potentially be filled by participant or management directors, the views
of the independent directors would not be given enough consideration.
While independent directors would have less than a majority
representation on the Board under the Voting Interest Focus
Alternative, they would have a meaningful opportunity to contribute to
determinations made by the Board and the various Board committees. The
Commission is proposing to require at least 35% independent directors
combined with the proposal to limit participant voting interests in a
security-based swap clearing agency, both on an individual and
aggregate basis, as a means of effectively mitigating conflict of
interest concerns while also permitting a greater proportion of
participants to serve on the Board of a security-based swap clearing
agency.\101\ This aspect of the proposal may address potential concerns
that requiring a majority independent Board would affect the Board's
ability to effectively perform risk management functions.
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    \98\ The term ``Board'' would be defined as the Board of
Directors or Board of Governors of the SB SEF, SBS exchange or
facility thereof that posts or makes available for trading security-
based swaps, or security-based swap clearing agency, as applicable,
or any equivalent body. See proposed Rule 700(c) under Regulation
MC.
    \99\ The term ``director'' would be defined as any member of the
Board. See Proposed Rule 700(f) under Regulation MC.
    \100\ Other regulators have previously chosen 35% as an
appropriate level for independent representation on the Board of
self-regulatory organizations. See 72 FR 6936 (February 14, 2007),
which adopts final rules to address conflicts of interest at self-
regulatory organizations regulated by the CFTC. Specifically, the
final rules establish acceptable practices under Core Principle 15
applicable to DCMs and that provide that the Board is composed of at
least 35% public directors.
    \101\ Proposed Rule 700(c) under Regulation MC does not
prescribe the number of participant directors that are required to
be on the Board. A security-based swap clearing agency may choose to
have the majority of the Board be composed of independent directors.
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    The Commission also proposes that no director may qualify as an
independent director unless the Board affirmatively determines that the
director does not have a material relationship with the security-based
swap clearing agency or any affiliate of the security-based swap
clearing agency, or a participant in the security-based swap clearing
agency, or any affiliate of a participant in the security-based swap
clearing agency. The purpose of this proposal is to provide assurance
that an independent director candidate does not have any relationships
or affiliations that would prevent the candidate from being independent
of the security-based swap clearing agency. Accordingly, the Commission
proposes to define the term ``independent director,'' as it is used
with respect to a security-based swap clearing agency, as a director
who has no material relationship with:
    (1) The security-based swap clearing agency;
    (2) Any affiliate of the security-based swap clearing agency;
    (3) A participant in the security-based swap clearing agency; or
    (4) Any affiliate of a participant in the security-based swap
clearing agency.\102\
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    \102\ See proposed Rule 700(j) under Regulation MC.
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    Some relationships or affiliations would clearly exclude a director
from qualifying as independent of a security-based swap clearing
agency. For example, a director would not be considered independent if
any of the following circumstances exists:
     The director, or an immediate family member, is employed
by or otherwise has a material relationship with the security-based
swap clearing agency or any affiliate thereof; or within the past three
years was employed by or otherwise had a material relationship with the
security-based swap clearing agency or any affiliate thereof;
     The director is a participant in the security-based swap
clearing agency or within the past three years was employed by or
affiliated with a participant or any affiliate thereof, or the director
has an immediate family member that is, or within the past three years
was, an executive officer of a participant in the security-based swap
clearing agency or any affiliate thereof;
     The director, or an immediate family member, has received
during any twelve-month period within the past three years payments
that reasonably could affect the independent judgment or decision-
making of the director from the security-based swap clearing agency or
any affiliate thereof or from a participant in the security-based swap
clearing agency or any affiliate thereof, other than the following:
    [cir] Compensation for Board or Board committee services;
    [cir] Compensation to an immediate family member who is not an
executive officer of the security-based swap clearing agency or any
affiliate thereof or of a participant in the security-based

swap clearing agency or any affiliate thereof; or
    [cir] Pension and other forms of deferred compensation for prior
services, not contingent on continued service.
     The director, or an immediate family member, is a partner
in, or controlling shareholder or executive officer of, any
organization to or from which the security-based swap clearing agency
or any affiliate thereof 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,
other than the following:
    [cir] Payments arising solely from investments in the securities of
the security-based swap clearing agency or affiliate thereof; or
    [cir] Payments under non-discretionary charitable contribution
matching programs.
     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 executive officers of the security-based swap clearing
agency serve on that entity's compensation committee;
     The director, or an immediate family member, is a current
partner of the outside auditor of the security-based swap clearing
agency or any affiliate thereof, or was a partner or employee of the
outside auditor of the security-based swap clearing agency or any
affiliate thereof who worked on the audit of the security-based swap
clearing agency or any affiliate thereof, at any time within the past
three years; or
     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 security-based swap clearing agency or any
affiliate thereof or a participant in the security-based swap clearing
agency or any affiliate thereof, 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.\103\
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    \103\ See proposed Rule 700(j)(2) under Regulation MC.
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    Under the proposed rule, the term ``material relationship'' would
be defined as a relationship, whether compensatory or otherwise, that
reasonably could affect the independent judgment or decision-making of
the director.\104\ This definition is intended to encompass all
significant instances in which a director's independence is
compromised.\105\ In determining whether a ``material relationship''
exists, security-based swap clearing agencies should consider the known
relationships between a director and the security-based swap clearing
agency to determine whether the relationship is likely to impair the
independence of the director in making decisions that affect the
security-based swap clearing agency. The proposed definitions of
``independent director'' and ``material relationship'' should help to
reduce the potential that the independent directors on the Board of the
security-based swap clearing agency are subject to conflicts of
interest.
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    \104\ See proposed Rule 700(l) under Regulation MC.
    \105\ See Securities Exchange Act Release No. 48745 (November 4,
2003), 68 FR 64154 (November 12, 2003) (order approving SRO rules
that would find a director independent only where that director does
not have a relationship with the company that would impair her
independence).
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    Under the Voting Interest Focus Alternative, the security-based
swap clearing agency would be required to establish policies and
procedures to require each director, on his or her own initiative or
upon request of the security-based swap clearing agency, to inform the
security-based swap clearing agency of the existence of any
relationship or interest that may reasonably be considered to bear on
whether such director is an independent director.\106\ The security-
based swap clearing agency would be expected to take reasonable
measures to confirm the accuracy of the information provided. This
requirement should help the security-based swap clearing agency to
assure that it is informed of the existence of any relationship or
interest that may reasonably be considered to bear on whether a
director is independent as soon as possible and without requiring the
security-based swap clearing agency to investigate for such
information.
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    \106\ See proposed Rule 701(a)(3)(iii) under Regulation MC.
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6. Voting Interest Focus Alternative: Board Committees
a. Nominating Committee
    The Voting Interest Focus Alternative would require security-based
swap clearing agencies to create and maintain a nominating committee
for the selection of Board members, and would require that such
nominating committee be composed of a majority of independent
directors.\107\ Directors serving on the nominating committee that are
not independent may be more likely to select Board candidates whose
views align with such directors' interests instead of the interests of
the security-based swap clearing agency or the markets generally.
Having a nominating committee that is composed of majority independent
directors should help to address and facilitate the selection of
independent directors.
---------------------------------------------------------------------------

    \107\ See proposed Rule 701(a)(4)(i) under Regulation MC.
---------------------------------------------------------------------------

    The Voting Interest Focus Proposal would also require that the
nominating committee identify candidates for Board membership through a
consultative process with the participants of the security-based swap
clearing agency consistent with criteria approved by the Board.\108\
This should help assure that the selection of directors of the Board is
conducted in a prudent manner while at the same time allowing for the
participants of the security-based swap clearing agency to have fair
representation in the selection of the directors of the Board.\109\
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    \108\ See proposed Rule 701(a)(4)(ii) under Regulation MC.
    \109\ Section 17A(a)(3)(C) of the Exchange Act requires fair
representation among participants of a clearing agency by providing
them with a meaningful opportunity to participate in the selection
of directors. 15 U.S.C. 78q-1(a)(3)(C).
---------------------------------------------------------------------------

b. Other Board Committees
    The Voting Interest Focus Alternative would require that other
Board committees of a security-based swap clearing agency that are
delegated authority to act on the Board's behalf, including but not
limited to the risk committee, consist of at least 35% independent
directors similar to the requirement that would be imposed on the Board
itself.\110\ This requirement should give independent directors a
meaningful voice, similar to the one they would have in the Board
itself, within Board committees that essentially perform the functions
of a Board. The proposed requirement would also apply to an ``advisory
committee'' to the extent that the committee is authorized to act on
behalf of the Board, including instances where the Board is required to
seek approval from the committee before making a determination.
However, the Commission preliminarily believes that the independence
requirement should not extend to a committee that functions in a purely
advisory role, because members of those committees are not in a
position to exercise powers of the

Board or exert influence over the Board by dictating how the Board will
act.
---------------------------------------------------------------------------

    \110\ See proposed Rule 701(a)(5) under Regulation MC.
---------------------------------------------------------------------------

c. Disciplinary Panels
    The Commission's Voting Interest Focus Alternative would impose
special requirements on the composition of disciplinary panels (or
their equivalents) of security-based swap clearing agencies that have
not been delegated authority to act on the Board's behalf.\111\ The
Commission believes that participants of a security-based swap clearing
agency should be appropriately disciplined for failure to comply with
the rules of a security-based swap clearing agency, particularly as
they relate to the ongoing risk management related requirements
applicable to participants. Accordingly, the Commission is proposing
that the disciplinary processes of a security-based swap clearing
agency preclude any group or class of persons that are participants in
the security-based swap clearing agency from exercising
disproportionate influence on any disciplinary panels. In other words,
to the extent that there is more than one type of group or class of
persons that are participants in a security-based swap clearing agency,
the composition of the disciplinary panel shall include representation
of each group or class and shall not allow one group or class to have
representation on the disciplinary panel that is out of proportion as
compared to other groups or classes of persons that are participants in
the security-based swap clearing agency. Furthermore, the disciplinary
panel of the security-based swap clearing agency would include at least
one person who would qualify as an independent director.
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    \111\ See proposed Rule 701(a)(6) under Regulation MC. If the
security-based swap clearing agency does not have a disciplinary
panel, these requirements should be interpreted as applying to the
equivalent of a disciplinary panel in the security-based swap
clearing agency's internal processes, unless the disciplinary panel
(or its equivalent) has been delegated authority to act on the
Board's behalf, in which case it would be subject to the 35%
independent director requirement.
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7. Voting Interest Focus Alternative: Request for Comment
    The Commission requests comment on all aspects of the voting
limitations under the Voting Interest Focus Alternative, including
whether the 20% limitations on individual participant voting interest
and the 40% aggregate limitation on participant voting interest are
sufficient to limit the ability of a participant or a group of
participants to exercise undue influence or control over the governance
of a security-based swap clearing agency. Should the 20% and 40%
limitations be lower given the existing concentration of the industry
in a small number of large dealers? If so, what limitations would be
appropriate and why? Are there other conflicts of interest not
discussed in this release that the Commission should consider generally
and specifically with respect to voting limitations? Would the proposed
restrictions have an effect on the ability to form new security-based
swap clearing agencies or to effectively operate existing security-
based swap clearing agencies?
    The Commission also requests comment on whether there may be other
ways to structure the interests in a security-based swap clearing
agency to mitigate potential conflicts of interest. Are there other
thresholds for voting limitations or approaches that the Commission
should consider? Are there other methods for mitigating conflicts of
interest the Commission should consider, such as limitations on holding
non-voting interests in a security-based swap clearing agency? How
would non-voting interests affect the potential for conflicts of
interests?
    Section 765 enumerates Specified Entities for the Commission to
consider in its rulemaking. The proposed rule would apply only to
Specified Entities that are participants of the security-based swap
clearing agency and not to other Specified Entities, because the
Commission preliminarily believes that those entities that are
participants of a clearing agency are most likely to have a conflict of
interest that would affect the access, product eligibility, and risk
management issues discussed in this release. However, the Commission
requests comment on whether all Specified Entities, regardless of
participant status, should be subject to the proposed restrictions on
voting interests. What are the potential conflicts of interest
associated with Specified Entities that are not participants? Might
Specified Entities that are not participants in a security-based swap
clearing agency have an interest in limiting the number or type of
security-based swaps that are accepted for clearing to the extent that
they may profit from trading security-based swaps that are not
centrally cleared? Are there any other classes of persons, such as
participants or members of SB SEFs or SBS exchanges, that should also
be subject to the proposed restrictions even though they are not
participants of a security-based swap clearing agency? What effect
would such restrictions have on mitigating conflicts of interest at
security-based swap clearing agencies? What effect would such
restrictions have on the ability to form new security-based swap
clearing agencies?
    The Voting Interest Focus Alternative would require that voting
limitations be determined by including interests held directly by a
participant in the security-based swap clearing agency, by including
indirect interests of a participant in the security-based swap clearing
agency, and by including interests held by related persons of a
participant in the security-based swap clearing agency. The Commission
requests comment on whether its formulation for calculating the
aggregate and individual limits is appropriate. Specifically, the
Commission requests comment on whether the scope of the definitions of
``affiliate,'' ``immediate family member,'' and ``related person'' are
over-inclusive or under-inclusive and, if either, why? Is there a
different methodology to reach the interest of any person with whom a
security-based swap clearing agency participant may be able to act in
concert with to unduly influence or control a security-based swap
clearing agency that the Commission should consider?
    The Commission seeks comment on whether requiring the Board of a
security-based swap clearing agency to be composed of at least 35%
independent directors would improve governance of the security-based
swap clearing agency and mitigate potential conflicts of interest. Is
35% sufficient to give independent directors a meaningful voice within
the Board, or would a higher or lower level be appropriate? Should the
Commission require that a majority of the Board be composed of
independent directors? How are these independent directors likely to
affect the activities of the security-based swap clearing agency? What
are their incentives to assure open and fair access, increased product
eligibility, and sound risk management at a security-based swap
clearing agency? Do independent directors have any conflicts of
interest that would affect their ability to facilitate these
objectives?
    The Commission also requests comment on whether other measures
concerning governance should be used to mitigate conflicts of interest
at security-based swap clearing agencies, either in addition to or
instead of the proposals outlined in this release. In particular, what
other approaches would improve governance and mitigate conflicts of
interest for security-based swap clearing agencies? For example, would
State laws governing the fiduciary duty owed by the Board to a
corporation help to mitigate conflicts of interest? Should the
Commission

consider any additional requirements related to fiduciary duties? The
policies and charter documents of individual corporations also often
impose additional responsibilities and obligations on directors. Should
security-based swap clearing agencies be required to put in place
specific policies or charters to address conflicts of interest by the
Board? What policies or charters would be necessary to provide
assurance that participant directors will act in the best interests of
the security-based swap clearing agency? What other requirements, if
any, should be in place with respect to the duties owed by the Board in
order to mitigate conflicts of interest at security-based swap clearing
agencies?
    In addition, the Commission requests comment on its proposed
definitions, including the definitions of ``independent director'' and
``material relationship.'' Are there other ways to define ``independent
director'' or ``material relationship?'' If so, what are they? Should
the Commission adopt other provisions that contain particular
circumstances that would preclude a finding that a director is
independent or that would deem a relationship material? Should the
Commission take into account a director's salary or benefits he or she
receives for being a director in order to consider whether an interest
in keeping the directorship could make a director more likely to act
favorably toward those that control the Board? Should the Commission
adopt a specific look-back period within which to determine whether a
``material relationship'' exists? Should additional terms used in the
proposed rule be defined?
    The Commission requests comment on the proposed compositional
requirements of committees of the Board under the Voting Interest Focus
Alternative. Is the requirement that Board committees that are
delegated authority to act on behalf of the Board be composed of at
least 35% independent directors appropriate? The Commission also
requests comment on whether there may be other ways to structure
governance restrictions for security-based swap clearing agencies to
mitigate potential conflicts of interest. In particular, the Commission
requests comment on the proposed compositional requirements of the
nominating committee. What is the potential effect of requiring a
security-based swap clearing agency to have a majority independent
nominating committee? Are there other processes for the selection of
independent directors and the fair representation of the participants
and shareholders of a security-based swap clearing agency that the
Commission should consider with respect to the nominating committee?
Should end-users or any other group be given guaranteed rights of
participation in the governance of the security-based swap clearing
agency? Should the Commission participate in the Board selection
process, such as by requiring consultation on appointments? Should the
Commission consider an alternative to a compositional requirement for a
nominating committee, such as allowing a security-based swap clearing
agency to have a board of trustees responsible for nominating
candidates for the Board? If this were a viable alternative, should
there be compositional requirements or other limits imposed on the
board of trustees? How should such a board of trustees be appointed?
Would the alternative of a board of trustees to nominate directors
provide greater assurance that independent directors are truly
independent not only at the time of their nomination but during their
service on the Board as well?
    With respect to governance as it relates to the risk committee,
should there be special requirements relating to the risk committee, or
its equivalent, of the Board? For instance, one possible alternative
approach could be to provide separate requirements applicable only to
the risk committee that reflect the highly specialized risk management
expertise required of directors serving on that committee. For example,
instead of requiring that the risk committee be composed of at least
35% independent directors (where such committee is delegated authority
to act on the Board's behalf), the requirement could apply to a smaller
number of independent directors, and also explicitly require that other
interested persons, such as customers of participants, be represented
on the risk committee. The Commission requests comment on whether a
more prescriptive approach such as the one described above would be
appropriate for the risk committee and what levels of participation by
participants, customers of participants, or others would be
appropriate. Are there factors that warrant treating the risk committee
differently from other Board committees? Should the Commission require
the Board to report to the Commission if the Board disagrees with a
recommendation of the risk committee? Is the risk committee more or
less prone to conflict of interest issues? Are there factors other than
conflicts of interest that should be taken into consideration? Is it
desirable to have an explicit requirement with respect to customers of
participants? If so, how many customers should serve on the risk
subcommittee relative to independent directors and participant
directors? What definition of customer should be used for these
purposes? Are there distinctions that should be made between the
different types of customer firms for this purpose?
    Another possible alternative approach could be to limit the
applicable restrictions on the risk committee to circumstances where a
specific range of topics is being addressed. For example, restrictions
on participation in a risk committee could be limited to only those
circumstances in which a determination about issues such as participant
standards and product eligibility were being made. What are the
potential advantages or disadvantages of such an approach? Would it be
possible to separate activities of a committee based on topics? Are
there certain issues that pose more or less of a concern with respect
to conflicts of interests?
    The Commission also requests comment regarding whether any
requirements should be imposed on advisory committees. Would an
independence requirement on a purely advisory committee mitigate
potential conflicts of interest? Are there circumstances in which a
purely advisory committee exercises substantial power over the Board?
    The Commission requests comment on the composition of the
disciplinary panel of the security-based swap clearing agency. Would
the proposed rule be sufficient to address potential conflicts of
interest that may interfere with the fair and effective disciplinary
processes of a security-based swap clearing agency? Should different
restrictions be imposed?
    Although independent directors may address some of the conflicts of
interest concerns that underlie Section 765 of the Dodd-Frank Act, they
may not effectively eliminate all conflicts. The Commission, however,
believes that effective governance via a partially independent Board is
compatible with the characteristics of security-based swap clearing
agencies, and the types of conflicts that may be inherent with respect
to such entities.

B. Alternative II: Governance Focus Alternative

    As more fully described below, under the Governance Focus
Alternative, the Commission is proposing governance restrictions
including requiring a majority of independent directors on the Board
and voting restrictions that would be applicable only to individual

participants of a security-based swap clearing agency. The Governance
Focus Alternative differs from the Voting Interest Focus Alternative in
that it provides greater emphasis on requirements regarding the
governance arrangements of a security-based swap clearing agency as the
primary means to mitigate conflicts of interest. As with the Voting
Interest Focus Alternative, the Commission is proposing rules related
to the governance of a security-based swap clearing agency and the
voting interests held by participants because the Commission believes
each contributes to conflict of interest concerns. However, the Voting
Interest Focus Alternative places greater emphasis on the ability of
participants to hold voting interests in the security-based swap
clearing agency than it does on participants' ability to participate in
the governance of the security-based swap clearing agency, while the
Governance Focus Alternative, as described in more detail below, places
greater emphasis on the ability of participants to participate in the
governance of the security-based swap clearing agency than it does on
the ability of participants on a collective basis to hold a voting
interest in the security-based swap clearing agency.
1. Governance Focus Alternative: Voting Limitation
    The Governance Focus Alternative would require that a security-
based swap clearing agency may not permit a participant, either alone
or together with its related persons, to (1) beneficially own, directly
or indirectly, any interest in the security-based swap clearing agency
that exceeds 5% of any class of securities, or other ownership
interest, entitled to vote of such security-based swap clearing agency
or (2) directly or indirectly vote, cause the voting of, or give any
consent or proxy with respect to the voting of, any interest in the
security-based swap clearing agency that exceeds 5% of the voting power
of any class of securities or other ownership interest of such
security-based swap clearing agency.\112\ The 5% limitation on
participant voting interest is intended to help mitigate conflicts of
interest because each individual participant's voting interest would be
substantially limited and, therefore, its ability to control the
security-based swap clearing agency would also be limited.\113\ As
discussed previously, the Voting Interest Focus Alternative would
permit a higher individual participant voting interest of 20%, but
would limit the aggregate voting interests held by all participants to
40%. However, the Voting Interest Focus Alternative would allow a
security-based swap clearing agency to have a Board with a majority of
directors selected by participants. The Commission believes that the 5%
limit per participant, in combination with the requirements related to
governance arrangements described below, is sufficiently low that there
is no need for the 40% aggregate cap on the voting interests held by
all participants.
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    \112\ See proposed Rule 701(b)(1) under Regulation MC.
    \113\ The 5% threshold level for ownership has previously been
found by the Commission in other contexts to trigger reporting
requirements to the Commission related to the ability to control an
organization. See Rule 13d-1(a) under the Exchange Act, 17 CFR
240.13d-1(a) (``Any person who, after acquiring directly or
indirectly the beneficial ownership of any equity security of a
class which is specified in paragraph (i) of this section, is
directly or indirectly the beneficial owner of more than 5% of the
class shall, within 10 days after the acquisition, file with the
Commission, a statement containing the information required by
Schedule 13D''). In addition, investors acquiring more than a 5%
interest in a company must file a form certifying that they acquired
that interest without ``the effect of changing or influencing the
control of the issuer * * *'' Rule 13d-1(c)(1) under the Exchange
Act, 17 CFR 240.13d-1(c)(1). See, also, Gaf Corp. v. Milstein, 453
F.2d 709 (2d Cir. N.Y. 1971), stating that ``[T]he purpose of
section 13(d) is to alert the marketplace to every large, rapid
aggregation or accumulation of securities, regardless of technique
employed, which might represent a potential shift in corporate
control. * * *'' Id. at 717.
---------------------------------------------------------------------------

    Furthermore, the Commission notes that the 40% aggregate cap on
participant voting interests proposed in the Voting Interest Focus
Alternative may restrict the potential formation of participant-owned
security-based swap clearing agencies. Some clearing agencies currently
registered with the Commission are user-owned or user-controlled
institutions that function as quasi-utilities. This structure may
provide certain benefits to the participants and the securities markets
generally because such clearing agencies generally seek to match the
fees charged to participants to the clearing agency's costs and not to
maximize profits.\114\
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    \114\ See, e.g., ``The US Model for Clearing and Settlement: An
Overview of DTCC,'' available at: http://www.dtcc.com/downloads/
about/US%20Model%20for%20Clearing%20and%20Settlement.pdf.
(``[O]wnership and governance of [The National Securities Clearing
Corporation] and [The Depository Trust Company] were from the outset
those typical of market utilities.'').
---------------------------------------------------------------------------

    In addition, potential users may have a strong incentive to form a
new clearing agency if they believe an existing clearing agency is not
effectively serving the security-based swaps market. Not imposing an
aggregate cap on participant voting interests in a security-based swap
clearing agency could help encourage the formation of new security-
based swap clearing agencies and thereby increase the potential for
competition among security-based swap clearing agencies. In addition,
the 5% voting interest limitation may encourage open access by creating
incentives for a larger number of participants to acquire a voting
interest in the security-based swap clearing agency. While the
Commission has not previously adopted voting limitations or governance
rules for registered clearing agencies in the other securities markets,
as previously discussed under the Voting Interest Focus Alternative,
the security-based swaps market presents different concerns with
respect to potential conflicts of interests that warrant additional
scrutiny and efforts to mitigate such conflicts.
2. Governance Focus Alternative: Indirect or Affiliate Ownership and
Ownership Through Related Persons
    The Commission believes that a rule that limits only direct voting
interests could be circumvented by holding the interest through an
affiliated party or by holding an interest in a controlling entity.
Accordingly, similar to the Voting Interest Focus Alternative,\115\ the
Governance Focus Alternative would address conflicts of interest
created by indirect voting interests of the security-based swap
clearing agency and would require aggregation of a security-based swap
clearing agency participant's voting interest with its related persons'
\116\ voting interests.\117\
---------------------------------------------------------------------------

    \115\ See supra Section I.A.3.
    \116\ See supra note 92 and accompanying text.
    \117\ See proposed Rule 701(b)(1) under Regulation MC.
---------------------------------------------------------------------------

3. Governance Focus Alternative: Divestiture and Voting Restriction
Requirement
    Similar to the Voting Interest Focus Alternative,\118\ the
Governance Focus Alternative would require security-based swap clearing
agencies to have rules in place for the divestiture of voting interests
that exceed the 5% limitation and a mechanism to not give effect to the
portion of any voting interest held by a participant in excess of the
5% voting limitation.\119\ The Commission believes that this
requirement is essential to a security-based swap clearing agency's
ability to monitor voting interests by its participants in relation to
the proposed voting limitations.
---------------------------------------------------------------------------

    \118\ See supra Section I.A.4.
    \119\ See proposed Rule 701(b)(2) under Regulation MC.

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4. Governance Focus Alternative: Majority Independent Board
    As discussed previously, the Governance Focus Alternative differs
from the Voting Interest Focus Alternative by placing greater emphasis
on the governance arrangements of the security-based swap clearing
agency. Each alternative approach seeks to strike a balance between the
appropriate restrictions imposed on a security-based swap clearing
agency relating to governance and voting rights held by participants.
Under the Governance Focus Alternative, participants on a collective
basis could potentially own all voting interests in a security-based
swap clearing agency. While this option allows for potential benefits
in terms of participants' ability to form new clearing agencies, it
also allows participants' to control 100% of the voting interest in a
security-based swap clearing agency, in contrast to the Voting Interest
Focus Alternative, which would limit participants to holding no more
than 40% of the voting interest. Accordingly, in order to balance the
increased voting interest that may be held by participants
collectively, the Commission proposes that a greater proportion of the
Board be composed of independent directors under the Governance Focus
Alternative.
    The Governance Focus Alternative is intended to mitigate conflicts
of interest by limiting the influence participants may have in the
determinations of the Board or in the administration of a security-
based swap clearing agency. Specifically, the Governance Focus
Alternative would require the Board \120\ of a security-based swap
clearing agency to be composed of a majority of independent
directors.\121\ The presence of a majority of independent directors on
the Board of a security-based swap clearing agency is intended to
reduce the ability of non-independent directors to influence the
operation of the security-based swap clearing agency in favor of their
own self-interests and to promote open and fair access, product
eligibility, and sufficient risk management standards. This should in
turn benefit non-participant firms that enter into correspondent
clearing arrangements with participants, and SBS exchanges and SB SEFs
who will rely on the availability of a security-based swap clearing
agency. A majority independent Board requirement is consistent with
accepted corporate governance ``best practices.'' \122\ Furthermore,
requiring a majority of the Board of a security-based swap clearing
agency to be independent would still permit the security-based swap
clearing agency to provide participants with fair representation in the
selection of directors and the administration of the affairs of the
security-based swap clearing agency as required under the Exchange
Act.\123\
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    \120\ See supra note 98.
    \121\ See proposed Rule 701(b)(3)(i) under Regulation MC. See
supra note 99 for the definition of ``director.''
    \122\ See, e.g., James H. Cheek III, et al., Report of the
American Bar Association Task Force on Corporate Responsibility
(2003); and The Business Roundtable, Principles of Corporate
Governance (May 2010).
    \123\ Section 17A(b)(3)(C) of the Exchange Act requires that the
rules of a registered clearing agency assure a fair representation
of its shareholders (or members) and participants in the selection
of its directors and administration of its affairs. 15 U.S.C. 78q-
1(b)(3)(C).
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    The Commission also proposes that no director may qualify as an
independent director unless the Board affirmatively determines that the
director does not have a material relationship with the security-based
swap clearing agency or any affiliate of the security-based swap
clearing agency,\124\ or a participant in the security-based swap
clearing agency, or any affiliate of a participant in the security-
based swap clearing agency.\125\ The proposed definitions of
``independent director'' and ``material relationship'' are designed to
reduce the potential that the Board of the security-based swap clearing
agency is controlled by persons who are subject to conflicts of
interest.
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    \124\ See supra note 102 and accompanying text.
    \125\ See proposed Rule 701(b)(3)(ii) under Regulation MC.
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    While the proposal that a majority of the Board be composed of
independent directors should help to mitigate certain conflicts of
interest, and particularly those conflicts that are most likely to
result in an adverse effect on the security-based swap clearing agency,
the Commission recognizes that it would not completely eliminate
conflicts of interest. Participant directors would still be permitted
to serve on the Board. The Commission believes that participants may
have operational, risk management, and market expertise that may be
useful for effective oversight of a security-based swap clearing
agency.
    In addition, independent directors themselves may not be free of
conflicts of interest. Although the independent directors would not
have a material relationship with the clearing agency or any of its
participants, they could still be influenced by other sources such as
non-participant shareholders of the security-based swap clearing
agency. The presence of independent directors may be an effective
mechanism to address certain types of conflicts in certain types of
institutions but not necessarily in all instances nor for all
institutions. The Commission, however, believes that effective
governance via a majority independent Board is compatible with the
characteristics of security-based swap clearing agencies, and the types
of conflicts that may be inherent with respect to such entities.
    To help address these concerns, the proposed rules would require
each security-based swap clearing agency to establish policies and
procedures to require each director, on his or her own initiative or
upon request of the security-based swap clearing agency, to inform the
security-based swap clearing agency of the existence of any
relationship or interest that may reasonably be considered to bear on
whether such director is an independent director.\126\ This requirement
should keep the security-based swap clearing agency informed of the
existence of any relationship or interest that may reasonably be
considered to bear on whether a director is independent as soon as
possible without requiring the security-based swap clearing agency to
investigate for such relationships or interest.
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    \126\ See proposed Rule 701(b)(3)(iii) under Regulation MC.
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5. Governance Focus Alternative: Board Committees
a. Nominating Committee
    The Governance Focus Alternative would require security-based swap
clearing agencies to create and maintain a nominating committee
composed entirely of independent directors.\127\ This is consistent
with the purpose of the Governance Focus Alternative to place enhanced
requirements on the governance arrangements of a security-based swap
clearing agency, including the composition of the Board and Board
committees, with less emphasis on the requirements with respect to the
voting interests held by participants. Non-independent directors on the
nominating committee could circumvent the majority independence
requirement by nominating a candidate that is subject to their
influence. Specifically, directors serving on the nominating committee
that are not independent may be more likely to select Board candidates
whose views align with such directors' interests instead of the
interests of the security-based swap clearing agency or the markets
generally. A requirement that

all directors serving on the nominating committee be independent of
participants would address these concerns by limiting participants'
control over the nomination process. A fully independent nominating
committee may be warranted under the Governance Focus Alternative
because the lack of an aggregate cap in this proposal means that
participants may collectively hold greater voting interests in
selecting the independent directors.
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    \127\ See proposed Rule 701(b)(4)(i) under Regulation MC.
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    The Governance Focus Alternative would also require that the
nominating committee identify candidates for Board membership through a
consultative process with the participants of the security-based swap
clearing agency consistent with criteria approved by the Board.\128\
This should assure that the selection of the independent directors of
the Board is conducted in a prudent manner while at the same time
allowing participants of the security-based swap clearing agency to
have a fair voice in the selection of the directors of the Board.\129\
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    \128\ See proposed Rule 701(b)(4)(ii) under Regulation MC.
    \129\ See supra note 123.
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b. Other Board Committees
    The Governance Focus Alternative would require that other Board
committees of a security-based swap clearing agency that are delegated
authority to act on the Board's behalf, including but not limited to
the risk committee, consist of a majority of independent directors
similar to the requirement that would be imposed on the Board
itself.\130\ This requirement should prevent the dilution of the
majority Board independence requirement that may result if Board
committees that essentially perform the functions of a Board are not
themselves subject to a similar requirement. The proposed requirement
would also apply to an ``advisory committee'' to the extent that such a
committee is authorized to act on behalf of the Board, including
instances where the Board is required to seek approval from the
committee before making a determination. However, the Commission
preliminarily believes that this majority independence requirement
should not extend to a committee that functions in a purely advisory
role, because members of those committees are not in a position to
exercise powers of the Board or exert influence over the Board by
dictating the actions of the Board.
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    \130\ See proposed Rule 701(b)(5) under Regulation MC.
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c. Disciplinary Panels
    Similar to the Voting Interest Focus Alternative,\131\ the
Governance Focus Alternative would impose special requirements on the
composition of disciplinary panels (or their equivalents) of security-
based swap clearing agencies that have not been delegated authority to
act on the Board's behalf.\132\
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    \131\ See supra Section I.A.8.d. and accompanying text.
    \132\ See proposed Rule 701(b)(6) under Regulation MC.
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6. Governance Focus Alternative: Request for Comment
    The Commission requests comment on all aspects of the 5%
participant voting interest limitation. Is the 5% voting limitation
appropriate, or should the Commission consider a higher or lower
limitation? How does the relative concentration of the security-based
swaps market among a small number of large dealers affect whether a 5%
limitation is appropriate? Would 5% still allow a relatively small
number of participants to effectively dominate the Board of a clearing
agency? Should the Commission consider any form of an aggregate cap
under this alternative? How likely is it that a security-based swap
clearing agency would adopt a utility model, given the status of the
security-based swaps market? Would the 5% limit impede the ability of a
clearing agency to adopt a utility model? What advantages or
disadvantages would such a model have? Are there other conflicts of
interest, not discussed in this release, that the Commission should
consider generally and specifically with respect to voting interest
limitations? Would the proposed restrictions have an effect on the
ability to form new security-based swap clearing agencies?
    Are there other ways to more narrowly target voting limitations?
Should the Commission impose voting restrictions on only the largest
participants because those participants control the majority of the
security-based swaps market (based on either the volume of transactions
cleared at the security-based swap clearing agency or the notional
value of the participant's outstanding security-based swap positions)?
If such an approach is preferable, what should the threshold be for
determining whether a participant is ``large''? Should the Commission
require the security-based swap clearing agency to consider the
participant's volume of cleared transactions at the security-based swap
clearing agency, the notional value of the participant's outstanding
security-based swap positions at the security-based swap clearing
agency, or both? Should the Commission require the security-based swap
clearing agency to consider either volume or outstanding notional value
of a participant's positions held outside of a security-based swap
clearing agency? How often should the Commission require the security-
based swap clearing agency to reevaluate its standard? How effectively
would such an approach address conflict of interest concerns? What
would be the advantages and disadvantages of this approach compared to
the approach proposed above? Are there administrative complexities
associated with determining and monitoring the point at which a firm
reaches large participant status? Are the conflicts of interest
concerns regarding all large participants similar or should there be
differences in the voting limitations among large participants?
    Should the restrictions on voting interests apply to other large
entities, such as the Specified Entities listed in Section 765, even if
they are not participants in a security-based swap clearing agency?
What potential conflicts of interest could result if Specified Entities
that are not large participants controlled the voting interest in a
security-based swap clearing agency? How should such potential
conflicts of interest be addressed?
    Should the Commission consider a limitation on the non-voting
interests owned by participants? Should the Commission consider a
limitation on the voting and non-voting interests held by Specified
Entities?
    The Commission seeks comment on whether requiring the Board of a
security-based swap clearing agency to be composed of a majority of
independent directors would improve governance of the security-based
swap clearing agency and mitigate potential conflicts of interest.
Would a majority independent Board be helpful in mitigating conflicts
of interest if the voting interest of a security-based swap clearing
agency is owned by participants? If a majority independent Board is not
appropriate to mitigate conflicts, what percentage of the Board should
be independent? What are the costs and benefits of requiring the Boards
of security-based swap clearing agencies to be composed of a majority
of independent directors? How do these costs and benefits differ from
the proposal that 35% of the Board be composed of independent
directors? Would independent directors be likely to have the necessary
experience and

expertise to serve on the Board? Could less experience or expertise
negatively affect risk management practices or the efficiency of the
clearing agency and, if so, how? If any such experience or efficiency
issues exist, how could they be overcome? What are the independent
directors' incentives regarding fair and open access, product
eligibility, and sound risk management? How are these incentives
different from those of participants? Do they result in conflicts of
interest? If so, how are the conflicts of interest different from those
of participants? How should they be addressed by the Commission?
    Should the Commission consider alternative limits, or alternative
combinations of limits, on voting interests or independent directors?
For example, should the voting interest restrictions of 20% on
individual interests and 40% in the aggregate be combined with the
requirements for a majority independent Board and a 100% independent
nominating committee? Would an alternative combination of requirements
related to voting interests and independent directors be more
effective? For example, would a higher requirement in each case (e.g.,
a 10% limit on individual voting interests and a requirement for 60%
independent directors) be more effective? Or would other combinations
be more effective? Should the Commission reduce the restrictions over
time if conflict of interest concerns are lessened as the security-
based swaps market develops? For example, if participation in the
security-based swaps market becomes more open and includes a broader
range of participants, the interests of the participants may become
more aligned with those of the clearing agency and the markets
generally. Would restrictions on voting interests and governance still
be needed in this circumstance? Are there other circumstances where the
voting interest and governance restrictions may be reduced or
eliminated altogether? If, over time, the security-based swaps market
does not become more competitive, should the Commission consider
additional governance and voting measures to promote open access and
competition? What measures would be appropriate? What standards should
the Commission use to determine whether additional restrictions should
or should not be imposed?
    Could restrictions regarding the governance structure of a
security-based swap clearing agency alone be sufficient to address
conflict of interest concerns or are both restrictions on governance
and voting interests needed? Would participants of a security-based
swap clearing agency be able to exercise undue influence over a
security-based swap clearing agency through a voting interest even if a
majority of the Board is independent? Are requirements related to the
governance structure of a security-based swap clearing agency more or
less effective than voting limitations at addressing conflicts of
interest?
    The Commission requests comment on the proposed compositional
requirements of the nominating committee. What is the potential effect
of requiring a security-based swap clearing agency to have an entirely
independent nominating committee? Would requiring an entirely
independent nominating committee, which is required to consult with
participants of the security-based swap clearing agency, be consistent
with the fair representation requirement under the Exchange Act? Should
end-users or any other group be given guaranteed rights of
participation in the governance of the security-based swap clearing
agency? Should the Commission have some oversight of the Board
selection process? Should the Commission consider an alternative to a
compositional requirement for a nominating committee, such as allowing
a security-based swap clearing agency to have a board of trustees
responsible for nominating candidates for the Board? If this were a
viable alternative, should there be compositional requirements or other
limits imposed on the board of trustees? How should such a board of
trustees be appointed? Would the alternative of a board of trustees to
nominate directors provide greater assurance that independent directors
are truly independent not only at the time of their nomination but
during their service on the Board as well?
    The Commission requests comment on the proposed compositional
requirements of committees of the Board under the Governance Focus
Alternative. Is the requirement that Board committees that are
delegated authority by the Board be composed of a majority of
independent directors appropriate? Should there be special requirements
relating to the risk committee, or its equivalent, of the Board? The
Commission requests comment on the possible alternatives for risk
committee governance as discussed in Section IV.A.7. Would the possible
alternatives for the risk committee be more or less desirable with
respect to the Governance Focus Alternative? Under the Governance Focus
Alternative, should the percentage of directors on the risk committee
be higher or lower than what is proposed? The Commission also requests
comment on whether there are other ways to structure governance
arrangements for security-based swap clearing agencies to mitigate
potential conflicts of interest.
    The Commission requests comment on the composition of the
disciplinary panel of the security-based swap clearing agency. Would
the proposed rule be sufficient to address potential conflicts of
interest that may interfere with the fair and effective disciplinary
processes of a security-based swap clearing agency? Should different
restrictions be imposed?

C. Existing Standards for Registered Clearing Agencies

    In addition to any new rules adopted by the Commission with respect
to conflicts of interest at security-based swap clearing agencies, the
standards in the Exchange Act that apply to all securities clearing
agencies registered with the Commission will apply to security-based
swap clearing agencies. The Dodd-Frank Act requires security-based swap
clearing agencies to be registered as clearing agencies with the
Commission under Section 17A of the Exchange Act.\133\ Thus, security-
based swap clearing agencies will be required to comply with the
standards in Section 17A of the Exchange Act. Some of these standards
may be used to address concerns related to conflicts of interest,
regardless of whether a security-based swap clearing agency elects the
Voting Interest Focus Alternative or the Governance Focus Alternative.
As a result, the standards in Section 17A would be used in addition to
specific conflict of interest rules adopted under Section 765 of the
Dodd-Frank Act.\134\
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    \133\ Depository institutions or derivatives clearing
organizations that have previously cleared swaps pursuant to an
exemption from registration as a clearing agency will be deemed to
be registered with the Commission under Section 17A of the Exchange
Act. See Public Law 111-203, Section 763(l).
    \134\ See Section 17A(b)(3) of the Exchange Act, which sets
forth the standards for registered clearing agencies. 15 U.S.C. 78q-
1(b)(3). See also Securities Exchange Act Release No. 16900
(``Standards Release'') (June 17, 1980), 20 FR 416 (July 1, 1980).
The Standards Release provides guidance on the standards to be used
by the Commission's Division of Trading and Markets in connection
with the registration of clearing agencies. The standards also serve
as staff guidelines to assist clearing agencies in modifying their
organizations, capacities, and rules to comply with the clearing
agency registration provisions of the Exchange Act.
    The Commission is also considering matters related to conflicts
of interests as part of broader standards that would be applicable
to clearing agencies in association with requirements under Sections
763(b) and 805(a) of the Dodd-Frank Act.
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    The Section 17A standards may be used to mitigate conflicts of
interest or the effects of conflicts of interest in a

number of ways. As part of the initial registration process, the
Commission approves the organizational structure of a clearing
agency.\135\ The Commission also reviews and approves significant
changes to a clearing agency's governance structure after it is
registered.\136\ In addition, a clearing agency must admit persons such
as banks and broker-dealers, and other entities that the Commission may
designate by rule, as participants,\137\ subject to the participation
standards of the clearing agency.\138\
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    \135\ Section 17A(b)(3)(A) provides in full a clearing agency
shall not be registered unless the Commission determines that the
``clearing agency is so organized and has the capacity to facilitate
the prompt and accurate clearance and settlement of securities
transactions and derivative agreements, contracts, and transactions
for which it is responsible, to safeguard securities and funds in
its custody or control or for which it is responsible, to comply
with the provisions of [the Exchange Act] and the rules and
regulations thereunder, to enforce (subject to any rule or order of
the Commission pursuant to section 17(d) or 19(g)(2) of [the
Exchange Act]) compliance by its participants with the rules of the
clearing agency, and to carry out the purposes of [Section 17A of
the Exchange Act].'' 15 U.S.C. 78q-1(a)(3)(C).
    \136\ See Securities Exchange Act Release Nos. 612194 (December
22, 2009), 74 FR 68883 (December 22, 2009) (File No. SR-FICC-2009-
10); 61215 (December 22, 2009), 74 FR 68888 (December 29, 2009)
(File No. SR-NSCC-2009-10); and 61216 (December 22, 2009), 74 FR
68877 (December 29, 2009) (File No. SR-DTC-2009-16), notice and
order granting accelerated approval of proposed rule changes filed
by the clearing agency subsidiaries of the Depository Trust and
Clearing Corporation (DTC, NSCC, and FICC) to permit DTCC to
nominate non-participant candidates for election to its Board.
    \137\ 15 U.S.C. 78q-1(b)(3)(B).
    \138\ Id. See also Section 17A(b)(4)(B), which provides that a
registered clearing agency may deny participation to, or condition
the participation of, any person if such person does not meet such
standards of financial responsibility, operational capability,
experience, and competence as are prescribed by the rules of the
clearing agency. A registered clearing agency may examine and verify
the qualifications of an applicant to be a participant in accordance
with procedures established by the rules of the clearing agency. 15
U.S.C. 78q-1(b)(4)(B).
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    Clearing agencies also may not permit unfair discrimination in the
admission of participants or among participants in the use of the
clearing agency.\139\ These standards in Section 17A help to mitigate
concerns related to conflicts of interest by promoting access to and
use of a clearing agency by all qualified persons on an equivalent
basis.\140\ The Section 17A standards also help to prevent a
participant from using its influence to amend the rules of the clearing
agency in a manner that favors its own institution to the disadvantage
of other participants because the rules of a clearing agency may not be
applied on a discriminatory basis.\141\
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    \139\ 15 U.S.C. 78q-1(b)(3)(F).
    \140\ See Standards Release, supra note 134, at 419. All
participants utilizing similar clearing agency services, with the
exception of participants that are registered clearing agencies for
which specialized requirements apply, should be required to comply
fully with the clearing agency's internal financial and operational
rules such as clearing fund deposits, mark-to-market payments, and
margin deposits related to the services used.
    \141\ Id at 418. The provisions in Section 17A recognize that a
clearing agency may discriminate among persons in the admission to,
or the use of, the clearing agency, by requiring that participants
meet certain financial, operational, and other fitness standards.
However, Section 17A also requires that sanctioned discriminations
must not be unfair. In addition, the Commission must find that
clearing agency rules embodying any discriminations are in the
public interest and are consistent with the requirements of the
Exchange Act.
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    Finally, the Section 17A standards help to mitigate conflict of
interest concerns by providing that the rules of a registered clearing
agency may not impose a burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Exchange Act. This
helps assure that the clearing agency operates in a manner that is
consistent with the public interest and is not used by participants or
other interested parties to gain an unfair competitive advantage.\142\
The Commission staff has previously interpreted these standards as
requiring that a clearing agency must justify any anticompetitive
effect of membership criteria and that it will evaluate an
anticompetitive effect in light of the following factors: (1) The
essential nature of the service; (2) the number and type of potential
participants denied access to clearance and settlement services; (3)
the number of entities providing comparable clearance and settlement
services; and (4) the availability of correspondent clearing
arrangements to provide indirect access to a clearing agency's
services.\143\ The Commission believes these factors should also be
used to evaluate the anticompetitive effect of the membership standards
of security-based swap clearing agencies once they are registered
clearing agencies under Section 17A of the Exchange Act.
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    \142\ The standard does not prohibit all burdens on competition.
However, if a proposed rule of a clearing agency would impose a
burden on competition, the burden must be weighed against the
benefits of the rule in achieving the purposes of the Exchange Act.
For example, a clearing agency may impose participation standards
that have an anticompetitive effect as long as any such
anticompetitive effect is justified.
    \143\ See Standards Release, supra note 134, at 419.
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    The Commission requests comment on the application of the standards
under Section 17A to security-based swap clearing agencies in
conjunction with the proposed rules to address conflicts of interest.
Will the proposed rules effectively build on the Section 17A standards?
Should the Commission take a more targeted approach by focusing new
requirements under Section 765 of the Dodd-Frank Act on Section 17A
standards alone, such as by having requirements addressing only
membership standards and determinations whether to clear products?
Would such an approach sufficiently address conflicts of interests? If
not, are the proposed rules sufficient to address potential gaps in the
way Section 17A alone would address conflicts of interest with respect
to security-based swap clearing agencies? Should additional rules be
proposed under Section 17A to further address conflict of interest
concerns? Should the Commission extend the application of the proposed
rules for security-based swap clearing agencies to all registered
clearing agencies? To what extent would competitive pressures in the
security-based swaps market, particularly as it continues to develop,
help to mitigate conflicts of interest? Would the standards under
Section 17A help to promote competition in a way that would help to
mitigate conflicts of interest? To what extent does the Commission's
oversight of clearing agencies pursuant to the standards under Section
17A alleviate the need for ownership limitations and governance
requirements?

V. Discussion of Proposed Rule 702 Under Regulation MC for Security-
Based Swap Execution Facilities and National Securities Exchanges That
Post or Make Available for Trading Security-Based Swaps

A. Ownership and Voting Limitations

    Section 765 requires the Commission to adopt rules to mitigate
conflicts of interest, which may include numerical limits on control
of, or the voting rights with respect to, any clearing agency that
clears security-based swaps, or on the control of any SB SEFs or SBS
exchanges. Pursuant to this directive, the Commission is proposing
ownership and voting limits for a SB SEF that would apply to any SB SEF
participant and for a SBS exchange or facility of a national securities
exchange that posts or makes available for trading security-based swaps
(``SBS exchange facility'') that would apply to any SBS exchange
member. Specifically, the Commission proposes that a SB SEF, SBS
exchange, or SBS exchange facility shall not permit any SB SEF
participant or SBS exchange member, as applicable, either alone or
together with its related persons, to: (1) Beneficially own, directly
or indirectly, any interest in the SB SEF, SBS exchange, or SBS
exchange facility, as applicable, that exceeds 20% of any class of
securities, or other

ownership interest, entitled to vote of such SB SEF, SBS exchange, or
SBS exchange facility; or (2) directly or indirectly vote, cause the
voting of, or give any consent or proxy with respect to the voting of,
any interest in the SB SEF, SBS exchange, or SBS exchange facility, as
applicable, that exceeds 20% of the voting power of any class of
securities or other ownership interest of such SB SEF, SBS exchange, or
SBS exchange facility.\144\
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    \144\ See proposed Rule 702(b) under Regulation MC.
---------------------------------------------------------------------------

    The Commission is concerned that if a SB SEF participant or SBS
exchange member, either alone or together with its related persons,
were to own a significant stake in the SB SEF, SBS exchange, or SBS
exchange facility, respectively, the SB SEF participant or SBS exchange
member could use its significant ownership interest to influence the
operations of the SB SEF, SBS exchange, or SBS exchange facility to
unduly derive benefits at the expense of other owners and market
participants. The Commission is particularly concerned that a SB SEF
participant or SBS exchange member may have financial incentives to
limit the level of access to, and the scope of products traded on,
these trading venues as a means to impede competition from other market
participants. For example, the Commission understands that many of the
electronic multi-dealer trading platforms that exist today for OTC
derivatives or fixed income products limit the number of dealers from
which a customer can request a quote. The Commission believes that a
fewer number of dealers participating on a platform or exchange could
result in less competition on pricing. The Commission believes that
imposing ownership and voting limits, as described above, could
mitigate potential conflicts of interest with respect to the level of
access to the market and determinations as to which products are traded
by limiting the ability of a small group of persons (such as dealers)
to control the Board \145\ and thus the governance of the SB SEF, SBS
exchange, or SBS exchange facility.\146\
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    \145\ See supra note 98 for the proposed definition of
``Board.''
    \146\ The Commission also believes that such limits would
further the ability of the SB SEF and SBS exchange to effectively
carry out its obligations. Section 763(c) of the Dodd-Frank Act and
Section 6 of the Exchange Act, respectively, and, in particular,
provide market participants with impartial access to SB SEFs. See
Section 763(c) of the Dodd-Frank Act, Public Law 111-203, Section
763(c), and 15 U.S.C. 78f.
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    Unlike the Voting Interest Focus Alternative or the Governance
Focus Alternative for security-based swap clearing agencies, the
Commission is not proposing an aggregate 40% voting interest limit
collectively on all SB SEF participants (with respect to SB SEFs) and
SBS exchange members (with respect to SBS exchanges) or a 5% individual
voting interest limit, respectively. The Commission recognizes that, as
with security-based swap clearing agencies, the proposed rule would
limit, but not eliminate, the ability of a small group of SB SEF
participants or SBS exchange members, as applicable, to own a SB SEF,
SBS exchange, or SBS exchange facility. Specifically, as few as five
entities could own SB SEFs, SBS exchanges, and SBS exchange facilities
under this proposal. However, the Commission's concerns with respect to
concentration of ownership in security-based swap clearing agencies and
SB SEFs, SBS exchanges, and SBS exchange facilities are informed by the
differences in the structure for clearing and trading of security-based
swaps. The Commission's experience has been that the central clearing
model in the securities markets historically has tended toward
convergence to a single clearing agency for each type of cleared
product, while the market structure for securities trading historically
has not necessarily tended toward a similar model.\147\ The Commission
also notes that security-based swap clearing agencies perform a
critical function in mitigating financial risk for security-based swaps
market participants. Although SB SEFs, SBS exchanges, and SBS exchange
facilities are critical to promoting price transparency and therefore
market efficiency, the Commission does not believe that the operation
of SB SEFs, SBS exchanges, and SBS exchange facilities would pose the
same level of systemic risk as security-based swap clearing agencies.
There generally will be a lower barrier to entry with respect to
trading platforms because participants of a SB SEF or members of an SBS
exchange would not incur the margin, guaranty fund, or other
obligations that members of a clearing agency would incur, and thus
multiple venues for the trading of security-based swaps are more likely
to emerge. Thus, the Commission is not proposing identical ownership
requirements for security-based swap clearing agencies and SB SEFs, SBS
exchanges, and SBS exchange facilities.
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    \147\ The Commission has not made any determinations about
whether security-based swap clearing agencies will also tend to
converge to a single clearing agency or even a small number of
clearing agencies, as the central clearing of security-based swaps
is still a developing area.
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    For purposes of calculating a SB SEF participant's or SBS exchange
member's ownership and voting interests, the proposed rule would
aggregate such person's ownership and voting interests with those of
its related persons. When used with respect to a SB SEF, proposed Rule
700(u) under Regulation MC would define the term ``related person'' to
mean: (1) Any affiliate of a security-based swap execution facility
participant; (2) any person associated with a security-based swap
execution facility participant; (3) any immediate family member of a
security-based swap execution facility participant or any immediate
family member of the spouse of such person, who, in each case, has the
same home as the security-based swap execution facility participant or
who is a director or officer of the security-based swap execution
facility or any of its parents or subsidiaries; or (4) any immediate
family member of a person associated with a security-based swap
execution facility participant or any immediate family member of the
spouse of such person, who, in each case, has the same home as the
person associated with the security-based swap execution facility
participant or who is a director or officer of the security-based swap
execution facility or any of its parents or subsidiaries.
    Further, when used with respect to a SBS exchange or SBS exchange
facility, proposed Rule 700(u) under Regulation MC would define the
term ``related person'' to mean: (1) Any affiliate of a member of the
national securities exchange that posts or makes available for trading
security-based swaps; (2) any person associated with a member of the
national securities exchange that posts or makes available for trading
security-based swaps; (3) any immediate family member of a member of
the national securities exchange that posts or makes available for
trading security-based swaps or any immediate family member of the
spouse of such person, who, in each case, has the same home as the
member of the national securities exchange that posts or makes
available for trading security-based swaps or who is a director or
officer of the national securities exchange or facility thereof that
posts or makes available for trading security-based swaps, or any of
its parents or subsidiaries; or (4) any immediate family member of a
person associated with a member of the national securities exchange
that posts or makes available for trading security-based swaps or any
immediate family member of the spouse of such person, who, in each
case, has the same home as the person associated with the

national securities exchange that posts or makes available for trading
security-based swaps or who is a director or officer of the national
securities exchange or facility thereof that posts or makes available
for trading security-based swaps or any of its parents or subsidiaries.
To further the purpose of the proposed limits, the Commission
preliminarily believes that it would be important to aggregate the SB
SEF participant's or SBS exchange member's ownership and voting
interests with the interest of any person with whom such person may be
able to act together to influence or control the SB SEF, SBS exchange,
or SBS exchange facility.
    The proposed rule would restrict indirect as well as direct
ownership and voting of a SB SEF, SBS exchange, or SBS exchange
facility. Because the proposed rule could be easily circumvented if the
Commission were to limit solely direct ownership and voting, the
Commission preliminarily believes it would be important to further the
purpose of imposing ownership and voting limits to also restrict the
indirect ownership and voting interests of SB SEF participants and SBS
exchange members. For example, if the Commission simply proposed to
prohibit a SB SEF participant from directly owning or voting shares,
the participant could hold its ownership interests in the SB SEF
through a holding company, thus easily circumventing the intent of the
proposed rule. Accordingly, the ownership and voting limits would apply
to ownership and voting of interests in a parent company of the SB SEF,
SBS exchange, or SBS exchange facility. For example, if the SB SEF were
wholly-owned by a holding company, a SB SEF participant would be
prohibited from owning or voting more than 20% of the voting interest
in the parent company. Finally, the proposed limits also would apply to
a SB SEF participant or SBS exchange member that beneficially owns more
than 25% of an entity that itself owns more than 20% of a SB SEF, SBS
exchange, or SBS exchange facility.\148\
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    \148\ See supra note 93 for the proposed definition of
``control.''
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    To assure that SB SEFs, SBS exchanges, and SBS exchange facilities
maintain an ownership structure consistent with the proposed ownership
and voting limits, the Commission proposes that these entities have
rules that (1) provide an effective mechanism to divest a SB SEF
participant's or SBS exchange member's ownership that, alone or
together with its related persons, exceeds 20% and (2) are reasonably
designed not to give effect to a SB SEF participant's or SBS exchange
member's voting interest that, alone or together with its related
persons, exceeds 20%.\149\ The Commission believes that in order for
the ownership and voting limits to be effective, each SB SEF, SBS
exchange, and SBS exchange facility must take measures to reduce a SB
SEF participant's or member's ownership interest or not give effect to
any voting interest that exceeds the proposed limits. The Commission
intends to provide SB SEFs, SBS exchanges, and SBS exchange facilities
flexibility in determining how to implement these requirements. Any
rules adopted by these trading venues, however, must assure that they
have a viable, enforceable mechanism to divest a SB SEF participant or
SBS exchange member of any interest held in excess of the 20% limit and
to not give effect to the portion of voting interest held in excess of
the 20% limit. The Commission also proposes to require each SB SEF, SBS
exchange, or SBS exchange facility to have rules to provide a mechanism
to obtain information relating to its ownership and voting
interests.\150\ The Commission believes that a requirement to collect
information regarding ownership and voting interests of SB SEF
participants and SBS exchange members is essential for registered
trading venues to monitor and comply with the proposed ownership and
voting limits.\151\
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    \149\ See proposed Rules 702(c)(1) and (2) under Regulation MC.
    \150\ See proposed Rule 702(c)(3) under Regulation MC.
    \151\ See supra Section IV.A.4.
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    The Commission believes that an ownership and voting limit of 20%
is an appropriate threshold. On the one hand, the restriction would
limit the ability of a SB SEF participant or SBS exchange member to
exert undue influence over the governance of a SB SEF, SBS exchange, or
SBS exchange facility, respectively. On the other hand, such an
ownership and voting limit should not overly interfere in such an
entity's organizational structure or the ability of a SB SEF
participant or SBS exchange member to acquire a substantial equity
interest in a SB SEF, SBS exchange, or SBS exchange facility, as
applicable.\152\ Thus, the proposed ownership and voting limits should
strike an appropriate balance between the objectives of mitigating
conflicts of interest and refraining from unnecessarily hindering the
ability of entities to form new trading venues. In addition, there may
be incentives to create a new SBS exchange or SB SEF because a SBS
exchange or SB SEF may draw significant new business by making
available to trade a security-based swap that is required to be cleared
under Section 763(a).\153\ Furthermore, the risk management and
economies of scale issues that may create a barrier to entry with
respect to new security-based swap clearing agencies generally would
not affect the creation of SBS exchanges or SB SEFs.
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    \152\ National securities exchanges that may trade security-
based swaps currently prohibit a member from owning or voting more
than 20% of the exchange, although an exchange's method of
calculating the 20% interest, aggregated with any person with whom
such person may be able to act together to influence or control an
exchange, may vary from the Commission's proposal. See, e.g.,
Amended and Restated Certificate of Incorporation of BATS Global
Markets, Inc., Article FIFTH; Amended and Restated Certificate of
Incorporation of NYSE Euronext, Article V.
    \153\ The counterparties to a transaction in a security-based
swap that is required to be cleared under Section 763(a)(2) of the
Dodd-Frank Act will be required to execute the transaction on a SBS
exchange or on a SB SEF. There is an exception from the execution
requirement if no SBS exchange or SB SEF makes the security-based
swap available to trade. See Public Law 111-203, Section 763(h). The
exception from trade execution is also available if the exception
from mandatory clearing under Section 763(g) applies. See Public Law
111-203, Section 763(g).
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    While the Commission believes that the proposed 20% ownership and
voting limits are appropriate, it also understands that the movement of
trading of security-based swaps onto SB SEFs, SBS exchanges, or SBS
exchange facilities will foster enhanced transparency and market
efficiency. The Commission does not intend to unnecessarily impede the
emergence of what could be vital sources of, among other things,
liquidity and pricing transparency for security-based swaps. However,
imposing on SB SEFs and SBS exchanges ownership and voting limits
similar to those that shareholder-owned cash equities and options
exchanges have in place could have the unintended consequence of
deterring new, competitive trading venues at a time when organized
markets for security-based swaps are just beginning to develop. A
trading platform that currently trades security-based swaps in the OTC
market but would not meet the proposed ownership and voting limits
would need to revise its ownership structure if it chooses to become a
SB SEF. There could be costs and delays as the potential SB SEF seeks
to find one or more additional owners to satisfy the proposed limits,
with a possible diminution in the value of the original owner(s)'
investment. Moreover, it is possible that imposing these limits may
affect the security-based swaps market differently than the cash
equities and listed options markets. Ownership and

voting limits were implemented at national securities exchanges at a
time when the trading of exchange-listed securities was fairly well
established and competitive. Consequently, a 20% ownership and voting
limit may not negatively affect the ability of cash equity and options
exchanges to promote competing trading venues but, if applied to the
security based-swaps market that is in its infancy, could retard market
development.
    The Commission is sensitive to arguments against imposing ownership
and voting limits for SB SEFs, SBS exchanges, and SBS exchange
facilities, some of which were articulated at the Conflicts Roundtable.
However, it also understands that the OTC derivatives market is highly
concentrated and dealer dominated. Although ownership and voting limits
arguably may have a less negative effect on new entrants to the cash
equities and options markets and their ability to compete, there may
also be less need for such limitations in those markets. In contrast,
although ownership and voting limits may more directly affect the
ability of SB SEFs and SBS exchanges to start up, the lack of market
characteristics to promote competing trading venues for security-based
swaps may emphasize the greater need for ownership and voting limits.
If the market characteristics for security-based swaps naturally
promote dealer domination without robust competing trading venues,
there is more need to mitigate the types of concerns that underlie
Section 765, such as by imposing ownership and voting limits.\154\
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    \154\ In the equities market a small group of broker-dealers or
single-dealer proprietary firms can and do own alternative trading
systems (``ATSs'') and thus it can be argued that SB SEFs and SBS
exchanges should be permitted to operate similarly. See Securities
Exchange Act Release No. 60997 (November 13, 2009), 74 FR 61208
(November 23, 2009) (as of November 2009, there were approximately
73 ATSs that are subject to Regulation ATS). However, ATSs exist in
the context of a marketplace with robust competition among numerous
trading venues. Therefore, ATSs that are owned by one broker-dealer
or a small group of broker-dealers, by virtue of their ownership
structure alone, generally do not present a concern that they could
lessen price competition or market efficiency.
---------------------------------------------------------------------------

    The Commission must weigh the potential implications of imposing
ownership and voting limits against imposing other requirements that
would allow a dealer-dominated security-based swaps market to continue.
As part of the balance between mitigating conflicts of interest without
unduly restricting the ability of a competitive market for trading of
security-based swaps to emerge, the Commission proposes to limit
ownership in SB SEFs, SBS exchanges, and SBS exchange facilities
specifically to those interests entitled to vote.\155\ Consequently, a
SB SEF participant or SBS exchange member would not be prohibited from
owning any percentage of a nonvoting interest in a SB SEF, SBS
exchange, or SBS exchange facility. In contrast, national securities
exchanges generally limit their members from owning more than 20% of
any interest, voting or otherwise. However, as discussed above, trading
venues for exchange-listed securities are well established and highly
competitive. In this regard, the Commission does not believe that it is
necessary to propose the same ownership limits as those currently in
place at national securities exchanges. Further, the proposed 20% limit
on ownership and voting would still allow as few as five entities to
own a SB SEF, SBS exchange, or SBS exchange facility. Thus, the
proposed limit by itself would not completely prohibit a small number
of entities from potentially exerting undue influence over SB SEFs, SBS
exchanges, or SBS exchange facilities in a way that could benefit the
few to the detriment of others.
---------------------------------------------------------------------------

    \155\ See supra note 64.
---------------------------------------------------------------------------

    The Commission requests comment on all aspects of the proposed
ownership and voting limits, including whether it is necessary and
appropriate to have ownership and voting limits at all. If commenters
believe that it is necessary and appropriate to impose ownership and
voting limits to mitigate conflicts of interest, the Commission
requests comment on whether the proposed limits are appropriate, or
whether they would unduly hinder the development of SB SEFs without
serving to mitigate any conflicts.\156\ Should the Commission require a
voting limit, but not an ownership limit or a different limit for
ownership versus voting? Even with the prohibition against owning more
than 20% of any interest entitled to vote, a SB SEF participant or SBS
exchange member could have sufficient ownership of nonvoting interest,
either alone or in addition to voting interest, to exert influence on
these trading venues. Should the Commission require the ownership limit
to apply to any class of equity securities or other ownership interest
rather than any class of securities, or ownership interest, entitled to
vote? \157\ Would the proposed limits impede the number or types of SB
SEFs from being established? Should the proposed ownership and voting
limits be phased in for SB SEFs to provide a grace period for those
entities that would not meet the requirements under Regulation MC?
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    \156\ In the SRO Governance Proposing Release, the Commission
proposed a similar 20% ownership and voting limit for members of a
national securities exchange. A number of commenters favored this
proposal, including several commenters that were national securities
exchanges or a facility of a registered securities association. See,
e.g., letter from Michael J. Simon, Secretary, ISE, to Jonathan G.
Katz, Secretary, Commission, dated March 8, 2005 (``ISE Comment
Letter'') (``[The ownership limitation] provides SROs with
flexibility, yet recognizes the unique conflicts that could arise if
a member were to own a controlling interest in an SRO with
regulatory responsibility for the member.''); letter from Meyer S.
Frucher, Chairman and Chief Executive Officer, Phlx, to Jonathan G.
Katz, Secretary, Commission, dated March 8, 2005 (``Phlx Comment
Letter'') (``The Exchange unequivocally agrees with the Commission
that a significant shareholder could use its voting power to
influence the operations of an exchange in a way that adversely
affects the mission, integrity or regulatory capacity of the
exchange, or otherwise is detrimental to the public interest.'');
letter from Philip D. DeFeo, Chairman and Chief Executive Officer,
Pacific Exchange, Inc. (``PSX''), to Jonathan G. Katz, Secretary,
Commission, dated March 8, 2005 (``PSX Comment Letter''); letter
from Edward S. Knight, Executive Vice President and General Counsel,
Nasdaq Stock Market, Inc., to Jonathan G. Katz, Secretary,
Commission, dated March 8, 2005 (``Nasdaq Comment Letter''). The
Commission notes, however, that the SRO Governance Proposing Release
related to national securities exchanges that trade equity
securities and listed options and registered securities
associations, and the comments received did not address potential
conflicts in other contexts.
    \157\ The CFTC has proposed similar ownership and voting limits
for DCMs and registered SEFs, and applies the ownership limit only
to any class of equity securities entitled to vote. See http://
www.cftc.gov/ucm/groups/public/@newsroom/documents/file/
federalregister_governance.pdf.
---------------------------------------------------------------------------

    The Commission also seeks comment on whether the proposed ownership
and voting limits would continue to be important as the market for
security-based swaps evolves. If multiple SB SEFs emerge as this market
develops, would competitive pressures alleviate any of the conflicts of
interest that are the basis for the Commission's proposals? In that
case, would it be appropriate for the Commission to impose different
limits? Should the Commission reduce the restrictions over time, if
conflict of interest concerns are lessened as the security-based swaps
market develops? For example, if participation in the trading of
security-based swaps becomes more open and includes a broader range of
participants, and multiple SB SEFs or SBS exchanges evolve to trade the
same security-based swaps, would there still be a need to retain
ownership and voting limits or are there factors that would allow such
limits to be revised? What factors should the Commission consider in
assessing whether any ownership and voting limits it may impose on SB
SEFs should be revisited?
    As mentioned above, each national securities exchange currently
prohibits

its members from owning an interest, voting or otherwise, or voting
more than 20% (or less) of the exchange or a facility of the
exchange.\158\ Therefore, the Commission preliminarily does not believe
that the proposed rules would have a material effect on an exchange's
ability to post or make available for trading security-based swaps.
Nevertheless, the Commission requests comment on whether the proposed
limits in this rulemaking could affect a national securities exchange's
ability or decision to post or make available for trading security-
based swaps. Also, given that national securities exchanges currently
have limits on ownership and voting by members, would codifying the
proposed limits help to further mitigate the types of conflicts of
interest that underlie the Dodd-Frank Act for SBS exchanges? Would
there be any effect on the willingness of entities to register to
become a national securities exchange and trade security-based swaps?
What would be the implication, if any, on an exchange that chose to
trade security-based swaps through a facility that is a separate legal
entity? More generally, for SB SEFs and SBS exchanges or SBS exchange
facilities, should ownership and voting be limited to the same
threshold or should they be different? If the Commission should take a
different approach for ownership and voting, what should that approach
be?
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    \158\ A member has in the past been permitted on a pilot basis
to own more than 20% of a facility of an exchange subject to certain
terms and conditions. See Securities Exchange Act Release Nos. 59281
(January 22, 2009), 74 FR 5014 (January 28, 2009) (order approving
on a pilot basis 50% ownership of the New York Block Exchange, a
trading facility of NYSE, by BIDS ATS, a member of NYSE). This pilot
has since been extended for an additional year and will expire on
January 22, 2011 unless further extended or permanently approved.
See Securities Exchange Act Release No. 61409 (January 22, 2010), 75
FR 4889 (January 29, 2010).
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    As described above, Section 765 enumerates Specified Entities that
the Commission should consider in its rulemaking. The Commission
understands that, depending on who may be permitted to directly effect
transactions on a SB SEF (or is a SBS exchange member), limits on
ownership and voting that apply only to SB SEF participants or SBS
exchange members could be either over-inclusive or under-inclusive or
both, with respect to the Specified Entities. For example, restricting
control of a SB SEF based on an entity's direct participation on the SB
SEF could capture a person who is not one of the Specified Entities or,
conversely, fail to take into consideration a Specified Entity.
Accordingly, the Commission requests comment on whether the scope of
the proposed ownership and voting limits is appropriate. Should the
limits on ownership and voting extend to all or some of the Specified
Entities, regardless of their direct participation on the SB SEF or SBS
exchange? If so, why? What are the potential conflicts concerns that
such Specified Entities may pose? How are conflicts concerns posed by
such Specified Entities different from those posed by SB SEF
participants or SBS exchange members who are not also Specified
Entities? In this regard, the Commission notes that the definition of
``related person'' would encompass any such entity that is affiliated
with such a SB SEF participant or SBS exchange member, although it may
not itself be a SB SEF participant or SBS exchange member.
    In addition, national securities exchanges generally limit
ownership and voting by non-members, as well as members.\159\
Specifically, exchanges generally limit each non-member to no more than
40% ownership of the exchange. The limit on ownership by non-members of
an exchange is designed in part to provide the Commission and the
exchange with the proper tools (such as access to books and records)
necessary to carry out the Commission's and the exchange's respective
regulatory oversight responsibilities, as well as to mitigate more
general conflict concerns between owners' commercial interests and the
exchange's regulatory obligations. The Commission requests comment on
whether it should impose, as part of this rulemaking, similar limits on
ownership and voting. Such an ownership limit would apply to the
Specified Entities, to the extent they are not subject to the proposed
ownership limit described above. In addition to the requirements of
Section 765, the Dodd-Frank Act more generally requires a SB SEF to
establish and enforce rules to minimize conflicts of interest in its
decision-making process and establish a process for resolving the
conflicts of interest. What are the types of conflicts that a person
who is not a SB SEF participant or SBS exchange member may pose?
---------------------------------------------------------------------------

    \159\ See supra Section III.B.
---------------------------------------------------------------------------

    The Commission also requests comment on whether its formulation for
calculating the 20% threshold is appropriate. Specifically, the
Commission requests comment on all prongs of the definition of
``related person,'' including whether the definition is over-inclusive
or under-inclusive. What other method could the Commission use to reach
the interest of any person with whom a SB SEF participant or SBS
exchange member may be able to act together to influence or control a
SB SEF or SBS exchange? Finally, the Commission expects a SB SEF, SBS
exchange, and SBS exchange facility to have in place an effective
mechanism for enforcing the ownership and voting limits. The Commission
requests comment on whether the proposed rules related to divesture of
ownership and voting limits are appropriate. Should the Commission
explicitly require in the proposed rules specific ways to divest
ownership and voting interest of SB SEF participants and SBS exchange
members who violate the ownership and voting limits? Is the proposed
rule pertaining to obtaining information on ownership and voting
interest of SB SEFs, SBS exchanges, and SBS exchange facilities
appropriate? Should the Commission require that trading venues collect
information pertaining to certain ownership or voting thresholds?

B. Governance Requirements

    The Commission is proposing substantive requirements with respect
to the governance of SB SEFs, SBS exchanges, and SBS exchange
facilities that are designed to address the conflict of interest
concerns identified above, including the concern that dealer-owners
could unduly influence the governance and operation of a SB SEF or SBS
exchange. These governance provisions, as discussed below, should help
mitigate conflicts of interest as directed by Section 765 of the Dodd-
Frank Act.
1. Board
    The Commission proposes that the Board of a SB SEF, SBS exchange,
or SBS exchange facility be composed of a majority of independent
directors.\160\ The presence of a majority of independent directors on
the Board should reduce the ability of owner-directors of a SB SEF, SBS
exchange, or SBS exchange facility to improperly influence the
operation of such entity to their own advantage and to the detriment of
other users or potential users of the facility or exchange. A majority
independent director requirement should help foster a greater degree of
independent decision-making consistent with the objectives of the Dodd-
Frank Act and the Exchange Act and should reduce the ability of owners
that are participants or members to control key decisions regarding the
operation of the SB SEF or SBS exchange and thereby potentially limit

access to, or limit the products made available for trading on, the SB
SEF or SBS exchange, which could adversely affect the trading of
security-based swaps in regulated markets. Further, the definition of
independent director is designed to assure that the independent
director would not have a direct economic stake in the SB SEF or SBS
exchange, or other relationship that would call into question the
impartiality of the director, and thus would not be subject to the
conflicts of interest identified above.
---------------------------------------------------------------------------

    \160\ See proposed Rule 702(d)(1) under Regulation MC. See also
supra note 102 and accompanying text for the proposed definition
``independent director.''
---------------------------------------------------------------------------

    SB SEFs and SBS exchanges are intended to serve important roles in
providing centralized, transparent trading of security-based swaps and,
under Section 763(c) of the Dodd-Frank Act or existing Section 6 of the
Exchange Act, as applicable, will have a number of
responsibilities.\161\ Requiring a majority independent Board should
help assure that SB SEFs and SBS exchanges would operate in an
impartial manner with respect to these (and other) mandated duties.
Moreover, requiring a majority independent Board for SB SEFs and SBS
exchanges would be commensurate with the manner in which national
securities exchanges generally are governed today \162\ and comports
with the listing rules of exchanges, which are approved by the
Commission.\163\
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    \161\ For SB SEFs, these responsibilities include establishing
and enforcing rules with respect to the terms and conditions of the
security-based swaps traded or processed on or through the facility
and any limitation on access to the facility; trading procedures to
be used in entering and executing orders traded on SB SEFs; and
monitoring trading in SB SEFs to prevent manipulation, price
distortion, and disruptions of the settlement process through
surveillance, compliance and disciplinary practices and procedures.
See Section 763(c) of the Dodd-Frank Act, Public Law 111-203,
Section 763(c).
    \162\ See supra Section III.B. Currently, the governance
structure of a facility of an exchange that is a separate legal
entity from the exchange and that is not a wholly-owned subsidiary
of the exchange is not subject to any specific board or committee
compositional requirements. Given the nature of the conflict
concerns for the trading of security-based swaps and the structure
of the security-based swaps market--namely, the dominance by a small
group of dealers and the concern with respect to undue influence in
the operation of the SB SEF or SBS exchange--the Commission believes
that it is necessary and appropriate to impose the same board and
committee compositional requirements on a facility of an exchange if
that facility posts or makes available for trading security-based
swaps.
    \163\ See Securities Exchange Act Release No. 48745 (November 4,
2003), 68 FR 64154 (November 12, 2003) (order approving File Nos.
SR-NYSE-2002-33, SR-NASD-2002-77, SR-NASD-2002-80, SR-NASD-2002-138,
SR-NASD-2002-139, and SR-NASD-2002-141).
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    One of the alternatives the Commission proposes for security-based
swap clearing agencies is to require the Board of any security-based
swap clearing agency be composed of 35% independent directors. The
Commission proposes this 35% independence alternative to address
potential concerns that requiring a majority independent Board for
security-based swap clearing agencies would affect the Board's ability
to effectively perform risk management functions. Security-based swap
clearing agencies perform a critical function in mitigating financial
risk for security-based swaps market participants. Although critical to
promoting price transparency and therefore market efficiency, as noted
above, the Commission does not believe that the operation of SB SEFs,
SBS exchanges, and SBS exchange facilities would pose the same level of
systemic risk as security-based swap clearing agencies because they do
not assume the risk of managing open positions or of guaranteeing the
settlement of transactions. Thus, the Commission is not making the same
proposal with respect to SB SEFs, SBS exchanges, and SBS exchange
facilities.
    Although a majority independent Board may address conflicts of
interest concerns that underlie Section 765 of the Dodd-Frank Act, it
may not effectively eliminate all conflicts. The presence of
independent directors may be an effective mechanism to address certain
types of conflicts in certain types of institutions but not necessarily
in all instances nor for all institutions. The Commission, however,
does not believe that the characteristics of SB SEFs and SBS exchanges,
and the types of conflicts that may be inherent with respect to such
entities, pose a set of circumstances that are incompatible with an
effective governance via a majority independent Board.
    Taking into account these and other concerns, the Commission has
considered a less prescriptive governance rule to address conflicts of
interest for venues that trade security-based swaps. However,
especially because SB SEFs are not SROs and thus their rules are not
subject to Commission approval pursuant to Section 19 of the Exchange
Act,\164\ a principles-based approach to governance may not give the
Commission sufficient ability to address potential conflicts in the
operation of SB SEFs. Although the Commission, through its authority to
approve applications to register as a SB SEF, may be able to ascertain
that a SB SEF at the time of its registration has a governance
structure that sufficiently would mitigate conflicts of interest, a
less prescriptive approach could make it more difficult for the
Commission to assure that the SB SEF's governance structure continues
to meet the proposed requirements over time.
---------------------------------------------------------------------------

    \164\ 15 U.S.C. 78s.
---------------------------------------------------------------------------

    The Commission welcomes commenters' insights to inform its
understanding of the governance of trading venues for security-based
swaps. As discussed above, a majority independent Board may not
effectively address all conflicts. The Commission therefore seeks
comment on all aspects of its proposal for a majority independent
Board. Should the Commission adopt a less prescriptive approach to
mitigating conflicts of interest in the governance of SB SEFs and SBS
exchanges? Are there other approaches that would improve governance and
mitigate conflicts of interest? For example, would State laws governing
the fiduciary duty owed by corporate board members help to mitigate
conflicts of interest or, as noted above, would such laws potentially
aggravate the types of conflicts of interest that the Commission is
trying to address? Should the Commission consider any additional
requirements related to fiduciary duties to either enhance mitigation
of conflicts or address deficiencies?
    Further, the Commission requests comment on whether requiring the
Board of a SB SEF, SBS exchange, or SBS exchange facility to be
composed of a majority of independent directors would improve the
governance of the SB SEF, SBS exchange, or SBS exchange facility, as
applicable, and mitigate conflicts of interest that could arise. The
Commission specifically requests comment on whether there are other
Board structures that could help mitigate conflicts of interest. If
having a majority independent Board is not necessary to mitigate
conflicts, but some lesser percentage of independent directors would
help address such concerns, what percentage of Board members should be
required to be independent? What are the benefits and costs of
requiring Boards of SB SEFs, SBS exchanges, and SBS exchange facilities
to be composed of a majority of independent directors? Would a majority
independent Board help to mitigate conflicts of interest if the
ownership of a SB SEF, SBS exchange, or SBS exchange facility is
concentrated in a small group of owners (e.g., five owners) rather than
a larger group (e.g., greater than ten owners)? Would a majority
independent Board help to mitigate conflicts of interest that could
arise between the commercial interests of a SB SEF, SBS exchange, or
SBS exchange facility or the owners of the SB SEF, SBS exchange or SBS
exchange

facility and the regulatory responsibilities of the SB SEF or SBS
exchange? Are there experience or efficiency issues if a majority of
the Board must be composed of independent directors? Are there remedies
for overcoming any such experience or efficiency issues? \165\
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    \165\ The SRO Governance Proposing Release proposed that the
board of a national securities exchange or national securities
association be composed of a majority of independent directors. See
SRO Governance Proposing Release, supra note 59. A number of
commenters, particularly national securities exchanges, favored this
proposal. See, e.g., PSX Comment Letter, supra note 156; Letter from
Anthony K. Stankiewicz, Esq., Vice President, Legal and Governance,
BSE, to Jonathan G. Katz, Secretary, Commission, dated March 8, 2005
(supporting the majority independent board requirement but objecting
to the definition of independence) (``BSE Comment Letter''); Letter
from Mary Yeager, Assistant Secretary, NYSE, to Jonathan G. Katz,
Secretary, Commission, dated March 8, 2005 (``NYSE Comment
Letter''). A few commenters objected to it as being an unnecessary
requirement to mandate for all exchanges. See, e.g., ISE Comment
Letter, supra note 156; Letter from William J. Brodsky, Chairman and
Chief Executive Officer, Chicago Board Options Exchange,
Incorporated, to Jonathan G. Katz, Secretary, Commission, dated
March 8, 2005 (``CBOE Comment Letter''). The Commission notes,
however, that the SRO Governance Proposing Release related to
national securities exchanges that trade equity securities and
listed options and registered securities associations, and the
comments received did not address potential conflicts in other
contexts.
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    The Commission also notes that currently, for national securities
exchanges, at a minimum, the number of non-industry directors should
equal or exceed the number of industry directors.\166\ The Commission
requests comment on whether requiring a majority independent Board
could further mitigate conflicts for SBS exchanges or whether the
current standards exchanges have in place would sufficiently address
the conflict concerns with respect to exchanges that would post or make
available for trading security-based swaps. Further, the Commission
requests comment as to whether the requirement for Board composition
should be different for SB SEFs and SBS exchanges and, if so, why and
how?
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    \166\ See supra Section III.B.
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    The Commission also requests comment on the proposed definitions of
``independent director'' and ``material relationship.'' \167\ Are the
definitions of ``independent director'' and ``material relationship''
appropriate? If not, how should they be defined? The proposed rule
provides circumstances that would preclude a finding that a director is
independent.\168\ The Commission requests comment on whether this
approach is appropriate or whether the Commission should take a less
prescriptive approach. The Commission also notes that the proposed rule
precludes a director from being deemed independent if he or she has
received from the SB SEF, SBS exchange, or SBS exchange facility within
the past three years payments that reasonably could affect his or her
independent judgment or decision-making, excluding remunerations for
Board or Board committee services. The Commission requests comment on
whether it is appropriate to exclude compensation for Board or Board
committee service from disqualifying a director as an independent
director. Are there circumstances or levels of compensation that should
disqualify a candidate from being deemed independent? The Commission
also requests comment on whether, instead of independence requirements,
it should require that the number of ``non-industry'' directors equal
or exceed the number of ``industry'' directors, as such terms are
generally defined by the exchanges.\169\ Are there other types of
affiliations that the Commission should be concerned about that are not
addressed by the proposed definitions of ``independent director'' or
``material relationship''?
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    \167\ See proposed Rules 700(j) and (l) under Regulation MC.
    \168\ See Section 303A.02 of the NYSE Listed Company Manual and
Nasdaq Rule 5605(a)(2), both of which contain specific circumstances
that, if satisfied, would preclude a determination that the director
is independent.
    \169\ See supra note 66.
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    The Commission is not proposing that the Board composition
requirement apply to parent companies of a SB SEF, SBS exchange, or SBS
exchange facility.\170\ In other words, the Commission is not proposing
to require a holding company that wholly owns, or entities that
control, a SB SEF, SBS exchange, or SBS exchange facility to have a
majority independent Board.\171\ The Commission preliminarily believes
that the composition of the Board of a parent that wholly owns or
controls a SB SEF, SBS exchange, or SBS exchange facility does not
raise conflicts concerns that require Commission rulemaking. The
Commission, however, requests comment on whether the majority
independent Board requirement should apply to an entity that owns and
controls a SB SEF, SBS exchange, or SBS exchange facility.
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    \170\ If the parent company of a SB SEF, SBS exchange or SBS
exchange facility was itself a regulated entity that is subject to
the Exchange Act and rules and regulations thereunder, then it would
comply with any requirements that it is subject to in that capacity.
    \171\ The CFTC has proposed to apply a ``public director''
requirement to parent companies that operate DCMs and SEFs. See
http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/
federalregister_governance.pdf.
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2. Regulatory Oversight Committee
    In addition to a majority independent Board, the Commission
proposes that a SB SEF or SBS exchange establish a ROC that is composed
solely of independent directors to oversee the SB SEF's obligations
under Section 763(c) of the Dodd-Frank Act or the SBS exchange's
regulatory oversight responsibilities under Section 6 of the Exchange
Act, respectively.\172\ This requirement also would apply to a national
securities exchange that posts or makes available for trading security-
based swaps through a facility of the exchange.\173\ The ROC would
oversee the regulatory program on behalf of the Board. Specifically,
the Commission expects that a ROC, among other things, would monitor a
SB SEF's or SBS exchange's regulatory program for sufficiency,
effectiveness, and independence; oversee all facets of the regulatory
program; review the size and allocation of the regulatory budget and
resources; and review regulatory proposals and advise the Board as to
whether and how such changes may affect regulation. The proposed rule
also would require that any recommendation of the ROC that is not
adopted or implemented by the Board be reported promptly to the
Commission.\174\
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    \172\ See Section 763(c) of the Dodd-Frank Act, Public Law 111-
203, Section 763(c), and 15 U.S.C. 78(f). See also proposed Rule
702(e)(1) under Regulation MC.
    \173\ Proposed Rule 702(e) under Regulation MC does not
explicitly include a SBS exchange facility. A facility that posts or
makes available for trading a security-based swap would do so under
the registration of an exchange of which it is a facility.
Therefore, the exchange is deemed the statutory entity posting or
making available for trading the security based swap and is
responsible for the regulatory oversight of the facility.
Accordingly, the exchange whose facility posts or makes available
for trading a security-based swap must itself establish the
requisite ROC.
    \174\ See proposed Rule 702(e)(2) under Regulation MC.
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    The proposed provisions relating to the ROC should help limit the
ability of owners of the SB SEF and SBS exchange to unduly influence
the operation of these entities, and thus would further the objectives
of good governance and mitigation of conflicts of interest that
underlie Section 765 of the Dodd-Frank Act. A ROC is intended to have
an important role in assuring that a SB SEF or SBS exchange carries out
its obligations in an even-handed and effective manner and that its
oversight functions are adequately funded.
    Although the Commission encourages national securities exchanges to
have a wholly independent ROC, it has not in

the past required them to do so.\175\ As mentioned above, however, the
conflict concerns that Section 765 is intended to address are not
entirely analogous to those posed by national securities exchanges.
Rather, there is a heightened concern regarding conflicts of interest
for trading venues of security-based swaps because a small group of
dealers may exert undue influence to control the level of access to,
and the scope of products traded on such venues. Further, while SB SEFs
do not possess the full range of self-regulatory obligations that
exchanges have, they nonetheless have a number of regulatory duties
that are set forth in the core principles for SB SEFs contained in
Section 763(c) of the Dodd-Frank Act.\176\ Thus, it appears that a need
for a wholly independent ROC may be greater for SB SEFs and SBS
exchanges than for other registered national securities exchanges.\177\
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    \175\ In the SRO Governance Proposing Release, the Commission
proposed to require SROs to have a ROC and to require that all
members of such committee be independent. See SRO Governance
Proposing Release, supra note 59. Some commenters generally favored
the requirement of a ROC. See, e.g., PSX Comment Letter, supra note
156; CBOE Comment Letter, supra note 165. However, a number of
commenters objected to the requirement that certain board
committees, including the ROC, be composed solely of independent
directors. See, e.g., Phlx Comment Letter, supra note 156 (``To
impose this requirement on all Standing Committees would potentially
exclude persons with the most experience and knowledge from serving
on these committees.''); CBOE Comment Letter, supra note 165; letter
from Neal Wolkoff, Acting Chief Executive Officer, the American
Stock Exchange LLC, to Jonathan G. Katz, Secretary, Commission,
dated March 8, 2005 (``[A] number of the exchanges may find it
difficult to find enough qualified independent directors with
sufficient expertise to satisfy all of these committees.''); letter
from the Archipelago Exchange, BSE, the Chicago Stock Exchange, ISE,
the Nasdaq Stock Market, and Phlx, to Jonathan G. Katz, Secretary,
Commission, dated March 8, 2005 (``[As] a result of the potential
loss of flexibility, we disagree with the mandated requirement for
specific committees composed exclusively of directors that meet the
[Commission's] proposed definition of independence.''). The
Commission notes, however, that the SRO Governance Proposing Release
related to national securities exchanges that trade equity
securities and listed options and registered securities
associations, and the comments received did not address potential
conflicts in other contexts.
    \176\ See supra note 54.
    \177\ Some exchanges have voluntarily created ROCs. See, e.g.,
Securities Exchange Act Release Nos. 51149 (February 8, 2005), 70 FR
7531 (February 14, 2005) (order approving demutualization of the
Chicago Stock Exchange (``CHX'')) (at the time of the
demutualization, CHX proposed to have, and currently has, majority
public directors on its ROC) and 62158 (May 24, 2010), 75 FR 30082
(May 28, 2010) (order approving the demutualization of CBOE) (CBOE's
ROC is composed solely of non-industry directors).
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    The Commission also recognizes that, as mentioned above, an
independent director, who by definition would be outside the management
of a SB SEF or SBS exchange and not a SB SEF participant or SBS
exchange member may not have access to the same amount or types of
information as non-independent directors. Therefore, a ROC composed
solely of independent directors may need to rely on management or non-
independent directors for information, with attendant biases of
information from such sources. If directors on a ROC, moreover, lack
necessary information or are otherwise not sufficiently knowledgeable,
the committee's effectiveness as a whole may be compromised. Such ROC
may defer to management's expertise or the expertise of non-independent
directors on the Board. Further, as mentioned above, independent
directors may have their own biases that could compromise the
structural protections intended by a wholly independent ROC. Therefore,
the Commission seeks comment on the proposal relating to the