Via Electronic Delivery 

Ms. Eileen Donovan 

Acting Secretary 

Received CFTC 

Record' Section 

'follo7 

April 25, 2007 

Commodity Futures Trading Commission 

Three Lafayette Centre 

1155 21 51 Street, NW 

Washington, DC 20581 

• ~I "-•'. . ' :r, .. 

) I -- ' - • • ....._ 

•. ~ .. -· . r--·· "'·-:-> 

\,.' • < ' .' /_. .) 

.... 

~ 

1 

~· COMMENT 

• .. ...... 

Re: Conflicts of Interest in Self-Regulatory Organizations; 72 Fed. Reg. 14,051 

(March 26, 2007) 

Dear Ms. Donovan: 

I. Introduction 

The Chicago Mercantile Exchange Inc. ("CME") has twice commented on the 

Commodity Futures Trading Commission's ("Commission" or "CFTC") rules respecting Core 

Principle 15. On September 7, 2006, CME provided extensive comments: (1) challenging the 

Commission's authority under the Act to adopt the proposed prescriptive rule in the form of an 

acceptable practice, and (2) demonstrating that the acceptable practice was not related to 

compliance with Core Principle 15 of the Commodity Exchange Act ("CEA" or "Act"). The 

issues raised by CME's comments were not fairly addressed by the Commission's final rule 

published in the Federal Register on February 14, 2007. In fact, the problems with the 

proposed rule were exacerbated by material alterations adopted subsequent to the close of the 

comment period. 

On March 13, 2007, CME, with other exchanges, petitioned the Commission to repeal 

the definition of "public director" in the final rule. The exchanges urged the Commission to 

retract the public director definition because compliance would be infeasible and because the 

definition materially deviated from the definition in the proposed rule published for public 

comment. The exchanges argued that the final public director definition was not a logical 

outgrowth of the proposed rule and therefore did not comply with the notice and comment 

requirements of the Administrative Procedure Act. The exchanges reserved all of their prior 

arguments that the rule exceeded the Commission's authority. 

On March 26, 2007, the Commission's proposed technical amendments to the 

acceptable practices for Core Principle 15 were published in the Federal Register. The 

proposed revisions were a commendable effort to cure the over-breadth of the final rule. 

Unfortunately, the corrections to the technical drafting errors contained in the February 14, 2007 

version of the rule do not cure the fundamental problems described in CME's prior comments. 

We believe that the drafting problems are symptomatic of the rule's lack of foundation in the 

language or intent of the CEA. 

• 

.i 

0 

* 
Ms. Eileen Donovan 

April 25, 2007 

Page 2 

II. Summary of Prior Arguments 

The Commission's final rule, mistitled as an acceptable practice, imposes a board 

composition requirement on publicly-owned designated contract markets ("DCMs"), requires an 

arbitrary percentage of "public" directors, imposes a test that can not practically be performed or 

satisfied, and imposes prescriptive rules for regulatory oversight committees ("ROC") and 

disciplinary panels. The CEA does not grant the Commission authority to require an arbitrary 

minimum percentage of "public" directors on publicly-traded DCM boards. The relevant Core 

Principle, 14, which is not cited by the Commission as authority, provides: 

(14) Governance fitness standards 

The board of trade shall establish and enforce appropriate fitness 

standards for directors, members of any disciplinary committee, members 

of the contract market, and any other persons with direct access to the 

facility (including any parties affiliated with any of the persons described 

in this paragraph). 

The Act directs the exchange, not the Commission, to establish such standards. CME is 

in full compliance with Core Principle 14 and with Core Principle 15, which provides: 

(15) Conflicts of interest 

The board of trade shall establish and enforce rules to minimize conflicts of 

interest in the decisionmaking process of the contract market and establish a 

process for resolving such conflicts of interest. 

CME's fitness and conflict of interest standards, which are publicly available, are consistent with 

corporate governance best practices. Additionally, the Act does not grant the Commission 

power to dictate the formation or conduct of a ROC. The proposed safe harbor for Core 

Principle 15 bears no reasonable relationship to the Core Principle upon which it rests. CME's 

comment letter of September 7, 2006, demonstrated that: 

• The proposed acceptable practices impermissibly impose required means for 

complying with the Core Principles that contravene the performance 

standards approach of the Commodity Futures Modernization Act. 

• The Commission does not have statutory authority to regulate board 

composition of demutualized exchanges or to regulate the board's decisionmaking process and the day-to-day operations of board committees. 

• The obligation of CME's directors to serve the needs of all market participants 

is defined and controlled by CME's obligation to ensure that we fully comply 

with all of our legal obligations. The Commission's formulation of this 

responsibility seems to go beyond these parameters and impose an 

unidentified obligation on our directors to act in a manner that serves the 

interest of market participants which may be inconsistent with his or her 

fiduciary duties under Delaware law. 
Ms. Eileen Donovan 

April 25, 2007 

Page 3 

• The Commission failed to consider the costs and benefits of the proposed 

acceptable practices as required by the Act. 

• The Commission relied on uninformed and biased speculation to support its 

efforts to dictate board structure for demutualized exchanges. Its own orders, 

investigations and rule compliance reviews demonstrated that demutualized 

exchanges have properly performed their statutory functions under their 

previously approved conflict of interest rules and policies. 

• There is no basis to conclude that a "public" director will have a greater 

incentive than any exchange or other industry member would have to make 

the optimal investment in self-regulation. 

• The proposed acceptable practices impose inflexible uniform requirements 

upon all exchanges without regard to the nature of a particular exchange or 

the futures products traded on that exchange. 

• To the extent this proposal evidences a return to a prescriptive regulatory 

regime, U.S. exchanges will be unfairly disadvantaged vis-a-vis their 

European counterparts, which are able to compete more effectively under 

flexible, principles-based guidelines. 

Ill. Notwithstanding the Proposed Amendments, the Acceptable Practices Remain 

Flawed 

Our March 13, 2007 petition highlighted a number of problematic consequences of the 

final rule. While the Commission now suggests that those inequities flowed purely from drafting 

errors, those problems were informally discussed with the Commission before the final rule was 

published. The proposed corrections slightly mitigate some of those consequences, but they 

are far from cured. For example, to determine whether the Commission's identified $100,000-

in-payments disqualifying threshold for potential public directors is being reached in a given 

case requires an inquiry into whether the total payment made by all exchange members, and 

the affiliates of those members, to any of the entities with which a purported non-industry 

director is affiliated totaled more than $100,000 during the previous year or were likely to total 

$100,000 at any time during her tenure as a director. As we noted on March 13: "The range of 

the required inquiry [to determine whether a director is "public"] is astronomical. CME currently 

has 3,000+ persons who own memberships, 1 ,500+ persons who lease memberships and 1 00+ 

persons who are deemed members for the purpose of participating in certain CME incentive 

programs." Neither CME, nor any person seeking to qualify as an independent director, can 

reasonably identify the affiliates of those thousands of "members." Compounding the problem 

is the requirement to conduct a similarly implausible analysis for each immediate family member 

of the director. 

The proposed revisions do eliminate complexities related to this test, in particular the 

need to identify and assess relationships between the directors and "affiliates of members." 

The revisions also limit the definition of "payments" to "professional fees," however, the term 

"professional fees" is not even defined. It is not clear whether professional fees include those 

fees charged by doctors, lawyers, accountants, architects, speakers, writers, or other 

categories. It is not clear why fees in a non-defined "professional" category should be subject to 

some kind of disfavored status. 
Ms. Eileen Donovan 

April 25, 2007 

Page4 

The scope of the Commission's definition would automatically preclude a large number 

of persons from serving as "public" directors. It is fair to ask whether the Commission tested the 

scope of its definition by applying it to the talent pools from which great institutions try to draw 

their "public" directors. By way of example, in Chicago, Northwestern Hospital has an 

extraordinary reputation and treats many in the financial services industry. It certainly receives 

more than $100,000 in annual payments from members or officers or directors of members of 

contract markets. Presumably, the Commission's rule would preclude from service as public 

directors everyone who is an employee, officer or director of the hospital. Similarly, employees, 

directors or officers of many large institutions or companies that provide goods and services to 

the public could also be excluded from the pool of "public" directors. 

The changes that were made to correct what the Commission has categorized as 

"drafting errors" do not provide any significant relief. The definition of "public director" no longer 

begins with an inquiry into the firms with which a director is affiliated. Instead, the Commission 

proposes an objective test that examines direct payments to the exchange director or to a firm 

of which that exchange director is an employee, officer, or director. This is an improvement but 

the Commission did not adopt a relevance or materiality exception for the employee category. 

Thus, one is affiliated with a firm or company regardless of the capacity in which one is 

employed. It does not make sense that the managing partner at a major law firm is on a par 

with a clerk at that firm. Additionally, it is not clear why the payment of professional fees 

exceeding the $100,000 limit to a law firm employing a candidate's immediate family member in 

any capacity should preclude him from serving as an independent director. 

IV. The Commission's Comments Regarding ROCs Should be Tempered 

The proposed revisions do not fix the disconnect between the Commission's comments 

regarding the final rules for ROCs, which impose requirements beyond the plain language of the 

final rules, and the Commission's rulemaking authority. For example, the Commission states 

that ''ROCs have the absolute right to whatever resources and authority they may require to 

fulfill their responsibilities, including resources within their DCMs." 72 Fed. Reg. at 6951. The 

Commission also purports to regulate the ROCs' choice of counsel, stating that ''ROCs should 

not rely on outside professionals or firms that also provide services to the full board, other board 

committees, or other units or management of their DCMs." J.sl at n.78. There is no basis for the 

Commission to dictate the ROC's choice of professional advisers. Similarly, the Commission's 

comments state that ROCs must determine regulatory budgets and supervise and manage 

regulatory personnel. We are concerned that the Commission's comments prescribe a far 

broader managerial role for ROCs than do the final acceptable practices and that DCMs cannot 

effectively govern themselves when the day-to-day management of DCMs must be channeled 

substantially through ROCs. 

V. Conclusion 

The ongoing inability of the Commission to express adequately the "intent" of the rule 

does not appear to be a drafting problem-it flows from the lack of legitimate purpose and 

principle that informed the Commission's decision to control the characterization of a director 

rather than to control her quality and the independence of her decision-making. The 

Commission's effort to force exchanges to fill their boards with so-called "public" directors is a 

solution to an unidentified problem. Three years of careful study demonstrated no need for 

such a rule. We hereby renew our March 13, 2007 petition and respectfully ask the 

Commission to repeal the definition of "public director'' in the acceptable practices for Core 
Ms. Eileen Donovan 

April 25, 2007 

Page 5 

Principle 15, 17 CFR Part 38, and to delete in its entirety the acceptable practice for Core 

Principle 15. It is unlikely that an exchange can make the certification required by the final 

rules. There is a very direct and meaningful way in which to draft an acceptable practice for 

Core Principle 15 and we would be pleased to participate in that effort. We also renew our 

petition to the Commission to repeal its comments to the final rule regarding ROCs because 

those comments differ substantially from the terms of the acceptable practice. 

Thank you for the opportunity to comment upon the Commission's proposed rule 

amendments. If you have any questions or comments, please do not hesitate to contact either 

of us, Richard Lamm, CME Managing Director and Regulatory Counsel, at (312) 930-2041, or 

Matthew F. Kluchenek, CME Director and Associate General Counsel, at (312) 338-2861. 

6~5' s: glltf~ Craig S. Donohue 

Chicago Mercantile Exchange Inc. 

Jeff C. Borchardt 

Kansas City Board of Trade 

cc: Chairman Reuben Jeffery 

Commissioner Michael Dunn 

Commissioner Walter Lukken 

Respectfully submitted, 

Chicago Mercantile Exchange Inc. 

and 

Kansas City Board of Trade