Proposed Rule

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Explanation of Proposed Amendments

NFA's Board consists of 45 directors, drawn from each category of NFA membership and the public. The basic structure of NFA's Board has remained unchanged since 1982. Obviously, the industry itself has changed dramatically over the years and the pace of change remains so rapid that all organizations, including NFA, must be able to adapt quickly to changes in the business environment. These factors have led other self-regulatory organizations in both the futures and securities industries to dramatically reduce the size of their boards. For these reasons, the Board approved amendments to NFA's Articles and Bylaws to reflect the changes explained below:

  • The Board will be reduced in size to 25 directors, all of whom would serve two-year terms except the exchange representatives whose terms would be one year;

  • The transition to the new Board will be completed by February 2002;

  • A super-majority voting rule (two-thirds of the directors present and voting) will replace the category voting rules for those matters that now require a category vote; and

  • The Appeals Committee will have five members, all of whom are directors, and the Membership Committee will consist of nine members, five of whom are directors.

The following chart compares NFA's existing and proposed restructured Board by category:

Exchange FCM/IB CPO/CTA Public Total
Current Board 13 14/3 6 9 45
Proposed Board 6 8/2 4 5 25

Four exchange directors would represent the top four exchanges based on volume; the other two would be elected by the remaining exchanges that are not affiliated with any of the top four. Similarly, four FCM representatives would come from the top ten FCMs based on the amount of segregated funds and secured amount and the rest from all other FCMs. One IB director would be an independent IB and the second, a guaranteed IB. In the CPO/CTA category, two directors would be affiliated with either CPOs or CTAs that are ranked in the top 20% of funds under management allocated to futures. The number of public directors satisfies the CFTC's requirement that 20% of the Board must be public representatives.

The current structure of the contract market category on the Board provides that all exchanges are entitled to a representative on NFA's Board, up to a maximum of 11 exchanges. Additionally, each exchange that accounts for more than 20% of aggregate volume is entitled to two representatives. Historically, this has meant that there have been 13 exchange directors on the Board.

To ensure adequate and diverse representation of the exchange community but still reduce the size of the Board, the Board decided that the four largest exchanges based on volume should be entitled to seats on the Board and that two other exchanges elected by the remaining exchanges should also be represented. In keeping with the principle that only one director should represent an exchange and all of its affiliates, the Board determined that the six contract market directors must represent exchanges not affiliated with each other. Similarly, only exchanges that are not affiliated with the four exchanges whose Board seats are based on volume will vote for the two contract market directors that come from their ranks.

The Board also felt that the current arrangement of having more FCM directors than exchange directors should continue since NFA's regulatory activities impact FCMs more than contract markets. In light of this, the Board decided that there should be eight FCMs directors. These seats would also be divided by size, so that four of the eight would represent FCMs ranked in the top ten FCMs based on segregated funds. The FCM ranking would also be based on secured amount of funds. The other four directors would represent the remaining FCMs. Unlike the exchange category, however, all FCMs would vote for all FCM directors, splitting votes between the "large FCM" subcategory and the remaining FCMs. IBs will continue to be represented by a guaranteed and an independent IB.

CPO/CTA directors comprise 6 of 45 directors on the existing Board. The Board determined that four directors should represent the CPO/CTA category on the restructured Board. As is currently the case, and like the exchange and FCM categories, the Board believes that size should determine to a certain extent how the CPO/CTA seats are allocated. Under the existing structure, one CPO director and one CTA director must come from a CPO and CTA, respectively, ranked in the top one-third of money under management allocated to futures. To make the size distinction more meaningful and to provide some flexibility, the Board decided that two of the four directors should be affiliated with either CPOs or CTAs that are ranked in the top 20% of funds under management allocated to futures.

The number of public director seats is determined by the CFTC regulation that requires public directors to comprise at least 20% of the Board. The other categories account for 20 directors. Therefore, there must be five public directors on the restructured Board. The current rules specify that none of the public directors may be employed by an NFA Member. Additionally, at least four of the current nine public directors must have no direct association with a business enterprise in the futures industry and the rest may come from entities such as commercial banks, commercial firms and other users of the futures markets. The Board believed that these rules are overly rigid and felt that all public directors should simply meet the standards of the CFTC regulation, which provides that they cannot be principals, officers or employees of an NFA Member.

The Board is strongly committed to broad and diverse representation in each of the categories. Though the Board has recognized size as a very significant criterion and therefore built size into the category composition requirements, other factors are also important to ensuring representation of all segments of the membership. For example, the type of business firms conduct and the type of customers they service may also differentiate firms within a category. Similarly, whether an exchange is an open-outcry or electronic exchange is a differentiating factor, as is the exchanges' history in the industry. However, the Board concluded that constructing each category in accordance with rigid criteria was not workable. Rather, it felt that the best way to ensure diversity on the Board is to include directions to the Nominating Committee that these factors must be considered when selecting nominees for Board seats.

In order to be successful, the Board felt that the transition from the current Board to the restructured Board must accomplish a number of things. It should minimize the disruption to the Board and its proper functioning. The quality of the directors must be maintained and the current directors' prior service to NFA needs to be recognized. Finally, the transition should be accomplished as quickly as possible consistent with these goals.

The Board decided on a single-step process to accomplish the transition. The process requires an amendment to the Bylaws for the creation of an Interim Board that would consist of the existing directors. The Interim Board will have all the powers of the Board except the power to adopt, amend or repeal the Articles of Incorporation. All interim directors' terms would end in February 2002 and all 25 of the new directors would be elected. The Annual Election date, which is currently the second Tuesday in January, will be changed to the third Tuesday in January to accommodate the elections for contract market directors. The terms of the new directors would be staggered based upon the number of votes they receive. Half of the directors in each category would serve two-year terms and the other half would serve one-year terms. The directors receiving the highest number of votes in the election will serve two-year terms.

NFA's Articles currently require category votes in three instances: delegation of authority to amend NFA Bylaws; changes in dues or assessment fees; and amendment of the Articles. A majority vote of the representatives of each category is required for the delegation of authority to amend the Bylaws. Amendments of the Articles require a majority vote in each category except that two-thirds of the exchange representatives must approve the amendment (two-thirds of the exchange Members voting must also approve the amendments). Changes to dues and assessment fees also require a majority vote of each category, except that the unanimous consent of the exchange representatives is required if the change affects contract market Members. These rules enable, at least theoretically in certain instances, any single category to dominate the Board and in matters involving changes to dues and assessments, a single director could control the outcome. In fact, however, this has rarely been an issue.

The Board believed that the protection that the category voting requirements provides is no longer necessary. However, the Board also believed that the issues that currently require category votes are sufficiently important that they deserve special attention. The Board determined to substitute super-majority requirements (two-thirds of the directors present and voting) for category votes on these issues. This would eliminate the potential domination by a few directors or even one director but maintain protection against dominance of a simple majority on critical issues. The Board also determined to replace the requirement that two-thirds of the contract market Members voting approve Articles amendments with a simple majority rule as is the case with all other categories.

The amendments also reflect changes to some NFA committees. There are currently five standing subcommittees of the Board: Executive, Appeals, Audit, Finance and Membership. The Board felt that there should be no changes to the basic structure of the Executive Committee. The current Articles provide for one Executive Committee seat to a representative of a contract market having two Board seats and one to a contract market with one Board representative. Under the revised provisions, however, no contract market will have two Directors. Consequently, a technical amendment to the Articles regarding the composition of the Executive Committee was made to retain the current arrangement.

The Bylaws currently provide that the Appeals and Membership Committees each have nine members. Given the reduction from 45 to 25 Board members, the Board concluded that having both of these committees continue in their present size and composition is not tenable. The Board considered a number of ways to address this issue and decided that the size of the Appeals Committee should be reduced from nine members to five, a reduction in line with the overall reduction of the size of the Board. However, this approach does not work well with the Membership Committee because of its activities and workload.

The Membership Committee establishes general policies governing fitness of firms and individuals for registration and membership and oversees staff's implementation of those policies. It discharges its oversight responsibility by periodically reviewing staff's decisions to grant registration and membership and to institute adverse actions to deny or revoke registration and membership. The Membership Committee also reviews settlement offers and conducts evidentiary hearings for persons who are subject to adverse registration actions. The Board decided that the Membership Committee's responsibilities and workload require more than a five-person committee. The Board, therefore, recommended that the Membership Committee will be comprised of nine members, five of whom are directors. The remaining four will be affiliated with NFA Members.

The Board felt that no changes to the current structure of the Audit and Finance Committee are necessary.

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