Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-77617; File No. S7-25-11]

RIN 3235-AL10

Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

In accordance with Section 764 of Title VII (“Title VII”) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Securities and Exchange Commission (“SEC” or “Commission”) is adopting new rules under the Securities Exchange Act of 1934 (“Exchange Act”) that are intended to implement provisions of Title VII relating to business conduct standards and the designation of a chief compliance officer for security-based swap dealers and major security-based swap participants. The final rules also address the cross-border application of the rules and the availability of substituted compliance.

DATES:

Effective Date:

July 12, 2016.

Compliance Date:

The compliance dates are discussed in Section IV.B of this release.

FOR FURTHER INFORMATION CONTACT:

Lourdes Gonzalez, Assistant Chief Counsel—Sales Practices, Joanne Rutkowski, Senior Special Counsel, Cindy Oh, Special Counsel, Lindsay Kidwell, Special Counsel, Stacy Puente, Special Counsel, Devin Ryan, Special Counsel, Office of Chief Counsel, Division of Trading and Markets, at (202) 551-5550, at the Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549. For further information on cross-border application of the rules, contact: Carol McGee, Assistant Director, Richard Gabbert, Senior Special Counsel, Joshua Kans, Senior Special Counsel, and Margaret Rubin, Special Counsel, Office of Derivatives Policy, Division of Trading and Markets, at (202) 551-5550, at the Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction

A. Summary of Final Rules

B. Cross-Border Application of the Final Rules

C. Consistency With CFTC Rules

D. Department of Labor ERISA Fiduciary Regulations

E. Investment Adviser and Municipal Advisor Status

F. Intersection With SRO Rules

II. Discussion of Rules Governing Business Conduct

A. Scope, Generally

B. Exceptions for Anonymous SEF or Exchange-Traded Transactions

C. Application of the Rules to SBS Dealers and Major SBS Participants

D. Reliance on Representations

E. Policies and Procedures Alternative

F. Definitions

G. Business Conduct Requirements

1. Counterparty Status

2. Disclosure

a. Disclosure Not Required When the Counterparty Is an SBS Entity or a Swap Entity

b. Timing and Manner of Certain Disclosures and Scope of Disclosure Rules

c. Material Risks and Characteristics of the Security-Based Swap

d. Material Incentives or Conflicts of Interest

e. Daily Mark

f. Clearing Rights

3. Know Your Counterparty

4. Recommendations by SBS Dealers

5. Fair and Balanced Communications

6. Obligation Regarding Diligent Supervision

H. Rules Applicable to Dealings With Special Entities

1. Scope of Definition of “Special Entity”

2. “Acts as an Advisor” to a Special Entity

3. Definition of “Best Interests”

4. Antifraud Provisions

5. SBS Entities Acting as Counterparties to Special Entities

6. Qualifications of the Independent Representative

a. Written or Other Representations Regarding Qualifications

b. Sufficient Knowledge To Evaluate Transaction and Risks

c. No Statutory Disqualification

d. Undertakes a Duty To Act in the Best Interests of the Special Entity

e. Makes Appropriate and Timely Disclosures to Special Entity

f. Pricing and Appropriateness

g. Subject to “Pay To Play” Prohibitions

h. ERISA Fiduciary

i. Safe Harbor

7. Disclosure of Capacity

8. Exceptions for Anonymous, Special Entity Transactions on an Exchange or SEF

9. Certain Political Contributions by SBS Dealers

I. Chief Compliance Officer

J. Prime Brokerage Transactions

K. Other Comments

III. Cross-Border Application and Availability of Substituted Compliance

IV. Explanation of Dates

A. Effective Date

B. Compliance Date

C. Application to Substituted Compliance

V. Paperwork Reduction Act

VI. Economic Analysis

A. Introduction and Broad Economic Considerations

B. Baseline

1. Available Data Regarding Security-Based Swap Activity

2. Security-Based Swap Market: Market Participants and Dealing Structures

a. Security-Based Swap Market Participants

b. Participant Domiciles

c. Market Centers

d. Common Business Structures for Firms Engaged in Security-Based Swap Dealing Activity

e. Current Estimates of Number of SBS Dealers and Major SBS Participants

3. Security-Based Swap Market: Levels of Security-Based Swap Trading Activity

4. Global Regulatory Efforts

5. Dually Registered Entities

6. Cross-Market Participation

7. Pay To Play Prohibitions

C. Costs and Benefits of Business Conduct Rules

1. Verification of Status and Know Your Counterparty Rules

2. Disclosures and Communications

a. Risks, Characteristics, and Conflicts of Interest

b. Daily Mark

c. Clearing Rights

3. Suitability

a. Costs and Benefits

b. Institutional Suitability Alternative

4. Special Entities

a. Scope and Verification

b. SBS Entities as Counterparties to Special Entities

c. SBS Dealers as Advisors to Special Entities

d. Independent Representation: Alternatives

e. Reliance on Representations

f. Magnitude of the Economic Effects

5. Fraud, Fair and Balanced Communications, Supervision

a. Antifraud

b. Fair and Balanced Communications

c. Supervision

6. CCO Rules

a. Annual Compliance Report, Conflicts of Interest, Policies and Procedures

b. CCO Removal and Compensation

7. Pay To Play

8. Scope

a. Inter-Affiliate Transactions

b. Opt Out

9. Cross-Border Application

a. Scope of Application to SBS Entities

b. Substituted Compliance

D. Effects on Efficiency, Competition and Capital Formation

VII. Regulatory Flexibility Act Certification

Statutory Basis and Text of Final Rules

I. Introduction

The Commission is adopting Rules 15Fh-1 through 15Fh-6 and Rule 15Fk-1 to implement the business conduct standards and chief compliance officer (“CCO”) requirements for security-based swap dealers (“SBS Dealers”) and major security-based swap participants (“Major SBS Participants” and, together with SBS

Dealers, “SBS Entities”) as set forth in Title VII of the Dodd-Frank Act.

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The Commission is also amending Rules 3a67-10 and 3a71-3 and adopting Rule 3a71-6 with respect to the cross-border application of the rules and the availability of substituted compliance.

1

Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010).

The Dodd-Frank Act was enacted, among other reasons, to promote the financial stability of the United States by improving accountability and transparency in the financial system.

2

The 2008 financial crisis highlighted significant issues in the over-the-counter derivatives markets, which experienced dramatic growth in the years leading up to the financial crisis and are capable of affecting significant sectors of the U.S. economy. Title VII of the Dodd-Frank Act provides for a comprehensive new regulatory framework for swaps and security-based swaps by, among other things: (1) Providing for the registration and comprehensive regulation of SBS Entities, swap dealers (“Swap Dealers”), and major swap participants (“Major Swap Participants” and, together with Swap Dealers, “Swap Entities”); (2) imposing clearing and trade execution requirements for swaps and security-based swaps, subject to certain exceptions; (3) creating recordkeeping, regulatory reporting, and public dissemination requirements for swaps and security-based swaps; and (4) enhancing the rulemaking and enforcement authorities of the Commission and the Commodity Futures Trading Commission (“CFTC”).

2

See

Public Law 111-203, Preamble.

The Commission initially proposed Rules 15Fh-1 through 15Fh-6 and Rule 15Fk-1 in June 2011.

3

In May 2013, the Commission re-opened the comment period for all of its outstanding Title VII rulemakings, including the external business conduct rulemaking.

4

3

See

Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants, Exchange Act Release No. 64766 (Jun. 29, 2011), 76 FR 42396 (Jul. 18, 2011) (“Proposing Release”).

4

See

Reopening of Comment Periods for Certain Rulemaking Releases and Policy Statement Applicable to Security-Based Swaps Proposed Pursuant to the Securities Exchange Act of 1934 and the Dodd-Frank Wall Street Reform and Consumer Protection Act, Exchange Act Release No. 69491 (May 1, 2013), 78 FR 30800 (May 23, 2013) (“Reopening Release”).

The Commission received 40 comments on the Proposing Release, of which 9 were comments submitted in response to the Reopening Release.

5

Of the comments directed at the Cross-Border Proposing Release,

6

five referenced the proposed external business conduct standards specifically,

7

while others addressed cross-border issues generally, such as the application of substituted

compliance,

8

without specifically referring to the Proposing Release. Of the comments submitted in response to the U.S. Activity Proposing Release,

9

eight addressed the proposed cross-border application of the business conduct standards.

10

5

See

letters from Kenneth M. Fisher, Senior Vice President and Chief Financial Officer, Noble Energy, dated July 7, 2011 (“Noble”); Chris Barnard, dated Aug. 10, 2011 (“Barnard”); R. Glenn Hubbard, Co-Chair, Committee on Capital Markets Regulation, John L. Thornton, Co-Chair, Committee on Capital Markets Regulation, and Hal S. Scott, Director, Committee on Capital Markets Regulation, dated Aug. 26, 2011 (“CCMR”); John F. Damgard, President, Futures Industry Association, Robert Pickel, Executive Chairman, International Swaps and Derivatives Association, Inc., and Kenneth E. Bentsen, Jr., Executive Vice President, Public Policy and Advocacy, Securities Industry and Financial Markets Association, dated Aug. 26, 2011 (“FIA/ISDA/SIFMA”); Gerald W. McEntee, President, American Federation of State, County and Municipal Employees, dated Aug. 29, 2011 (“AFSCME”); Mark Hepsworth, President, Institutional Business, Interactive Data Corporation, dated Aug. 29, 2011 (“IDC”); Sen. Carl Levin, U.S. Senate, dated Aug. 29, 2011 (“Levin”); Susan N. Kelly, Senior Vice President of Policy Analysis and General Counsel, American Public Power Association, and Noreen Roche-Carter, Chair, Tax and Finance Task Force, Large Public Power Council, dated Aug. 29, 2011 (“APPA”); Stuart J. Kaswell, Executive Vice President & Managing Director, General Counsel, Managed Funds Association, dated Aug. 29, 2011 (“MFA”); Dennis M. Kelleher, President & CEO, and Stephen W. Hall, Securities Specialist, Better Markets, Inc., dated Aug. 29, 2011 (“Better Markets (August 2011)”); Christopher A. Klem and Molly Moore, Ropes & Gray LLP, dated Aug. 29, 2011 (“Ropes & Gray”); Joanne T. Medero, BlackRock, Inc., dated Aug. 29, 2011 (“BlackRock”); Joseph Dear, Chief Investment Officer, California Public Employees' Retirement System, Jennifer Paquette, Chief Investment Officer, Colorado PERA, Keith Bozarth, Executive Director, State of Wisconsin Investment Board, Brian Guthrie, Executive Director, Teacher Retirement System of Texas, and Rick Dahl, Chief Investment Officer, Missouri State Employees' Retirement System, dated Aug. 29, 2011 (“CalPERS (August 2011)”); Barbara Roper, Director of Investor Protection, Consumer Federation of America, Marcus Stanley, Policy Director, Americans for Financial Reform, and Michael Greenberger, Law School Professor and Founder & Director, University of Maryland Center for Health & Homeland Security, dated Aug. 29, 2011 (“CFA”); American Benefits Council, dated Aug. 29, 2011 (“ABC”); Jeff Gooch, Chief Executive Officer, MarkitSERV, dated Aug. 29, 2011 (“MarkitSERV”); Timothy W. Cameron, Esq. Managing Director, Asset Management Group, Securities Industry and Financial Markets Association, dated Aug. 29, 2011 (“SIFMA (August 2011)”); John D. Walda, President and Chief Executive Officer, National Association of College and University Business Officers, dated Aug. 29, 2011 (“NACUBO”); Kevin Gould, President, Markit North America, Inc., dated Aug. 29, 2011 (“Markit”); Daniel F. C. Crowley, Partner, K&L Gates LLP, on behalf of the Church Alliance, dated Aug. 29, 2011 (“Church Alliance (August 2011)”); Christopher J. Ailman, California State Teachers' Retirement System, dated Aug. 30, 2011 (“CalSTRS”); John M. McNally, National Association of Bond Lawyers, dated Sept. 1, 2011 (“NABL”); Colette J. Irwin-Knott, National Association of Independent Public Finance Advisors, dated Sept. 6, 2011 (“NAIPFA”); ABA Securities Association, American Council of Life Insurers, Financial Services Roundtable, Futures Industry Association, Institute of International Bankers, International Swaps and Derivatives Association, and Securities Industry and Financial Markets Association, dated Sept. 8, 2011 (“ABA Securities Association”); Kent A. Mason, Davis & Harman LLP, dated Sept. 15, 2011 (“Mason”); Senator Tim Johnson, Chairman, U.S. Senate Committee on Banking, Housing, and Urban Affairs, and Representative Barney Frank, U.S. House Committee on Financial Services, dated Oct. 4, 2011 (“Johnson”); Lawrence B. Patent, K&L Gates LLP, on behalf of the Church Alliance, dated Oct. 4, 2011 (“Church Alliance (October 2011)”); Joseph Dear, Chief Investment Officer, California Public Employees' Retirement System et al., dated Oct. 4, 2011 (“CalPERS (October 2011)”); Susan Gaffney Director, Federal Liaison Center, Government Finance Officers Association, dated Oct. 31, 2011 (“GFOA”); Jeffery W. Rubin, Chair, Federal Regulation of Securities Committee, American Bar Association Business Law Section and Nir D. Yarden, Chair, Institutional Investors Committee, American Bar Association, dated Dec. 7, 2011 (“ABA Committees”); Bruce E. Stern, Chairman, Association of Financial Guaranty Insurers, dated Sept. 17, 2012 (“AFGI (September 2012)”); Financial Services Roundtable, Future Industry Association, Institute of International Bankers, International Swaps and Derivatives Association, Investment Company Institute, Securities Industry and Financial Markets Association, dated May 21, 2013 (“Financial Services Roundtable”); Bruce E. Stern, Chairman, Association of Financial Guaranty Insurers, dated July 22, 2013 (“AFGI (July 2013)”); Robert Pickel, Executive Vice Chairman, International Swaps and Derivatives Association, Inc., dated July 22, 2013 (“ISDA (July 2013)”); Dennis M. Kelleher, President and CEO, and Stephen W. Hall, Securities Specialist, Better Markets, Inc., dated July 22, 2013 (“Better Markets (July 2013)”); Dennis M. Kelleher, President and CEO, Better Markets, Inc., dated Oct. 18, 2013 (“Better Markets (October 2013)”); Angie Karna, Managing Director, Legal, Nomura Global Financial Products Inc., dated Sept. 10, 2014 (“Nomura”); Kyle Brandon, Managing Director, Securities Industry and Financial Markets Association, dated Aug. 7, 2015 (“SIFMA (August 2015)”); Kyle Brandon, Managing Director, Securities Industry and Financial Markets Association, dated Sept. 23, 2015 (“SIFMA (September 2015)”); Kyle Brandon, Managing Director, Securities Industry and Financial Markets Association, dated Nov. 3, 2015 (“SIFMA (November 2015)”). The comments that the Commission received on the Proposing Release and the Reopening Release are available on the Commission's Web site at

http://www.sec.gov/comments/s7-25-11/s72511.shtml

.

6

Cross-Border Security-Based Swap Activities; Re-Proposal of Regulation SBSR and Certain Rules and Forms Relating to the Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants, Exchange Act Release No. 69490 (May 1, 2013), 78 FR 30968 (May 23, 2013) (“Cross-Border Proposing Release”).

7

See

letters from Robert Pickel, International Swaps and Derivatives Association, Inc., dated Aug. 14, 2013 (“ISDA (August 2013)”); Karrie McMillan, General Counsel, Investment Company Institute and Dan Waters, Managing Director, ICI Global, dated Aug. 21, 2013 (“ICI”); Dennis M. Kelleher, President & CEO, Better Markets, Inc., Stephen W. Hall, Securities Specialist, Better Markets, Inc., and Katelynn O. Bradley, Attorney, Better Markets, Inc., dated Aug. 21, 2013 (“Better Markets (August 2013)”); Kenneth E. Bentsen, Jr., President, Securities Industry and Financial Markets Association, Walt Lukken, President & Chief Executive Officer, Futures Industry Association; and Richard M. Whiting, Executive Director and General Counsel, The Financial Services Roundtable, dated Aug. 21, 2013 (“SIFMA (August 2013)”); Matti Leppälä, Secretary General/CEO, PensionsEurope, dated Sep. 3, 2013 (“PensionsEurope”). These comment letters are available on the Commission's Web site at

https://www.sec.gov/comments/s7-02-13/s70213.shtml

.

8

See

letters from Stephen Maijoor, Chair, European Securities and Markets Authority, dated Aug. 21, 2013 (“ESMA”); Stuart J. Kaswell, Executive Vice President & Managing Director, General Counsel, Managed Funds Association and Adam Jacobs, Director, Head of Markets Regulation, Alternative Investment Management Association, dated Aug. 19, 2013 (“MFA/AIMA”); Marcus Stanley, Policy Director, Americans for Financial Reform, dated Aug. 22, 2013 (“AFR”); Sarah A. Miller, Chief Executive Officer, Institute of International Bankers, dated Aug. 21, 2013 (“IIB (August 2013)”); Catherine T. Dixon, Chair, Federal Regulation of Securities Committee, American Bar Association, Business Law Section, dated Oct. 2, 2013 (“ABA (October 2013)”); Agricultural Retailers Association, Business Roundtable, Financial Executives International, National Association of Corporate Treasurers, National Association of Manufacturers, U.S. Chamber of Commerce, dated Aug. 21, 2013 (“CDEU”); Futures Options Association, dated Aug. 21, 2013 (“FOA”); Kevin Nixon, Managing Director, Institute of International Finance, dated August 8, 2013 (“IIF”); Koichi Ishikura, Executive Chief of Operations for International Headquarters, Japan Securities Dealers Association, dated Aug. 21, 2013 (“JSDA”); Patrick Pearson, European Commission, dated Aug. 21, 2013 (“EC”); Jonathan Kindred and Shigesuke Kashiwagi, Japan Financial Markets Council, dated Aug. 15, 2013.

The SEC Chair and Commissioners were copied on a comment letter to the CFTC in connection with the CFTC's own cross-border initiative.

See

letter from Sherrod Brown, U.S. Senator, Tom Harkin, U.S. Senator, Jeff Merkley, U.S. Senator, Carl Levin, U.S. Senator, Elizabeth Warren, U.S. Senator, Dianne Feinstein, U.S. Senator, to the Honorable Gary Gensler, dated May 22, 2013 (“U.S. Senators”).

9

See

Application of Certain Title VII Requirements to Security-Based Swap Transactions Connected with a Non-U.S. Person's Dealing Activity that are Arranged, Negotiated, or Executed by Personnel Located in a U.S. Branch or Office or in a U.S. Branch or Office of an Agent, Exchange Act Release No. 74843 (Apr. 29, 2015), 80 FR 27443 (May 13, 2015) (“U.S. Activity Proposing Release”).

10

See

letters from Kenneth E. Bentsen, Jr., President & CEO, Securities Industry and Financial Markets Association and Financial Services Roundtable and Rich Foster, Senior Vice President & Senior Counsel for Regulatory and Legal Affairs, Financial Services Roundtable, dated July 13, 2015 (“SIFMA/FSR (July 2015)”); Sarah A. Miller, Chief Executive Officer, Institute of International Bankers, dated July 13, 2015 (“IIB (July 2015)”); Dan Waters, Managing Director, ICI Global, dated July 13, 2015 (“ICI Global (July 2015)”); Dennis M. Kelleher, President and CEO, Stephen W. Hall, Securities Specialist, Todd Phillips, Attorney, Better Markets, Inc., dated July 13, 2015 (“Better Markets (July 2015)”); Timothy W. Cameron, Esq., Managing Director and Laura Martin, Managing Director and Associate General Counsel, Asset Management Group, Securities Industry and Financial Markets Association, dated July 13, 2015 (“SIFMA-AMG (July 2015)”); David Geen, General Counsel, International Swaps and Derivatives Association, Inc. (“ISDA (July 2015)”); Chris Barnard, dated June 26, 2015 (“Barnard (July 2015)”); Stuart J. Kaswell, Executive Vice President, Managing Director & General Counsel, Managed Funds Association, dated July 13, 2015 (“MFA (July 2015)”). These comment letters are available on the Commission's Web site at

http://www.sec.gov/comments/s7-06-15/s70615.shtml

.

The Commission is now adopting Rules 15Fh-1 through 15Fh-6 and Rule 15Fk-1, with certain revisions suggested by commenters or designed to clarify the rules and conform them to the rules adopted by the CFTC. The principal aspects of the rules are briefly described immediately below. A detailed discussion of each rule follows in Sections II.A.-II.J, below.

11

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If any of the provisions of these rules, or the application thereof to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application.

A. Summary of Final Rules

Rule 15Fh-1, as adopted, defines the scope of Rules 15Fh-1 through 15Fh-6 and Rule 15Fk-1, and provides that an SBS Entity can rely on the written representations of a counterparty or its representative to satisfy its due diligence requirements under the rules, unless it has information that would cause a reasonable person to question the accuracy of the representation.

Rule 15Fh-2, as adopted, sets forth the definitions used throughout Rules 15Fh-1 through 15Fh-6. The defined terms are discussed in connection with the rules in which they appear.

Rule 15Fh-3, as adopted, defines the business conduct requirements generally applicable to SBS Entities with respect to: (1) Verification of counterparty status as an eligible contract participant (“ECP”) or special entity; (2) disclosure to the counterparty of material information about the security-based swap, including material risks, characteristics, incentives, and conflicts of interest; (3) disclosure of information concerning the daily mark of the security-based swap; (4) disclosure regarding the ability of the counterparty to require clearing of the security-based swap; (5) communication with counterparties in a fair and balanced manner based on principles of fair dealing and good faith; and (6) the establishment of a supervisory and compliance infrastructure. Rule 15Fh-3, as adopted, additionally requires an SBS Dealer to: (1) Establish, maintain and enforce written policies and procedures reasonably designed to obtain and retain a record of the essential facts concerning each known counterparty that are necessary to conduct business with that counterparty; and (2) comply with certain suitability obligations when recommending a security-based swap, or trading strategy involving a security-based swap, to a counterparty.

Rule 15Fh-4(a), as adopted, provides that it shall be unlawful for an SBS Entity to: (i) Employ any device, scheme, or artifice to defraud any special entity or prospective customer who is a special entity; (ii) engage in any transaction, practice, or course of business that operates as a fraud or deceit on any special entity or prospective customer who is a special entity; or (iii) to engage in any act, practice, or course of business that is fraudulent, deceptive, or manipulative.

Rule 15Fh-4(b), as adopted, sets forth particular requirements for SBS Dealers acting as advisors to special entities.

12

Specifically, an SBS Dealer that acts as an advisor to a special entity must act in the “best interests” of the special entity, and make reasonable efforts to obtain information that it needs to determine that the recommendation is in the “best interests” of the special entity.

13

12

The statutory definition of “special entity” includes federal agencies, states and political subdivisions, employee benefit plans as defined under the Employee Retirement Income Security Act of 1974 (“ERISA”), governmental plans as defined under ERISA, and endowments.

See

Rule 15Fh-2(d) (defining “special entity” to include employee benefit plans that are defined in Title I of ERISA but permitting employee benefit plans that are not subject to regulation under Title I of ERISA to elect not to be special entities).

13

Rule 15Fh-2(a), as adopted, defines what it means to “act as an advisor” to a special entity, and provides a safe harbor under which the parties can establish that the SBS Dealer is not acting as an advisor to the special entity.

Rule 15Fh-5, as adopted, sets forth particular requirements for SBS Entities acting as counterparties to special entities. Under the rule, those SBS Entities must have a reasonable basis to believe that the counterparty has a qualified representative who: (1) Has sufficient knowledge to evaluate the transaction and risks; (2) is not subject to a statutory disqualification; (3) is independent of the SBS Entity; (4) undertakes a duty to act in the best interests of the special entity; (5) makes appropriate and timely disclosures to the special entity of material information concerning the security-based swap; and (6) provides written representations regarding fair pricing and the appropriateness of the security-based swap. If the special entity is an employee benefit plan that is subject to regulation under Title I of ERISA (“ERISA plan”), these requirements are satisfied if the independent representative is a “fiduciary” under ERISA. In addition, the independent representative must be subject to pay-to-play regulation if the special entity is a “municipal entity” or a “governmental plan” as defined in Section 3 of ERISA.

Rule 15Fh-6, as adopted, imposes certain pay-to-play restrictions on SBS Dealers. The rule generally prohibits an SBS Dealer from engaging in security-

based swap transactions with a “municipal entity” within two years after certain political contributions have been made to officials of the municipal entity. As with other pay-to-play rules, Rule 15Fh-6 does not prohibit political contributions.

Rule 15k-1, as adopted, requires an SBS Entity to designate a CCO and imposes certain duties and responsibilities on that CCO.

B. Cross-Border Application of the Final Rules

Rule 3a71-3(c) and related amendments to Rule 3a71-3(a), as adopted, define the scope of application of the business conduct standards described in Section 15F(h) of the Exchange Act, and the rules and regulations thereunder (other than the rules and regulations prescribed by the Commission pursuant to Section 15F(h)(1)(B)) to SBS Dealers. As adopted, these rules require a registered U.S. SBS Dealer to comply with transaction-level business conduct requirements with respect to all of its transactions, except for certain transactions conducted through such dealer's foreign branch. The rules further require a registered foreign SBS Dealer to comply with transaction-level business conduct requirements with respect to any transaction with a U.S. person (except for a transaction conducted through a foreign branch of the U.S. person) and any transaction that the SBS Dealer arranges, negotiates, or executes using personnel located in the United States.

Rule 3a67-10(d) and related amendments to Rule 3a67-10(a), as adopted, define the scope of application of the business conduct standards described in Section 15F(h) of the Exchange Act, and the rules and regulations thereunder (other than the rules and regulations prescribed by the Commission pursuant to Section 15F(h)(1)(B)) to registered Major SBS Participants. As adopted, these rules, like those applicable to registered SBS Dealers, require a registered U.S. Major SBS Participant to comply with transaction-level business conduct requirements with respect to all of its transactions, except for certain transactions conducted through such participant's foreign branch. The rules further require a registered foreign Major SBS Participant to comply with transaction-level business conduct requirements with respect to any transaction with a U.S. person (except for a transaction conducted through a foreign branch of the U.S. person) but not any transaction with a non-U.S. person.

Finally, Rule 3a71-6, as adopted, provides a framework under which foreign SBS Dealers and foreign Major SBS Participants may seek to satisfy certain business conduct requirements under Title VII by means of substituted compliance.

In developing these final rules, including their cross-border application, we have consulted and coordinated with the CFTC and the prudential regulators

14

in accordance with the consultation mandate of the Dodd-Frank Act.

15

The Commission also has consulted and coordinated with foreign regulatory authorities through Commission staff participation in numerous bilateral and multilateral discussions with foreign regulatory authorities addressing the regulation of OTC (over-the-counter) derivatives.

16

Through these discussions and the Commission staff's participation in various international task forces and working groups,

17

we have gathered information about foreign regulatory reform efforts and their impact on and relationship with the U.S. regulatory regime. The Commission has taken and will continue to take these discussions into consideration in developing rules, forms, and interpretations for implementing Title VII of the Dodd-Frank Act.

18

14

The term “prudential regulator” is defined in section 1a(39) of the Commodity Exchange Act, 7 U.S.C. 1a(39), and that definition is incorporated by reference in section 3(a)(74) of the Exchange Act, 15 U.S.C. 78c(a)(74). Pursuant to the definition, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Farm Credit Administration, or the Federal Housing Finance Agency (collectively, the “prudential regulators”) is the “prudential regulator” of a security-based swap dealer or major security-based swap participant if the entity is directly supervised by that regulator.

15

Section 712(a)(2) of the Dodd-Frank Act provides in part that the Commission shall “consult and coordinate to the extent possible with the Commodity Futures Trading Commission and the prudential regulators for the purposes of assuring regulatory consistency and comparability, to the extent possible.”

16

For example, senior representatives of authorities with responsibility for regulation of OTC derivatives have met on a number of occasions to discuss international coordination of OTC derivatives regulations.

See, e.g.,

Report of the OTC Derivatives Regulators Group to G20 Leaders on Cross-Border Implementation Issues November 2015 (Nov. 2015), available at:

http://www.cftc.gov/idc/groups/public/@internationalaffairs/documents/file/odrgreportg20_1115.pdf

.

17

Commission representatives participate in the Financial Stability Board's Working Group on OTC Derivatives Regulation (“ODWG”), both on the Commission's behalf and as the representative of the International Organization of Securities Commissions (“IOSCO”), which is co-chair of the ODWG.

See

Security-Based Swap Transactions Connected with a Non-U.S. Person's Dealing Activity That Are Arranged, Negotiated, or Executed By Personnel Located in a U.S. Branch or Office or in a U.S. Branch or Office of an Agent; Security-Based Swap Dealer

De Minimis

Exception, Exchange Act Release No. 77104 (February 10, 2016), 81 FR 8597 n.15 (Feb. 19, 2016) (“U.S. Activity Adopting Release”), (describing the Commission representative's role).

18

See

Section 752(a) of the Dodd-Frank Act (providing in part that “[i]n order to promote effective and consistent global regulation of swaps and security-based swaps, the Commodity Futures Trading Commission, the Securities and Exchange Commission, and the prudential regulators . . . as appropriate, shall consult and coordinate with foreign regulatory authorities on the establishment of consistent international standards with respect to the regulation (including fees) of swaps.”).

C. Consistency With CFTC Rules

The Commission and CFTC staffs, prior to the proposal of rules by their respective agency, held approximately 30 joint meetings with interested parties regarding the agencies' respective business conduct rules to solicit a variety of views.

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As discussed in Section I.D. below, the agencies' staffs also consulted with Department of Labor (“DOL”) representatives on this rulemaking. In the Proposing Release, the Commission solicited comment on the impact of any differences between the Commission's and CFTC's approaches to business conduct regulations, and whether the Commission's proposed business conduct regulations should be modified to conform to the proposals made by the CFTC.

20

Subsequently, in February 2012, the CFTC adopted final rules with respect to the external business conduct standards of Swap Entities that are generally consistent with the Commission's proposed rules.

21

In addition, in April 2013, the CFTC adopted final rules with respect to internal business conduct standards regarding, among other things, the obligation of a Swap Entity to diligently supervise its business.

22

These rules also require each Swap Entity to designate a CCO, prescribe qualifications and duties of the CCO, and require that the CCO prepare, sign, and furnish the annual report containing an assessment of the

registrant's compliance activities to either the board of directors or the senior officer.

23

The rules further require the annual report to be furnished to the CFTC.

24

19

A list of Commission staff meetings in connection with this rulemaking is available on the Commission's Web site under “Meetings with SEC Officials” at

http://www.sec.gov/comments/df-title-vii/swap/swap.shtml

and at

http://www.sec.gov/comments/s7-25-11/s72511.shtml

.

20

See

Proposing Release, 76 FR at 42438,

supra

note 3.

21

See

Business Conduct Standards for Swap Dealers and Major Swap Participants With Counterparties, 77 FR 9734 (Feb. 17, 2012) (“CFTC Adopting Release”).

22

See

Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; Futures Commission Merchant and Introducing Broker Conflicts of Interest Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants, 77 FR 20128 (Apr. 3, 2013) (“CFTC CCO Release”).

23

Id.

24

Id.

In May 2013, in the Reopening Release, the Commission sought comment on certain specific issues, including: (1) The relationship of the proposed rules to any parallel requirements of other authorities, including the CFTC and relevant foreign regulatory authorities; and (2) with respect to the CFTC rules, whether and to what extent the Commission, in adopting its own rules, should emphasize consistency with the CFTC rules versus adopting rules that are more tailored to the security-based swap market, including any specific examples where consistency or tailoring of a particular rule or rule set is more critically important.

25

25

See

Reopening Release,

supra

note 4.

The Commission received numerous comments regarding consistency with the CFTC's external business conduct rules both before and after the CFTC adopted its final rules.

26

Comments specific to individual rules are addressed in the discussions of the respective rules below. As a general matter, these comments had, as an overarching theme, that the Commission should coordinate with the CFTC to achieve consistent regulations.

27

Commenters stressed that differences between the regulatory regimes would, among other things, increase regulatory burdens and costs for market participants, delay execution of transactions, and lead to confusion.

28

26

See, e.g.,

Barnard,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; AFSCME,

supra

note 5; Levin,

supra

note 5; APPA,

supra

note 5; Ropes & Gray,

supra

note 5; BlackRock,

supra

note 5; Nomura,

supra

note 5; GFOA,

supra

note 5; NABL,

supra

note 5; ISDA (July 2013),

supra

note 5; AFGI (July 2013),

supra

note 5; CFA,

supra

note 5; SIFMA (August 2015),

supra

note 5; SIFMA (September 2015),

supra

note 5; SIFMA (November 2015),

supra

note 5.

27

See, e.g.,

Barnard,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; AFSCME,

supra

note 5; Levin,

supra

note 5; APPA,

supra

note 5; Ropes & Gray,

supra

note 5; BlackRock,

supra

note 5; Nomura,

supra

note 5; GFOA,

supra

note 5; NABL,

supra

note 5; ISDA (July 2013),

supra

note 5; AFGI (July 2013),

supra

note 5; SIFMA (August 2015),

supra

note 5; SIFMA,

supra

note 5 (September 2015); SIFMA (November 2015),

supra

note 5.

28

See, e.g.,

Barnard,

supra

note 5; Levin,

supra

note 5; BlackRock,

supra

note 5; NABL,

supra

note 5; GFOA,

supra

note 5.

Before the CFTC adopted its final external business conduct rules, commenters were divided as to whether they preferred the Commission's

29

or the CFTC's

30

proposed approach to specific issues, in instances in which the CFTC's proposed approach differed from the Commission's proposed rules. However, the comments received by the Commission in response to the Reopening Release, which was issued after the CFTC adopted its final rules, overwhelmingly urged the Commission to harmonize its external business conduct rules with those of the CFTC because the CFTC's rules have already been implemented by the industry.

31

A number of these comments have suggested specific and detailed modifications. Where we believe the external business conduct rules, if modified in accordance with these suggestions, will continue to provide the protections (as explained in the context of the particular rule) that the rules are intended to accomplish, we have modified the proposed rules to harmonize with CFTC requirements to create efficiencies for entities that have already established infrastructure for compliance with analogous CFTC requirements.

32

29

See, e.g.,

SIFMA (August 2011),

supra

note 5; GFOA,

supra

note 5; NABL,

supra

note 5.

30

See, e.g.,

CFA,

supra

note 5.

31

See, e.g.,

Nomura,

supra

note 5; GFOA,

supra

note 5; ISDA (July 2013),

supra

note 5; SIFMA (August 2015),

supra

note 5; SIFMA (September 2015),

supra

note 5; SIFMA (November 2015),

supra

note 5.

Commenters also urged, with respect to supervision and CCO obligations (“internal” business conduct standards), that our final rules be informed by industry experience complying with the analogous Financial Industry Regulatory Authority, Inc. (“FINRA”) supervision and CCO rules, as well as the CFTC internal business conduct standards.

See

SIFMA (September 2015),

supra

note 5, at 2 (urging the Commission to harmonize its rules with, among other things, “the FINRA Supervision Rules, [and] the FINRA CCO Rule”).

32

One commenter noted that more than 17,000 entities have already adhered to a multilateral protocol that had been developed in response to the CFTC rules.

See

SIFMA (November 2015),

supra

note 5.

D. Department of Labor ERISA Fiduciary Regulations

Section 15F(h)(2)(C) of the Exchange Act defines the term “special entity” to include “an employee benefit plan, as defined in section 3 of the Employee Retirement Income Security Act of 1974.”

33

33

29 U.S.C. 1001

et seq.

See

History of EBSA and ERISA, available at

http://www.dol.gov/ebsa/aboutebsa/history.html

.

Prior to proposing the business conduct standards rules, the Commission received submissions from commenters concerning the interaction with ERISA, DOL's proposed fiduciary rule, and current regulation regarding the definition of ERISA fiduciaries.

34

As noted above, the Commission, CFTC and DOL staffs consulted on issues regarding the intersection of ERISA fiduciary status with the Dodd-Frank Act business conduct provisions, prior to the Commission's proposing rules in this area.

35

34

See, e.g.,

letter from Kenneth E. Bentsen, Jr., Executive Vice President, Public Policy and Advocacy, Securities Industry and Financial Markets Association and Robert G. Pickel, Executive Vice Chairman, International Swaps and Derivatives Association, Inc. to Elizabeth M. Murphy, Secretary, Commission and David A. Stawick, Secretary, CFTC (Oct. 22, 2010) (“SIFMA/ISDA 2010 Letter”), at 8 n.19. This comment letter is available on the Commission's Web site at

http://www.sec.gov/comments/df-title-vii/swap/swap.shtml

.

35

See

Proposing Release, 76 FR at 42398,

supra

note 3.

The Commission received numerous comments concerning the interaction of ERISA and existing fiduciary regulation with the business conduct standards under the Exchange Act and the Commission's proposed rules.

36

Commenters, including ERISA plan sponsors, dealers and institutional asset managers, stated that although ERISA plans currently use security-based swaps as part of their overall hedging or investment strategy, the statutory and regulatory intersections of ERISA and the external business conduct standards under Title VII of the Dodd-Frank Act could prevent ERISA plans from participating in security-based swap markets in the future, and the proposed business conduct standards rules, if adopted without clarification, could have unintended consequences for SBS Entities dealing with ERISA plans.

37

36

See, e.g.,

ABC,

supra

note 5; CFA,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; IDC,

supra

note 5; MFA,

supra

note 5; BlackRock,

supra

note 5; Johnson,

supra

note 5.

37

See, e.g.,

ABC,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; IDC,

supra

note 5; MFA,

supra

note 5; BlackRock,

supra

note 5; Johnson,

supra

note 5.

Commenters were primarily concerned that compliance with the business conduct standards under the Exchange Act or the Commission's proposed rules would cause an SBS Entity to be an ERISA fiduciary to an ERISA plan and thus, subject to ERISA's prohibited transaction provisions.

38

If an SBS Entity were to become an ERISA fiduciary to an ERISA plan, it would be prohibited from entering into a security-based swap with that ERISA plan absent an exemption.

39

One commenter

asserted that the penalties for violating ERISA's prohibited transaction provisions would discourage SBS Entities from dealing with ERISA plans.

40

Other commenters asserted that compliance by SBS Entities with the following obligations could cause an SBS Entity to be an ERISA fiduciary: (1) Providing information regarding the risks of the security-based swap; (2) providing the daily mark; (3) reviewing the ability of the special entity's advisor to advise the special entity with respect to the security-based swap; and (4) acting in the best interests of the special entity.

41

Accordingly, commenters requested that the Commission and DOL coordinate the respective rules to clarify that compliance with the business conduct standards rules will not make an SBS Entity an ERISA fiduciary.

42

38

Section 406(b) of ERISA (29 U.S.C. 1106(b)) states that an ERISA fiduciary with respect to an ERISA plan shall not (1) deal with the assets of the plan in his own interest or for his own account, (2) in his individual or in any other capacity act in any transaction involving the plan on behalf of a party (or represent a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries, or (3) receive any consideration for his own personal account from any party dealing with such plan in connection with a transaction involving the assets of the plan.

39

In addition to other statutory exemptions, Section 408(a) of ERISA (29 U.S.C. 1108(a)) gives

DOL authority to grant administrative exemptions from prohibited transactions prescribed in Section 406 of ERISA.

40

See

ABC,

supra

note 5.

41

See, e.g.,

ABC,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; IDC,

supra

note 5; MFA,

supra

note 5; BlackRock,

supra

note 5; Johnson,

supra

note 5.

42

See, e.g.,

ABC,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; IDC,

supra

note 5; MFA,

supra

note 5; BlackRock,

supra

note 5; Johnson,

supra

note 5.

DOL staff reviewed the CFTC's final business conduct standards rules for Swap Entities and provided the CFTC with the following statement:

The Department of Labor has reviewed these final business conduct standards and concluded that they do not require swap dealers or major swap participants to engage in activities that would make them fiduciaries under the Department of Labor's current five-part test defining fiduciary advice 29 CFR 2510.3-21(c). In the Department's view, the CFTC's final business conduct standards neither conflict with the Department's existing regulations, nor compel swap dealers or major swap participants to engage in fiduciary conduct. Moreover, the Department states that it is fully committed to ensuring that any changes to the current ERISA fiduciary advice regulation are carefully harmonized with the final business conduct standards, as adopted by the CFTC and the SEC, so that there are no unintended consequences for swap dealers and major swap participants who comply with these business conduct standards.

43

43

See

Letter from Phyllis C. Borzi, Assistant Secretary, Employee Benefits Security Administration, U.S. Department of Labor to The Hon. Gary Gensler

et al.,

CFTC (Jan. 17, 2012), CFTC Adopting Release, Appendix 2—Statement of the Department of Labor, 77 FR 9835,

supra

note 21.

Thereafter, in April 2015, the DOL reproposed a change to the definition of fiduciary under ERISA.

44

The DOL noted that its staff had “consulted with staff of the SEC.”

45

44

See

Definition of the Term “Fiduciary”; Conflict of Interest Rule—Retirement Investment Advice, 80 FR 21927 (Proposed Rule, Apr. 20, 2015).

45

Id.

at 21937.

On April 6, 2016, DOL issued its final rule.

46

We understand that DOL's revised definition of “fiduciary” in its final rule is intended to allow SBS Entities to avoid becoming ERISA fiduciaries when acting as counterparties to a swap or security-based swap transaction. For example, DOL makes the following statement in the preamble to its final rule:

46

See

Definition of the Term “Fiduciary”; Conflict of Interest Rule—Retirement Investment Advice, 81 FR 20946 (Final Rule, Apr. 8, 2016).

The Department has provided assurances to the CFTC and the SEC that the Department is fully committed to ensuring that any changes to the current ERISA fiduciary advice regulation are carefully harmonized with the final business conduct standards, as adopted by the CFTC and the SEC, so that there are no unintended consequences for swap and security-based swap dealers and major swap and security-based swap participants who comply with the business conduct standards.

See, e.g.,

Letter from Phyllis C. Borzi, Assistant Secretary, Employee Benefits Security Administration, U.S. Department of Labor, to The Hon. Gary Gensler et al., CFTC (Jan. 17, 2012). In this regard, we note that the disclosures required under the business conduct standards, including those regarding material information about a swap or security-based swap concerning material risks, characteristics, incentives and conflicts of interest; disclosures regarding the daily mark of a swap or security-based swap and a counterparty's clearing rights; disclosures necessary to ensure fair and balanced communications; and disclosures regarding the capacity in which a swap or security-based swap dealer or major swap participant is acting when a counterparty to a special entity, do not in the Department's view compel counterparties to ERISA-covered employee benefit plans, other plans or IRAs to make a recommendation for purposes of paragraph (a) of the final rule or otherwise compel them to act as fiduciaries in swap and security-based swap transactions conducted pursuant to section 4s of the Commodity Exchange Act and section 15F of the Securities Exchange Act. This section of this Notice discusses these issues in the context of the express provisions in the final rule on swap and security-based swap transactions and on transactions with independent fiduciaries with financial expertise.

47

47

Id.

at 20985, n. 36.

Furthermore, DOL's final rule establishes a “swap and security-based swap transactions” exclusion

48

which, in DOL's view, is intended to establish conditions under which persons acting as SBS Entities, among others, “do not become investment advice fiduciaries as a result of communications and activities conducted during the course of swap or security-based swap transactions regulated under the Dodd-Frank Act provisions in the Commodity Exchange Act or the Securities Exchange Act of 1934 and applicable CFTC and SEC implementing rules and regulations.”

49

In addition, DOL has stated that its exclusion for “transactions with independent plan fiduciaries with financial expertise” has been significantly adjusted and expanded in the final rule and gives an alternative avenue for parties involved in swap, security-based swap, or other investment transactions to conduct the transaction in a way that would ensure they do not become investment advice fiduciaries under the final rule.

50

48

See id.

at 20984-86 (discussing the swap and security-based swap transactions exception).

49

Id.

at 20985.

See also

id.

(explaining that in DOL's view, “when Congress enacted the swap and security based swap provisions in the Dodd-Frank Act, including those expressly applicable to ERISA covered plans, Congress did not intend that engaging in regulated conduct as part of a swap or security-based swap transaction with an employee benefit plan would give rise to additional fiduciary obligations or restrictions under Title I of ERISA”).

50

See id.

at 20986 (noting that DOL “does not believe extending the swap and security-based swap provisions to IRA investors is appropriate” and, rather, concluding “that it was more appropriate to address this issue in the context of the `independent plan fiduciary with financial expertise' provision described elsewhere in this Notice”).

The Commission staff has continued to coordinate with DOL staff to ensure that the final business conduct standards rules are appropriately harmonized with ERISA and DOL regulations. DOL staff has provided the Commission with a statement that:

It is the Department's view that the draft final business conduct standards do not require security-based swap dealers or major security-based swap participants to engage in activities that would make them fiduciaries under the Department's current five-part test defining fiduciary investment advice. 29 CFR 2510.3-21(c). The standards neither conflict with the Department's existing regulations, nor compel security-based swap dealers or major security-based swap participants to engage in fiduciary conduct. Moreover, the Department's recently published final rule amending ERISA's fiduciary investment advice regulation was carefully harmonized with the SEC's business conduct standards so that there are no unintended consequences for security-based swap dealers and major security-based swap participants who comply with the business conduct standards. As explained in the preamble to the Department's final rule, the disclosures required under the SEC's business conduct rules do not, in the Department's view, compel counterparties to ERISA-covered employee benefit plans to make investment advice recommendations within the meaning of the Department's final rule or otherwise compel them to act as ERISA fiduciaries in

swap and security-based swap transactions conducted pursuant to section 4s(h) of the Commodity Exchange Act and section 15F of the Securities Exchange Act of 1934.

51

51

See

Letter from Phyllis C. Borzi, Assistant Secretary, Employee Benefits Security Administration, U.S. Department of Labor to The Hon. Mary Jo White

et al.,

SEC (Apr. 12, 2016).

Finally, the Commission has modified its proposed treatment of special entities to take into account the comprehensive regulatory scheme established under ERISA. In particular, as discussed more fully in Section II.H below, if the special entity is an ERISA plan, our rules deem certain requirements satisfied if the plan has an independent representative that is a fiduciary under ERISA.

E. Investment Adviser and Municipal Advisor Status

In addition to questions about ERISA fiduciary status, commenters also questioned whether compliance with the business conduct standards might cause an SBS Entity to be deemed an investment adviser or, when transacting with a special entity that meets the definition of municipal entity, a municipal advisor.

52

Two commenters expressed concern more generally that compliance with the daily mark requirement (in Rule 15Fh-3(c)) might raise questions as to whether an SBS Entity has advisory or fiduciary responsibilities under applicable common law, state law or federal law (

e.g.,

DOL regulations, provisions of the Investment Advisers Act of 1940 (“Advisers Act”), or the Dodd-Frank Act's municipal advisor provisions).

53

52

See, e.g.,

FIA/ISDA/SIFMA,

supra

note 5; SIFMA (August 2011),

supra

note 5.

53

See

FIA/ISDA/SIFMA,

supra

note 5; SIFMA (August 2011),

supra

note 5.

As we noted in the Proposing Release, the duties imposed on an SBS Dealer (or Major SBS Participant) under the business conduct rules are specific to this context, and are in addition to any duties that may be imposed under other applicable law.

54

Thus, an SBS Entity must separately determine whether it is subject to regulation as a broker-dealer, an investment adviser, a municipal advisor or other regulated entity.

55

For example, an SBS Dealer that acts as an advisor to a special entity may fall within the definition of “investment adviser” under Section 202(a)(11) of the Advisers Act.

56

54

See

Proposing Release,

supra

note 3, 76 FR at 42424.

55

The Dodd-Frank Act amended the Exchange Act definition of “dealer” so that a person would not be deemed to be a dealer as a result of engaging in security-based swaps with eligible contract participants.

See

Section 3(a)(5) of the Exchange Act, 15 U.S.C. 78c(a)(5), as amended by section 761(a)(1) of the Dodd-Frank Act. The Dodd-Frank Act does not include comparable amendments for persons who act as brokers in swaps and security-based swaps. Because security-based swaps, as defined in Section 3(a)(68) of the Exchange Act, are included in the Exchange Act Section 3(a)(10) definition of “security,” persons who act as brokers in connection with security-based swaps must, absent an exception or exemption, register with the SEC as a broker pursuant to Exchange Act Section 15(a), and comply with the Exchange Act's requirements applicable to brokers.

As discussed in Section I.F,

infra,

the Commission has issued temporary exemptions under the Exchange Act in connection with the revision of the “security” definition to encompass security-based swaps. Among other aspects, these temporary exemptions extended to certain broker activities involving security-based swaps.

56

See

15 U.S.C. 80b-2(a)(11).

We further stated in the Proposing Release that an SBS Dealer that acts as an advisor to a municipal entity also may be a “municipal advisor” under Section 15B(e) of the Exchange Act.

57

We note, however, that we subsequently adopted rules in 2013 that interpret the statutorily defined term “municipal advisor” and provide a regulatory exemption for persons engaging in municipal advisory activities in circumstances in which a municipal entity or obligated person is otherwise represented by an independent registered municipal advisor with respect to the same aspects of a municipal financial product or an issuance of municipal securities so long as the following requirements are satisfied: (1) The independent registered municipal advisor is registered pursuant to Section 15B of the Exchange Act and the rules and regulations thereunder, and is not, and within at least the past two years was not, associated with the person seeking to rely on the exemption; (2) the person seeking to use the exemption receives from the municipal entity or obligated person a representation in writing that it is represented by, and will rely on the advice of, the independent registered municipal advisor, and such person has a reasonable basis for relying on the representation; and (3) the person seeking to use the exemption provides written disclosure to the municipal entity or obligated person, with a copy to the independent registered municipal advisor, stating that such person is not a municipal advisor and is not subject to the fiduciary duty to municipal entities that the Exchange Act imposes on municipal advisors, and such disclosure is made at a time and in a manner reasonably designed to allow the municipal entity or obligated person to assess the material incentives and conflicts of interest that such person may have in connection with the municipal advisory activities.

58

We explained that if a municipal entity or obligated person is represented by a registered municipal advisor, parties to the municipal securities transaction and others who are not registered municipal advisors should be able to provide advice to the municipal entity or obligated person without being deemed themselves to be municipal advisors, so long as the responsibilities of each person are clear.

59

57

See

15 U.S.C. 78o-4(e)(4).

58

See

Registration of Municipal Advisors, Exchange Act Release No. 70462 (Sept. 20, 2013), 78 FR 67468, 67509-11 (Nov. 12, 2013) (“Municipal Advisor Registration Release”).

59

Id.

at 67471.

F. Intersection With SRO Rules

Under the framework established in the Dodd-Frank Act, SBS Entities are not required to be members of self-regulatory organizations (“SROs”). Some commenters have, however, urged us to harmonize Title VII business conduct requirements applicable to SBS Entities with relevant SRO requirements applicable to the SRO's members to avoid unnecessary differences, which they argue could create duplication and conflicts when an SBS Entity is also registered as a broker-dealer, or when an SBS Entity uses a registered broker-dealer to intermediate its transactions.

60

60

See

IIB (July 2015),

supra

note 10, at 13; SIFMA/FSR (July 2015),

supra

note 10, at 9-10 (due to the possibility of dually registered firms, the Commission and FINRA, “must work to harmonize existing sales practice requirements” because, to the extent requirements differ, “there may be unnecessary duplication and conflicts that cause a disparate impact on security-based swap dealers acting through broker-dealers as compared to other security-based swap dealers.”); SIFMA (September 2015),

supra

note 5, at 2 (urging the Commission to harmonize its rules with, among other things, “the FINRA Supervision Rules, [and] the FINRA CCO Rule”).

The rules we proposed were designed to implement the business conduct requirements enacted by Congress regarding security-based swap activity of SBS Entities. At the same time, in proposing these rules, we were mindful that an SBS Entity also may engage in activity that will require it to register as a broker-dealer, and thus become subject to SRO rules applicable to registered broker-dealers that may impose similar business conduct requirements.

61

As we noted in the Proposing Release, the existing rules of various SROs served as an important point of reference for our proposed

business conduct rules.

62

For example, a number of the proposed rules, including those regarding “know your counterparty,”

63

suitability,

64

fair and balanced communications,

65

supervision,

66

and designation of a CCO,

67

were patterned on standards that have been established by SROs for their members. However, we tailored the proposed rules to the specifics of the regulatory scheme for security-based swaps under Title VII.

68

61

See

Exchange Act Section 15(b)(8) (generally making it illegal for a registered broker-dealer to effect a transaction in, or induce or attempt to induce the purchase or sale of, any security unless it is a member of a registered securities association or effects transactions in securities solely on a national securities exchange of which it is a member). 15 U.S.C. 78o(b)(8).

62

We looked, in particular, to the requirements imposed by FINRA, the Municipal Securities Rulemaking Board (“MSRB”), and the National Futures Association (“NFA”), in addition to the business conduct standards, both internal and external, adopted by the CFTC.

63

Proposed Rule 15Fh-3(e).

Cf.

FINRA Rule 2090.

64

Proposed Rule 15Fh-3(f).

Cf.

FINRA Rules 2090 and 2111.

65

Proposed Rule 15Fh-3(g).

See

Exchange Act Section 15F(h)(3)C), 15 U.S.C. 78o-10(h)(3)(C).

Cf.

NASD Rule 2210(d)(1)(A).

66

Proposed Rule 15Fh-3(h).

See

Exchange Act Section 15F(h)(1)(B), 15 U.S.C. 78o-10(h)(1)(B).

Cf.

NASD Rules 3010 and 3012.

67

Proposed Rule 15Fk-1.

See

Exchange Act Section 15F(k), 15 U.S.C. 78o-10(k).

Cf.

FINRA Rule 3130.

68

For example, we provided in the proposed rules for an institutional suitability alternative, which was modeled on FINRA's institutional suitability rule (Rule 2111(b)) but tailored to take into account the definition of eligible contract participant included in Title VII, which includes, among other persons, individuals with aggregate amounts of more than $10 million invested on a discretionary basis (or $5 million if hedging), and entities with a net worth of at least $1 million that are hedging commercial risk.

See

discussion in Section II.G.4,

infra.

In addition, proposed Rule 15Fh-3(g) would impose obligations regarding fair and balanced communications that are consistent with, but less detailed than, the obligations imposed on registered broker-dealers under FINRA Rule 2210.

See

Section II.G.5,

infra.

We recognize, as the commenters noted, that the security-based swap and other securities activities of certain entities may require them to register both as broker-dealers and as SBS Dealers or Major SBS Participants.

69

To the extent an entity will be subject to regulation both as a broker-dealer and as an SBS Entity, there may be overlapping regulatory requirements applicable to the same activity. The Commission is mindful of potential regulatory conflicts or redundancies and has sought in adopting these final rules to avoid such conflicts and minimize redundancies, consistent with the statutory business conduct requirements for SBS Entities. As discussed throughout this release, the rules we are adopting today take into account the comments received, both comments specific to the application of the proposed rules to the security-based swap market and the role that the SBS Entities play in that market, and comments asking us to modify the proposed rules to more closely align with the similar SRO rules applicable to broker-dealers.

70

Overall, we believe that the business conduct rules we are adopting today are generally designed to be consistent with the relevant SRO requirements, taking into account the nature of the security-based swap market and the statutory requirements for SBS Entities.

71

69

See, e.g.,

IIB (July 2015),

supra

note 10. In addition, as noted above, there may instances in which a registered broker-dealer acts on behalf of an SBS Entity, and so both our rules and the SRO business conduct rules may apply to the activity of the broker-dealer in its capacity as agent of the SBS Entity.

70

One commenter urged harmonization with SRO (as well as CFTC) rules to allow SBS Entities “to leverage existing processes and speed implementation.” SIFMA (September 2015),

supra

note 5, at 2.

71

Generally, when a business conduct standard in these proposed rules is based on a similar SRO standard, we would expect—at least as an initial matter—to take into account the SRO's interpretation and enforcement of its standard when we interpret and enforce our rule. At the same time, we are not bound by an SRO's interpretation and enforcement of an SRO rule, and our policy objectives and judgments may diverge from those of a particular SRO. Accordingly, we would also expect to take into account such differences in interpreting and enforcing our rules. Proposing Release, 76 FR at 42399,

supra

note 3.

On July 1, 2011, the Commission issued a separate order granting temporary exemptive relief (the “Temporary Exemptions”) from compliance with certain provisions of the Exchange Act in connection with the revision, pursuant to Title VII of the Dodd-Frank Act, of the Exchange Act definition of “security” to encompass security-based swaps.

72

Consistent with the Commission's action, on July 8, 2011, FINRA filed for immediate effectiveness FINRA Rule 0180, which, with certain exceptions, is intended to temporarily limit the application of FINRA rules with respect to security-based swaps, thereby helping to avoid undue market disruptions resulting from the change to the definition of “security” under the Act.

73

72

See

Order Granting Temporary Exemptions Under the Securities Exchange Act of 1934 in Connection With the Pending Revision of the Definition of “Security” Encompass Security-based Swaps, and Request for Comment, Exchange Act Release No. 64795 (Jul. 1, 2011), 76 FR 39927 (Jul. 7, 2011) (the “Exemptive Release”). The term “security-based swap” is defined in Section 761 of the Dodd-Frank Act. 15 U.S.C. 78c(a)(68).

See also

Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, Exchange Act Release No. 67453 (Jul. 18, 2012), 77 FR 48208 (Aug. 13, 2012) (“Products Definitions Adopting Release”) for further discussion regarding the meaning of the term security-based swap.

73

FINRA Rule 0180 temporarily limits the application of certain FINRA rules with respect to security-based swaps.

See

Notice of Filing and Immediate Effectiveness of Proposed Rule Change to Adopt FINRA Rule 0180 (Application of Rules to Security-Based Swaps); File No. SR-FINRA-2011-033, Exchange Act Release No. 64884 (Jul. 14, 2011), 76 FR 42755 (July 19, 2011) (“FINRA Rule 0180 Notice of Filing”).

See also

Notice of Filing and Immediate Effectiveness of a Proposed Rule Change to Extend the Expiration Date of FINRA Rule 0180 (Application of Rules to Security-Based Swaps); File No. SR-FINRA-2016-001, Exchange Act Release No. 76850 (Jan. 7, 2016), 81 FR 1666 (Jan. 13, 2016) (extending until February 11, 2017 the expiration date of the exemptions under FINRA Rule 0180) (“FINRA Rule 0180 Extension Notice”).

In its Exemptive Release, the Commission noted that the relief is targeted and does not include, for instance, relief from the Exchange Act's antifraud and anti-manipulation provisions. FINRA has noted that FINRA Rule 0180 is similarly targeted. For instance, paragraph (a) of FINRA Rule 0180 provides that FINRA rules shall not apply to members' activities and positions with respect to security-based swaps, except for FINRA Rules 2010 (Standards of Commercial Honor and Principles of Trade), 2020 (Use of Manipulative, Deceptive or Other Fraudulent Devices), 3310 (Anti-Money Laundering Compliance Program) and 4240 (Margin Requirements for Credit Default Swaps).

See also

paragraphs (b) and (c) of FINRA Rule 0180 (addressing the applicability of additional rules); FINRA Rule 0180 Notice of Filing; FINRA Rule 0180 Extension Notice.

The Commission, noting the need to avoid a potential unnecessary disruption to the security-based swap market in the absence of an extension of the Temporary Exemptions, and the need for additional time to consider the potential impact of the revision of the Exchange Act definition of “security” in light of recent Commission rulemaking efforts under Title VII of the Dodd-Frank Act, issued an order that extended and refined the applicable expiration dates of the previously granted Temporary Exemptions.

74

In the Temporary Exemptions Extension Release, the Commission extended the expiration date of the expiring Temporary Exemptions that are not directly linked to pending security-based swap rulemakings until the earlier of such time as the Commission issues an order or rule determining whether any continuing exemptive relief is appropriate for security-based swap activities with respect to any of these Exchange Act provisions or until three years following the effective date of the

Temporary Exemptions Extension Release.

75

The Commission further extended the expiration date for many expiring Temporary Exemptions directly related to pending security-based swap rulemakings until the compliance date for the related security-based swap-specific rulemaking.

76

74

See

Order Extending Temporary Exemptions Under the Securities Exchange Act of 1934 in Connection With the Revision of the Definition of “Security” to Encompass Security-Based Swaps, and Request for Comment, Exchange Act Release No. 71485 (Feb. 5, 2014), 79 FR 7731 (Feb. 10, 2014) (“Temporary Exemptions Extension Release”).

See also

Extension of Exemptions for Security-Based Swaps, Securities Act of 1933 (“Securities Act”) Release No. 9545, Exchange Act Release No. 71482 (Feb. 5, 2014), 79 FR 7570 (Feb. 10, 2014) (extending the expiration dates in interim final rules that provide exemptions under the Securities Act, the Exchange Act, and the Trust Indenture Act of 1939 for those security-based swaps that prior to July 16, 2011 were security-based swap agreements and are defined as “securities” under the Securities Act and the Exchange Act as of July 16, 2011 due solely to the provisions of Title VII of the Dodd-Frank Act).

75

See

Temporary Exemptions Extension Release, 79 FR at 7734, supra note 74. These Temporary Exemptions are currently scheduled to expire in February 2017.

76

Id.

at 7731. The Commission extended a subset of the Temporary Exemptions until they are addressed within relevant rulemakings relating to: (i) Capital, margin, and segregation requirements for security-based swap dealers and major security-based swap participants, (ii) recordkeeping and reporting requirements for security-based swap dealers and major security-based swap participants, (iii) security-based swap trade acknowledgement rules, and/or (iv) registration requirements for security-based swap execution facilities.

In establishing Rule 0180, and in extending the rule's expiration date,

77

FINRA noted its intent, pending the implementation of any Commission rules and guidance that would provide greater regulatory clarity in relation to security-based swap activities, to align the expiration date of FINRA Rule 0180 with the termination of relevant provisions of the Temporary Exemptions provided by the Commission, so as to avoid undue market disruptions resulting from the change to the definition of “security” under the Exchange Act.

77

As noted in the FINRA Rule 0180 Extension Notice, FINRA has indicated that it intends to amend the expiration date of Rule 0180 in subsequent filings as necessary such that the expiration date will be coterminous with the termination of relevant provisions of the Temporary Exemptions.

II. Discussion of Rules Governing Business Conduct

A. Scope, Generally

1. Proposed Rule

Proposed Rule 15Fh-1 would provide that Rules 15Fh-1 through 15Fh-6 (governing business conduct) and Rule 15Fk-1 (requiring designation of a CCO) are not intended to limit, or restrict, the applicability of other provisions of the federal securities laws, including but not limited to Section 17(a) of the Securities Act, Sections 9 and 10(b) of the Exchange Act, and the rules and regulations thereunder. Additionally, it would provide that Rules 15Fh-1 through 15Fh-6 and Rule 15Fk-1 would not only apply in connection with entering into security-based swaps but also would continue to apply, as appropriate, over the term of executed security-based swaps.

In the Proposing Release, the Commission solicited comment on the scope of the business conduct rules, including whether the rules should apply to transactions between an SBS Entity and its affiliates, whether any of the rules should apply to security-based swaps that were entered into prior to the effective date of the rules, and to the extent that any of the rules were intended to provide additional protections for a particular counterparty, whether the counterparty should be able to opt out of those protections.

78

78

See

Proposing Release, 76 FR at 42401-42402,

supra

note 3.

2. Comments on the Proposed Rule

a. General

Eleven commenters addressed the general scope of the proposed business conduct standards.

79

One commenter recommended that the Commission apply the proposed rules to security-based swaps that are offered as well as those that are executed.

80

The other commenters addressed: The application of the rules to inter-affiliate transactions, the application of the rules to security-based swaps entered into prior to the effective date, and whether counterparties should be able to opt out of the protections provided by the rules.

79

See

CFA,

supra

note 5; ABA Securities Association,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; SIFMA (August 2011),

supra

note 5; NABL,

supra

note 5; AFGI (September 2012),

supra

note 5; AFGI (July 2013),

supra

note 5; CalPERS (August 2011),

supra

note 5; ABC,

supra

note 5; MFA,

supra

note 5; CalSTRS,

supra

note 5; SIFMA (August 2015),

supra

note 5.

80

See

CFA,

supra

note 5.

b. Application to Security-Based Swaps Entered Into Prior to the Effective Date

Seven commenters addressed the application of the rules to security-based swaps that were entered into prior to the compliance date of the rules, and all seven recommended that the rules not apply to such transactions.

81

Three further indicated that the rules should not generally apply to amendments to, or other lifecycle events arising under, a security-based swap that was executed before the compliance date of the rules.

82

Another commenter also specifically argued that the rules should not apply to either partial or full terminations of security-based swaps executed prior to the compliance date, or the exercise of an option on a security-based swap where the option was executed prior to the compliance date.

83

81

See

SIFMA (August 2011),

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; NABL,

supra

note 5; AFGI (September 2012),

supra

note 5; AFGI (July 2013),

supra

note 5; ABC,

supra

note 5; SIFMA (August 2015),

supra

note 5.

82

See

FIA/ISDA/SIFMA,

supra

note 5; NABL,

supra

note 5; SIFMA (August 2011),

supra

note 5.

83

See

SIFMA (August 2015),

supra

note 5.

One commenter argued that amendments to existing transactions typically do not alter the risk and other characteristics of a transaction sufficiently to merit application of the rules and that application of the rules in these cases may frustrate their purpose.

84

Others believed that any potential retroactive application would be burdensome, noting that it would undermine the expectations that the parties had when entering into the security-based swap.

85

84

See

FIA/ISDA/SIFMA,

supra

note 5.

85

See

AFGI (September 2012),

supra

note 5; AFGI (July 2013),

supra

note 5; SIFMA (August 2011),

supra

note 5.

c. Application to Inter-Affiliate Transactions

Three commenters discussed the application of the rules to inter-affiliate transactions.

86

All three recommended that the rules generally not apply to security-based swap transactions between affiliates,

87

but one recognized that entity-level requirements (such as CCO and supervision responsibilities) will necessarily apply.

88

One commenter asserted that the rules are intended to protect investors in arm's length transactions and therefore, would be irrelevant in inter-affiliate transactions.

89

The second commenter similarly argued that because affiliates are not “external clients” of the SBS Entity, the protections afforded by the rules are inapposite.

90

The second commenter also suggested that the Commission define “affiliate” to mean an entity that is “under common control and that reports information or prepares its financial statements on a consolidated basis” with another entity, and opined that the definition should be consistently applied across Title VII rulemakings.

91

The third commenter also advocated for a common control standard, arguing that the rules should not apply to transactions between an SBS Entity and “a person controlling, controlled by, or under common control with the [SBS Entity].”

92

86

See

ABA Securities Association,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; SIFMA (August 2015),

supra

note 5.

87

See

ABA Securities Association,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; SIFMA (August 2015),

supra

note 5.

88

See

ABA Securities Association,

supra

note 5.

89

See

FIA/ISDA/SIFMA,

supra

note 5.

90

See

ABA Securities Association,

supra

note 5.

91

Id.

92

See

SIFMA (August 2015),

supra

note 5.

d. Counterparty Opt-Out

Nine commenters addressed whether to permit counterparties to opt out of certain protections provided by the

rules.

93

Six commenters were in favor of allowing an opt out in at least some circumstances,

94

and three were against it.

95

93

See

FIA/ISDA/SIFMA,

supra

note 5; CalPERS (August 2011),

supra

note 5; SIFMA (August 2011),

supra

note 5; ABC,

supra

note 5; MFA,

supra

note 5; CalSTRS,

supra

note 5; CFA,

supra

note 5; Better Markets (August 2011),

supra

note 5; Levin,

supra

note 5.

94

See

FIA/ISDA/SIFMA,

supra

note 5; CalPERS (August 2011),

supra

note 5; SIFMA (August 2011),

supra

note 5; ABC,

supra

note 5; MFA,

supra

note 5; CalSTRS,

supra

note 5.

95

See

CFA,

supra

note 5; Better Markets (August 2011),

supra

note 5; Levin,

supra

note 5.

Three commenters suggested that the Commission permit institutional or “sophisticated investors” to opt out of provisions intended to protect counterparties.

96

Specifically, one endorsed allowing “qualified institutional buyers” as defined in Rule 144A under the Securities Act and institutions with total assets of $100 million or more to opt out, asserting that the costs, delays in execution, and requirements to make detailed representations and disclosure to the SBS Entity may outweigh the benefits that such counterparties would receive.

97

Another asserted that “sophisticated” counterparties should be able to opt out of receiving “material information” disclosures and the written disclosures related to clearing rights to lower their hedging costs and avoid potential trading delays and inefficiencies.

98

96

See

FIA/ISDA/SIFMA,

supra

note 5; CalPERS (August 2011),

supra

note 5; MFA,

supra

note 5.

97

See

FIA/ISDA/SIFMA,

supra

note 5.

98

See

MFA,

supra

note 5.

Three other commenters suggested an opt out for specific types of counterparties.

99

One suggested that an ERISA plan should be permitted to opt out because SBS Entities might use the information they receive as a result of compliance with the business conduct standards to disadvantage the ERISA plan.

100

A second asserted that pension funds acting as end users should be allowed to opt out of any rules that impose “heightened fiduciary duties” on SBS Dealers because pension funds do not need extra protection, and compliance with the fiduciary duties would only increase costs for SBS Dealers, leading them to either pass the costs along or refrain from entering into transactions with pension funds.

101

A third suggested that any entity advised by a qualified independent representative should be able to waive the protections of the rules to avoid execution delays and administrative costs.

102

99

See

ABC,

supra

note 5; CalSTRS,

supra

note 5; SIFMA (August 2011),

supra

note 5.

100

See

ABC,

supra

note 5.

101

See

CalSTRS,

supra

note 5.

102

See

SIFMA (August 2011),

supra

note 5.

Three commenters opposed allowing counterparties to opt out of the special protections in the rules.

103

One commenter noted that a “theoretically optional opt out would likely become mandatory” because SBS Dealers would make it a condition of doing business, and that an opt-out approach could be used to perpetuate abuses the rules are intended to prevent.

104

Another commented that an opt-out would “only add confusion to an already complex regulatory framework and create opportunities for market participants to evade compliance with the much-needed business conduct standards.”

105

A third specifically opposed allowing counterparties to opt out of the disclosure requirements, noting that even sophisticated investors may be misled.

106

103

See

CFA,

supra

note 5; Better Markets (August 2011),

supra

note 5; Levin,

supra

note 5.

104

See

CFA,

supra

note 5.

105

See

Better Markets (August 2011),

supra

note 5.

106

See

Levin,

supra

note 5.

3. Response to Comments and Final Rule

After considering the comments, the Commission is adopting Rule 15Fh-1, predesignated as Rule 15Fh-1(a), with certain modifications.

a. General

The Commission is adopting, as proposed, the provision in final Rule 15Fh-1(a) specifying that Rules 15Fh-1 through 15Fh-6 and Rule 15Fk-1 apply “in connection with entering into security-based swaps” and also will continue to apply, as appropriate, over the term of executed security-based swaps. Many of the rules impose obligations on an SBS Entity with respect to its “counterparty” that must be satisfied before the SBS Entity has actually entered into a security-based swap with that counterparty (

e.g.,

Rule 15Fh-3(a) (verification of counterparty status) and Rule 15Fh-3(b) (disclosure of material risks and characteristics, and material incentives or conflicts of interest)). This is consistent with the language specifying that the rules apply “in connection with entering into security-based swaps” in Rule 15Fh-1(a). Accordingly, when the rules refer to a “counterparty” of the SBS Entity, the term “counterparty” includes a potential counterparty where compliance with the obligation is required before the SBS Entity and the “counterparty” has actually entered into the security-based swap.

107

107

We believe that our reading of the term “counterparty” to include a potential counterparty addresses the concerns raised by the commenter that requested that the Commission apply the rules to security-based swaps that are offered as well as those that are executed.

See

CFA,

supra

note 5.

b. Application to Security-Based Swaps Entered Into Prior to the Effective Date

To address concerns raised by commenters,

108

the Commission is clarifying that the business conduct rules generally will not apply to any security-based swap entered into prior to the compliance date of the rules, and generally will apply to any security-based swap entered into after the compliance date of these rules, including a new security-based swap that results from an amendment or modification to a pre-existing security-based swap.

109

108

See

SIFMA (August 2011),

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; NABL,

supra

note 5; AFGI (September 2012),

supra

note 5; AFGI (July 2013),

supra

note 5; ABC,

supra

note 5; SIFMA (August 2015),

supra

note 5.

109

See infra

Sections IV.B and C (discussing the compliance dates of these rules).

In response to commenters' concerns about applying the business conduct rules to amendments to and other lifecycle events of a security-based swap entered into before the compliance date of these rules,

110

the Commission is clarifying that the business conduct rules generally will not apply to amendments or modifications to a pre-existing security-based swap unless the amendment or modification results in a new security-based swap (and occurs after the compliance date of these rules). The Commission has previously determined that if the material terms of a security-based swap are amended or modified during its life based on an exercise of discretion and not through predetermined criteria or a predetermined self-executing formula, the amended or modified security-based swap is viewed as a new security-based swap.

111

Thus, if there is such a material amendment or modification, which could include a change in the economic terms of the transaction that the parties would not have provided for when entering into the security-based swap contract, the Commission will consider the amended or modified security-based swap to be a new

security-based swap for purposes of the business conduct rules. If that material amendment or modification occurs after the compliance date of these rules, these rules will apply to the resulting new security-based swap.

110

See

FIA/ISDA/SIFMA,

supra

note 5; NABL,

supra

note 5; SIFMA (August 2015),

supra

note 5.

111

See

Products Definitions Adopting Release,

supra

note 72, 77 FR at 48286 (“If the material terms of a Title VII instrument are amended or modified during its life based on an exercise of discretion and not through predetermined criteria or a predetermined self-executing formula, the Commissions view the amended or modified Title VII instrument as a new Title VII instrument.”).

In response to concerns raised by a commenter, the Commission also is clarifying that the rules generally will not apply to either a partial or full termination of a pre-existing security-based swap.

112

In these instances we anticipate that the expectations of the parties will be governed by the pre-existing terms of the original security-based swap, and so the business conduct requirements generally will not apply. If, however, the partial termination involves a change in the material terms of the original security-based swap “based on an exercise of discretion and not through predetermined criteria or a predetermined self-executing formula” the business conduct rules will apply.

112

See

SIFMA (August 2015),

supra

note 5.

As requested by a commenter,

113

we are clarifying that the business conduct rules generally will not apply to a new security-based swap that results from the exercise of an option on a security-based swap (whether or not the exercise occurs before or after the compliance date of these rules), as long as the terms upon which a party can exercise the option and the terms of the underlying security-based swap that will result upon the exercise of the option are governed by the terms of the pre-existing option. If, however, the material terms of either the option or the resulting security-based swap are amended or modified based on an exercise of discretion and not through predetermined criteria or a predetermined self-executing formula, our business conduct rules will apply to the amended or modified option or security-based swap resulting from the exercise of the option (assuming that such amendment or modification occurs after the compliance date of these rules).

113

Id.

We believe it appropriate to apply the rules in this manner to help to ensure that counterparties receive the benefits of the rules in circumstances where they are warranted, while providing firms adequate time to review the business conduct rules being adopted today and make appropriate changes to their operations before they have to begin complying with those rules.

The Commission emphasizes that the above clarifications relate to the business conduct rules that by their terms apply when an SBS Entity offers to enter into or enters into a security-based swap, such as verification of status (Rule 15Fh-3(a)), certain disclosures (Rule 15Fh-3(b) and (d)), requirements for special entities as counterparties (Rule 15Fh-5), and pay-to-play (Rule 15Fh-6)). Other rules being adopted today are broader in their application, such as those relating to know your counterparty (Rule 15Fh-3(e)), recommendations of security-based swaps or trading strategies (Rule 15Fh-3(f)), fair and balanced communications (Rule 15Fh-3(g)), supervision (Rule 15Fh-3(h)), antifraud (Rule 15Fh-4(a)), requirements when an SBS Dealer is acting as an advisor to a special entity (Rule 15Fh-4(b)), and the CCO (Rule 15Fk-1). Thus, if an SBS Entity takes an action after the compliance date that independently implicates one of the business conduct rules, it will need to comply with the applicable requirements. For example, if an SBS Dealer makes a recommendation of a trading strategy that involves termination of a pre-existing security-based swap, the SBS Dealer would need to comply with the suitability requirements of Rule 15Fh-3(f) regarding such recommendation. In addition, an SBS Entity will need to comply with “entity level” rules relating to supervision and CCO after the compliance date of those rules for all of its security-based swap business.

c. Application to Inter-Affiliate Transactions

The Commission agrees with the concerns raised by commenters regarding the treatment of inter-affiliate transactions.

114

As the Commission noted in the Definitions Adopting Release (defined below), market participants may enter into inter-affiliate security-based swaps for a variety of purposes, such as to allocate risk within a corporate group or to transfer risks within a corporate group to a central hedging or treasury entity.

115

As discussed below, we believe that transactions by SBS Entities with certain of their affiliated persons do not implicate the concerns that the business conduct requirements regarding verification of counterparty status (Rule 15Fh-3(a)), disclosures regarding the product and potential conflicts of interest, daily mark and clearing rights (Rule 15Fh-3(b), (c) and (d)), “know your counterparty” and suitability obligations (Rules 15Fh-3(e) and (f)), and obligations when advising or acting as counterparty to a special entity (Rules 15Fh-4(b) and 15Fh-5) are intended to address (referred to as “transaction specific obligations”).

116

We therefore are providing in Rule 15Fh-1(a) as adopted that Rules 15Fh-3(a) through (f), 15Fh-4(b) and 15Fh-5 are not applicable to security-based swaps that SBS Entities enter into with certain affiliates.

114

See

ABA Securities Association,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; SIFMA (August 2015),

supra

note 5.

115

See

Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant,” Exchange Act Release No. 66868 (Apr. 27, 2012), 77 FR 30596, 30624-30625 (May 23, 2012) (“Definitions Adopting Release”).

116

As one commenter suggested, because affiliates are not “external clients” of the SBS Entity, the protections afforded by these rules may be inapposite.

See

ABA Securities Association,

supra

note 5.

We are not, however, extending the exception to transactions with all affiliates, as requested by some commenters.

117

Rather, the Commission is limiting the exception from the business conduct requirements to security-based swap transactions between majority-owned affiliates. The rule defines “majority-owned affiliates” consistent with the Definitions Adopting Release such that, for these purposes, the counterparties to a security-based swap are majority-owned affiliates if one counterparty directly or indirectly owns a majority interest in the other, or if a third party directly or indirectly owns a majority interest in both counterparties to the security-based swap, where “majority interest” is the right to vote or direct the vote of a majority of a class of voting securities of an entity, the power to sell or direct the sale of a majority of a class of voting securities of an entity, or the right to receive upon dissolution or the contribution of a majority of the capital of a partnership.

118

117

See

SIFMA (August 2015),

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5.

See also

ABA Securities Association,

supra

note 5 (suggesting an “affiliated group” definition that was considered but not adopted in the Definitions Adopting Release). As noted above, the Commissions instead adopted the exception for “majority-owned affiliates” that we are providing here.

See

Definitions Adopting Release,

supra

note 115.

118

See

Exchange Act Rules 3a71-1(d)(1) and 15Fh-1(a).

The transaction-specific obligations outlined above and included in Rule 15Fh-1(a) generally are designed to provide an SBS Entity counterparty with certain information in connection with the security-based swap transaction that would help reduce potential information asymmetries, and to help ensure that the SBS Entity knows its counterparty and acts in a fair manner towards that counterparty, even in the face of potential conflicts of interest. The Commission does not believe that these objectives and

concerns are implicated in the same manner or to the same extent when there is an alignment of economic interests between the SBS Entity and a counterparty, such as is the case when the counterparty is a majority-owned affiliate. However, absent majority ownership, we cannot be confident that there would be an alignment of economic interests that is sufficient to eliminate the concerns that underpin the need for regulation in this area.

119

Accordingly, the Commission is modifying Rule 15Fh-1(a) to provide that Rules 15Fh-3(a)-(f), 15Fh-4(b) and 15Fh-5 are not applicable to security-based swaps that SBS Entities enter into with their majority-owned affiliates. These generally are the transaction specific exceptions requested by a commenter.

120

119

See

Definitions Adopting Release, 77 FR at 30625,

supra

note 115 (declining to adopt a “common control” standard, noting that, “[a]bsent majority ownership, we cannot be confident that there would be an alignment of economic interests that is sufficient to eliminate the concerns that underpin dealer regulation.”).

120

See

SIFMA (August 2015),

supra

note 5 (requesting exceptions with respect to Rules 15Fh-3(a) through (f), 15Fh-4(b) and 15Fh-5).

Further, consistent with the commenter's request, we are not granting an exception for transactions with affiliates with respect to the antifraud requirements of Rule 15Fh-4(a) or the requirements of Rule 15Fh-3(g) (fair and balanced communications).

121

The exception for inter-affiliate transactions from the transaction specific obligations discussed above is generally predicated on the assumption that entities with aligned economic interests have an incentive to act fairly when dealing with each other. However, we believe it important to continue to provide the protections of the antifraud and fair and balanced communication rules in situations where an SBS Entity acts in a manner contrary to this assumption. We also are not granting exceptions to the entity-level requirements regarding supervision (Rule 15Fh-3(h)) and CCO obligations (Rule 15Fk-1), which are intended to help to ensure the compliance of SBS Entities in their security-based swap transactions.

121

See id.

d. Counterparty Opt-Out

The Commission has considered the concerns raised by commenters

122

and determined, on balance, not to permit counterparties generally to opt out of the protections provided by the business conduct rules. As discussed throughout the release in the context of specific rules, the rules being adopted today are intended to provide certain protections for counterparties, including certain heightened protections for special entities. We think it is appropriate to apply the rules so that counterparties receive the benefits of those protections and so do not think it appropriate to permit parties generally to elect to “opt out” of the benefits of those provisions.

123

122

See

FIA/ISDA/SIFMA,

supra

note 5; CalPERS (August 2011),

supra

note 5; SIFMA (August 2011),

supra

note 5; ABC,

supra

note 5; MFA,

supra

note 5; CalSTRS,

supra

note 5; CFA,

supra

note 5; Better Markets (August 2011),

supra

note 5; Levin,

supra

note 5.

123

However, as discussed in Section II.H.1.c.iii below, in order to resolve any tension between Exchange Act Sections 15F(h)(2)(C)(iii) and (iv), we are allowing employee benefit plans that are defined in Section 3 of ERISA but not subject to Title I of ERISA to opt out of special entity status.

While we are not adopting a general opt-out provision, as discussed below in connection with the relevant rules, the Commission has determined to permit means of compliance with the final rules that should promote efficiency and reduce costs (

e.g.,

Rule 15Fh-1(b) (reliance on representations)) and, where appropriate, allow SBS Entities to take into account the sophistication of the counterparty (

e.g.,

Rule 15Fh-3(f) (regarding recommendations of security-based swaps or trading strategies)).

B. Exceptions for Anonymous SEF or Exchange-Traded Transactions

Section 15F(h)(7) of the Exchange Act provides a statutory exception “from the requirements of this subsection” for security-based swap transactions that are: “(A) initiated by a special entity on an exchange or security-based swaps execution facility; and (B) the security-based swap dealer or major security-based swap participant does not know the identity of the counterparty to the transaction.”

124

More generally, commenters have asked the Commission to provide exceptions to the application of our rules in situations in which an SBS Entity does not know the identity of its counterparty, or where a security-based swap transaction is executed on a registered national securities exchange or security-based swap execution facility (“SEF”), without regard to whether the counterparty is a special entity.

125

124

15 U.S.C. 78o-10(h)(7).

125

See, e.g.,

SIFMA (August 2011),

supra

note 5; BlackRock,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5.

1. Proposal

Noting that there may be circumstances in which it may be unclear which party “initiated” the communications that resulted in the parties entering into a security-based swap transaction on a registered SEF or registered national securities exchange, the Commission proposed to interpret Section 15F(h)(7) to apply to any transaction with a special entity on a registered SEF or registered national securities exchange, where the SBS Entity does not know the identity of its counterparty at any time up to and including execution of a transaction.

The Commission further proposed to interpret Section 15F(h)(7) to apply with respect to requirements specific to dealings with special entities. Proposed Rule 15Fh-4(b)(3) would provide an exception from the special requirements for SBS Dealers acting as advisors to special entities, including the requirement that an SBS Dealer act in the best interests of a special entity for whom it acts as an advisor, if the transaction is executed on a registered exchange or SEF and the SBS Dealer does not know the identity of the counterparty at any time up to and including execution of the transaction. Under the same circumstances, proposed Rule 15Fh-5(c) would similarly provide an exception from the special requirements for SBS Entities acting as counterparties to special entities, including the qualified independent representative and disclosure requirements of proposed Rule 15Fh-5.

126

Proposed Rule 15Fh-6(b)(2)(iii) would provide an exception from the pay to play rules with respect to transactions on a registered exchange or SEF where the SBS Dealer does not know the identity of the counterparty at any time up to and including execution of the transaction.

127

126

See

Section II.H.8,

infra

for a discussion of the proposed exceptions from the requirements of Rules 15Fh-4(b) and 15Fh-5.

127

Rule 15Fh-6, as proposed, would apply only with respect to transactions “initiated” by a municipal entity. The Commission is modifying the exception under Rule 15Fh-6(b)(2)(iii) to apply to all security-based swap transactions that are executed on a registered national securities exchange or registered or exempt SEF, rather than just with respect to transactions “initiated by a municipal entity” on such exchange or registered SEF (as long as the other conditions of Rule 15Fh-6(b)(2)(iii) are met). These revisions are consistent with the exceptions to Rules 15Fh-4 and 15Fh-5 for anonymous, exchange-traded or SEF transactions.

See

Section II.H.9,

infra.

Consistent with Section 15F(h)(7), we also proposed to limit the application of certain other requirements to situations in which the identity of a counterparty (whether a special entity or not) is known to the SBS Entity. The rules as proposed would limit the verification of counterparty status obligations (proposed Rule 15Fh-3(a)),

128

and know your counterparty obligations (proposed Rule 15Fh-3(e)) to transactions with

counterparties whose identity is known to the SBS Entity.

129

128

See

Section II.G.1,

infra.

129

See

Sections II.G.1 and II.G.3,

infra.

2. Comments on the Proposal

The Commission received five comment letters that addressed the exception for anonymous, exchange or SEF-traded security-based swaps in the context of special entity-specific requirements,

130

and four comment letters that addressed more broadly the issue of an exception for anonymous or SEF and exchange-traded security-based swaps.

131

The comment letters that address the exception in the context of the special entity requirements are discussed

infra

in Sections II.H.8 and II.H.9. The comment letters that address the broader issue of an exception from business conduct requirements for anonymous or SEF and exchange-traded security-based swaps are discussed below.

130

See

ABC,

supra

note 5; CFA,

supra

note 5; SIFMA (August 2015),

supra

note 5; Better Markets (August 2011),

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5.

131

See

SIFMA (August 2011),

supra

note 5; MFA,

supra

note 5; BlackRock,

supra

note 5; SIFMA (August 2015),

supra

note 5

Two commenters asserted that, where a security-based swap is cleared (through registered clearing organizations) and SEF or exchange-traded, the transaction should not be subject to the requirements of the proposed rules—regardless of whether the identity of the counterparty is known at the time of execution.

132

The commenters argued that knowledge or identification of a counterparty's identity should not compel compliance with the business conduct standards.

133

The commenters further argued that the concerns addressed by business conduct standards were largely inapplicable to security-based swaps entered into through registered SEFs, swap execution facilities or registered national securities exchanges.

134

The commenters asserted that compliance with the proposed rules would result in delay, additional complexity, individual negotiation and potentially less transparency, which the trading and clearing requirements of the Dodd-Frank Act sought to avoid.

135

132

See

SIFMA (August 2011),

supra

note 5 (arguing that parties to exchange-traded security-based swaps likely know the identity of their counterparty before the transaction, either because the exchange uses a request for quote system (where the participants can seek quotes from specific counterparties) or a single-dealer platform, or because information about the counterparties to the trade is necessary to complete the execution process); BlackRock,

supra

note 5.

133

See

SIFMA (August 2011),

supra

note 5 (“mere knowledge”); BlackRock,

supra

note 5 (“mere identification”).

134

See

SIFMA (August 2011),

supra

note 5 (“largely inapplicable”); BlackRock,

supra

note 5 (“simply will not be an issue”).

135

See

SIFMA (August 2011),

supra

note 5; BlackRock,

supra

note 5.

However, one of the commenters acknowledged that some security-based swaps executed on a SEF or exchange might be bilaterally negotiated, and the SEF or exchange subsequently used to process the trade, in which case it might be appropriate to apply the business conduct standards.

136

136

See

BlackRock,

supra

note 5 (also noting that, conversely, generally “when a swap or a security-based swap is cleared and exchange-traded, the counterparty to the trade should be viewed as fungible, rendering compliance with the specific requirements of [the proposed rules] unnecessary”).

After adoption of the CFTC's business conduct standards, one commenter urged the Commission to adopt an exception for exchange-traded security-based swaps that are intended to be cleared if: (1)(a) The transaction is executed on a registered or exempt SEF or registered national securities exchange; and (b) is of a type that is, as of the date of execution, required to be cleared pursuant to Section 3C of the Exchange Act; or (2) the SBS Entity does not know the identity of the counterparty, at any time up to and including execution of the transaction.

137

The commenter argued that these changes would harmonize the scope of the Commission's requirements with the scope of the parallel requirements under the relief provided by CFTC No-Action Letter 13-70.

138

The commenter argued that the considerations on which the CFTC staff based its no-action relief would also apply to the security-based swap market, namely: “(i) the impossibility or impracticability of compliance with certain rules by a Swap Entity when the identity of the counterparty is not known prior to execution; (ii) the likelihood that swaps initiated anonymously on a designated contract market or swap execution facility will be standardized and, thus, information about the material risks and characteristics of such swaps is likely to be available from the designated contract market or swap execution facility or other widely available source (including the product specifications of a derivatives clearing organization where the swaps are accepted for clearing); and (iii) the likelihood that such relief would provide an incentive to transact on designated contract markets and swap execution facilities, thus enhancing transparency in the swaps market.”

139

137

See

SIFMA (August 2015),

supra

note 5.

138

Id. See Swaps Intended to Be Cleared,

CFTC Letter No. 13-70 (Nov. 15, 2013), available at

http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/13-70.pdf

.

139

Id.

3. Response to Comments and Final Rules

After considering the comments, the Commission has determined to adopt two sets of exceptions from the business conduct requirements. As discussed in Sections II.H.8 and II.H.9,

infra,

we are adopting exceptions from the requirements of Rules 15Fh-4(b), 15Fh-5 and 15Fh-6 (collectively, “special entity exceptions”) for anonymous transactions executed on a registered national securities exchange or a registered or exempt SEF, where the identity of the special entity is not known to the SBS Entity at a reasonably sufficient time prior to execution of the transaction to permit the SBS Entity to comply with the obligations of the rule.

140

140

See

Rules 15Fh-4(b)(3)(ii), 15Fh-5(d)(2) and 15Fh-6(b)(3)(iii). We have similarly modified the verification of special entity counterparty status requirements in Rule 15Fh-3(a)(2), as discussed

infra

in Section II.G.1.

In addition to the special entity exceptions, the Commission is adopting a second set of exceptions that are not limited to transactions with special entities, under which certain of the business conduct standards rules will apply only where the SBS Entity knows the identity of the counterparty at a reasonably sufficient time prior to execution of the transaction to permit the SBS Entity to comply with the obligations of the rule.

141

These exceptions are intended to address the impracticalities and potential business disruption that could result if an SBS Entity were required to comply with the disclosure requirements in Rule 15Fh-3(b) (requiring an SBS Entity to disclose material risks and characteristics of a security-based swap and material incentives or conflicts in connection with a security-based swap, prior to entering into that security-based swap with a counterparty) and Rule 15Fh-3(d) (requiring certain pre-transaction disclosures to counterparties regarding clearing rights), before learning the identity of its counterparty.

142

By only applying these rules' requirements to situations where the counterparty's identity is known “at a reasonably sufficient time prior to” the execution of a transaction, the rules' requirements are limited to situations where an SBS

Entity has sufficient time before the execution of the transaction to comply with its obligations under the rules. For this reason, we decline to adopt language, suggested by a commenter, which would apply the exception to circumstances where the identity of the counterparty “is not known at any time up to and including execution of the transaction.”

143

141

See

ABC,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5.

142

As discussed in Section II.G.3,

infra,

we are adopting as proposed the exception in Rule 15Fh-3(e), which limits SBS Dealers' counterparty obligations under the rule to transactions with “known” counterparties.

143

See

SIFMA (August 2015),

supra

note 5.

We are not, however, accepting the commenter's suggestion that we revise our exceptions to provide an exception for transactions intended to be cleared so long as the transaction is either executed on a registered national securities exchange or registered or exempt SEF and required to be cleared pursuant to Section 3C of the Exchange Act, regardless of whether or not the transaction is anonymous.

144

Similarly, we reject commenters' more general assertions that the exceptions should apply to all SEF or exchange-traded transactions, even where the identity of the counterparty is known,

145

and that the protections provided by the business conduct standards are unnecessary for security-based swaps that are entered into through registered SEFs, swap execution facilities or registered national securities exchanges.

146

The rules being adopted today are intended to provide certain protections for counterparties, and we think it is appropriate to apply the rules, to the extent practicable, so that counterparties receive the benefits of those protections. We have determined not to apply those rules where it may not be possible or practical to do so, specifically where a transaction is executed on a registered exchange or SEF and the identity of the counterparty is not known to the SBS Entity at a reasonably sufficient time prior to execution of the transaction to permit the SBS Entity to comply with the obligations of the rule. However, where the identity of the counterparty is known in a timely manner, we believe that it is appropriate to apply the rules so that the counterparty receives the benefits of the protections provided by the rules, including the assistance of an advisor or qualified independent representative acting in the best interests of a counterparty that is special entity.

144

Id.

145

See

SIFMA (August 2011),

supra

note 5; BlackRock,

supra

note 5.

146

See

SIFMA (August 2011),

supra

note 5.

C. Application of the Rules to SBS Dealers and Major SBS Participants

1. Proposal

As noted in the Proposing Release, in general, where the Dodd-Frank Act imposes a business conduct requirement on both SBS Dealers and Major SBS Participants, we proposed rules that would apply to SBS Dealers and Major SBS Participants.

147

Where, however, a business conduct requirement is not expressly addressed by the Dodd-Frank Act, the proposed rules generally applied only to SBS Dealers.

148

We solicited comment on whether this approach was appropriate. Specifically, where the Dodd-Frank Act requires that a business conduct rule apply to all SBS Entities, we asked if the rule should impose the same requirements on Major SBS Participants as on SBS Dealers, and where we proposed rules for SBS Dealers that are not expressly addressed by the Dodd-Frank Act, we asked if any of those rules should also apply to Major SBS Participants.

147

See

Proposing Release, 76 FR at 42400-42401,

supra

note 3.

148

As noted in the Proposing Release, there are exceptions to this principle. We proposed that all SBS Entities be required to determine if a counterparty is a special entity. In addition, Section 3C(g)(5) of the Exchange Act creates certain rights with respect to clearing for counterparties entering into security-based swaps with SBS Entities but does not require disclosure. We proposed a rule that would require an SBS Entity to disclose to a counterparty certain information relating to these rights.

See

15 U.S.C. 78c-3(g)(5); Proposing Release, 76 FR at 42401 n.39,

supra

note 3.

2. Comments on the Proposal

Three commenters addressed the general application of the rules to SBS Dealers and Major SBS Participants.

149

One commenter agreed it may be appropriate, “in light of their somewhat different roles,” to adopt different approaches to rules governing SBS Dealers and Major SBS Participants in certain areas.

150

The commenter asserted that absent an affirmative reason to adopt a different approach for SBS Dealers and Major SBS Participants, the Commission should seek to promote consistency and adopt uniformly strong rules.

151

The commenter argued that the determining factor should be whether Major SBS Participants are likely to be engaged in conduct that would appropriately be regulated under the relevant standard.

152

149

See

CFA,

supra

note 5; MFA,

supra

note 5; BlackRock,

supra

note 5.

150

See

CFA,

supra

note 5.

151

Id.

152

Id.

In contrast, another commenter urged the Commission to consider separate regulatory regimes for SBS Dealers and Major SBS Participants, arguing that they are different, and there are “different reasons why the Dodd-Frank Act requires additional oversight of each.”

153

The commenter recommended that the Commission focus regulation of Major SBS Participants on reducing default risk, and focus regulation of SBS Dealers on market making and pricing and sales practices in addition to reducing default risk.

154

The commenter argued that to the extent Major SBS Participants transact at arm's-length, they will not be advising counterparties and therefore, neither fiduciary duties nor “dealer-like obligations” (regarding “know your counterparty,” suitability and “pay-to-play” restrictions, for example) should be imposed on them.

155

153

See

MFA,

supra

note 5.

154

Id.

155

Id.

A third commenter generally supported our proposed approach in not applying certain business conduct requirements to Major SBS Participants where the Dodd-Frank Act does not expressly impose such standards.

156

In the alternative, if the Commission determines to require Major SBS Participants to disclose “material information” and to provide daily marks to their counterparties, the commenter asked that we make these requirements inapplicable to transactions between a Major SBS Participant and an SBS Dealer, and to allow all other parties to opt out of receiving such disclosures in their dealings with a Major SBS Participant.

157

156

See

BlackRock,

supra

note 5.

157

Id.

3. Response to Comments and Final Rules

After considering the comments, the Commission has determined to apply the rules to SBS Dealers and Major SBS Participants as proposed. To that end, as discussed below, where a statutory provision encompasses both SBS Dealers and Major SBS Participants,

158

we are adopting rules that would apply equally to SBS Dealers and Major SBS Participants.

159

We think this is important to ensure that counterparties of Major SBS Participants, as well as counterparties of SBS Dealers, receive the protections the rules are intended to provide. For example, to the extent that Major SBS Participants may be better informed about the risks and valuations of security-based swaps due to information asymmetries, disclosures may help inform counterparties concerning the material risks and characteristics of security-based swaps, and material conflicts of interest of Major SBS Participants entering into security-based swaps.

160

158

See

Section 15F(h)(1) (requiring SBS Dealers and Major SBS Participants to conform to business conduct standards as prescribed by Section 15F(h)(3) (regarding duty to verify counterparty status as ECP, required pre-trade disclosures and ongoing daily mark disclosures)); Section 15F(h)(1)(A) (requiring SBS Dealers and Major SBS Participants to comply with standards as may be prescribed by the Commission regarding fraud); Section 15F(h)(1)(B) (requiring SBS Dealers and Major SBS Participants to comply with standards as may be prescribed by the Commission regarding diligent supervision of the business of the SBS Dealer or Major SBS Participant); Section 15F(h)(4)(A) (antifraud provisions applicable to both SBS Dealers and Major SBS Participants); Section 15F(h)(5) (regarding special requirements

for SBS Dealers and Major SBS Participants that enter into a security-based swap with a special entity); and Section 15F(k) (imposing CCO obligations).

159

See

Rules 15Fh-3(a) (verification of counterparty status), 15Fh-3(b) (pre-trade disclosures), 15Fh-3(c) (daily mark), 15Fh-3(h) (supervision), 15Fh-5 (special requirements for SBS Entities acting as counterparties to special entities) and 15Fk-1 (CCO requirements).

160

See

discussion

infra

in Section VI.B.

Where, however, a business conduct requirement is not expressly addressed by the Dodd-Frank Act or we read the statute to apply a requirement only to SBS Dealers,

161

the adopted rules generally would not apply to Major SBS Participants.

162

Thus, the obligations under Rules 15Fh-3(e) (know your counterparty), 15Fh-3(f) (recommendations of security-based swaps or trading strategies), 15Fh-4(b) (special obligations when acting as an advisor to a special entity) and 15Fh-6 (pay to play rules) do not apply to a Major SBS Participant. In addition, our rules provide exceptions to Major SBS Participants, as discussed in Section II.G.2.a, from certain disclosure requirements when entering into security-based swaps with an SBS Dealer, another Major SBS Participant, a swap dealer or a swap participant.

161

See

Section II.H.2 (regarding application of “act as an advisor” obligations under Rule 15Fh-4(b) to SBS Dealers but not Major SBS Participants).

162

As noted in the Proposing Release, there are exceptions to this principle. Because an SBS Entity must comply with the requirements of Rule 15Fh-5 if it is acting as a counterparty to a special entity, the obligation to verify special entity status under Rule 15Fh-3(a)(2) applies to all SBS Entities.

See

Section II.G.1. In addition, Section 3C(g)(5) of the Exchange Act creates certain rights with respect to clearing for counterparties entering into security-based swaps with SBS Entities but does not require disclosure. As discussed in Section II.G.2.f,

infra,

Rule 15Fh-3(d) would require all SBS Entities to disclose to a counterparty certain information relating to these clearing rights.

In determining whether or not to apply certain requirements to Major SBS Participants, as explained in the Proposing Release, we have considered how the differences between the definitions of SBS Dealer and Major SBS Participant may be relevant in formulating the business conduct standards applicable to these entities. The Dodd-Frank Act and our rules define “security-based swap dealer” in a functional manner, by reference to the way a person holds itself out in the market and the nature of the conduct engaged in by that person, and how the market perceives the person's activities.

163

Unlike the definition of “security-based swap dealer,” which focuses on those persons whose function is to serve as the points of connection in those markets, the definition of “major security-based swap participant” focuses on the market impacts and risks associated with an entity's security-based swap positions.

164

Despite the differences in focus, however, the Dodd-Frank Act applies substantially the same statutory standards to SBS Dealers and Major SBS Participants.

165

We explained in the Proposing Release that, in this way, the statute applies comprehensive regulation to entities (

i.e.,

Major SBS Participants) whose security-based swap activities do not cause them to be dealers, but nonetheless could pose a high degree of risk to the U.S. financial system generally.

163

See

Exchange Act Section 3(a)(71), 15 U.S.C. 78c(a)(71), and Rule 3a-71, 17 CFR 240.3a71.

164

See

Exchange Act Section 3(a)(67), 15 U.S.C. 78c(a)(67), and Rule 3a-67, 17 CFR 240.3a67.

165

In particular, under Section 15F of the Exchange Act, SBS Dealers and Major SBS Participants generally are subject to the same types of margin, capital, business conduct and certain other requirements, unless an exclusion applies.

See

15 U.S.C. 78o-10.

We are mindful, as noted by a commenter, that there are “different reasons why the Dodd-Frank Act requires additional oversight of each.”

166

We have attempted to take into account these differing definitions and regulatory concerns in considering whether the business conduct requirements that we proposed, and that we are adopting, for SBS Dealers should or should not apply to Major SBS Participants as well. Accordingly, as noted, in general, where the Dodd-Frank Act imposes a business conduct requirement on both SBS Dealers and Major SBS Participants, the rules will apply equally to SBS Dealers and Major SBS Participants, and where a business conduct requirement is not expressly addressed by the Dodd-Frank Act, the rules generally will not apply to Major SBS Participants. We believe this approach addresses the concern of the commenter who argued that the determining factor should be the conduct in which a Major SBS Participant is likely to be engaged.

167

166

See

MFA,

supra

note 5.

167

See

CFA,

supra

note 5.

The external business conduct requirements promulgated under Section 15F(h) are intended to provide certain protections for counterparties, and we believe the rules we are adopting today appropriately apply those requirements to SBS Dealers and Major SBS Participants so that counterparties receive the benefit of those protections. At the same time, mindful of the different role to be played by Major SBS Participants (which, by definition, are not SBS Dealers), we have not sought to impose the full range of business conduct requirements on Major SBS Participants. We note that our approach in this regard largely mirrors that of the CFTC, under whose rules Swap Dealers and Major Swap Participants have operated for some time. We believe that this consistency will result in efficiencies for entities that have already established infrastructure to comply with the CFTC standard.

We proposed and are adopting limited exceptions (as discussed in connection with the applicable rules) from the disclosure requirements in Rules 15Fh-3(b), 15Fh-3(c) and 15Fh-3(d) for transactions with an SBS Entity or a Swap Entity.

168

We are not, however, adopting the suggestion that we broaden the exceptions to permit other types of counterparties to opt out of the disclosures and other protections provided under the rules when entering into a transaction with a Major SBS Participant. As noted above, the external business conduct requirements promulgated under Section 15F(h) are intended to provide certain protections for counterparties, and we believe the rules we are adopting today appropriately tailor those requirements so that counterparties receive the benefit of those protections.

168

See

BlackRock,

supra

note 5.

D. Reliance on Representations

1. Proposal

The Proposing Release solicited input on whether the rules adopted by the Commission should include a standard addressing the circumstances in which an SBS Entity may rely on representations to establish compliance with the business conduct rules.

169

We sought comment on two alternative approaches.

170

One approach would permit an SBS Entity to rely on a representation from a counterparty

unless it knows that the representation is not accurate (“actual knowledge standard”).

171

The other would permit an SBS Entity to rely on a representation unless the SBS Entity has information that would cause a reasonable person to question the accuracy of the representation (“reasonable person standard”).

172

After the Commission issued its proposed rules, the CFTC in its final rules adopted a “reasonable person standard” that generally permits a Swap Entity to rely on written representations to satisfy its due diligence obligations unless it has information that would cause a reasonable person to question the accuracy of the representation.

173

169

See

Proposing Release, 76 FR at 42404,

supra

note 3.

170

Id.

171

Id.

172

Id.

173

See

CFTC Adopting Release, 77 FR at 9749,

supra

note 21.

2. Comments on the Proposal

Twelve commenters generally addressed the proposed standards for reliance on counterparty representations.

174

With one exception,

175

these comments predate the 2012 adoption of the CFTC rules.

174

See

CCMR,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; APPA,

supra

note 5; BlackRock,

supra

note 5; SIFMA (August 2011),

supra

note 5; ABC,

supra

note 5; ABA Committees,

supra

note 5; NABL,

supra

note 5; Better Markets (August 2011),

supra

note 5; AFSCME,

supra

note 5; CFA,

supra

note 5; SIFMA (August 2015),

supra

note 5.

175

See

SIFMA (August 2015),

supra

note 5 (asking the Commission to adopt a reasonable person standard consistent with the standard under the parallel CFTC rules).

In 2011, seven commenters supported the actual knowledge standard.

176

One asserted its view that the actual knowledge standard would offer greater legal certainty to SBS Entities when making required subjective judgments under the rules (for example, judgments regarding the qualifications of a special entity's independent representative).

177

Another commenter argued that the actual knowledge standard is preferable because the reasonable person standard would require an assessment of what a reasonable person would conclude if such person had the same information as the SBS Entity, which could cause uncertainty and additional cost for market participants.

178

176

See

FIA/ISDA/SIFMA,

supra

note 5; APPA,

supra

note 5; BlackRock,

supra

note 5; SIFMA (August 2011),

supra

note 5; ABC,

supra

note 5; ABA Committees,

supra

note 5; NABL,

supra

note 5.

177

See

FIA/ISDA/SIFMA,

supra

note 5.

178

See

NABL,

supra

note 5.

One commenter, writing after the CFTC rules were adopted, asked the Commission to adopt a “reasonable person standard” that is “consistent with the parallel CFTC EBC Rules,” which generally permit a Swap Entity to rely on written representations to satisfy its due diligence obligations unless it has information that would cause a reasonable person to question the accuracy of the representations.

179

Additionally, two other commenters supported the reasonable person standard in 2011.

180

One commenter asserted that the reasonable person standard would help to ensure that SBS Entities are acting on reliable information because of the duty it would impose to verify the accuracy of a representation if the SBS Entity had some reason to question it.

181

The commenter also argued that the reasonable person standard would be easier to monitor and enforce because it would be objective rather than subjective.

182

179

See

SIFMA (August 2015),

supra

note 5.

180

See

Better Markets (August 2011),

supra

note 5; CCMR,

supra

note 5.

See also

CFA,

supra

note 5 (opposing both proposed standards but noting a preference for the reasonable person standard over the actual knowledge standard).

181

See

Better Markets (August 2011),

supra

note 5.

182

Id.

Some commenters suggested that the Commission require detailed representations.

183

One commenter asked the Commission to clarify that, for purposes of “red flags,” the knowledge test should apply only to individuals with knowledge of the security-based swap transaction; information that may be available to other parts of the SBS Entity organization should not be imputed to those individuals.

184

Another commenter requested that the Commission clarify that any representations made by a special entity or its representative to satisfy the rules do not give any party any additional rights, such as rescission or monetary compensation (

e.g.,

if the representations turn out to be incorrect).

185

Additionally, the commenter asserted that an SBS Dealer should be permitted to rely on a single set of representations made by a special entity at the beginning of a trading relationship, rather than requiring the SBS Dealer to obtain a new representation with each transaction, if the special entity represents that it will notify the SBS Dealer when the representations become inaccurate.

186

183

See

AFSCME,

supra

note 5 (recommending requiring written representations that are “sufficiently detailed and informative to permit reliance,” and requiring SBS Entities to have a reasonable basis for believing the representations to be true); CFA,

supra

note 5 (recommending requiring that the written representations be sufficiently detailed to allow such an assessment).

184

See

FIA/ISDA/SIFMA,

supra

note 5.

185

See

ABC,

supra

note 5.

186

Id.

More generally, another commenter recommended allowing representations to be contained in counterparty relationship documentation if agreed to by the counterparties, and requiring counterparties to undertake to update such representations with any material changes.

187

The commenter also suggested that an SBS Entity that is also registered with the CFTC as a Swap Entity should be permitted to rely on a counterparty's written representations with respect to the CFTC's business conduct rules to satisfy its due diligence requirements under the Commission's business conduct rules provided that the SBS Entity provides notice of such reliance to the counterparty and the counterparty does not object.

188

The commenter argued that this would speed implementation and lower costs without reducing counterparty protections.

189

Finally, the commenter recommended including both a general reliance on representations provision and also specific reliance on representations safe harbors in the individual rules that specify what representations the SBS Entity should obtain to satisfy the safe harbor.

190

187

See

SIFMA (August 2015),

supra

note 5.

188

Id.

In a subsequent letter, the commenter explained that there is a multilateral protocol that has been adopted by most market participants as a means of complying with the CFTC rules.

See

SIFMA (November 2015),

supra

note 5. The commenter noted that the representations contained in this protocol only expressly address market participants' trading in swaps, but asserted that “the factual matters addressed by those representations typically do not vary as between trading in swaps and trading in [security-based swaps]. As a result, requiring SBS Entities to obtain separate representations specifically addressing [security-based swaps] would impose additional costs with few, if any, additional benefits.”

Id.

189

SIFMA (November 2015),

supra

note 5.

190

Id.

3. Response to Comments and Final Rule

The Commission is adopting new Rule 15Fh-1(b), which provides that an SBS Entity may rely on written representations to satisfy its due diligence requirements under the business conduct rules unless it has information that would cause a reasonable person to question the accuracy of the representation. Under this standard, if an SBS Entity has in its possession information that would cause a reasonable person to question the accuracy of the representation, it will need to make further reasonable inquiry to verify the accuracy of the representation.

191

191

See

Proposing Release, 76 FR at 42404,

supra

note 3. As described

infra

in Section II.G.0, Rule 15Fh-3(e) will require an SBS Dealer to have policies and procedures reasonably designed to

obtain and retain certain essential facts regarding a known counterparty. As a result, information in the SBS Entity's possession will include information gathered by an SBS Dealer through compliance with the “know your counterparty” provisions of Rule 15Fh-3(e), as well as any other information the SBS Entity has acquired through its interactions with the counterparty, including other representations obtained from the counterparty by the SBS Entity.

We understand that this is a market in which parties rely heavily on representations both with respect to relationship documentation and the transactions themselves. While both standards we proposed for comment could be workable in this context, we recognize that neither provides the absolute certainty sought by some commenters. As we explained in the Proposing Release, under either approach an SBS Entity could not ignore information in its possession as a result of which the SBS Entity would know that a representation is inaccurate.

192

Under an “actual knowledge” standard, however, an SBS Entity can rely on a representation unless it knows that the representation is inaccurate. This alternative could allow SBS Entities to rely on questionable representations insofar as they do not have actual knowledge that the representation is inaccurate, even if they have information that would cause reasonable persons to question their accuracy. As a result, this alternative could potentially reduce the benefits of the verification of status, know your counterparty, suitability and special entity requirements and result in weaker protections for counterparties to SBS Entities. In contrast, the “reasonable person” standard under the rule as adopted should help ensure that SBS Entities do not disregard facts that call into question the validity of the representation.

193

192

See

Proposing Release, 76 FR at 42404,

supra

note 3.

193

Cf.

Exchange Act Rule 3a71-3(4) (permitting reliance on a counterparty representation unless the party seeking to rely on the representation “knows or has reason to know that the representation is not accurate; . . . a person would have reason to know that the representation is not accurate if a reasonable person should know, under all of the facts of which the person is aware, that it is not accurate”).

See also

Application of “Security-Based Swap Dealer” and “Major Security-Based Swap Participant” Definitions to Cross-Border Security-Based Swap Activities; Final Rule; Republication, Exchange Act Release No. 72472 (Jun. 25, 2014), 79 FR 47277, 47313 (Aug. 12, 2014 (republication)) (“Cross-Border Adopting Release”) (noting that “this `known or have reason to know' standard should help ensure that potential [SBS Entities] do not disregard facts that call into question the validity of the representation”).

Further, this standard also is consistent with the standard adopted by the CFTC under which a Swap Entity cannot rely on a representation if the Swap Entity has information that would cause a reasonable person to question the accuracy of the representation.

194

This consistency will result in efficiencies for entities that have already established infrastructure to comply with the CFTC standard.

194

See

CFTC Adopting Release, 77 FR at 9749,

supra

note 21.

The rule as adopted would permit an SBS Entity to reasonably rely on the representations of a counterparty or its representative to satisfy its due diligence obligations under the business conduct rules, including Rules 15Fh-2(a) and (d), 15Fh-3(a), (e) and (f), 15Fh-4 and 15Fh-5. We are not requiring a specified level of detail for these representations but note that they should be detailed enough to permit the SBS Entity to form a reasonable basis for believing that the applicable requirement is satisfied.

195

195

See

AFSCME,

supra

note 5 (recommending requiring written representations that are “sufficiently detailed and informative to permit reliance,” and requiring SBS Entities to have a reasonable basis for believing the representations to be true); CFA,

supra

note 5 (recommending requiring that the written representations be sufficiently detailed to allow such an assessment).

Nothing in our rules would prohibit an arrangement under which the parties agree that representations will be provided in counterparty relationship documentation, and that they will update such representations with any material changes, as suggested by commenters.

196

196

See

FIA/ISDA/SIFMA,

supra

note 5; SIFMA (August 2015),

supra

note 5.

We are not accepting the commenter's suggestion that we provide that in every instance an SBS Entity that is also registered with the CFTC as a Swap Entity will be permitted to rely on a counterparty's pre-existing written representations with respect to the CFTC's business conduct rules to satisfy its due diligence requirements under the Commission's business conduct rules, provided that the SBS Entity provides notice of such reliance to the counterparty and the counterparty does not object.

197

Rule 15Fh-1(b) as adopted sets out the standard pursuant to which an SBS Entity can rely on representations to satisfy its due diligence obligations, and does not speak to the process the SBS Entity will need to undertake to meet the standard. The question of whether reliance on the representations that had been obtained with respect to the CFTC business conduct rules, including the process by which the SBS Entity makes that determination, would satisfy an SBS Entity's obligations under our business conduct rules will depend on the facts and circumstances of the particular matter.

198

197

Id.

In a subsequent letter, the commenter explained that there is a multilateral protocol that has been adopted by most market participants as a means of complying with the CFTC rules.

See

SIFMA (November 2015),

supra

note 5. The commenter noted that the representations contained in this protocol only expressly address market participants' trading in swaps, but asserted that “the factual matters addressed by those representations typically do not vary as between trading in swaps and trading in [security-based swaps]. As a result, requiring SBS Entities to obtain separate representations specifically addressing [security-based swaps] would impose additional costs with few, if any, additional benefits.”

Id.

198

See

SIFMA (August 2015),

supra

note 5; SIFMA (November 2015),

supra

note 5.

We are not adopting the suggestion of one commenter that “the knowledge test should be applied only to individuals with knowledge of the SBS transaction.”

199

In some instances it may be appropriate to look only to the knowledge of persons involved in a security-based swap transaction for purposes of determining whether an SBS Entity reasonably relied on representations. However, the determination whether to impute to the individuals that are involved in a securities-based swap transaction knowledge that may be available in other parts of the SBS Entity will depend on the facts and circumstances of the particular matter. At a minimum, an SBS Entity seeking to rely on representations cannot ignore information that would cause a reasonable person to question the accuracy of those representations.

199

See

FIA/ISDA/SIFMA,

supra

note 5 (arguing that information that may be available to other parts of the SBS Entity organization should not be imputed to those individuals involved in the SBS transaction).

E. Policies and Procedures Alternative

1. Proposal

The Commission solicited comment on whether an SBS Entity should be deemed to have complied with a requirement under the proposed rules if it has: (1) Established and maintained written policies and procedures, and a documented system for applying those policies and procedures, that are reasonably designed to achieve compliance with the requirement; and (2) reasonably discharged the duties and obligations required by the written policies and procedures and documented system, and did not have a reasonable basis to believe that the written policies and procedures and documented system were not being followed.

200

200

See

Proposing Release, 76 FR at 42402,

supra

note 3.

2. Comments on the Proposal

One commenter addressed the policies and procedures alternative.

201

The commenter opposed the alternative, arguing that it would reward the process of achieving compliance more than actually achieving compliance.

202

However, the commenter asserted that SBS Entities should be required to establish, maintain, document and enforce appropriate policies and procedures, and that the Commission should take them into account when determining the sanctions for violations.

203

The commenter argued that the requirement regarding policies and procedures should supplement the requirements or prohibitions in the rules, not supplant them.

204

201

See

CFA,

supra

note 5.

202

Id.

203

Id.

204

Id.

3. Response to Comments and Final Rule

After taking into consideration the comment, the Commission is not adopting a general policies and procedures safe harbor. The Commission acknowledges the importance of policies and procedures as a tool to achieving compliance with applicable regulatory and other requirements but agrees with the commenter that a general policies and procedures safe harbor could have the unintended effect of rewarding the process towards achieving compliance more than the result of actually achieving compliance.

205

205

See

CFA,

supra

note 5.

As discussed more fully herein, Rule 15Fh-3(h) requires that an SBS Entity establish, maintain and enforce written policies and procedures that are reasonably designed to prevent violations of applicable securities laws, and rules and regulations thereunder. Rule 15Fh-3(h) also provides an affirmative defense to a charge of failure to supervise diligently based, in part, on the establishment and maintenance of these policies and procedures, where the entity has reasonably discharged the duties and obligations required by the written policies and procedures and documented system, and did not have a reasonable basis to believe that the written policies and procedures and documented system were not being followed. In addition, consistent with the approach of the CFTC, we are providing targeted representations-based safe harbors,

206

which should result in efficiencies for entities that have already established infrastructure to comply with the CFTC rules.

206

See, e.g.,

Rule 15Fh-3(f)(3), discussed in Section II.G.3,

infra,

under which an SBS Dealer can generally satisfy its obligations by obtaining representations with respect to certain suitability requirements, and Rule 15Fh-5(b), discussed in Section II.H.6,

infra,

under which an SBS Entity can generally satisfy its obligations with respect to having a reasonable basis to believe that a special entity counterparty has a qualified independent representative.

F. Definitions

1. Proposed Rule

Proposed Rules 15Fh-2(a), (c), (e) and (f), which would define “act as an advisor to a special entity,” “independent representative of a special entity,” “special entity,” and “subject to a statutory disqualification,” respectively are discussed in Section II.H below in the context of the special entity requirements.

Proposed Rule 15Fh-2(b) would define “eligible contract participant” to mean any person defined in Section 3(a)(66) of the Exchange Act.

Proposed Rule 15Fh-2(d) would provide that “security-based swap dealer or major security-based swap participant” would include, where relevant, an associated person of the SBS Dealer or Major SBS Participant.

2. Comments on the Proposed Rule

a. Definitions Relating to the Rules Applicable to Dealings With Special Entities

Comments on paragraphs (a), (c), (e) and (f) of proposed Rule 15Fh-2 defining “act as an advisor,” “independent representative of a special entity,” “special entity” and “subject to a statutory disqualification,” respectively are addressed below in Section II.H.

b. Eligible Contract Participant

One commenter addressed proposed Rule 15Fh-2(b) defining “eligible contract participant.”

207

The commenter pointed out an error in the cross-reference in the rule to the Exchange Act definition and recommended adding a reference to applicable rules and interpretations of the Commission and the CFTC.

208

207

See

SIFMA (August 2015),

supra

note 5.

208

Id.

c. SBS Dealer or Major SBS Participant

Three commenters addressed proposed Rule 15Fh-2(d) defining SBS Dealer or Major SBS Participant.

209

Two commenters suggested that the Commission adopt a broader definition that would apply the business conduct rules to any person acting on behalf of the SBS Entity, including an associated person, consistent with the CFTC business conduct rules.

210

One commenter asserted that this would prevent SBS Entities from “evad[ing] the business conduct rules by doing through third parties what they would not be permitted to do directly.”

211

The commenter also discouraged the Commission from seeking to identify all of the requirements that would apply to an associated person of an SBS Entity, suggesting that the rules should apply in any circumstance where an SBS Entity acts through or by means of an associated person or other party.

212

209

See

CFA,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; SIFMA (August 2015),

supra

note 5.

210

See

CFA,

supra

note 5; SIFMA (August 2015),

supra

note 5.

211

See

CFA,

supra

note 5.

212

Id.

A third commenter recommended that the Commission clarify that associated persons of an SBS Entity should only be directly responsible for complying with the disclosure rules and rules involving interactions with counterparties, and should not be responsible for complying with internal business conduct standards, such as the rules relating to supervision and requiring designation of a CCO.

213

The commenter also suggested that the Commission define “associated person” as “an associated person of an [SBS Dealer] or [Major SBS Participant] through whom the [SBS Dealer] or [Major SBS Participant] acts.”

214

213

See

FIA/ISDA/SIFMA,

supra

note 5.

214

Id.

3. Response to Comments and Final Rule

The Commission is moving the definition of “independent representative of a special entity” from Rule 15Fh-2 to Rule 15Fh-5 and accordingly, re-designating paragraphs (d) through (f) of Rule 15Fh-2 as paragraphs (c) through (e). The definition of “independent representative of a special entity” and paragraphs (a), (d) and (e) of Rule 15Fh-2 (defining “act as an advisor,” “special entity” and “subject to a statutory disqualification,” respectively) are addressed below in Section II.H.

The Commission is adopting Rule 15Fh-2(b) with two modifications. In response to a suggestion from a commenter,

215

the Commission is correcting a typographical error in the cross-reference to the Exchange Act definition of “eligible contract participant” in the proposed rule. The proposed rule referenced “Section 3(a)(66)” of the Exchange Act, but should have referenced Section 3(a)(65) of the Exchange Act, which defines an

eligible contract participant. Section 3(a)(65) of the Exchange Act, in turn, provides that the term eligible contract participant “has the same meaning as in section 1a of the Commodity Exchange Act.” We have also revised the definition in response to the same commenter's request that we add a reference to applicable rules and interpretations of the Commission and the CFTC to incorporate the joint SEC-CFTC rulemaking adopted in May 2012.

216

In this regard, we note that the Commission and the CFTC jointly further defined the term eligible contract participant by adopting rules and regulations under the Commodity Exchange Act.

217

Thus, as adopted, the definition of “eligible contract participant” in Rule 15Fh-2(b) refers to: “any person as defined in Section 3(a)(65) of the Act and the rules and regulations thereunder and in Section 1a of the Commodity Exchange Act and the rules and regulations thereunder.”

215

See

SIFMA (August 2015),

supra

note 5.

216

Section 712(d)(1)(A) of the Dodd-Frank Act provides, among other things, that the CFTC and the Commission, in consultation with the Board of Governors, shall further define the term “eligible contract participant.” Public Law 111-203, 124 Stat. 1376 (2010). Moreover, Section 712(d)(4) provides that any interpretation of, or guidance by either Commission regarding, a provision of Title VII of the Dodd Frank Act shall be effective only if issued jointly by the CFTC and the Commission, after consultation with the Board of Governors, if this title requires the Commissions to issue joint regulations to implement the provision.

Id.

217

See

Definitions Adopting Release,

supra

note 115.

After considering the comments, the Commission is adopting Rule 15Fh-2(d) as proposed, re-designated as Rule 15Fh-2(c). The statute defines the term “associated person of a security-based swap dealer or major security-based swap participant” to include “any person directly or indirectly controlling, controlled by, or under common control with” an SBS Dealer or Major SBS Participant.

218

While the SBS Entity remains ultimately responsible for compliance with the business conduct standards, to the extent that an SBS Entity acts through, or by means of, an associated person of that SBS Entity, the associated person must comply as well with the applicable business conduct standards.

218

Section 3(a)(70)(A)(ii) of the Exchange Act, 15 U.S.C. 78c(a)(70)(A)(ii).

The Commission declines to modify the definition, as requested by some commenters, to apply to persons acting on behalf of the SBS Entity.

219

We believe it unnecessary to expand the definition because, as noted above, the SBS Entity remains ultimately responsible for compliance with the business conduct standards, whether the SBS Entity is acting through, or by means of, an associated person or other person.

219

See

CFA,

supra

note 5; SIFMA (August 2015),

supra

note 5.

In response to the commenter that raised concerns that associated persons should not be responsible for complying with “internal” business conduct standards,

220

the Commission notes that Rule 15Fh-2(c) provides that the definition of an SBS Entity includes associated persons of the SBS Entity “where relevant.” Certain rules, including the so-called “internal” business conduct rules (

e.g.,

Rule 15Fh-3(h) (supervision) and Rule 15Fk-1 (designation of CCO)) may apply to some but not all associated persons of an SBS Entity, and the registrant remains ultimately responsible for compliance with all of the business conduct rules that are the subject of this rulemaking.

220

See

FIA/ISDA/SIFMA,

supra

note 5.

G. Business Conduct Requirements

1. Counterparty Status

a. Proposed Rule

Section 15F(h)(3)(A) of the Exchange Act directs that business conduct requirements adopted by the Commission shall establish a duty for an SBS Entity to verify that any counterparty meets the eligibility standards for an ECP.

221

221

15 U.S.C. 78o-10(h)(3)(A).

Proposed Rule 15Fh-3(a)(1) would require an SBS Entity to verify that a counterparty whose identity is known to an SBS Entity prior to the execution of the transaction meets the eligibility standards for an ECP, before entering into a security-based swap with that counterparty other than on a registered national securities exchange or SEF.

222

Proposed Rule 15Fh-3(a)(2) would require an SBS Entity to verify whether a counterparty whose identity is known to the SBS Entity prior to the execution of the transaction is a special entity before entering into a security-based swap with that counterparty, no matter where the transaction is executed.

223

222

Proposed Rule 15Fh-3(a)(1).

See

Section 6(l) of the Exchange Act (making it unlawful to effect a security-based swap transaction with or for a person that is not an ECP unless such transaction is effected on a registered national securities exchange).

See also

Section 5(e) of the Securities Act of 1933, 15 U.S.C. 77e(e)) (“unless a registration statement meeting the requirements of section 10(a) [of the Securities Act] is in effect as to a security-based swap, it shall be unlawful for any person . . . to offer to sell, offer to buy or purchase or sell a security-based swap to any person who is not an eligible contract participant”).

See also

Registration and Regulation of Security-Based Swap Execution Facilities, Exchange Act Release No. 63825 (Feb. 2, 2011), 76 FR 10948 (Feb. 28, 2011) (“SEF Registration Proposing Release”) (proposed Rule 809 would limit SEF participation to registered SBS Dealers, Major SBS Participants, brokers and ECPs).

223

Proposed Rule 15Fh-3(a)(2).

See generally

Section 15F(h)(1)(D) of the Exchange Act, 15 U.S.C. 78o-10(h)(1)(D) (authorizing the Commission to prescribe business conduct standards that relate to “such other matters as the Commission determines to be appropriate”).

b. Comments on the Proposed Rule

Three commenters addressed proposed Rule 15Fh-3(a).

224

One opposed limiting the application of the rule to known counterparties, noting that this would invite SBS Entities to promote anonymous off-exchange transactions that would allow them to avoid obligations otherwise owed to special entities.

225

The commenter asserted that the only exemption from the verification requirement should be for transactions on a registered exchange or SEF, and that for such transactions, if the SBS Entity knows the identity of the counterparty prior to the transaction and has reason to believe it may not be an ECP, the SBS Entity should be required to undertake an additional inquiry to verify the counterparty's status.

226

The commenter also recommended that verification take place before the SBS Entity offers to enter into a transaction, rather than before execution.

227

224

See

CFA,

supra

note 5; FIA/ISDA/SIFMA,

supra

note 5; SIFMA (August 2015),

supra

note 5.

225

See

CFA,

supra

note 5.

226

Id.

The commenter also recommended that the Commission conform to the CFTC's then-pending proposal, which would have required counterparty status verification in any transaction other than anonymous transactions on a swap execution facility. We note, however, that the CFTC subsequently adopted a rule that clarified that the exemption from verification applies to all transactions on a designated contract market (“DCM”) and to anonymous transactions on a swap execution facility.

See

CFTC Adopting Release, 77 FR at 9757,

supra

note 21.

227

See

CFA,

supra

note

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