–

1, to state that associations would file an initial 

application for registration on new Form 2. This is 

a technical change that would not impose 

recordkeeping or information collection 

requirements, or other collections of information 

within the meaning of the PRA.

Question 166. With regard to the SRO 

Ownership Proposal, are there any 

direct conflicts of law in your 

jurisdiction? Has your jurisdiction had 

recent experience with the issues raised 

by this proposal? If so, please describe 

the approach taken in your jurisdiction. 

IX. Paperwork Reduction Act Analysis 

A. Proposed Rule 3b–19

The proposed amendments to Rule 

3b–19 under the Exchange Act do not 

impose recordkeeping or information 

collection requirements, or other 

collections of information that require 

approval of the Office of Management 

and Budget (‘‘OMB’’) under 44 U.S.C. 

3501, et seq. Accordingly, the 

Paperwork Reduction Act does not 

apply. 

B. Proposed Amendments to Rule 6a–2, 

Revised Form 1, Rule 15Aa–2, and New 

Form 2

Proposed Rule 6a–2, revised Form 1, 

proposed Rule 15Aa–2, and new Form 

2 contain ‘‘collection of information’’

requirements within the meaning of the 

Paperwork Reduction Act of 1995 

(‘‘PRA’’).533 The Commission has 

submitted them to the OMB for review 

in accordance with 44 U.S.C. 3507(d) 

and 5 CFR 1320.11. The title for the 

collection of information with respect to 

exchanges is ‘‘Form 1 and Rules 6a–1 

and 6a–2: Form of Application and 

Amendments.’’ The collection of 

information contains a currently 

approved collection of information 

under OMB control number 3235–0017. 

The title for the new collection of 

information with respect to associations 

is ‘‘Form 2 and Rules 15Aa–1 and 

15Aa–2: Form of Application and 

Amendments.’’ OMB has not yet 

assigned a control number for the new 

collection of information contained in 

proposed Rules 15Aa–1 and 15Aa–2 and 

new Form 2. An agency may not 

conduct or sponsor, and a person is not 

required to respond to, a collection of 

information unless it displays a 

currently valid control number.534

1. Summary of Collections of 

Information 

The Commission proposes to require 

that an applicant for registration as a 

national securities exchange, or an 

exemption from exchange registration 

based on limited volume, file Form 1, as 

proposed to be revised. An applicant for 

registration as a securities association or 

an affiliated securities association 

would be required to file Form 2 

(formerly Form X–15AA–1), as 

proposed to be revised.535 Proposed 

Rule 6a–2 would require national 

securities exchanges to submit annual 

amendments and certain interim 

updating amendments to their 

registration application on the revised 

Form 1. Proposed Rule 15Aa–2 would 

require registered associations to submit 

annual amendments and certain interim 

updating amendments to their 

registration application on the new 

Form 2. The Commission also proposes 

to repeal Forms X–15AJ–1 and X–15AJ–

2, which are now used by associations 

to file amendments to Form X–15AA–1. 

The proposals would require an 

exchange or association to disclose more 

detailed information about its 

governance, regulatory functions, and 

ownership in its registration form and 

amendments thereto. The current Form 

1 Exhibits that would be incorporated in 

revised Form 1 and new Form 2 require 

the following information: 

• Copies of the applicant’s 

constitution or articles of incorporation, 

by-laws, and rules (Exhibit A); 

• Written rulings, settled practices 

and interpretations of the applicant 

(Exhibit B); 

• Information about officers (current 

Exhibit J, proposed Exhibit D); 

• Audited financial statements 

(Exhibit I); 

• Separate financial statements for 

each affiliate of the applicant (current 

Exhibit D, proposed Exhibit J); 

• General information about the 

applicant’s affiliates and any 

unaffiliated entity that operates an SRO 

trading facility (current Exhibit C, 

proposed Exhibit K);

• A description of the manner of 

operation of any SRO trading facility 

used to effect transactions on the 

applicant (current Exhibit E, proposed 

Exhibit L); 

• A complete set of all forms 

pertaining to application for 

membership, participation or 

subscription to the applicant, 

application for approval as a person 

associated with a member, participant, 

or subscriber, and any other similar 

materials (current Exhibit F, proposed 

Exhibit M); 

• A complete set of all forms of 

financial statements, reports or 

questionnaires required of members, 

participants, subscribers, or any other 

users relating to financial responsibility 

or minimum capital requirements 

(current Exhibit G, proposed Exhibit N); 

• A complete set of documents 

comprising listing applications (current 

Exhibit H, proposed Exhibit O); 

• A description of the criteria for 

membership, conditions leading to 

suspension or termination of 

membership, and any procedures for 

suspension or termination (current 

Exhibit L, proposed Exhibit R); and 

• A list of all members, participants, 

subscribers or other users and general 

information about such person (current 

Exhibit M, proposed Exhibit S). 

The proposed additional Exhibits to 

the revised Form 1 and new Form 2 

would require enhanced disclosures of 

exchanges and associations, as follows: 

• A description of the composition, 

structure, and responsibilities of the 

applicant’s board of directors and 

information about its Chairman and/or 

Chief Executive Officer (Exhibit C); 

• A description of the structure, 

composition and responsibilities of any 

executive board and committee of the 

applicant and a complete governance 

chart of the applicant (Exhibit E); 

• Copies of the applicant’s 

governance guidelines and code of 

conduct and ethics (and a disclosure of 

any waivers of the code) (Exhibit F); 

• An organizational chart illustrating 

the internal governance structure of the 

applicant and indicating each 

department or division and their 

respective responsibilities (Exhibit G); 

• A description of the applicant’s 

regulatory program, including its 

independence from the other functions 

of the applicant, any significant planned 

changes in the applicant’s regulatory 

program, and any significant regulatory 

issues or events that may affect the 

applicant’s regulatory program and a 

copy of any delegation plans or other 

contracts relating to regulatory services 

to be provided to the applicant (Exhibit 

H); 

• A detailed description of the 

applicant’s financial activities, 

including an itemization of the 

applicant’s revenues and expenses 

derived from the applicant’s regulatory 

activities, an itemization of nonregulatory expenses, a discussion of 

information necessary to an 

understanding of the financial condition 

of the applicant and any material 

changes in its financial condition, a 

discussion of any unusual or infrequent 

events or transactions or any significant 

economic changes that have had a 

material effect on the financial 

condition of the applicant and any 

known demands, commitments, events 

or uncertainties that would result in or 

are reasonably likely to result in a 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71185

536See proposed Rules 6a–2(a)(1)–(2) and 15Aa–

2(a)(1)–(2). The referenced Exhibits would solicit 

the following information: (1) Information regarding 

the composition, structure, and responsibilities of 

the Board (Exhibit C); (2) information with respect 

to the officers (Exhibit D); (3) information regarding 

the structure, composition, and responsibilities of 

the executive board and each committee (Exhibit E); 

(4) information regarding the regulatory program 

(Exhibit H); (5) audited financial statements 

(Exhibit I); (6) separate financial statements, 

including a balance sheet and an income statement 

and statement of cash flows (Exhibit J); (7) 

information regarding each affiliate of the applicant 

and any unaffiliated entity that operates an SRO 

trading facility (Exhibit K); (8) the forms pertaining 

to the application for membership, participation, or 

subscription (Exhibit M); (9) the forms of financial 

statements, reports, or questionnaires required of 

members, participants, subscribers, or any other 

users relating to financial responsibility or 

minimum capital requirements (Exhibit N); (10) 

documents comprising the applicant’s listing 

applications, including any agreements required to 

be executed in connection with listing and a 

schedule of listing fees (Exhibit O); (11) information 

on exchanges, associations, their facilities, and their 

respective affiliates (Exhibit P); (12) list of members, 

participants, subscribers, or other users and general 

information about each (Exhibit S); (13) location of 

books and records (Exhibit U); (14) disclosure of 

any waivers of the code of conduct and ethics for 

directors or officers (Item 3 of Exhibit F); or (15) 

information about each class or series of 

outstanding securities or other ownership interest 

of an exchange, association, or facility of either; 

whether and how each person and Related Person 

possess the power to influence the management or 

policies of the exchange, association or facility; if 

a Disclosure Entity is a partnership, a list of 

partners that have the right to or have contributed 

more than 5% of the partnership’s capital; and 

contracts, arrangements, understandings or 

relationships between such persons, and between 

such persons and any other person with respect to 

any securities or other ownership interest of the 

Disclosure Entity (Items 1, 5, 6, and 7 of Exhibit Q).

537See proposed Rules 6a–2(a)(3) and 15Aa–

2(a)(3). Items 2 and 3 of Exhibit Q would require 

the following information: (1) General information 

about any person who alone or together with its 

Related Persons, directly or indirectly beneficially 

owns more than 5% of any class of securities or 

other ownership interest in a Disclosure Entity 

(Item 2 of Exhibit Q); and (2) information regarding 

each Related Person identified above whose 

ownership in a Disclosure Entity is included in the 

calculation of beneficial ownership and the number 

and percentage of shares of ownership interest of 

such security that are beneficially owned (Item 3 of 

Exhibit Q). See proposed Exhibit Q of revised Form 

1 and new Form 2.

538See proposed Rules 6a–2(b) and 15Aa–2(b).

539See proposed Rules 6a–2(c) and 15Aa–2(c). 

Pursuant to Rule 6a–2(d), however, an exchange 

would not be required to file amendments under 

paragraphs (a) or (b) of proposed Rule 6a–2 with 

respect to Exhibits A, B, M, N, S, or T or Items 1–

7 of Exhibit L in paper form, as long as the exchange 

or association makes such information continuously 

available on an Internet Web site under its control, 

indicates the location of the Web site where such 

information could be found, and certifies that the 

information available at such location is accurate as 

of its date.

540See Sections 6(b)(1) and 15A(b)(2) of the 

Exchange Act, 15 U.S.C. 78f(b)(1) and 78o–3(b)(2).

material change in financial condition, 

a description of any significant business 

development involving the applicant, a 

description of all material contracts and 

all material related party transactions, a 

description of material commitments by 

the applicant for expenditures as of the 

end of the latest fiscal period, certain 

charitable contributions of the applicant 

in excess of $1,000, a table detailing the 

compensation (and the material terms of 

the employment agreements) of the five 

most highly compensated executives of 

the applicant, and a description of the 

compensation provided to directors 

(Exhibit I); 

• An organizational chart of the 

relationship between the applicant, any 

facility of the applicant, and any 

affiliate of the applicant or a facility of 

the applicant, and information about the 

nature and ownership structure of those 

entities (Exhibit P); 

• Enhanced disclosures of the 

ownership interest of any applicant or 

facility (‘‘disclosure entity’’), and 

information on any person and its 

‘‘Related Persons’’ that directly or 

indirectly beneficially owns more than 

5% of any class of securities or other 

ownership interest in a disclosure entity 

(Exhibit Q); 

• The location of where the 

applicant’s books and records are 

maintained (Exhibit U); and 

• A schedule of listed securities and 

securities admitted to unlisted trading 

privileges, including information about 

the ‘‘self-listing’’ of the applicant, an 

SRO trading facility of the applicant, or 

any affiliate of the applicant or of an 

SRO trading facility of the applicant 

(current Exhibit N, proposed Exhibit T). 

The proposals further would require 

exchanges and associations to submit 

any amendments to revised Form 1 or 

new Form 2 on a basis more frequent 

than is currently required. Proposed 

Rules 6a–2 and 15Aa–2 under the 

Exchange Act would require a national 

securities exchange, an exchange 

exempted from such registration as a 

national securities exchange based on 

limited volume, a national securities 

association, or an affiliated securities 

association to file an amendment to the 

revised Form 1 or new Form 2 (as 

applicable) within 10 calendar days 

after any material event takes place that 

renders inaccurate, or that causes to be 

incomplete: (i) Any information filed on 

the Execution Page of proposed Form 1 

or new Form 2, or an amendment 

thereto; (ii) any information filed as part 

of proposed Exhibits C, D, E, H, I, J, K, 

M, N, O, P, S or U and as part of Item 

3 of Exhibit F or Items 1, 5, 6, and 7 of 

Exhibit Q to the proposed Form 1 or 

new Form 2, or any amendments 

thereto; 536 and (iii) information filed as 

part of Items 2 or 3 of Exhibit Q, or any 

amendment thereto, except that such 

information is not required to be filed 

with respect to any person whose 

ownership change is less than 1% from 

the ownership interest last reported on 

the revised Form 1 or new Form 2, or 

any amendment thereto.537

An exchange or association also 

would be required to file an annual 

amendment to update revised Form 1 or 

new Form 2 (as applicable) in its 

entirety within 60 days of the end of its 

fiscal year. With respect to this annual 

amendment, each Exhibit would be 

required to be up to date as of the end 

of the latest fiscal year of the exchange 

or association.538 An exchange or 

association also would be required to 

post continuously any amendments 

required to be filed under proposed 

Rules 6a–2(a)–(b) and 15Aa–2(a)–(b) on 

a publicly accessible Internet Web site, 

simultaneous with the filing of such 

information in paper form with the 

Commission.539

In addition, exchanges and 

associations that are registered with the 

Commission as of the date of 

publication in the Federal Register of 

adoption of the proposed amendments 

to the forms would be subject to a onetime requirement to file a complete 

revised Form 1 or new Form 2, as 

applicable, no later than six months 

following such publication date. 

2. Proposed Use of Information 

The purpose of the collections of 

information in proposed Rules 6a–2 and 

15Aa–2, revised Form 1, and new Form 

2 is to keep the Commission, market 

participants, and the public informed of 

the governance and ownership structure 

and regulatory program of each 

applicant and harmonize the procedures 

for application as a national securities 

exchange and as a registered securities 

association and for the submission of 

amendment to such applications. The 

information required to be disclosed 

should enable the Commission, market 

participants, and the public to gain a 

greater awareness of key features of the 

exchange’s or association’s governance 

and ownership structure and its 

regulatory programs. The disclosure 

items on the revenues and expenditures 

of the SRO’s regulatory programs should 

be particularly useful to the 

Commission, market participants, and 

the public.540 Further, the information 

collected should significantly enhance 

the transparency of each applicant’s 

organizational and ownership structure 

and regulatory programs and assist the 

Commission in monitoring each 

applicant’s compliance with the 

governance requirements contained in 

proposed Rules 6a–5 and 15Aa–3 under 

the Exchange Act.

71186 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

541These nine registered national securities 

exchanges are the Amex, BSE, CHX, CBOE, ISE, 

NSX, NYSE, PCX, and the Phlx. The collection of 

information does not apply to national securities 

exchanges registered under Section 6(g) of the 

Exchange Act and limited purpose securities 

associations registered under Section 15(k) of the 

Exchange Act. Currently, Virt-X Exchange Limited 

(‘‘Virt-X’’) is operating under an exemption from 

registration as a national securities exchange based 

on limited volume. However, the Commission 

exempted Virt-X from Rules 6a–1, 6a–2 and 6a–3 

under the Exchange Act. See Securities Exchange 

Act Release No. 41199 (March 22, 1999), 64 FR 

14953 (March 29, 1999). Therefore, the Commission 

has determined not to include Virt-X as a 

respondent to the collection of information.

542The national securities association is the 

NASD. There currently are no registered affiliated 

securities associations.

543The current average burden of 47 hours for 

filing an initial application for registration on Form 

1 is based on the Paperwork Reduction Act update 

as of Spring 2004.

544Current Rule 15Aa–1 under the Exchange Act, 

which prescribes Form X–15AA–1 as the initial 

registration application for associations, also does 

not have a pre-existing paperwork burden.

545The current average burden of 25 hours for 

filing annual and periodic updates on Form 1 is 

based on the PRA update for Form 1 as of Spring 

2004.

546See Rules 19b–4(l) and (m) under the 

Exchange Act, 17 CFR 240.19b–4(l) and (m) 

(requiring SROs to post all proposed rule changes, 

as well as current versions of their rules, on their 

Web sites).

547The basis for the Commission’s belief is the 

time estimated for posting by SROs on their Web 

sites of their proposed rule changes and current and 

complete versions of their rules. See Exchange Act 

Release No. 50486, supra note 423.

548The Commission estimates that an initial 

application and copies would weigh approximately 

180 lbs and would be mailed via courier/shipping 

service.

549 Id.

550The Commission estimates that an amendment 

and copies would weigh approximately 60 lbs and 

would be mailed via courier/shipping service.

551This total includes the burden of preparing 

and submitting the initial registration form, but 

does not include any initial start-up burden for 

creating a website (this is a burden on which the 

Commission is soliciting comments).

3. Respondents 

The collection of information in Rule 

6a–1, proposed Rule 6a–2, and revised 

Form 1 would apply to every registered 

national securities exchange and every 

exchange exempt from registration as a 

national securities exchange based on 

limited volume. Currently, there are 

nine registered securities exchanges.541

The collection of information in Rule 

15Aa–1, proposed Rules 15Aa–2, and 

new Form 2 would apply to every 

national securities association and every 

affiliated securities association. 

Currently, there is one national 

securities association.542

4. Reporting and Recordkeeping Burden 

Based on the information available to 

the Commission at this time, the 

Commission estimates that an applicant 

for registration as a national securities 

exchange, a securities association, or an 

affiliated securities association, or for an 

exemption from registration as a 

national securities exchange based on 

limited volume would incur an average 

burden of 157 hours to obtain 

information necessary to, and to 

prepare, each initial Form 1 or Form 2 

application, respectively. The 

Commission estimates that the 

additional information required in Form 

1, as proposed to be revised, would 

impose an additional paperwork burden 

of 110 hours on an applicant, for a total 

recordkeeping and reporting burden of 

157 hours per applicant.543 Proposed 

Form 2 would be a completely new 

form, and therefore does not have an 

existing ‘‘collection of information’’

burden within the meaning of the 

PRA.544 However, because new Form 2 

would impose the same paperwork 

burden on association applicants that 

revised Form 1 would impose on 

exchange applicants, the Commission 

estimates that the paperwork burden for 

Form 2 also would be 157 hours per 

applicant. Those exchanges and 

associations that are registered with the 

Commission as of the publication date 

of adoption of the proposed revisions to 

the forms would be subject to a one-time 

requirement to file a complete new 

registration statement on Form 1 or 

Form 2, as applicable, within six 

months following such publication date, 

and thus they also would have an initial 

paperwork burden of 157 hours each. 

The Commission estimates that any 

registered exchange or association, 

whose fiscal year ends after the date by 

which the one-time complete new 

registration statement on revised Form 1 

or new Form 2, as applicable, would be 

required to be filed, but within the same 

calendar year that such one-time filing 

is required, would incur an additional 

reporting and recordkeeping burden of 

20 hours for the first year to prepare an 

annual amendment to the revised Form 

1 or new Form 2, as applicable.

In addition, the Commission estimates 

that an applicant will incur a yearly 

burden of 40 hours to comply with the 

requirement in proposed Rules 6a–2 and 

15Aa–2 to file annual and periodic 

amendments to revised Form 1 or new 

Form 2. This figure represents a 15 hour 

increase from the current Form 1 

average burden due to the estimated 

additional burden of the annual 

reporting requirements.545

Proposed Rules 6a–2 and 15Aa–2 also 

would require exchanges and 

associations to post their amendments 

on a publicly accessible Internet Web 

site. The Commission notes that 

exchanges and associations currently 

are required to maintain a publicly 

accessible Web site.546 The Commission 

estimates that an exchange or 

association would incur a paperwork 

burden of 4 hours to post its amendment 

on a publicly available Web site,547 and 

that the exchange or association would 

post an average of two amendments per 

year, for a total burden of 8 hours 

annually per exchange or association. 

The Commission requests comment on 

its estimate of the average number of 

amendments an SRO would file per 

year, as well as on its estimate of how 

long it would take an exchange or 

association to post an amendment on its 

Web site. The Commission also requests 

comment as to whether an SRO would 

incur any start-up costs in preparation 

for compliance with this Internet 

posting requirement under proposed 

Rules 6a–2 and 15Aa–2.

An applicant also would incur costs 

in the mailing of paper filings and 

copies to the Commission. The 

Commission estimates that the costs of 

mailing an initial application on revised 

Form 1 or new Form 2 would be 

$673.33.548 The costs of filing a 

complete registration form on revised 

Form 1 or new Form 2 no later than six 

months following the final rules 

publication date is also estimated by the 

Commission to be $673.33.549 The 

Commission estimates that the costs of 

mailing an amendment to revised Form 

1 or new Form 2 would be $365.86.550

The Commission estimates that total 

reporting and recordkeeping burden for 

an exchange that submits an initial 

registration or exemption application on 

the revised Form 1 would be 157 hours 

and $673.33 per applicant.551 For 

exchanges that are already registered 

with the Commission, the estimated 

reporting and recordkeeping burden for 

filing a complete revised Form 1 and 

any requisite updating amendments for 

the first year in which the final rules’

are published would be 177 hours and 

approximately $1,039 per exchange. 

Thus, the Commission estimates that the 

total recordkeeping and reporting 

burden for all nine registered exchanges 

for the first year in which the final rules 

are published would be 1,593 hours and 

approximately $9,351. After the year in 

which an exchange initially files the 

revised Form 1, the Commission 

estimates that such exchange would 

bear an annual reporting and 

recordkeeping burden of 48 hours and 

$731.72, and that all exchanges would 

bear a total annual reporting and 

recordkeeping burden of 432 hours and 

approximately $6,585.

The Commission estimates that total 

reporting and recordkeeping burden for 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71187

552This total includes the burden of preparing 

and submitting the initial registration form, but 

does not include any initial start-up burden for 

preparation for compliance with the Internet 

posting requirement (this is a burden on which the 

Commission is soliciting comments).

553 17 CFR 240.17a–1.

554 44 U.S.C. 3501 et seq.

555See 44 U.S.C. 3512.

556Pursuant to proposed Rules 6a–5(b)(18) and 

15Aa–3(b)(19), ‘‘regulatory subsidiary’’ would mean 

any person that, directly or indirectly, is controlled 

by the national securities exchange or registered 

securities association, as applicable, and that 

provides, whether pursuant to contract, agreement 

or rule, regulatory services to or on behalf of the 

national securities exchange or registered securities 

association, as applicable. Several SROs have 

delegated to one or more subsidiaries the 

responsibility to carry out certain functions arising 

out of the SRO’s obligations under the Exchange 

Act. See supra notes 78–81 and accompanying text.

557See proposed Rules 6a–5(c)(2) and 15Aa–

3(c)(2).

558See id.

559Proposed Rules 6a–5(n)(4)(i) and 15Aa–

3(n)(4)(i) would prohibit an exchange or 

association, respectively, from applying regulatory 

fees, fines or penalties to fund anything other than 

programs and operations directly related to their 

regulatory responsibilities. See discussion supra at 

II.B.8.b.

560 17 CFR 240.17a–1.

561See 5 CFR 1320.3(b)(2).

562 17 CFR 240.19b–4.

an association that submits an initial 

registration application on the new 

Form 2 would be 157 hours and $673.33 

per applicant.552 For associations that 

are already registered with the 

Commission, the estimated reporting 

and recordkeeping burden for filing a 

complete new Form 2 and any requisite 

updating amendments for the first year 

in which the final rules are published 

would be 177 hours and approximately 

$1,039 per association. Thus, the 

Commission estimates that the total 

recordkeeping and reporting burden for 

the one registered association for the 

first year in which the final rules are 

published would be 177 hours and 

approximately $1,039. After the year in 

which an association initially files the 

new Form 2, the Commission estimates 

that such association would bear an 

annual reporting and recordkeeping 

burden of 48 hours and $731.72.

5. Collections of Information are 

Mandatory 

These collections of information 

would be mandatory. The collections of 

information filed with the Commission 

on revised Form 1 and new Form 2 with 

the Commission would be available to 

the public.

6. Record Retention Period 

Exchanges and associations would be 

required to retain any collections of 

information required by revised Form 1 

and new Form 2, respectively, in 

accordance with, and for the periods 

specified in, Exchange Act Rule 17a–

1.553

C. Proposed Rules 6a–5 and 15Aa–3

Proposed Rules 6a–5 and 15Aa–3 

contain ‘‘collection of information’’

requirements within the meaning of the 

PRA.554 The Commission has submitted 

them to the OMB for review in 

accordance with 44 U.S.C. 3507(d) and 

5 CFR 1320.11. The title of the new 

collection of information under 

proposed Rules 6a–5 and 15Aa–3 under 

the Exchange Act is ‘‘Rules 6a–5 and 

15Aa–3: Fair Administration and 

Governance of National Securities 

Exchanges and Registered Securities 

Associations.’’ OMB has not yet 

assigned a control number for the new 

collection of information contained in 

proposed Rules 6a–5 and 15Aa–3 under 

the Exchange Act. An agency may not 

conduct or sponsor, and a person is not 

required to respond to, a collection of 

information unless it displays a 

currently valid control number.555

1. Summary of Collection of Information 

Proposed Rules 6a–5 and 15Aa–3 

under the Exchange Act would require 

national securities exchanges and 

registered securities associations to 

comply with, and have rules that 

comply with, the proposed rules’

requirements, which are designed to 

facilitate the fair administration and 

governance of exchanges and 

associations. Various provisions of the 

proposed rules’ also would apply to any 

‘‘regulatory subsidiary’’ of the exchange 

or association.556

In particular, proposed Rules 6a–

5(c)(2) and 15Aa–3(c)(2) under the 

Exchange Act would require the board 

of each SRO to affirmatively determine 

that each independent director has no 

material relationship with the national 

securities exchange or registered 

securities association, or any affiliate of 

the national securities exchange or 

registered securities association.557 The 

board must make this determination 

upon the director’s nomination or 

appointment to the board and thereafter 

no less frequently than annually and as 

often as necessary in light of the 

director’s circumstances.558 In order to 

allow the board to obtain the 

information necessary to make such 

determination, proposed Rules 6a–

5(c)(3) and 15Aa–3(c)(3) would require 

a national securities exchange or 

registered securities association to 

establish policies and procedures to 

require each director, on his or her own 

initiative and upon request of the 

exchange or association, to inform the 

exchange or association of the existence 

of any relationship or interest that may 

reasonably be considered to bear on 

whether such director is an independent 

director. If the exchange or association 

were to request to receive this 

information from such directors, that 

would be a collection of information.

In addition, proposed Rules 6a–5(o)(5) 

and 15Aa–3(o)(5) under the Exchange 

Act would require a national securities 

exchange or registered securities 

association to have an effective 

mechanism for obtaining information 

from any owner of any interest in such 

exchange or association or any facility 

of such exchange or association relating 

to such ownership interest. If the 

exchange or association were to request 

to receive such information from such 

owners, that would be a collection of 

information. 

Proposed Rules 6a–5(n)(4)(ii) and 

15Aa–3(n)(4)(ii) under the Exchange Act 

would require national securities 

exchanges and registered securities 

associations to make and keep books 

and records necessary to evidence their 

compliance with proposed Rules 6a–

5(n)(4)(i) and 15Aa–3(n)(4)(i).559

However, the Commission believes that 

any reporting and recordkeeping burden 

that would be imposed by proposed 

Rules 6a–5(n)(4)(ii) and 15Aa–3(n)(4)(ii) 

would fall under the paperwork burden 

for Rule 17a–1 under the Exchange Act, 

which requires exchanges and 

associations to keep a copy of all 

documents and other such records as 

shall be made or received by them in the 

course of their business as such and in 

the conduct of their self-regulatory 

activities for a period of not less than 

five years.560 The Commission 

preliminarily believes that exchanges 

already maintain records relating to the 

collection and use of regulatory fees, 

fines or penalties pursuant to Rule 17a–

1 as part of their usual and customary 

activities and therefore such collection 

would not result in a burden under the 

PRA.561 The Commission requests 

comment on whether exchanges already 

maintain these records.

With the exception of proposed Rules 

6a–5(c)(3) and (o)(5) and 15Aa–3(c)(3) 

and (o)(5), the Commission believes that 

any other collection of information, 

within the meaning of the PRA, that 

would be imposed by proposed Rules 

6a–5 and 15Aa–3 would be covered 

pursuant to the approved collection of 

information for Exchange Act Rule 19b–

4.562 In this regard, the Commission 

notes that exchanges and associations 

likely would need to amend their rules 

(including their or their regulatory 

71188 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

563See proposed Rules 6a–5(f)(2), (g)(2), (h)(2), 

(i)(2), and (j)(2) and 15Aa–3(f)(2), (g)(2), (h)(2), (i)(2), 

and (j)(2). The Standing Committees are the 

Nominating Committee, Governance Committee, 

Compensation Committee, Audit Committee, and 

Regulatory Oversight Committee. See proposed 

Rules 6a–5(b)(21) and 15Aa–3(b)(22).

564See proposed Rules 6a–5(p) and (q) and 15Aa–

3(p) and (q).

565See proposed Rules 6a–5(f)(5), (g)(3), (h)(3), 

(i)(3) and (j)(6) and 15Aa–3(f)(5), (g)(3), (h)(3), (i)(3) 

and (j)(6).

566See proposed Rules 6a–5(c)(3) and 15Aa–

3(c)(3).

567See proposed Rules 6a–5(c)(4), (c)(7) and (f)(3) 

and 15Aa–3(c)(4), (c)(7) and (f)(3).

568See proposed Rules 6a–5(n)(1) and 15Aa–

3(n)(1).

569See proposed Rules 6a–5(n)(5) and 15Aa–

3(n)(5).

570See proposed Rules 6a–5(o) and 15Aa–3(o).

571See proposed Rules 6a–5(c)(1) and 15Aa–

3(c)(1).

572See proposed Rules 6a–5(c)(2) and 15Aa–

3(c)(2).

573 15 U.S.C. 78f, 78o–3, 78q, and 78s.

574The Commission assumes that each request 

and response will weigh one ounce and will be 

mailed via first class mail at a rate of $0.37 per 

ounce.

575The Commission assumes that the request will 

weigh five ounces and will be mailed via first class 

mail at a rate of $0.37 for the first ounce and $0.23 

for each additional ounce, for a total of $1.29.

subsidiary’s or facility’s constitutions, 

charters, bylaws, rules or other 

governing documents) to comply with 

proposed Rules 6a–5 and 15Aa–3. 

Pursuant to Exchange Act Rule 19b–4, 

any such amendments would need to be 

filed with the Commission as proposed 

rule changes. The Commission notes 

that provisions of the proposed 

governance standards that would result 

in paperwork burdens for exchanges 

and associations, including with respect 

to any regulatory subsidiaries, would 

encompass: (i) A written charter for 

each Standing Committee; 563 (ii) a code 

of conduct and ethics and governance 

guidelines; 564 (iii) annual performance 

evaluations of each Standing 

Committee; 565 (iv) policies and 

procedures to require each director to 

inform the exchange or association of 

the existence of any relationship or 

interest that may reasonably be 

considered to bear on whether such 

director is an independent director; 566

(v) provisions relating to the fair 

representation of members; 567 (vi) 

policies and procedures for the 

separation of regulatory and market 

functions; 568 (vii) policies and 

procedures with respect to the 

dissemination of regulatory information 

and confidential information; 569 and 

(viii) rules that limit ownership and 

voting by members.570 However, this 

collection of information would be 

collected pursuant to Exchange Act Rule 

19b–4 and therefore would not be a new 

collection of information for proposed 

Rules 6a–5 and 15Aa–3.

2. Proposed Use of Information 

The purpose of the collection of 

information in proposed Rules 6a–

5(c)(3) and 15Aa–3(c)(3) is to enable 

national securities exchanges and 

registered securities associations to 

monitor the independence of their 

directors. This collection of information 

would provide exchanges and 

associations with a mechanism to 

determine whether they are in 

compliance with the requirement that 

their board be composed of a majority 

of independent directors,571 as well as 

allow the board to affirmatively 

determine that a director has no 

material relationship with the exchange 

or association or any affiliate of the 

exchange or association.572

The purpose of the collection of 

information in proposed Rules 6a–

5(o)(5) and 15Aa–3(o)(5) is to enable 

national securities exchanges and 

registered securities associations to 

monitor ownership of the exchange, 

association, or facility thereof, and 

analyze their capacity to meet their 

statutory responsibilities under Sections 

6, 15A, 17, and 19 of the Exchange 

Act.573 In this manner, investor 

confidence in the integrity of the 

marketplace would be enhanced.

Further, the collection of information 

may aid the exchange or association in 

complying with the disclosure 

requirements pertaining to director 

independence and ownership that are 

contained in revised Form 1 and new 

Form 2. 

3. Respondents 

The proposed collection of 

information in proposed Rules 6a–

5(c)(3) and 15Aa–3(c)(3) would apply to 

nine national securities exchanges, one 

registered securities association and 

each director of a national securities 

exchange or registered securities 

association. The proposed collection of 

information in proposed Rules 6a–

5(o)(5) and 15Aa–3(o)(5) would apply to 

nine national securities exchanges, one 

registered securities association and the 

owners of voting and ownership 

interests in each national securities 

exchange, national securities 

association, or facility of a national 

securities exchange or national 

securities association. 

4. Reporting and Recordkeeping Burden 

The Commission is unable to estimate 

precisely how many responses per year 

would be generated by proposed Rules 

6a–5(c)(3) and 15Aa–3(c)(3), because 

any collection of information by an 

exchange or association from its 

directors would differ depending upon 

the number of directors on the 

exchange’s or association’s board, and 

also would depend on how often the 

board is required to request such 

information based on a director’s 

circumstances. The Commission 

preliminarily estimates, however, that 

each exchange or association would 

request information approximately 2 

times per year from approximately 17 

directors, and that each request for 

information and response from each 

director would require approximately 1 

hour to prepare and $0.37 to send,574 for 

a total annual reporting and 

recordkeeping burden of 2 hours and 

$0.74 per director and 34 hours and 

$12.58 per exchange or association, for 

a total annual reporting and 

recordkeeping burden of 680 hours and 

approximately $252. The Commission 

specifically requests comment on these 

estimates.

The Commission is unable to estimate 

precisely how many responses per year 

would be generated by proposed Rules 

6a–5(o)(5) and 15Aa–3(o)(5) under the 

Exchange Act, because any collection of 

information by an exchange or 

association from an owner of the 

exchange or association, or a facility of 

the exchange or association, would 

differ depending upon the number of 

shareholders or other owners of the 

exchange, association or facility. The 

Commission preliminarily estimates, 

however, that each exchange or 

association would request information 

approximately 2 times per year from 

approximately 500 owners and that it 

would cost each exchange or association 

$1.29 575 to mail the request to each 

owner, resulting in a total annual cost 

of $1,290 to each exchange or 

association and $12,900 annually for all 

exchanges and associations. The 

Commission also estimates that the 

initial preparation and sending of the 

request for information would require 

approximately 4 hours, the preparation 

and sending of each subsequent request 

would require 2 hours, and reviewing 

the responses to each of the 2 annual 

requests for information would require 

5 hours, for a total initial annual 

reporting and recordkeeping burden of 

16 hours for each exchange or 

association and an annual burden of 14 

hours thereafter, and a total initial 

annual burden for all exchanges and 

associations of 160 hours and an annual 

burden of 140 hours thereafter. The 

Commission preliminarily estimates 

that each owner would require 1 hour 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71189

576The Commission assumes that each response 

will weigh five ounces and will be mailed via first 

class mail at a rate of $0.37 for the first ounce and 

$0.23 for each additional ounce, for a total of $1.29.

577See supra Sections IV.C.2. and IV.C.9. for a 

discussion of Exhibits C and Q in revised Form 1 

and new Form 2.

578 17 CFR 240.17a–1.

579 44 U.S.C. 3501, et seq.

580 44 U.S.C. 3512.

581Such report must be approved by the 

exchange’s or association’s Regulatory Oversight 

Committee. See proposed Rule 800(c)(i).

582Such report must be filed no later than 60 

calendar days following the end of the exchange’s 

or association’s fiscal year. See proposed Rule 

800(b)(2)(ii).

583Such report must be approved by the 

exchange’s or association’s Regulatory Oversight 

Committee. See proposed Rule 800(c)(i).

584 ISE, which does not have rules to list or trade 

any securities other than standardized options 

(which the Commission has proposed to exempt 

from the definition of ‘‘affiliated security’’), would 

not be subject to proposed Regulation AL. In 

addition, because the Commission has proposed to 

exempt security futures products from the 

definition of ‘‘affiliated security,’’ the two national 

securities exchanges registered pursuant to Section 

6(g) of the Exchange Act and the limited purpose 

national securities association registered pursuant 

to Section 15A(k) of the Exchange Act would not 

be required to comply with proposed Regulation 

AL.

585The Commission notes that currently one 

exchange and one association would be subject to 

proposed Regulation AL with respect to one 

affiliated security each.

to prepare and $1.29 576 to send to the 

exchange or association his or her 

response to the request, for a total 

annual reporting and recordkeeping 

burden of 2 hours and $2.58 for each 

owner and a total annual burden for all 

owners of 10,000 hours and $12,900. 

The Commission requests comment on 

these estimates.

Thus, the Commission estimates that 

the total annual reporting and 

recordkeeping burden for proposed 

Rules 6a5–3 and 15Aa–3 would be 

10,840 hours and approximately 

$26,052. The Commission requests 

comment on this estimate. 

5. Collection of Information is 

Mandatory 

The collection of information under 

proposed Rules 6a–5(c)(3) and (o)(5) and 

15Aa–3(c)(3) and (o)(5) would be 

mandatory. The collection of 

information under proposed Rules 6a–

5(c)(3) and 15Aa–3(c)(3) would be 

required from directors of the exchange 

or association upon the request of the 

exchange or association. The collection 

of information under proposed Rules 

6a–5(o)(5) and 15Aa–3(o)(5) would be 

required from owners of an exchange or 

association, or a facility of the exchange 

or association, upon the request of the 

exchange or association. The ownership 

information would be made public if 

such information were required to be 

disclosed by the exchange or association 

pursuant to the proposed changes to 

revised Form 1 and new Form 2, which 

would require exchanges and 

associations to report certain 

information with regard to any person 

that, alone or together with its related 

persons, directly or indirectly 

beneficially owns more than 5% of any 

class of securities or other ownership 

interest in the exchange, association, or 

any facility of the exchange or 

association.577

6. Record Retention Period

Exchanges and associations would be 

required to retain any collection of 

information required under proposed 

Rules 6a–5(c)(3) and (o)(5) and 15Aa–

3(c)(3) and (o)(5), as applicable, in 

accordance with, and for the periods 

specified in, Exchange Act Rule 17a–

1.578

D. Proposed Regulation AL 

Proposed Regulation AL contains 

‘‘collection of information’’

requirements within the meaning of the 

PRA.579 The Commission has submitted 

them to the OMB for review in 

accordance with 44 U.S.C. 3507(d) and 

5 CFR 1320.11. The title of the new 

collection of information under 

proposed Regulation AL under the 

Exchange Act is ‘‘Regulation AL.’’ OMB 

has not yet assigned a control number 

to the new collection of information 

contained in proposed Regulation AL 

under the Exchange Act. An agency may 

not conduct or sponsor, and a person is 

not required to respond to, a collection 

of information unless it displays a 

currently valid control number.580

1. Summary of Collection of Information 

Pursuant to proposed Rule 

800(b)(2)(i), if an affiliated security is 

listed on, approved for trading on, or 

trades pursuant to the rules of, a 

national securities exchange or 

registered securities association, the 

exchange or association would be 

required to file quarterly reports with 

the Commission summarizing such 

exchange’s or association’s (1) 

monitoring of the affiliated security’s 

compliance with the exchange’s or 

association’s listing rules, including an 

explanation of such affiliated security’s 

compliance with each applicable rule, 

and (2) surveillance of the trading of the 

affiliated securities by its members.581

Pursuant to proposed Rule 

800(b)(2)(ii), if an affiliated security is 

listed on, approved for trading on, or 

trades pursuant to the rules of, a 

national securities exchange or 

registered securities association, the 

exchange or association would be 

required to file annually with the 

Commission a report prepared by a third 

party analyzing compliance by the 

affiliated security with the exchange’s or 

association’s listing rules.582 Moreover, 

proposed Rule 800(b)(2)(iii)–(v) would 

require, in the event that the exchange 

or association alleges that the affiliated 

security is not in compliance with any 

applicable listing rule of the exchange 

or association, the exchange or 

association to: (1) Promptly notify the 

affiliated issuer; (2) file a report with the 

Commission within five days of 

providing such notice to the affiliated 

issuer, identifying the date on which the 

exchange or association alleged that the 

affiliated security was not in 

compliance, the action the exchange or 

association proposes to take, the 

applicable listing rule, and any other 

material information conveyed to the 

affiliated issuer; 583 and (3) provide the 

Commission with a copy of any 

response from the affiliated issuer 

regarding its alleged non-compliance.

2. Proposed Use of Information 

The purpose of the collection of 

information in proposed Regulation AL 

is to provide further assurance that 

SROs carry out their regulatory 

responsibilities under the Act with 

respect to surveillance of affiliated 

securities, and provide the Commission 

greater ability to monitor the efforts of 

SROs. 

3. Respondents 

If an affiliated security is listed on, 

approved for trading on, or trades 

pursuant to the rules of, an exchange or 

association, the exchange or association 

would be required to comply with 

proposed Regulation AL. The 

Commission estimates that eight 

registered national securities exchanges 

and one registered securities association 

would potentially be subject to 

proposed Regulation AL.584

4. Reporting and Recordkeeping Burden 

Although it is difficult to predict how 

often an exchange or association would 

list or trade an affiliated security that 

would trigger the requirements of 

proposed Regulation AL, for purposes of 

this Paperwork Reduction Act analysis 

the Commission estimates one such 

occurrence for each exchange and 

association.585 The Commission 

specifically requests comment on this 

estimate.

With regard to the requirement of 

proposed Rule 800(b)(2)(i) that would 

require an exchange or association to 

71190 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

586The Commission assumes that each report will 

weigh five ounces and will be mailed via first class 

mail at a rate of $0.37 for the first ounce and $0.23 

for each additional ounce, for a total of $1.29.

587The Commission assumes that each report will 

weigh five ounces and will be mailed via first class 

mail at a rate of $0.37 for the first ounce and $0.23 

for each additional ounce, for a total of $1.29. 588The estimate assumes that the report will be 

prepared by outside legal counsel for the exchange 

or association at an estimated cost of $300 per hour, 

based on an hourly estimate for outside legal 

services obtained from industry sources. The 

Commission requests comment on this estimate, 

and on what type of entity the SRO may hire to 

prepare this report. 589The Commission assumes that each notice will 

weigh five ounces and will be mailed via first class 

mail at a rate of $0.37 for the first ounce and $0.23 

for each additional ounce, for a total of $1.29.

590The Commission assumes that each report will 

weigh five ounces and will be mailed via first class 

mail at a rate of $0.37 for the first ounce and $0.23 

for each additional ounce, for a total of $1.29.

591The Commission believes this likely 

overestimates the burden because it would assume 

that each affiliated security fell out of compliance 

each year. The Commission requests comment on 

this estimate.

592The Commission assumes that each response 

will weigh five ounces and will be mailed via first 

class mail at a rate of $0.37 for the first ounce and 

$0.23 for each additional ounce, for a total of $1.29.

file quarterly reports with the 

Commission summarizing its 

monitoring of the listing and trading of 

the affiliated security on its facilities, 

the Commission understands that the 

exchanges and associations already have 

in place systems to monitor the 

compliance of listed securities with 

their listing rules and to monitor the 

trading of such securities through their 

facilities. The Commission preliminarily 

does not believe that exchanges or 

associations would need to make 

significant changes to these systems to 

comply with proposed Regulation AL, 

and that the cost of the monitoring and 

surveying pursuant to proposed Rule 

800(b)(2)(i) would be incremental and 

insubstantial. The Commission 

recognizes, however, that exchanges and 

associations may need to conduct a 

review of an affiliated security’s 

compliance with its listing standards 

more frequently to meet the quarterly 

reporting requirements, if the exchange 

or association does not currently 

conduct such review at least quarterly. 

The Commission preliminarily believes 

that exchanges and associations 

currently review for compliance on a 

quarterly basis, but assumes for 

purposes of estimating the burden of 

these proposed requirements that each 

SRO would perform two additional 

reviews per year and that an exchange 

or association would incur an additional 

burden of 8 hours per review, resulting 

in a total annual reporting and 

recordkeeping burden of 144 hours. The 

Commission requests comment on this 

estimate and whether SROs would need 

to perform any additional reviews to 

comply with the proposed 

requirements. 

In addition, the Commission estimates 

that each of the eight registered national 

securities exchanges and the one 

registered securities association would 

spend $1.29 586 to send each report to 

the Commission, 17 hours preparing 

and filing the initial quarterly report 

and 12 hours for each quarterly report 

thereafter to comply with the proposed 

rule, for a total of $5.16 and 53 hours 

per exchange or association for the first 

year and $5.16 and 48 hours per 

exchange or association for subsequent 

years, resulting in an initial total annual 

reporting and recordkeeping burden of 

$46.44 and 477 hours and a total annual 

burden of $46.44 and 432 hours 

thereafter. The Commission specifically 

solicits comment on these estimates and 

whether SROs would be required to 

modify their systems to comply with 

this proposed quarterly reporting 

requirement.

With regard to the requirement that an 

exchange or association file annually 

with the Commission a report prepared 

by a third party analyzing compliance 

by an affiliated security with the 

exchange’s or association’s listing rules, 

the Commission estimates that each 

exchange or association would spend 

approximately 5 hours interacting with 

the third party with respect to their 

preparation of the report, 4 hours 

reviewing each report received from the 

third party, and $1.29 587 to send each 

report to the Commission, for a total of 

$1.29 and 9 hours per exchange or 

association per year, for a total annual 

reporting and record keeping burden of 

$11.61 and 81 hours for all exchange 

and associations. The Commission 

estimates that it would take each third 

party approximately 22 hours to prepare 

and file each annual report, for a total 

annual cost per exchange or association 

of $6,600,588 resulting in a total annual 

cost burden of approximately $59,400.

With regard to the requirement in 

proposed Rule 800(b)(2)(iii) that an 

exchange or association promptly notify 

an affiliated issuer of alleged noncompliance with listing rules, the 

Commission believes that exchanges 

and associations currently have rules for 

the provision of notice to listed 

companies that fail to continue to meet 

certain listing requirements. Therefore, 

the Commission believes that any 

additional paperwork burden on the 

exchange or association created by this 

proposed requirement would be 

incremental and insubstantial. The 

Commission recognizes, however, that 

exchanges and associations may incur 

additional costs if they were required to 

notify an affiliated issuer more often 

than pursuant to their existing rules. 

The Commission does not know 

precisely how frequently notification 

would be required under the proposed 

rule, but estimates that each exchange or 

association would spend approximately 

2 hours and $1.29 589 to prepare and 

send each notification. The Commission 

requests comment on this estimate and 

whether exchanges’ and associations’

existing rules would require them to 

provide the notice to affiliated issuers 

that would be required by the proposed 

rule, and if so, whether their rules 

would require the notice to be required 

more often than pursuant to their 

existing rules.

Pursuant to proposed Rule 

800(b)(2)(iv), if an affiliated security was 

alleged not to be in compliance with an 

exchange’s or association’s listing rules, 

the exchange or association would have 

to file a report with the Commission 

identifying the date the exchange or 

association alleged that the affiliated 

security was not in compliance, the 

action the exchange or association 

proposes to take, the applicable listing 

rule, and any other material information 

conveyed to the affiliated issuer. The 

Commission does not know how many 

responses would be generated by this 

requirement because it is unknown 

whether, or how often, an exchange or 

association would allege that an 

affiliated security fails to comply with 

the exchange’s or association’s listing 

rules, but estimates that a national 

securities exchange or registered 

securities association would spend 

approximately 5 hours per report and 

$1.29 590 to send each report to the 

Commission to comply with the 

proposed rule. Assuming that each 

exchange and association had one 

affiliated security, and assuming that 

the exchange or association alleged that 

the affiliated security failed to comply 

with the exchange’s or association’s 

listing rules at least once per year, that 

would result in an annual total burden 

of 45 hours and $11.61.591 For the same 

reason, the Commission does not know 

how many responses the exchange or 

association would receive from an 

affiliated issuer to whom it gave notice 

of non-compliance for which the 

exchange or association would need to 

file a copy with the Commission 

pursuant to proposed Rule 800(b)(2)(v). 

The Commission, however, estimates 

that an exchange or association would 

spend approximately 2 hours and 

$1.29 592 per response to comply with 

the proposed requirement to file a copy 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71191

593 17 CFR 240.17a–1.

594 44 U.S.C. 3501, et seq. 595 44 U.S.C. 3512.

596 15 U.S.C. 78f(g).

597 15 U.S.C. 78o–3(k)(l).

of the response with the Commission. 

Assuming that each affiliated issuer 

responded once, that would result in a 

total annual burden of 2 hours per 

respondent, or 18 total hours. Thus, 

based on information available to the 

Commission at this time, the estimated 

total initial annual burden for proposed 

Regulation AL for all respondents 

would be 783 hours and approximately 

$59,504 and 738 hours and 

approximately $59,504 thereafter. The 

Commission requests comment on the 

estimates included in this analysis.

5. Collection of Information Is 

Mandatory

The collection of information would 

be mandatory if an affiliated security is 

listed on, approved for trading on, or 

trades pursuant to the rules of, an 

exchange or association. The collection 

of information filed pursuant to 

proposed Regulation AL with the 

Commission would be available to the 

public unless the exchange or 

association requested, and the 

Commission granted, confidential 

treatment pursuant to existing 

Commission rules and statutory 

authority. 

6. Record Retention Period 

Exchanges and associations would be 

required to retain any collection of 

information required under proposed 

Regulation AL in accordance with, and 

for the periods specified in, Exchange 

Act Rule 17a–1.593

E. Proposed Amendments to Rule 17a–

1

The proposed amendments to Rule 

17a–1 under the Exchange Act do not 

impose any new recordkeeping or 

information collection requirements, or 

other collections of information that 

require approval of OMB under 44 

U.S.C. 3501, et seq. Accordingly the 

PRA does not apply. 

F. Proposed Rule 17a–26

Proposed Rule 17a–26 contains 

‘‘collection of information’’

requirements within the meaning of the 

PRA.594 The Commission has submitted 

them to the OMB for review in 

accordance with 44 U.S.C. 3507(d) and 

5 CFR 1320.11. The title of the new 

collection of information under 

proposed Rule 17a–26 under the 

Exchange Act is ‘‘Rule 17a–26: 

Regulatory Reports of National 

Securities Exchanges and Registered 

Securities Associations.’’ OMB has not 

yet assigned a control number for the 

new collection of information contained 

in proposed Rule 17a–26 under the 

Exchange Act. An agency may not 

conduct or sponsor, and a person is not 

required to respond to, a collection of 

information unless it displays a 

currently valid control number.595

1. Summary of Collection of Information 

Proposed Rule 17a–26 under the 

Exchange Act would require national 

securities exchanges and registered 

securities associations to file with the 

Commission quarterly and annual 

reports, in electronic format, that 

provide details on the operation of their 

self-regulatory programs. In the 

proposed quarterly reports, exchanges 

and associations would be required to 

file with the Commission information 

on specified matters regarding their 

regulatory programs, including results 

of their surveillance programs; 

summaries of complaints relating to the 

operation of their regulatory programs; 

summaries of all investigations, 

examinations, and enforcement cases 

active during the reporting period; 

summaries of listings activity; and 

copies of the agenda of any board or 

board committee meeting that occurred 

during the quarter. In the proposed 

annual reports, exchanges and 

associations would be required to file 

with the Commission a year-end 

aggregation of the information 

submitted pursuant to the proposed 

quarterly reporting requirement, except 

for the board and board committee 

agenda; a discussion of their regulatory 

processes; an organizational staffing 

chart; an evaluation of the effectiveness 

of their regulatory programs; a 

discussion of their internal controls; a 

summary of employment arrangements 

with the Chief Regulatory Officer and 

senior regulatory personnel; copies of 

the most recent annual performance 

evaluation of the Standing Committees 

of the board (i.e., Nominations, 

Compensation, Audit, and Regulatory 

Oversight Committees) and of the most 

recent annual performance evaluation of 

the Governance Committee; a discussion 

of efforts to comply with any 

recommendations or plan resulting from 

any inspection or examination 

conducted by Commission staff; and a 

report of a third-party audit of any 

electronic SRO trading facility owned, 

operated, or sponsored by the exchange 

or association. Exchanges and 

associations would be required to 

submit supplemental filings to report 

interim changes to their regulatory 

programs. The proposed rule also would 

direct each exchange and association to 

establish procedures for the preparation 

of the quarterly and annual reports in a 

uniform, readily accessible, and usable 

electronic format. 

2. Proposed Use of Information 

The purpose of the collection of 

information in proposed Rule 17a–26 is 

to enhance the Commission’s ability to 

monitor compliance by national 

securities exchanges and registered 

securities associations with their 

regulatory responsibilities and to 

support the Commission’s program of 

examinations of self-regulatory 

organizations. The information collected 

should help to keep the Commission 

informed of new developments and 

challenges affecting the regulatory 

programs of exchanges and associations, 

and should assist the Commission in 

more closely monitoring the exchanges’

and associations’ responses to critical 

regulatory issues affecting them. The 

collection of the information also 

should aid the Commission in better 

targeting its inspection resources. 

3. Respondents 

The proposed collection of 

information in proposed Rule 17a–26 

would apply to every national securities 

exchange and every registered securities 

association, other than a national 

securities exchange registered pursuant 

to Section 6(g) of the Exchange Act 596

and a limited purpose national 

securities association registered 

pursuant to Section 15A(k)(l) of the 

Exchange Act,597 which at this time 

includes nine registered national 

securities exchanges and one registered 

securities association.

4. Reporting and Recordkeeping Burden 

The Commission believes that 

national securities exchanges and 

registered securities associations 

currently collect and retain much of the 

data that would be necessary to prepare 

the quarterly and annual reports that 

would be required by the proposed rule 

in connection with the execution of 

their self-regulatory responsibilities. To 

comply with the proposed rule, 

however, exchanges and associations 

would incur an additional burden in 

assembling the information into 

quarterly and annual reports and filing 

those reports with the Commission. The 

Commission expects that requiring the 

collection of information to be 

submitted in electronic format should 

lessen the burden on exchanges and 

associations, as well as reduce the 

burdens of printing, transmission, and 

71192 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

598The Commission estimates that an average 

filing will weigh two ounces, accounting for a 

diskette and accompanying letter, and will be 

mailed via first class mail at a rate of $0.37 for the 

first ounce and $0.23 for the additional ounce, for 

a total of $0.60 per filing. At four quarterly reports, 

one annual report, and an estimated five interim 

supplements, the Commission expects that each 

exchange or association would incur a cost of $6 

to comply with the proposed rule. The Commission 

solicits comments on the accuracy of this estimate.

599The estimate assumes that the report will be 

prepared for the exchange or association by an 

independent accounting firm or similar entity at an 

estimated cost of $150 per hour, based on an hourly 

estimate for auditing services obtained from 

industry sources. The Commission requests 

comment on this estimate, and on what type of 

entity an exchange or association may hire to 

prepare this report.

600 17 CFR 240.17a–1.

601 44 U.S.C. 3501, et seq.

602 44 U.S.C. 3512.

603A member would be required to file the initial 

statement within ten calendar days of becoming 

subject to the requirements of proposed Rule 17a–

27(b). See proposed Rule 17a–27(b)(3).

record retention that are typically 

incurred with hardcopy reports. 

Based on information available to the 

Commission at this time, the 

Commission estimates that each 

national securities exchange and 

registered securities association would 

incur an average burden of 40 hours to 

prepare each quarterly report and 35 

hours to prepare each annual report, for 

an annual burden of 195 hours per 

respondent. Accounting for nine 

national securities exchanges and one 

registered securities association, the 

total burden to comply with the 

quarterly and annual reporting 

requirements in proposed new Rule 

17a–26 is therefore estimated to be 

1,950 hours per year. The Commission 

is unable to estimate with certainty the 

number of interim updates an exchange 

or association would need to file, since 

the need for any such updates would 

depend on each exchange’s or 

association’s particular circumstances. 

Nevertheless, for purposes of this 

burden analysis, the Commission 

estimates that an exchange or 

association would incur a burden of 4 

hours to prepare each interim updating 

amendment, which would likely be 

required, on average, 5 times per year 

for a total of 20 hours per respondent 

and 200 hours total for the nine 

exchanges and one association. The 

Commission requests comment on the 

accuracy of these estimates. The total 

burden resulting from the proposed 

rule’s quarterly and annual reporting 

provisions is estimated to be 2,150 

hours and $60 598 to prepare and file 

with the Commission each report and 

interim supplement.

For those exchanges or associations 

that own, operate, or sponsor an 

electronic SRO trading facility, the 

proposed rule would require such 

exchange or association to file annually 

with the Commission, as part of its 

annual report, an audit report prepared 

by an independent third party with 

respect to the electronic SRO trading 

facility or facilities of the exchange or 

association. The Commission estimates 

that nine national securities exchanges 

and one registered securities association 

would be required to obtain an annual 

audit, and each such exchange or 

association owning, operating, or 

sponsoring at least one such facility 

would spend approximately 15 hours 

interacting with the third party with 

respect to their conduct of the audit and 

preparation of the audit report and 20 

hours reviewing each audit report 

received from the third party, for a total 

of 35 hours per exchange or association 

per year, for a total annual reporting and 

recordkeeping burden of 350 hours. 

With respect to the third-party auditor, 

the Commission estimates that it would 

take each third party 100 hours to 

conduct the audit of any such facility or 

facilities and prepare the audit report 

for each exchange or association that 

owns, operates, or sponsors at least one 

electronic SRO trading facility, for a 

total annual cost per exchange or 

association of $15,000,599 resulting in a 

total annual burden cost of $150,000.

With respect to the burden imposed 

on exchanges and associations in 

connection with establishing procedures 

for the preparation of the reports 

required by the proposed rule in a 

uniform, readily accessible, and usable 

electronic format, based on information 

available to the Commission, the 

Commission estimates that each 

exchange or association would spend 

approximately 35 hours during the 

initial year of the proposed rule’s 

effectiveness to comply with this 

requirement. Accounting for nine 

national securities exchanges and one 

registered securities association, the 

total burden per year to comply with the 

provision in proposed Rule 17a–26 

regarding the uniform format for the 

quarterly and annual reports is 

estimated to be 350 hours. 

Thus, based on information available 

to the Commission at this time, the 

estimated total reporting and 

recordkeeping burden for proposed Rule 

17a–26 is 2,850 hours and $150,060. 

The Commission requests comment on 

the accuracy of these estimates. 

5. Collection of Information Is 

Mandatory 

The collection of information in 

proposed Rule 17a–26 under the 

Exchange Act would be mandatory. An 

exchange or association could request 

confidential treatment of any report or 

other information that the exchange or 

association provides to the Commission 

pursuant to proposed Rule 17a–26. The 

Commission would accord confidential 

treatment to the information to the 

extent permitted by law.

6. Record Retention Period 

Exchanges and associations would be 

required to retain any collection of 

information required under proposed 

Rule 17a–26 in accordance with, and for 

the periods specified in, Exchange Act 

Rule 17a–1.600

G. Proposed Rule 17a–27

Proposed Rule 17a–27 under the 

Exchange Act contains ‘‘collection of 

information’’ requirements within the 

meaning of the PRA.601 The 

Commission has submitted them to the 

OMB for review in accordance with 44 

U.S.C. 3507(d) and 5 CFR 1320.11. The 

title of the new collection of information 

under proposed Rule 17a–27 under the 

Exchange Act is ‘‘Rule 17a–27: 

Ownership of a National Securities 

Exchange, Registered Securities 

Association, Facility of a National 

Securities Exchange, or Registered 

Securities Association.’’ OMB has not 

yet assigned a control number for the 

new collection of information contained 

in proposed Rule 17a–27 under the 

Exchange Act. An agency may not 

conduct or sponsor, and a person is not 

required to respond to, a collection of 

information unless it displays a 

currently valid control number.602

1. Summary of Collection of Information 

Proposed Rule 17a–27(b) under the 

Exchange Act would require any 

member of a national securities 

exchange or registered securities 

association that is a broker or dealer to 

file a statement with the Commission if 

such member, alone or together with its 

related persons, directly or indirectly 

beneficially owns more than 5% of any 

class of securities or other ownership 

interest of an exchange or association of 

which it is a member or any facility of 

an exchange or association through 

which the member is permitted to effect 

transactions.603 The member would be 

required to include in the statement 

certain information about the member 

and its related persons, information 

about the securities or other ownership 

interest that is the subject of the filing, 

detailed information about the member 

and its related persons’ holdings, and a 

description of the ability of the member 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71193

604See supra discussion in Section VI.B.

605Based on information available to the 

Commission at this time, there are approximately 

6,800 registered brokers and dealers. Approximately 

6,553 brokers and dealers filed FOCUS reports 

pursuant to 17 CFR 240.17a–5 (Exchange Act Rule 

17a–5) at the end of 2003.

606Each registered broker or dealer must be either 

a member of an exchange or an association, and 

every member of an exchange or association is 

required to be a registered broker or dealer. See

Section 15(b)(8) of the Exchange Act (15 U.S.C. 

78o(b)(8)), Section 15A(g)(1) of the Exchange Act 

(15 U.S.C. 78o–3(g)(1)) and Section 6(b)(2) of the 

Exchange Act (15 U.S.C. 78f(b)(2)). The Commission 

believes, however, that using the number of 

registered brokers and dealers overestimates the 

number of members that would exceed the 5% 

ownership threshold and thus trigger the reporting 

requirements of proposed Rule 17a–27, given the 

amount of ownership it would take to trigger the 

requirement. The Commission requests comment on 

this estimate.

607The proposed rule would not apply to 

ownership in exchanges registered pursuant to 

Section 6(g) of the Exchange Act or limited purpose 

national securities associations registered pursuant 

to Section 15A(k)(l) of the Exchange Act. See

proposed Rule 17a–27(a)(6).

608The Commission notes that although certain 

ownership information currently is reported to the 

Commission pursuant to Regulation 13D with 

respect to issuers registered pursuant to Section 12 

of the Exchange Act, and Exhibit K to Form 1, 

which requires information with respect to each 

shareholder of an exchange that directly owns 5% 

or more of a class of a voting security of such 

exchange, information relating to members’

interests in exchanges and associations and 

facilities generally is not currently required to be 

reported to the Commission.

609Based on the Commission’s knowledge of 

exchanges that have demutualized and facilities of 

exchanges that the Commission has approved, the 

Commission estimates that the number of members 

that are brokers or dealers and that currently own 

more than 5% of an exchange, association or facility 

is less than 20, but has conservatively assumed 100 

members would trigger the requirements of the 

proposed Rule. Furthermore, the Commission notes 

that the capital requirements necessary to enable a 

member to own more than 5% would be 

considerably high, and therefore limit the number 

of members likely to trigger the requirements. The 

Commission believes that this estimate 

overestimates the number of members that are 

brokers or dealers and that would own more than 

5% of an exchange, association or facility, thus 

triggering the filing requirement of proposed Rule 

17a–27. The Commission requests comment on this 

estimate, and a process for more accurately 

estimating the number of respondents.

610For example, to comply with Regulation 13D 

under the Exchange Act, 17 CFR 240.13d–1 through 

13d–7, members must be able to track and report 

on Schedule 13D or Schedule 13G, 17 CFR 

240.13d–1(a) and (b), as applicable, their beneficial 

ownership of any issuer specified in Exchange Act 

Rule 13d–1, 17 CFR 240.13d–1, if such beneficial 

ownership exceeds 5%. The Commission also 

believes it likely, given the nature of their business, 

that members keep records of their ownership in 

entities not covered by the requirements of 

Regulation 13D under the Act, particularly with 

respect to ownership in any exchange or association 

of which they are a member or any facility through 

which they effect transactions. The Commission 

requests comment on this belief.

611The Commission believes that this estimate 

may overestimate the amount of time required for 

members to prepare the statement, and requests 

comment on this estimate.

and its related persons to control the 

exchange or association.604

Pursuant to proposed Rule 17a–

27(b)(4), a member would be required to 

file a periodic amendment to the 

statement within ten calendar days of 

any change in the information required 

to be provided on the statement, except 

in the event of an increase or decrease 

of less than 1% of ownership of a class 

of securities or other ownership interest 

last reported on the statement, or any 

amendment thereto. Proposed Rule 17a–

27(c) under the Exchange Act would 

require any member that is required to 

file the statement required pursuant to 

proposed Rule 17a–27(b)(1) or any 

amendment required pursuant to 

proposed Rule 17a–27(b)(4) to provide a 

copy of such statement or amendment to 

the exchange or association for which 

ownership information is being 

reported, or, if the relevant entity is a 

facility, to the applicable exchange or 

association. 

Finally, proposed Rule 17a–27(d) 

under the Exchange Act would require 

an exchange or association that receives 

a copy of the report from a member to 

post the statement or amendment on a 

publicly-accessible Web site controlled 

by the exchange or association. 

2. Proposed Use of Information 

The purpose of the collection of 

information in proposed Rule 17a–27 is 

to enable the Commission and each 

exchange or association to monitor the 

accumulation of significant ownership 

interests in SROs by members, so as to 

further the ability of the SRO to perform 

its statutory obligations under the 

Exchange Act and the Commission’s 

ability to perform its oversight 

responsibilities. Proposed Rule 17a–27 

also would provide the Commission and 

each exchange or association with 

information relevant to monitor 

compliance with proposed Rules 6a–

5(o) and 15Aa–3(o), which would 

require exchanges and associations to 

implement rules to prohibit their 

broker-dealer members from owning or 

voting more than 20% of the exchange, 

association, or a facility of the exchange 

or association, and an effective 

mechanism to divest any member and 

its related persons of any interest owned 

in excess of the 20% limitation. 

3. Respondents 

The requirements in proposed Rule 

17a–27(b) to file a statement and 

updates with the Commission and in 

proposed Rule 17a–27(c) to provide a 

copy of the statement and any 

amendment to the applicable exchange 

or association would apply to the 

members of the nine registered national 

securities exchanges and the one 

registered securities association that are 

brokers or dealers and that beneficially 

own more than 5% of any class of 

securities or other ownership interest in 

the exchange or association, or a facility 

of the exchange or association through 

which such member is permitted to 

effect transactions. The Commission 

estimates that there are approximately 

6,800 registered brokers and dealers 605

that would be subject to this 

requirement.606 The requirement of 

proposed Rule 17a–27(d) that an 

exchange or association post a copy of 

any statement received from a member 

on an Internet Web site would apply to 

each of the nine registered exchanges 

and the one registered association.607

4. Reporting and Recordkeeping Burden 

Because the amount of a member’s 

interest in an exchange, association or 

facility could fluctuate, and because 5% 

is a fairly high threshold, the 

Commission is not able to determine 

with certainty how many broker-dealer 

members would be required to file a 

statement pursuant to proposed Rule 

17a–27(b).608 For purpose of this 

paperwork burden analysis, however, 

the Commission assumes that 100 of the 

6,800 members that are brokers or 

dealers would file a statement with 

respect to ownership in one exchange or 

facility, and estimates that each of those 

members would amend such statement 

once per year.609

Based on information available to the 

Commission at this time, the 

Commission believes that, given the 

nature of their business, most members 

that would be subject to proposed Rule 

17a–27 likely already have in place 

systems and procedures for tracking 

their ownership of securities, and that 

the new burden of tracking the 

ownership interests in an exchange, 

association or a facility necessary to 

prepare the statement required by 

proposed Rule 17a–27 would not be a 

substantial additional burden.610 The 

Commission recognizes, however, that 

the scope of the reporting requirement 

may exceed the scope of ownership for 

which a member currently keeps 

records, since a member would need to 

aggregate its ownership interest with 

those of its related persons.

The Commission therefore estimates 

that proposed Rule 17a–27(b) would 

require approximately 35 hours per 

statement to prepare and file the initial 

statement,611 that proposed Rule 17a–

27(c) would require approximately 2 

71194 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

612The Commission assumes that the statement 

will weigh five ounces and will be mailed via first 

class mail at a rate of $0.37 for the first ounce and 

$0.23 for each additional ounce, for a total of $1.29.

613See supra note 547 and accompanying text.

614 17 CFR 240.17a–3 and 17a–4. 615 17 CFR 240.17a–1.

616See supra Section I.B. for a discussion of 

recent developments involving SROs.

hours and $1.29 612 to prepare and send 

the copy of the statement or any 

amendment to the exchange or 

association, and that each amendment 

required by proposed Rule 17a–27(b)(4) 

would require 10 hours per amendment 

to prepare and file the amendment, for 

a total initial annual burden of 47 hours 

per respondent and 12 hours annually 

thereafter. Thus, based on information 

available to the Commission at this 

time, the Commission estimates the total 

initial annual burden imposed by 

proposed Rule 17a–27 on all members 

would be 4,700 hours and $258, and the 

annual burden thereafter would be 

1,200 hours and $258. The Commission 

requests comment on the accuracy of 

these estimates.

If a national securities exchange or 

registered securities association receives 

a copy of a statement from a member 

pursuant to proposed Rule 17a–27(c), 

the exchange or association must post 

the statement on its Internet Web site 

pursuant to proposed Rule 17a–27(d). 

The Commission staff preliminarily 

estimates that 4 hours is the amount of 

time that would be required to post the 

statement on an exchange’s or 

association’s Web site.613 The 

Commission staff estimates that the total 

annual burden for posting statements 

would be 400 hours. The Commission 

requests comment on its estimate of 

how long it would take an exchange or 

association to post a statement on its 

Web site.

Thus, the Commission estimates that 

the total initial annual reporting and 

recordkeeping burden for proposed Rule 

17a–27 is 5,100 hours and $258, and 

1,600 and $258 annually thereafter. The 

Commission requests comment on these 

estimates. 

5. Collection of Information Is 

Mandatory 

The collection of information under 

proposed Rule 17a–27 would be 

mandatory if a member that is a broker 

or dealer exceeds the ownership 

threshold. The collection of information 

required pursuant to proposed Rule 

17a–27 would be provided by members 

to the Commission, as well as to the 

relevant exchange or association, and 

the exchange or association would be 

required by proposed Rule 17a–27(d) to 

post the information on its publicly 

available Web site.

6. Record Retention Period 

Members would be required to retain 

any collection of information required 

under proposed Rule 17a–27 in 

accordance with, and for the periods 

specified in, Exchange Act Rules 17a–3 

and 17a–4.614 Exchanges and 

associations would be required to retain 

any collection of information required 

under proposed Rules 17a–27(c) and (d) 

in accordance with, and for the periods 

specified in, Exchange Act Rule 17a–

1.615

H. Request for Comment 

Pursuant to 44 U.S.C. 3506(c)(2)(B), 

the Commission solicits comments to: 

(i) Evaluate whether the proposed 

collections of information are necessary 

for the proper performance of the 

functions of the Commission, including 

whether the information would have 

practical utility; (ii) evaluate the 

accuracy of the Commission’s estimates 

of the burden of the proposed 

collections of information and provide 

the Commission with data on proposed 

Rules 6a–2, 6a–5, 15Aa–1, 15Aa–2, 

15Aa–3, 17a–26, 17a–27, Regulation AL, 

and revised Form 1 and new Form 2; 

(iii) enhance the quality, utility, and 

clarity of the information to be 

collected; and (iv) minimize the burden 

of the collections of information on 

those required to respond, including 

through the use of electronic or 

automated collection techniques or 

other forms of information technology. 

Persons wishing to submit comments 

on the collection of information 

requirements should direct them to the 

following persons: (1) Desk Officer for 

the Securities and Exchange 

Commission, Office of Information and 

Regulatory Affairs, Office of 

Management and Budget, Washington, 

DC 20503; and (2) Jonathan G. Katz, 

Secretary, Securities and Exchange 

Commission, 450 Fifth Street, NW., 

Washington, DC 20549–0609, with 

reference to File No. S7–39–04. 

Requests for materials submitted to 

OMB by the Commission with regard to 

this collection of information should be 

in writing, refer to File No. S7–39–04, 

and be submitted to the Securities and 

Exchange Commission, Records 

Management, Office of Filings and 

Information Services, 450 Fifth Street, 

NW., Washington, DC 20549–0609. As 

OMB is required to make a decision 

concerning the collections of 

information between 30 and 60 days 

after publication of this release in the 

Federal Register, a comment to OMB is 

best assured of receiving full 

consideration if OMB receives it within 

30 days of publication of this release. 

X. Consideration of Costs and Benefits 

The system of regulation of our 

nation’s securities markets and market 

participants is grounded on the 

principle of self-regulation. Recent 

developments, including allegations of 

governance failures on the part of SROs, 

enforcement actions and examinations 

involving SROs and their members, 

increasing competitive pressures faced 

by SROs, and the growing trend of SROs 

to reorganize from mutual organizations 

to shareholder-owned entities, have 

prompted the Commission to review 

aspects of the SROs’ governance and the 

transparency of their governance and 

regulatory processes. At the same time, 

the Commission has determined to 

review its regulation and oversight of 

SROs and to consider whether changes 

are necessary in light of recent 

developments involving SROs.616

Accordingly, the Commission is 

proposing to adopt new rules and 

amend existing rules and forms under 

the Exchange Act to strengthen SRO 

governance and the Commission’s 

regulation and oversight of SROs. The 

proposals relate to the governance, 

administration, transparency, and 

ownership of SROs that are national 

securities exchanges and registered 

securities associations, and the periodic 

reporting of information by these SROs 

with respect to their regulatory 

programs. The proposals also relate to 

the listing and trading by SROs of their 

own or an affiliate’s securities. 

The Commission is sensitive to the 

costs and benefits that may result from 

the proposed rules and amendments, 

and has identified below certain costs 

and benefits associated with the 

proposals. The Commission encourages 

commenters to identify, discuss, 

analyze, and supply relevant data, 

including empirical data, regarding 

costs or benefits that may be associated 

with the proposals. The Commission 

preliminarily believes that the benefits 

of the proposed rulemaking to investors, 

users of the SROs’ facilities, and other 

market participants, as well as the 

SROs, justify the costs. 

A. Costs and Benefits of Proposed Rules 

6a–5 and 15Aa–3

The Commission is proposing new 

Rules 6a–5 and 15Aa–3 under the 

Exchange Act that would set forth 

minimum standards of governance to be 

adopted and implemented by exchanges 

and associations, respectively. The 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71195

617See supra Section II.B. for a discussion of 

proposed Rules 6a–5 and 15Aa–3. 618See proposed Rule 6a–5(f)(3) and 15Aa–3(f)(3).

proposed governance rules are intended 

to strengthen the governance of 

exchanges and associations, promote a 

greater degree of objectivity and 

impartiality in important SRO 

processes, foster a greater degree of 

independence of the regulatory 

programs of exchanges and associations, 

and address the conflicts that can arise 

when a mutual organization (such as an 

exchange) converts to another form of 

ownership.617

Proposed Rules 6a–5 and 15Aa–3 

would require an exchange’s or 

association’s governing board to be 

composed of a majority of independent 

directors, with key board committees to 

be composed solely of independent 

directors (‘‘Standing Committees’’). For 

a director to be considered independent, 

the board of the exchange or association 

would be required to affirmatively 

determine that the director has no 

material relationship with the exchange 

or association or any affiliate of the 

exchange or association. The board 

would be required to make this 

determination upon the director’s 

nomination or appointment to the board 

and thereafter no less frequently than 

annually and as often as necessary in 

light of the director’s circumstances. 

Further, the exchange or association 

would be required to establish policies 

and procedures to require each director, 

on his or her own initiative and upon 

request of the exchange or association, 

to inform the exchange or association of 

the existence of any relationship or 

interest that may reasonably be 

considered to bear on whether such 

director is an independent director. 

Each Standing Committee would be 

required to conduct an annual selfevaluation of its performance, except 

that the Governance Committee would 

be required to conduct an annual 

evaluation of the governance of the 

exchange or association as a whole. 

Exchanges and associations would be 

required to provide sufficient funding 

and other resources to each Standing 

Committee, as determined by each 

Standing Committee, to permit it to 

fulfill its responsibilities and retain 

independent counsel and advisors. 

Additionally, the independent directors 

of the exchange’s or association’s board 

would be required to meet regularly in 

executive session, without the presence 

of management. When the board 

considered any matter that is 

recommended by or otherwise is within 

the authority or jurisdiction of any 

Standing Committee, a majority of the 

directors who vote on the matter would 

be required to be independent. 

Under proposed Rules 6a–5 and 

15Aa–3, each exchange and association 

would be required to separate its 

regulatory function from its market 

operations and other commercial 

interests, whether through functional or 

structural separation. Exchanges and 

associations also would be required to 

prevent the dissemination of regulatory 

and certain other information and to 

apply regulatory fees, fines, and 

penalties toward the funding of 

regulatory operations. In addition, the 

proposed governance rules would 

require exchanges and associations to 

impose on their members that are 

brokers or dealers ownership and voting 

limitations on their interest in the 

exchange, the association, or a facility of 

the exchange or association. Finally, the 

proposed governance rules would 

require that exchanges and associations 

adopt both a code of conduct and ethics 

for directors, officers and employees 

and governance guidelines. 

To further strengthen the governance 

of exchanges and associations, the 

proposed rules also would apply to any 

person that, directly or indirectly, is 

controlled by the exchange or 

association and that provides, whether 

pursuant to contract, agreement or rule, 

regulatory services to or on behalf of the 

exchange or association (i.e., a 

regulatory subsidiary), because they are 

an integral part of the SRO structure and 

carry out certain regulatory duties on 

behalf of the exchange or association. 

Thus, the Commission proposes to 

require these regulatory subsidiaries to 

be subject to the same governance 

standards applicable to the SRO itself. 

The proposals contemplate that each 

exchange and association would file 

with the Commission proposed rule 

changes pursuant to Section 19(b) of the 

Exchange Act to amend their existing 

charters, bylaws, or rules to comply 

with the proposed rules. 

1. Benefits 

As discussed below, the Commission 

believes that exchanges and 

associations, as well as their members, 

users of their facilities, institutional and 

retail investors, shareholders or other 

owners of those exchanges that have 

demutualized, and the public generally, 

are likely to benefit significantly from 

the proposed governance rules.

The proposed rules are designed to 

enhance the independence and 

effectiveness of the boards of exchanges 

and associations, as well as their 

regulatory subsidiaries, by requiring 

those boards to be composed of a 

majority of independent directors. By 

mandating a structure that would 

require a majority of the board to be 

independent, the governance of these 

entities should be less susceptible to 

competing internal interests. The 

independent directors would constitute 

a majority of the SRO’s board and thus 

should help foster a greater degree of 

independent decision-making by the 

exchange’s and association’s governing 

bodies. Further, a board whose 

independent directors constitute at least 

a majority of the board should help 

strengthen the hand of the independent 

directors when dealing with 

management. In the Commission’s view, 

requiring SRO boards to have a majority 

of independent directors should help 

reduce conflicts of interest that 

otherwise might arise when persons 

with a nexus to the SRO are involved in 

key decisions. A board constituting a 

majority of independent directors also 

should help further the SRO’s ability to 

meet its obligations under the Exchange 

Act, because those directors would not 

have relationships with the SRO, its 

members, or listed issuers that 

otherwise would impair disinterested 

viewpoints or judgments. Further, the 

requirement that each exchange and 

association establish policies and 

procedures to require each director on 

his or her own initiative or upon request 

of the exchange or association, to inform 

the exchange or association of the 

existence of any relationship or interest 

that may reasonably be considered to 

bear on whether such director is an 

independent director would aid the 

board in affirmatively determining 

whether such director could be 

considered independent. In addition, 

such requirement would provide the 

exchange or association with a 

mechanism by which to determine 

whether such exchange or association is 

in compliance with the majority 

independent board requirement. While 

meeting in executive session, free from 

the presence of management, the 

independent directors would be 

afforded the opportunity to discuss 

important matters regarding the 

exchange or association in a frank and 

open manner. 

The proposed governance rules also 

would require that exchanges and 

associations, as well as their regulatory 

subsidiaries, administer a fair process 

that provides members with the 

opportunity to select at least 20% of the 

total number of directors.618 The 

Nominating Committee would be 

required to nominate at least one 

director who is representative of issuers 

and at least one director who is 

71196 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

619See proposed Rules 6a–5(f)(4) and 15Aa–

3(f)(4).

620See proposed Rules 6a–5(m)(1) and 15Aa–

3(m)(1).

621See proposed Rules 6a–5(m)(2) and (4) and 

15Aa–3(m)(2) and (4).

622See proposed Rules 6a–5(m)(3) and 15Aa–

3(m)(3). See supra Section II.B.7. for a discussion 

of these proposed rules.

623See proposed Rules 6a–5(l)(2) and 15Aa–

3(l)(2). See supra Section II.B.5. for a discussion of 

this proposed requirement.

624See proposed Rules 6a–5(n)(1) and 15Aa–

3(n)(1).

625See proposed Rules 6a–5(n)(4) and 15Aa–

3(n)(4).

626See proposed Rules 6a–5(n)(5) and 15Aa–

3(n)(5).

627See supra Section II.B.8. for a discussion of 

these proposed rules.

628See proposed Rule 6a–5(n)(5)(i)(C) and 15Aa–

3(n)(5)(i)(C). This requirement would not apply if 

such information is aggregated to such an extent 

that no person whose information is included in the 

aggregated information can be identified, or unless 

the person has consented to the dissemination and 

use of its information by the exchange.

629See proposed Rules 6a–5(n)(5)(A) and (B) and 

15Aa–3(n)(5)(A) and (B). See supra Section II.B.8.c. 

for a discussion of this proposed requirement.

representative of investors and who, in 

each case, is not associated with a 

member or broker or dealer.619 These 

proposals balance the Commission’s 

goal of greater board independence with 

the right of members to participate in 

the governance of the exchange or 

association by providing members with 

a practical voice in exchange or 

association affairs, without jeopardizing 

the overall independence of the board.

Standing Committees composed 

solely of independent directors should 

result in a greater degree of objective 

decision-making with respect to the 

exchange’s or association’s core 

responsibilities. The Standing 

Committees’ annual evaluation process 

should assist the exchange or 

association in identifying potential 

strengths and deficiencies in the 

governance, administration, regulatory 

programs and financial matters of the 

exchange or association and any 

regulatory subsidiary. Further, requiring 

exchanges and associations to provide 

sufficient funding and other resources to 

permit the independent directors and 

the Standing Committees to fulfill their 

responsibilities and to retain 

independent legal counsel and other 

advisors should provide independent 

directors with the ability to serve 

effectively. 

Although the proposed governance 

rules do not require that an exchange’s 

or association’s Chairman be an 

independent director, the rules would 

require that if the exchange’s or 

association’s CEO is not also the 

Chairman, the Chairman must be an 

independent director.620 Further, in the 

event an exchange or association elected 

to have a single individual serve as 

Chairman and CEO, the proposed 

governance rules would prohibit that 

person—who, as the CEO would not be 

‘‘independent’’—from participating in 

any executive sessions of the board and 

from serving on any Standing 

Committee.621 If a single individual 

served as both Chairman and CEO, the 

board would be required to designate an 

independent director as a lead director 

to preside over executive sessions of the 

board, and the board would be required 

to publicly disclose such lead director’s 

name and a means by which interested 

parties may communicate with the lead 

director.622 These provisions should 

further a greater degree of independent 

decision-making by the governing body 

of an exchange or association.

The proposed rules would require 

exchanges and associations to explicitly 

mandate that each director, in 

discharging his or her responsibilities as 

a member of the board, reasonably 

consider all requirements applicable to 

the exchange or association under the 

Exchange Act.623 The Commission 

believes that this requirement would 

benefit investors, members, and other 

users of the facilities of the exchange or 

association by helping to ensure that 

directors of exchanges and associations 

fully recognize that the exchange or 

association has certain obligations 

under the Exchange Act, and that the 

directors act in accordance with those 

obligations. In particular, explicitly 

requiring directors to take into account 

the exchange’s or association’s 

obligations under the Exchange Act 

should help promote greater awareness 

and accountability on the part of 

directors about the responsibilities of 

the exchange or association, thus 

furthering the objectives of the 

Exchange Act.

Moreover, the Commission believes 

that the proposals to separate the 

regulatory operations of an exchange or 

association, and any regulatory 

subsidiary, from its market operations 

and other commercial interests,624 to 

require regulatory funds to be applied 

only to fund programs and operations 

directly related to the exchange’s or 

association’s regulatory 

responsibilities,625 and to require an 

exchange or association to establish 

procedures to prevent the dissemination 

of regulatory information other than to 

persons carrying out the exchange’s or 

association’s regulatory obligations,626

should allow SROs to better manage the 

conflicts of interest inherent in the selfregulatory structure between the SRO’s 

regulatory responsibilities and its 

market operations.627 These provisions 

of the proposed governance rules would 

help promote greater accountability on 

the part of exchanges and associations 

with respect to their regulatory 

programs and strengthen their ability to 

meet their statutory obligations.

In particular, the proposal to require 

an exchange or association to use funds 

collected from regulatory fees, fines or 

penalties only to fund programs and 

operations directly related to the 

exchange’s or association’s regulatory 

responsibilities is designed to diminish 

the potential for an exchange or 

association to use its authority to raise 

regulatory funds for the purpose of 

benefiting its shareholders, or for other 

non-regulatory purposes, such as to 

fund executive compensation. The 

Commission believes that the proposed 

requirements to use regulatory funds 

only to fund regulatory activities would 

further advance the SROs’ ability to 

effectively comply with statutory 

requirements, by helping to ensure that 

an SRO’s regulatory activities are 

properly funded and the SRO is not 

abusing its regulatory authority. 

The proposed rules also would 

require an exchange or association to 

establish policies and procedures 

reasonably designed to maintain the 

confidentiality of information required 

to be submitted to effectuate a 

transaction on or through the facilities 

of an exchange or association.628 The 

proposed rules also would require that 

an exchange’s or association’s policies 

and procedures to be designed to 

reasonably prevent the dissemination of 

information collected from its members 

in the course of performing its 

regulatory obligations under the 

Exchange Act (‘‘regulatory 

information’’) to any person that is not 

an officer, director, employee, or agent 

of the exchange or association directly 

involved in carrying out the exchange’s 

or association’s regulatory obligations 

under the Exchange Act, and would 

prohibit an exchange or association 

from using regulatory information other 

than for regulatory purposes.629 By 

helping to ensure that regulatory 

information is only used for regulatory 

purposes, the Commission believes that 

these proposed requirements would 

benefit investors and the public by 

helping to maintain the independence 

of an exchange’s or association’s selfregulatory function, thus furthering the 

ability of the exchange or association to 

carry out its regulatory responsibilities 

in compliance with the Exchange Act. 

In addition, because the proposed rules 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71197

630See supra Section II.B.9. for a discussion of 

proposed Rules 6a–5(o) and 15Aa–3(o). 631 15 U.S.C. 78s(b)(1).

would help to assure members that any 

information they provide to the 

exchange or association for regulatory 

purposes would not be used for 

competitive or other non-regulatory 

purposes, it would facilitate the 

provision of information to the 

exchange or association that would help 

the exchange or association carry out its 

regulatory obligations under the 

Exchange Act.

The proposed governance rules also 

would require the rules of an exchange 

or association to prohibit any member 

that is a broker or dealer, either alone 

or together with its ‘‘related persons,’’

from directly or indirectly beneficially 

owning and voting any interest in the 

exchange, the association, or a facility of 

an exchange or association through 

which the member is permitted to effect 

transactions, that exceeds 20% of any 

class of securities or other ownership 

interest of the exchange, association, or 

facility.630 This proposed requirement 

would serve to mitigate the conflict of 

interest that could occur if a brokerdealer were to control a significant 

interest in its regulator. For example, an 

ownership and voting limit would 

reduce the ability of a member to 

influence the regulatory operation of the 

exchange or association for its benefit 

(such as by directing the exchange to 

refrain from diligently surveilling the 

member’s conduct or from punishing 

conduct that violates the rules of the 

exchange or the federal securities laws). 

In addition, imposing such a limitation 

would make it more difficult for a 

member to direct or affect the business 

of an exchange or association to 

enhance its own commercial interests. 

Thus, the Commission believes that 

requiring exchanges and associations to 

impose ownership and voting limits on 

members could benefit investors and the 

public by reducing the risk that a 

member could use its controlling 

interest in its regulator to influence the 

regulatory process to its benefit.

The Commission believes that it is 

important that there be sufficient 

independence within the self-regulatory 

process to adequately check undue 

interference or influence from the 

persons or entities being regulated. 

These proposed rules, individually and 

as a whole, would help insulate the 

regulatory activities of an exchange or 

association from the conflicts of interest 

that may otherwise arise by virtue of its 

market operations. The independence of 

the regulatory process would be further 

strengthened through the appointment 

of a Chief Regulatory Officer who would 

administer the regulatory program and 

who would report directly to the 

independent Regulatory Oversight 

Committee. 

The Commission believes that 

requiring exchanges and associations to 

adopt a code of conduct and ethics 

should help foster the ethical behavior 

of directors, officers and employees, 

because these individuals would be 

informed of the standards of conduct 

expected of them in fulfilling the 

responsibilities of their positions. 

Similarly, requiring exchanges and 

associations to adopt governance 

guidelines should help promote greater 

awareness of the governance principles 

that are intended to guide the exchange 

or association in implementing good 

governance. 

2. Costs 

The Commission anticipates that 

proposed Rules 6a–5 and 15Aa–3 would 

impose costs on exchanges and 

associations. Moreover, because the 

proposed governance rules also would 

apply to regulatory subsidiaries of the 

exchange or association, exchanges and 

associations would incur additional 

costs related to compliance by these 

entities with the proposed rules. 

Exchanges and associations not 

currently in compliance with the 

proposed governance rules would need 

to spend time and incur costs in 

modifying their internal processes and 

operations, as well as taking necessary 

steps to amend their rules, including 

their charters and bylaws, to comply 

with any new standards. Changes also 

would need to be made to the internal 

processes and operations, and rules, 

including charters and bylaws, of any 

regulatory subsidiaries or facility of the 

exchange or association to the extent the 

exchange or association would be 

required to apply the rules to those 

entities. Exchanges and associations 

would have to file with the Commission 

under Section 19(b) of the Exchange 

Act 631 proposed rule changes that 

would contain new rules or rule 

amendments that comply with the 

proposed governance rules. Modifying 

internal processes, drafting new charter, 

bylaw, and rule provisions, and 

preparing proposed rule changes to file 

with the Commission would impose 

costs on exchanges and associations, 

although some, if not all, SROs most 

likely would rely on in-house legal staff 

to perform these tasks. The Commission 

seeks comment on these costs.

Exchanges and associations that do 

not already have a board composed of 

a majority of independent directors 

would incur additional costs in 

modifying the composition of their 

boards. An exchange or association 

could comply with the majority 

independent board requirement by 

decreasing the size of its board and 

allowing some non-independent 

directors to resign; maintaining the 

current size of its board and replacing 

some non-independent directors with 

independent directors; or by increasing 

the size of its board and electing 

additional independent directors. In any 

event, unless an exchange or association 

currently complies with the proposed 

standards, it would incur costs in 

adding new directors or replacing 

existing directors. If an exchange or 

association elects to add independent 

directors to comply with the proposed 

requirement for a majority independent 

board, it could incur costs in finding 

qualified candidates that fit the 

proposed independence criteria. An 

exchange or association also could incur 

costs associated with preparing, as well 

as administering and reviewing, 

questionnaires to be completed by a 

director to determine whether such 

director could be considered 

independent. As discussed above in 

Section IX, the Commission estimates 

that each exchange or association would 

annually spend 34 hours and $12.58 if 

it were to request information from its 

directors regarding their independence, 

resulting in a total annual reporting and 

recordkeeping burden of approximately 

340 hours and approximately $126 for 

all exchanges and associations.

Exchanges and associations that do 

not already have an independent 

Chairman, in the event that the 

Chairman and CEO are two individuals, 

could incur additional costs in hiring 

and compensating a new Chairman. An 

exchange or association could elect to 

name a current independent member of 

the board as Chairman; however, such a 

move would still likely impose 

compensation costs, in addition to costs 

incurred in changing leadership. Also, 

when modifying the composition of 

their boards, exchanges and associations 

could incur additional costs associated 

with preparing, mailing and processing 

proxy or information statements that 

would be necessary to hold a meeting to 

elect new directors. The Commission 

seeks comment on these costs. 

In addition, exchanges and 

associations could have additional costs 

in adjusting to new board practices and 

providing independent directors with 

the necessary funding and resources to 

71198 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

632See proposed Rules 6a–5(d)(3) and 15Aa–

3(d)(3).

633See proposed Rules 6a–5(d)(1) and 15Aa–

3(d)(1).

634See proposed Rules 6a–5(d)(2) and 15Aa–

3(d)(2).

635See proposed Rules 6a–5(c)(4) and (f)(3) and 

15Aa–3(c)(4) and (f)(3).

636See proposed Rule 6a-5(f)(4) and 15Aa-3(f)(4).

637See 15 U.S.C. 78f(b)(3) and 15 U.S.C. 78o3(b)(4).

638See proposed Rules 6a–5(f)(1), (g)(1), (h)(1), 

(i)(1) and (j)(1) and 15Aa–3(f)(1), (g)(1), (h)(1), (i)(1) 

and (j)(1).

639See proposed Rules 6a–5(f)(5), (g)(3), (h)(3), 

(i)(3) and (j)(6) and 15Aa–3(f)(5), (g)(3), (h)(3), (i)(3) 

and (j)(6).

640See proposed Rules 6a–5(e)(3) and 15Aa–

3(e)(3).

641See proposed Rules 6a–5(n)(1) and 15Aa–

3(n)(1).

642See proposed Rules 6a-5(n)(2) and 15Aa–

3(n)(2).

643See proposed Rules 6a–5(n)(3) and 15Aa–

3(n)(3).

644See supra Section II.B.8.b. for a discussion of 

proposed Rules 6a–5(n)(4) and 15Aa–3(n)(4).

carry out their duties.632 For example, 

the proposed rules would require that 

independent directors meet regularly in 

executive session.633 In addition, 

independent directors would be 

permitted to hire and obtain advice and 

assistance from independent legal 

counsel and other advisors as they 

determine necessary to carry out their 

duties.634 The Commission seeks 

comment on these costs.

The proposed governance rules also 

would require exchanges and 

associations to administer a fair process 

that provides members with the 

opportunity to select at least 20% of the 

total number of directors.635 Further, the 

Nominating Committee would be 

required to nominate at least one 

director who is representative of issuers 

and at least one director who is 

representative of investors and who, in 

each case, is not associated with a 

member or broker or dealer.636 These 

proposed provisions are intended to 

codify in rules the fair representation 

requirements set forth in the Exchange 

Act.637 Some SROs currently may be in 

compliance with these proposed 

requirements because they are 

commensurate with statutory standards 

that SROs currently must satisfy. 

However, the Commission requests 

comment concerning whether 

exchanges and associations would incur 

additional costs to comply with the 

specific requirements set forth in the 

proposed rules.

The proposed governance rules would 

require that each Standing Committee 

be composed entirely of independent 

directors; 638 that each Standing 

Committee perform an annual selfevaluation, except that the Governance 

Committee would perform an annual 

evaluation of the governance of the 

exchange or association as a whole; 639

and that each Standing Committee be 

provided sufficient funding and other 

resources, as determined by each 

Standing Committee, to permit it to 

retain independent legal counsel and 

other advisors.640 The exchange or 

association could incur costs to organize 

board functions along the lines of the 

proposed Standing Committees. As 

noted above, an exchange or association 

could incur costs to add independent 

directors to its board, but there should 

not be any costs incurred as a result of 

appointing those independent directors 

to serve on Standing Committees. 

Similarly, the Commission does not 

believe that costs would be incurred in 

connection with the annual 

performance evaluation by each 

Standing Committee, unless such 

Standing Committee had to hire new 

employees or outside advisors to 

perform the evaluation. However, to the 

extent that the proposal causes an 

increase in the duties of board 

committee members, and a 

corresponding increase in the amount of 

time that directors spend fulfilling their 

committee obligations, exchanges and 

associations could find that there are 

additional costs in compensating 

directors for their duties. The 

Commission requests comment on the 

likelihood of this scenario. Further, to 

the extent that current funding is not 

sufficient to permit the independent 

directors to retain independent legal 

counsel and other advisors, an exchange 

or association could incur additional 

costs in providing such funding. The 

Commission seeks comment on these 

costs.

The proposed governance rules would 

require exchanges and associations to 

establish policies and procedures to 

assure the independence of their 

regulatory program from the operation 

or administration of any market 

operations and other commercial 

interests.641 To this end, the proposed 

governance rules would require that the 

exchange’s or association’s regulatory 

program either be structurally separated 

from its market operations and other 

commercial interests or functionally 

separated but contained within the same 

entity.642 In either case, the proposed 

governance rules would require that the 

board appoint a Chief Regulatory Officer 

to administer the regulatory program 

and that the Chief Regulatory Officer 

report directly to the independent 

Regulatory Oversight Committee.643 The 

Commission seeks comment on these 

costs.

An exchange or association that 

undertakes a structural separation of its 

regulatory program from its market 

operations and other commercial 

interests through the creation of a new 

separate legal entity would incur costs 

associated with the formation or 

incorporation of such new entity, as 

well as costs associated with hiring and 

compensating individuals to manage 

such new entity. An exchange or 

association that undertakes to 

functionally separate its regulatory 

program from its market operations and 

other commercial interests also would 

incur additional costs associated with 

analyzing the exchange’s or 

association’s current regulatory 

practices and modifying such practices 

to comply with the proposed 

governance rules. Unless an exchange or 

association currently employs a Chief 

Regulatory Officer, the Commission 

expects that exchanges and associations 

would incur costs associated with hiring 

and compensating a Chief Regulatory 

Officer. The Commission seeks 

comment on these costs. 

The Commission recognizes that an 

exchange or association could incur 

costs to establish policies and 

procedures necessary to segregate 

regulatory funds and to keep books and 

records necessary to demonstrate 

compliance with the proposed 

requirement to use regulatory funds 

only to fund programs and operations 

directly related to the exchange’s or 

association’s regulatory 

responsibilities.644 The Commission 

preliminarily believes that those funds 

should be readily identifiable, and that 

exchanges and associations likely 

already segregate certain funds derived 

from regulatory fees, fines and penalties. 

To the extent that exchanges and 

associations do not already segregate 

regulatory funds, they would have to 

modify their existing financial controls 

to assure that they operate in 

compliance with the proposed 

requirement. The Commission seeks 

comment on whether exchanges and 

associations currently segregate 

regulatory funds, or can easily identify 

such funds, and the costs that would be 

incurred to make modifications. The 

Commission also seeks comment on 

whether exchanges and associations 

would have to put in place new 

financial controls, or whether the 

existing financial controls of an 

exchange or association are sufficient to 

assure that it operates in compliance 

with the proposed rules.

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71199

645See supra Section II.B.8.c. for a discussion of 

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

646See proposed Rules 6a–5(o)(5) and 15Aa–

3(o)(5).

647See supra Section II.B.5. for a discussion of 

proposed Rules 6a–5(l)(2) and 15Aa–3(l)(2).

648At the time that the Commission approved 

BOX as a trading facility of BSE, Interactive Brokers 

Group LLC (a registered broker-dealer) owned more 

than a 20% interest in BOX. See Securities 

Exchange Act Release No. 49067, supra note 59. 

Also, at the time the Commission approved a PCX 

rule filing relating to the IPO of Archipelago 

Holdings, one member of PCX held both an equity 

trading permit issued by PCX Equities and more 

than a 20% interest in Archipelago Holdings. See

Securities Exchange Act Release No. 50170, supra

note 65.

649See supra Section II.B.10. for a discussion of 

the proposed code of conduct and ethics and 

governance guidelines.

The Commission also recognizes that 

an exchange or association could incur 

costs to establish the policies and 

procedures reasonably designed to 

prevent the dissemination of regulatory 

information to any person not directly 

involved in carrying out the exchange’s 

or association’s regulatory obligations 

under the Exchange Act, and to keep 

certain other transaction-related 

information confidential, unless made 

available in aggregated form.645 As part 

of their existing policies to comply with 

their obligations under the Exchange 

Act, the Commission believes that 

exchanges and associations already have 

policies and procedures designed to 

safeguard and restrict the use and 

dissemination of such information. 

Therefore, the Commission 

preliminarily believes that exchanges 

and associations would not need to 

expend substantial resources to modify 

their internal processes to comply with 

the proposed requirements. The 

Commission requests comment from 

exchanges and associations as to 

whether the measures they employ, if 

any, to safeguard and restrict the use 

and dissemination of confidential 

information currently comply with the 

proposed requirements, or whether 

exchanges and associations will need to 

modify their internal processes. An 

exchange or association also could incur 

costs in taking action necessary to 

assure that its officers, directors, 

employees and agents agree to comply 

with the proposed requirements (as 

required by the proposed rules),646 and 

to educate new, as well as existing, 

employees about these requirements. 

The Commission seeks comment on the 

extent of these identified costs.

While the Commission believes that 

members of the boards of exchanges and 

associations already consider the 

Exchange Act responsibilities of the 

exchange or association in the course of 

performing their duties, the Commission 

recognizes that an exchange or 

association would incur costs necessary 

to amend its rules to explicitly require 

its directors to reasonably consider its 

Exchange Act responsibilities when 

discharging their responsibilities as 

members of the board.647 The exchange 

or association also would incur costs 

necessary to inform its current board 

members of the rule and their 

obligations, and to inform new board 

members. The Commission seeks 

comment on these costs.

The Commission recognizes that 

exchanges and associations (and their 

facilities) likely would incur costs 

associated with establishing and 

enforcing rules to effectuate the 

proposed ownership and voting limits 

on members that are brokers or dealers. 

These costs could include exchange or 

association staff resources and legal fees 

related to drafting, preparing, and filing 

proposed rule changes with the 

Commission. The costs also would 

include staff resources, legal and filing 

fees related to filing corporate governing 

documents with the exchange’s, 

association’s or facility’s state of 

incorporation. The Commission also 

recognizes that an exchange or 

association might need to obtain the 

approval of its members or 

shareholders, or of the owners of its 

facility, to implement such rules, which 

could require the exchange or 

association to prepare a proxy 

statement. The costs that would be 

required to obtain the necessary 

approval of any required change would 

depend on the number of such persons, 

the ownership concentration of the 

exchange, association or facility, and 

such persons’ receptiveness to the 

proposed rules. In addition, corporate 

law might require the exchange or 

facility to notify its shareholders or 

owners of any ownership or voting 

restrictions by either sending a notice or 

by inserting a legend on the stock or 

ownership certificates. The Commission 

seeks comment on these costs.

The Commission also recognizes that 

exchanges and associations would incur 

ongoing costs associated with obtaining 

ownership information and monitoring 

the ownership interests of members for 

compliance with the proposed 

ownership and voting limits. Facilities 

also could incur these costs to the extent 

the exchange or association requires the 

facility’s help to obtain and monitor 

ownership by members and their related 

persons in the facility. As stated above 

in Section IX., the Commission 

estimates that an exchange or 

association would spend approximately 

14 hours and $1,290 annually if it 

determined to request ownership 

information from owners of voting and 

ownership interests. Thus, the 

Commission estimates that all 

exchanges and associations annually 

would spend a total of approximately 

140 hours and $12,900 if they requested 

such ownership information. The 

Commission requests comment on this 

estimate. In addition, an exchange or 

association, as well as a facility, could 

incur costs of enforcing the ownership 

and voting limits. For example, an 

exchange could incur costs involved 

with redeeming shares held in excess of 

the proposed limits if the exchange 

chooses to provide that any such excess 

shares would be purchased by the 

exchange. An exchange, association or 

facility also could incur costs associated 

with monitoring votes cast at any 

shareholder meeting to determine that 

no member and its related persons 

subject to the voting limits exceeded 

those limits. 

Any member and its related persons 

that owns in excess of the proposed 

limit of any class of securities or other 

ownership interest of the exchange, 

association, or facility could incur costs 

involved with divesting the portion of 

its ownership interest that exceeds the 

limit. As stated above in Section IX., the 

Commission preliminarily believes that 

only two members that are brokers or 

dealers currently own greater than 20% 

of a demutualized exchange or 

facility.648 The Commission specifically 

requests comment on this issue, and 

whether any other broker-dealer 

members (alone or together with their 

related persons) currently own more 

than 20% of an SRO or a facility of an 

SRO. The Commission also recognizes 

that implementation of the proposed 

ownership and voting restrictions on 

members that are brokers or dealers 

potentially could reduce the value of the 

ownership interests in the exchange, 

association, or facility, to the extent that 

the proposed requirements adversely 

affect the free transferability of the 

securities, which would impact the 

owner of the securities, as well as the 

exchange, association, or facility. The 

Commission seeks comment on these 

costs.

Finally, the proposed governance 

rules would require each exchange and 

association to adopt a code of conduct 

and ethics for directors, officers and 

employees, as well as governance 

guidelines that include specified 

provisions.649 Some exchanges or 

associations could already have codes 

and guidelines that comply with the 

proposed governance rules, in which 

71200 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

650See supra Section III. for a discussion of 

proposed Regulation AL.

651See proposed Rule 800(b)(1).

652See proposed Rule 800(b)(2)

653See id.

654The Commission notes that an exchange or 

association only would incur costs necessary to 

comply with proposed Regulation AL if it approved 

for listing an affiliated security that is to be traded 

on or through its facilities.

case, little or no costs would be 

incurred. However, other exchanges or 

associations may be required to utilize 

in-house staff or hire legal counsel to 

draft such codes or guidelines. The 

Commission requests comment on the 

extent to which exchanges and 

associations already have codes and 

guidelines that comply with the 

proposed rules.

3. Request for Comment 

The Commission generally requests 

comment as to whether the operation of 

proposed Rules 6a–5 and 15Aa–3 would 

result in the potential costs discussed 

above, and how to quantify these 

potential costs. In addition, the 

Commission requests data to quantify 

the costs and benefits described above. 

The Commission seeks estimates of 

these costs and benefits, as well as any 

costs and benefits not already defined, 

which may result from the adoption of 

these proposed new rules. 

B. Costs and Benefits of Proposed 

Regulation AL 

As discussed above, the listing of 

securities issued by an SRO, the facility 

of an SRO, or an affiliate of either 

(‘‘affiliated securities’’) on the SRO 

raises questions as to the SRO’s ability 

to independently and effectively enforce 

its rules against itself.650 For instance, 

the SRO might be reluctant to 

vigorously monitor for compliance with 

its initial and continued listing rules by 

the securities of an affiliated issuer or its 

own securities, and may be tempted to 

allow its own securities, or the 

securities of an affiliate, to be listed (and 

continue to be listed) on its market even 

if the security is not in full compliance 

with the SRO’s listing rules. The trading 

of securities of an SRO or the securities 

of an affiliated issuer on the SRO also 

raises similar potential conflict 

concerns, in that the SRO might choose 

to selectively enforce (or not enforce) its 

trading rules with respect to trading in 

its own stock or that of an affiliate so as 

to benefit itself. For example, the SRO 

may determine to look the other way 

with respect to improper trading in an 

affiliated security that creates the 

appearance of increased volume, such 

as through wash sales, or trading that 

artificially inflates or sustains the price 

of the stock, such as marking the close.

Proposed Regulation AL would 

prohibit an exchange or association 

from approving for listing an affiliated 

security unless such exchange’s or 

association’s Regulatory Oversight 

Committee (composed of independent 

directors) certified that such security 

satisfies the exchange’s or association’s 

rules for listing.651 Proposed Regulation 

AL also would impose reporting and 

notice requirements on an exchange or 

association with respect to an affiliated 

security.652 Specifically, an exchange or 

association would have to file quarterly 

reports with the Commission regarding 

its monitoring of the listing and trading 

of an affiliated security on its market; on 

an annual basis provide the Commission 

a copy of a report prepared by a third 

party analyzing compliance by the 

affiliated security with the exchange’s or 

association’s listing rules; promptly 

notify an affiliated issuer of alleged noncompliance with a listing rule; provide 

the Commission with a report detailing 

such alleged non-compliance; and 

provide the Commission with a copy of 

any response from the affiliated 

issuer.653 The exchange’s or 

association’s Regulatory Oversight 

Committee would have to approve the 

quarterly reports and the report 

detailing non-compliance.

1. Benefits 

The Commission believes that 

requiring an exchange’s or association’s 

Regulatory Oversight Committee to have 

a role in monitoring compliance with 

the exchange’s or association’s rules 

with regard to an affiliated security 

would reduce the potential for conflict 

between an exchange’s or association’s 

self-regulatory responsibility to 

vigorously oversee the listing and 

trading of the affiliated security on its 

market, and its own commercial or 

economic interests. In particular, 

requiring the Regulatory Oversight 

Committee—a fully independent 

committee—to certify that an initial 

listing of an affiliated security satisfies 

the listing rules would bring a level of 

independence to the process. Also, 

requiring the Regulatory Oversight 

Committee to approve the quarterly 

reports and reports detailing noncompliance prior to filing with the 

Commission would serve to bring 

independent oversight to the ongoing 

monitoring process, and provide the 

Regulatory Oversight Committee with 

timely notice of potential concerns. In 

addition, the Commission believes that 

requiring a third party to analyze 

compliance with listing rules would 

serve to add an additional layer of 

impartiality to the oversight process. 

Regulation AL also would require the 

exchange or association to apply its 

listing rules to affiliated securities in a 

manner that is not materially different 

than the treatment afforded to other 

securities listed on the exchange or 

association, and that any action taken by 

the exchange or association with respect 

to listing and trading of an affiliated 

security be in compliance with the rules 

of the exchange or association. The 

Commission believes that these steps 

would help to address the potential 

conflict of interest, which would benefit 

investors and the market generally by 

helping to prevent fraud and 

manipulation and by helping to ensure 

that the exchange or association does 

not give preferential treatment to 

affiliated securities.

2. Costs 

Each exchange or association already 

should have in place established 

policies and procedures for monitoring 

the listing and trading of securities on 

or through its facilities.654 The 

Commission believes that the 

monitoring of the listing and trading of 

an affiliated security should fall within 

these existing procedures, thus 

minimizing costs necessary to monitor 

the listing and trading of an affiliated 

security’s compliance with proposed 

Regulation AL.

The Commission recognizes that each 

exchange or association that lists an 

affiliated security could incur costs 

associated with a more frequent review 

for compliance with listing rules if the 

exchange or association does not 

perform such review at least once a 

quarter. As stated above in Section IX., 

the Commission estimates that an 

exchange or association that does not 

review for compliance on a quarterly 

basis would incur an additional 

reporting and recordkeeping burden of 8 

hours per review, and further estimates 

that two additional reviews per year 

would be required. The Commission’s 

preliminary belief, however, is that each 

exchange and association already 

performs some level of review for 

compliance with its listing rules on at 

least a quarterly basis. The Commission 

requests comment on this issue. 

In addition, the exchange or 

association could incur costs associated 

with requiring the Regulatory Oversight 

Committee to certify the initial listing of 

the affiliated security, and to approve 

each quarterly and any non-compliance 

reports, because the Committee would 

need time to review the listing rules and 

reports. An exchange or association also 

would incur in-house legal, compliance 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71201

655The exchange or association may also incur 

outside legal costs, to the extent they choose to 

outsource the preparation of these reports. The 

Commission does not believe it likely that an 

exchange or association would outsource the 

preparation of these reports, but requests comment 

on the issue.

656The Commission assumes that each report and 

notification will weigh five ounces and will be 

mailed via first class mail at a rate of $0.37 for the 

first ounce and $0.23 for each additional ounce, for 

a total of $1.29.

657The Commission believes that most, if not all, 

exchange and association listing rules include fairly 

objective quantitative (e.g. market capitalization) 

and qualitative (e.g. that the majority of the board 

be independent) listing standards. For example, see

Sections 1 and 3 of the NYSE Listed Company 

Manual and Rules 4300, et seq., of the NASD 

Manual.

658 15 U.S.C. 78e.

659Currently, securities associations are required 

to register on Form X–15AA–1 and to file 

amendments and supplements on Forms X–15AJ–

1 and X–15AJ–2. The Commission proposes to 

redesignate Form X–15AA–1 as Form 2 and to 

amend Form 2 in a manner consistent with the 

proposals contained in this release. For clarity, we 

refer to the registration form for exchanges, as 

proposed to be amended, as ‘‘revised Form 1’’ and 

the registration form for securities associations, as 

proposed to be redesignated and amended, as ‘‘new 

Form 2.’’

660 17 CFR 240.6a–2.

661The term ‘‘facility’’ when used with respect to 

an exchange would have the same meaning as in 

Section 3(a)(2) of the Exchange Act. 15 U.S.C. 

78c(a)(2). The term ‘‘facility’’ when used with 

respect to an association is defined in proposed 

Rule 15Aa–3(b)(11).

662The proposed Exhibits to revised Form 1 and 

new Form 2 for which an exchange or association 

would need to include information with respect to 

a facility or regulatory subsidiary are Exhibits A 

(governance documents and rules), B (written 

rulings, interpretations), C (composition, structure 

and responsibilities of the board), D (list of officers), 

E (information about executive board and 

committees), F (governance guidelines, code of 

conduct and ethics (and waivers), G (internal 

organizational charts), H (regulatory program), and 

I (financial information).

663See proposed Instructions to revised Form 1 

and new Form 2.

664See supra Section IV.

and administrative costs related to 

preparing and filing quarterly reports 

with the Commission and, if an 

exchange or association were to allege 

that an affiliated security was not in 

compliance with listing rules, with 

preparing and filing a report with the 

Commission detailing such alleged noncompliance.655 As discussed above in 

Section IX., the Commission estimates 

that each exchange or association would 

spend approximately 17 hours 

preparing and filing the initial quarterly 

report and 12 hours for each quarterly 

report thereafter, for a total of 53 hours 

per exchange or association for the first 

year and 48 hours per exchange or 

association thereafter. Additionally, the 

Commission estimates that each 

exchange or association would spend 

approximately 5 hours to prepare and 

file a non-compliance report, 2 hours to 

notify an issuer of alleged noncompliance, 2 hours to comply with the 

proposed requirement to file a copy 

with the Commission of a response to 

any issuer that notifies the exchange or 

association of alleged non-compliance 

and $1.29 656 each time the exchange or 

association notifies an issuer of alleged 

non-compliance, files a report with the 

Commission, sends notice of noncompliance to an issuer or files a copy 

with the Commission of any notice of 

non-compliance. The Commission is not 

able to estimate how many noncompliance reports would need to be 

filed, how many times an exchange or 

association would need to notify an 

issuer of non-compliance, and how 

many times an exchange or association 

would need to file a copy with the 

Commission of any response to any 

issuer that notifies the exchange or 

association of its non-compliance, but 

estimates that one occurrence of each 

such event per exchange or association 

would occur each year. Accordingly, the 

Commission estimates that each 

exchange or association would spend 9 

hours per year and $3.87, for a total of 

81 hours and approximately $35 for all 

exchanges and associations.

In addition, the exchange or 

association would incur the costs of 

hiring a third party to analyze and 

prepare a report regarding the affiliated 

security’s compliance with the 

exchange’s or association’s listing rules 

on an annual basis.657 The Commission 

also estimates that an exchange or 

association would spend approximately 

9 hours reviewing and participating in 

the preparation of such third party 

reports. As discussed above in Section 

IX., the Commission preliminarily 

estimates that it would take a third party 

approximately 22 hours to prepare and 

file each report, for a total annual cost 

per exchange or association of 

approximately $6,612, or $59,508 

annually for all exchanges and 

associations.

3. Request for Comment 

The Commission seeks comment on 

any additional benefits of proposed 

Regulation AL. The Commission also 

generally requests comment as to 

whether the operation of the proposed 

rule would result in the potential costs 

discussed above, and how to quantify 

these potential costs. The Commission 

also seeks comment on any additional 

anticipated costs and benefits of the 

proposed rule, including specifics of the 

dollar amount of such cost or benefit 

impact. 

C. Costs and Benefits of Proposed Rule 

6a–2 and Revised Form 1, and Rule 

15Aa–2 and New Form 2

The Commission proposes to amend 

the procedures for application as a 

national securities exchange (or 

exchange exempt from registration 

based on limited volume) or registered 

securities association (or affiliated 

securities association), and for the 

submission of amendments to such 

applications. In addition, the proposals 

would harmonize the disclosure 

requirements for exchanges and 

associations. 

Under the proposals, an applicant for 

registration as a national securities 

exchange or an exchange exempt from 

registration pursuant to Section 5 of the 

Exchange Act,658 or as a registered 

securities association or an affiliated 

securities association, would be 

required to submit a registration 

statement and provide disclosure to the 

Commission on revised Form 1 (for 

exchanges) or new Form 2 (for 

associations).659 Any exchange or 

association that is registered with the 

Commission as of the publication date 

of adoption of any proposed 

amendments to the forms would be 

required to file a complete registration 

statement on revised Form 1 or new 

Form 2, as applicable, within six 

months following such publication date. 

Exchanges and associations also would 

use revised Form 1 and new Form 2, 

respectively, to submit amendments. An 

exchange or association further would 

be required to comply with proposed 

amendments to Rule 6a–2 660 and 

revised Form 1, and proposed Rule 

15Aa–2 and new Form 2, on behalf of 

any facility that is a separate legal 

entity 661 or any regulatory subsidiary of 

the exchange or association with respect 

to the filing of specified Exhibits.662 The 

term ‘‘regulatory subsidiary’’ would 

mean any person that, directly or 

indirectly, is controlled by the exchange 

or association and that provides, 

whether pursuant to contract, agreement 

or rule, regulatory services to or on 

behalf of the exchange or association.663

The Commission’s proposals would 

require the disclosure of greater 

information about exchanges and 

associations, particularly with respect to 

their governance and organizational 

structure, their regulatory programs, and 

significant ownership of the exchange or 

association or facility of the exchange or 

association.664 Under the Commission’s 

proposals, certain Exhibits to the 

current Form 1 (exchanges) would be 

revised to require more detailed 

disclosures; comparable disclosures 

would be required pursuant to Form 2 

(associations). These revised Exhibits 

71202 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

665See proposed Exhibit D to revised Form 1 and 

new Form 2.

666See proposed Exhibit E to revised Form 1 and 

new Form 2.

667See proposed Exhibit I to revised Form 1 and 

new Form 2.

668See proposed Exhibit Q to revised Form 1 and 

new Form 2.

669See proposed Exhibit T to revised Form 1 and 

new Form 2. The term ‘‘SRO trading facility’’ would 

mean any facility of a national securities exchange 

or registered securities association that executes 

orders in securities. See proposed Instructions to 

revised Form 1 and new Form 2.

670See proposed Exhibit C to revised Form 1 and 

new Form 2.

671See proposed Exhibit F to revised Form 1 and 

new Form 2.

672See proposed Exhibit C to revised Form 1 and 

new Form 2.

673See proposed Exhibit G to revised Form 1 and 

new Form 2.

674See proposed Exhibit H to revised Form 1 and 

new Form 2.

675See proposed Exhibit P to revised Form 1 and 

new Form 2.

676See proposed Exhibit U to revised Form 1 and 

new Form 2.

677See proposed Exhibit C to revised Form 1 and 

new Form 2.

678See proposed Exhibit H to revised Form 1 and 

new Form 2.

679See proposed Exhibit I to revised Form 1 and 

new Form 2.

680See proposed Rules 6a–2(a) and 15Aa–2(a).

681See proposed Rules 6a–2(b) and 15Aa–2(b).

682See proposed Rules 6a–2(c) and 15Aa–2(c).

683See proposed Rules 6a–2(d) and 15Aa–2(d).

would pertain to information about the 

officers of exchanges and 

associations; 665 a description of the 

structure, composition, and 

responsibilities of any executive board 

and each committee; 666 financial 

information, including an itemization of 

revenues and expenses; 667 the 

ownership interest of any exchange, 

association, or facility of an exchange or 

association, and information on persons 

owning more than 5% of such 

ownership interest; 668 and information 

about securities listed or traded on the 

SRO or on any SRO trading facility.669

In addition, the Commission is 

proposing to add several new Exhibits 

to the current Form 1 and to incorporate 

those Exhibits in new Form 2. These 

Exhibits would pertain to the 

composition, structure, and 

responsibilities of the board; 670 the 

governance guidelines, code of conduct 

and ethics (and waivers thereof),671 and 

the method established by the exchange 

or association for interested parties to 

communicate their concerns regarding 

any matter within the authority or 

jurisdiction of a Standing Committee 

directly to independent directors; 672 the 

organizational structure of the exchange 

or association; 673 the regulatory 

program of the exchange or 

association; 674 the relationship between 

and among the exchange (or 

association), any facility of an exchange 

(or association), and any affiliate of the 

exchange (or association) or facility of 

the exchange (or association); 675 and 

the location of the exchange’s or 

association’s books and records.676

One of the most significant proposed 

features is the requirement that 

exchanges and associations provide 

more in-depth disclosures about their 

regulatory programs and a breakdown of 

the revenues and expenses associated 

with those programs. Exchanges and 

associations would need to provide a 

description of their regulatory programs 

(and those of any regulatory subsidiary). 

The description would include 

information concerning member firm 

regulation, market surveillance, 

enforcement, listing qualifications, 

arbitrations, rulemaking and 

interpretation, and the process for 

assessment and development of 

regulatory policy. Exchanges and 

associations would be required to 

provide a copy of any delegation plan or 

other contract or agreement relating to 

regulatory services that are provided or 

will be provided to the exchange or 

association by another SRO, a regulatory 

subsidiary, or a regulatory subsidiary of 

another SRO. Exchanges and 

associations also would be required to 

describe fully the method established by 

the board for interested parties to 

communicate their concerns regarding 

any matter within the authority or 

jurisdiction of a Standing Committee 

directly to independent directors.677

Further, revised Form 1 and new 

Form 2 would require the exchange or 

association to provide a description of 

the structural or functional 

independence of the regulatory program 

from the market operations and other 

commercial interests of the exchange or 

association, and to discuss fully any 

significant regulatory issues that have 

arisen or any significant events that 

have taken place in the past year and 

the effect these significant issues or 

events may have on the mission, 

strategy, and future operations of the 

exchange’s or association’s regulatory 

program.678

In addition, the proposals would 

require exchanges and associations to 

disclose their regulatory expenses as a 

proportion of their total budget, and 

separately as a proportion of their total 

annual revenues. Pursuant to this 

provision, exchanges and associations 

would be required to disclose the 

aggregate amounts that they expend on 

regulatory activities, as well as the 

amounts that they expend on certain 

subcategories of regulatory activities, 

including supervisory activities (e.g., 

routine examinations and oversight of 

member activity conducted in the 

regular course of business), surveillance 

activities (e.g., manual and automated 

surveillance to ensure compliance with 

rules, such as trading rules and financial 

responsibility rules), and disciplinary 

activities (e.g., enforcement activities). 

Revised Form 1 and new Form 2 also 

would require exchanges and 

associations to disclose the dollar 

amount of their revenues and expenses 

of their regulatory programs, with 

detailed itemization within the 

following broad categories: revenues; 

direct expenses; and allocated expenses. 

Exchanges and associations would 

provide this information for each area of 

their regulatory programs, such as 

surveillance, supervision, and 

discipline, and provide aggregate data 

for all program areas.679

Further, the proposals would require 

exchanges and associations to amend 

Form 1 and Form 2 closer in time to the 

occurrence of an event that requires 

amendment.680 The Commission also is 

proposing to require that each exchange 

and association prepare annually an 

updated Form 1 or Form 2, as 

applicable,681 and continuously post its 

most recent form and any subsequent 

amendments on a publicly accessible 

Internet Web site controlled by the 

exchange or association.682 The 

proposed amendments would give 

exchanges and associations the option 

of complying with the annual filing 

requirements for specified Exhibits by 

posting the required information on an 

Internet Web site and certifying that the 

posted information is accurate.683

1. Benefits 

By requiring that national securities 

exchanges (and exchanges exempted 

from registration based on limited 

volume) and registered securities 

associations (and affiliated securities 

association) to provide equivalent 

information on revised Form 1 

(exchanges) and new Form 2 

(associations), the Commission expects 

that the proposals would benefit an 

exchange’s or association’s members, 

users of their facilities, institutional and 

retail investors, and the shareholders or 

other owners of the exchange or 

association, as well as the Commission, 

by providing them with access to more 

frequent and more detailed information 

about aspects of exchanges’ and 

associations’ governance and 

organizational structures, their 

regulatory programs, and their 

significant owners. Further, the 

proposals are intended to align the 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71203

684See Sections 6 and 15A of the Exchange Act, 

15 U.S.C. 78f and 78o–3.

685See Sections 6(b) and 15A(b) of the Exchange 

Act, 15 U.S.C. 78f(b) and 78o–3(b).

regulatory disclosure framework for 

exchanges and associations by 

mandating comparable disclosure 

requirements for both types of SROs, 

particularly as they are charged with 

nearly identical obligations under the 

Exchange Act.684 The Commission also 

believes that disclosure of information 

with respect to the facility or regulatory 

subsidiary of an exchange or association 

would provide benefits to investors, 

market participants, and others by 

providing a more accurate and complete 

overview of the structure and 

governance of an SRO.

In the Commission’s view, the 

proposed amendments to Rule 6a–2 and 

new Rule 15Aa–2, along with revised 

Form 1 and new Form 2, should bring 

a much greater degree of transparency to 

the administration, organization, 

governance, and ownership of 

exchanges and associations than 

currently exists. The Commission and 

the public would have access to more 

detailed information about the board 

members, officers, and committee 

members of exchanges and associations; 

the structure, composition, and 

responsibilities of the board, executive 

board, and each committee; financial 

information, including an itemization of 

revenues and expenses; the ownership 

interest of any exchange, association, or 

facility of an exchange or association, 

and information on persons owning 

more than 5% of such ownership 

interest; and information about 

securities listed or traded on the SRO or 

on any SRO trading facility. In addition, 

the Commission and the public would 

be able to obtain information about the 

governance guidelines, waiver of the 

code of conduct and ethics, and method 

by which interested parties may 

communicate concerns to independent 

directors with respect to a Standing 

Committee; the organizational structure 

of the exchange or association; the 

regulatory program of the exchange or 

association; the relationship between 

and among the SRO, its facilities, and 

any affiliate of the SRO or a facility of 

the SRO; and the location of the 

exchange’s or association’s books and 

records. 

These enhanced disclosure 

requirements would enable a wide range 

of individuals and entities, including 

members of exchanges and associations, 

users of their facilities, institutional and 

retail investors, other market 

participants, shareholders and other 

owners of demutualized exchanges or 

facilities and the public generally, as 

well as regulators, to have access to 

important information about exchanges 

and associations. Such specific, detailed 

disclosure requirements would further 

the goal of providing market 

participants, investors, and the public 

generally with disclosures by SROs that 

present a greater degree of clarity and 

transparency. As SROs, exchanges and 

associations are accorded a public trust 

to oversee their markets and members 

and to protect investors and the public 

interest. The proposed disclosure 

requirements are intended to shed more 

light on those aspects of an SRO that are 

central to its carrying out its obligations 

under the Exchange Act.685 Thus, the 

proposed disclosure requirements 

should enhance investors’ confidence in 

the fairness and integrity of the 

securities markets by requiring 

exchanges and associations to provide 

specific disclosures about their 

governance and administration.

The proposed disclosure requirements 

also should benefit exchanges and 

associations because they would require 

these SROs to periodically focus on 

their governance structures and 

regulatory programs, as well to identify 

their significant owners, when they 

prepare the annual updates to Forms 1 

and 2. Moreover, the proposals would 

provide the Commission with access to 

a stream of important information about 

exchanges and associations that could 

be used for oversight purposes. For 

instance, requiring an SRO to report on 

persons that own more than 5% of the 

SRO or its facilities would serve to focus 

the SRO’s attention on persons who 

accumulate significant interests. SROs 

could use this information to assess the 

ability of those persons to affect the 

operation of the SRO and its 

performance of its regulatory 

responsibilities. Providing detailed 

information regarding significant 

owners of the SRO or its facilities to the 

Commission, investors, members, and 

users of an SRO’s facilities should help 

ensure greater accountability on the part 

of the exchange to monitor for undue 

influence or control of its regulatory and 

commercial operations, as well as 

further the ability of the Commission to 

carry out its oversight responsibilities 

over the SRO.

The Commission believes that 

requiring those exchanges and 

associations that are registered with the 

Commission as of the date of 

publication in the Federal Register of 

adoption of any proposed amendments 

to the forms to file a complete 

registration statement on revised Form 1 

or new Form 2 within six months 

following such publication date would 

establish a baseline for all registered 

exchanges and associations and would 

facilitate bringing such exchanges and 

associations into the disclosure process 

as proposed to be revised. In addition, 

the Commission’s proposal to require 

more frequent updates of amendments 

to revised Form 1 and new Form 2, and 

to post recent versions of the forms on 

a publicly accessible Internet Web site 

in lieu of paper filing, should benefit 

investors, market participants, and the 

Commission. The proposed 

amendments should enhance investor 

confidence in the integrity of the 

markets by requiring exchanges and 

associations to provide more regular and 

up-to-date disclosures about significant 

changes in their governance, regulation, 

administration, and significant 

ownership. The Commission expects 

that posting the most recent version of 

completed Form 1 or Form 2 on an 

Internet Web site would make such 

information more readily accessible to 

both the Commission and the public, 

thereby enhancing the transparency of 

each exchange and association. Web site 

disclosure should assist market 

participants and the public in their 

understanding and awareness of 

significant aspects of these SROs. 

Moreover, SRO members, market 

participants, investors and regulators 

would be able to more easily monitor 

the effectiveness and performance of 

SROs, thus helping to promote greater 

accountability by SROs with their 

Exchange Act obligations. 

Finally, the Commission believes that 

the proposed elimination of Forms X–

15AJ–1 and X–15AJ–2 and the proposed 

use of Form 2 as both the application for 

initial registration as a registered 

securities association or affiliated 

securities association, and the form for 

submitting amendments to the initial 

application, would provide for more 

uniform disclosure requirements for 

exchanges and associations than the 

existing regulatory scheme. The 

Commission believes that more closely 

aligning the disclosure requirements for 

exchanges and associations would 

benefit the Commission and the public, 

particularly in light of the fact that the 

Exchange Act imposes comparable 

requirements on these SROs. The 

Commission requests comment on the 

benefits of its proposals to increase 

disclosure on revised Form 1 and new 

Form 2. 

2. Costs 

The Commission anticipates that the 

additional disclosure requirements 

contained in the proposals, and the 

proposed requirements for more 

71204 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

686The Commission estimates that an initial 

application and copies would weigh approximately 

180 lbs, and would be mailed via courier/shipping 

service.

687See supra note 686.

688The Commission estimates that an amendment 

and copies would weigh approximately 60 lbs, and 

would be mailed via courier/shipping service.

689This total includes the burden of preparing 

and submitting the initial registration form, but 

does not include any initial start-up burden for 

creating a website (this is a burden on which the 

Commission is soliciting comments).

690This total includes the burden of preparing 

and submitting the initial registration form, but 

does not include any initial start-up burden for 

creating a website (this is a burden on which the 

Commission is soliciting comments).

691See proposed Exhibits A and B of revised 

Form 1 and new Form 2.

frequent filing, would impose costs on 

exchanges and associations in terms of 

additional staff time dedicated to 

recordkeeping, the obtaining and 

compilation of data, annual preparation 

and internal review of revised Form 1 

and new Form 2, respectively, and 

periodic amendments to the applicable 

form. However, much of the required 

information should be readily available 

to the boards of exchanges and 

associations and management of these 

SROs, particularly with respect to 

matters relating to governance structure. 

The Commission anticipates, however, 

that an exchange or association would 

incur greater costs in the first year or 

two after adoption of the proposals than 

in subsequent years. This is in part 

because the exchange or association 

would incur costs as it becomes familiar 

with the new requirements and sets up 

the mechanisms and internal 

procedures to collect and provide the 

information required by the forms’

Exhibits, particularly the information 

relating to ownership of the exchange, 

association or a facility of either. Once 

these systems have been established, the 

Commission anticipates that the cost to 

maintain them would be relatively low. 

Under the proposed implementation 

schedule, the requirement that 

exchanges and associations that are 

registered with the Commission as of 

the publication date of adoption of any 

proposed amendments to the forms 

submit an initial complete revised Form 

1 or new Form 2 from within six months 

following such publication date also 

would impose a higher initial cost on 

such exchanges and associations in the 

first year after the adoption of the 

proposals. A registered exchange or 

association, whose fiscal year ends after 

the final date by which such initial 

complete revised Form 1 or new Form 

2, as applicable, must be submitted 

before the end of the calendar year in 

which such initial complete form is 

submitted, would incur higher costs in 

that first year because it also would be 

required to file an annual amendment in 

the same year as it submits the initial 

complete revised Form 1 or new Form 

2, as applicable. The Commission 

believes that this is a necessary and 

justified cost, however, in order to bring 

currently registered exchanges and 

associations into the disclosure process, 

as proposed to be revised. 

As discussed above in Section IX, 

Commission staff believes that 

exchanges and associations would incur 

some costs in gathering the 

documentation to comply with the 

proposed rule and form amendments. 

The Commission believes the initial 

paperwork burdens for an exchange or 

association filing an initial registration 

statement is estimated to be 157 hours 

per applicant. The yearly ongoing 

paperwork burdens for an exchange or 

association that has been approved for 

registration is estimated to be 48 hours 

per SRO. 

The Commission also believes that 

those exchanges and associations that 

are registered with the Commission as of 

the publication date of adoption of any 

proposed amendments to the forms, and 

thus would need to file a complete 

registration on revised Form 1 or new 

Form 2 no later than six months 

following such publication date would 

incur a paperwork burden of 157 hours 

per exchange or association for the 

complete revised Form 1 or new Form 

2, plus an additional 20 hours if an 

annual amendment is required within 

the same calendar year. The yearly 

ongoing paperwork burden for each 

such exchange or association would be 

48 hours. As a result, these exchanges 

and associations could have to file a 

completed registration form twice 

within a twelve month period. An 

exchange or association also would 

incur costs in the mailing of paper 

filings and copies to the Commission. 

The Commission estimates that the costs 

of mailing an initial application on 

revised Form 1 or new Form 2 would be 

$673.33 per exchange or association.686

The costs of filing a complete 

registration statement on revised Form 1 

or new Form 2 no later than six months 

following the final rules’ publication 

date is also estimated by the 

Commission to be $673.33 per exchange 

or association.687 The Commission 

estimates that the costs of mailing an 

amendment to revised Form 1 or new 

Form 2 would be $365.86 per exchange 

or association.688 We request comment 

on the costs associated with this 

implementation proposal.

As discussed in Section IX., for PRA 

purposes, the Commission estimates 

that total reporting and recordkeeping 

burden for an exchange that submits an 

initial registration or exemption 

application on the revised Form 1 

would be 157 hours and $673.33 per 

applicant.689 For exchanges that are 

already registered with the Commission, 

the estimated reporting and 

recordkeeping burden for filing a 

complete revised Form 1 and any 

requisite updating amendments for the 

first year in which the final rules’ are 

published would be 177 hours and 

approximately $1,039 per exchange. 

Thus, the Commission estimates that the 

total recordkeeping and reporting 

burden for all nine registered exchanges 

for the first year in which the final rules’

are published would be 1,593 hours and 

approximately $9,351. After the year in 

which an exchange initially files the 

revised Form 1, the Commission 

estimates that such exchange would 

bear an annual reporting and 

recordkeeping burden of 48 hours and 

$731.72, and that all exchanges would 

bear a total annual reporting and 

recordkeeping burden of 432 hours and 

approximately $6,585.

The Commission estimates that total 

reporting and recordkeeping burden for 

an association that submits an initial 

registration application on the new 

Form 2 would be 157 hours and $673.33 

per applicant.690 For associations that 

are already registered with the 

Commission, the estimated reporting 

and recordkeeping burden for filing a 

complete new Form 2 and any requisite 

updating amendments for the first year 

in which the final rules’ are published 

would be 177 hours and approximately 

$1,039 per association. Thus, the 

Commission estimates that the total 

recordkeeping and reporting burden for 

the one registered association for the 

first year in which the final rules’ are 

published would be 177 hours and 

approximately $1,039. After the year in 

which an association initially files the 

new Form 2, the Commission estimates 

that such association would bear an 

annual reporting and recordkeeping 

burden of 48 hours and $731.72.

Revised Form 1 and new Form 2 

would require that exchanges and 

associations provide copies of certain 

documents to the Commission. For 

example, exchanges and associations 

would be required to provide a copy of 

the constitution and other governing 

documents, and a copy of all written 

rulings and interpretations.691

Exchanges and associations also would 

be required to provide a copy of the 

written charter for each Standing 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71205

692See proposed Exhibit E of revised Form 1 and 

new Form 2.

693See proposed Exhibit F of revised Form 1 and 

new Form 2.

694See proposed Exhibit C of revised Form 1 and 

new Form 2.

695See proposed Exhibit H of revised Form 1 and 

new Form 2.

696See proposed Exhibit M of revised Form 1 and 

new Form 2.

697See proposed Exhibit N of revised Form 1 and 

new Form 2.

698See proposed Exhibit O of revised Form 1 and 

new Form 2.

699Moreover, as discussed below, the costs of 

filing some of the exhibits should be further 

reduced for exchanges and associations that choose 

to comply by posting specified Exhibits on an 

Internet Web site. See proposed Rules 6a–2(d) and 

15Aa–2(d).

700See proposed Exhibits E, G, and P of revised 

Form 1 and new Form 2.

701See proposed Exhibit I of revised Form 1 and 

new Form 2.

702See proposed Exhibits H and I of revised Form 

1 and new Form 2.

703See proposed Exhibit H to revised Form 1 and 

new Form 2.

704See proposed Exhibit I to revised Form 1 and 

new Form 2.

705See proposed Exhibit I to revised Form 1 and 

new Form 2.

Committee.692 In addition, exchanges 

and association would be required to 

submit a copy of the governance 

guidelines, code of conduct and 

ethics,693 and copy of the procedures for 

interested persons to communicate 

concerns regarding matters within the 

jurisdiction or authority of a Standing 

Committee to independent directors.694

Copies of delegation plans or other 

agreement relating to regulatory services 

provided to the exchange or 

association,695 membership 

applications,696 forms of financial 

statements, reports or questionnaires 

relating to financial responsibility or 

minimum capital requirements,697 and 

listing applications 698 also would be 

required to be provided on revised Form 

1 and new Form 2. The Commission 

believes that exchanges and associations 

already maintain these documents, and 

should only incur mailing costs, as 

discussed earlier.699 The Commission, 

however, requests comment on whether 

exchanges and associations currently 

retain such documents.

However, other Exhibits to Forms 1 

and 2 would require the exchange or 

association, respectively, to provide 

charts detailing aspects of its 

governance structure and internal 

organizational structure, as well as the 

relationship among the exchange, 

association, its facilities, and any 

affiliates.700 If the exchange or 

association currently does not prepare 

such charts, it would incur costs in 

preparing these charts. The exchange or 

association also must provide a table 

indicating the compensation of the five 

most highly compensated executives.701

The Commission does not expect that 

exchanges and associations would incur 

significant costs in preparing such 

charts or tables as this information is 

readily available to them. The 

Commission requests comment on the 

costs associated with the preparation of 

charts or tables in compliance with 

revised Form 1 and new Form 2.

Exchanges and associations also 

would be required to provide more 

detailed information regarding their 

regulatory programs, including revenues 

and expenditures related to those 

regulatory programs.702 Exhibit H to 

revised Form 1 and new Form 2 would 

require exchanges and associations to 

provide a description of all of their 

regulatory programs. Further, Exhibit H 

would require a description of the 

structural independence of the 

regulatory program from market 

operation and other commercial 

interests of the exchange or association. 

Exchanges and associations would be 

required to discuss any significant 

changes that are planned for their 

regulatory programs. In addition, each 

exchange and association would be 

required to discuss fully any significant 

regulatory issues that have arisen or any 

significant events that have taken place 

in the past year, that relate to or 

otherwise may affect the exchange’s or 

association’s regulatory responsibilities 

or the operation of its regulatory 

program. Exhibit H also would require 

exchanges and associations to discuss 

the effect that these significant issues or 

events may have on the mission, 

strategy, and future operations of the 

exchange’s or association’s regulatory 

program.703 An exchange or association 

would be likely to incur costs with 

regard to the description and discussion 

of the specified aspects of regulatory 

program that is necessary for 

compliance with proposed Exhibit H to 

revised Form 1 and new Form 2. The 

Commission requests comment on the 

costs of compliance with this proposal. 

The Commission further requests 

comment on whether the SRO would be 

likely to incur costs related to hiring 

and compensating outside counsel or 

consultants to aid in completing the 

description and discussion of specific 

aspects of the exchange’s or 

association’s regulatory program.

Revised Form 1 and new Form 2 

would require exchanges and 

associations to submit audited financial 

statements. This requirement is 

contained in the current Form 1 and the 

Commission believes that there should 

not be significant new costs associated 

with providing audited financial 

statements. The Commission requests 

comment on the costs associated with 

the preparation and filing of audited 

financial statements in accordance with 

revised Form 1 and new Form 2. 

Exchanges and associations would be 

required to disclose their regulatory 

expenses as a proportion of their total 

budget, and separately as a proportion 

of their total annual revenues. Pursuant 

to proposed Exhibit I to revised Form 1 

and new Form 2, exchanges and 

associations would be required to 

disclose the aggregate amounts that they 

expend on regulatory activities, as well 

as the amounts that they expend on 

certain subcategories of regulatory 

activities, including supervisory 

activities, surveillance activities, and 

disciplinary activities. Revised Form 1 

and new Form 2 also would require 

exchanges and associations to disclose 

the dollar amount of their revenues and 

expenses for each area (e.g., 

surveillance, supervision, and 

discipline) of their regulatory programs, 

with detailed itemization within the 

following broad categories: revenues; 

direct expenses; and allocated 

expenses.704 The Commission believes 

that the SROs currently track and 

maintain records of this financial 

information and that the costs of 

compliance with revised Form 1 and 

new Form 2 therefore would not be 

substantial. The Commission requests 

comment on the costs of compiling 

information about their regulatory 

revenues and expenses.

Exchanges and associations also 

would be required to provide an 

itemization of their non-regulatory 

expenditures, including, but not limited 

to, personnel expenses, program 

expenses, systems and other technology 

expenses, consultants and advisors, and 

overhead.705 The Commission believes 

that the SROs currently track and 

maintain records of this financial 

information and that the costs of 

compliance with revised Form 1 and 

new Form 2 therefore would not be 

substantial. The Commission requests 

comment on the costs of compiling 

information about their non-regulatory 

expenditures.

Exchanges and associations also 

would be required to disclose all 

charitable contributions of the exchange 

or association (whether made directly or 

indirectly) in excess of $1,000 to a 

charity in which an executive officer or 

director of the applicant, or any of their 

immediate family members, is an 

executive officer or director of the 

71206 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

706See id.

707See id.

708See id. 709See id. 710See proposed Rules 6a–2(d) and 15Aa–2(d).

charity.706 Exchange and associations 

would incur costs in obtaining this 

financial information. The Commission 

requests comment on the costs of 

compiling information about charitable 

contributions of the exchange or 

association. The Commission further 

requests comment on whether SROs 

currently obtain information about 

charitable contributions from officers, 

directors, and their immediate family 

members. Commenters also are asked to 

comment on the ease by which an SRO 

could obtain information regarding 

charitable contributions required to be 

disclosed on revised Form 1 and new 

Form 2.

Further, under proposed Exhibit I, the 

exchange or association would have to 

incorporate a discussion of any unusual 

or infrequent events or transactions or 

any significant economic changes that 

have had a material effect on the 

financial condition of the exchange or 

association, and any known demands, 

commitments, events or uncertainties 

that would result in or are reasonably 

likely to result in a material change in 

financial condition. Proposed Exhibit I 

also would require a description of any 

significant business development 

involving the exchange or association, 

including a reorganization, merger or 

consolidation, acquisition or disposition 

of significant assets, or any other 

material change in business or 

operations.707 An exchange or 

association is likely to incur costs with 

regard to the staff and board analysis 

and internal discussion of such events 

and changes that is necessary for 

compliance with proposed Exhibit I to 

revised Form 1 and new Form 2. The 

Commission requests comment on the 

costs of compliance with this proposal. 

The Commission further requests 

comment on whether the SRO would be 

likely to incur costs related to hiring 

and compensating outside counsel or 

consultants to aid in completing the 

requirements of proposed Exhibit I.

In addition, proposed Exhibit I would 

require exchanges and associations to 

describe all material contracts and all 

material related party transactions. 

Further, Exhibit I would require a 

description of the material 

commitments of the exchange or 

association for expenditures as of the 

end of the latest fiscal period, and 

indicate the general purpose of such 

commitments and the anticipated 

source of funds needed to fulfill such 

commitments.708 SROs would incur 

costs to track and maintain records of 

this financial information. The 

Commission requests comment on the 

costs of compiling information about 

their material contracts and material 

related party transactions. The 

Commission further requests comment 

on whether SROs currently maintain 

records of their material contracts and 

related party transactions, and, if not, 

the ease of with which an SRO could 

obtain such information.

Finally, proposed Exhibit I would 

require a description of the material 

terms of the employment agreements of 

the five most highly compensated 

executives of the exchange or 

association and would require the 

exchange or association to provide a 

description of the compensation 

provided to members of its board.709

The Commission believes that the SROs 

currently track and maintain records of 

their compensation agreements with 

executives and that the costs of 

compliance would therefore not be 

substantial. The Commission requests 

comment on the costs of compiling 

information about employment 

agreements with the five most highly 

compensated executives of the exchange 

or association.

Overall, the Commission requests 

comment as to the types of records 

exchanges and associations presently 

maintain with respect to their budgets, 

revenues, and expenses, and, in 

particular, the revenues and expenses 

associated with their regulatory 

programs. Further, the Commission 

recognizes that exchanges and 

associations, would incur costs in the 

first year or two in setting up the format 

for disclosing revenues and 

expenditures according to the categories 

set forth in proposed Exhibit I to Forms 

1 and 2, and in becoming familiar with 

the format. The Commission seeks 

comment on the costs that would be 

incurred by an exchange or association 

in preparing the proposed financial data 

contained in proposed Exhibit I 

according to the categories set forth 

therein. 

Proposed Exhibit Q to revised Form 1 

and new Form 2 would require the 

exchange or association to disclose 

detailed information regarding direct 

and indirect significant (more than 5%) 

owners of the exchange or association or 

a facility thereof. Although an exchange 

or association may already collect or 

have access to some of this information, 

it is likely that it would incur costs 

associated with putting in place a 

process to obtain more detailed 

information, both in terms of the type of 

ownership information (e.g., number of 

shares, contracts relating to ownership) 

and the scope of persons whose 

ownership interest must be aggregated 

together (e.g., a person’s interest must be 

aggregated with any of its ‘‘related 

persons’’ ‘‘its affiliates, associated 

persons, and immediate family 

members). Facilities of the exchange or 

association also may incur costs 

associated with obtaining and providing 

ownership information to the exchange 

or association. The Commission believes 

that these costs would likely be more in 

the first year or two as the exchange, 

association or facility becomes familiar 

with the process, but recognizes that 

there would be ongoing costs to 

continually obtain this information. The 

Commission requests comment on the 

accuracy of this view and on the 

specific costs of obtaining and providing 

such detailed ownership information 

pursuant to revised Form 1 and new 

Form 2. The Commission further 

requests comment on the ease or 

difficulty an SRO would encounter to 

obtain all the information required to be 

disclosed by proposed Exhibit Q, 

including information regarding related 

persons. In addition, commenters are 

requested to provide information on 

costs associated with monitoring 

ownership on an on-going basis, 

including whether exchanges and 

associations would have to file a 

proposed rule change with the 

Commission to make changes to their 

rules to allow them to request this 

information from their or a facility’s 

owners. 

The Commission proposes to more 

closely align the disclosure 

requirements for exchanges and 

associations. Currently, associations are 

not required to provide the same kind 

of information as exchanges. As a result 

of the proposed revisions that would 

require associations to disclose 

information in a format that is 

comparable to the one currently used by 

exchanges, associations likely would 

incur greater costs to comply with the 

disclosure requirements of new Form 2 

than exchanges would face in 

complying with revised Form 1. The 

Commission requests comment on the 

costs of requiring more uniform 

registration forms for exchanges and 

associations. 

With limited exceptions,710 revised 

Form 1 or new Form 2, and all 

subsequent amendments thereto, would 

be required to be filed in paper format 

with the Commission, as well as posted 

on a publicly accessible Internet Web 

site controlled by the exchange or 

association. The exchanges registered 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71207

711See supra note 546 and accompanying text.

712These proposed Exhibits to revised Form 1 

and new Form 2 would require disclosure of: 

governance documents and rules (Exhibit A); 

written rulings and interpretations (Exhibit B); 

membership forms (Exhibit M); documents relating 

of financial responsibility or minimum capital 

requirements (Exhibit N); list of members and other 

users (Exhibit S); securities listed and traded 

(Exhibit T); and certain information regarding the 

manner of operation of an SRO trading facility 

(Items 1–7 of Exhibit L).

713 15 U.S.C. 78q(a).

714 17 CFR 240.17a–1. See supra Section IV.C.11 

for a discussion of the proposed change to Rule 

17a–1.

715 15 U.S.C. 78q.

716 15 U.S.C. 78f(g).

717 15 U.S.C. 78o–3(k)(l).

718See proposed Rule 17a–26(b)(2).

under Section 6(a) of the Exchange Act 

and the only association registered 

under Section 15A(a) of the Exchange 

Act, the NASD, all currently maintain 

publicly accessible Internet Web 

sites.711 Therefore, each exchange and 

association should incur minimal costs 

in updating their Internet Web sites to 

meet the proposed requirements. The 

Commission seeks comment on these 

costs.

The Commission recognizes that 

certain exhibits require information that 

changes frequently; in addition, the 

paper involved to prepare those Exhibits 

could be voluminous. For that reason, 

the proposed rules provide that with 

respect to Exhibits A, B, M, N, S, or T, 

or Items 1–7 of Exhibit L,712 of revised 

Form 1 and new Form 2, an exchange 

or association, in lieu of filing such 

information on paper, would be 

required only to identify the Internet 

Web site it controls where such 

information is available continuously 

and to certify to the accuracy of such 

information as of the date of filing. The 

Commission, in the future, may 

consider the feasibility of eliminating 

the paper filing requirement and 

permitting the forms and exhibits to be 

posted on an Internet Web site 

controlled by the SRO, filed 

electronically with the Commission or 

through some other means. The 

Commission seeks comment on these 

costs.

3. Request for Comment 

The Commission requests data to 

quantify the costs and benefits 

associated with its proposals to improve 

SRO transparency and provide for 

uniform regulatory treatment of 

exchanges and associations. The 

Commission seeks estimates of these 

costs and benefits, as well as any costs 

and benefits not already defined, which 

may result from the adoption of these 

proposed amendments to Rule 6a–2, 

new Rule 15Aa–1, revised Form 1, and 

new Form 2, along with the proposed 

repeal of Forms X–15AJ–1 and X–15AJ–

2. Commenters are requested to provide 

empirical data and other factual support 

for their views to the extent possible. 

D. Costs and Benefits of Proposed 

Amendments to Rule 17a–1

The proposed change to Rule 17a–1 

would require national securities 

exchanges, national securities 

associations, registered clearing 

agencies and the Municipal Securities 

Rulemaking Board to keep in the United 

States at least one copy of all documents 

required to be kept by Section 17(a) 713

of the Exchange Act and Rule 17a–1 

thereunder.714

1. Benefits 

While the Commission believes that 

in practice SROs subject to Rule 17a–2 

currently keep copies of all documents 

in the United States, the Commission is 

concerned that, given the globalization 

of the securities markets and the trend 

of SROs to demutualize, there is a 

greater potential that an SRO may be 

owned by a non-U.S. entity. By 

proposing to require that at least one 

copy of each document is kept in the 

United States, such documents should 

be more readily accessible for 

inspection and examination by the 

Commission pursuant to Section 17 of 

the Exchange Act,715 thus increasing the 

efficiency and effectiveness of 

Commission examinations and aiding 

the Commission’s ability carry out its 

oversight responsibilities. The 

Commission seeks comment on any 

additional benefits of the proposed 

changes to Rule 17a–1.

2. Costs 

The Commission preliminarily 

believes that the proposed changes to 

Rule 17a–1 would impose minimal 

costs, if any, on national securities 

exchanges, national securities 

associations, registered clearing 

agencies and the Municipal Securities 

Rulemaking Board. The Commission 

believes that the proposed changes to 

Rule 17a–1 would reflect the current 

practice of these entities to keep at least 

one copy of their documents in the 

United States. To the extent one of these 

entities currently keeps its documents 

outside the United States, the 

Commission preliminarily believes that 

any storage and staff costs incurred in 

keeping the documents in the United 

States would be at least partially off-set 

by the reduction in storage and staff 

costs of keeping the documents outside 

of the United States. The Commission 

recognizes, however, that such SRO may 

incur costs to maintain duplicate sets of 

books and records. 

3. Request for Comment 

The Commission seeks comment on 

whether there are any additional costs 

of the proposed change to Rule 17a–1, 

including specifics of the dollar amount 

of such cost impact, and whether any 

national securities exchanges, national 

securities associations, registered 

clearing agencies or the Municipal 

Securities Rulemaking Board currently 

keeps documents solely outside of the 

United States. The Commission also 

requests comment on any additional 

benefits associated with the proposed 

change to Rule 17a–1.

E. Costs and Benefits of Proposed Rule 

17a–26

The Commission proposes to adopt 

new Rule 17a–26 under the Exchange 

Act, which would require every national 

securities exchange and registered 

securities association, other than a 

national securities exchange registered 

pursuant to Section 6(g) of the Exchange 

Act 716 and a limited purpose national 

securities association registered 

pursuant to Section 15A(k)(l) of the 

Exchange Act,717 to file with the 

Commission, on a quarterly and annual 

basis, reports that contain the 

information specified by the rule. The 

reports would be submitted 

electronically. Proposed Rule 17a–26 

would require exchanges and 

associations to establish procedures for 

the preparation of the required reports 

in a uniform, readily accessible, and 

usable electronic format.

The quarterly reports would include 

information with respect to an 

exchange’s or association’s surveillance 

program; complaints received; 

investigations, examinations, and 

enforcement cases; and listings 

information; as well as copies of final 

agenda from any board or board 

committee meeting that took place 

during the quarter.718 The annual report 

would contain: (1) An aggregated yearend cumulative summary of specified 

categories of information regarding the 

SRO’s regulatory program in the 

quarterly reports; (2) additional updated 

information on all items that are 

required to be part of the annual report, 

including a discussion of regulatory 

program procedures, the effectiveness of 

the regulatory program, internal controls 

addressing conflicts of interest, 

employment arrangements with senior 

regulatory personnel, efforts to comply 

71208 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

719See proposed Rule 17a–26(a)(2) and (b)(3). The 

term ‘‘electronic SRO trading facility’’ would be 

defined as a facility of an exchange or association 

that executes orders in securities on an electronic 

basis. See proposed Rule 17a–26 (j)(3).

720See proposed Rule 17a–26(d)(1).

721The Commission estimates that an average 

filing will weigh two ounces, accounting for a 

diskette and accompanying letter, and will be 

mailed via first class mail at a rate of $0.37 for the 

first ounce and $0.23 for the additional ounce, for 

a total of $0.60 per filing. At four quarterly reports, 

one annual report, and an estimated five interim 

supplements, the Commission expects that each 

exchange or association would incur a cost of $6 

to comply with the proposed rule. The Commission 

solicits comments on the accuracy of this estimate.

with undertakings made to the 

Commission, and copies of the proposed 

Standing Committee self-evaluations 

and the annual governance performance 

evaluation prepared by the Governance 

Committee; and (3) an independent 

audit of any electronic SRO trading 

facility.719 Finally, exchanges and 

associations would be required to file a 

supplement under certain 

circumstances in order to provide 

information concerning material 

changes or material events that affect 

the SRO’s regulatory program.720

1. Benefits 

Proposed new Rule 17a–26 is 

intended to enhance the Commission’s 

ability to monitor national securities 

exchanges’ and registered securities 

associations’ compliance with their selfregulatory responsibilities, particularly 

during the period between inspections 

by the Commission. The reports filed by 

these SROs would enable the 

Commission to monitor, on a routine 

basis, key aspects of the exchanges’ and 

associations’ regulatory programs; assess 

the SROs’ responses to critical issues 

affecting them; and better target the 

Commission’s inspection resources. 

Moreover, analysis of information 

provided in the reports should aid the 

Commission and SROs in the regulation 

and evaluation of other regulated 

entities, such as brokers and dealers. By 

utilizing the information in the reports, 

the Commission and SROs would better 

be able to target their resources to adopt 

rules to deter violative behavior, or to 

remove regulation that may be 

unnecessary. 

The Commission also would be able 

to use the reports to identify compliance 

trends within and among the exchanges 

and associations, including trends in 

exception reports and enforcement 

activities. The quarterly and annual 

reports would allow the Commission to 

monitor for developments, both within 

a given exchange or association and 

among the various exchanges and 

associations, upon which the 

Commission may be required to act. 

Thus, proposed Rule 17a–26 would 

assist the Commission in its efforts to 

stay abreast of new developments and 

challenges affecting exchanges and 

associations, their regulatory programs, 

their members and investors, and would 

permit the Commission and its staff to 

better identify, on a more 

contemporaneous basis, issues that 

warrant further investigation or 

immediate attention. The proposed rule 

also would assist the Commission by 

allowing it to utilize its inspection staff 

and resources more effectively. 

The Commission also believes that 

proposed Rule 17a–26 would provide 

benefits to exchanges and associations. 

The proposed rule should have a 

positive effect on exchange and 

association compliance practices. For 

example, the requirement that 

exchanges and associations obtain an 

annual audit of the operations of any of 

their electronic SRO trading facilities 

would help assure that such facilities 

are operated in compliance with all 

applicable legal and regulatory 

requirements. Given the technological 

and operational complexity of many 

electronic SRO trading facilities, the 

annual audit could help to ensure the 

integrity of these systems in practice 

with respect to their proper functioning 

and regulatory compliance. The 

Commission would be able to use such 

information in monitoring SRO 

compliance with Exchange Act rules 

and regulations, and SROs could be 

encouraged to take action on their own 

initiative to address any regulatory 

concerns raised by such audit. 

In addition, the proposed rule would 

require exchanges and associations to 

review, on at least a quarterly basis, the 

operation and performance of their 

regulatory programs. In summarizing 

material and preparing the reports 

required under the proposed rule, 

exchanges and associations would 

benefit by the opportunity to review on 

a quarterly basis the strengths and 

weaknesses of their regulatory 

programs. Exchanges and associations 

could use the reports to track 

surveillance and enforcement trends 

within their regulatory programs, as 

well as monitor trends in complaints 

received regarding the operation of their 

regulatory programs. The Commission 

expects that the reporting requirements 

should help exchanges and associations 

identify potential weaknesses in their 

compliance practices and surveillance 

programs, allowing them to update and 

strengthen their regulatory programs as 

needed. 

The Commission also expects that 

proposed Rule 17a–26 would encourage 

exchanges and associations to stress the 

importance of an active, top-quality 

compliance program, including 

thorough and diligent surveillance and 

enforcement, to their members and to 

their listed issuers, as well as to the 

senior management of the exchange or 

association. The annual and quarterly 

reports also would be a useful tool to 

allow the board of the exchange or 

association, as well as management, to 

monitor the operation of the exchange’s 

or association’s regulatory program over 

time. Finally, knowledge that SROs are 

submitting reports on a periodic basis to 

the Commission on their regulatory 

programs should contribute to an 

increased confidence by investors, 

issuers, and other market participants in 

the market as a whole. 

2. Costs 

Proposed Rule 17a–26 would require 

national securities exchanges and 

registered securities associations to file 

quarterly and annual reports with the 

Commission. As discussed above in 

Section IX., the Commission believes 

that exchanges and associations would 

incur costs to comply with the proposed 

rule. In particular, based on information 

available to the Commission at this 

time, the Commission estimates that 

each national securities exchange and 

registered securities association would 

incur an average burden of 40 hours to 

prepare each quarterly report and 35 

hours to prepare each annual report 

required by the proposed rule, for an 

annual burden of 195 hours per 

respondent. Accounting for nine 

national securities exchanges and one 

registered securities association, the 

total burden to comply with the 

quarterly and annual reporting 

requirements in proposed new Rule 

17a–26 is therefore estimated to be 

1,950 hours per year. Further, for 

purposes of this release, the 

Commission estimates that an exchange 

or association would incur a burden of 

4 hours to prepare each interim 

updating amendment, which would 

likely be required, on average, 5 times 

per year for a total of 20 hours per 

respondent and 200 hours total for the 

nine exchanges and one association. 

Accordingly, as discussed above in 

Section IX., the total burden resulting 

from the proposed rule’s quarterly and 

annual reporting provisions would be 

2,150 hours and $60 721 to prepare and 

file with the Commission each report 

and interim supplement.

The Commission notes that some 

exchanges and associations could need 

to hire additional staff to comply with 

the requirements of the proposed rule. 

Whether an exchange or association 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71209

722The estimate assumes that the report will be 

prepared by an independent accounting firm or 

similar entity for the exchange or association at an 

estimated cost of $150 per hour, based on an hourly 

estimate for auditing services obtained from 

industry sources. The Commission requests 

comment on this estimate, and on what type of 

entity an exchange or association may hire to 

prepare this report.

would need to hire additional staff to 

gather information and prepare the 

required reports would depend on the 

thoroughness and effectiveness of an 

exchange’s or association’s current 

recordkeeping systems and practices, 

the level and extent of regulatory 

activity subject to quarterly reporting 

(e.g., an exchange that experiences 

unusually heavy enforcement activity or 

has highly active listings activity could 

incur a greater reporting burden), and 

the current workloads of existing staff. 

The Commission expects that most 

exchanges and associations, in fulfilling 

their self-regulatory and recordkeeping 

requirements, are currently collecting 

most, if not all, of the information 

required to be reported under the 

proposed rule. Based on conversations 

with two of the larger SROs, the 

Commission understands that much of 

the information required by the 

proposed rule, in particular with respect 

to the quarterly reports, currently is 

maintained by those SROs. Specifically, 

the information that would be required 

to appear in the quarterly reports, 

including the results of surveillance 

programs; information on complaints 

received; information on investigations 

and examinations; information on 

enforcement cases; information on new 

listings, delistings, and alleged failures 

to satisfy listing standards; and board 

and board committee agenda, generally 

is retained by those SROs in varying 

formats. Accordingly, the primary cost 

to those SROs with respect to the 

information they currently retain would 

be in assembling that information into 

an electronic report for submission to 

the Commission. Thus, a primary 

burden on an exchange or association 

would be to prepare a consolidated 

electronic report containing all of the 

information proposed to be required, to 

the extent that it is not doing so already 

as part of its routine business practices. 

The Commission seeks comment on 

these costs. The Commission also 

requests comment on the extent to 

which exchanges and associations 

currently maintain this information in 

electronic format.

The required annual reports would 

require exchanges and associations to 

aggregate information contained in the 

quarterly reports to be submitted as part 

of the annual report; however, the 

Commission expects that those costs 

would not be substantial. Given the 

proposed electronic nature of the 

quarterly reports, the Commission 

would expect that it would not be a 

costly or complicated task for an SRO to 

aggregate the quarterly information and 

incorporate the data into the proposed 

annual report. The Commission requests 

comment on the costs of compiling the 

data and preparing the proposed annual 

report. Exchanges and associations 

should comment on whether such 

reports would be prepared in-house or 

by outside counsel or advisors. 

Comment is also requested on whether 

exchanges and associations would 

expect to purchase software or hardware 

to aid in the preparation of the proposed 

annual reports. 

The Commission believes that 

exchanges and associations would incur 

costs related to the proposed 

requirement to include in the annual 

report an audit of any electronic SRO 

trading facility, which must be prepared 

by an independent third party. The 

purpose of this audit is to assess 

whether the operations of the electronic 

SRO trading facility comply with the 

rules governing the facility. Because the 

exchange or association would need to 

hire an independent third party to 

conduct this annual audit, it would 

incur ongoing yearly costs to comply 

with this requirement. As discussed 

above in Section IX., the Commission 

estimates that nine national securities 

exchanges and one registered securities 

association would be required to obtain 

and submit as part of the annual report, 

an annual audit of any electronic SRO 

trading facility, and each such exchange 

or association owning, operating, or 

sponsoring at least one such facility 

would spend approximately 15 hours 

interacting with the third party with 

respect to their conduct of the audit and 

preparation of the audit report and 20 

hours reviewing each audit report 

received from the third party, for a total 

of 35 hours per exchange or association 

per year, for a total annual reporting and 

recordkeeping burden of 350 hours. 

With respect to the third-party auditor, 

the Commission estimates that it would 

take each third party 100 hours to 

conduct the audit and prepare the audit 

report for each exchange or association 

that owns, operates, or sponsors at least 

one electronic SRO trading facility, for 

a total annual cost per exchange or 

association of $15,000,722 resulting in a 

total annual burden cost of $150,000. 

The Commission requests comment on 

the expected costs of hiring an 

independent third-party to conduct the 

proposed annual audit. Exchanges and 

associations should comment as to 

whether they currently use the services 

of an independent third party to audit 

their operations and what type of 

business the third party is primarily 

engaged in (e.g., legal, consultant, 

financial). The Commission notes, 

however, that certain other annual 

report requirements, such as the 

discussion of internal controls and the 

discussion of the processes for carrying 

out regulatory responsibilities, should 

not impose significant costs on 

exchanges and associations.

Further, the Commission believes that 

exchanges and associations would incur 

initial start-up costs as part of the 

proposed rule. Exchanges and 

associations would be required to 

establish procedures for a uniform, 

readily accessible, electronic format for 

the required data. While these SROs 

would incur start-up costs in 

establishing these procedures, the 

Commission does not believe that these 

start-up costs would be significant. As 

stated above in Section IX., the 

Commission estimates that each 

exchange or association would spend 

approximately 35 hours during the 

initial year of the proposed rule’s 

effectiveness to establish procedures for 

the preparation of the reports required 

by the proposed rule in a uniform, 

readily accessible, and usable electronic 

format. Accounting for nine national 

securities exchanges and one registered 

securities association, the total burden 

per year to comply with the provision 

in proposed Rule 17a–26 regarding the 

uniform format for the quarterly and 

annual reports is estimated to be 350 

hours. The Commission seeks comment 

on these costs. 

3. Request for Comment 

The Commission requests data to 

quantify the costs and benefits of 

proposed Rule 17a–26. The Commission 

seeks estimates of these costs and 

benefits, as well as any costs and 

benefits not discussed above, that may 

result from the adoption of this 

proposed rule. Commenters are 

requested to provide empirical data and 

other factual support for their views to 

the extent possible. The Commission 

specifically requests comment on the 

costs and benefits associated with the 

Commission’s proposal to require 

periodic regulatory reports from 

exchanges and associations, including 

both start-up costs and annual ongoing 

compliance costs. The Commission also 

specifically requests comment on the 

costs and benefits of obtaining the 

report of an independent third party 

relating to the annual review of the 

71210 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

723See supra Section VI. for a discussion of the 

proposed rule.

724For example, members may monitor their 

ownership interests to prevent and monitor 

conflicts of interests and for supervision and 

compliance purposes.

725The Commission preliminarily believes that 

most, if not all, members require their associated 

persons to report their securities transactions and 

holdings to the member. See, e.g., NASD Rule 3050. 

Thus, the member could incorporate this 

information into its system for tracking ownership 

as would be required by proposed Rule 17a–27.

726 15 U.S.C. 78l.

727 17 CFR 240.13d–1 through 13d–7.

728 17 CFR 240.13d–101 or 240.13d–102.

729 15 U.S.C. 78l.

operations of an electronic SRO trading 

facility. 

F. Costs and Benefits of Proposed Rule 

17a–27

Proposed Rule 17a–27 would require 

any member of an exchange or 

association that is a broker or dealer to 

provide a report to the Commission and 

the exchange or association of which it 

is a member when it, alone or together 

with its related persons, acquires, 

directly or indirectly, more than 5% of 

any class of securities or other 

ownership interest of such exchange, 

association, or of a facility of such 

exchange or association through which 

it is permitted to effect transactions.723

1. Benefits 

As discussed above, a member of an 

exchange or association that is a broker 

or dealer and that owns a significant 

interest in such exchange, association, 

or a facility thereof potentially could 

control or influence the regulatory 

process and market operations of the 

exchange or association to its benefit. 

Requiring such members to furnish a 

statement to the Commission, and a 

copy of the statement to the SRO, 

describing their ownership interests in 

an exchange, association or facility, 

along with information regarding the 

member’s ability to influence the 

management of the exchange or 

association, would help guard against 

any potential abuses of influence or 

control of the SRO’s regulatory authority 

by alerting the Commission and the 

applicable exchange or association to 

accumulations of significant ownership 

interests by its members that are brokers 

or dealers. Providing information to the 

Commission on accumulations of 

interest by these members would 

facilitate the SRO’s ability to effectively 

perform its regulatory obligations, and 

the Commission’s ability to effectively 

carry out its statutory oversight 

responsibilities with respect to the 

exchange or association, by allowing the 

Commission and the applicable 

exchange or association to more easily 

monitor for accumulations of significant 

interests, to monitor the effects of such 

ownership, and to monitor the ability of 

a person or group of related persons to 

influence the operation of the exchange, 

association, or facility. 

Moreover, providing copies of the 

statement to the applicable exchange or 

association for which ownership 

information is provided would facilitate 

the exchange’s or association’s ability to 

monitor whether the ownership 

interests of its members that are brokers 

or dealers are in compliance with the 

proposed limits on broker-dealer 

members’ ownership in and voting of 

interests in the SRO or its facilities. In 

addition, proposed Rule 17a–27 would 

assist exchanges and associations in 

complying with the proposed 

requirement of Exhibit Q to revised 

Form 1 and new Form 2 that would 

require exchanges and associations to 

provide disclosure to the Commission 

regarding any person that owns more 

than 5% of the exchange, association, or 

a facility thereof.

2. Costs 

The Commission recognizes that the 

proposed rule would impose costs on 

members that are brokers or dealers to 

track, calculate, and report ownership of 

more than 5% in an exchange or 

association of which it is a member or 

of a facility of an exchange or 

association through which it is 

permitted to effect transactions. The 

Commission preliminarily believes that, 

given the nature of their business, most 

members that are brokers or dealers 

currently have in place systems to track 

their ownership (and that of their 

affiliates) of securities, even for 

securities for which there is no 

reporting requirement under Sections 

13(d) or 13(g) of the Exchange Act, but 

specifically requests comment on this 

issue.724 The proposed rule likely 

would, however, require these members 

to make modifications to their systems 

and procedures to obtain additional 

ownership information for ‘‘related 

persons’’ for which they might not 

already obtain such information. For 

instance, the definition of ‘‘related 

person’’ includes immediate family 

members of the member (if such 

member is a natural person) and of a 

person associated with a member.725

The Commission notes that if the 

exchange, association, or facility is a 

public reporting company under Section 

12 of the Exchange Act,726 members of 

the exchange or facility are required 

under Regulation 13D under the 

Exchange Act 727 to monitor their 

ownership interests in such entity and 

to file a Schedule 13D or 13G if they 

exceed the 5% reporting threshold.728

However, because the scope of the 

reporting requirement of proposed Rule 

17a–27 is broader than what is required 

by Schedule 13D and 13G, members 

may incur additional costs to comply 

with the proposed rule. In addition, for 

exchanges, associations or facilities that 

are not public reporting companies 

under Section 12 of the Exchange 

Act,729 the member likely would incur 

greater costs to comply with proposed 

Rule 17a–27 because such members 

currently are not required to monitor 

their ownership interests in those 

entities. The Commission requests 

comment on the costs associated with 

obtaining and calculating ownership 

information under the proposed rule.

A member of an exchange or 

association that is a broker or dealer and 

that exceeds the reporting threshold also 

would incur costs to prepare and file the 

statement required by proposed Rule 

17a–27. Such members would incur inhouse legal, compliance and 

administrative costs associated with 

preparing and filing the initial report 

and periodic amendments in the event 

of an increase or decrease of more than 

1% of the ownership interest last 

reported. The members also may incur 

outside legal costs associated with 

preparing these reports; although the 

Commission preliminarily believes that 

preparation of the report likely would 

not be outsourced, the Commission 

requests comment on this issue. As 

discussed above in Section IX., the 

Commission estimates that a member 

would spend approximately 35 hours to 

prepare and file the initial report, 2 

hours and $1.29 to prepare and send a 

copy of the report or any amendment to 

the exchange or association and 10 

hours to prepare and file any 

amendment, resulting in a total initial 

annual burden for all members of 4,700 

hours and $258, and 1,200 hours and 

$258 annually thereafter. Additionally, 

the Commission estimates that each 

exchange or association would spend 4 

hours to post a member’s report on its 

Web site, resulting in a total annual 

burden of 400 hours for all exchanges 

and associations. 

3. Request for Comment 

The Commission requests comment 

on whether there are any additional 

costs of the proposed Rule 17a–27. The 

Commission also requests comment on 

quantifying the amount of time and the 

dollar amount of the costs discussed 

above and any additional costs, 

including the costs associated with 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71211

730 15 U.S.C. 78c(f).

731 15 U.S.C. 78w(a).

732 15 U.S.C. 78w(a)(2).

733Pub. L. 104–121, Title II, 110 Stat. 857 (1996) 

(codified in various sections of 5 U.S.C., 15 U.S.C., 

and as a note to 5 U.S.C. 601).

tracking and reporting ownership 

interests pursuant to the proposed rule. 

The Commission also seeks comment on 

any additional benefits of the proposed 

Rule 17a–27. 

XI. Consideration of Burden on 

Competition, and Promotion of 

Efficiency, Competition, and Capital 

Formation 

Section 3(f) of the Exchange Act 

requires the Commission, whenever it 

engages in rulemaking or in the review 

of a rule of an SRO, and it is required 

to consider or determine whether an 

action is necessary or appropriate in the 

public interest, to consider, in addition 

to the protection of investors, whether 

the action will promote efficiency, 

competition, and capital formation.730

Section 23(a)(2) of the Exchange Act 731

requires the Commission, in adopting 

rules under the Exchange Act, to 

consider the impact that any such rules 

would have on competition. Section 

23(a)(2) also prohibits the Commission 

from adopting any rule that would 

impose a burden on competition not 

necessary or appropriate in furtherance 

of the purposes of the Exchange Act.732

The Commission has considered the 

proposed rules in light of these 

standards and preliminarily believes 

that they will not impose a burden on 

competition not necessary or 

appropriate in furtherance of the 

purposes of the Exchange Act. In 

addition, the Commission believes that 

the proposed governance rules should 

have a beneficial impact on efficiency, 

competition, and capital formation. In 

particular, proposed Exchange Act 

Rules 6a–5 and 15Aa–3 are designed to 

strengthen the independence of SROs’

governance and regulatory processes by 

enhancing the independence and 

effectiveness of exchange and 

association boards and those board 

committees. Moreover, the 

independence of exchanges’ and 

associations’ regulatory programs 

should be strengthened by the proposal 

to require the separation of their 

regulatory programs from their market 

operations and other commercial 

interests, as well as by the prohibition 

on using regulatory funds for nonregulatory purposes and the prohibition 

on using regulatory information for 

competitive purposes. Further, the 

proposed limitations on ownership and 

voting should help prevent members of 

an exchange or association that are 

brokers or dealers from being able to 

influence the operation of the exchange 

or association and the performance of its 

regulatory function in a manner 

detrimental to its competitors or in a 

manner favorable to such person or its 

affiliates. Overall, these requirements 

would help prevent an exchange or 

association from disregarding the 

regulatory process, and should help 

bolster investors’ confidence in the 

entities that oversee and operate our 

nation’s securities markets. Similarly, 

the Commission believes that the 

disclosure requirements under proposed 

Exchange Act Rules 6a–2, 15Aa–1, 

15Aa–2 and the related Forms 1 and 2 

are appropriately tailored to provide the 

Commission and the public with 

important information about an 

exchange’s or association’s governance 

practices and regulatory programs. To 

the extent that the proposed rules would 

affect efficiency, competition, and 

capital formation, we believe that any 

effect would be positive because these 

proposals should help improve the 

transparency of exchanges and 

associations and thus increase investor 

confidence in the administration and 

operation of the securities markets. 

The Commission believes that the 

reporting requirements of proposed new 

Exchange Act Rule 17a–26 would not 

impose any unnecessary or 

inappropriate burden on competition 

because they would enhance the 

Commission’s ability to monitor 

exchanges’ and associations’

compliance with their regulatory 

responsibilities, particularly during the 

period between inspections by 

Commission staff. Further, proposed 

Rule 17a–26 should enable the 

Commission to deploy its inspection 

resources more efficiently and to 

monitor more effectively these SROs’

responses to critical issues affecting 

their markets. In addition, the 

Commission believes that, to the extent 

that there is any impact on efficiency, 

competition, and capital formation as a 

result of proposed Rule 17a–26, the 

result would be a positive one. The 

proposal is designed to require 

exchanges and associations to provide 

quarterly and annual information about 

key features of their regulatory 

programs, which in turn should 

heighten these SROs’ attention to their 

regulatory responsibilities under the 

Exchange Act as they prepare the 

required quarterly and annual reports. 

The proposed amendments to Rule 

17a–1 and proposed new Rule 17a–27 

should bolster investor confidence in 

the markets by helping to ensure that 

the Commission is able to carry out its 

oversight responsibilities over national 

securities exchanges and registered 

securities associations. In addition, 

proposed Regulation AL, by requiring 

notice and heightened reporting by an 

exchange or association to the 

Commission with respect to the 

exchange’s or association’s oversight of 

the listing and trading of the securities 

of an affiliated issuer, should help 

bolster investor confidence that the 

exchange or association is fairly and 

effectively carrying out its regulatory 

obligations with respect to the listing 

and trading of the affiliated security. 

By promoting investor confidence in 

the fairness and integrity of our markets, 

and in the entities that oversee and 

operate our securities markets, investors 

may be more willing to effect 

transactions in those markets, which in 

turn would help to increase liquidity 

and to foster the capital formation 

process. The Commission requests 

comment on whether the proposed rules 

are expected to affect efficiency, 

competition, and capital formation.

XII. Consideration of Impact on the 

Economy 

For purposes of the Small Business 

Regulatory Enforcement Fairness Act of 

1996, or ‘‘SBREFA,’’ 733 the Commission 

must advise the Office of Management 

and Budget as to whether proposed 

Exchange Act Rules 3b–19, 6a–5, 15Aa–

3, 17a–26, 17a–27, or Regulation AL; the 

proposed amendments to Form 1 under 

the Exchange Act, redesignated Form 2 

under the Exchange Act, Exchange Act 

Rules 6a–2, 15Aa–1 and 17a–1, or 

redesignated Exchange Act Rule 15Aa–

2; or the removal of Forms X–15AJ–1 

and X–15AJ–2 under the Exchange Act 

constitute a ‘‘major’’ rule. Under 

SBREFA, a rule is considered ‘‘major’’

where, if adopted, it results or is likely 

to result in:

• An annual effect on the economy of 

$100 million or more (either in the form 

of an increase or a decrease); 

• A major increase in costs or prices 

for consumers or individual industries; 

or 

• A significant adverse effect on 

competition, investment, or innovation. 

If a rule is ‘‘major,’’ its effectiveness 

will generally be delayed for 60 days 

pending Congressional review. We 

request comment on the potential 

impact of the proposed Exchange Act 

rules on the economy on an annual 

basis. Commenters are requested to 

provide empirical data and other factual 

support for their views to the extent 

possible. 

71212 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

734 5 U.S.C. 603(a).

735 5 U.S.C. 605(b).

736 5 U.S.C. 603.

737Pursuant to proposed Rule 17a–27(a)(13), the 

term ‘‘related person’’ would be defined to mean, 

with respect to any member that is a broker or 

dealer: (i) Any affiliate of the member; (ii) any 

person associated with the member; (iii) any 

immediate family member of such member, or any 

immediate family member of the member’s spouse, 

who, in each case, has the same home as the 

member or who is a director or officer of the 

disclosure entity or any of its parents or 

subsidiaries; and (iv) any immediate family member 

of the person associated with the member, or any 

immediate family member of that person’s spouse, 

who, in each case, has the same home as the person 

associated with the member or who is a director or 

officer of the disclosure entity or any of its parents 

or subsidiaries. Pursuant to proposed Rule 17a–

27(a)(6), the term ‘‘disclosure entity’’ would be 

defined to mean, with respect to any member: (i) 

A national securities exchange of which it is a 

member, other than an exchange registered 

pursuant to Section 6(g) of the Exchange Act; (ii) 

a registered securities association of which it is a 

member, other than a limited purpose national 

securities association registered pursuant to Section 

15A(K)(l) of the Exchange Act; and (iii) a facility of 

such national securities exchange or registered 

securities association through which it is permitted 

to effect transactions.

738See id.

739Based on the data in reports filed pursuant to 

Exchange Act Rule 17a–5, the Commission has 

determined that 906 of the 6,553 filers are ‘‘small 

entities.’’ Paragraph (c) of Rule 0–10 of the Act 

states that the term ‘‘small business,’’ when 

referring to a broker or dealer, means a broker or 

dealer that: (i) Had total capital (net worth plus 

subordinated liabilities) of less than $500,000 on 

the date in the prior fiscal year as of which its 

audited financial statements were prepared 

pursuant to 17 CFR 240.17a–5(d) or, if not required 

to file such statements, a broker or dealer that had 

total capital (net worth plus subordinated 

liabilities) of less than $500,000 on the last business 

day of the preceding fiscal year (or in the time that 

it has been in business, if shorter); and (ii) is not 

affiliated with any person (other than a natural 

person) that is not a small business or small 

organization as defined in Rule 0–10.

740 17 CFR 240.0–10(c)(1). See supra note 739.

741For example, there were 46,310,865 

outstanding shares of common stock of Archipelago 

Holdings, Inc. as of August 12, 2004 (see

Archipelago Holdings, Inc.’s prospectus dated 

August 12, 2004, filed with the Commission on 

August 12, 2004). Based on the closing price of 

$17.46 per share for Archipelago Holdings, Inc.’s 

common stock on November 3, 2004, 5% of the 

common stock of Archipelago Holdings, Inc. would 

be valued at approximately $43,886,461 (assuming 

the number of outstanding shares has not increased 

or decreased). There are 1,366 ‘‘seats’’ on the NYSE. 

These seats represent an ownership interest in the 

NYSE. Based on the last reported sale price of a 

NYSE seat on October 29, 2004 of $1,035,000 (see

NYSE’s Web site, www.nyse.com), a 5% ownership 

interest in the NYSE would be valued at 

approximately $70,690,500. Similarly, there are 

over 200 seats on the BSE. Assuming 200 seats and 

based on the last reported sale price of $5,000 on 

April 6, 2004 (see BSE’s Web site, 

‘‘www.bostonstock.com’’), a 5% ownership interest 

in the BSE would be valued at approximately 

$50,000. The Commission believes it unlikely that 

an entity with total capital of less than $500,000 

would be the holder of an ownership interest of 

such value or, if it did hold such interest, would 

not be affiliated with an entity (other than a natural 

person) that is not a small entity.

742For example, the Commission believes that the 

possibility of a small broker or dealer acquiring a 

5% interest in the BSE would be greater than the 

possibility of a small broker or dealer acquiring a 

5% interest in the NYSE.

743The Commission notes that, if any small 

entities are required to prepare and file reports 

pursuant to proposed Rule 17a–27, the Commission 

estimates that the rule would require: (i) 

approximately 35 hours per statement to prepare 

and file the initial statement pursuant to proposed 

Rule 17a–27(b), including the time required for a 

member to modify its system for monitoring 

ownership for purposes of preparing the statement; 

(ii) approximately 2 hours and $1.29 to prepare and 

send the copy of the statement or any amendment 

XIII. Regulatory Flexibility Act 

Certification 

Section 3(a) of the Regulatory 

Flexibility Act (‘‘RFA’’) 734 requires the 

Commission to undertake an Initial 

Regulatory Flexibility Analysis 

(‘‘IRFA’’) of the proposed rules and 

amendments on small entities unless 

the Commission certifies that the 

proposed rules and amendments, if 

adopted, would not have a significant 

economic impact on a substantial 

number of small entities.735 The 

Commission hereby certifies, pursuant 

to 5 U.S.C. 605(b), that the proposed 

Rules 3b–19, 6a–5, 15Aa–2, 15Aa–3, 

17a–26, and 17a–27, proposed 

Regulation AL, revised Rules 6a–2, 

15Aa–1, 17a–1, and revised Form 1 and 

new Form 2, if adopted, would not have 

a significant economic impact on a 

substantial number of small entities. 

Proposed Rules 3b–19, 6a–5, 15Aa–2, 

15Aa–3, and 17a–26, proposed 

Regulation AL, Section (d) of proposed 

Rule 17a–27, revised Rules 6a–2, 15Aa–

1, 17a–1, and revised Form 1 and new 

Form 2 would apply only to national 

securities exchanges, exchanges 

exempted from such registration based 

on limited volume, registered securities 

associations, or affiliated securities 

associations. Neither national securities 

exchanges, exchanges exempted from 

such registration based on limited 

volume, registered securities 

associations, nor affiliated securities 

associations, are considered ‘‘small 

entities’’ within the meaning of the 

Regulatory Flexibility Act.736

Accordingly, the Commission does not 

believe that proposed Rules 6a–5, 15Aa–

2, 15Aa–3, and 17a–26, proposed 

Regulation AL, revised Rules 6a–2, 

15Aa–1, 17a–1, and revised Form 1 and 

new Form 2 would have a significant 

economic impact on a substantial 

number of small entities.

Proposed Rules 17a–27(b) and (c) 

would apply to any member of an 

exchange or association that is a broker 

or dealer. The Commission 

preliminarily believes that proposed 

Rules 17a–27(b) and (c) would not have 

a significant economic impact on a 

substantial number of small entities. 

Proposed Rules 17a–27(b) and (c) would 

apply to any member of a national 

securities exchange or registered 

securities association that is a broker or 

dealer and that, alone or together with 

its ‘‘related persons,’’ 737 directly or 

indirectly beneficially owns more than 

5% of any class of securities or other 

ownership interest of such exchange or 

association, or a facility of an exchange 

or association. The Commission 

estimates there are approximately 6,800 

members of an exchange or association 

that are registered brokers or dealers, 738

of which approximately 906 are 

considered small entities. 739 Although 

the Commission does not have sufficient 

data to determine how many members 

that are brokers or dealers and are small 

entities have or would have, alone or 

together with their related persons, 

ownership interests that would trigger 

the requirements of proposed Rule 17a–

27, the Commission believes it is 

unlikely that any member that is a 

broker or dealer and is a small entity 

would trigger the 5% threshold, given 

the $500,000 capital limit a broker or 

dealer must not exceed to be considered 

a small entity. 740 Based upon 

information available to the 

Commission at this time, the 

Commission estimates that there are less 

than 20 brokers or dealers that would 

trigger the requirements of proposed 

Rules 17a–27(b) and (c), and that these 

brokers or dealers would not be 

considered small entities. The 

Commission requests comment on this 

estimate. Furthermore, because of the 

cost of acquiring 5% or more of the 

securities of or other ownership interest 

in an exchange, association or facility 

thereof, the Commission believes it is 

unlikely that any broker or dealer that 

is a small entity would acquire such a 

substantial interest. 741 Even if such a 

broker or dealer did acquire an interest 

in excess of 5%, 742 the Commission 

does not believe that a substantial 

number would do so, given the limited 

number of exchanges, associations and 

facilities, and the relatively high price of 

acquiring such an interest. 

Consequently, the Commission does not 

believe that a substantial number of 

small entities would be required to 

prepare and file reports with the 

Commission pursuant to proposed Rule 

17a–27. In addition, if a small broker or 

dealer did have to file a report with the 

Commission because it exceeded the 5% 

threshold, the Commission does not 

believe that the preparation and filing of 

that report would have a significant 

economic impact on the broker or 

dealer. 743

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71213

to the applicable exchange or association pursuant 

to proposed Rule 17a–27(c); and (iii) that each 

amendment required by proposed Rule 17a–27(b)(4) 

would require 10 hours per amendment. See supra

Section IX.G.4. for further discussion of the 

Commission’s estimates of the reporting and 

recordkeeping burden for proposed Rule 17a–27.

Even if a small broker or dealer did 

not trigger the 5% ownership threshold, 

it may feel the need to monitor 

ownership levels. The Commission 

believes that any system or other 

changes a small broker or dealer would 

need to make to monitor ownership 

interest would not cause a significant 

economic impact. The Commission 

believes that given the nature of their 

business, most members that are brokers 

or dealers, including those that are 

small entities, would have in place the 

necessary systems and procedures for 

tracking their ownership of securities, 

both for ownership of entities subject to 

reporting under Section 13(d) of the 

Exchange Act and for other entities as 

well. The Commission preliminarily 

believes that members could monitor 

their and their related persons’

ownership interests in exchanges, 

associations and facilities pursuant to 

these existing systems. The Commission 

does recognize, however, that members 

may need to update their systems to 

meet the scope of the reporting 

parameters of the proposed rule (for 

instance, to include all ‘‘related 

persons’’), but preliminarily does not 

believe that these changes would create 

a significant economic impact. In 

addition, a broker or dealer that is 

considered a small entity likely would 

have fewer ‘‘related persons’’ for which 

to track ownership. Therefore, the 

Commission does not believe that 

proposed Rule 17a–27 would have a 

‘‘significant economic impact’’ on a 

substantial number of small entities. 

The Commission encourages written 

comments regarding this certification. 

The Commission requests that 

commentators describe the nature of any 

impact on small entities and provide 

empirical data to support the extent of 

the impact. In particular, the 

Commission requests comments on (a) 

the number of small entities that would 

be affected by proposed Rule 17a–27; (b) 

the nature of any impact the by 

proposed Rule 17a–27 would have on 

small entities and empirical data 

supporting the extent of the impact; and 

(c) how to quantify the number of small 

entities that would be affected by or 

how to quantify the impact of by 

proposed Rule 17a–27. Commentators 

are asked to describe the nature of any 

impact and provide empirical data 

supporting the extent of the impact. 

Persons wishing to submit written 

comments should refer to the 

instructions for submitting comments in 

the front of this release.

XIV. Statutory Authority and Text of 

Proposed Rules 

Pursuant to the Exchange Act, 15 

U.S.C. 78a et seq., and particularly, 

Sections 3, 6, 11A, 15A, 17, 19, 23(a) 

and 36(a) thereof, the Commission is 

proposing to (1) adopt §§ 240.3b–19, 

240.6a–5, 240.15Aa–3, 240.17a–26, 

240.17a–27 and Regulation AL under 

the Exchange Act; (2) amend Form 1 

and §§ 240.6a–2, 240.15Aa–1 and 

240.17a–1 under the Exchange Act; (3) 

redesignate § 240.15Aj–1 under the 

Exchange Act as § 240.15Aa–2 and 

amend newly redesignated § 240.15Aa–

2; (4) redesignate Form X–15AA–1 as 

Form 2 and amend newly redesignated 

Form 2; and (5) remove Forms X–15AJ–

1 and X–15AJ–2.

List of Subjects in 17 CFR Parts 240, 

242 and 249

Brokers, Reporting and recordkeeping 

requirements, Securities.

For the reasons stated in the 

preamble, the Commission is proposing 

to amend Title 17, Chapter II of the 

Code of the Federal Regulations as 

follows:

PART 240—GENERAL RULES AND 

REGULATIONS, SECURITIES 

EXCHANGE ACT OF 1934

1. The general authority citation for 

part 240 is revised to read as follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 

77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, 

77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 78j, 

78j–1, 78k, 78k–1, 78l, 78m, 78n, 78o, 78o–

3, 78p, 78q, 78s, 78u–5, 78w, 78x, 78ll, 

78mm, 79q, 79t, 80a–20, 80a–23, 80a–29, 

80a–37, 80b–3, 80b–4, 80b–11, and 7201 et 

seq.; and 18 U.S.C. 1350, unless otherwise 

noted.

* * * * *

1. Section 240.3b–19 is added to read 

as follows:

§ 240.3b–19 Definition of rules of an 

exchange and rules of an association. 

(a) Definitions. The terms rules of an 

exchange and rules of an association

shall include the constitution, articles of 

incorporation, bylaws, and rules, or 

instruments corresponding to the 

foregoing, of a regulatory subsidiary of 

an exchange or of an association of 

brokers and dealers. 

(b) Exemptions. Upon written request 

or on its own motion, the Commission 

may grant an exemption from the 

provisions of this section, either 

unconditionally or on specified terms 

and conditions, if the Commission 

determines that such exemption is 

necessary or appropriate in the public 

interest and is consistent with the 

protection of investors. 

3. Section 240.6a–2 is amended by: 

a. Revising paragraphs (a)(2) and 

paragraphs (b) through (e), and 

b. Adding paragraph (a)(3) and new 

paragraph (g). 

The revisions and additions read as 

follows:

§ 240.6a–2 Amendments to application. 

(a) * * *

(2) Information filed as part of 

Exhibits C, D, E, H, I, J, K, M, N, O, P, 

S, or U and as part of Item 3 of Exhibit 

F or Items 1, 5, 6, and 7 of Exhibit Q, 

or any amendments thereto; or 

(3) Information filed as part of Items 

2 or 3 of Exhibit Q, or any amendment 

thereto, except that such information is 

not required to be filed with respect to 

any ownership change that is less than 

one percent from the ownership interest 

last reported on Form 1 (17 CFR 249.1), 

or any amendment thereto. 

(b) Within 60 days of the end of its 

fiscal year, a national securities 

exchange or an exchange exempted from 

such registration based on limited 

volume, must submit an amendment to 

its Form 1 that updates the Form 1 in 

its entirety. Each Exhibit to the 

amended Form 1 shall be up to date as 

of the end of the latest fiscal year of the 

exchange. 

(c) Except as set forth in paragraph (d) 

of this section, a national securities 

exchange or an exchange exempted from 

such registration based on limited 

volume, must continuously post any 

amendments required to be filed under 

paragraphs (a) and (b) of this section on 

a publicly-accessible Internet web site 

controlled by the exchange, 

simultaneous with the filing of such 

information in paper form with the 

Commission. Only the most recent 

annual amendment filed under 

paragraph (b) of this section and any 

subsequent updates filed under 

paragraph (a) of this section are required 

to be posted on such Internet Web site. 

In its filing with the Commission, such 

exchange shall: 

(1) Indicate the location of the 

Internet Web site where such 

information may be found; and 

(2) Certify that the information 

available at such location is accurate as 

of its date. 

(d)(1) If the information required to be 

filed under paragraphs (a) or (b) of this 

section for Exhibits A, B, M, N, S, or T 

or Items 1–7 of Exhibit L is available 

continuously on an Internet Web site 

controlled by an exchange, in lieu of 

filing such information in paper form 

71214 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

with the Commission, such exchange 

may: 

(i) Indicate the location of the Internet 

Web site where such information may 

be found; and 

(ii) Certify that the information 

available at such location is accurate as 

of its date. 

(2) Only the most recent annual 

amendment required under paragraph 

(b) of this section and any subsequent 

updates required under paragraph (a) of 

this section must be continuously 

posted on an Internet Web site 

controlled by an exchange under 

paragraph (d)(1) of this section. 

(e) Upon written request or on its own 

motion, the Commission may grant an 

exemption from any of the requirements 

of this section, either unconditionally or 

on specified terms and conditions, if the 

Commission determines that such 

exemption is necessary or appropriate 

in the public interest and is consistent 

with the protection of investors.

* * * * *

(g) A national securities exchange 

shall file as an amendment to Form 1 a 

complete new statement together with 

all exhibits which are prescribed to be 

filed in connection with Form 1 no later 

than [six months following the date of 

publication of final rules in the Federal 

Register].

* * * * *

4. Section 240.6a–5 is added to read 

as follows:

§ 240.6a–5 Fair administration and 

governance of national securities 

exchanges. 

(a) General. Each national securities 

exchange must comply with, and have 

rules that comply with, the provisions 

of this section, and must have the 

capacity to carry out the purposes of 

this section. If the national securities 

exchange has a regulatory subsidiary, 

the provisions of paragraphs (c), (d), (e), 

(f), (g), (h), (i), (j), (k), (l), (m), (n), (p) and 

(q) of this section shall apply to such 

regulatory subsidiary in the same 

manner as the national securities 

exchange; provided, however, that to the 

extent that a Standing Committee of the 

national securities exchange is 

authorized to carry out responsibilities 

on behalf of the regulatory subsidiary, as 

set forth in its written charter, the 

regulatory subsidiary shall not be 

required to have a Standing Committee 

that performs the same responsibilities 

and to the extent that the Chief 

Regulatory Officer of the national 

securities exchange performs the same 

responsibilities for the regulatory 

subsidiary as he or she does for the 

national securities exchange, the 

regulatory subsidiary shall not be 

required to appoint a Chief Regulatory 

Officer. When used in paragraphs (c), 

(d), (e), (f), (g), (h), (i), (j), (k), (l), (m), 

(n), (p) and (q) of this section, the terms 

‘‘exchange’’ shall also mean the 

regulatory subsidiary of the exchange; 

‘‘Board’’ shall also mean the Board of 

the regulatory subsidiary; ‘‘director’’ or 

‘‘directors’’ shall also mean the directors 

or directors of the regulatory subsidiary; 

‘‘independent director’’ or 

‘‘independent directors’’ shall also mean 

the independent director or 

independent directors of the regulatory 

subsidiary; ‘‘executive session’’ shall 

also mean executive session of the 

Board of the regulatory subsidiary; and 

‘‘Standing Committee’’ or ‘‘Standing 

Committees’’ shall also mean the 

Standing Committee or Standing 

Committees of the Board of the 

regulatory subsidiary. 

(b) Definitions. For purposes of this 

section, the following definitions shall 

apply: 

(1) The term affiliate means any 

person that, directly or indirectly, 

controls, is controlled by, or is under 

common control with, the national 

securities exchange. 

(2) The term affiliated issuer means 

the national securities exchange, an 

SRO trading facility of the national 

securities exchange, an affiliate of the 

national securities exchange, or an 

affiliate of an SRO trading facility of the 

national securities exchange. 

(3) The term affiliated security means 

any security issued by an affiliated 

issuer, except that it shall not include 

any option exempt from the Securities 

Act of 1933 under § 230.238 of this 

chapter and any security futures 

product exempt from the Securities Act 

of 1933 under section 3(a)(14) of the 

Securities Act of 1933 (15 U.S.C. 

77c(a)(14)). 

(4) The terms beneficial ownership, 

beneficially owns or any derivative 

thereof shall have the same meaning, 

with respect to any security or other 

ownership interest, as set forth in 

§ 240.13d–3, as if (and whether or not) 

such security or other ownership 

interest were a voting equity security 

registered under section 12 of the Act 

(15 U.S.C. 78l); provided that to the 

extent any person beneficially owns any 

security or other ownership interest 

solely because such person is a member 

of a group within the meaning of section 

13(d)(3) of the Act (15 U.S.C. 78m(d)(3)), 

such person shall not be deemed to 

beneficially own such security or other 

ownership interest for purposes of this 

section, unless such person has the 

power to direct the vote of such security 

or other ownership interest. 

(5) The term Board means the Board 

of Directors or Board of Governors of the 

national securities exchange, or any 

equivalent body. 

(6) The term compensation means any 

form of compensation and any material 

perquisites awarded, or that are to be 

awarded, whether or not set forth in any 

written documents, to any executive 

officer of the national securities 

exchange, including, without limitation, 

salary, bonus, pension, deferred 

compensation, compensation awarded 

pursuant to any incentive plan or 

equity-based plan, or any other plan, 

contract, authorization or arrangement 

pursuant to which cash or securities 

may be received. 

(7) The term control means the 

possession, direct or indirect, of the 

power to direct or cause the direction of 

the management and policies of a 

person, whether through the ownership 

of voting securities, by contract, or 

otherwise. A person is presumed to 

control another person if the person: 

(i) Is a director, general partner or 

officer exercising executive 

responsibility (or having similar status 

or functions);

(ii) Directly or indirectly has the right 

to vote 25 percent or more of a class of 

voting securities or has the power to sell 

or direct the sale of 25 percent or more 

of a class of voting securities; or 

(iii) In the case of a partnership, has 

the right to receive, upon dissolution, or 

has contributed, 25 percent or more of 

the capital. 

(8) The term director means any 

member of the Board. 

(9) The term executive session means 

a meeting of the independent directors 

of the Board, without the presence of 

management of the national securities 

exchange or the directors who are not 

independent directors. 

(10) The term facility has the same 

meaning as set forth in section 3(a)(2) of 

the Act (15 U.S.C. 78c(a)(2)). 

(11) The term immediate family 

member means a person’s spouse, 

parents, children, and siblings, whether 

by blood, marriage or adoption, or 

anyone residing in such person’s home. 

(12) The term independent director

means a director who has no material 

relationship with the national securities 

exchange or any affiliate of the national 

securities exchange, any member of the 

national securities exchange or any 

affiliate of such member, or any issuer 

of securities that are listed or traded on 

the national securities exchange or a 

facility of the national securities 

exchange. A director is not independent 

if any of the following circumstances 

exists: 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71215

(i) The director, or an immediate 

family member, is employed by or 

otherwise has a material relationship 

with the national securities exchange or 

any affiliate of the national securities 

exchange, or within the past three years 

was employed by or otherwise had a 

material relationship with the national 

securities exchange or any affiliate of 

the national securities exchange. 

(ii) The director is a member or is 

employed by or affiliated with a 

member or any affiliate of a member or, 

within the past three years was a 

member or was employed by or 

affiliated with a member or any affiliate 

of a member, or the director has an 

immediate family member that is, or 

within the past three years was, an 

executive officer of a member or any 

affiliate of a member. 

(iii) The director, or an immediate 

family member, has received during any 

twelve month period within the past 

three years more than $60,000 in 

payments from the national securities 

exchange or any affiliate of the national 

securities exchange or from a member or 

any affiliate of a member, other than the 

following: 

(A) Compensation for Board or Board 

committee service; 

(B) Compensation to an immediate 

family member who is not an executive 

officer of the national securities 

exchange or any affiliate of the national 

securities exchange or of a member or 

any affiliate of a member; and 

(C) Pension and other forms of 

deferred compensation for prior service, 

provided such compensation is not 

contingent in any way on continued 

service. 

(iv) The director, or an immediate 

family member, is a partner in, or 

controlling shareholder or executive 

officer of any organization to which the 

national securities exchange or any 

affiliate of the national securities 

exchange made, or from which the 

national securities exchange or any 

affiliate of the national securities 

exchange received, payments for 

property or services in the current or 

any of the past three full fiscal years that 

exceed two percent of the recipient’s 

consolidated gross revenues for that 

year, or $200,000, whichever is more, 

other than the following: 

(A) Payments arising solely from 

investments in the securities of the 

national securities exchange or any 

facility or affiliate of the national 

securities exchange; or 

(B) Payments under non-discretionary 

charitable contribution matching 

programs. 

(v) The director, or an immediate 

family member, is, or within the past 

three years was, an executive officer of 

an issuer of securities listed or primarily 

traded on the national securities 

exchange or a facility of the national 

securities exchange. 

(vi) The director, or an immediate 

family member, is, or within the past 

three years was, employed as an 

executive officer of another entity where 

any of the national securities exchange’s 

executive officers serves on that entity’s 

compensation committee. 

(vii) The director, or an immediate 

family member, is a current partner of 

the outside auditor of the national 

securities exchange or any affiliate of 

the national securities exchange, or was 

a partner or employee of the outside 

auditor of the national securities 

exchange or any affiliate of the national 

securities exchange who worked on the 

national securities exchange’s or any 

affiliate’s audit, at any time within the 

past three years. 

(viii) In the case of a director that is 

a member of the Audit Committee, such 

director (other than in his or her 

capacity as a member of the Audit 

Committee, the Board, or any other 

Board committee), accepts, directly or 

indirectly, any consulting, advisory, or 

other compensatory fee from the 

national securities exchange, any 

affiliate of the national securities 

exchange, any member, or any affiliate 

of a member, other than fixed amounts 

of pension and other forms of deferred 

compensation for prior service, 

provided such compensation is not 

contingent in any way on continued 

service. 

(13) The term material relationship

means a relationship, whether 

compensatory or otherwise, that 

reasonably could affect the independent 

judgment or decision-making of the 

director. 

(14) The term member has the same 

meaning as set forth in section 3(a)(3)(A) 

of the Act (15 U.S.C. 78c(a)(3)(A)). 

(15) The term person has the same 

meaning as set forth in section 3(a)(9) of 

the Act (15 U.S.C. 78c(a)(9)). 

(16) The term person associated with 

a member has the same meaning as set 

forth in section 3(a)(21) of the Act (15 

U.S.C. 78c(a)(21)). 

(17) The term regulatory information

means any information collected by a 

national securities exchange in the 

course of performing its regulatory 

obligations under the Act. 

(18) The term regulatory subsidiary

means any person that, directly or 

indirectly, is controlled by the national 

securities exchange and that provides, 

whether pursuant to contract, agreement 

or rule, regulatory services to or on 

behalf of the national securities 

exchange. 

(19) The term related person means, 

with respect to any member that is a 

broker or dealer: 

(i) Any affiliate of the member; 

(ii) Any person associated with the 

member; 

(iii) Any immediate family member of 

the member, or any immediate family 

member of the member’s spouse, who, 

in each case, has the same home as the 

member or who is a director or officer 

of the national securities exchange or 

facility or any of its parents or 

subsidiaries; and 

(iv) Any immediate family member of 

a person associated with the member, or 

any immediate family member of such 

person’s spouse, who, in each case, has 

the same home as the person associated 

with the member or who is a director or 

officer of the national securities 

exchange or facility or any of its parents 

or subsidiaries. 

(20) The term SRO trading facility

means any facility of a national 

securities exchange that executes orders 

in securities. 

(21) The term Standing Committees

means the following committees of the 

Board: Nominating Committee, 

Governance Committee, Compensation 

Committee, Audit Committee, and 

Regulatory Oversight Committee, or 

their equivalent. 

(c) Board. (1) The Board of each 

national securities exchange must be 

composed of a majority of independent 

directors. 

(2) No director may qualify as an 

independent director unless the Board 

affirmatively determines that the 

director has no material relationship 

with the national securities exchange or 

any affiliate of the national securities 

exchange. The Board must make this 

determination upon the director’s 

nomination or appointment to the Board 

and thereafter no less frequently than 

annually and as often as necessary in 

light of the director’s circumstances. 

(3) The national securities exchange 

must establish policies and procedures 

to require each director, on his or her 

own initiative and upon request of the 

national securities exchange, to inform 

the national securities exchange of the 

existence of any relationship or interest 

that may reasonably be considered to 

bear on whether such director is an 

independent director. 

(4) At least 20 percent of the total 

number of directors must be selected by 

members.

(5) At least one director must be 

representative of issuers and at least one 

director must be representative of 

investors, and, in each case, such 

71216 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

director must not be associated with a 

member or broker or dealer. 

(6) When the Board considers any 

matter that is recommended by or 

otherwise is within the authority or 

jurisdiction of a Standing Committee, a 

majority of the directors who vote on 

the matter must be independent 

directors. 

(7) The national securities exchange 

must adopt rules establishing a fair 

process for members to nominate an 

alternative candidate or candidates to 

the Board by petition and the percentage 

of members that is necessary to put forth 

such alternative candidate or 

candidates. The percentage of members 

that is necessary to put forth an 

alternative candidate or candidates must 

not exceed 10 percent of the total 

numbers of members. 

(8) If the national securities exchange 

fails to comply with the requirement 

that the Board be composed of a 

majority of independent directors 

because there is a vacancy on the Board 

or a director ceases to be independent, 

it must comply with this requirement by 

the earlier of its next annual meeting or 

one year from the date of the occurrence 

of the event that caused the failure to 

comply with this requirement. 

(9) The national securities exchange 

must establish procedures for interested 

persons to communicate their concerns 

regarding any matter within the 

authority or jurisdiction of a Standing 

Committee directly to the independent 

directors. 

(d) Executive session. (1) Independent 

directors of the national securities 

exchange must meet regularly in 

executive session. 

(2) The independent directors must 

have the authority to direct and 

supervise inquiries into any matter 

brought to their attention within the 

scope of their duties and to obtain 

advice and assistance from independent 

legal counsel and other advisors as they 

determine necessary to carry out their 

duties. 

(3) The national securities exchange 

must provide sufficient funding and 

other resources, as determined by the 

independent directors, to permit the 

independent directors to fulfill their 

responsibilities and to retain 

independent legal counsel and other 

advisors. 

(e) Standing Committees of the Board.

(1) The national securities exchange, at 

a minimum, must have the following 

Standing Committees of the Board, or 

their equivalent: Nominating 

Committee, Governance Committee, 

Compensation Committee, Audit 

Committee, and Regulatory Oversight 

Committee. Each of these Standing 

Committees must report to the Board. 

(2) Each Standing Committee must 

have the authority to direct and 

supervise inquiries into any matter 

brought to its attention within the scope 

of its duties, and to obtain advice and 

assistance from independent legal 

counsel and other advisors as it deems 

necessary to carry out its duties. 

(3) The national securities exchange 

must provide sufficient funding and 

other resources, as determined by each 

Standing Committee, to permit the 

Standing Committees to fulfill their 

responsibilities and to retain 

independent legal counsel and other 

advisors. 

(f) Nominating Committee. (1) The 

Nominating Committee must be 

composed solely of independent 

directors. 

(2) The Nominating Committee must 

have a written charter that addresses the 

Nominating Committee’s purpose and 

responsibilities, which, at a minimum, 

must be to identify individuals qualified 

to become Board members, consistent 

with criteria approved by the Board and 

administer a process for the nomination 

of individuals to the Board. 

(3) The Nominating Committee must 

administer a fair process that provides 

members with the opportunity to select 

at least 20 percent of the total number 

of directors. The Nominating Committee 

must also administer the process 

established by the exchange under 

paragraph (c)(7) of this section for the 

nomination of an alternative candidate 

or candidates by members through 

petition. 

(4) The Nominating Committee must 

nominate at least one director who is 

representative of issuers and at least one 

director who is representative of 

investors and who, in each case, is not 

associated with a member or broker or 

dealer. 

(5) The Nominating Committee must 

conduct an annual performance selfevaluation. 

(g) Governance Committee. (1) The 

Governance Committee must be 

composed solely of independent 

directors. 

(2) The Governance Committee must 

have a written charter that addresses the 

Committee’s purpose and 

responsibilities, which, at a minimum, 

must be to develop and recommend to 

the Board a set of governance principles 

applicable to the national securities 

exchange and to oversee the evaluation 

of the Board and management. 

(3) The Governance Committee must 

conduct an annual performance 

evaluation of the governance of the 

national securities exchange, including 

the effectiveness of the Board and its 

committees. 

(h) Compensation Committee. (1) The 

Compensation Committee must be 

composed solely of independent 

directors. 

(2) The Compensation Committee 

must have a written charter that 

addresses the Compensation 

Committee’s purpose and 

responsibilities, which, at a minimum, 

must be to have direct responsibility to 

review and approve corporate goals and 

objectives relevant to the compensation 

of the executive officers of the national 

securities exchange; evaluate the 

performance of the executive officers in 

light of those goals and objectives; and 

consider and approve recommendations 

with respect to the compensation level 

of the executive officers, based on this 

evaluation. 

(3) The Compensation Committee 

must conduct an annual performance 

self-evaluation. 

(i) Audit Committee. (1) The Audit 

Committee must be composed solely of 

independent directors. 

(2) The Audit Committee must have a 

written charter that addresses the Audit 

Committee’s purpose and 

responsibilities, which, at a minimum, 

must be to assist the Board in oversight 

of the integrity of the national securities 

exchange’s financial statements; the 

national securities exchange’s 

compliance with related legal and 

regulatory requirements; and the 

qualifications and independence of the 

national securities exchange’s auditor, 

including direct responsibility for the 

hiring, firing, and compensation of the 

auditor; overseeing the auditor’s 

engagement; meeting regularly in 

executive session with the auditor; 

reviewing the auditor’s reports with 

respect to the national securities 

exchange’s internal controls; preapproving all audit and non-audit 

services performed by the auditor; 

determining the budget and staffing of 

the national securities exchange’s 

internal audit department; and 

establishing procedures for the receipt 

of complaints regarding accounting, 

internal accounting controls, or auditing 

matters of the national securities 

exchange and the confidential 

submission by employees of the 

national securities exchange of concerns 

regarding questionable accounting or 

auditing matters. 

(3) The Audit Committee must 

conduct an annual performance selfevaluation. 

(j) Regulatory Oversight Committee.

(1) The Regulatory Oversight Committee 

must be composed solely of 

independent directors. 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71217

(2) The Regulatory Oversight 

Committee must have a written charter 

that addresses the Regulatory Oversight 

Committee’s purpose and 

responsibilities, which, at a minimum, 

must be to assure the adequacy and 

effectiveness of the regulatory program 

of the national securities exchange; 

assess the exchange’s regulatory 

performance; determine the regulatory 

plan, programs, budget, and staffing for 

the regulatory functions of the 

exchange; assess the performance of, 

and recommend compensation and 

personnel actions involving, the Chief 

Regulatory Officer and other senior 

regulatory personnel to the 

Compensation Committee; monitor and 

review regularly with the Chief 

Regulatory Officer matters relating to 

the exchange’s surveillance, 

examination, and enforcement units; 

assure that the exchange’s disciplinary 

and arbitration proceedings are 

conducted in accordance with the 

exchange’s rules and policies and any 

other applicable laws or rules, including 

those of the Commission; prior to the 

exchange’s approval of an affiliated 

security for listing, certify that such 

security meets the exchange’s rules for 

listing; and approve reports filed with 

the Commission as required by 

Regulation AL (§ 242.800 of this 

chapter). 

(3) At least 20 percent of the members 

of any committee, subcommittee, or 

panel that is responsible for conducting 

hearings, rendering decisions, and 

imposing sanctions with respect to 

disciplinary matters must be members 

of the national securities exchange. 

(4) Any committee, subcommittee, or 

panel that is responsible for conducting 

hearings, rendering decisions, and 

imposing sanctions with respect to 

disciplinary matters must be subject to 

the jurisdiction of the Regulatory 

Oversight Committee.

(5) The Regulatory Oversight 

Committee must oversee the preparation 

of the national securities exchange’s 

annual regulatory report, as required by 

§ 240.17a–26. 

(6) The Regulatory Oversight 

Committee must conduct an annual 

performance self-evaluation. 

(k) Other committees of the Board. (1) 

The national securities exchange may 

establish such other committees of the 

Board as it deems appropriate. However, 

if such committee has the authority to 

act on behalf of the Board, the 

committee must be composed of a 

majority of independent directors. The 

national securities exchange may not 

delegate to any committee not 

consisting solely of independent 

directors the authority to act on matters 

that otherwise are within the 

jurisdiction of a Standing Committee. 

(2) At least 20 percent of the members 

of any committee must be members of 

the national securities exchange if such 

committee: 

(i) Is not a Standing Committee, or is 

a committee, subcommittee, or panel 

that is subject to the jurisdiction of a 

Standing Committee; and 

(ii) Is responsible for providing advice 

with respect to trading rules or 

disciplinary rules. 

(l) Other requirements applicable to 

directors and officers. The rules of the 

national securities exchange must 

provide that: 

(1) Any person subject to a statutory 

disqualification as defined in section 

3(a)(39) of the Act (15 U.S.C. 78c(a)(39)) 

shall not be an officer or director of the 

exchange. 

(2) Each director, in discharging his or 

her responsibilities as a member of the 

Board, must reasonably consider all 

requirements applicable to such 

exchange under the Act. 

(m) Separation of positions of 

Chairman of the Board and Chief 

Executive Officer.

(1) If the Chief Executive Officer of 

the national securities exchange is not 

also the Chairman of the Board, the 

Chairman of the Board must be an 

independent director. 

(2) The Chief Executive Officer must 

not participate in any executive sessions 

of the Board. 

(3) If a single individual serves as 

both Chairman of the Board of the 

national securities exchange and the 

Chief Executive Officer, the Board must 

designate an independent director as a 

lead director to preside over executive 

sessions of the Board. The Board must 

publicly disclose such lead director’s 

name and a means by which interested 

parties may communicate with the lead 

director. 

(4) The Chairman of the Board of the 

national securities exchange must not 

serve on the Nominating, Governance, 

Compensation, Audit, or Regulatory 

Oversight Committees, unless the 

Chairman of the Board is an 

independent director. 

(n) Separation of regulatory and 

market operations. (1) The national 

securities exchange must establish 

policies and procedures to assure the 

independence of its regulatory program 

from its market operations or other 

commercial interests. 

(2) The national securities exchange’s 

regulatory program must be: 

(i) Structurally separated from the 

market operations and other commercial 

interests of the exchange, by means of 

separate legal entities; or 

(ii) Functionally separated within the 

same legal entity from the market 

operations and other commercial 

interests of the exchange. 

(3) The Board must appoint a Chief 

Regulatory Officer to administer the 

regulatory program of the national 

securities exchange. The Chief 

Regulatory Officer must report directly 

to the Regulatory Oversight Committee. 

(4)(i) Any funds received by the 

national securities exchange from 

regulatory fees, fines, or penalties must 

be applied only to fund programs and 

operations directly related to such 

exchange’s regulatory responsibilities; 

and 

(ii) The national securities exchange 

must make and keep books and records 

necessary to demonstrate compliance 

with the requirement in paragraph 

(n)(4)(i) of this section. 

(5)(i) A national securities exchange 

must establish policies and procedures 

reasonably designed to: 

(A) Prevent the dissemination of 

regulatory information to any person 

other than an officer, director, 

employee, or agent of the exchange 

directly involved in carrying out the 

exchange’s regulatory obligations under 

the Act; 

(B) Prevent the use of regulatory 

information for any purpose other than 

carrying out the exchange’s regulatory 

obligations under the Act; and 

(C) Maintain the confidentiality of any 

information required to be submitted to 

effectuate a transaction on or through 

such exchange or its facilities, unless 

such information is aggregated to such 

an extent that no person whose 

information is included in the 

aggregated information can be 

identified, or unless the person has 

consented to the dissemination and use 

of its information by the exchange. 

(ii) An exchange’s policies and 

procedures must require its officers, 

directors, employees, and agents to 

agree to comply with the requirements 

of paragraph (n)(5)(i) of this section. 

(o) Limits on member ownership and 

voting. (1) The rules of a national 

securities exchange must prohibit any 

member of such exchange that is a 

broker or dealer, alone or together with 

its related persons, from either: 

(i) Beneficially owning, directly or 

indirectly, any interest in the national 

securities exchange or a facility of such 

exchange through which the member is 

permitted to effect transactions that 

exceeds 20 percent of any class of 

securities or other ownership interest of 

such national securities exchange or 

facility; or 

(ii) Directly or indirectly voting, 

causing the voting of, or giving any 

71218 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

consent or proxy with respect to the 

voting of, any interest in the national 

securities exchange or a facility of such 

exchange through which the member is 

permitted to effect transactions that 

exceeds 20 percent of the voting power 

of any class of securities or other 

ownership interest of such national 

securities exchange or facility. 

(2) The prohibition in paragraph 

(o)(1)(ii) shall not apply to any 

solicitation or receipt of a revocable 

proxy by any member that is a broker or 

dealer or its related persons from other 

shareholders of the national securities 

exchange or facility that is conducted 

pursuant to, and in accordance with, 

Regulation 14A under the Act (15 U.S.C. 

78n), except that a member and its 

related persons may not conduct a 

solicitation or receive a proxy pursuant 

to § 240.14a–2(b)(2) with regard to or 

from a person or persons whose interest 

in the national securities exchange or 

facility, together with the member’s and 

its related person’s aggregate interest, 

would exceed the voting limitation in 

paragraph (o)(1) of this section. 

(3) The rules of the national securities 

exchange must provide an effective 

mechanism to divest any member that is 

a broker or dealer and its related 

persons of any interest owned in excess 

of the ownership limitation in 

paragraph (o)(1) of this section. 

(4) The rules of the national securities 

exchange must be reasonably designed 

to not give effect to the portion of a vote 

by a member that is a broker or dealer 

and its related persons that is in excess 

of the voting limitation in paragraph 

(o)(1) of this section. 

(5) The rules of the national securities 

exchange must provide an effective 

mechanism for the national securities 

exchange to obtain information relating 

to ownership and voting interests in the 

national securities exchange or any 

facility of the national securities 

exchange from any owner of any 

interest. 

(p) Code of conduct and ethics. (1) 

The rules of the national securities 

exchange must provide: 

(i) For a code of conduct and ethics 

for directors, officers and employees 

that, at a minimum, establishes policies 

and procedures regarding: conflicts of 

interest; corporate opportunities; 

confidentiality; fair dealing; protection 

and proper use of the exchange’s assets; 

compliance with laws, rules, and 

regulations by directors, officers and 

employees; and the reporting of illegal 

or unethical behavior; and 

(ii) That any waiver of the code of 

conduct and ethics established under 

paragraph (p)(1)(i) of this section must 

be approved by the Board. 

(2) The rules of the national securities 

exchange must prohibit any of its 

employees or officers from being a 

member of the board of directors of a 

listed issuer or member firm. 

(q) Governance guidelines. The 

national securities exchange must adopt 

rules implementing governance 

guidelines that, at a minimum, establish 

policies regarding: director qualification 

standards; director responsibilities; 

director access to management and 

independent advisors; director 

compensation; director orientation and 

continuing education; management 

succession; and annual performance 

evaluations of the Board. 

(r) Implementation. (1) The rules of 

each national securities exchange must 

be designed to meet the requirements of 

this section and must be operative no 

later than [one year following the date 

of publication of final rules in the 

Federal Register].

(2) Each national securities exchange 

must submit to the Commission a 

proposed rule change that complies 

with this section no later than [four 

months following the date of 

publication of final rules in the Federal 

Register]. 

(3) Each national securities exchange 

must have final rules that comply with 

this section approved by the 

Commission no later than [ten months 

following the date of publication of final 

rules in the Federal Register]. 

(s) Exemptions. (1) A national 

securities exchange registered pursuant 

to section 6(g)(1) of the Act (15 U.S.C. 

78f(g)(1)) is exempt from the 

requirements of this section. 

(2) Upon written request or on its own 

motion, the Commission may grant an 

exemption from any provision of this 

section, either unconditionally or on 

specified terms and conditions, if the 

Commission determines that such 

exemption is necessary or appropriate 

in the public interest and is consistent 

with the protection of investors.

§ 240.15Aa–1 [Amended] 

5. Section 240.15Aa–1 is amended by 

revising the reference to ‘‘Form X–

15AA–1’’ to read ‘‘Form 2’’.

§ 240.15Aj–1 [Removed] 

6. Section 240.15Aj–1 is removed. 

7. Section 240.15Aa–2 is added to 

read as follows:

§ 240.15Aa–2. Amendments to application. 

(a) A registered securities association 

or an affiliated securities association 

shall file an amendment to Form 2, 

which shall set forth the nature and 

effective date of the action taken, and 

shall provide any new information and 

correct any information rendered 

inaccurate on Form 2, within 10 

calendar days after any material event 

takes place that renders inaccurate, or 

that causes to be incomplete, any of the 

following: 

(1) Information filed on the Execution 

Page of Form 2, or amendment thereto; 

(2) Information filed as part of 

Exhibits C, D, E, H, I, J, K, M, N, O, P, 

S, or U and as part of Item 3 of Exhibit 

F or Items 1, 5, 6, and 7 of Exhibit Q, 

or any amendments thereto; or 

(3) Information filed as part of Items 

2 or 3 of Exhibit Q, or any amendment 

thereto, except that such information is 

not required to be filed with respect to 

any ownership change that is less than 

one percent from the ownership interest 

last reported on Form 2, or any 

amendment thereto. 

(b) Within 60 days of the end of its 

fiscal year, a registered securities 

association or an affiliated securities 

association must submit an amendment 

to its Form 2 that updates the Form 2 

in its entirety. Each Exhibit to the 

amended Form 2 shall be up to date as 

of the end of the latest fiscal year of the 

association. 

(c) Except as set forth in paragraph (d) 

of this section, a registered securities 

association or an affiliated securities 

association must continuously post any 

amendments required to be filed under 

paragraphs (a) and (b) of this section on 

a publicly-accessible Internet web site 

controlled by the association, 

simultaneous with the filing of such 

information in paper form with the 

Commission. Only the most recent 

annual amendment filed under 

paragraph (b) of this section and any 

subsequent updates filed under 

paragraphs (a) of this section are 

required to be posted on such Internet 

web site. In its filing with the 

Commission, such association shall: 

(1) Indicate the location of the 

Internet web site where such 

information may be found; and 

(2) Certify that the information 

available at such location is accurate as 

of its date. 

(d)(1) If the information required to be 

filed under paragraphs (a) or (b) of this 

section for Exhibits A, B, M, N, S, or T 

or Items 1–7 of Exhibit L is available 

continuously on an Internet web site 

controlled by an association, in lieu of 

filing such information in paper form 

with the Commission, such association 

may: 

(i) Indicate the location of the Internet 

web site where such information may be 

found; and 

(ii) Certify that the information 

available at such location is accurate as 

of its date. 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71219

(2) Only the most recent annual 

amendment required under paragraph 

(b) of this section and any subsequent 

updates required under paragraph (a) of 

this section must be continuously 

posted on an Internet web site 

controlled by an association under 

paragraph (d)(1) of this section. 

(e) Upon written request or on its own 

motion, the Commission may grant an 

exemption from any of the requirements 

of this section, either unconditionally or 

on specified terms and conditions, if the 

Commission determines that such 

exemption is necessary or appropriate 

in the public interest and is consistent 

with the protection of investors. 

(f) A registered securities association 

or an affiliated securities association 

shall file as an amendment to Form 2 a 

complete new statement together will 

all exhibits which are prescribed to be 

filed in connection with Form 2 no later 

than [six months following the date of 

publication of final rules in the Federal 

Register]. 

8. Section 240.15Aa–3 is added to 

read as follows:

§ 240.15Aa–3 Fair administration and 

governance of registered securities 

associations. 

(a) General. Each association must 

comply with, and have rules that 

comply with, the provisions of this 

section, and must have the capacity to 

carry out the purposes of this section. If 

the association has a regulatory 

subsidiary, the provisions of paragraphs 

(c), (d), (e), (f), (g), (h), (i), (j), (k), (l), (m), 

(n), (p) and (q) of this section shall 

apply to such regulatory subsidiary in 

the same manner as the association; 

provided, however, that to the extent 

that a Standing Committee of the 

association is authorized to carry out 

responsibilities on behalf of the 

regulatory subsidiary, as set forth in its 

written charter, the regulatory 

subsidiary shall not be required to have 

a Standing Committee that performs the 

same responsibilities and to the extent 

that the Chief Regulatory Officer of the 

association performs the same 

responsibilities for the regulatory 

subsidiary as he or she does for the 

association, the regulatory subsidiary 

shall not be required to appoint a Chief 

Regulatory Officer. When used in 

paragraphs (c), (d), (e), (f), (g), (h), (i), (j), 

(k), (l), (m), (n), (p) and (q) of this 

section, the terms ‘‘association’’ shall 

also mean the regulatory subsidiary of 

the association; ‘‘Board’’ shall also mean 

the Board of the regulatory subsidiary; 

‘‘director’’ or ‘‘directors’’ shall also 

mean the directors or directors of the 

regulatory subsidiary; ‘‘independent 

director’’ or ‘‘independent directors’’

shall also mean the independent 

director or independent directors of the 

regulatory subsidiary; ‘‘executive 

session’’ shall also mean executive 

session of the Board of the regulatory 

subsidiary; and ‘‘Standing Committee’’

or ‘‘Standing Committees’’ shall also 

mean the Standing Committee or 

Standing Committees of the Board of the 

regulatory subsidiary. 

(b) Definitions. For purposes of this 

section, the following definitions shall 

apply: 

(1) The term affiliate means any 

person that, directly or indirectly, 

controls, is controlled by, or is under 

common control with, the association. 

(2) The term affiliated issuer means 

the association, an SRO trading facility 

of the association, an affiliate of the 

association, or an affiliate of an SRO 

trading facility of the association. 

(3) The term affiliated security means 

any security issued by an affiliated 

issuer, except that it shall not include 

any option exempt from the Securities 

Act of 1933 under § 230.238 of this 

chapter and any security futures 

product exempt from the Securities Act 

of 1933 under section 3(a)(14) of the 

Securities Act of 1933 (15 U.S.C. 

77c(a)(14)). 

(4) The term association means any 

association registered under section 15A 

of the Act (15 U.S.C. 78o–3). 

(5) The terms beneficial ownership, 

beneficially owns or any derivative 

thereof shall have the same meaning, 

with respect to any security or other 

ownership interest, as set forth in 

§ 240.13d–3, as if (and whether or not) 

such security or other ownership 

interest were a voting equity security 

registered under section 12 of the Act 

(15 U.S.C. 78l); provided that to the 

extent any person beneficially owns any 

security or other ownership interest 

solely because such person is a member 

of a group within the meaning of section 

13(d)(3) of the Act (15 U.S.C. 78m(d)(3)), 

such person shall not be deemed to 

beneficially own such security or other 

ownership interest for purposes of this 

section, unless such person has the 

power to direct the vote of such security 

or other ownership interest. 

(6) The term Board means the Board 

of Directors or Board of Governors of the 

association, or any equivalent body. 

(7) The term compensation means any 

form of compensation and any material 

perquisites awarded, or that are to be 

awarded, whether or not set forth in any 

written documents, to any executive 

officer of the association, including, 

without limitation, salary, bonus, 

pension, deferred compensation, 

compensation awarded pursuant to any 

incentive plan or equity-based plan, or 

any other plan, contract, authorization 

or arrangement pursuant to which cash 

or securities may be received.

(8) The term control means the 

possession, direct or indirect, of the 

power to direct or cause the direction of 

the management and policies of a 

person, whether through the ownership 

of voting securities, by contract, or 

otherwise. A person is presumed to 

control another person if the person: 

(i) Is a director, general partner or 

officer exercising executive 

responsibility (or having similar status 

or functions); 

(ii) Directly or indirectly has the right 

to vote 25 percent or more of a class of 

voting securities or has the power to sell 

or direct the sale of 25 percent or more 

of a class of voting securities; or 

(iii) In the case of a partnership, has 

the right to receive, upon dissolution, or 

has contributed, 25 percent or more of 

the capital. 

(9) The term director means any 

member of the Board. 

(10) The term executive session means 

a meeting of the independent directors 

of the Board, without the presence of 

management of the association or the 

directors who are not independent 

directors. 

(11) The term facility when used with 

respect to an association includes its 

premises, tangible or intangible property 

whether on the premises or not, any 

right to the use of such premises or 

property or any service thereof for the 

purpose of effecting or reporting a 

transaction (including, among other 

things, any system of communication to 

or from the association, by ticker or 

otherwise, maintained by or with the 

consent of the association), and any 

right of the association to the use of any 

property or service. 

(12) The term immediate family 

member means a person’s spouse, 

parents, children, and siblings, whether 

by blood, marriage or adoption, or 

anyone residing in such person’s home. 

(13) The term independent director

means a director who has no material 

relationship with the association or any 

affiliate of the association, any member 

of the association or any affiliate of such 

member, or any issuer of securities that 

are listed or traded on a facility of the 

association. A director is not 

independent if any of the following 

circumstances exists: 

(i) The director, or an immediate 

family member, is employed by or 

otherwise has a material relationship 

with the association or any affiliate of 

the association, or within the past three 

years was employed by or otherwise had 

a material relationship with the 

71220 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

association or any affiliate of the 

association. 

(ii) The director is a member or is 

employed by or affiliated with a 

member or any affiliate of a member or, 

within the past three years was a 

member or was employed by or 

affiliated with a member or any affiliate 

of a member, or the director has an 

immediate family member that is, or 

within the past three years was, an 

executive officer of a member or any 

affiliate of a member. 

(iii) The director, or an immediate 

family member, has received during any 

twelve month period within the past 

three years more than $60,000 in 

payments from the association or any 

affiliate of the association or from a 

member or any affiliate of a member, 

other than the following: 

(A) Compensation for Board or Board 

committee service; 

(B) Compensation to an immediate 

family member who is not an executive 

officer of the association or any affiliate 

of the association or of a member or any 

affiliate of a member; and 

(C) Pension and other forms of 

deferred compensation for prior service, 

provided such compensation is not 

contingent in any way on continued 

service. 

(iv) The director, or an immediate 

family member, is a partner in, or 

controlling shareholder or executive 

officer of any organization to which the 

association or any affiliate of the 

association made, or from which the 

association or any affiliate of the 

association received, payments for 

property or services in the current or 

any of the past three full fiscal years that 

exceed two percent of the recipient’s 

consolidated gross revenues for that 

year, or $200,000, whichever is more, 

other than the following: 

(A) Payments arising solely from 

investments in the securities of the 

association or any facility or affiliate of 

the association; or 

(B) Payments under non-discretionary 

charitable contribution matching 

programs. 

(v) The director, or an immediate 

family member, is, or within the past 

three years was, an executive officer of 

an issuer of securities listed or primarily 

traded on a facility of the association. 

(vi) The director, or an immediate 

family member, is, or within the past 

three years was, employed as an 

executive officer of another entity where 

any of the association’s executive 

officers serves on that entity’s 

compensation committee. 

(vii) The director, or an immediate 

family member, is a current partner of 

the outside auditor of the association or 

any affiliate of the association, or was a 

partner or employee of the outside 

auditor of the association or any affiliate 

of the association who worked on the 

association’s or any affiliate’s audit, at 

any time within the past three years. 

(viii) In the case of a director that is 

a member of the Audit Committee, such 

director (other than in his or her 

capacity as a member of the Audit 

Committee, the Board, or any other 

Board committee), accepts, directly or 

indirectly, any consulting, advisory, or 

other compensatory fee from the 

association, any affiliate of the 

association, any member, or any affiliate 

of a member, other than fixed amounts 

of pension and other forms of deferred 

compensation for prior service, 

provided such compensation is not 

contingent in any way on continued 

service. 

(14) The term material relationship

means a relationship, whether 

compensatory or otherwise, that 

reasonably could affect the independent 

judgment or decision-making of the 

director. 

(15) The term member has the same 

meaning as set forth in section 3(a)(3)(B) 

of the Act (15 U.S.C. 78c(a)(3)(B)). 

(16) The term person has the same 

meaning as set forth in section 3(a)(9) of 

the Act (15 U.S.C. 78c(a)(9)). 

(17) The term person associated with 

a member has the same meaning as set 

forth in section 3(a)(21) of the Act (15 

U.S.C. 78c(a)(21)). 

(18) The term regulatory information

means any information collected by an 

association in the course of performing 

its regulatory obligations under the Act. 

(19) The term regulatory subsidiary

means any person that, directly or 

indirectly, is controlled by the 

association and that provides, whether 

pursuant to contract, agreement or rule, 

regulatory services to or on behalf of the 

association. 

(20) The term related person means, 

with respect to any member: 

(i) Any affiliate of the member; 

(ii) Any person associated with the 

member; 

(iii) Any immediate family member of 

the member, or any immediate family 

member of the member’s spouse, who, 

in each case, has the same home as the 

member or who is a director or officer 

of the association or facility or any of its 

parents or subsidiaries; and 

(iv) Any immediate family member of 

a person associated with the member, or 

any immediate family member of such 

person’s spouse, who, in each case, has 

the same home as the person associated 

with the member or who is a director or 

officer of the association or facility or 

any of its parents or subsidiaries. 

(21) The term SRO trading facility

means any facility of an association that 

executes orders in securities. 

(22) The term Standing Committees

means the following committees of the 

Board: Nominating Committee, 

Governance Committee, Compensation 

Committee, Audit Committee, and 

Regulatory Oversight Committee, or 

their equivalent. 

(c) Board. (1) The Board of each 

association must be composed of a 

majority of independent directors. 

(2) No director may qualify as an 

independent director unless the Board 

affirmatively determines that the 

director has no material relationship 

with the association or any affiliate of 

the association. The Board must make 

this determination upon the director’s 

nomination or appointment to the Board 

and thereafter no less frequently than 

annually and as often as necessary in 

light of the director’s circumstances. 

(3) The association must establish 

policies and procedures to require each 

director, on his or her own initiative 

and upon request of the association, to 

inform the association of the existence 

of any relationship or interest that may 

reasonably be considered to bear on 

whether such director is an independent 

director. 

(4) At least 20 percent of the total 

number of directors must be selected by 

members.

(5) At least one director must be 

representative of issuers and at least one 

director must be representative of 

investors, and, in each case, such 

director must not be associated with a 

member or broker or dealer. 

(6) When the Board considers any 

matter that is recommended by or 

otherwise is within the authority or 

jurisdiction of a Standing Committee, a 

majority of the directors who vote on 

the matter must be independent 

directors. 

(7) The association must adopt rules 

establishing a fair process for members 

to nominate an alternative candidate or 

candidates to the Board by petition and 

the percentage of members that is 

necessary to put forth such alternative 

candidate or candidates. The percentage 

of members that is necessary to put forth 

an alternative candidate or candidates 

must not exceed 10 percent of the total 

numbers of members. 

(8) If the association fails to comply 

with the requirement that the Board be 

composed of a majority of independent 

directors because there is a vacancy on 

the Board or a director ceases to be 

independent, it must comply with this 

requirement by the earlier of its next 

annual meeting or one year from the 

date of the occurrence of the event that 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71221

caused the failure to comply with this 

requirement. 

(9) The association must establish 

procedures for interested persons to 

communicate their concerns regarding 

any matter within the authority or 

jurisdiction of a Standing Committee 

directly to the independent directors. 

(d) Executive session. (1) Independent 

directors of the association must meet 

regularly in executive session. 

(2) The independent directors must 

have the authority to direct and 

supervise inquiries into any matter 

brought to their attention within the 

scope of their duties and to obtain 

advice and assistance from independent 

legal counsel and other advisors as they 

determine necessary to carry out their 

duties. 

(3) The association must provide 

sufficient funding and other resources, 

as determined by the independent 

directors, to permit the independent 

directors to fulfill their responsibilities 

and to retain independent legal counsel 

and other advisors. 

(e) Standing Committees of the Board.

(1) The association, at a minimum, must 

have the following Standing Committees 

of the Board, or their equivalent: 

Nominating Committee, Governance 

Committee, Compensation Committee, 

Audit Committee, and Regulatory 

Oversight Committee. Each of these 

Standing Committees must report to the 

Board. 

(2) Each Standing Committee must 

have the authority to direct and 

supervise inquiries into any matter 

brought to its attention within the scope 

of its duties, and to obtain advice and 

assistance from independent legal 

counsel and other advisors as it deems 

necessary to carry out its duties. 

(3) The association must provide 

sufficient funding and other resources, 

as determined by each Standing 

Committee, to permit the Standing 

Committees to fulfill their 

responsibilities and to retain 

independent legal counsel and other 

advisors. 

(f) Nominating Committee. (1) The 

Nominating Committee must be 

composed solely of independent 

directors. 

(2) The Nominating Committee must 

have a written charter that addresses the 

Nominating Committee’s purpose and 

responsibilities, which, at a minimum, 

must be to identify individuals qualified 

to become Board members, consistent 

with criteria approved by the Board and 

administer a process for the nomination 

of individuals to the Board. 

(3) The Nominating Committee must 

administer a fair process that provides 

members with the opportunity to select 

at least 20 percent of the total number 

of directors. The Nominating Committee 

must also administer the process 

established by the association under 

paragraph (c)(7) of this section for the 

nomination of an alternative candidate 

or candidates by members through 

petition. 

(4) The Nominating Committee must 

nominate at least one director who is 

representative of issuers and at least one 

director who is representative of 

investors and who, in each case, is not 

associated with a member or broker or 

dealer. 

(5) The Nominating Committee must 

conduct an annual performance selfevaluation. 

(g) Governance Committee. (1) The 

Governance Committee must be 

composed solely of independent 

directors. 

(2) The Governance Committee must 

have a written charter that addresses the 

Committee’s purpose and 

responsibilities, which, at a minimum, 

must be to develop and recommend to 

the Board a set of governance principles 

applicable to the association and to 

oversee the evaluation of the Board and 

management. 

(3) The Governance Committee must 

conduct an annual performance 

evaluation of the governance of the 

association, including the effectiveness 

of the Board and its committees. 

(h) Compensation Committee. (1) The 

Compensation Committee must be 

composed solely of independent 

directors. 

(2) The Compensation Committee 

must have a written charter that 

addresses the Compensation 

Committee’s purpose and 

responsibilities, which, at a minimum, 

must be to have direct responsibility to 

review and approve corporate goals and 

objectives relevant to the compensation 

of the executive officers of the 

association; evaluate the performance of 

the executive officers in light of those 

goals and objectives; and consider and 

approve recommendations with respect 

to the compensation level of the 

executive officers, based on this 

evaluation. 

(3) The Compensation Committee 

must conduct an annual performance 

self-evaluation. 

(i) Audit Committee. (1) The Audit 

Committee must be composed solely of 

independent directors. 

(2) The Audit Committee must have a 

written charter that addresses the Audit 

Committee’s purpose and 

responsibilities, which, at a minimum, 

must be to assist the Board in oversight 

of the integrity of the association’s 

financial statements; the association’s 

compliance with related legal and 

regulatory requirements; and the 

qualifications and independence of the 

association’s auditor, including direct 

responsibility for the hiring, firing, and 

compensation of the auditor; overseeing 

the auditor’s engagement; meeting 

regularly in executive session with the 

auditor; reviewing the auditor’s reports 

with respect to the association’s internal 

controls; pre-approving all audit and 

non-audit services performed by the 

auditor; determining the budget and 

staffing of the association’s internal 

audit department; and establishing 

procedures for the receipt of complaints 

regarding accounting, internal 

accounting controls, or auditing matters 

of the association and the confidential 

submission by employees of the 

association of concerns regarding 

questionable accounting or auditing 

matters. 

(3) The Audit Committee must 

conduct an annual performance selfevaluation. 

(j) Regulatory Oversight Committee.

(1) The Regulatory Oversight Committee 

must be composed solely of 

independent directors. 

(2) The Regulatory Oversight 

Committee must have a written charter 

that addresses the Regulatory Oversight 

Committee’s purpose and 

responsibilities, which, at a minimum, 

must be to assure the adequacy and 

effectiveness of the regulatory program 

of the association; assess the 

association’s regulatory performance; 

determine the regulatory plan, 

programs, budget, and staffing for the 

regulatory functions of the association; 

assess the performance of, and 

recommend compensation and 

personnel actions involving, the Chief 

Regulatory Officer and other senior 

regulatory personnel to the 

Compensation Committee; monitor and 

review regularly with the Chief 

Regulatory Officer matters relating to 

the association’s surveillance, 

examination, and enforcement units; 

assure that the association’s disciplinary 

and arbitration proceedings are 

conducted in accordance with the 

association’s rules and policies and any 

other applicable laws or rules, including 

those of the Commission; prior to the 

association’s approval of an affiliated 

security for listing, certify that such 

security meets the association’s rules for 

listing; and approve reports filed with 

the Commission as required by 

Regulation AL (§ 242.800 of this 

chapter). 

(3) At least 20 percent of the members 

of any committee, subcommittee, or 

panel that is responsible for conducting 

hearings, rendering decisions, and 

71222 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

imposing sanctions with respect to 

disciplinary matters must be members 

of the association. 

(4) Any committee, subcommittee, or 

panel that is responsible for conducting 

hearings, rendering decisions, and 

imposing sanctions with respect to 

disciplinary matters must be subject to 

the jurisdiction of the Regulatory 

Oversight Committee. 

(5) The Regulatory Oversight 

Committee must oversee the preparation 

of the association’s annual regulatory 

report, as required by § 240.17a–26. 

(6) The Regulatory Oversight 

Committee must conduct an annual 

performance self-evaluation.

(k) Other committees of the Board. (1) 

The association may establish such 

other committees of the Board as it 

deems appropriate. However, if such 

committee has the authority to act on 

behalf of the Board, the committee must 

be composed of a majority of 

independent directors. The association 

may not delegate to any committee not 

consisting solely of independent 

directors the authority to act on matters 

that otherwise are within the 

jurisdiction of a Standing Committee. 

(2) At least 20 percent of the members 

of any committee must be members of 

the association if such committee: 

(i) Is not a Standing Committee, or is 

a committee, subcommittee, or panel 

that is subject to the jurisdiction of a 

Standing Committee; and 

(ii) Is responsible for providing advice 

with respect to trading rules or 

disciplinary rules. 

(l) Other requirements applicable to 

directors and officers. The rules of the 

association must provide that: 

(1) Any person subject to a statutory 

disqualification as defined in section 

3(a)(39) of the Act (15 U.S.C. 78c(a)(39)) 

shall not be an officer or director of the 

association. 

(2) Each director, in discharging his or 

her responsibilities as a member of the 

Board, must reasonably consider all 

requirements applicable to such 

association under the Act. 

(m) Separation of positions of 

Chairman of the Board and Chief 

Executive Officer. (1) If the Chief 

Executive Officer of the association is 

not also the Chairman of the Board, the 

Chairman of the Board must be an 

independent director. 

(2) The Chief Executive Officer must 

not participate in any executive sessions 

of the Board. 

(3) If a single individual serves as 

both Chairman of the Board of the 

association and the Chief Executive 

Officer, the Board must designate an 

independent director as a lead director 

to preside over executive sessions of the 

Board. The Board must publicly 

disclose such lead director’s name and 

a means by which interested parties 

may communicate with the lead 

director. 

(4) The Chairman of the Board of the 

association must not serve on the 

Nominating, Governance, 

Compensation, Audit, or Regulatory 

Oversight Committees, unless the 

Chairman of the Board is an 

independent director. 

(n) Separation of regulatory and 

market operations. (1) The association 

must establish policies and procedures 

to assure the independence of its 

regulatory program from its market 

operations or other commercial 

interests. 

(2) The association’s regulatory 

program must be: 

(i) Structurally separated from the 

market operations and other commercial 

interests of the association, by means of 

separate legal entities; or 

(ii) Functionally separated within the 

same legal entity from the market 

operations and other commercial 

interests of the association. 

(3) The Board must appoint a Chief 

Regulatory Officer to administer the 

regulatory program of the association. 

The Chief Regulatory Officer must 

report directly to the Regulatory 

Oversight Committee. 

(4)(i) Any funds received by the 

association from regulatory fees, fines, 

or penalties must be applied only to 

fund programs and operations directly 

related to such association’s regulatory 

responsibilities; and 

(ii) The association must make and 

keep books and records necessary to 

demonstrate compliance with the 

requirement in paragraph (n)(4)(i) of this 

section. 

(5)(i) An association must establish 

policies and procedures reasonably 

designed to: 

(A) Prevent the dissemination of 

regulatory information to any person 

other than an officer, director, 

employee, or agent of the association 

directly involved in carrying out the 

association’s regulatory obligations 

under the Act; 

(B) Prevent the use of regulatory 

information for any purpose other than 

carrying out the association’s regulatory 

obligations under the Act; and 

(C) Maintain the confidentiality of any 

information required to be submitted to 

effectuate a transaction on or through 

such association or its facilities, unless 

such information is aggregated to such 

an extent that no person whose 

information is included in the 

aggregated information can be 

identified, or unless the person has 

consented to the dissemination and use 

of its information by the association. 

(ii) An association’s policies and 

procedures must require its officers, 

directors, employees, and agents to 

agree to comply with the requirements 

of paragraph (n)(5)(i) of this section. 

(o) Limits on member ownership and 

voting. (1) The rules of an association 

must prohibit any member of such 

association, alone or together with its 

related persons, from either: 

(i) Beneficially owning, directly or 

indirectly, any interest in the 

association or a facility of such 

association through which the member 

is permitted to effect transactions that 

exceeds 20 percent of any class of 

securities or other ownership interest of 

such association or facility; or 

(ii) Directly or indirectly voting, 

causing the voting of, or giving any 

consent or proxy with respect to the 

voting of, any interest in the association 

or a facility of such association through 

which the member is permitted to effect 

transactions that exceeds 20 percent of 

the voting power of any class of 

securities or other ownership interest of 

such association or facility. 

(2) The prohibition in paragraph 

(o)(1)(ii) shall not apply to any 

solicitation or receipt of a revocable 

proxy by any member or its related 

persons from other shareholders of the 

association or facility that is conducted 

pursuant to, and in accordance with, 

Regulation 14A under the Act (15 U.S.C. 

78n), except that a member and its 

related persons may not conduct a 

solicitation or receive a proxy pursuant 

to § 240.14a–2(b)(2) with regard to or 

from a person or persons whose interest 

in the association or facility, together 

with the member’s and its related 

person’s aggregate interest, would 

exceed the voting limitation in 

paragraph (o)(1) of this section. 

(3) The rules of the association must 

provide an effective mechanism to 

divest any member and its related 

persons of any interest owned in excess 

of the ownership limitation in 

paragraph (o)(1) of this section. 

(4) The rules of the association must 

be reasonably designed to not give effect 

to the portion of a vote by a member and 

its related persons that is in excess of 

the voting limitation in paragraph (o)(1) 

of this section. 

(5) The rules of the association must 

provide an effective mechanism for the 

association to obtain information 

relating to ownership and voting 

interests in the association or any 

facility of the association from any 

owner of any interest. 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71223

(p) Code of conduct and ethics. (1) 

The rules of the association must 

provide: 

(i) For a code of conduct and ethics 

for directors, officers and employees 

that, at a minimum, establishes policies 

and procedures regarding: conflicts of 

interest; corporate opportunities; 

confidentiality; fair dealing; protection 

and proper use of the association’s 

assets; compliance with laws, rules, and 

regulations by directors, officers and 

employees; and the reporting of illegal 

or unethical behavior; and 

(ii) That any waiver of the code of 

conduct and ethics established under 

paragraph (p)(1)(i) of this section must 

be approved by the Board. 

(2) The rules of the association must 

prohibit any of its employees or officers 

from being a member of the board of 

directors of a listed issuer or member 

firm. 

(q) Governance guidelines. The 

association must adopt rules 

implementing governance guidelines 

that, at a minimum, establish policies 

regarding: director qualification 

standards; director responsibilities; 

director access to management and 

independent advisors; director 

compensation; director orientation and 

continuing education; management 

succession; and annual performance 

evaluations of the Board. 

(r) Implementation. (1) The rules of 

each association must be designed to 

meet the requirements of this section 

and must be operative no later than [one 

year following the date of publication of 

final rules in the Federal Register]. 

(2) Each association must submit to 

the Commission a proposed rule change 

that complies with this section no later 

than [four months following the date of 

publication of final rules in the Federal 

Register]. 

(3) Each association must have final 

rules that comply with this section 

approved by the Commission no later 

than [ten months following the date of 

publication of final rules in the Federal 

Register]. 

(s) Exemptions. (1) A limited purpose 

national securities association registered 

pursuant to section 15A(k)(1) of the Act 

(15 U.S.C. 78o–3(k)(1)), is exempt from 

the requirements of this section.

(2) Upon written request or on its own 

motion, the Commission may grant an 

exemption from any provision of this 

section, either unconditionally or on 

specified terms and conditions, if the 

Commission determines that such 

exemption is necessary or appropriate 

in the public interest and is consistent 

with the protection of investors. 

9. Section 240.17a–1 is amended by 

revising paragraph (b) to read as follows:

§ 240.17a–1 Recordkeeping rule for 

national securities exchanges, national 

securities associations, registered clearing 

agencies and the Municipal Securities 

Rulemaking Board.

* * * * *

(b) Every national securities exchange, 

national securities association, 

registered clearing agency and the 

Municipal Securities Rulemaking Board 

shall keep all such documents for a 

period of not less than five years at a 

place within the United States, the first 

two in an easily accessible place, subject 

to the destruction and disposition 

provisions in § 240.17a-6.

* * * * *

10. Section 240.17a–26 is added to 

read as follows:

§ 240.17a–26 Regulatory reports of 

national securities exchanges and 

registered securities associations. 

(a)(1) Quarterly and annual reports.

Every national securities exchange and 

every registered securities association 

must file with the Commission reports, 

in electronic format, prepared by the 

exchange or association containing the 

information required by paragraph (b) of 

this section. Unless otherwise noted, the 

information specified in paragraph 

(b)(2) of this section must be filed on a 

quarterly basis within 20 business days 

after the end of each calendar quarter. 

In addition, an annual report containing 

the information specified in paragraphs 

(a)(2), (b)(2)(i) through (b)(2)(vii), and 

(b)(3) of this section must be filed on an 

annual basis within 60 calendar days 

after the year end. 

(2) Electronic SRO trading facilities.

Every national securities exchange and 

registered securities association that 

owns, operates, or sponsors an 

electronic SRO trading facility must file, 

as part of the annual report, a report of 

an independent audit designed to assess 

whether the operations of any electronic 

SRO trading facility of the exchange or 

association comply with the rules 

governing such facility. The report must 

be prepared by a third party not 

affiliated with the exchange or 

association that is qualified to render an 

opinion on such matters. 

(b)(1)(i) Scope. The quarterly and 

annual reports required by paragraph (a) 

of this section must include the 

information specified in paragraphs 

(b)(2) and (b)(3) of this section, relating 

to the regulatory program of the national 

securities exchange or registered 

securities association and any affiliate, 

including any surveillance, 

examination, and disciplinary programs. 

In the event that the exchange or 

association has entered into a contract 

or agreement with a regulatory 

subsidiary or with another selfregulatory organization pursuant to 

which such regulatory subsidiary or 

other self-regulatory organization 

provides regulatory services to or on 

behalf of the exchange or association, 

the information required by paragraph 

(b) of this section must include the 

information relating to the regulatory 

subsidiary’s or other self-regulatory 

organization’s activities on behalf of the 

exchange or association. In addition, the 

quarterly and annual reports must 

contain information, including 

surveillance reporting, both for those 

members for which the exchange or 

association is the designated examining 

authority and for any other members 

that use any facility of the exchange or 

association. 

(ii) Uniform format. Every national 

securities exchange and registered 

securities association subject to this 

section shall establish procedures for 

the preparation of the quarterly and 

annual reports required by this section 

in a uniform, readily accessible, and 

usable electronic format, review the 

reporting procedures from time to time 

to evaluate their efficacy, and revise the 

procedures as necessary. 

(2) Quarterly reports. The following 

information must be filed with the 

Commission by every national securities 

exchange and registered securities 

association on a quarterly basis: 

(i) Results of the surveillance 

programs, both manual and automated, 

during the reporting period, including, 

but not limited to: The number of 

exception reports and alerts generated, 

sorted by applicable rule or category; 

the number of exception reports and 

alerts reviewed by the exchange or 

association; and the number of 

exception reports and alerts closed or 

referred for further investigation or for 

enforcement proceedings; 

(ii) Results of surveillance programs 

relating to financial and operational 

requirements of members and other 

entities over which the exchange or 

association exercises examining 

authority during the reporting period, 

including, but not limited to: A list of 

member firms with net capital 

computation errors exceeding ten 

percent of excess net capital, using a 

unique identifier specific to the member 

firm to identify such member firm, and 

a factual description of any action taken 

by the exchange or association in 

response thereto; a list of member firms 

that filed late reports on Form X–17A–

5 under § 240.17a–5(a), using a unique 

identifier specific to the member firm to 

identify such member firm, and a 

factual description of any action taken 

by the exchange or association in 

71224 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

response thereto; and a list of member 

firms that filed amendments to their 

reports on Form X–17A–5 under 

§ 240.17a–5(a), using a unique identifier 

specific to the member firm to identify 

such member firm, and a factual 

description of any action taken by the 

exchange or association in response 

thereto; 

(iii) A summary of all complaints 

relating to the exchange’s or 

association’s regulatory program 

received during the reporting period 

from any source, grouped by subject 

matter and using a unique identifier 

specific to the member and any 

associated person(s) involved; and 

including the date the complaint was 

received; the type of source from which 

the complaint originated; and a factual 

description of any response or action 

taken by the exchange or association in 

response to the complaint, including 

any disposition of the matter and the 

date of any response; 

(iv) A summary of all investigations 

opened, closed, and pending during the 

reporting period including the aggregate 

number of investigations for each such 

category, and a summary of the facts of 

each investigation including, but not 

limited to: The member firm and any 

associated person(s) under review using 

a unique identifier specific to the 

member firm and associated person(s) 

under review; a factual description of 

any alleged violations; the type of 

source that led to the investigation; a 

factual description of the matter under 

investigation and the relevant security 

symbol or specific type of security 

involved; the date of the occurrence of 

the matter under investigation and the 

date it was reported or detected; the 

date the investigation was opened and, 

as applicable, closed; the length of time 

the investigation has been or was open; 

and, if applicable, a factual description 

of the recommendations and disposition 

of the investigation. In addition, the 

report should include a summary of the 

number of investigations conducted 

during the reporting period and the 

average elapsed time, in days, for all 

investigations closed during the 

reporting period; 

(v) A summary of all examinations 

opened, closed, and pending during the 

reporting period including the aggregate 

number of examinations for each such 

category, and a summary of the facts of 

each examination including, but not 

limited to: A list of the members 

examined during the reporting period 

using a unique identifier specific to the 

member firm; the frequency with which 

each such member is examined; the type 

of examination, including whether the 

examination was a cycle or for-cause 

examination and a factual description of 

any reasons for a cause examination; 

whether the examination was of a new 

member and, if so, the date the member 

was registered under the Act and the 

date the examination of the new 

member commenced; a factual 

description of the scope and subject 

matter of such examination; the date the 

examination was opened and, as 

applicable, closed; the length of time the 

examination has been or was open; 

whether the examination included an 

on-site branch examination; a factual 

description of any potential violations; 

and, if applicable, a factual description 

of the recommendations and disposition 

of the examination. In addition, the 

report should include a summary of the 

number of examinations conducted 

during the reporting period and the 

average elapsed time, in days, for all 

examinations closed during the 

reporting period; 

(vi) A summary of all enforcement 

cases opened, closed, and pending 

during the reporting period including 

the aggregate number of enforcement 

cases in each category, grouped by 

subject matter, and a summary of the 

facts of each case including, but not 

limited to: The member firm and any 

associated person(s) under review using 

a unique identifier specific to the 

member firm and associated person(s) 

under review; the type of source that led 

to the case; a factual description of any 

alleged violations and, as applicable, the 

relevant security symbol or specific type 

of security involved; the date of the 

occurrence of any alleged violations and 

the date they were reported or detected; 

the date the enforcement case was 

opened and, as applicable, closed; the 

length of time the case has been or was 

open; and, if applicable, a factual 

description of the disposition of the 

case, including whether the case was 

settled and any sanctions imposed. In 

addition, the report should include a 

summary of the number of enforcement 

cases conducted during the reporting 

period and the average elapsed time, in 

days, for all enforcement cases closed 

during the reporting period; 

(vii) A summary of listings 

information during the reporting period, 

including, but not limited to: A list of 

all securities that were newly listed or 

were delisted during the reporting 

period, including the name, symbol, and 

issuer; a list of all issuers to whom the 

exchange or association, or a facility 

thereof, sent during the reporting period 

a notice alleging that such issuer does 

not satisfy a rule or standard for 

continued listing on the exchange or 

association, or a facility thereof, and, in 

the case of an exchange, a notice that 

the exchange has submitted an 

application under § 240.12d–2 to the 

Commission to delist a class of the 

issuer’s securities, or, in the case of an 

association, a notice that the association 

has taken all necessary steps under it 

rules to delist the security from its 

facility; a list of all issuers, using unique 

identifiers, alleged to not satisfy a rule 

or standard for continued listing and 

any action taken with respect to any 

listed issuer that allegedly failed to 

satisfy any rule or standard for 

continued listing; and a list of any 

issuers, using unique identifiers, that 

are alleged to have failed to file timely 

quarterly or annual reports. The 

summary must set forth the rule or 

standard for continued listing that the 

issuer is alleged to have failed to satisfy 

and the date when the issuer was 

alleged to have failed to satisfy any rule 

or standard for continued listing; and 

the status of any compliance plan for 

the issuer, including any alleged failure 

by the issuer to satisfy the requirements 

of the compliance plan. In addition, for 

listed options, the report should include 

a list and a factual description of the 

circumstances surrounding options 

classes or series that were improperly 

listed; and 

(viii) Copies of the final agenda of any 

meeting of the board and of any 

executive board of the exchange or 

association, or of any committee of the 

board or executive board, that occurred 

during the reporting period.

(3) Annual report. In addition to a 

year-end cumulative presentation of the 

information specified in paragraph 

(b)(2)(i) through (b)(2)(vii), and the 

information specified in paragraph 

(a)(2), the following information must be 

filed with the Commission by every 

national securities exchange and 

registered securities association as part 

of the annual report: 

(i) A complete discussion of the 

internal policies and procedures for 

carrying out the regulatory 

responsibilities of the exchange or 

association, including a discussion of 

the overall program of surveillance and 

enforcement and any new, revised, or 

terminated surveillance programs along 

with a discussion of the reasons for any 

change. In addition, the exchange or 

association must submit as part of the 

annual report a chart indicating by 

group or section the regulatory activities 

performed by such group or section, the 

number of staff involved in each group 

or section, the names of the staff 

responsible for such regulatory 

activities, and the names of the 

supervisors of each group or section; 

(ii) An evaluation of the effectiveness 

of the exchange’s or association’s 

Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 71225

regulatory programs in effect during the 

reporting period, including a discussion 

of the overall operation and 

effectiveness of the regulatory program; 

the particular strengths and weaknesses 

of the regulatory program; areas in 

which the regulatory program needs to 

be improved; and any planned revisions 

to the regulatory program in response to 

any weaknesses, including those 

weaknesses uncovered during the 

process of preparing the annual and 

quarterly reports required by this 

section; 

(iii) A complete discussion of the 

internal controls implemented by the 

exchange or association that are 

designed to detect, prevent, and control 

for any conflicts of interest between the 

market operations and other commercial 

interests of the exchange or association 

and its self-regulatory responsibilities, 

and to assure that the exchange or 

association appropriately carries out its 

self-regulatory responsibilities; 

(iv) A complete discussion of the 

exchange’s or association’s employment 

arrangements with its Chief Regulatory 

Officer and other senior regulatory 

program personnel; 

(v) Copies of the most recent annual 

performance self-evaluation of each 

standing committee of the board of a 

national securities exchange or 

registered securities association, as well 

as the annual governance performance 

evaluation prepared by each exchange’s 

or association’s Governance Committee, 

as set forth in § 240.6a–5 and 

§ 240.15Aa–3; and 

(vi) A complete discussion of the 

exchange or association’s efforts to 

comply with any recommendations or 

plan resulting from any inspection or 

examination conducted by the 

Commission’s staff. 

(c) Certifications. The reports 

provided for in paragraph (a) of this 

section, as well as any supplement 

provided for in paragraph (d) of this 

section, must be accompanied by a 

certification, executed by an exchange’s 

or association’s chief executive officer 

on behalf of, and with the authority of, 

the exchange or association, 

representing that the information 

contained in the respective report or 

amendment is current, true, and 

complete as of the date filed with the 

Commission. 

(d)(1) Interim changes to the 

regulatory program. Any material 

change to the regulatory program of a 

national securities exchange or 

registered securities association, or any 

material developments that affect such 

regulatory program, including any 

changes to the parameters used in 

surveilling for and enforcing 

compliance with the federal securities 

laws and rules and regulations 

thereunder and the exchange’s or 

association’s rules, including any new, 

revised, or terminated surveillance and 

enforcement programs that occurred 

since the filing of the prior quarterly 

report required by this section, must be 

reported in a supplemental filing with 

the Commission within ten business 

days of such change, along with a 

discussion of the reasons for such 

change. 

(2) Interim changes to the regulatory 

department or unit. Any material 

change to the organization or staffing of 

any regulatory or supervisory 

department or unit must be reported in 

a supplemental filing with the 

Commission within ten business days of 

such change, along with a discussion of 

the reasons for such change. 

(e) Confidentiality. All information 

submitted pursuant to this section will 

be accorded confidential treatment to 

the extent permitted by law. 

(f) Compliance date. Every national 

securities exchange and national 

securities association must comply with 

this section beginning with the first full 

quarterly reporting period commencing 

[six months from the date of publication 

of the final rule in the Federal Register]. 

(g) Extensions. Upon written request 

or on its own motion, the Commission 

may grant an extension of time for filing 

any reports or materials required by this 

section, if the Commission determines 

that such extension is necessary or 

appropriate in the public interest and is 

consistent with the protection of 

investors. 

(h)(1) Exemptions. Upon written 

request or on its own motion, the 

Commission may grant an exemption 

from any of the requirements of this 

section, either unconditionally or on 

specified terms and conditions, if the 

Commission determines that such 

exemption is necessary or appropriate 

in the public interest and is consistent 

with the protection of investors. 

(2) A national securities exchange 

registered pursuant to section 6(g) of the 

Act (15 U.S.C. 78f(g)), and a limited 

purpose national securities association 

registered pursuant to section 15A(k)(1) 

of the Act (15 U.S.C. 78o–3(k)(1)) are 

exempt from the requirements of this 

section. 

(i) Each report filed pursuant to this 

section shall constitute a ‘‘report’’

within the meaning of sections 17(a), 

18(a), and 32(a) of the Act (15 U.S.C. 

78q(a), 78r(a), and 78ff(a)), and any 

other applicable provisions of the Act. 

(j) Definitions. For purposes of this 

section, 

(1) The term Act means the Securities 

Exchange Act of 1934. 

(2) The term board means the Board 

of Directors or Board of Governors of a 

national securities exchange or 

registered securities association, or any 

equivalent body. 

(3) The term electronic SRO trading 

facility means a facility of an exchange 

or association that executes orders in 

securities on an electronic basis. 

(4) The term facility has the same 

meaning as set forth in section 3(a)(2) of 

the Act (15 U.S.C. 78c(a)(2)), or 

§ 240.15Aa–3, as applicable. 

(5) The term regulatory subsidiary

means any person that, directly or 

indirectly, is controlled by the national 

securities exchange or registered 

securities association and that provides, 

whether pursuant to contract, agreement 

or rule, regulatory services to or on 

behalf of the national securities 

exchange or registered securities 

association. 

(6) The term standing committee has 

the same meaning as defined in 

§ 240.6a–5(b)(21) for a national 

securities exchange and in § 240.15Aa–

3(b)(22) for a registered securities 

association. 

11. Section 240.17a–27 is added to 

read as follows:

§ 240.17a–27 Ownership of a national 

securities exchange, registered securities 

association, or facility of a national 

securities exchange or registered securities 

association. 

(a) Definitions. (1) The term Act

means the Securities Exchange Act of 

1934. 

(2) The term affiliate means, with 

respect to any person, any other person 

that directly or indirectly controls, is 

controlled by, or is under common 

control with, the person. 

(3) The terms beneficial ownership,

beneficially owns or any derivative 

thereof shall have the same meaning, 

with respect to any security or other 

ownership interest, as set forth in 

§ 240.13d–3, as if (and whether or not) 

such security or other ownership 

interest were a voting equity security 

registered under section 12 of the Act 

(15 U.S.C. 78l); provided that to the 

extent any person beneficially owns any 

security or other ownership interest 

solely because such person is a member 

of a group within the meaning of section 

13(d)(3) of the Act (15 U.S.C. 78m(d)(3)), 

such person shall not be deemed to 

beneficially own such security or other 

ownership interest for purposes of this 

section, unless such person has the 

power to direct the vote of such security 

or other ownership interest. 

(4) The term class of securities of a 

disclosure entity means the outstanding 

71226 Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / Proposed Rules 

securities of such class, exclusive of any 

securities of such class held by or for 

the account of the disclosure entity or 

a subsidiary of the disclosure entity. 

(5) The term control means the 

possession, direct or indirect, of the 

power to direct or cause the direction of 

the management and policies of a 

person, whether through the ownership 

of voting securities, by contract, or 

otherwise. A person is presumed to 

control another person if the person: 

(i) Is a director, general partner or 

officer exercising executive 

responsibility (or having similar status 

or functions); 

(ii) Directly or indirectly has the right 

to vote 25 percent or more of a class of 

voting securities or has the power to sell 

or direct the sale of 25 percent or more 

of a class of voting securities; or

(iii) In the case of a partnership, has 

the right to receive, upon dissolution, or 

has contributed, 25 percent or more of 

the capital. 

(6) The term disclosure entity means, 

with respect to a member, 

(i) A national securities exchange of 

which it is a member, other than an 

exchange registered pursuant to section 

6(g) of the Act (15 U.S.C. 78f(g)); 

(ii) A registered securities association 

of which it is a member, other than a 

limited purpose national securities 

association registered pursuant to 

section 15A(k)(1) of the Act (15 U.S.C. 

78o–3(k)(1)); and 

(iii) A facility of such national 

securities exchange or registered 

securities association through which it 

is permitted to effect transactions. 

(7) The term facility shall have the 

meaning in section 3(a)(2) of the Act (15 

U.S.C. 78c(a)(2)) or § 240.15Aa–3, as 

applicable. 

(8) The term immediate family 

member means a person’s spouse, 

parents, children, and siblings, whether 

by blood, marriage, or adoption, or 

anyone residing in such person’s home. 

(9) The term member shall have the 

meaning set forth in section 3(a)(3) of 

the Act (15 U.S.C. 78c(a)(3)). 

(10) The term national securities 

exchange means any exchange 

registered pursuant to section 6 of the 

Act (15 U.S.C. 78g). 

(11) The term person shall have the 

meaning in section 3(a)(9) of the Act (15 

U.S.C. 78c(a)(9)). 

(12) The term registered securities 

association means any association of 

brokers and dealers registered pursuant 

to section 15A of the Act (15 U.S.C. 

78o–3). 

(13) The term related person means, 

with respect to any member that is a 

broker or dealer: 

(i) Any affiliate of the member; 

(ii) Any person associated with the 

member; 

(iii) Any immediate family member of 

such member, or any immediate family 

member of the member’s spouse, who, 

in each case, has the same home as the 

member or who is a director or officer 

of the disclosure entity or any of its 

parents or subsidiaries; and 

(iv) Any immediate family member of 

a person associated with the member, or 

any immediate family member of that 

person’s spouse, who, in each case, has 

the same home as the person associated 

with the member or who is a director or 

officer of the disclosure entity or any of 

its parents or subsidiaries. 

(14) The term share means a share of 

stock in a corporation or unit of interest 

in an unincorporated person. 

(b)(1) Filing requirement. A member 

of a national securities exchange or 

registered securities association that is a 

broker or dealer must file with the 

Commission a statement containing the 

information required by paragraph (b)(2) 

of this section if such member, directly 

or indirectly, alone or together with its 

related persons, beneficially owns more 

than five percent of any class of 

securities or other ownership interest in 

a disclosure entity. 

(2) Required information. A statement 

that a member is required to file under 

paragraph (b)(1) of this section must 

include the following: 

(i) The title of the class of securities 

or other ownership interest for which 

the member is required to file this 

statement, and the identity and form of 

organization (e.g. LLC) of the disclosure 

entity; 

(ii) If the member is a corporation, 

general partnership, limited 

partnership, syndicate or other group of 

persons, its name, the state or other 

place of its organization, its principal 

business, the address of its principal 

business, and the address of its 

principal office; 

(iii) If the member is a natural person, 

his or her name, residence or business 

address, present principal occupation or 

employment, and the name, principal 

business and address of any corporation 

or other organization in which such 

employment is conducted; 

(iv) A description of the securities or 

other ownership interest that are the 

subject of the filing, including: 

(A) The total number of securities or 

other ownership interests issued and 

outstanding in each class or series; 

(B) If the securities are publicly 

traded, the market(s) where they trade; 

(C) Any restrictions on ownership, 

voting, transfers, or other disposition of 

such securities or other ownership 

interest; and 

(D) Any other material provisions 

relating to ownership of the disclosure 

entity; 

(v) Whether such disclosure entity is 

a reporting issuer under section 12 of 

the Act (15 U.S.C. 78l); 

(vi)(A) The aggregate number and 

percentage of shares of a class of 

securities or other ownership interest in 

such disclosure entity that are 

beneficially owned by the member; 

(B) The aggregate number of shares or 

ownership interest as to which the 

member: 

(1) Has the sole power to vote or to 

direct the vote; 

(2) Has shared power to vote or to 

direct the vote; 

(3) Has sole power to dispose or to 

direct the disposition; 

(4) Has shared power to dispose or to 

direct the disposition; and 

(C) If any other person is known to 

have the right to receive or the power 

to direct the receipt of dividends from, 

or the proceeds from the sale of, such 

securities or other ownership interest, a 

statement to that effect should be 

included in response to this section and, 

if such interest relates to more than five 

percent of the securities or other 

ownership interest, such person should 

be identified; provided that, a listing of 

the shareholders of an investment 

company registered under the 

Investment Company Act of 1940 or the 

beneficiaries of an employee benefit 

plan, pension fund or endowment fund 

is not required. 

(vii) Separately identify each related 

person whose ownership in a disclosure 

entity is included in the calculation of 

beneficial ownership required to be 

disclosed by the member pursuant to 

this paragraph (b) and state the 

aggregate number and percentage of 

shares of a class of securities or other 

ownership interest in such disclosure 

entity that are beneficially owned by the 

related person. For each related person 

identified provide the following 

information: 

(A) Indicate the aggregate number of 

shares or ownership interest as to which 

the related person: 

(1) Has the sole power to vote or to 

direct the vote; 

(2) Has shared power to vote or to 

direct the vote; 

(3) Has sole power to dispose or to 

direct the disposition; 

(4) Has shared power to dispose or to 

direct the disposition; and 

(B) If any other person is known to 

have the right to receive or the power 

to direct the receipt of dividend from, or 

the proceeds from the sale of, such 

securities or other ownership interest, a 

statement to that effect should be 

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included in response to this provision 

and, if such interest relates to more than 

five percent of the securities or other 

ownership interest, such person should 

be identified; provided that, a listing of 

the shareholders of an investment 

company registered under the 

Investment Company Act of 1940 or the 

beneficiaries of an employee benefit 

plan, pension fund or endowment fund 

is not required; 

(viii) For each member and its related 

persons, indicate whether and how such 

member, alone or together with its 

related persons, possesses the power, 

directly or indirectly, to direct or cause 

the direction of the management and 

policies of the disclosure entity, 

whether through ownership of voting 

securities, by contract, or otherwise; 

(ix) Specifically describe the ability of 

each member and its related persons, 

through governance provisions or 

otherwise, to exercise any influence or 

control over the regulatory 

responsibilities of the exchange or 

association; and 

(x) A description of any contracts, 

arrangements, understandings or 

relationships (legal or otherwise) among 

the member and its related persons and 

between such persons and any other 

person with respect to any securities or 

other ownership interest of the 

disclosure entity, including but not 

limited to transfer or voting of any of the 

securities or other ownership interest, 

finder’s fees, joint ventures, loan or 

option arrangements, put or calls, 

guarantees of profits, division of profits 

or loss, or the giving or withholding of 

proxies. Name the persons with whom 

such contracts, arrangements, 

understandings or relationships have 

been entered into. Include such 

information for any of the securities or 

other ownership interest that are 

pledged or otherwise subject to a 

contingency the occurrence of which 

would give another person voting power 

or investment power over such 

securities or interest except that 

disclosure of standard default and 

similar provisions contained in loan 

agreements need not be included. 

(3) Timing of initial filing. A member 

must file a statement containing the 

information specified in paragraph 

(b)(2) of this section within 10 calendar 

days after becoming subject to such 

filing requirement under paragraph 

(b)(1) of this section.

(4) Periodic update. A member must 

file an amendment to the statement 

required pursuant to paragraph (b)(1) of 

this section within ten calendar days of 

any change in the information specified 

under paragraph (b)(2) of this section, 

except in the event of an increase or 

decrease of less than 1 percent of 

ownership of a class of securities or 

other ownership interest last reported 

on the statement filed pursuant to 

paragraph (b)(1) of this section, or any 

amendment thereto. 

(c) Copy to exchange or association.

The member shall provide a copy of the 

statement required by paragraph (b)(1) 

and amendment required by paragraph 

(b)(4) of this section to the disclosure 

entity if the disclosure entity is a 

national securities exchange or 

registered securities association, or to 

the applicable national securities 

exchange or registered securities 

association, if the disclosure entity is a 

facility. 

(d) SRO posting requirements. A 

national securities exchange or 

registered securities association must 

continuously post any statement 

received from a member pursuant to 

paragraph (c) of this section on a 

publicly-accessible Web site controlled 

by the exchange or association within 

ten calendar days of receipt of such 

statement. 

(e) Other provisions. (1) Each 

statement filed pursuant to this section 

shall constitute a ‘‘report’’ within the 

meaning of sections 17(a), 18(a), and 

32(a) of the Act (15 U.S.C. 78q(a), 78r(a), 

and 78ff(a)), and any other applicable 

provisions of the Act. 

(2) Each statement filed pursuant to 

this section shall be considered filed 

upon receipt by the Division of Market 

Regulation at the Commission’s 

principal office in Washington, DC. 

(f) Exemptions. Upon written request 

or on its own motion, the Commission 

may grant an exemption from the 

provisions of this section, either 

unconditionally or on specified terms 

and conditions, if the Commission 

determines that such exemption is 

necessary or appropriate in the public 

interest and is consistent with the 

protection of investors.

PART 242—REGULATIONS M, ATS, 

AC, NMS, AL, B and SHO AND 

CUSTOMER MARGIN REQUIREMENTS 

FOR SECURITY FUTURES 

12. The authority citation for part 242 

continues to read as follows:

Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 

78b, 78c, 78g(c)(2), 78i(a), 78j, 78k–1(c), 78l, 

78m, 78n, 78o(b), 78o(c), 78o(g), 78q(a), 

78q(b), 78q(h), 78w(a), 78dd–1, 78mm, 80a–

23, 80a–29, and 80a–37.

13. The part heading for part 242 is 

revised as set forth above. 

14. Part 242 is amended by adding an 

undesignated center heading and 

§ 242.800, to read as follows: 

Regulation AL—National Securities 

Exchanges and Registered Securities 

Associations Listing and Trading 

Affiliated Securities

§ 242.800 Regulation AL; National 

securities exchanges and registered 

securities associations listing and trading 

affiliated securities. 

(a) Definitions. For purposes of this 

section: 

(1) The term Act means the Securities 

Exchange Act of 1934. 

(2) The term affiliate means, with 

respect to any person, any other person 

that directly or indirectly controls, is 

controlled by, or is under common 

control with, the person. 

(3) The term affiliated issuer means: 

(i) With respect to a national 

securities exchange, the national 

securities exchange, an SRO trading 

facility of the national securities 

exchange, an affiliate of the national 

securities exchange, or an affiliate of an 

SRO trading facility of the national 

securities exchange, and 

(ii) With respect to a registered 

securities association, the registered 

securities association, an SRO trading 

facility of the registered securities 

association, an affiliate of the registered 

securities association, or an affiliate of 

an SRO trading facility of the registered 

securities association. 

(4) The term affiliated security means 

any security issued by an affiliated 

issuer, except that it shall not include 

any option exempt from the Securities 

Act of 1933 under § 230.238 of this 

chapter and any security futures 

product exempt from the Securities Act 

of 1933 under section 3(a)(14) of the 

Securities Act of 1933 (15 U.S.C. 

77c(a)(14)). 

(5) The term control means the 

possession, direct or indirect, of the 

power to direct or cause the direction of 

the management or policies of a person, 

whether through ownership of voting 

securities, by contract, or otherwise. A 

person is presumed to control another 

person if the person: 

(i) Is a director, general partner or 

officer exercising executive 

responsibility (or having similar status 

or functions); 

(ii) Directly or indirectly has the right 

to vote 25 percent or more of a class of 

voting securities or has the power to sell 

or direct the sale of 25 percent or more 

of a class of voting securities; or 

(iii) In the case of a partnership, has 

the right to receive, upon dissolution, or 

has contributed, 25 percent or more of 

the capital. 

(6) The term SRO trading facility

means any facility of a national 

securities exchange or registered 

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securities association that executes 

orders in securities. 

(7) The term facility shall have the 

meaning in section 3(a)(2) of the Act (15 

U.S.C. 78c(a)(2)) and § 240.15Aa–3 of 

this chapter. 

(8) The term member shall have the 

meaning in section 3(a)(3) of the Act (15 

U.S.C. 78c(a)(3)). 

(9) The term regulatory oversight 

committee means a committee of the 

national securities exchange or 

registered securities association as 

required by § 240.6a–5(j) or § 240.15Aa–

3(j) of this chapter. 

(b) Listing and trading of affiliated 

securities. (1) A national securities 

exchange or registered securities 

association may not approve for listing 

an affiliated security unless such 

exchange’s or association’s regulatory 

oversight committee certifies that such 

security satisfies the exchange’s or 

association’s rules for listing. 

(2) If an affiliated security is listed on, 

approved for trading on, or trades 

pursuant to the rules of, a national 

securities exchange or registered 

securities association, the exchange or 

association must: 

(i) File with the Commission not more 

than 30 calendar days after the end of 

each calendar quarter a report that: 

(A) Summarizes such exchange’s or 

association’s monitoring of the affiliated 

security’s compliance with exchange’s 

or association’s listing rules, including a 

statement regarding such affiliated 

security’s compliance with each 

applicable rule; and 

(B) Summarizes such exchange’s or 

association’s surveillance of the trading 

of the affiliated security by the 

exchange’s or association’s members; 

(ii) File with the Commission not 

more than 60 calendar days after the 

end of such exchange’s or association’s 

fiscal year a report prepared by a third 

party analyzing compliance by the 

affiliated security with the exchange’s or 

association’s listing rules; 

(iii) Notify the affiliated issuer 

promptly if the exchange or association 

alleges that the affiliated security is not 

in compliance with any applicable 

listing rule of the exchange or 

association; 

(iv) Within five business days of 

notifying an affiliated issuer under 

paragraph (b)(2)(iii) of this section, file 

a report with the Commission that 

identifies the date the exchange or 

association alleged that the affiliated 

security was not in compliance, the 

listing rule(s) with which the exchange 

or association alleged such affiliated 

security failed to comply, the action the 

exchange or association proposes to take 

with respect to such affiliated security, 

and any other material information 

conveyed to the affiliated issuer; and 

(v) Provide the Commission with a 

copy of any response from the affiliated 

issuer regarding the exchange’s or 

association’s allegation that its affiliated 

security failed to comply with exchange 

or association rules within five business 

days of receipt of such response. 

(c) Regulatory Oversight Committee 

approval. (1) The exchange’s or 

association’s regulatory oversight 

committee must approve the reports 

required to be filed pursuant to 

paragraphs (b)(2)(i) and (b)(2)(iv) of this 

section prior to filing with the 

Commission. 

(2) Within five business days of 

receipt, the exchange or association 

must provide to the exchange’s or 

association’s regulatory oversight 

committee a copy of the report prepared 

by a third party pursuant to paragraph 

(b)(2)(ii) of this section and any 

response received from an affiliated 

issuer that is provided to the 

Commission pursuant to paragraph 

(b)(2)(v) of this section. 

(d) Application of rules. Except as 

otherwise required by this section:

(1) Any action taken by the national 

securities exchange or registered 

securities association with regard to the 

listing of an affiliated security must be 

in compliance with the rules of the 

exchange or association; 

(2) The exchange or association must 

not apply the same listing rules to 

affiliated securities in a manner that is 

materially different than the treatment 

afforded to other securities listed on the 

exchange or association; and 

(3) Any action taken by the exchange 

or association with regard to trading of 

an affiliated security by the exchange’s 

or association’s members must be in 

compliance with the rules of the 

exchange or association and with the 

federal securities laws, and must not be 

materially different than action taken 

with respect to the trading of other 

securities traded on the exchange or 

association. 

(e) Other provisions. (1) Each report 

filed pursuant to paragraphs (b)(2)(i), 

(b)(2)(ii), and (b)(2)(iv) of this section 

shall constitute a ‘‘report’’ within the 

meaning of sections 17(a), 18(a), and 

32(a) of the Act (15 U.S.C. 78q(a), 78r(a), 

and 78ff(a)), and any other applicable 

provisions of the Act. 

(2) Each report or response filed 

pursuant to this section shall be 

considered filed upon receipt by the 

Division of Market Regulation at the 

Commission’s principal office in 

Washington, DC. 

(f) Exemptions. Upon written request 

or on its own motion, the Commission 

may grant an exemption from the 

provisions of this section, either 

unconditionally or on specified terms 

and conditions, if the Commission 

determines that such exemption is 

necessary or appropriate in the public 

interest and is consistent with the 

protection of investors.

PART 249—FORMS, SECURITIES 

EXCHANGE ACT OF 1934

15. The authority citation for part 249 

continues to read in part as follows:

Authority: 5 U.S.C. 78a et seq. and 7201 et 

seq.; and 18 U.S.C. 1350, unless otherwise 

noted.

* * * * *

16. Form 1 (referenced in § 249.1) is 

revised to read as follows:

Note: The text of Form 1 does not and this 

amendment will not appear in the Code of 

Federal Regulations.

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17. Section 249.2 and Form 2 

(referenced in § 249.2) are added to read 

as follows:

§ 249.2 Form 2, for application for, and 

amendments to applications for, 

registration as a registered securities 

association or affiliated securities 

association. 

The form shall be used for application 

for, and amendments to applications for, 

registration as a registered securities 

association or affiliated securities 

association.

Note: The text of Form 2 does not and this 

amendment will not appear in the Code of 

Federal Regulations.


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§§ 249.801, 249.802, and 249.803

[Removed] 

18. Sections 249.801, 249.802, and 

249.803 are removed.

Dated: November 18, 2004. By the Commission. 

Margaret H. McFarland, 

Deputy Secretary.

[FR Doc. 04–26153 Filed 12–7–04; 8:45 am] 

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