(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

SEC Proposes SRO Governance, Transparency Requirements

The SEC unanimously approved the issuance for public comment of proposed corporate governance standards for self-regulatory organizations. In addition, the Commission issued a concept release on alternatives to the current self-regulatory model. The governance proposals are similar to those adopted by the New York Stock Exchange and NASD, and would provide minimum requirements across all self-regulatory organizations. The comment period for the SRO rule proposals will be open for 45 days from the date of publication in the Federal Register, while the comment period on the concept release will extend fors 90 days.

Annette Nazareth, the director of the Division of Market Regulation, explained that recent lapses in regulatory oversight by the exchanges called into question their corporate governance standards. The SRO rule proposals would require that all SRO boards of directors be comprised of a majority of independent directors and would provide a uniform definition of independence modeled after the definition in the Sarbanes-Oxley Act. The proposals would require that at least 20 percent of the directors be selected by members of the exchange. One director must represent issuers and another must represent investors. Independent directors would have to meet without management on a regular basis.

Members of all key standing committees, including the nominating, governance, audit, compensation and regulatory oversight committees, must be fully independent. The SRO regulatory functions, to be overseen by a chief regulatory officer, would be separated from their market operations and other business interests. The chief regulatory officer would report to the oversight committee, not to management.

The proposals include a transparency element which would require disclosure comparable to that of a public company, including information about the structure and authority of the board, the code of ethics and any waivers thereto, an organizational chart, any affiliated entities, control persons, material contracts and charitable contributions.

The SROs would have to provide quarterly and annual reports to the SEC on their examinations, investigations and enforcement activities. This information will help the SEC's examination staff to identify trends such as increased violations in certain areas, and to ensure that the SROs are taking appropriate actions in response.

Amendments to Form 1 and new Form 2 would require that SROs restrict ownership and voting levels of individual members to no more than 20 percent and to report any significant accumulations of ownership. This provision responds to the movement away from non-profit, member-owned organizations and to for-profit, shareholder owned organizations by a number of exchanges. While members' ownership is restricted to 20 percent, a non-member could acquire 100 percent of an exchange.

The SEC also proposed a new Regulation AL to impose reporting and notification requirements on an SRO that lists or trades its own securities or those of its trading facilities or affiliates.

In response to questioning by Chairman William Donaldson, Ms. Nazareth said the staff chose to propose the governance changes at the same time as the concept release, rather than issuing the concept release first, because it did not want to defer actions on improving transparency for the SROs. The staff did not want the markets to be at risk while it analyzes potential alternative regulatory models, she explained. She added that the staff provided more time to respond to the concept release because it raises complex questions that require more time to respond. The rulemaking release, while dense, is not surprising or controversial, she said, and the staff would like to achieve those benefits as soon as possible.

Commissioner Harvey Goldschmid noted that the current self-regulatory system not only was not working adequately, but was appalling, based on the lapses that were discovered. He said the SRO standards should be as strong as those imposed on their listed companies. Goldschmid believes that the proposed transparency may have prevented the compensation controversy at the NYSE. The NYSE has since dramatically improved its governance standards, he added.

Both Mr. Goldschmid and Commissioner Roel Campos questioned whether the proposal goes far enough, given that it does not call for the separation of the chairman and CEO positions. Mr. Campos believes there is a strong reason to separate the positions. Chairman Donaldson said the corporate world is different from mutual funds, on which the SEC imposed a requirement to split the chairman and CEO positions. However, he said he welcomes comments on whether the requirement should apply to SROs as well.