NATIONAL FUTURES ASSOCIATION 

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November 13, 2008 

COMMENT 

Via E-Mail (secretarv@cftc.gov) 

Mr. David Stawick 

Secretary 

Commodity Futures Trading Commission 

Three Lafayette Centre 

1155 21st Street, N.W. 

Washington, D.C. 20581 

Received CFTC 

Records Section 

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Re: Joint Audit Committee, 73 Fed. Reg. 52832 (September 11, 2008) 

Dear Mr. Stawick: 

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Self-regulation plays a crucial role in ensuring that futures commission 

merchants (FCMs) are financially solvent and conduct themselves equitably in their 

dealings with customers. When self-regulatory organizations (SROs) all attempt to 

audit dual members, however, the process becomes inefficient for both the FCMs and 

the SROs. The Joint Audit Agreement (Agreement) is designed to eliminate duplicate 

audits and make the process more efficient. 

The original Agreement has been in effect since 1984, and NFA has been 

a party to the Agreement since it was adopted. In 2004, the Joint Audit Committee 

(JAC), which is responsible for implementing the Agreement, attempted to update the 

then two-decades old Agreement. Although NFA voted for most of the provisions, it 

objected to two: voting rights and the procedures for assigning an SRO to be an FCM's 

designated self-regulatory organization (DSRO). 

As the Commission noted in its September 11, 2008 Federal Register 

release, JAC has made additional changes to the Agreement since 2004. Those 

changes do not eliminate the concerns that NFA raised in its June 16, 2004 comment 

letter, however. We refer you to that letter (which is attached) for our comments on the 

provisions relating to voting rights and DSRO assignments. We would also like to 

emphasize several points regarding voting rights. 

300 South Riverside Plaza Suite 1800 Chicago, Illinois 60606 312.781.1300 800.621.3570 312.781.1467 fax www.nfa.futures.org 

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Certain aspects of the voting rights section have changed since the 2004 

version. One significant change eliminates the discrimination between parties who 

became signatories before 2000 and those who became signatories during or after 

2000, which is a step in the right direction. Unfortunately, the most problematic part of 

this section remains unchanged-the 2008 version continues to disenfranchise both 

non-DSROs and those DSROs that subcontract their auditing activities to another entity. 

Under this provision, only three of the current Parties would have a vote: the Chicago 

Mercantile Exchange, the Kansas City Board of Trade, and NFA. 

In practice, JAC functions primarily as a consultative committee. The 

existing agreement calls for the majority of JAC parties to elect officers but does not 

affirmatively require a vote on any other issues, such as audit steps. That will not 

change under the revised Agreement. Therefore, for the most part, voting rights are 

irrelevant. 

Where they do become relevant, however, is for amendments to the 

Agreement. None of the three versions ( 1984, 2004, and 2008) provide for either the 

parties or the voting members to vote on amendments to the agreement. In practice, 

however, that is how the JAC adopts changes when the parties cannot reach a 

consensus, and we recognize that it is the only workable solution. 

All three versions (1984, 2004, and 2008) say that the Agreement may not 

be modified except "in writing duly executed by each of the parties." On the surface, 

this language gives every party a veto, but as a practical matter it leaves dissenting 

parties with two options: go along or get out. Therefore, it remains crucial for each 

party to have a voice in any amendments, particularly where they may impose 

increased costs on the party.1 

As an example, Paragraph 7 of the 2008 version of the agreement 

provides-as did the 2004 version-that "each of the parties will bear its own costs and 

expenses associated with its activities as DSR0."2 Under the proposed agreement, 

those parties with voting rights could presumably amend the agreement to change this 

provision and impose costs on parties without voting rights. While we are not 

suggesting this is likely to happen, it does illustrate the pitfalls in the proposed voting 

rights provisions. 

1 We note that the 2008 version provides that parties under common control have only 

one vote, and we support this change. It does not affect our argument, however. 

Parties under common control presumably speak with one voice, and they exercise that 

voice through their voting representative. A DSRO that contracts out its auditing 

responsibilities may have a conflicting view from its subcontractor, however, and 

denying it a vote can deny it a voice. 

2 The 2008 version deletes a provision that would have allowed JAC (presumably 

through its voting parties) to approve extraordinary expenses and make non-voting 

parties share the cost. We support this change. 
Lastly, Paragraph 13 of the amended Agreement gives the voting 

members the right to vote on adding new parties. We believe it is important for all 

futures SROs with FCM members to participate in JAC. Therefore, we would prefer to 

delete this provision. 

NFA recommends amending Paragraph 13 to read as follows: 

13. Amendments. This agreement may not be amended or modified 

except upon majority vote of all Parties (regardless of whether they are 

considered voting Parties for other purposes). 

For the reasons stated in this letter and in our June 16, 2004 letter, NFA 

asks the Commission to consider the effect of the provisions on voting rights and 

DSRO assignments before determining whether the agreement meets the objectives 

described in Regulation 1.52(g) and is in the public interest. If you have any questions 

regarding the comments in either letter, please contact me (312-781-1413 or 

tsexton@nfa.futures.org) or Kathryn Camp (312-781-1393 or kcamp@nfa.futures.org). 

Respectfully submitted, 

Thomas W. Sexton 

Senior Vice President and General Counsel 

Attachment 

(kpc/Comment Letters/JAG Agreement-2) 
NATIONAL FUTURES ASSOCIATION 

Via E-Mail (Secretarv@cftc.gov) 

Ms. Jean A. Webb 

Secretary 

Commodity Futures Trading Commission 

Three Lafayette Centre 

1155 21st Street, N.W. 

Washington, D.C. 20581 

June 16, 2004 

Re: Futures Market Self-Regulation, 69 Fed. Reg. 19166 (April12, 2004) 

Dear Ms. Webb: 

Self-regulation plays a vital role in the futures industry. Experience has 

shown that self-regulation - subject to appropriate governmental oversight- maximizes 

regulatory effectiveness while minimizing regulatory burdens and saving taxpayers 

money. Having multiple self-regulatory organizations (SROs) can increase regulatory 

effectiveness where they regulate different entities or different activities, but it can result 

in unnecessary duplication when membership and responsibilities overlap, creating 

inefficiencies for both the SROs and the people they regulate. Since 1978, the 

Commission has sought to alleviate this problem by encouraging the SROs to allocate 

FCM auditing and financial surveillance responsibilities among themselves by assigning 

each FCM to a designated self-regulatory organization (DSRO). NFA supports this 

approach because it eliminates unnecessary duplication. 

NFA has been a party to the Joint Audit Agreement (JAA) and an active 

participant in the Joint Audit Committee (JAC)- which is responsible for implementing 

the JAA - since the JAA was adopted in 1984.3 We participated in the process to revise 

the JAA, and we voted to support most of its provisions. We particularly support those 

provisions that merge the separate sales practice agreement into the JAA. NFA 

3 Prior to that time, NFA participated in two joint audit plans that were superseded by 

the 1984 agreement. 

200 West Madison Street Suite 1600 Chicago, Illinois 60606 312.781.1300 800.621.3570 312.781.1467 fax www.nfa.futures.org 
Ms. Jean A. Webb 2 June 16, 2004 

dissented, however, on two significant provisions: voting rights and assignment 

procedures. 

The current JAA worked well when it was adopted. Since 1984, however, 

innovation and rapid change have altered the landscape of the futures industry. Futures 

exchanges are now competing for business in the same products, which creates 

potential conflicts-of-interest in the auditing process. Many exchanges are no longer 

DSROs, and not all DSROs conduct their own audits. And NFA, which was still a 

fledgling organization in 1984, now has a proven track record of operating efficient and 

effective regulatory programs in a number of areas, including operational audits and 

financial surveillance of exchange-member FCMs. 

The Commission's release asks commenters to address eight issues 

raised by the revised JAA. We will start with the two provisions we voted against when 

JAC considered the recent amendments. We will then discuss the remaining issues in 

order. 

Issue 2: Voting Rights 

All JAC members should be allowed to vote. The public interest- and, in 

fact, everyone's interest - dictates that SROs should conserve resources and avoid 

legal confusion by harmonizing rules in areas subject to joint regulation, coordinating 

audits, and sharing information. JAC is the vehicle for achieving these public benefits. 

Every SRO has the right- whether or not it chooses to exercise all of those rights- to 

adopt rules, perform audits, and share information. Therefore, every JAC member 

should be able to vote.4 

The existing JAA states that each member gets one vote. In recent years, 

however, JAC has conditioned membership by new exchanges on waiving those voting 

rights. 5 

The revised JAA provides that only two groups of members can vote: 

those that are DSROs and conduct their own auditing activities, and those that became 

members before 2000 regardless of whether they are DSROs or conduct their own 

auditing activities. We voted against this provision and continue to object to it. 

4 Since FCMs can own and carry positions on multiple exchanges, no SRO has a 

complete picture of the financial risk to the exchanges and their clearing organizations. 

Therefore, all SROs must share information to help guard against systemic risk. This 

makes it particularly important for all SROs to participate in JAC and have voting rights. 

5 While NFA preferred that these exchanges be voting members, we felt it was 

important for them to participate in JAC even if they did not receive voting rights. 
Ms. Jean A. Webb 3 June 16, 2004 

The exchanges argue that the voting provisions simply maintain the status 

quo, and they are correct. They are not right, however. Just because something was 

done in the past does not mean it was right at the time and is certainly not a justification 

for continuing to do it. The grandfathering provision for pre-2000 members protects 

established exchanges while discriminating against new entrants. It is simply unfair to 

hinge voting rights on the age of the exchange. 

On the other hand, we can understand why some DSROs would be 

concerned about giving non-DSROs an equal voice on auditing matters. We would be 

happy to discuss alternatives that address this concern without disenfranchising nonDSROs on other JAC issues. For example, at the February 2001 JAC meeting, NFA 

proposed amending the JAA to provide that only DSROs with 5 or more firms had the 

right to vote on issues affecting the JAC audit programs but that all members could 

vote on issues that affect the overall agreement. JAC never voted on this proposal. 

We prefer that all JAC members have voting rights. If that approach is not 

adopted, however, then at least all DSROs should have voting rights. A DSRO is and 

should be responsible for the effectiveness of its audit and financial surveillance 

programs regardless of whether it conducts its own audits or outsources them to a third 

party. Therefore, all DSROs should have voting rights. 

Issue 3: DSRO Assignments 

NFA also dissented from and continues to object to the provision that 

governs how FCMs are assigned to a particular DSRO. The existing JAA does not 

specify how DSRO assignments will be made, while the revised agreement would codify 

the assignment procedures that JAC follows in practice. This proposed amendment to 

the JAA is out-of-step with the rapid changes in the futures industry. 

We believe it is a bad idea to codify assignment procedures in the JAA. 

The need for flexibility is demonstrated by the very fact that the JAA has not been 

amended in twenty years even though the industry has undergone rapid change. 

Furthermore, the JAA provides that it cannot be amended without the signature of each 

party. Therefore, although amendments don't necessarily require a unanimous vote, 

any party can stymie them by simply refusing to sign the revised agreement. Codifying 

the assignment procedures in the JAA will eliminate any flexibility to adapt those 

procedures as the industry changes.6 

Leaving the assignment process out of the JAA will also give JAC and the 

Commission time to consider the viability of various alternate assignment processes. 

For example, one possibility is for all the SROs of which the FCM is a member to meet 

at least once a year and decide how to divide up those FCMs, with any disagreements 

6 We do believe that the assignment procedures should be reduced to writing and 

formally adopted by JAC, however. 
Ms. Jean A. Webb 4 June 16, 2004 

being resolved by majority vote of those SROs. Another possibility is to adopt 

assignment procedures similar to those used by the securities options SROs under the 

Plan for Allocation of Regulatory Responsibilities. 7 

If the assignment procedures are codified in the JAA, however, using 

some variant of the current procedure, then NFA believes at the very least that all 

participants should have the same right of first refusal. The proposed revision gives 

exchanges that conduct their own auditing activities greater control over the assignment 

process than other DSROs have. Theoretically at least, a DSRO that already knows an 

FCM's operations and regulatory history should be able to conduct examinations and 

financial surveillance of that FCM more efficiently than a new DSRO that has to become 

familiar with the FCM.8 Therefore, under an assignment process that includes rights of 

first refusal, all DSROs should have the same rights. 9 

7 The Plan for Allocation of Regulatory Responsibilities for securities options requires 

firms to be allocated equally among the SROs of which they are common members 

based on both numbers and size. Sections Vl.(b) and (c) of the Plan contemplate that if 

three SROs share 16 members, two SROs would receive 5 members and one would 

receive 6 members, with each SRO receiving one of the three firms with the most 

activity and so on down the line. See 69 Fed. Reg. 7046, 7048 (Feb. 12, 2004). 

8 On the other hand, there are also advantages to bringing a fresh eye to those 

operations. For securities options, Section VI.( d) of the Plan for Allocation of Regulatory 

Responsibilities provides for rotating options broker-dealers among the SROs and 

states that a firm should not be allocated to a particular SRO if the SRO was its 

designated options examining authority within the last two years. See 69 Fed. Reg. 

7046, 7048 (Feb. 12, 2004). 

9 We understand the exchanges' concern that audits of exchange members should 

focus on the risk to the exchange's clearing organization. We agree that guarding 

against systemic risk is a very important part of a DSRO's auditing and financial 

surveillance responsibilities, although protecting customers from financial, operational, 

and sales practice risks is an equally important goal. To the extent that the exchanges' 

concern is based on their vested interest in protecting their clearing organizations, 

however, the current system does not address that concern any differently. Exchanges 

regularly rely on other exchange DSROs to review the risk an FCM poses to the first 

exchange's clearing organization, and one of the larger exchange DSROs recently cut 

its ties with its affiliated clearing organization and outsourced the entire clearing process 

to another exchange. Furthermore, the exchanges are not the only SROs capable of 

assessing risks to clearing organizations. Over the years NFA has gained significant 

experience auditing members of those exchanges that outsource their auditing and 

financial surveillance functions to us (e.g., Minneapolis Grain Exchange, New York 

Board of Trade), and this experience includes assessing a firm's ability to meet its 

obligations to the exchange's clearing organization. 
Ms. Jean A. Webb 5 June 16, 2004 

Issue 1: Membership 

All contract markets and registered futures associations should be parties 

to the JAA and members of JAC to address potential systemic risk. We understand that 

some clearing organizations may want to become members, and we have no objection 

to their membership. In fact, given the importance of assessing and guarding against 

risk to a clearing organization, maybe all clearing organizations should be affirmatively 

invited to join. 

Issues 4 and 5: Delegation and Outsourcing 

The release asks for comments on delegation versus outsourcing of 

examination services and on distinctions between registered futures associations and 

non-registered futures associations with respect to delegation and outsourcing issues. 

In most cases, a delegation involves a transfer of all rights and responsibilities to the 

party receiving the delegation, while outsourcing is a contractual arrangement where the 

rights and responsibilities remain with the original party with only the functions 

themselves being contracted out. Because of this distinction, we believe that delegation 

and outsourcing should have different consequences, which in turn should dictate who 

an SRO can delegate or outsource to. 

Section 5c(b) of the Commodity Exchange Act provides that an exchange 

can comply with applicable core principles through delegation to NFA or another 

registered entity but that the exchange retains responsibility. We believe this provision 

should be amended during reauthorization to authorize exchanges to delegate both the 

function and the corresponding responsibility to NFA or another registered entity and to 

clarify that exchanges can contractually outsource functions to any qualified entity -

registered or unregistered- as long as the exchange retains full responsibility. This 

would be consistent with the Commission's position in approving NQLX's outsourcing 

arrangement with NASD. 10 

Issue 6: DSRO/SRO Responsibilities 

The release also asks for comments on the distinction between SRO and 

DSRO responsibilities. As Rule 1.52(h)(1) recognizes, only the DSRO should have an 

affirmative responsibility to conduct audits and financial surveillance for those activities 

covered by the JAA. All SROs should continue to be responsible for monitoring 

10 In considering its recommendation to Congress, the Commission could determine that 

certain functions should only be outsourced - not delegated - so that the exchange 

retains full responsibility. Even where delegation is allowed, however, the entities 

involved could choose to enter into a contractual outsourcing arrangement rather than a 

delegation. 
Ms. Jean A. Webb 6 June 16, 2004 

activities not covered by JAC programs and for enforcing their own rules unless they 

have delegated these responsibilities to another futures SRO. 

Issue 7: CFTC Review 

NFA believes the Commission should review JAC's governance and 

operation more frequently. This is a rapidly changing industry, and practices that work 

well at one point may be outmoded several years later. Commission staff should attend 

and participate in JAC meetings and keep current on those issues facing JAC. In 

addition, the Commission should review the JAA whenever there are significant 

changes to SRO activities and responsibilities. 

Issue 8: Transparency 

Finally, the release asks for comments on the general transparency of the 

DSRO system and its operation. Obviously the actual joint audit programs and most 

examination records must remain confidential to ensure the integrity of the audit 

process. However, the JAA, the assignment procedures, the list of DSRO assignments, 

and JAC's guidance to its SRO members on how to interpret various regulatory 

requirements should be made publicly available in a prompt manner. 

*** 

NFA encourages the Commission to take an active role in the DSRO 

process to ensure that it meets the objectives described in Regulation 1.52(g). If you 

have any questions regarding the comments in this letter, please contact me (312-781-

1413 ortsexton@nfa.futures.org) or Kathryn Camp (312-781-1393 or 

kcamp@nfa.futures.org). 

Respectfully submitted, 

Thomas W. Sexton 

Vice President and General Counsel 

(kpdComment Letters/JAG Agreement)