Independence among directors has proved a contentious issue at securities and futures exchanges. In 2003, the New York Stock Exchange mandated that all its directors, except its chief executive officer, have no securities-industry ties. And the Securities & Exchange Commission is considering making that a firm rule for all the exchanges it oversees.
But the Chicago Mercantile Exchange has stuck by its structure, with most of its board composed of people intimately involved in the business. Its directors include executives at firms that trade on the Merc and others who work for it. One, a past chairman, is a paid adviser to its board. The Merc contends that such directors can be independent because they are not directly on its payroll.
Merc officials, including Chairman Terrence A. Duffy, Chief Executive Officer Craig S. Donohue, and General Counsel Kathleen M. Cronin, talked recently with BusinessWeek Chicago Bureau Manager Joseph Weber about the issue. Edited excerpts of that conversation follow:
Q: You have only 7 out of 20 directors who are not associated with the futures industry or the exchange presently. Is that right?
Q: Good-governance folks at outfits like Glass, Lewis and the Corporate Library say you should have at least a majority of such nonassociated folks. Why are they wrong?
Donohue: We have a governance system that has worked extraordinarily well for us. First, it has very effectively allowed us to do what so far no one else [in exchanges] has done, and that is transition from a mutual organization to a public company.
Second, it has allowed us to transition from a purely floor-based delivery system for product to one that in only five years [has moved to where] 70% of all transactions are electronic.
Third, we've obviously created enormous shareholder value with the governance system we have. We went from a membership organization to a $7 billion [market capitalization] company and quintupled our stock price. We're very proud of our governance. We think the structure of our governance has enabled us to do those things. And it's hard to argue with the success of those things.
Q: Can the industry people on your board really represent all shareholders? Won't they be biased by their own interests in the exchange?
Donohue: The answer is absolutely, unequivocally clear that they represent shareholders. They have a legal and fiduciary obligation to represent the shareholders. They have done that extremely well.
Cronin: As with any board, obviously we're cognizant of potential conflicts of interest with respect to any particular matter that comes before the board. If a director has a particular conflict of interest with respect to an issue, it's obviously disclosed to the full board, and the director will generally abstain from participating in the decision-making process.
Q: How big is your business now?
Donohue: Average daily volume is about 4.5 million contracts. We had a record quarter in terms of the first quarter this year, again. Our strategy, the one we're committed to as an institution, is hard to argue with. We've outgrown all our competitors and captured global market share.
Q: Is there a virtue to having such industry-affiliated folks in a majority position on the board?
Donohue: What we've done is make a remarkable transition. It's a very difficult thing to take a 100-year-old membership institution and make it a successful, thriving, and growing public company. It's especially difficult to do that when you are not only undergoing a transition of moving away from membership control to public company [decision-making] but also at the very same time going from 100% floor-based trading to 70% electronic. The industry knowledge on our board has helped guide us and ensured harmony, trust, and confidence as we've gone through dramatic changes.
Q: Over time, do you expect to move to more nonindustry directors?
Donohue: I wouldn't ever comment on that. That is usurping the judgment of the governance committee and the board as a whole.
Duffy: We have a nominating committee obviously put in place, and they look at candidates based on who is best qualified.
Q: The NYSE takes a different approach toward independence, with people associated with the industry not considered independent for purposes of serving on it board. Is its approach too restrictive in your view?
Donohue: It's up to them to determine what governance works well for them. We know what works well for us. We only comment on what we know best.
Q: The NYSE board also gets input from its board of executives. Why not do something like that?
Donohue: We don't comment on that. I think we are very clearly the model they are trying to emulate. [Through their merger with the Archipelago (AX) electronic exchange], they are moving toward being a public company. They are trying to acquire good technology [and build up] electronic trading vs. floor-based. They are trying to emulate what we have done, and our governance structure allows us to thrive.
Q: The SEC has proposed rules that would require a majority of nonindustry independent directors at securities exchanges. Is there something different about futures exchanges that means this kind of rule wouldn't be good?
Donohue: We've commented on that proposal, even though we're not subject to it if it's implemented. We have a different view from the SEC's. Ours is based on the practical experience we've had and what we think have been important ingredients in the ability to transition successfully. We have a different view, but we do not draw a distinction between the futures exchanges and the securities exchanges. Our view is that this has worked well for us. We know a lot about exchanges and exchange governance.
Q: John Damgard, head of the Futures Industry Assn., says your idea of independent governance doesn't pass the laugh test. Any response?
Donohue: John Damgard fundamentally does not understand corporate-governance principles, and that lack of knowledge is clearly demonstrated when he suggests that some of our largest customers, who also are some of the largest members of his trade association, would enhance our board of directors. Serving his narrow and parochial interests would not serve the best interests of [the Chicago Mercantile Exchange's] shareholders.