2010 31588a

Wednesday,
December 22, 2010
Part III
Commodity Futures
Trading Commission
17 CFR Parts 23 and 155
Business Conduct Standards for Swap
Dealers and Major Swap Participants With
Counterparties; Proposed Rule
srobinson on DSKHWCL6B1PROD with PROPOSALS3
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80638 Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules
COMMODITY FUTURES TRADING remove any or all of your submission G. Proposed § 23.434—Recommendations
COMMISSION from http://www.cftc.gov that it may to Counterparties—Institutional
deem to be inappropriate for Suitability
17 CFR Parts 23 and 155 H. Proposed § 155.7—Execution
publication, such as obscene language. Standards 2
RIN 3038–AD25 All submissions that have been redacted III. Proposed Rules for Swap Dealers and
or removed that contain comments on Major Swap Participants With Special
Business Conduct Standards for Swap the merits of the rulemaking will be Entities
Dealers and Major Swap Participants retained in the public comment file and A. Definition of ‘‘Special Entity’’ Under
With Counterparties will be considered as required under the Section 4s(h)(2)(C)
Administrative Procedure Act and other B. Proposed § 23.440—Requirements for
AGENCY: Commodity Futures Trading Swap Dealers Acting as Advisors to
applicable laws, and may be accessible
Commission. Special Entities
under the Freedom of Information Act. 1. Act as an Advisor to a Special Entity
ACTION: Proposed rules. FOR FURTHER INFORMATION CONTACT: 2. Best Interests
SUMMARY: The Commodity Futures Phyllis J. Cela, Deputy Director and 3. Reasonable Efforts
Chief Counsel, Division of Enforcement, 4. Reasonable Reliance To Satisfy the
Trading Commission (‘‘Commission’’ or ‘‘Reasonable Efforts’’ Obligation
‘‘CFTC’’) is proposing for comment new or Peter Sanchez, Special Counsel,
C. Proposed § 23.450—Requirements for
rules under Section 4s(h) of the Division of Clearing and Intermediary
Swap Dealers and Major Swap
Commodity Exchange Act (‘‘CEA’’) to Oversight, Commodity Futures Trading Participants Acting as Counterparties to
implement provisions of Title VII of the Commission, 1155 21st Street, NW., Special Entities
Dodd-Frank Wall Street Reform and Washington, DC 20581. Telephone 1. Qualifications of the Independent
Consumer Protection Act of 2010 number: (202) 418–7642. Representative
SUPPLEMENTARY INFORMATION: The 2. Statutory Disqualification
(‘‘Dodd-Frank Act’’) relating generally to 3. Independent
external business conduct standards for Commission is proposing §§ 23.400–
4. Best Interests
swap dealers and major swap 402, 23.410, 23.430–434, 23.440, 5. Makes Appropriate and Timely
participants. 23.450–451, and 155.7 under Section Disclosures
4s(h) of the CEA. The Commission is 6. Evaluates Fair Pricing and the
DATES: Written comments must be soliciting comments on all aspects of the Appropriateness of the Swap
received on or before February 22, 2011. proposed rules and will carefully 7. ERISA Fiduciary
ADDRESSES: You may submit comments, consider any comments received. 8. Restrictions on Political Contributions
identified by RIN number 3038–AD25, by Independent Representative of a
by any of the following methods: Table of Contents Municipal Entity
• Agency Web site, via its Comments 9. Unqualified Independent Representative
I. Introduction 10. Disclosure of Capacity
Online process: http:// A. Business Conduct Standards—Dealing 11. Inapplicability
comments.cftc.gov/. Follow the With Counterparties Generally D. Proposed § 23.451—Political
instructions for submitting comments B. Business Conduct Standards—Dealing Contributions by Certain Swap Dealers
through the Web site. With Counterparties That Are Special and Major Swap Participants
• Mail: David A. Stawick, Secretary of Entities 1. Prohibitions
the Commission, Commodity Futures C. Consultations With Stakeholders 2. Exceptions
D. Consultation and Coordination With the 3. Exemptions
Trading Commission, Three Lafayette SEC, Prudential Regulators and Other
Centre, 1155 21st Street, NW., IV. Request for Comment
Domestic and Foreign Regulatory A. Generally
Washington, DC 20581. Authorities B. Consistency With SEC Approach
• Hand Delivery/Courier: Same as II. Proposed Rules for Swap Dealers and V. Related Matters
mail above. Major Swap Participants Dealing With A. Regulatory Flexibility Act
• Federal eRulemaking Portal: http:// Counterparties Generally B. Paperwork Reduction Act
www.regulations.gov. Follow the A. Proposed §§ 23.400, 23.401 and C. Cost-Benefit Analysis
instructions for submitting comments. 23.402—Scope, Definitions and General
Provisions I. Introduction
Please submit your comments using B. Proposed § 23.410—Prohibition on
only one method. On July 21, 2010, President Obama
Fraud, Manipulation and Other Abusive
All comments must be submitted in Practices
signed the Dodd-Frank Act.3 Title VII of
English, or if not, accompanied by an C. Proposed § 23.430—Verification of the Dodd-Frank Act amended the CEA 4
English translation. Comments will be Counterparty Eligibility to establish a comprehensive new
posted as received to http:// D. Proposed § 23.431—Disclosures of regulatory framework for swaps and
www.cftc.gov. You should submit only Material Risks, Characteristics, Material certain security-based swaps. The
information that you wish to make
Incentives and Conflicts of Interest legislation was enacted to reduce risk,
Regarding a Swap increase transparency, and promote
available publicly. If you wish the 1. Timing and Manner of Disclosures
Commission to consider information 2. Disclosure of Material Risks 2 The proposed swap execution standards § 155.7
that you believe is exempt from 3. Scenario Analysis for High-Risk would apply to any Commission registrant,
disclosure under the Freedom of Complex Bilateral Swaps and including a swap dealer or major swap participant,
Information Act, a petition for Counterparty ‘‘Opt-In’’ for Bilateral handling an order for a swap that is available for
confidential treatment of the exempt Swaps Not Available for Trading on a trading on a designated contract market or a swap
Designated Contract Market or Swap execution facility.
information may be submitted according 3 See Dodd-Frank Wall Street Reform and
to the procedures established in § 145.9 Execution Facility
4. Material Characteristics Consumer Protection Act, Public Law 111–203, 124
of the Commission’s Regulations.1 5. Material Incentives and Conflicts of
Stat. 1376 (2010) (‘‘Dodd-Frank Act’’). The text of
The Commission reserves the right, the Dodd-Frank Act may be accessed at http://
Interest www.cftc.gov/LawRegulation/OTCDERIVATIVES/
but shall have no obligation, to review, 6. Daily Mark index.htm.
pre-screen, filter, redact, refuse or E. Proposed § 23.432—Clearing 4 7 U.S.C. 1 et seq., as amended by the Dodd-
F. Proposed § 23.433—Communications— Frank Act. All references to the CEA are to the CEA
1 17 CFR 145.9. Fair Dealing as amended by the Dodd-Frank Act.
Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 80639
market integrity within the financial and adherence to position limits.8 The organization (‘‘SRO’’) rules.11 The
system by, among other things: (1) proposed rules incorporate the anti- Commission also considered standards
Providing for the registration and fraud provision for swap dealers and adopted by prudential regulators,
comprehensive regulation of swap major swap participants contained in industry recommendations concerning
dealers and major swap participants; (2) Section 4s(h)(4), and also would ‘‘best practices’’ and requirements
imposing clearing and trade execution prohibit swap dealers and major swap applicable under foreign regulatory
requirements on standardized derivative participants from disclosing regimes.12 To the extent practicable, the
products; (3) creating robust confidential counterparty information, Commission has modeled the proposed
recordkeeping and real-time reporting or front running or trading ahead of rules on these existing rules and
regimes; and (4) enhancing the counterparty transactions. The standards. Among the proposed
Commission’s rulemaking and Commission also proposes to adopt requirements that are based on these
enforcement authorities with respect to, certain counterparty-specific analogous rules and standards are: An
among others, all registered entities and supervisory and compliance duties institutional suitability requirement for
intermediaries subject to the including a ‘‘know your counterparty’’ swap dealers and major swap
Commission’s oversight. requirement and policies and participants when making
Section 731 of the Dodd-Frank Act procedures to enforce these business recommendations to counterparties;
amends the CEA by adding Section conduct rules and to prevent evasion of swap execution standards that would
4s(h). This section provides the the requirements of the CEA and apply to all Commission registrants,
Commission with both mandatory and Commission Regulations.9 including swap dealers, for swaps
discretionary rulemaking authority to Section 4s(h)(3) directs the available for trading on a designated
impose business conduct requirements Commission to promulgate rules that contract market (‘‘DCM’’) or swap
on swap dealers and major swap would require swap dealers and major execution facility (‘‘SEF’’); and, as part of
participants in their dealings with swap participants to: Verify the a swap dealer’s or major swap
counterparties, including ‘‘Special eligibility of their counterparties; participant’s duty to disclose the
Entities.’’ 5 Such entities are generally disclose to their counterparties material material risks and characteristics of the
defined to include Federal agencies, information about swaps, including swap, a duty to provide a scenario
States and political subdivisions, material risks, characteristics, incentives analysis of potential exposure for high-
employee benefit plans as defined under and conflicts of interest; and provide risk complex bilateral swaps, and on an
the Employee Retirement Income counterparties with information ‘‘opt-in’’ basis scenario analysis for
Security Act of 1974 (‘‘ERISA’’), concerning the daily mark for swaps. bilateral swaps not available for trading
governmental plans as defined under The Commission also is directed to on a DCM or SEF.13 The Commission
ERISA, and endowments. Congress establish a duty for swap dealers and also is proposing that both swap dealers
granted the Commission broad major swap participants to and independent representatives of
discretionary authority to promulgate communicate in a fair and balanced Special Entities, including those that are
business conduct requirements, as manner based on principles of fair registered with the Commission as
appropriate in the public interest, for dealing and good faith.
11 In this regard, the Commission has looked to
the protection of investors, or otherwise In addition, using its discretionary
the requirements imposed by the National Futures
in furtherance of the purposes of the authority under 4s(h)(3)(D), the Association (‘‘NFA’’), CME Group, Inc. (‘‘CME’’),
CEA.6 Commission is proposing to require that IntercontinentalExchange, Inc. (‘‘ICE’’), Financial
swap dealers and major swap Industry Regulatory Authority, Inc. (‘‘FINRA’’) and
A. Business Conduct Standards— participants comply with certain the Municipal Securities Rulemaking Board
Dealing With Counterparties Generally disclosure requirements based on
(‘‘MSRB’’). SRO rules, in particular, provide a useful
model because historically the Commission has
Section 4s(h)(1) grants the certain clearing provisions of the Dodd- relied on SROs to regulate conduct that is unethical
Commission authority to promulgate Frank Act and the CEA.10 or otherwise undesirable, but may not be
fraudulent. See, e.g., NFA Compliance Rule 2–4,
rules applicable to swap dealers and The Commission proposes to use its Just and Equitable Principles of Trade.
major swap participants related to, rulemaking authority under Section 12 See, e.g., International Organization of
among other things: Fraud, 4s(h) to promulgate several Securities Commissions, ‘‘Operational and Financial
manipulation and abusive practices requirements adapted from analogous Risk Management Control Mechanisms for Over-
standards and practices applicable to the-Counter Derivatives Activities of Regulated
involving swaps; diligent supervision; 7 Securities Firms’’ (Jul. 1994); Derivatives Policy
certain financial market professionals. Group, ‘‘Framework for Voluntary Oversight’’ (Mar.
5 Congress enacted a virtually identical provision In drafting the proposed rules, the 1995) (‘‘DPG Framework’’), available at http://
in Dodd-Frank Act Section 764 which adds Section Commission considered existing www.riskinstitute.ch/137790.htm; The Counterparty
15F(h) to the Securities Exchange Act of 1934 Risk Management Policy Group, ‘‘Improving
(‘‘Exchange Act’’) (15 U.S.C. 78a et seq.). All
requirements for market intermediaries
Counterparty Risk Management Practices’’ (June
references to the Exchange Act are to the Exchange under the CEA, Commission 1999) (CRMPG is composed of OTC derivatives
Act, as amended by the Dodd-Frank Act. Section Regulations and the Federal securities dealers including Bank of America, BNP Paribas,
712(a)(1) of the Dodd-Frank Act requires that the laws, as well as self-regulatory Citigroup, Goldman Sachs, HSBC, JP Morgan and
Commission consult with the Securities and Morgan Stanley); The Counterparty Risk
Exchange Commission and prudential regulators in Management Policy Group, ‘‘Toward Greater
promulgating rules pursuant to Section 4s(h). requirements on swap dealers and major swap Financial Stability: A Private Sector Perspective—
6 See Section 4s(h)(3)(D) (‘‘Business conduct participants). The Report of the Counterparty Risk Management
8 Id. (proposed § 23.601 imposing requirements

requirements adopted by the Commission shall Policy Group II’’ (Jul. 27, 2005); The Counterparty
establish such other standards and requirements as for swap dealers and major swap participants Risk Management Policy Group, ‘‘Containing
the Commission may determine are appropriate in related to monitoring position limits). Systemic Risk: The Road to Reform, The Report of
the public interest, for the protection of investors, 9 Dodd-Frank Act Sections 722(d) (amending CEA the CRMPG III (Aug. 6, 2008) (‘‘CRMPG III Report’’),
or otherwise in furtherance of the purposes of this Section 2(i)), 723(a)(3) (amending CEA Sections available at http://www.crmpolicygroup.org/.
Act’’); see also Sections 4s(h)(1)(D), 4s(h)(5)(B) and 2(h)(4)(A) and 2(h)(7)(F)) and 741(b)(11) (amending 13 The CRMPG III Report identifies the
4s(h)(6). CEA Section 6(e)) amend the CEA by prohibiting a characteristics of high-risk complex bilateral swaps
7 See also Regulations Establishing and Governing swap dealer or major swap participant from to be: The degree and nature of leverage, the
the Duties of Swap Dealers and Major Swap ‘‘knowingly or recklessly’’ evading certain potential for periods of significantly reduced
Participants, 75 FR 71397, Nov. 23, 2010 (proposed provisions of the CEA. liquidity, and the lack of price transparency. The
§ 23.602 imposing additional diligent supervision 10 See Sections 2(h)(7)(A) and (B) of the CEA. CRMPG III Report, at 54–57.
commodity trading advisors (‘‘CTAs’’), standards.16 Commission staff Authority staff. Staff also considered the
be subject to certain restrictions with conducted many of these consultations existing and ongoing work of the
respect to political contributions to jointly with Securities and Exchange International Organization of Securities
certain governmental Special Entities Commission (‘‘SEC’’) staff. The Commissions (‘‘IOSCO’’). Staff
(‘‘pay-to-play’’). consultations included discussions of consultations with foreign authorities
the general nature of counterparty revealed many similarities in the
B. Business Conduct Standards— relationships today, counterparty proposed rules and foreign regulatory
Dealing With Counterparties That Are practices unique to different types of requirements.18
Special Entities swaps and asset classes, and
II. Proposed Rules for Swap Dealers
Section 4s(h)(4) requires that a swap interpretive recommendations
and Major Swap Participants Dealing
dealer who ‘‘acts as an advisor to a concerning certain provisions of Section
With Counterparties
Special Entity’’ must act in the ‘‘best 4s(h).
interests’’ of the Special Entity and The proposed business conduct rules
D. Consultation and Coordination With dealing with counterparty relationships
undertake ‘‘reasonable efforts’’ to obtain the SEC, Prudential Regulators and
information necessary to determine that are contained in subpart H of new part
Other Domestic and Foreign Regulatory 23 of the Commission’s regulations.19
a recommended swap is in the best Authorities
interests of the Special Entity. The While the CEA and other provisions of
Commission proposes to incorporate the In compliance with Sections 712(a)(1) the Commission’s rules will govern
statutory text in a proposed rule and to and 752(a) 17 of the Dodd-Frank Act, swap transactions and the business of
specify that certain swaps-related Commission staff has consulted and swap dealers and major swap
conduct would be included within the coordinated with the SEC, prudential participants, subpart H will contain the
meaning of the term ‘‘act as an advisor regulators and foreign authorities. principal regulations governing sales
to a Special Entity.’’ Commission staff has worked closely practices and counterparty
Section 4s(h)(5) authorizes the with SEC staff in the development of the relationships. A section-by-section
Commission to establish duties for swap proposed rules. The Commission’s description of the proposed rules
dealers and major swap participants that objective was to establish consistent follows.
offer swaps or enter into swaps with requirements for CFTC and SEC
registrants to the extent practicable A. Proposed §§ 23.400, 23.401 and
Special Entities, including requiring a 23.402—Scope, Definitions and General
swap dealer or major swap participant given the differences in existing
regulatory regimes and approaches. Provisions
to have a reasonable basis to believe that
With respect to the prudential These proposed rules set out the
the Special Entity has a representative,
regulators, Commission staff consulted scope, definitions and general
independent of the swap dealer or major
and considered certain existing business provisions that apply, as appropriate, to
swap participant, that meets certain
conduct standards that apply to banks. subpart H of new part 23 of the
criteria, including having sufficient
Commission staff also consulted Commission’s regulations. The ‘‘scope’’
knowledge to evaluate the transaction
informally with staff from the provision, under proposed § 23.400,
and risks, undertaking a duty to act in
Department of Labor (‘‘DOL’’) and the states that the rules in subpart H apply
the ‘‘best interests’’ of the Special Entity,
Internal Revenue Service with respect to to swap dealers and major swap
and being subject to pay-to-play
certain Special Entity definitions and participants and that the rules do not
restrictions. The statute requires swap the intersection of their regulatory limit the applicability of other
dealers and major swap participants to requirements with the Dodd-Frank Act provisions of the CEA, Commission
disclose in writing the capacity in business conduct provisions. Regulations or other laws.20 So, for
which they are acting before initiating a In addition, Commission staff example, in addition to the anti-fraud
transaction with a Special Entity. The consulted with foreign authorities, provision that would apply only to
Commission is proposing to establish specifically, European Commission and swap dealers and major swap
the duties described in Section 4s(h)(5) United Kingdom Financial Services participants in proposed § 23.410, swap
for swap dealers and major swap
dealers and major swap participants
participants dealing with all categories 16 The Commission received several written
will be subject to all other applicable
of Special Entities. submissions from the public including: National
Futures Association, Aug. 25, 2010 (‘‘NFA Letter’’);
anti-fraud provisions in the CEA and
The Dodd-Frank Act requires the
Swap Financial Group, Aug. 9, 2010 (‘‘SFG Letter’’);
Commission to promulgate the Swap Financial Group, ‘‘Briefing for SEC/CFTC 18 See generally European Union Markets in
mandatory rules by July 15, 2011.14 The Joint Working Group’’ Aug. 9, 2010 (‘‘SFG Financial Instruments Directive (‘‘MiFID’’), Directive
Commission requests comment on all Presentation’’); Christopher Klem, Ropes & Gray 2004/39/EC of the European Parliament and of the
aspects of the proposed rules, as well as LLP, Sept. 2, 2010 (‘‘Ropes & Gray Letter’’); Council of 21 April 2004 on markets in financial
American Benefits Council, Sept. 8, 2010 (‘‘ABC instruments, available at http://eur-lex.europa.eu/
comment on the specific provisions and Letter’’); American Benefits Council and the LexUriServ/LexUriServ.do?uri
issues highlighted in the discussion Committee on Investment of Employee Benefit =CONSLEG:2004L0039:20070921:EN:PDF;
below. Assets, Oct. 19, 2010 (‘‘ABC/CIEBA Letter’’); and European Union Market Abuse Directive (‘‘Market
Securities Industry and Financial Markets Abuse Directive’’), Directive 2006/6/EC of the
C. Consultations With Stakeholders Association and International Swaps and European Parliament and of the Council of 28
Derivatives Association, Oct. 22, 2010 (‘‘SIFMA/ January 2003 on market abuse, available at http://
Commission staff held more than two ISDA Letter’’), available at http://www.cftc.gov/ eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri
dozen external consultations 15 with
LawRegulation/DoddFrankAct/Rulemakings/OTC_ =OJ:L:2003:096:0016:0016:EN:PDF.
stakeholders representing a broad 3_BusConductStandardsCP.html. 19 The proposed swap execution § 155.7 would be
spectrum of views on business conduct 17 Dodd-Frank Act Section 752(a) states in part, promulgated in part 155. All the other proposed
‘‘the Commodity Futures Trading Commission, the rules would appear in subpart H of new part 23.
Securities and Exchange Commission, and the 20 In addition to its obligations under the
14 See Dodd-Frank Act Sections 712 and 754. prudential regulators (as that term is defined in proposed rules, to the extent a swap dealer or major
15 A list of Commission staff consultations in section 1a(39) of the [CEA]), as appropriate, shall swap participant is required to be a member of a
connection with this proposed rulemaking is posted consult and coordinate with foreign regulatory registered futures association it would be required
on the Commission’s Web site, available at http:// authorities on the establishment of consistent to comply as well with the business conduct and
www.cftc.gov/LawRegulation/DoddFrankAct/ international standards with respect to the other requirements of NFA and any other applicable
ExternalMeetings/index.htm. regulation (including fees) of swaps * * *.’’ SROs.
Commission Regulations, as and, in particular, to prevent a swap enter into a swap knowing, or acting in
appropriate.21 The scope section also dealer or major swap participant from reckless disregard of the fact, that its
provides that, where appropriate, the evading any provision of the CEA or counterparty will use the swap as part
rules also apply to swaps offered but not Commission Regulations. For example, of a device, scheme, or artifice to
entered into. For example, the fair and for a swap that is subject to mandatory defraud any third party.’’
balanced communications and fair clearing, a swap dealer or major swap Proposed § 23.402(d) would require
dealing requirements in proposed participant should only be offering to swap dealers and major swap
§ 23.433 apply to swap dealers and enter into such a swap on an uncleared participants to keep a record showing
major swap participants with respect to basis with a counterparty who has the true name and address of each
both counterparties and prospective qualified for a valid end-user exception counterparty, as well as a counterparty’s
counterparties. to the mandatory clearing of swaps.22 address and the same information for
The proposed rules under subpart H The Commission expects that these any other person guaranteeing the
will have most applicability when swap policies and procedures would be part counterparty’s performance or
dealers and major swap participants of a swap dealer’s or major swap controlling the counterparty’s positions.
have a pre-trade relationship with their participant’s overall system of This proposed rule is based on existing
counterparty, where that relationship supervision, compliance and risk § 1.37(a)(1) 26 of the Commission’s
includes discussions and negotiations management.23 Regulations which applies to futures
that would allow a swap dealer or major Section 4s(h)(1)(B) gives the commission merchants, introducing
swap participant to make appropriate Commission the authority to prescribe brokers and members of a designated
disclosures and conduct due diligence. rules relating to diligent supervision by contract market.
Indeed, when a swap is initiated on a swap dealers and major swap
DCM or SEF and the swap dealer or Another general provision, under
participants. In a separate release proposed § 23.402(e), states that swap
major swap participant does not know containing internal business conduct
the counterparty’s identity prior to dealers and major swap participants that
rules, the Commission has proposed seek to rely on the representations of
execution, disclosure and due diligence comprehensive supervision and risk
obligations, such as the duties to verify their counterparties to satisfy any
management program duties on swap requirements in the proposed rules must
counterparty eligibility under proposed dealers and major swap participants
§ 23.430, to disclose material have a reasonable basis to believe that
contained in new subpart J of part 23 of the representations are reliable under
information under proposed § 23.431, the Commission’s Regulations.24
and the duty to verify that a Special the circumstances. In addition, the
Proposed § 23.402(b) would require representations must be sufficiently
Entity has a qualified representative swap dealers and major swap
under proposed § 23.450, would not detailed to enable the swap dealer or
participants to diligently supervise their major swap participant to reasonably
apply because there would be no basis dealings with counterparties as required
on which to make those disclosures or conclude that the particular requirement
under subpart H in accordance with the is satisfied. Proposed § 23.402(e) would
opportunity to engage in discussions. diligent supervision requirements of
However, when a swap dealer or major allow the parties to a swap to agree that
subpart J. such representations can be included in
swap participant does not know the Proposed § 23.402(c) would establish
counterparty’s identity pre-execution, a master agreement 27 or other written
a ‘‘know your counterparty’’ requirement agreement between the parties and that
but does become aware of the on swap dealers and major swap
counterparty’s identity post-execution the representations can be deemed
participants.25 The proposed applicable or renewed, as appropriate,
of a bilateral swap, the swap dealer or
requirement would include the use of to subsequent swaps between the
major swap participant would still have
reasonable due diligence to know and parties. For example, particular
certain specific duties such as the one
retain a record of the essential facts counterparty representations about its
to provide a daily mark in proposed
concerning the counterparty, including sophistication or financial wherewithal
§ 23.431(c)(2), (3).
The Commission also proposes to information necessary to comply with relevant to the institutional suitability
define several terms for purposes of the law, to service the counterparty, to obligation imposed on swap dealers and
subpart H in proposed § 23.401. The implement a counterparty’s special major swap participants in proposed
term ‘‘counterparty’’ would include instructions, and to evaluate the § 23.434 may be contained in a master
‘‘prospective counterparty’’ as counterparty’s swaps experience and agreement, if agreed by the parties, and
appropriate in the rules. The terms swap objectives. The proposed rule also may be applied to subsequent swaps
dealer and major swap participant would assist swap dealers and major between the parties if the
would include anyone acting for or on swap participants in avoiding violations representations continue to be accurate
behalf of such persons, including of Section 4c(a)(7) of the CEA which
associated persons as defined in Section makes it ‘‘unlawful for any person to 26 17 CFR 1.37(a)(1).
1a(4) of the CEA. Proposed § 23.401 22 Separately,
27 The Commission understands that swaps are
the Commission is proposing rules
adopts the definition of Special Entity detailing when a counterparty may elect to use the
generally governed by a master agreement and
in Section 4s(h)(2). Additional terms are confirmation setting forth the relationship of the
exception to mandatory clearing under section counterparties and the particulars of the
defined in the proposed rules relating to 2(h)(7)(A)(iii) of the CEA. transaction. Master agreements, which have
Special Entities. 23 Separately, the Commission is proposing rules
typically been standard form agreements prepared
The ‘‘general provisions’’ for subpart H detailing the supervision, compliance and risk by industry associations like the International
management obligations for swap dealers and major Swaps and Derivatives Association (‘‘ISDA’’),
that are specified in proposed § 23.402 swap participants. See 75 FR 71397, Nov. 23, 2010. include basic representations and covenants that
include a requirement that swap dealers 24 See proposed §§ 23.600 and 23.602, 75 FR
are subject to negotiation by the parties and are
and major swap participants have 71397, Nov. 23, 2010. supplemented with modifications to account for
policies and procedures reasonably 25 This rule is based in part on NFA Compliance their specific interests. Master agreements contain
designed to ensure compliance with the Rule 2–30, Customer Information and Risk terms that govern all succeeding swaps between the
Disclosure, which NFA has interpreted to impose counterparties, and generally include provisions
business conduct rules in subpart H ‘‘know your customer’’ duties, and has been a key applicable to all swaps including: Payment netting,
component of NFA’s customer protection regime. events of default, cross-default provisions, early
21 See, e.g., Section 4b of the CEA. See NFA Interpretive Notice 9013. termination events and closeout netting.
and relevant with respect to the • Should the Commission specify any The Commission also proposes
subsequent swaps. particular restrictions or prohibitions to §§ 23.410(b) and 23.410(c), which
Proposed § 23.402(f) would provide further protect against evasion? would prohibit swap dealers and major
flexibility to swap dealers, major swap swap participants from disclosing
B. Proposed § 23.410—Prohibition on
participants and their counterparties to confidential counterparty information
Fraud, Manipulation and Other Abusive
agree to a reliable means for making and front running or trading ahead of
Practices
disclosures of material information. counterparty swap transactions.32 These
Furthermore, proposed § 23.402(g) Section 4s(h)(1) grants the rules are based on trading standards
would also allow swap dealers and Commission discretionary authority to applicable to futures commission
major swap participants to use, where promulgate rules applicable to swap merchants and introducing brokers that
appropriate, standardized formats to dealers and major swap participants prohibit trading ahead of a customer
make certain required disclosures of related to, among other things: Fraud, and protect the confidentiality of
material information to their manipulation and abusive practices.29 customer orders.33 Such abuses are
counterparties, and to include such To implement this provision the considered fraudulent practices.34
standardized disclosures in a master or Commission proposes to adopt the anti- Viewed together, proposed §§ 23. 410(b)
other written agreement between the fraud provision in Section 4s(h)(4)(A) as and 23.410(c) build on the code of
parties, if agreed to by the parties. While § 23.410, which prohibits fraudulent, ethics requirements and informational
standardized disclosures may be deceptive and manipulative practices by barriers in proposed subpart J which
appropriate to meet certain disclosure swap dealers and major swap add substantial protections for
obligations relating to the risks, participants.30 While the heading of counterparties from abuse of their
characteristics, incentives and conflicts Section 4s(h)(4) states ‘‘Special confidential information and business
of interest related to a particular swap, Requirements for Swap Dealers Acting opportunities.
it is unlikely that they would be as Advisors,’’ the anti-fraud provision Request for Comment: The
adequate to meet all such disclosure that follows in Section 4s(h)(4)(A) is not Commission requests comment
duties. Swap dealers and major swap so limited. The proposed rule follows generally on all of the proposed rules
participants are cautioned to consider the statutory text and applies to swap regarding fraud, manipulation, and
their disclosure obligations under the dealers and major swap participants abusive practices, and on the following
acting in any capacity, e.g., as an specific issues:
CEA and proposed rules with respect to
each swap that they offer or enter into
advisor, counterparty or other market • Should a swap dealer or major swap
participant in relation to counterparties participant be required to disclose to a
with a counterparty.
generally. The first two paragraphs of counterparty its pre-existing positions
Finally, proposed § 23.402(h) would
the rule focus on Special Entities and in a type of swap prior to entering into
require swap dealers and major swap
prohibit swap dealers and major swap the same type of swap with the
participants to create and retain a
participants from (1) employing any counterparty?
written record of their compliance with • Should the prohibitions on trading
device, scheme or artifice to defraud any
the requirements in subpart H. Such ahead of a counterparty transaction and
Special Entity; and (2) engaging in any
requirements would be part of the disclosure of confidential counterparty
transaction, practice, or course of
overall recordkeeping obligations information be limited in any way not
business that operates as a fraud or
imposed on swap dealers and major already provided in the proposed rule?
deceit on any Special Entity. The third
swap participants in the CEA and part For example, if a counterparty discusses
paragraph is not limited to Special
23 supbart F of the Commission’s a potential swap but does not
Entities and prohibits swap dealers and
Regulations, would be maintained in immediately enter into it with the swap
major swap participants from engaging
accordance with § 1.31 28 of the
in any act, practice, or course of
Commission’s Regulations, and would than upon the culpability of the person
business that is fraudulent, deceptive or
be accessible to applicable prudential responsible.’ Accordingly, scienter is not required
manipulative.31
regulators. under section 206(4), and the SEC did not have to
prove it in order to establish the appellants’ liability
Request for Comment: The 29 On October 26, 2010, the Commission
* * *.’’) (citations omitted).
Commission requests comment proposed rules to implement new anti- 32 Senator Lincoln noted in a colloquy that the
generally on all of the proposed rules manipulation authority in Section 753 of the Dodd- Commission should adopt rules to ensure that swap
regarding scope, general provisions and Frank Act. The proposed rules expand and codify dealers maintain the confidentiality of hedging and
the Commission’s authority to prohibit portfolio information provided by Special Entities,
definitions, and specifically on the manipulation. 75 FR 67657, Nov. 3, 2010. The same and prohibit swap dealers from using information
following specific issues: day, the Commission issued an advance notice of received from a Special Entity to engage in trades
• Should the Commission adopt any proposed rulemaking seeking comment on Section that would take advantage of the Special Entity’s
of the guidance from SRO rules relating 747 of the Dodd-Frank Act, which amends Section positions or strategies. 156 Cong. Rec. S5923 (daily
4c(a) of the CEA to expressly prohibit certain ed. Jul. 15, 2010) (statement of Sen. Lincoln). In
to know your customer requirements? Is trading practices deemed disruptive of fair and consultations with stakeholders, Commission staff
other guidance necessary in this area? equitable trading. 75 FR 67301, Nov. 2, 2010. has learned that these concerns apply more
• Are there additional terms that 30 In addition to the proposed anti-fraud rule, generally to all counterparties, rather than
should be defined by the Commission? swap dealers and major swap participants will be exclusively to Special Entities. Thus, the
subject to all other applicable provisions of the CEA Commission proposes that the business conduct
If so, how should such terms be defined and Commission Regulations, including those rules include prohibitions on these types of
and why? dealing with fraud and manipulation (e.g., Sections activities in all transactions between swap dealers
• Do any proposed requirements
4b, 6(c)(1), (3) and 9(a)(2) of the CEA). or major swap participants and their counterparties.
33 See, e.g., 17 CFR 155.3–4; cf. Market Abuse
conflict with any requirement imposed 31 This language mirrors the language in Section
206(4) of the Investment Advisers Act of 1940 Directive, at Para. 19, Art. 1(1) (prohibiting the
by an SRO such that it would be misuse of confidential customer information and
(‘‘Advisers Act’’) (15 U.S.C. 80b–1 et seq.), which
impracticable or impossible for a swap does not require scienter to prove liability. See SEC front running). The proposed rule would make clear
dealer or major swap participant that is v. Steadman, 967 F.2d 636, 647 (D.C. Cir. 1992) that the confidentiality requirements do not apply
a member of an SRO to meet both (‘‘[S]ection 206(4) uses the more neutral ‘act, when disclosure is made upon request of the
practice, or course or business’ language. This is Commission, Department of Justice or an applicable
obligations? If so, which ones and why? prudential regulator.
similar to section 17(a)(3)’s ‘transaction, practice, or
course of business,’ which ‘quite plainly focuses 34 See, e.g., United States v. Dial, 757 F.2d 163,
28 17 CFR 1.31. upon the effect of particular conduct * * * rather 168 (7th Cir. 1985).
dealer or major swap participant, should participant would not be required to the counterparty to assess the
there be a limit on the time during verify the ECP or Special Entity status disclosures. To satisfy its obligation, the
which the swap dealer or major swap of the counterparty for any swap swap dealer or major swap participant
participant must refrain from trading on initiated on a SEF where the swap would also be required to make such
or otherwise disclosing the dealer or major swap participant does disclosures at a time prior to entering
counterparty’s information? not know the identity of the into the swap that was reasonably
• Are there other specific fraudulent, counterparty.39 sufficient to allow the counterparty to
manipulative or abusive practices by Request for Comment: The assess the disclosures. Swap dealers and
swap dealers and major swap Commission requests comment major swap participants would have
participants that should be prohibited in generally on all of the proposed rules flexibility to make these disclosures
these proposed rules? If so, how would regarding verification of counterparties using reliable means agreed to by the
they assist in protecting swap markets as ECPs and Special Entities, and on the parties, as provided in proposed
and counterparties? Are there gaps in following specific issues: § 23.402(f).41
the existing requirements that should be • Should there be an ongoing, Standardized disclosure of some
filled here? affirmative duty to verify eligibility? If required information may be
so, how would it be met? Would the appropriate if the information is
C. Proposed § 23.430—Verification of
swap dealer or major swap participant’s applicable to multiple swaps of a
Counterparty Eligibility
duty change in any way if the ECP particular type and class.42 As discussed
The Dodd-Frank Act makes it status of the counterparty changes after below, the Commission believes that
unlawful for any person, other than an the swap has been entered into? most bespoke transactions, however,
eligible contract participant (‘‘ECP’’),35 to • Are there particular ‘‘red flags’’ that will require some combination of
enter into a swap unless it is executed should indicate a need for a swap dealer standardized and particularized
on or subject to the rules of a designated disclosures.
or major swap participant to obtain
contract market.36 Section 4s(h)(3)(A)
additional information about the status 2. Disclosure of Material Risks
also requires the Commission to
of the counterparty as an ECP or Special
establish a duty for a swap dealer or The proposed rule tracks the statutory
Entity?
major swap participant to verify that obligations under Section 4s(h)(3)(B)(i)
any counterparty meets the eligibility D. Proposed § 23.431—Disclosure of and would require the swap dealer or
standards for an ECP. Proposed § 23.430 Material Risks, Characteristics, Material major swap participant to disclose
would require swap dealers and major Incentives and Conflicts of Interest information to enable a counterparty to
swap participants to verify that a Regarding a Swap assess the material risks of a particular
counterparty meets the definition of an Section 4(s)(h)(3)(B) requires swap swap. The Commission anticipates that
ECP prior to offering or entering into a dealers and major swap participants to swap dealers and major swap
swap. The proposed rule also would disclose to their counterparties material participants typically will rely on a
require a swap dealer or major swap information about the risks, combination of general and more
participant to determine whether the characteristics, incentives and conflicts particularized disclosures to satisfy this
counterparty is a Special Entity as of interest regarding a swap. The requirement. The Commission
defined in Section 4s(h)(2) and requirements do not apply if both understands that there are certain types
proposed § 23.401. counterparties are any of the following: of risks that are associated with swaps
The Commission contemplates that, generally, including market,43 credit,44
Swap dealer, major swap participant,
in the absence of ‘‘red flags,’’ and as operational,45 and liquidity risks.46
security-based swap dealer or major
provided in proposed § 23.402(e), a Required risk disclosure would include
security-based swap participant.
swap dealer or major swap participant sufficient information to enable a
Proposed § 23.431 would implement the
would be permitted to rely on
statutory disclosure requirements and
reasonable written representations of a 41 Additionally, under proposed § 23.402(h),
provide specificity with respect to
potential counterparty to establish its swap dealers and major swap participants would be
certain material information that must required to maintain a record of their compliance
eligibility as an ECP.37 In addition,
be disclosed under the rule. Information with the proposed rules.
under proposed § 23.402(g), such
is material if there is a substantial 42 Cf. SIFMA/ISDA Letter, at 12 (recommending
written representations could be the use of standard disclosure templates that could
likelihood that a reasonable
expressed in a master agreement or be adopted on an industry-wide basis, with
counterparty would consider it disclosure requirements satisfied by a registrant on
other written agreement and, if agreed
important in making a swap related a relationship (rather than a transaction-by-
by the parties, could be deemed to be
decision.40 transaction) basis in cases where prior disclosures
renewed with each subsequent swap apply to and adequately address the relevant
transaction, absent any facts or 1. Timing and Manner of Disclosures transaction).
circumstances to the contrary.38 The Dodd-Frank Act does not address
43 Market risk refers to the risk to a counterparty’s
Finally, as set forth in proposed financial condition resulting from adverse

the timing and form of the required movements in the level or volatility of market
§ 23.430(c), a swap dealer or major swap
disclosures. Proposed § 23.431(a) would prices.
44 Credit risk refers to the risk that a party to a
35 ‘‘Eligible contract participant’’ is a defined term
require that the disclosures be made
swap will fail to perform on an obligation under the
in Section 1a(18) of the CEA. before entering into a swap and in a swap.
manner reasonably designed to allow
36 See Section 2(e) of the CEA. 45 Operational risk refers to the risk that
37 This position is consistent with industry deficiencies in information systems or internal
comment. See, e.g., NFA Letter, at 2 (recommending 39 This rule tracks the statutory language in controls, including human error, will result in
the Commission adopt a rule modeled after NFA Section 4s(h)(7). unexpected loss.
Compliance Rule 2–23, which permits NFA 40 Cf. CFTC v. R.J. Fitzgerald & Co., 310 F.3d 46 Liquidity risk is the risk that a counterparty
members to rely on information provided by the 1321, 1328–29 (11th Cir. 2002) (‘‘A representation may not be able to, or cannot easily, unwind or
customer to satisfy the member’s know-your- or omission is ‘‘material’’ if a reasonable investor offset a particular position at or near the previous
customer obligations). would consider it important in deciding whether to market price because of inadequate market depth,
38 Certain industry comments support this make an investment.’’) (citing Affiliated Ute Citizens unique trade terms or remaining party
approach. See, e.g., NFA Letter, at 2; SIFMA/ISDA of Utah v. United States, 406 U.S. 128, 153–54 characteristics or because of disruptions in the
Letter, at 12. (1972)). marketplace.
counterparty to assess its potential for SEF or DCM traded swaps versus would require swap dealers and major
exposure during the term of the swap bilateral swaps? swap participants to establish
and at expiration or upon early reasonable policies and procedures to
3. Scenario Analysis for High-Risk
termination. Consistent with industry identify high-risk complex bilateral
Complex Bilateral Swaps and
‘‘best practices,’’ information regarding swaps, and in connection with such
Counterparty ‘‘Opt-In’’ for Bilateral
specific material risks must identify the swaps, provide the additional risk
material factors that influence the day- Swaps Not Available for Trading on a disclosure specified in proposed
to-day changes in valuation, as well as Designated Contract Market or Swap § 23.431(a)(1).
the factors or events that might lead to Execution Facility
b. Market Risk Disclosures: Scenario
significant losses.47 Appropriate The Commission is proposing that
Analysis
disclosures should consider the effect of swap dealers and major swap
future economic factors and other participants be required to provide Scenario analysis, as required by the
material events that could cause the scenario analyses when they offer to proposed rule, would be an expression
swap to experience such losses. enter into high-risk complex bilateral of potential losses to the fair value of the
Disclosures should also identify, to the swaps to allow the counterparty to swap in market conditions ranging from
extent possible, the sensitivities of the assess its potential exposure in normal to severe in terms of stress.53
swap to those factors and conditions, as connection with the swap.49 In addition, Such analyses would be designed to
well as the approximate magnitude of the rule would allow counterparties to illustrate certain potential economic
the gains or losses the swap will likely elect to receive scenario analysis when outcomes that might occur and the
experience. offered bilateral swaps that are not effect of these outcomes on the value of
Swap dealers and major swap available for trading on a DCM or SEF. the swap. The proposed rule would
participants also should consider the The elective aspect of the rule reflects require that these outcomes or scenarios
unique risks associated with particular the expectation that there may be be developed by the swap dealer or
types of swaps, asset classes and trading circumstances where scenario analysis major swap participant in consultation
venues, and tailor their disclosures may be helpful for certain with the counterparty. In addition, the
accordingly. counterparties, even for swaps that are proposed rule would require that all
Request for Comment: The not high-risk complex. Proposed material assumptions underlying a
Commission requests comment § 23.431(a)(1) is modeled on the CRMPG given scenario and its impact on swap
generally on all of the proposed rules III industry best practices valuation be disclosed.54 In requiring
regarding material risk disclosures for recommendation for high-risk complex such disclosures, however, the
swaps and on the following specific financial instruments.50 Commission does not propose to require
issues: swap dealers or major swap participants
• Are there specific material risks that a. High-Risk Complex Bilateral Swap: to disclose proprietary information
the Commission should require a swap Characteristics about any pricing models.
dealer or major swap participant to The Commission does not propose to
The rule’s mandatory scenario
disclose to a counterparty? Are there define the parameters of the scenario
analysis delivery requirement would
specific risks that should be disclosed analysis in order to provide flexibility to
apply only when ‘‘high-risk complex
with respect to particular types of the parties to design the analyses in
bilateral swaps’’ are offered or
swaps, asset classes and trading venues? accordance with the characteristics of
recommended. Like the industry ‘‘best
• NFA and SIFMA/ISDA submitted practice’’ recommendation, the term
the bespoke swap at issue, as well as
letters that have suggested that the any criteria developed in consultations
‘‘high-risk complex bilateral swap’’ is
Commission develop a standard form with the counterparty. Further, the
not defined in the proposed rule; rather, proposed rule would require swap
risk disclosure statement for certain certain flexible characteristics are
generic-type disclosures, similar to dealers and major swap participants to
identified to avoid over inclusive and consider relevant internal risk analyses
those used today for futures, options under inclusive concerns. The
and retail foreign currency including any new product reviews
characteristics are: The degree and when designing the analyses.55 As for
transactions.48 Should the Commission nature of leverage,51 the potential for
undertake such an effort? Should the the format, the proposed rule would
periods of significantly reduced require both narrative and tabular
Commission encourage the industry or liquidity, and the lack of price
SROs to develop such disclosures, in expressions of the analyses.
transparency.52 The proposed rule To ensure fair and balanced
addition, or instead? If it would be
beneficial to have such forms, why has 49 Scenario analysis is in addition to required
communications and to avoid
the industry not developed such a disclosures for swaps which do not qualify as high-
misleading counterparties, swap dealers
standard form to date? Would standard risk complex. Such required disclosures include a and major swap participants also would
form disclosure be inconsistent with the clear explanation of the economics of the
instrument. complex and thus require the special treatment
requirement that disclosures be based 50 CRMPG III Report, at 60–61. outlined in this section. CRMPG III Report, at 56.
on the facts and circumstances 51 The leverage characteristic is particularly 53 These value changes originate from changes or
presented by each swap and relevant when the swap includes an embedded shocks to the underlying risk factors affecting the
counterparty? option, including one in which the counterparty is given swap, such as interest rates, foreign currency
• Are there other ways for the ‘‘short’’ or selling volatility. Such features can exchange rates, commodity prices and asset
significantly increase counterparty risk exposure in volatilities.

Commission to describe the risk ways that are not transparent. 54 Material assumptions include: (1) The
disclosure duty required by the CEA 52 CRMPG III Report states that: assumptions of the valuation model and any
that would provide additional guidance The aforementioned characteristics are neither an parameters applied and (2) a general discussion of
or clarify the obligation? exhaustive list nor should they be assumed to the economic state that the scenario is intended to
• Should the rule distinguish provide a strict definition of high-risk complex illustrate.
instruments, which the Policy Group believes 55 The Commission has proposed that swap
explicitly risk disclosure requirements should be avoided. Instead, market participants dealers and major swap participants adopt policies
should establish procedures for determining, based and procedures regarding a new product policy as
47 See CRMPG III Report, at 60. on the key characteristics discussed above, whether part of the risk management system. See proposed
48 See NFA Letter, at 2; SIFMA/ISDA Letter, at 12. an instrument is to be considered high-risk and § 23.600(c)(3), 75 FR 71397, Nov. 23, 2010.
be required to state the limitations of the 99 percent? Should there be any counterparty in more than one capacity
scenario analysis, including cautions minimum standards regarding the type should consider whether acting in
about the predictive value of the of VaR model chosen? Should there be multiple capacities creates material
scenario analysis, and any limitations a required time horizon such as the time incentives or conflict of interests that
on the analysis based on the between payments, the expected time to require disclosure.57
assumptions used to prepare it. The liquidate the position, or something Request for Comment: The
Commission’s proposed rule is aligned else? Commission requests comment
with longstanding industry best practice 4. Material Characteristics generally on all of the proposed rules
recommendations,56 and indeed, several regarding material incentives and
large swap dealers told Commission The proposed rule would require conflicts of interest and on the following
staff that they provide scenario analysis swap dealers and major swap specific issues:
upon request and without separate participants to include in their • Should the Commission impose
charge to counterparties today. disclosures of material characteristics, more specific requirements concerning
Request for Comment: The the material economic terms of the the content of the required disclosures
Commission requests comment swap, the material terms relating to the generally?
generally on all of the proposed rules operation of the swap and the material • Should the Commission require
regarding required scenario analysis for rights and obligations of the parties swap dealers and major swap
high-risk complex bilateral swaps and during the term of the swap. Under the participants to disclose their profit? If
opt-in scenario analysis for swaps not proposed rule, the Commission intends so, how should a swap dealer or major
available for trading on a DCM or SEF that the material characteristics would swap participant be required to compute
and on the following specific issues: include the material terms of the swap profitability for purposes of the rule?
• Regarding high-risk complex that would be included in any
bilateral swaps, should other ‘‘confirmation’’ of any swap sent by the 6. Daily Mark
characteristics be added to the rule? swap dealer or major swap participant Section 4s(h)(3)(B) directs the
Should any of the proposed high-risk to the counterparty upon execution. Commission to adopt rules that require:
complex bilateral swap characteristics 5. Material Incentives and Conflicts of (1) For cleared swaps, upon request of
be deleted or modified? Interest the counterparty, receipt of the daily
• Instead of high-risk complex mark from the appropriate DCO; and (2)
bilateral swaps, should the Commission The proposed rule tracks the statutory for uncleared swaps, receipt of the daily
require scenario analysis for all swaps language under Section 4s(h)(3)(B)(ii)
mark of the swap from the swap dealer
that are: (1) Not accepted or listed for and would require a swap dealer or
or major swap participant. The term
clearing on a derivatives clearing major swap participant to disclose to
‘‘daily mark’’ is not defined in the
any counterparty the material incentives
organization (‘‘DCO’’), or alternatively, statute, and the Commission
and conflicts of interest that the swap
(2) uncleared? What are the costs/ understands that the term ‘‘mark’’ is
dealer or major swap participant may
benefits of changing the requirement to used colloquially to refer to various
have in connection with the particular
option one or option two? types of valuation information.
• Regarding scenario analysis, should swap. Several stakeholders
a swap dealer/major swap participant be recommended that the Commission a. Cleared Swaps
required to provide such analysis for require added transparency concerning For a cleared swap, proposed
the components that make up the price § 23.431(c)(1) would require the swap
any swap upon reasonable request by
of a transaction. In response, the
any counterparty? Would there be a dealer or major swap participant to
Commission proposes that swap dealers
charge to counterparties that elect to notify a counterparty of their right to
and major swap participants be required
‘‘opt-in’’? How much on average would receive, upon request, the daily mark
to include with the price of a swap the
it cost? If the cost varies by swap type from the appropriate DCO.
mid-market value of the swap as defined
or asset class, provide an average cost by
in proposed § 23.431(c)(2). In addition, b. Uncleared Swaps
category. What are the costs and benefits
swap dealers and major swap For uncleared swaps, proposed
to swap dealers and major swap
participants would be required to § 23.431(c)(2) and (3) would require a
participants and counterparties
disclose any compensation or benefit swap dealer or major swap participant
associated with scenario analysis?
that they receive from any third party in
• Are there certain types of to provide a daily mark to its
connection with the swap. In counterparty on each business day
counterparties for which a scenario
connection with any recommended during the term of the swap as of the
analysis should always be provided? If
swap, swap dealers and major swap close of business, or such other time as
so, which ones and why?
• Should swap dealers and major participants would be expected to the parties agree in writing. The
swap participants be able to avoid their disclose whether their compensation Commission is proposing to define daily
duty to provide scenario analysis if a related to the recommended swap mark for uncleared swaps as the mid-
counterparty opts out of receiving it? would be greater than for another market value of the swap,58 which shall
• Should a Value at Risk (‘‘VaR’’) type instrument with similar economic terms
analysis be part of the mandatory offered by the swap dealer or major 57 This may exist, for example, when the swap
scenario analysis? swap participant. With respect to dealer or major swap participant acts both as an
• In the event that a swap dealer or conflicts of interest, the Commission underwriter in a bond offering and as a
expects such disclosure to include the counterparty to the swaps used to hedge such
major swap participant elects to disclose financing. In these circumstances, the swap dealer’s
a VaR type analysis, should any inherent conflicts in a counterparty or major swap participant’s duties to the
minimum parameters apply? For relationship, particularly when the counterparty would vary depending on the
instance, should there be any required swap dealer or major swap participant capacities in which it is operating and should be
recommends the transaction. The disclosed.
confidence levels such as 95 percent or 58 Cf. SIFMA and ISDA assert that ‘‘[b]y market
Commission also expects that a swap convention and often by contract, parties generally
56 See DPG Framework, at Part V(II)(G); but see dealer or major swap participant that agree to utilize a mid-market level for margin
SIFMA/ISDA Letter, at 13–14. engages in business with the Continued
not include amounts for profit, credit webpage containing the relevant manner based on principles of fair
reserve, hedging, funding, liquidity or information.62 Proposed § 23.402(f) dealing and good faith. Proposed
any other costs or adjustments.59 Based would permit swap dealers and major § 23.433 would establish such a duty
on staff consultations, the consensus swap participants to provide daily and, consistent with statutory language,
was that mid-market value is a marks by any reliable means agreed to would apply broadly to all swap dealer
transparent measure that would assist in writing by the counterparty. and major swap participant
counterparties in calculating valuations Request for Comment: The communications with counterparties.
for their own internal risk management Commission requests comments These principles are well established in
purposes. Further, the Commission is generally on the daily mark and on the the futures and securities markets,
proposing that swap dealers and major following specific issues: particularly through SRO rules.65 For
swap participants disclose both the • Should the Commission define the example, the duty to communicate in a
methodology and assumptions used to daily mark for uncleared swaps as fair and balanced manner is one of the
prepare the daily mark, and any proposed, on a different basis, or should primary requirements of the NFA
material changes to the methodology or it be subject to negotiation by the customer communication rule 66 and is
assumptions during the term of the parties? If so, why? designed to ensure a balanced treatment
swap. The Commission understands • In addition to the daily mark as of potential benefits and risks. In
that the daily mark for certain bespoke defined in the proposed rule, should the determining whether a communication
swaps may be generated using Commission require that swap dealers with a counterparty is fair and balanced,
proprietary models. The proposed rule or major swap participants provide the Commission expects that a swap
does not require the swap dealer or executable quotes to counterparties dealer or major swap participant would
major swap participant to disclose upon request? Should this be left to consider factors such as whether the
proprietary information relating to its negotiations between the parties? communication: (1) Provides a sound
model. E. Proposed § 23.432—Clearing basis for evaluating the facts with
Lastly, the Commission proposes that respect to any swap; 67 (2) avoids
swap dealers and major swap For swaps where clearing is
mandatory,63 proposed § 23.432(a) making exaggerated or unwarranted
participants provide appropriate claims, opinions or forecasts; 68 and (3)
clarifying statements relating to the would require that a swap dealer or
major swap participant notify the balances any statement that refers to the
daily mark. Such disclosures may potential opportunities or advantages
include, as appropriate, that the daily counterparty that the counterparty has
the sole right to select the DCO that will presented by a swap with statements of
mark may not necessarily be: (1) A price corresponding risks. The Commission
at which the swap dealer or major swap clear the swap. For swaps that are not
required to be cleared, under proposed also would expect that to deal fairly
participant would agree to replace or would require the swap dealer or major
terminate the swap; (2) the basis for a § 23.432(b), a swap dealer or major swap
participant must notify a counterparty swap participant to treat counterparties
variation margin call; 60 nor (3) the value in such a way so as not to advantage one
of the swap that is marked on the books that the counterparty may elect to
require the swap to be cleared and that counterparty or group of counterparties
of the swap dealer or major swap over another. Additionally,
participant.61 it has the sole right to select the DCO
for clearing the swap.64 Neither of these communications would be subject to the
Industry representatives have asked specific anti-fraud provisions of the
whether swap dealers and major swap notification provisions would apply
where the counterparty is a registered CEA and Commission Regulations, as
participants may satisfy their well as applicable SRO rules, if swap
obligations to provide daily marks for swap dealer, major swap participant,
security-based swap dealer, or major dealers and major swap participants are
uncleared swaps by making the relevant required to be SRO members.
information available to counterparties security-based swap participant.
Request for Comment: The Request for Comment: The
through password protected access to a Commission requests comment
Commission requests comment
generally on all of the proposed rules generally on all of the proposed rules
purposes. Counterparties understand that this level
does not represent a valuation at which a regarding clearing, and on the following regarding fair and balanced
transaction may be entered into or terminated and specific issues: communications, and on the following
accordingly may differ from actual market prices.
• Are there additional disclosures specific issues:
We recommend that the Commissions endorse this
that a swap dealer or major swap • Should the Commission specify in
use of mid-market levels for margin purposes as a
uniform market practice.’’ SIFMA/ISDA Letter, at participant should be required to make its final rule any additional
17. with respect to clearing of swaps?
59 For a discussion of mid-market value and costs, 65 See, e.g., 17 CFR 170.5 (‘‘A futures association
see ISDA Research Notes, The Value of a New F. Proposed § 23.433— must establish and maintain a program for * * *
Swap, Issue 3 (2010), available at http:// Communications—Fair Dealing the adoption of rules * * * to promote fair dealing
www.isda.org/researchnotes/pdf/NewSwapRN.pdf. with the public.’’); NFA Compliance Rule 2–29—
60 But see SIFMA/ISDA Letter at 17 (asserting that The Dodd-Frank Act requires that the Communications with the Public and Promotional
mid-market level is market convention for margin Commission establish a duty for swap Material; NFA Interpretative Notice 9041—
purposes and not a quote for entering into a Obligations to Customers and Other Market
dealers and major swap participants to Participants.
transaction or terminating the swap).
61 See also Trading & Capital-Markets Activities
communicate in a fair and balanced 66 See, e.g., NFA Compliance Rule 2–29(b)(2), (5);
Manual, section 2150.1 (Bd. of Gov. Fed. Reserve see also NFA Interpretive Notice 9043—NFA
62 SIFMA/ISDA Letter, at 17; NFA Letter, at 3. Compliance rule 2–29: Use of Past or Projected
Sys. Jan. 2009) (‘‘Trading & Capital-Markets
Activities Manual’’) (‘‘When providing a quote to a 63 See Section 2(h) of the CEA. Performance; Disclosing Conflicts of Interest for
counterparty, institutions should be careful that the 64 With respect to these proposed disclosure Security Futures Products (performance must be
counterparty does not confuse indicative quotes requirements, the Commission notes that, as presented in a balanced manner).
67 See, e.g., NFA Interpretive Notice 9041,
with firm prices. Firms receiving dealer quotes between the parties, the counterparty is entitled to
should be aware that these values may not be the choose whether and where to clear, but that no Obligations to Customers and Other Market
same as those used by the dealer for its internal DCM or SEF must make clearing available through Participants (‘‘Members * * * and their Associates
purposes and may not represent other ‘market’ or any DCO. In other words, it would be up to the should provide a sound basis for evaluating the
model-based valuations.’’), available at http:// parties to take the swap to a DCM or SEF that facts regarding any particular security futures
www.federalreserve.gov/boarddocs/supmanual/ provides for clearing through the counterparty’s product * * *’’).
trading/200901/0901trading.pdf. preferred DCO. 68 See, e.g., NFA Compliance Rule 2–29(b)(4)–(5).
requirements necessary to satisfy the related requirements, including NFA A swap dealer or major swap
duty? If so, what? ‘‘know your customer’’ duties,74 participant could rely on counterparty
• Should the Commission specify mandatory standard form risk representations to satisfy its suitability
additional considerations in the rule to disclosure,75 NFA’s fair and balanced obligations if: (1) It had a reasonable
guide compliance with the rule? Should communication rules and just and basis to believe that the counterparty
the Commission adopt interpretive equitable principles,76 and general anti- was capable of independently
guidance, instead or in addition? fraud provisions.77 These requirements evaluating relevant risks with regard to
developed to address the risks and the particular swap or trading strategy;
G. Proposed § 23.434— (2) the counterparty had affirmatively
Recommendations to Counterparties— characteristics of standardized
exchange-traded futures and options indicated that it was exercising
Institutional Suitability independent judgment in evaluating any
contracts. Because the definition of
To determine whether the swap includes a variety of different recommendations; 80 and (3) the swap
Commission should use its types of financial instruments and those dealer or major swap participant had a
discretionary authority under new instruments can be customized to have reasonable basis to believe that the
Section 4s(h), the Commission a wide range of risk/reward profiles, the counterparty had the capacity to absorb
considered requirements for Commission believes that standard risk potential losses related to the
professionals in other markets and in disclosure, alone, may not be sufficient recommended swap or swap trading
other jurisdictions. One common to ensure that counterparties understand strategy. To the extent that a swap
requirement is a suitability obligation their potential exposure. The dealer or major swap participant cannot
which is imposed when a market Commission also has considered that rely on a counterparty’s representations
professional recommends a product to a many swap dealers and major swap as contemplated by proposed § 23.434,
customer, including institutional or participants already are, or will be, it would need to undertake a suitability
sophisticated customers. For example, subject to institutional suitability analysis as set forth in the rule.
federally regulated banks acting as Whether a swap dealer or major swap
obligations by virtue of their status as
broker-dealers for government securities participant has made a recommendation
banks, broker-dealers or security-based and thus triggered its suitability
have an institutional suitability swap dealers. Thus, to promote
obligation when making obligation would depend on the facts
regulatory consistency 78 and to take and circumstances of the particular
recommendations to institutional account of the nature of swaps, the
customers.69 Securities broker-dealers case. A recommendation would include
Commission proposes to adopt an any communication by which a swap
are also subject to a suitability institutional suitability obligation for
obligation when recommending any dealer or major swap participant
swap dealers and major swap provides information to a counterparty
securities to an institutional customer.70 participants, modeled, in part, on
Municipal securities dealers have a about a particular swap or trading
existing obligations for banks and strategy that is tailored to the needs or
suitability obligation for any municipal broker-dealers dealing with institutional
security offered to a ‘‘sophisticated characteristics of the counterparty, but
clients. would not include information that is
municipal market professional.’’ 71 And,
in the European Union, investment Proposed § 23.434 would require a general transaction, financial, or market
services firms have a suitability swap dealer or major swap participant information, swap terms in response to
obligation with respect to financial to have reasonable grounds to believe a competitive bid request from the
instruments recommended to that any recommendation for a swap or counterparty.81 In implementing the
‘‘professional clients’’ under MiFID.72 trading strategy involving swaps is proposed institutional suitability rule,
In light of its broad application in suitable for its counterparty.79 A the Commission intends to consult
other markets and jurisdictions, the suitability determination would be relevant precedents and interpretive
Commission proposes an institutional based upon information the swap dealer guidance under Federal securities and
suitability obligation for any or major swap participant obtains banking requirements in the United
recommendation a swap dealer or major regarding the counterparty’s financial States.82
situation and needs, objectives, tax The Commission notes that swap
swap participant makes to a
status, ability to evaluate the dealers and major swap participants are
counterparty in connection with a swap
recommendation, liquidity needs, risk likely to be acting as CTAs 83 when they
or swap trading strategy. The
Commission recognizes that futures tolerance, ability to absorb potential
80 A counterparty may indicate that it is
market professionals have not been losses related to the recommended swap
exercising independent judgment on one or more
subject to an explicit ‘‘suitability’’ or trading strategy, and any other particular swaps or types of swaps, or in terms of
obligation.73 Instead, such professionals information known by the swap dealer all swaps.
have been required to meet a variety of or major swap participant. 81 NASD Notice to Members 01–23 (April 2001);
FINRA Proposed Suitability Rule, 75 FR 52562,

74 NFA Compliance Rule 2–30, Customer
52564–69, Aug. 26, 2010.
69 See, e.g., 12 CFR 13.4; Trading & Capital-
82 See, e.g., 12 CFR 13.4, 208.25(d), 368.4. In
Markets Activities Manual, Section 2150. Information and Risk Disclosure; NFA Interpretive
1997, the Federal banking agencies offered the
70 See NASD Rule 2310, Recommendations to Notice 901—NFA Compliance Rule 2–30: Customer
following guidance regarding recommendations in
Customers (Suitability); see also proposed FINRA Information and Risk Disclosure.
75 17 CFR 1.55.
the context of government securities sales practices:
Rule 2111 (Suitability), 75 FR 53562, Aug. 26, 2010. ‘‘While the agencies do not believe it is appropriate
71 See Municipal Securities Rulemaking Board 76 NFA Compliance Rules 2–29, 2–36,
to define the term ‘recommendation,’ they note that
Rule G–19, Suitability of Recommendations and Requirements for Forex Transactions. they would not view the provision of general
Transactions; Discretionary Accounts. 77 See, e.g., Section 4b of the CEA and §§ 32.9,
market information, including market observations,
72 MiFID Art. 19(3). ‘‘Professional clients’’ under 33.10 of the Commission’s Regulations (17 CFR forecasts about interest rates, and price quotations,
MiFID include certain financial institutions, 32.9, 33.10). as making a recommendation under the rule, absent
insurance companies, pension funds, and other 78 See, e.g., 12 CFR 13.4; Trading & Capital- other conduct.’’ 62 FR 13276, 13280, Mar. 19, 1997.
entities. See MiFID Art. 19(4), Annex II. Markets Activities Manual, section 2150. 83 Section 1a(12) of the CEA defines a commodity
73 The proposed institutional suitability 79 The rule would not apply to recommendations trading advisor, in relevant part, as any person who,
obligation would apply only to swap dealers and made to counterparties that are swap dealers, major for compensation or profit, trades, or advises (either
major swap participants, and only when they make swap participants, security-based swap dealers or directly or through publications, writings, or
swap recommendations, not futures. major security-based swap participants. Continued
make recommendations, particularly apply to swaps available for trading on principles of fair dealing,87 good faith,
recommendations tailored to the needs a DCM or SEF to ensure fair dealing and and, when acting as an agent for the
of their counterparty. As such, they protect against fraud and other abusive customer, the duty of loyalty.88 To have
would be subject to any additional practices. The proposed execution a reasonable relationship to the best
duties that might be applicable to CTAs standard rule would require terms available, the terms must be fair
under the CEA and Commission Commission registrants, with respect to and not excessive in light of all other
Regulations, including registration any swap that is available for trading on relevant circumstances. Additionally,
requirements and Section 4o of the CEA, a DCM or SEF, to execute the swap on whether the terms of any swap executed
the anti-fraud provision that applies to terms that have a ‘‘reasonable on behalf of a customer satisfy the
CTAs and commodity pool operators.84 relationship’’ to the best terms ‘‘reasonable relationship’’ duty would be
Request for Comment: The available.85 In addition, the registrant analyzed in connection with the specific
Commission requests comments anti-fraud provisions of the CEA and
would be required, prior to execution of
generally on the proposed rules Commission Regulations and would be
the order, to disclose the DCMs and
regarding recommendations and the considered in connection with the
SEFs on which the swap is available for
following specific issues: course of dealing between the registrant
• Should the Commission adopt a trading, and on which markets the
registrant has trading privileges. The and the customer.
suitability obligation for swaps in the To satisfy its reasonable relationship
absence of such an explicit requirement swap execution standards would apply
to all Commission registrants executing obligation, a Commission registrant
for exchange traded futures and would be expected to exercise
options? Have securities-style suitability customer orders for swaps made
available for trading on a DCM or SEF, reasonable diligence to ascertain which
obligations for institutional customers DCM or SEF offers the best terms
had demonstrable benefits for such whether execution occurs on or through
available for the transaction. To meet
customers? If so, provide examples. a DCM, SEF or bilaterally.86 The
their reasonable diligence duty,
• Are there additional factors that Commission notes that bilateral
Commission registrants would have to
swap dealers or major swap participants execution of swaps available for trading
survey a sufficient number of DCMs or
should consider in determining whether on a DCM or a SEF would only occur
SEFs to be able to make a reasonable
a particular swap is suitable for a pursuant to the ‘‘end user’’ exemption determination as to whether the terms
particular counterparty? provided under Section 2(h)(7)(A) of the
• Should the Commission specify they offer their clients bear a reasonable
CEA. relationship to the best terms available.
additional considerations in the rule to
In determining what constitutes a Such a survey would not necessarily be
guide compliance with the rule? Should
‘‘reasonable relationship,’’ the confined to markets on which the
the Commission adopt interpretive
guidance, similar to that provided by Commission registrant should consider registrant has trading privileges and
the prudential regulators in connection whether the terms offered to the would include reviewing available bids
with sales of government securities customer are fair and consistent with and offers, requests for quotes, and real
instead or in addition? time reporting of trades executed within
• Should swap dealers be subject to 85 The term ‘‘reasonable relationship’’ has been a reasonable period of time prior to
an explicit fiduciary duty when making used in evaluating execution standards over several execution of the order. In proposing this
decades in the securities industry. In an early execution standard, the Commission
a recommendation to a counterparty? securities law case, the Second Circuit stated that
‘‘[i]n its interpretation of Sec. 17(a) of the Securities notes that in separate rulemakings the
H. Proposed § 155.7—Execution Act, the Commission has consistently held that a Commission is proposing rules
Standards dealer cannot charge prices not reasonably related requiring DCMs and SEFs to provide
to the prevailing market price without disclosing market participants with open access to
The Commission is proposing a swap that fact.’’ Charles Hughes & Co. v. SEC, 139 F.2d
execution standard rule that would 434, 437 (2d Cir. 1943). The SEC issued a release their trading platforms and that current
in 1987, ‘‘Notice to broker-dealers concerning pre-trade price and quote information
electronic media) as to the value of, or the disclosure requirements for mark-ups on zero- will be available to all persons with
advisability of trading in, a commodity for future coupon securities,’’ which stated that the ‘‘duty of access to DCMs and SEFs. Post-trade
delivery, or swap. Section 1a(12)(B) of the CEA fair dealing includes the implied representation that
excludes from the definition of commodity trading the price a firm charges bears a reasonable data also will be available to registrants
advisor a variety of persons, but only if a person’s relationship to the prevailing market price.’’ 52 FR on a real-time reporting basis. The
commodity advice is solely incidental to the 15575, 15576, Apr. 21, 1987 (citing Charles Hughes, Commission’s proposed rule lists a
conduct of its principal business or profession. The 139 F.2d at 437). In IM–2440–1 the former NASD number of factors that the Commission
excluded persons include (i) banks and trust stated that ‘‘It shall be deemed a violation of Rule
companies and their employees, (ii) news reporters, 2110 [recommendations] and Rule 2440 [fair prices would consider in determining
news columnists, and news editors of print or and commissions] for a member to enter into any compliance with the rule which include
electronic media, (iii) lawyers, accountants, and transaction with a customer in any security at any an evaluation of the characteristics
teachers, (iv) floor brokers and futures commission price not reasonably related to the current market unique to the customer’s swap order as
merchants, (v) publishers and producers of any price of the security or to charge a commission
print or electronic data of general and regular which is not reasonable.’’ Although Rule 2440 and well as the prevailing market
dissemination, including their employees, (vi) IM–2440–1 related to OTC transactions, FINRA conditions.
fiduciaries of defined benefit plans subject to expanded the principle to include fees charged in As swaps trading transitions to and
ERISA, (vii) contract markets, and (viii) other exchange-traded transactions. See FINRA develops on DCMs and SEFs,
persons that the CFTC, by rule, regulation, or order, Regulatory Notice 08–36.
may exclude as ‘‘not within the intent of’’ the 86 The duty under the proposed rule would apply technology and other innovations are
definition. The revised definition does not exclude whether the Commission registrant was acting as
swap dealers whose advice is solely incidental to 87 Supra at footnote 85. The ‘‘duty of fair dealing
agent or principal in the transaction. This is
their swap dealer activities. Therefore, any consistent with existing duties for broker-dealers includes the implied representation that the price
‘‘advisory’’ activities by a swap dealer could bring under the Federal securities laws. See Newton v. a firm charges bears a reasonable relationship to the
it within the statutory definition of a commodity Merrill, Lynch, Pierce, Fenner & Smith, Inc., 135 prevailing market price.’’ 52 FR 15575, 15576, Apr.
trading advisor. F.3d 266, 270 n. 1 (3d Cir. 1988) (‘‘[T]he best 21, 1987.
84 Depending on the nature of the relationship, execution duty ‘does not dissolve when the broker/ 88 See Newton, 135 F.3d at 270 (‘‘The duty of best
swap dealers might also have common law dealer acts in its capacity as a principal.’’’) (citations execution * * * has its roots in the common law
fiduciary duties to their counterparties. Cf. omitted). Accord E.F. Hutton & Co., Release No. 34– agency obligations of undivided loyalty and
Commodity Trend Serv., Inc. v. CFTC, 233 F.3d 981, 25887, 49 S.E.C. 829, 832 (1988); NASD Rule reasonable care that an agent owes to his
990 (7th Cir. 2000). 2320(e). principal.’’)
likely to affect how Commission governmental plan, as defined in including an endowment that is an
registrants determine whether the terms Section 3 of ERISA; 90 or (v) any organization described in Section
they offer their customers are reasonably endowment, including an endowment 501(c)(3) of the Internal Revenue Code
related to the ‘‘best terms available’’ for that is an organization described in of 1986.96 Non-profit organizations that
purposes of satisfying the proposed Section 501(c)(3) of the Internal enter into swaps have asked whether
execution standards. For example, Revenue Code of 1986.91 they will be treated as Special Entities
registrants’ survey obligations may be The Commission has received a if their endowment is pledged as
satisfied by consulting, where available, number of letters from stakeholders collateral or is used to make payments
information aggregators that facilitate identifying a variety of ambiguities in on those swaps or whether the
the collection of information about the definition of Special Entity in definition of endowment is limited to
current trading activity across markets. Section 4s(h)(2)(C) and suggesting those endowments that are the named
The proposed rule is intended to be clarifications. For example, under counterparty to the swap.97 Others have
sufficiently flexible to take account of Section 4s(h)(2)(C)(iii), the term Special suggested that the phrase ‘‘any
such innovations and developments Entity includes employee benefit plans endowment’’ be limited to endowments
which should further the quality of as defined in Section 3 of ERISA.92 that are non-profit organizations
executions. Industry representatives have raised described in Section 501(c) of the
Request for Comment: The issues concerning whether the Internal Revenue Code or are
Commission requests comments definition requires ‘‘looking through’’ established for the benefit of such an
generally on the proposed rules investment vehicles to determine organization.
regarding the swap execution standard whether the vehicle is a Special Entity, Given the range of issues surrounding
and the following specific issues: including master trusts holding the the definition of Special Entity, the
• For the purpose of meeting the duty assets of one or more pension plans of Commission is not proposing to clarify
to use reasonable diligence to determine a single employer, and collective the definition at this time but, instead,
whether the terms it offers are investment vehicles in which Special is seeking comment on whether
reasonably related to the best terms Entities invest.93 clarification is necessary.
available for execution of a swap that is Stakeholders similarly have raised Request for Comment: The
available for trading on a DCM or SEF, issues with respect to whether plans Commission requests comments on the
should the Commission prescribe a defined in but not subject to ERISA definition of Special Entity in general
certain percentage of DCMs or SEFs that (unless they are covered by another and on the following specific issues:
must be reviewed/considered by the applicable prong of the Special Entity • Should the definition of State, State
Commission registrant? If so, what definition) are Special Entities,94 and agency, city, county, municipality, or
percentage is appropriate? whether only those plans subject to the other political subdivision of a State be
• Should the Commission define fiduciary responsibility provisions of clarified in any way?
ERISA should be included within the • Should the definition ‘‘employee
what it means for the terms of execution
Special Entity definition.95 benefit plans, as defined in Section 3 of
to have a ‘‘reasonable relationship to the
Under Section 4s(h)(2)(C)(v), the term ERISA’’ be clarified in any way?
best terms available’’? If so, how should • Should the definition ‘‘employee
the Commission define the phrase? Special Entity includes any endowment,
benefit plans, as defined in Section 3 of
• Should the Commission require any
3 of ERISA. This class of employee benefit plans is ERISA’’ be limited to plans subject to
additional disclosures to the customer, broader than the category of plans that are ‘‘subject regulation under ERISA?
including for example, the best terms to’’ ERISA for purposes of Section 4s(h)(5)(A)(i)(VII). • Should the Commission ‘‘look
available for execution of the swap Employee benefit plans not ‘‘subject to’’ regulation
through’’ an entity to determine whether
order and the difference between the under ERISA include: (1) Governmental plans; (2)
church plans; (3) plans maintained solely for the it is a Special Entity for the purposes of
best terms and the terms on which the purpose of complying with applicable workmen’s these rules? If so, why? If not, why not?
swap was executed? compensation laws or unemployment If so, should the Commission clarify that
compensation or disability insurance laws; (4) plans
III. Proposed Rules for Swap Dealers maintained outside the U.S. primarily for the master trusts, or similar entities, that
and Major Swap Participants Dealing benefit of persons substantially all of whom are hold assets of more than one pension
With Special Entities nonresident aliens; or (5) unfunded excess benefit plan from the same plan sponsor are
plans. See 29 U.S.C. 1003(b). within the definition of Special Entity?
In Section 4s(h), Congress created a 90 Section 3(32) of ERISA defines ‘‘governmental
• Should the Commission clarify in
separate category of swap counterparty plan’’ as a ‘‘plan established or maintained for its
any way the definition of governmental
called Special Entities, and imposed employees by the Government of the United States,
by the government of any State or political plan under Section 4s(h)(C)(iv)?
heightened duties and requirements for subdivision thereof, or by any agency or • Should the Commission clarify the
swap dealers that act as advisors to instrumentality of any of the foregoing.’’ 29 U.S.C. definition of endowment to include or
them, and for swap dealers and major 1002(32).
91 The term ‘‘endowment’’ is not defined in the
exclude charitable organizations that
swap participants that are their enter into swaps but whose
Dodd-Frank Act or in the CEA.
counterparties. 92 29 U.S.C. 1002. endowments have contractual
A. Definition of ‘‘Special Entity’’ Under 93 See, e.g., SIFMA/ISDA Letter, at 5 (investment obligations regarding that swap?
Section 4s(h)(2)(C) vehicle which 25 percent or more of its equity • Should the Commission clarify the
interest is owned by benefit plan investors and is definition of endowment to include or
Section 4s(h)(2)(C) defines a ‘‘Special subject to DOL plan assets rules (29 CFR 2510.3–
exclude foreign endowments? If so,
101) for purposes of ERISA).

Entity’’ as: (i) A Federal agency; (ii) a 94 See, e.g., SIFMA/ISDA Letter, at 2. why? If not, why not?
State, State agency, city, county, 95 SIFMA/ISDA Letter, at 5 (‘‘This would exclude
municipality, or other political such plans as (i) unfunded plans for highly 96 26 U.S.C. 501(c)(3). Section 501(c)(3) lists tax
subdivision of a State; (iii) any compensated employees; (ii) foreign pension plans exempt organizations including: ‘‘Corporations, and
employee benefit plan, as defined in (including foreign-based governmental plans); (iii) any community chest, fund, or foundation,
church plans that have elected not to subject organized and operated exclusively for religious,
Section 3 of ERISA; 89 (iv) any themselves to ERISA; (iv) Section 403(b) plans that charitable, scientific, testing for public safety,
accept only employee contributions; and (v) Section literary, or educational purposes * * *.’’
89 29 U.S.C. 1002. The term ‘‘Special Entities’’ 401(a), 403(b) and 457 plans sponsored by 97 SIFMA/ISDA Letter, at 6; SFG Presentation, at
includes employee benefit plans defined in section governmental entities.’’) (citations omitted). 8.
B. Proposed § 23.440—Requirements for swap dealers could act both as an Commission discretionary authority to
Swap Dealers Acting as Advisors to advisor to a Special Entity when prescribe additional types of
Special Entities recommending a swap and then as a information. The Commission proposes
Section 4s(h)(4) provides that a swap counterparty by entering into the same to add: (1) The authority of the Special
dealer that ‘‘acts as an advisor to a swap with the Special Entity, where the Entity to enter into a swap; (2) future
Special Entity’’ must act in the ‘‘best Special Entity has a representative funding needs of the Special Entity; (3)
interests’’ of the Special Entity and independent of the swap dealer on the experience of the Special Entity
undertake ‘‘reasonable efforts’’ to obtain which it can rely.99 The proposed rules with respect to entering into swaps,
information necessary to determine that are intended to allow existing business generally, and swaps of the type and
a recommended swap is in the best relationships to continue, albeit subject complexity being recommended; (4)
interests of the Special Entity. These to the new, higher statutory standards of whether the Special Entity has a
terms are not defined in the statute. The care.100 Thus, the proposed rule is not representative as provided in proposed
Commission’s proposed rules intended to preclude, per se, a swap § 23.450 and Section 4s(h)(5) that is
incorporate the statutory language and dealer from both recommending a swap capable of evaluating the recommended
clarify that ‘‘acts as an advisor to a to a Special Entity and entering into that swap in light of the needs and
Special Entity’’ includes to make a swap swap with the same Special Entity circumstances of the Special Entity; and
recommendation to a Special Entity. where the parties abide by the (5) whether the Special Entity has the
requirements of Sections 4s(h)(4) and (5) financial capability to withstand
1. Act as an Advisor to a Special Entity and the Commission’s proposed changes in market conditions during the
With respect to what it means to ‘‘act regulations.101 term of the swap. The Commission
as an advisor to a Special Entity,’’ the believes that this non-exclusive list
3. Reasonable Efforts
Commission proposes to clarify that a would assist a swap dealer in meeting
swap dealer that makes a Section 4s(h)(4)(C) requires swap its duty to act in the ‘‘best interests’’ of
recommendation to a Special Entity falls dealers to undertake ‘‘reasonable efforts’’ a Special Entity in recommending a
within the definition. The Commission to obtain information necessary to swap or swap trading strategy.
also proposes to clarify that a swap determine that a recommended swap is
in the best interests of the Special 4. Reasonable Reliance To Satisfy the
dealer that merely provides to a Special ‘‘Reasonable Efforts’’ Obligation
Entity general transaction, financial, or Entity. Such information includes the
market information or that provides financial and tax status of the Special Proposed § 23.440(c) would allow a
swap terms as part of a response to a Entity and the financing objectives of swap dealer to rely on the Special
competitive bid request from the Special the Special Entity. The statute grants the Entity’s representations to satisfy its
Entity does not fall within the ‘‘reasonable efforts’’ obligations. The
definition. The proposed definition does 99 Senator Blanche Lincoln stated in a floor Commission understands from
not address what it means to act as an colloquy that: stakeholders, including a number of
[N]othing in [CEA Section 4s(h)] prohibits a swap Special Entities, that Special Entities are
advisor in connection with any other dealer from entering into transactions with Special
dealings between a swap dealer and a Entities. Indeed, we believe it will be quite common
sometimes reluctant to provide
Special Entity. that swap dealers will both provide advice and offer complete information to swap dealers
to enter into or enter into a swap with a special about their investment portfolio or other
2. Best Interests entity. However, unlike the status quo, in this case, information that might be relevant to the
the swap dealer would be subject to both the acting appropriateness of a particular
The proposed rule would not define as advisor and business conduct requirements
the term ‘‘best interests.’’ There are under subsections (h)(4) and (h)(5). recommendation. To address this
established principles in case law under 156 Cong. Rec. S5923 (daily ed. Jul. 15, 2010) circumstance, the Commission proposes
the CEA, with respect to the duties of (statement of Sen. Lincoln). However, swap dealers to allow a swap dealer to meet its
have an obligation to ensure that any Special Entity ‘‘reasonable efforts’’ duty by relying on
advisors which will inform the meaning counterparty is represented by a sophisticated
of the term on a case-by-case basis. The representative, independent of the swap dealer,
representations of the Special Entity 102
Commission believes that those best when the swap dealer is acting both as an advisor and any other information known by the
interest principles, in the context of a and as counterparty to the Special Entity. (Section swap dealer. In such circumstances, the
recommended swap or swap trading 4s(h)(5)). swap dealer would be expected to make
100 The Commission anticipates that swap dealers
strategy, would impose affirmative clear to the Special Entity that the
and Special Entities will continue to rely on
duties to act in good faith and make full representations to inform the nature of their
recommendation is based on the limited
and fair disclosure of all material facts relationships, including, for example, information known to the swap dealer,
and conflicts of interest, and to employ representations that the Special Entity: (1) Is not and that the recommendation might be
relying on the swap dealer; (2) has an independent different if the swap dealer had more
reasonable care that any representative that, by virtue of their relationship,
recommendation given to a Special is legally obligated to act in the best interests of the
complete information as provided in
Entity is designed to further the Special Entity; and (3) is relying on the Section 4s(h)(4)(C) and proposed
purposes of the Special Entity.98 The independent representative’s advice in evaluating § 23.440(b)(2).103
Commission’s proposal is guided by the any recommendation from a swap dealer. The To rely, the swap dealer must have a
parties’ agreement, however, does not bind the reasonable basis to believe that the
statutory language in Sections 4s(h)(4) Commission or override the protections granted to
and (5) and Congressional intent that market participants under the CEA. Cf. Complaint representations of the Special Entity are
at ¶ 18, SEC v. Barclays Bank, 07–CV–04427 reliable based on the facts and
98 There is similar language in SEC v. Capital (S.D.N.Y. May 30, 2007) (so-called ‘‘Big Boy’’ letters
Gains Research Bureau, Inc., 375 U.S. 180, 191–94 may not insulate parties from enforcement actions 102 Certain Special Entity trade associations
(1963) in which the Supreme Court construed brought by the SEC for insider trading); SEC v. supported this approach. See ABC Letter, at 6–7;
Advisers Act Section 206 (15 U.S.C. 80b–6) as Barclays Bank, SEC Litig. Release No. 20132 (May ABC/CIEBA Letter, at 3.
creating an enforcement mechanism for violations 30, 2007) (Barclays Bank settles insider trading 103 In the absence of sufficient representations
of fiduciary duties under the common law. The charges). from the Special Entity, and if a swap dealer’s
fiduciary duty imposes upon investment advisers 101 The Commission staff has consulted with DOL
reasonable efforts produce incomplete information,
the ‘‘affirmative duty of ‘utmost good faith, and full staff, who has advised that any determination of the swap dealer would be required to assess
and fair disclosure of all material facts,’ as well as status under the Dodd-Frank Act is separate and whether it is able to make a swap recommendation
an affirmative obligation to ‘employ reasonable care distinct from the determination of whether an entity that is in the best interests of the Special Entity as
to avoid misleading’ ’’ their clients. is a fiduciary under ERISA. required by proposed § 23.440.
circumstances of the particular swap that offer swaps to or enter into swaps 1. Qualifications of the Independent
and the Special Entity. The with Special Entities comply with any Representative
representations themselves must be duty established by the Commission The proposed rule would require
detailed and include information that requires them to have a reasonable swap dealers and major swap
regarding the Special Entity’s ability to: basis to believe that the Special Entity participants to have a reasonable basis
evaluate the recommended transaction; has an independent representative that to believe that a Special Entity has a
exercise independent judgment; and meets certain criteria.105 The representative that satisfies the
absorb potential losses associated with Commission interprets the statute as enumerated criteria.110 The proposed
the swap. The Special Entity also would imposing this duty on swap dealers and rule provides that relevant
have to have a representative that meets major swap participants when they are considerations would include: (1) The
the criteria in Section 4s(h)(5) and counterparties to any Special Entity.106 nature of the Special Entity-
proposed § 23.450. This mechanism In making this determination the representative relationship; (2) the
would not relieve a swap dealer of its representative’s capability of making
Commission considered staff’s
duty to act in the ‘‘best interests’’ of the hedging or trading decisions; (3) use of
consultations with staff at other Federal
Special Entity. consultants or, with respect to employee
Request for Comment: The regulators, stakeholders, letters from the
public,107 as well as legislative benefit plans subject to ERISA, use of a
Commission requests comment Qualified Professional Asset Manager 111
generally on all of the proposed rules history.108 To meet their duties under
or In-House Asset Manager; 112 (4) the
regarding swap dealers that act as the proposed rule, swap dealers and
representative’s general level of
advisors to Special Entities, and on the major swap participants would be able experience in the financial markets and
following specific issues: to rely on reasonable, detailed particular experience with the type of
• Is the proposed clarification of the representations of the Special Entity product under consideration; (5) the
term ‘‘acts as an advisor to a Special concerning the qualifications of the representative’s ability to understand
Entity’’ appropriate? Should the independent representative.109 the economic features of the swap; (6)
Commission further define the term? the representative’s ability to evaluate
• Should the Commission define dealers and major swap participants that offer to or how market developments would affect
‘‘best interests’’ in this context, and if so, enter into a swap with a Special Entity. the swap; and (7) the complexity of the
what should the definition be? Accordingly, the Commission proposes to apply the
counterparty requirements to major swap
swap.
• Because a swap dealer has an participants as well as to swap dealers.
inherent conflict of interest when it acts 2. Statutory Disqualification
105 Pursuant to Section 4s(h)(7), the duty would
as both an advisor and a counterparty to not apply to transactions initiated on a DCM or SEF To guide swap dealers and major
Special Entity, are there additional where the swap dealer or major swap participant swap participants, the proposed rule
disclosures that a swap dealer should does not know the counterparty to the transaction. defines ‘‘statutory disqualification’’ as
have to make that could mitigate the 106 The statutory language is ambiguous as to
grounds for refusal to register or to
conflicts of interest? whether the duty is intended to apply with respect revoke, condition or restrict the
to all types of Special Entity counterparties, or just
• When acting as both an advisor and a sub-group. The ambiguities arise, in part, from the
registration of any registrant or
a counterparty to a Special Entity, reference to subclauses (I) and (II) of Section applicant for registration as set forth in
should a swap dealer have to disclose 1a(18)(A)(vii) of the CEA, which include certain Sections 8a(2) and 8a(3) of the CEA.
any positions it holds from which it governmental entities and multinational or
3. Independent
may profit should the swap in question supranational government entities. Yet,
multinational and supranational government Proposed § 23.450(b) would require
move against the Special Entity? entities do not fall within the definition of Special
• Should swap dealers have to that a swap dealer or major swap
Entity in Section 4s(h)(2)(C), and State agencies,
disclose to a Special Entity the profit it which are defined as Special Entities, are not participant ‘‘have a reasonable basis to
expects to make on swaps it enters into included in Section 1a(18)(A)(vii)(I) and (II) but are believe a Special Entity has a
with the Special Entity. included in (III).
• Should swap dealers be subject to
107 See, e.g., Ropes & Gray Letter, at 1; ABC/ 110 The criteria for an independent representative
CIEBA Statement letter, at 2; SIFMA/ISDA Letter, based generally on the statute and under proposed
an explicit fiduciary duty when acting at 11. § 23.450 would be: (1) Sufficient knowledge to
as an advisor to a Special Entity? 108 See H.R. Rep. No. 111–517, at 869 (June 29, evaluate the transaction and risks; (2) not subject to
• Would the proposed rule preclude 2010) (Conf. Rep.) (‘‘When acting as counterparties a statutory disqualification; (3) independent of the
swap dealers from continuing their to a pension fund, endowment fund, or state or swap dealer or major swap participant; (4)
local government, dealers are to have a reasonable undertakes a duty to act in the best interests of the
current practice of both recommending Special Entity it represents; (5) makes appropriate
and entering into swaps with Special basis to believe that the fund or governmental entity
has an independent representative advising them.’’). and timely disclosures to the Special Entity; (6)
Entities? If so, why? 109 See, e.g., ABC Letter, at 4; ABC/CIEBA Letter,
evaluates, consistent with any guidelines provided
• Should the Commission prescribe at 2; SIFMA/ISDA Letter, at 11. Stakeholders have
by the Special Entity, fair pricing and the
appropriateness of the swap; (7) in the case of
additional information that would be asserted that, even if Congress did intend for employee benefit plans subject to the ERISA, is a
relevant to a swap dealer’s ‘‘reasonable Section 4s(h)(5)(A) to apply to non-governmental fiduciary as defined in Section 3 of ERISA (29
efforts’’ and ‘‘best interests’’ duties under Special Entities, it did not intend for it to apply to U.S.C. 1002); and 8) in the case of a municipal
ERISA plans. Stakeholders further assert that, even entity as defined in proposed § 23.451, whether the
the proposed rule? if Section 4s(h)(5)(A) applies to ERISA plans, swap representative is subject to restrictions on certain
C. Proposed § 23.450—Requirements for dealers and major swap participants should only be political contributions imposed by the Commission,
expected to verify that the independent the SEC or a self-regulatory organization subject to
Swap Dealers and Major Swap representative satisfies the criteria of Section the jurisdiction of the Commission or the SEC.
Participants Acting as Counterparties to 4s(h)(5)(A)(i)(VII)—that the independent Criterion 8 is not in the statutory text under Section
Special Entities representative is a fiduciary as defined in Section 4s(h)(5)(A)(i)(I)–(VII). The Commission is proposing
3 of ERISA (29 U.S.C. 1002)—and not the criteria this criterion using its discretionary authority under
Section 4s(h)(5) requires that swap of Section 4s(h)(5)(A)(i)(I)–(VI). They contend that Section 4s(h)(5)(B).
dealers and major swap participants 104 verification of the duty under Section 111 See DOL Prohibited Transaction Exemption
4s(h)(5)(A)(i)(VII) is the equivalent of verification of (‘‘PTE’’) 84–14, 70 FR 49305, Aug. 23, 2005.
104 Although the title of Section 4s(h)(5) refers Section 4s(h)(5)(A)(i)(I)–(VI) and that to require 112 See DOL PTE 96–23, 61 FR 15975, Apr. 10,
only to swap dealers, the specific requirements in verification of all the criteria would lead to 1996; Proposed Amendment to PTE 96–23, 75 FR
Section 4s(h)(5)(A) are imposed on both swap regulatory conflicts under ERISA and the CEA. 33642, June 14, 2010.
representative that * * * is year of an offer to enter into a swap, the representative has sufficient information
independent of the swap dealer or major swap dealer or major swap participant to understand and assess the
swap participant * * * ’’ 113 This would have to ensure that the Special appropriateness of the swap prior to the
formulation of the duty is intended to Entity is informed of the compensation Special Entity’s entering into the
clarify that ‘‘independent’’ as it relates to and that the Special Entity agrees in transaction.118
a representative of a Special Entity writing, in consultation with the
5. Makes Appropriate and Timely
means independent of the swap dealer representative, that the compensation
Disclosures
or major swap participant,114 not does not constitute a material business
independent of the Special Entity.115 relationship between the representative The proposed rule refines the
As to what it means for the and the swap dealer or major swap criterion under Section 4s(h)(5)(A)(i)(V),
representative to be independent of the participant. The proposed rule defines a ‘‘appropriate disclosures,’’ to mean
swap dealer or major swap participant, material business relationship as any ‘‘appropriate and timely disclosures.’’ A
the Commission’s proposed rule relationship with a swap dealer or major swap dealer or major swap participant
provides that a representative would be swap participant, whether would have to have a reasonable basis
deemed to be independent if: (1) It is compensatory or otherwise, that to believe that a representative makes
not (with a one-year look back) an reasonably could affect the independent appropriate and timely disclosures to
associated person of the swap dealer or judgment or decision making of the the Special Entity for the representative
major swap participant within the representative. to meet the requirements of the
meaning of Section 1a(4) of the CEA; (2) proposed rule.
there is no ‘‘principal’’ relationship 4. Best Interests
6. Evaluates Fair Pricing and the
between the representative and the The Commission is not proposing to
Appropriateness of the Swap
swap dealer or major swap participant define what ‘‘best interests’’ means in
within the meaning of § 3.1(a)116 of the this context. As the Commission The Commission has received a
Commission’s Regulations; and (3) the explained regarding proposed § 23.440, number of questions regarding the
representative does not have a material the scope of the duty will be related to statutory criterion in Section
business relationship with the swap the nature of the relationship between 4s(h)(5)(A)(i)(VI) which states that the
dealer or major swap participant. the independent representative and the representative will provide ‘‘written
However, if the representative received Special Entity. There are established representations to the Special Entity
any compensation from the swap dealer principles in case law which will regarding fair pricing and the
or major swap participant within one inform the meaning of the term on a appropriateness of the transaction.’’ 119
case-by-case basis.117 The Commission’s proposed rule refines
113 Section 4s(h)(5)(A)(i) provides in relevant part: We would expect that, at a minimum, the statutory language to say that the
‘‘reasonable basis to believe that the counterparty the swap dealer or major swap representative ‘‘evaluates, consistent
that is a Special Entity has an independent participant would have a reasonable with any guidelines provided by the
representative that * * * (III) is independent of the basis for believing that the Special Entity, fair pricing and the
swap dealer or major swap participant * * *’’ By
including the word ‘‘independent’’ twice, an representative could assess: (1) How the appropriateness of the swap.’’ The
ambiguity was created as to whether the proposed swap fits within the Special Commission proposes to allow swap
representative had to be independent of both the Entity’s investment policy; (2) what role dealers and major swap participants to
swap dealer or major swap participant and the the particular swap plays in the Special rely on appropriate legal arrangements
Special Entity. The legislative history indicates that
was not the intent of Congress. Thus, the proposed Entity’s portfolio; and (3) the Special between Special Entities and their
rule drops the first ‘‘independent’’ to clarify that the Entity’s potential exposure to losses. independent representatives in applying
representative of a Special Entity only needs to be The swap dealer or major swap this criterion. For example, where a
independent of the swap dealer or major swap participant would also need to have a pension plan has a plan fiduciary that
participant. by contract has discretionary authority
114 See, e.g., ABC Letter, at 6; ABC/CIEBA Letter,
reasonable basis for believing that the
at 3; Ropes & Gray Letter, at 2; SIFMA/ISDA Letter,
to carry out the investment guidelines of
at 12; NFA Letter, at 6. 117 Under the CEA, a commodity trading advisor the plan, the swap dealer would be able
115 See 156 Cong. Rec. S5903 (daily ed. Jul. 15, will have a fiduciary duty towards its customer to rely, absent red flags, on the Special
2010) (statements of Sens. Lincoln and Harkin): when it offers personalized advice. See Savage v. Entity’s representations regarding the
Mrs. LINCOLN Our intention in imposing the CFTC, 548 F.2d 192, 194 (7th Cir. 1977);
Commodity Trend Serv., 233 F.3d at 990 (‘‘the party legal obligations of the fiduciary.
independent representative requirement was to
ensure that there was always someone independent
in [Savage] offered personalized advice and so Evidence of the legal relationship
would be considered a fiduciary under the common between the plan and its fiduciary
of the swap dealer or the security-based swap dealer
law’’) (citing Capital Gains, 375 U.S. at 194). Under would enable the swap dealer or major
reviewing and approving swap or security-based
the Advisers Act, an adviser is a fiduciary whose
swap transactions. However, we did not intend to swap participant to conclude that the
duty is to serve the best interests of its clients,
require that the special entity hire an investment fiduciary is evaluating fair pricing and
which includes an obligation not to subrogate
manager independent of the special entity. Is that
clients’ interests to its own. An adviser must deal the appropriateness of all transactions
your understanding, Senator Harkin?
fairly with clients and prospective clients, seek to
Mr. HARKIN. Yes, that is correct. We certainly avoid conflicts with its clients and, at a minimum,
prior to entering into such transactions
understand that many special entities have internal make full disclosure of any material conflict or on behalf of the plan. To comply with
managers that may meet the independent potential conflict. ‘‘Amendments to Form ADV,’’ this criterion, the swap dealer or major
representative requirement. For example, many Release No. IA–3060 (Aug. 12, 2010) (citing Capital
public electric and gas systems have employees
swap participant should also have a
Gains, 375 U.S. at 191–94). Under ERISA, ‘‘a
whose job is to handle the day-to-day hedging fiduciary shall discharge his duties with respect to
reasonable basis to believe that the
operations of the system, and we intended to allow a plan solely in the interest of the participants and
them to continue to rely on those in-house beneficiaries and * * * for the exclusive purpose 118 The description of the duties under Section
managers to evaluate and approve swap and of: (i) providing benefits to participants and their 4s(h)(5)(A)(i)(IV) is drawn from a description of
security-based swap transactions, provided that the beneficiaries; and (ii) defraying reasonable expenses ERISA fiduciary obligations in connection with the
manager remained independent of the swap dealer of administering the plan’’ (29 U.S.C. 1104(a)(1)(A)) use of derivatives in the management of a portfolio
or the security-based swap dealer and meet the and act ‘‘with the care, skill, prudence, and of assets of a pension plan that is subject to ERISA.
other conditions of the provision. Similarly, the diligence under the circumstances then prevailing See Letter of Olena Berg, DOL, to Honorable Eugene
named fiduciary or in-house asset manager-INHAM- that a prudent man acting in a like capacity and A. Ludwig, Comptroller of the Currency (March 21,
for a pension plan may continue to approve swap familiar with such matters would use in the 1996), available at, http://www.dol.gov/ebsa/
and security-based swap transactions. conduct of an enterprise of a like character and with programs/ori/advisory96/driv4ltr.htm.
116 17 CFR 3.1(a). like aims * * *’’ (29 U.S.C. 1104(a)(1)(B)). 119 See, e.g., ABC Letter, at 8; SFG Letter, at 1.
independent representative is political contributions, known as ‘‘pay- on the capacities in which they are
documenting its decisions about to-play’’ rules.125 The requirement operating.
appropriateness and pricing of all swap would not apply to in-house
11. Inapplicability
transactions and that such independent representatives of a
documentation is being retained in municipal entity.126 Proposed § 23.450 would not apply
accordance with any regulatory with respect to a swap that is initiated
requirements that might apply to the 9. Unqualified Independent on a DCM or SEF where the swap dealer
independent representative.120 This Representative or major swap participant does not
approach would apply to in-house Some stakeholders have expressed know the Special Entity’s identity.
independent representatives as well. concern that the independent Request for Comment: The
representative requirement places Commission requests comment
7. ERISA Fiduciary generally on all of the proposed rules
undue influence in the hands of the
The proposed rule tracks the statutory swap dealer or major swap participant regarding swap dealers and major swap
language that in the case of employee by allowing it to use Section participants that act as counterparties to
benefit plans subject to ERISA, the 4s(h)(5)(A)(i) to control who qualifies as Special Entities, and on the following
independent representative is a an independent representative.127 Thus, specific issues:
fiduciary as defined in Section 3 of that the proposed rule also provides that, if • Should the rule clarify the statutory
Act.121 Certain ERISA plans, fiduciaries a swap dealer or major swap participant language to give more guidance to the
and their trade associations, have urged were to determine that the independent criteria in Section 4s(h)(5)(A)(i)(I)–(VI)?
the Commission to interpret the statute representative of a Special Entity did If, yes, how?
to mean that the independent not meet the criteria established in this • Are there any specific qualifications
representative of a plan subject to provision, the swap dealer or major that should be considered in forming a
ERISA would not have to satisfy the swap participant would be required to reasonable basis regarding whether the
additional criteria in Section make a written record of the basis for independent representative has
4s(h)(5)(A)(i)(I)–(VI), because such such determination and submit such sufficient knowledge to evaluate the
criteria would be duplicative of or determination to its Chief Compliance transaction and risks?
inconsistent with ERISA Officer for review to ensure that the • Should the criterion in Section
requirements.122 After consultations swap dealer or major swap participant 4s(h)(5)(A)(i)(VII) be the only criterion
with DOL staff, the Commission is had a substantial, unbiased basis for the that applies to employee benefit plans
inclined, at this time, to treat ERISA determination. subject to ERISA? Why or why not? Are
fiduciaries like other independent the criteria in Section 4s(h)(5)(A)(i)(I)–
representatives of Special Entities with 10. Disclosure of Capacity (VI) inconsistent with a fiduciary’s
respect to the criteria in Section Section 4s(h)(5)(A)(ii) requires swap duties under ERISA? Do the criteria in
4s(h)(5)(A)(i)(I)–(VI). The Commission dealers and major swap participants to Section 4s(h)(5)(A)(i)(I)–(VI) add any
would expect that such ERISA disclose in writing to Special Entities protections for plans subject to ERISA
fiduciaries and plans would be able to the capacity in which they are acting that are not otherwise provided under
provide adequate representations to before initiation of a swap transaction. ERISA?
swap dealers and major swap The Commission proposes to adopt the • To resolve the ambiguity in the
participants to meet the additional statutory standard in a rule, and to statutory text referenced in footnote 106,
criteria without incurring significant require that, if a swap dealer or major should the rule be limited to certain
costs. The Commission seeks further swap participant were to engage in types of Special Entities? Why or why
comment from interested parties as to business with the Special Entity in more not? Which types should be included or
this approach, particularly with respect than one capacity, the swap dealer or excluded from coverage under the
to whether the additional criteria, as major swap participant would have to proposed rule?
proposed in the rule, are inconsistent in disclose the material differences • Should the rule define what it
any way with the requirements under between the capacities. This would means for the independent
ERISA. apply, for example, when the swap representative to be independent of the
8. Restrictions on Political dealer acts both as an advisor and as a swap dealer or major swap participant?
Contributions by Independent counterparty to the Special Entity, or If yes, should independence be
Representative of a Municipal Entity when firms act both as underwriters in measured in relation to ownership and
a bond offering and as counterparties in control, material business relationships,
As part of the process of determining or another measure? Should any
the qualifications of an independent swaps used to hedge such financing. In
these circumstances, the swap dealers’ ‘‘independence’’ test apply to employees
representative of a Special Entity that is of the independent representative, as
a municipal entity,123 the Commission or major swap participants’ duties to the
Special Entities would vary depending well as to the representative, itself?
proposes 124 to require swap dealers and • Should the Commission specify a
major swap participants to ensure that de minimis threshold below wh ich an
125 See, e.g., SEC Rule 206(4)–5 under the
the independent representative is independent representative will not be
Advisers Act (17 CFR 275.206(4)–5); MSRB Rule
subject to restrictions on certain G–37: Political Contributions and Prohibitions on deemed to have a material business
Municipal Securities Business. The Commission relationship with the swap dealer or
120 For example, CTAs are required to maintain proposes to impose comparable requirements on
books and records for 5 years pursuant to § 1.31 of swap dealers and major swap participants that act
major swap participant? If so, what
the Commission’s regulations. (17 CFR 1.31). as advisors or counterparties to Special Entities. See would be an appropriate threshold?
121 29 U.S.C. 1002. proposed § 23.432. In a separate release, the
122 See, e.g., ABC Letter, at 4–5; ABC/CIEBA Commission will also propose comparable D. Proposed § 23.451—Political
Letter, at 2–5. requirements on registered commodity trading Contributions by Certain Swap Dealers
123 Proposed § 23.451. advisors when they advise municipal entities. and Major Swap Participants
124 The Commission proposes this requirement 126 The definition of ‘‘municipal advisor’’ in
pursuant to its discretionary authority in Section Section 15B of the Exchange Act (15 U.S.C. 78o– Using its discretionary rulemaking
4s(h) of the CEA, including in particular Section 4) excludes employees of a municipal entity. authority under Section 4s(h) to impose
4s(h)(5)(B). 127 E.g., ABC Letter, at 8. business conduct requirements in the
public interest,128 the Commission is contribution to an official of the officer, or other individual with a
proposing to prohibit swap dealers and municipal entity. The proposed rule similar status or function; (ii) any
major swap participants from entering also would prohibit a swap dealer or employee who solicits a municipal
into swaps with ‘‘municipal entities’’ if major swap participant from paying a entity for the swap dealer or major swap
they make certain political third-party to solicit municipal entities participant and any person who
contributions to officials of such to enter into a swap, unless the third- supervises, directly or indirectly, such
entities.129 The proposed rule is party is a ‘‘regulated person’’ that is itself employee; and (iii) any political action
intended to complement existing pay-to- subject to a pay-to-play restriction under committee controlled by the swap
play prohibitions imposed by Federal applicable law.133 The proposed rule dealer or major swap participant or any
securities regulators to deter undue also would ban a swap dealer or major of its covered associates. This definition
influence and other fraudulent practices swap participant from soliciting or mirrors a similar provision in SEC
that harm the public. The Commission’s coordinating contributions to an official Advisers Act Rule 206(4)–5.
proposed rule would promote of a municipal entity with which the
consistency in the business conduct Because the proposed rule attributes
swap dealer or major swap participant
standards that apply to financial market to a firm contributions made by a person
is seeking to enter into, or has entered
professionals dealing with municipal even prior to becoming a covered
into a swap, or payments to a political
entities. associate of the firm, swap dealers and
party of a state or locality with which
The existing restrictions on pay-to- major swap participants must ‘‘look
the swap dealer or major swap
play practices are contained in SEC Rule back’’ in time to determine whether the
participant is seeking to enter into, or
206(4)–5 under the Investment Advisers has entered into a swap. These proposed time out applies when an employee
Act of 1940,130 which prohibits certain prohibitions are similar to those becomes a covered associate. For
political contributions by investment contained in SEC Advisers Act Rule example, if the contribution was made
advisers providing or seeking to provide 206(4)–5 and MSRB Rules G–37 and G– less than two years (or six months, as
investment advisory services to public 38. applicable) before an individual
pension plans and other government The proposed rule also includes a becomes a covered associate, the
investors,131 and under the Municipal provision that would make it unlawful proposed rule would prohibit the firm
Securities Rule Making Board (‘‘MSRB’’) for a swap dealer or major swap from entering into a swap with the
Rules G–37 and G–38,132 which impose participant to do indirectly or through relevant municipal entity until the two-
pay-to-play restrictions on municipal another person or means anything that year time out period has expired.
securities dealers and broker-dealers would, if done directly, result in a 2. Exceptions
engaging or seeking to engage in the violation of the prohibitions contained
municipal securities business. The in the proposed rule. a. De Minimis Contributions
proposed rule is intended to deter swap
dealers and major swap participants a. Two-Year ‘‘Time Out’’ The proposed rule would permit an
from engaging in pay-to-play practices. The proposed rule would prohibit individual that is a covered associate to
swap dealers and major swap make aggregate contributions up to $350
1. Prohibitions per election, without being subject to
participants from offering to enter into
Proposed § 23.451, generally, would or entering into a swap with a the two-year time out period for any one
make it unlawful for a swap dealer or municipal entity within two years after official for whom the individual is
major swap participant to offer to enter a contribution to an official of such entitled to vote, and up to $150, per
or to enter into a swap with a municipal municipal entity was made by the swap election, to an official for whom the
entity for a two-year period after the dealer or major swap participant or any individual is not entitled to vote. The
swap dealer or major swap participant of its covered associates. The two-year Commission believes this two-tiered de
or any of its covered associates makes a time out is consistent with the time out minimis approach is reasonable because
provisions contained in SEC Advisers of the more remote interest an
128 Section 4s(h)(5)(B).
Act Rule 206(4)–5 and MSRB Rule individual is likely to have in
129 See proposed § 23.451(a)(3). The proposed
G–37. contributing to a person for whom such
definition of ‘‘municipal entity’’ is based on
Exchange Act Section 15B(e)(8) (15 U.S.C. 78o– individual is not entitled to vote. This
4(e)(8)) and means any State, political subdivision
b. Covered Associates provision is similar to the one contained
of a State, or municipal corporate instrumentality Political contributions made to in SEC Advisers Act Rule 206(4)–5.
of a State, including— influence the firm selection process are
(A) Any agency, authority, or instrumentality of
typically made not by the firm itself, but b. New Covered Associates
the State, political subdivision, or municipal
corporate instrumentality; by officers and employees of the firm The prohibitions of the proposed rule
(B) Any plan, program, or pool of assets who have a stake in the business would not apply to contributions by an
sponsored or established by the State, political relationship with the municipal client.
subdivision, or municipal corporate instrumentality individual made more than six months
or any agency, authority, or instrumentality thereof;
For this reason, contributions by such prior to becoming a covered associate of
and persons, which the rule defines as the swap dealer or major swap
(C) Any other issuer of municipal securities. ‘‘covered associates,’’ would trigger the participant, unless such individual
130 17 CFR 275.206(4)–5 (‘‘SEC Advisers Act Rule two-year time out. A ‘‘covered associate’’ solicits the municipal entity after
206(4)–5’’). of a swap dealer or major swap becoming a covered associate.
131 See ‘‘Political Contributions by Certain
Investment Advisers,’’ Release No. IA–3043 (Jul. 1,

participant is defined as (i) any general
2010), 75 FR 41018, Jul. 14, 2010 (adopting a rule partner, managing member or executive c. Exchange and SEF Transactions
that prohibits certain political contributions by
investment advisers providing or seeking to provide 133 The Commission is proposing to define The prohibitions of the proposed rule
investment advisory services to public pension ‘‘regulated person,’’ for purposes of the rule, to mean would not apply to a swap that is
plans and other government investors). generally a person that is subject to rules of the SEC, initiated on a DCM or SEF, for which
132 See MSRB Rule G–37, Political Contributions the MSRB, a self-regulatory organization, or the
and Prohibitions on Municipal Securities Business; Commission prohibiting it from engaging in
the swap dealer or major swap
MSRB Rule G–38, Solicitation of Municipal specified activities if certain political contributions participant does not know the identity
Securities Business. have been made, or its officers or employees. of the counterparty.
3. Exemptions • Is the term ‘‘municipal entity’’ comply with the requirements? If so,
appropriately defined? If not, should the which requirements, and what is the
A swap dealer or major swap Commission refer to ‘‘a State, State compliance burden that should merit a
participant would be exempt from the agency, city, county, municipality, or delay?
prohibitions of the proposed rule where other political subdivision of a State, or
the contribution that was made by a B. Consistency With SEC Approach
any governmental plan, as defined in
covered associate did not exceed $150 Section 3 of [ERISA] (29 U.S.C. 1002)’’ The SEC is proposing rules related to
or $350, as applicable, was discovered within the meaning of Section business conduct standards for swap
by the swap dealer or major swap 4s(h)(2)(C)? Should the Commission use dealers and major swap participants as
participant within four months of the the definition of ‘‘government entity’’ required under Section 764 of the Dodd-
date of contribution, and was returned from SEC Advisers Act Rule 206(4)– Frank Act. Understanding that the
to the contributor within 60 calendar 5? 135 Should the Commission instead Commission and the SEC regulate
days of the date of discovery. This follow the approach of MSRB Rule different products and markets and
automatic exemption mirrors similar G–37? 136 thus, appropriately may be proposing
provisions contained in SEC Advisers • Should the proposed rule apply not alternative regulatory requirements, we
Act Rule 206(4)–5 and MSRB Rule to all swap dealers and major swap request comments generally on the
G–37. participants, but instead to only swap impact of any differences between the
In addition, the Commission proposes dealers? If so, why? Commission and SEC approaches to
a provision under which a swap dealer business conduct regulation in this area.
IV. Request for Comment • Do the regulatory approaches
or major swap participant may apply to
the Commission for an exemption from A. Generally proposed by the Commission and the
the two-year ban. In determining SEC result in duplicative or inconsistent
The Commission requests comment
whether to grant the exemption, the business conduct standards for market
on all aspects of the proposed rules. In
Commission would consider, among participants subject to both regulatory
addition, the Commission seeks regimes? Do the approaches result in
other factors: (i) Whether the exemption comment on the following specific
is necessary or appropriate in the public gaps or different levels of regulation
issues: between those regimes? If so, in what
interest and consistent with the • Should any proposed requirements
protection of investors and the purposes ways do commenters believe that such
be modified or deemed satisfied with
of the CEA; (ii) whether the swap dealer duplication, inconsistencies, or gaps
respect to swaps that are traded and/or
or major swap participant, before the should be minimized?
cleared on a registered entity? If so, • Do commenters believe there are
contribution resulting in a prohibition which requirements should be modified ways that would make the approaches
was made, had adopted and or deemed satisfied, and why? more consistent?
implemented policies and procedures • Should the Commission use its
reasonably designed to prevent discretionary authority, where V. Related Matters
violations of the proposed rule, prior to applicable, to distinguish among swap A. Regulatory Flexibility Act
or at the time of the contribution, had dealers depending on their size and the
any actual knowledge of the nature of their business? If so, under The Regulatory Flexibility Act
contribution, and, after learning of the what circumstances and how? (RFA)137 requires that agencies consider
contribution, has taken all available • Should any additional business whether the rules they propose will
steps to cause the contributor to obtain conduct requirements be imposed on have a significant economic impact on
return of the contribution and such swap dealers and/or major swap a substantial number of small entities
other remedial or preventative measures participants? If so, which requirements and, if so, provide a regulatory
as may be appropriate under the should be imposed, and why? flexibility analysis respecting the
circumstances; (iii) whether, at the time • Should the Commission delay the impact.138 The business conduct rules
of the contribution, the contributor was effective date of any of the proposed proposed by the Commission generally
a covered associate or otherwise an requirements to allow additional time to will affect swap dealers and major swap
employee of the swap dealer or major participants. Prior to Dodd-Frank, the
swap participant, or was seeking such 135 As used in SEC Advisers Act Rule 206(4)– Commission did not have jurisdiction
employment; (iv) the timing and amount 5(f)(5) (17 CFR 275.206(4)–5(f)(5)), the term over swaps, swap dealers and major
‘‘government entity’’ means any State or political swap participants. Thus, the
of the contribution; (v) the nature of the subdivision of a State, including:
election (e.g., Federal, State or local); Commission has not previously
(i) Any agency, authority, or instrumentality of
and (vi) the contributor’s intent or the State or political subdivision; addressed the question of whether swap
motive in making the contribution, as (ii) A pool of assets sponsored or established by dealers and major swap participants are,
evidenced by the facts and the State or political subdivision or any agency, in fact, ‘‘small entities’’ for purposes of
authority or instrumentality thereof, including, but the RFA.
circumstances surrounding the not limited to a ‘‘defined benefit plan’’ as defined
contribution.134 This exemption is in section 414(j) of the Internal Revenue Code (26
However, the Commission has
similar to automatic exemption U.S.C. 414(j)), or a State general fund; previously established certain
provisions contained in SEC Rule (iii) A plan or program of a government entity; definitions for small entities to be used
206(4)–5 and MSRB Rule G–37.
and by the Commission in evaluating the
(iv) Officers, agents, or employees of the State or impact of its regulations on small
Request for Comment: The political subdivision or any agency, authority or

entities in accordance with the RFA.139
Commission requests comments instrumentality thereof, acting in their official
capacity. For example, the Commission has
generally on the proposed rules 136 MSRB Rule G–37(g)(ii) references ‘‘the previously determined that futures
regarding restrictions on certain governmental issuer specified in section 3(a)(29) of commission merchants (‘‘FCMs’’) are not
political contributions by swap dealers the [Exchange] Act’’ which includes ‘‘a State or any small entities for the purpose of the
and major swap participants and the political subdivision thereof, or any agency or
following specific issues: instrumentality of a State or any political
137 5 U.S.C. 601 et seq.
subdivision thereof, or any municipal corporate
138 Id.
instrumentality of one more States * * *’’ (15
134 Proposed § 23.451(d). U.S.C. 78c(29)). 139 47 FR 18618, Apr. 30, 1982.
RFA140 based upon, among other things, This rulemaking contains collections greater weight to any one of the five
the requirements that FCMs meet of information, notably the proposed enumerated areas and could in its
certain minimum financial requirements rules that will require swap dealers and discretion determine that,
that enhance the protection of major swap participants to make notwithstanding its costs, a particular
customers’ segregated funds and protect records, document processes, and make order is necessary or appropriate to
the financial condition of FCMs disclosures to counterparties with protect the public interest or to
generally. The analogy to FCMs is whom they propose to enter into swaps. effectuate any of the provisions or
appropriate in that we anticipate that OMB has not yet assigned a control accomplish any of the purposes of the
swap dealers and major swap number to the new collections. OMB CEA.
participants may have to register as has not yet assigned a control number Summary of proposed requirements.
FCMs depending on the nature of their to the new collection. The proposed regulations would
business. Moreover, swap dealers and The collections of information implement Section 4s(h) which requires
major swap participants will be subject contained herein overlap the the Commission to promulgate rules to
to minimum capital and margin requirements that are being proposed by establish business conduct standards for
requirements, and are expected to the Commission in other rulemakings swap dealers and major swap
comprise the largest global financial implementing the Dodd-Frank Act. The participants governing their
firms. Entities that engage in a de Commission is seeking or will seek relationships with counterparties
minimis quantity of swap dealing in control numbers from OMB for these including special requirements with
connection with transactions with or on collections in association with the other respect to Special Entities. Among other
behalf of customers are exempt from the rulemakings. The other proposed things, the statute mandates that the
definition of swap dealers and major rulemakings are being issued Commission adopt rules requiring swap
swap participants. Accordingly, the contemporaneously within the CFTC’s dealers and major swap participants to
Commission is hereby determining that Business Conduct Standard–Internal verify that counterparties meet
swap dealers and major swap related rulemakings144 implementing eligibility criteria, disclose material
participants not be considered to be the Dodd-Frank Act. The Commission information about the contemplated
‘‘small entities’’ for essentially the same invites public comment on the accuracy swaps to counterparties, including
reasons that FCMs have previously been of its estimate that no additional material risks, characteristics, incentives
determined not to be small entities. recordkeeping or information collection and conflicts of interest; and an ongoing
requirements or changes to existing duty to provide counterparties a daily
Similarly, the Commission has also collection requirements would result mark for swaps. The Commission also is
previously determined that large traders from the rules proposed herein. directed to establish a duty for swap
are not ‘‘small entities’’ for RFA dealers and major swap participants to
purposes.141 The Commission C. Cost-Benefit Analysis
communicate in a fair and balanced
considered the size of a trader’s position Section 15(a) of the CEA requires the manner based on principles of fair
to be the only appropriate test for Commission to consider the costs and dealing and good faith.
purposes of large trader reporting.142 benefits of its actions before issuing a Costs. The Commission’s proposed
Major swap participants maintain rulemaking under the CEA. By its terms, rules implement new Section 4s(h) and
substantial positions in swaps, creating Section 15(a) does not require the enhance transparency, protect
substantial counterparty exposure that Commission to quantify the costs and counterparties from fraud and abuse,
could have serious adverse effects on benefits of an order or to determine bolster confidence in markets, reduce
the financial stability of the United whether the benefits of the order risk, and allow regulators to better
States banking system or financial outweigh its costs; rather, it requires monitor and manage our financial
markets. Accordingly, the Commission that the Commission ‘‘consider’’ the system. With respect to efficiency, the
is hereby determining that major swap costs and benefits of its actions. Section Commission has determined that
participants not be considered ‘‘small 15(a) further specifies that the costs and adhering to the new requirements under
entities’’ for essentially the same reasons benefits shall be evaluated in light of the proposed rules will not be unduly
that large traders have previously been five broad areas of market and public burdensome for swap dealers and major
determined not to be small entities. concern: (1) Protection of market swap participants. Indeed, the proposed
Therefore, the Chairman, on behalf of participants and the public; (2) rules, in part, reflect existing regulatory
the Commission, hereby certifies efficiency, competitiveness and requirements in other markets as well as
pursuant to 5 U.S.C. 605(b) that the financial integrity of futures markets; (3) current industry practices in the swaps
proposed rules will not have a price discovery; (4) sound risk market.145 In addition, the Commission
significant economic impact on a management practices; and (5) other has determined that the cost to market
substantial number of small entities. public interest considerations. The participants and the public if these rules
Commission may in its discretion give are not adopted could be substantial.
B. Paperwork Reduction Act
Significantly, without these rules to
144 The Business Conduct Standard-Internal
The Paperwork Reduction Act promote transparency and fair dealing,
Rulemakings are: Regulations Establishing and
(‘‘PRA’’) provides that an agency may Governing the Duties of Swap Dealers and Major the financial integrity and stability of
not conduct or sponsor, and a person is Swap Participants, 75 FR 71397, Nov. 23, 2010; the swaps markets could be
not required to respond to, a collection Designation of a Chief Compliance Officer, undermined.
of information unless it displays a Required Compliance Policies, and Annual Report Benefits. With respect to benefits, the
of a Futures Commission Merchant, Swap Dealer,
currently valid control number from the Major Swap Participant, 75 FR 70881, Nov. 19, Commission has determined that the
Office of Management and Budget 2010; and Implementation of Conflict-of-Interest proposed regulations would require a
(‘‘OMB’’). 143 Standards by Swap Dealers and Major Swap swap dealer or major swap participant
Participants, 75 FR 71391, Nov. 23, 2010. In to transact with market participants
addition, the Commission will be issuing proposed
140 Id. at 18619. rules regarding recordkeeping, reporting and daily according to the principles of fair
141 Id. at 18620. trading records for swap transactions consistent
142 Id. 145 See, e.g., Trading & Capital-Markets Activities
with § 1.31 of the Commission’s Regulations. (17
143 44 U.S.C. 3501 et seq. CFR § 1.31). Manual, Section 2150; CRMPG III Report.
dealing and good faith in a manner Subpart H—Business Conduct Income Security Act of 1974 (29 U.S.C.
intended to heighten the protection of Standards for Swap Dealers and Major 1002); or
market participants and the public. The Swap Participants Dealing With (5) Any endowment, including an
additional protections for Special Counterparties, Including Special endowment that is an organization
Entities reduces the overall risk to Entities described in Section 501(c)(3) of the
institutions critical to the public interest Internal Revenue Code of 1986 (26
Sec. U.S.C. 501(c)(3)).
and the stability of the financial system 23.400 Scope.
by providing tools and safeguards to Swap dealer. The term ‘‘swap dealer’’
23.401 Definitions.
market participants in order to means any person defined in Section
23.402 General provisions.
23.403–23.409 [Reserved] 1a(49) of the Act and § 1.3(aaa) of this
accurately assess risk, make informed
23.410 Prohibition on fraud, manipulation chapter and, as appropriate in this
decisions, and avoid crises. The
and other abusive practices. subpart, any person acting for or on
proposed rules, if adopted, will result in
23.411–23.429 [Reserved] behalf of a swap dealer, including an
greater certainty, reduced risk, increased 23.430 Verification of counterparty associated person defined in Section
transparency and market integrity in the eligibility. 1a(4) of the Act.
swap market. Therefore, the 23.431 Disclosures of material information.
Commission believes it is prudent to 23.432 Clearing. § 23.402 General provisions.
issue these business conduct 23.433 Communications—fair dealing. (a) Policies and Procedures to Ensure
requirements for swap dealers and 23.434 Recommendations to Compliance and Prevent Evasion of the
counterparties—institutional suitability.
major swap participants. Requirements of this Subpart.
23.435–23.439 [Reserved]
The Commission invites public 23.440 Requirements for swap dealers
(1) Swap dealers and major swap
acting as advisors to special entities. participants shall have policies and
comment on its cost-benefit
23.441–23.449 [Reserved] procedures reasonably designed to:
considerations. Commenters are also are (i) Ensure compliance with the
23.450 Requirements for swap dealers and
invited to submit any data or other requirements of this subpart; and
major swap participants acting as
information that they may have counterparties to special entities. (ii) Prevent a swap dealer or major
quantifying or qualifying the costs and 23.451 Political contributions by certain swap participant from evading or
benefits of the proposed regulations swap dealers and major swap participating in or facilitating an
with their comment letters. participants. evasion of any provision of the Act or
List of Subjects in 17 CFR Part 23 § 23.400 Scope. any regulation promulgated thereunder.
(2) Swap dealers and major swap
(a) Scope. The sections of this subpart
Antitrust, Commodity futures, participants shall implement and
shall apply to swap dealers and major
Business conduct standards, Conflict of monitor compliance with such policies
swap participants. These rules are not
Interests, Counterparties, Information, and procedures as part of their
intended to limit, or restrict the
Major swap participants, Registration, supervision and risk management
applicability of other provisions of the
Reporting and recordkeeping, Special requirements specified in subpart J of
Act, and rules and regulations
entities, Swap dealers, Swaps. this part.
thereunder, or other applicable laws,
(b) Diligent Supervision. Swap dealers
rules and regulations. The provisions of
List of Subjects in 17 CFR Part 155 and major swap participants shall
this subpart shall apply in connection
diligently supervise their compliance
Brokers, Commodity futures, with transactions in swaps as well as in
with the requirements of this subpart in
Consumer protection, Reporting and connection with swaps that are offered
accordance with the diligent
recordkeeping requirements, Swaps. but not entered into.
supervision requirements of subpart J of
For the reasons presented above, the § 23.401 Definitions. this part.
Commodity Futures Trading Counterparty. The term (c) Know your counterparty. Each
Commission proposes to amend part 23 ‘‘counterparty,’’ as appropriate in this swap dealer or major swap participant
subpart, includes any person who is a shall use reasonable due diligence to
(as proposed to be added by FR Doc
prospective counterparty to a swap. know and retain a record of the essential
2010–29024, published on November
Major swap participant. The term facts concerning each counterparty and
23, 2010, 75 FR 71379) and part 155 of
‘‘major swap participant’’ means any the authority of any person acting for
Title 17 of the Code of Federal such counterparty, including facts
Regulations as follows: person defined in Section 1a(33) of the
Act and § 1.33(bbb) of this chapter and, necessary to:
as appropriate in this subpart, any (1) Comply with applicable laws,
PART 23—SWAP DEALERS AND
person acting for or on behalf of a major regulations and rules;
MAJOR SWAP PARTICIPANTS (2) Effectively service the
swap participant, including an
Authority and Issuance associated person defined in Section counterparty;
1a(4) of the Act. (3) Implement any special
1. The authority citation for part 23 Special Entity. The term Special instructions from the counterparty; and
shall be revised to read as follows: Entity means: (4) Evaluate the previous swaps
(1) A Federal agency; experience, financial wherewithal and
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6c, 6p,
(2) A State, State agency, city, county, flexibility, trading objectives and
6s, 9, 9a, 12a, 13b, 13c, 16a, 18, 19, 21 as
municipality, or other political purposes of the counterparty.
amended by Title VII of the Dodd-Frank Wall
subdivision of a State or; (d) True name and owner. Each swap
Street Reform and Consumer Protection Act,
(3) Any employee benefit plan, as dealer or major swap participant shall
Pub. L. No. 111–203, 124 Stat. 1376 (Jul. 21,
2010). defined in Section 3 of the Employee keep a record which shall show the true
Retirement Income Security Act of 1974 name and address of each counterparty,
2. Add subpart H to read as follows: (29 U.S.C. 1002); the principal occupation or business of
(4) Any governmental plan, as defined such counterparty as well as the name
in Section 3 of the Employee Retirement and address of any other person
guaranteeing the performance of such (3) To engage in any act, practice, or reasonably designed to allow the
counterparty and any person exercising course of business that is fraudulent, counterparty to assess–
any control with respect to the positions deceptive, or manipulative. (1) The material risks of the particular
of such counterparty. (b) Confidential treatment of swap, which may include, market,
(e) Reasonable Reliance on counterparty information. It shall be credit, liquidity, foreign currency, legal,
Representations. A swap dealer or major unlawful for any swap dealer or major operational, and any other applicable
swap participant that seeks to rely on swap participant to disclose to any other risks. In addition to the disclosures of
the written representations of a person any material confidential material risks required in paragraph (a)
counterparty with respect to any information obtained from a of this section:
requirements under this subpart must counterparty, unless such disclosure is (i) Prior to entering into a bilateral
have a reasonable basis to believe that necessary for the effective execution of swap that is not available for trading on
the representations are reliable taking any swap for or with the counterparty a designated contract market or swap
into consideration the facts and or to hedge any exposure created by execution facility, swap dealers and
circumstances of the particular such swap, and the counterparty major swap participants shall notify the
relationship, assessed in the context of specifically consents to such disclosure, counterparty that it can request a
the particular transaction. The or such disclosure is made upon request scenario analysis as provided in
representations shall include of the Commission, Department of paragraph (a)(1) of this section. Swap
information sufficiently detailed for the Justice or an applicable prudential dealers and major swap participants
swap dealer or major swap participant regulator. shall, upon request of such
reasonably to conclude that the relevant (c) Trading ahead and front running counterparty, provide such scenario
requirement is satisfied. If agreed to by prohibited. It shall be unlawful for any analysis.
the counterparties, such representations swap dealer or major swap participant (ii) For a high-risk complex bilateral
may be contained in a master or other knowingly to enter into a transaction for swap with a counterparty, a swap dealer
written agreement between the its own benefit ahead of: or major swap participant shall provide
counterparties and may satisfy the (1) Any executable order for a swap a scenario analysis designed in
relevant requirements of this subpart for received from a counterparty, or consultation with the counterparty to
subsequent swaps offered to or entered (2) Any swap that is the subject of allow the counterparty to assess its
into with a counterparty, unless the negotiation with a counterparty, unless potential exposure in connection with
representations are inadequate to meet the counterparty specifically consents to the swap. The scenario analysis shall be
the requirements of this subpart with the prior execution of such swap done over a range of assumptions,
respect to any subsequent swap. transaction. including severe downside stress
(f) Manner of disclosure. A swap scenarios that would result in a
dealer or major swap participant may §§ 23.411–23.429 [Reserved] significant loss.
provide the information required by this § 23.430 Verification of counterparty (iii) For the purposes of paragraph
subpart by any reliable means agreed to eligibility. (a)(1)(ii) of this section, a swap dealer or
in writing by the counterparty. (a) Eligibility. A swap dealer or major major swap participant shall use
(g) Disclosures in a standard format. reasonable policies and procedures to
swap participant shall verify that a
If agreed to by a counterparty, the determine whether a bilateral swap is a
counterparty meets the eligibility
disclosure of material information that high-risk complex swap based on the
standards for an eligible contract
is applicable to multiple swaps between material characteristics of the swap
participant, as defined in Section 1a(18)
a swap dealer or major swap participant including, but not limited to, one or
of the Act and § 1.3(m) of this chapter,
and a counterparty, may be made in a more of the following criteria:
before offering to enter into or entering
standard format, including in a master (A) The degree and nature of leverage;
into a swap with that counterparty.
or other written agreement between the (B) The potential for periods of
(b) Special Entity. In verifying the
counterparties. significantly reduced liquidity; and
eligibility of a counterparty pursuant to
(h) Record Retention. Swap dealers (C) The lack of price transparency.
and major swap participants shall create paragraph (a) of this section, a swap
(iv) The scenario analysis required by
a record of their compliance with the dealer or major swap participant shall
paragraphs (a)(1)(i) and (a)(1)(ii) of this
requirements in this subpart and shall also verify whether the counterparty is
section shall be provided by the swap
retain such records in accordance with a Special Entity.
dealer or major swap participant in both
(c) This section shall not apply with
subpart F of this part and § 1.31 of this tabular and narrative formats. The swap
respect to a transaction that is:
chapter and make them available to (1) Initiated on a swap execution dealer or major swap participant shall
applicable prudential regulators, upon disclose all material assumptions and
facility; and
request. (2) One in which the swap dealer or explain the calculation methodologies
major swap participant does not know used to perform the required analysis;
§§ 23.403–23.409 [Reserved]
the identity of the counterparty to the provided that, the swap dealer or major
§ 23.410 Prohibition on fraud, transaction. swap participant is not required to
manipulation and other abusive practices. disclose confidential, proprietary
(a) It shall be unlawful for a swap § 23.431 Disclosures of material information about any model it may use
dealer or major swap participant– information. to value the swap.
(1) To employ any device, scheme, or (a) At a reasonably sufficient time (v) In designing the scenario analysis
artifice to defraud any Special Entity or prior to entering into a swap, a swap required by paragraphs (a)(1)(i) and
prospective customer who is a Special dealer or major swap participant shall (a)(1)(ii) of this section, a swap dealer or
Entity; disclose to any counterparty to the swap major swap participant shall consider
(2) To engage in any transaction, (other than a swap dealer, major swap any relevant analyses that it undertakes
practice, or course of business that participant, security-based swap dealer for its own risk management purposes,
operates as a fraud or deceit on any or major security-based swap including analyses performed as part of
Special Entity or prospective customer participant) material information its ‘‘New Product Policy’’ specified in
who is a Special Entity; or concerning the swap in a manner § 23.600(c)(3);
(2) The material characteristics of the major swap participant would agree to or trading strategy, and any other
particular swap, which shall include the replace or terminate the swap; information known by the swap dealer
material economic terms of the swap, (B) Depending upon the agreement of or major swap participant.
the terms relating to the operation of the the parties, calls for margin may be (b)(1) A swap dealer or major swap
swap and the rights and obligations of based on considerations other than the participant will fulfill its obligations
the parties during the term of the swap; daily mark provided to the under paragraph (a) of this section if:
and counterparty; and (i) The swap dealer has a reasonable
(3) The material incentives and (C) The daily mark may not basis to believe that the counterparty is
conflicts of interest that the swap dealer necessarily be the value of the swap that capable of evaluating, independently,
or major swap participant may have in is marked on the books of the swap the risks related to a particular swap or
connection with the particular swap, dealer or major swap participant. trading strategy involving swaps
which shall include: recommended to the counterparty;
(i) With respect to disclosure of the § 23.432 Clearing. (ii) The counterparty affirmatively
price of a swap, the price of the swap (a) For swaps required to be cleared— indicates that it is exercising
and the mid-market value of the swap right to select derivatives clearing independent judgment in evaluating the
as defined in paragraph (c)(2) of this organization. A swap dealer or major recommendations; and
section; and swap participant shall notify any (iii) The swap dealer has a reasonable
(ii) Any compensation or other counterparty (other than a registered basis to believe that the counterparty
incentive from any source other than the swap dealer, securities-based swap has the capacity to absorb potential
counterparty that the swap dealer or dealer, major swap participant or major losses related to the recommended swap
major swap participant may receive in securities-based swap participant) that or trading strategy involving swaps.
connection with the swap. enters into a swap or is offered to enter (2) Provided that, where a
(b) Paragraph (a) of this section shall into a swap that is subject to mandatory counterparty has delegated
not apply with respect to a transaction clearing under Section 2(h) of the Act, discretionary authority to another
that is: that the counterparty has the sole right person, such as a registered commodity
(1) Initiated on a designated contract to select the derivatives clearing trading advisor, the factors contained in
market or a swap execution facility; and organization at which the swap will be paragraphs (b)(1)(i) and (b)(1)(ii) of this
(2) One in which the swap dealer or cleared. section shall be applied to such person.
major swap participant does not know (b) For swaps not required to be (c) This section shall not apply:
the identity of the counterparty to the cleared—right to clearing. A swap (1) To any recommendations made to
transaction. dealer or major swap participant shall another swap dealer, major swap
(c) Daily mark. A swap dealer or notify any counterparty (other than a participant, security-based swap dealer,
major swap participant shall: registered swap dealer, securities-based or major security-based swap
(1) For cleared swaps, notify a swap dealer, major swap participant or participant; or
counterparty of the counterparty’s right major securities-based swap participant) (2) Where a swap dealer or major
to receive, upon request, the daily mark that enters into a swap that is not swap participant provides:
from the appropriate derivatives subject to the mandatory clearing (i) Information that is general
clearing organization; and requirements under Section 2(h) of the transaction, financial, or market
(2) For uncleared swaps, provide the Act that the counterparty: information; or
counterparty with a daily mark which (1) May elect to require clearing of the (ii) Swap terms in response to a
shall be the mid-market value of the swap, and competitive bid request from the
swap. The mid-market value of the swap (2) Shall have the sole right to select counterparty.
shall not include amounts for profit, the derivatives clearing organization at §§ 23.435–23.439 [Reserved]
credit reserve, hedging, funding, which the swap will be cleared.
liquidity or any other costs or § 23.440 Requirements for swap dealers
adjustments. The daily mark shall be § 23.433 Communications—fair dealing. acting as advisors to special entities.
provided to the counterparty on each With respect to any communication (a) For purposes of this section the
business day during the term of the between a swap dealer or major swap term ‘‘acts as an advisor to a Special
swap as of the close of business, or such participant and any counterparty, the Entity’’ shall include where a swap
other time as the parties agree in swap dealer or major swap participant dealer recommends a swap or trading
writing. shall communicate in a fair and strategy that involves the use of swaps
(3) For uncleared swaps, disclose to balanced manner based on principles of to a Special Entity. The term shall not
the counterparty: fair dealing and good faith. include where a swap dealer provides:
(i) The methodology and assumptions (1) Information to a Special Entity that
used to prepare the daily mark and any § 23.434 Recommendations to is general transaction, financial, or
material changes during the term of the counterparties—institutional suitability.
market information or
swap, provided that, the swap dealer or (a) A swap dealer or major swap (2) Swap terms in response to a
major swap participant is not required participant shall have a reasonable basis competitive bid request from the Special
to disclose to the counterparty to believe that any swap or trading Entity.
confidential, proprietary information strategy involving swaps recommended (b) A swap dealer that acts as an
about any model it may use to prepare to a counterparty is suitable for the advisor to a Special Entity regarding a
the daily mark. counterparty based on information swap shall comply with the following
(ii) Additional information obtained through reasonable due requirements:
concerning the daily mark to ensure a diligence concerning the counterparty’s (1) Duty. Any swap dealer that acts as
fair and balanced communication, financial situation and needs, an advisor to a Special Entity shall have
including, as appropriate: objectives, tax status, ability to evaluate a duty to act in the best interests of the
(A) The daily mark may not the recommendation, liquidity needs, Special Entity.
necessarily be a price at which either risk tolerance, ability to absorb potential (2) Reasonable Efforts. Any swap
the counterparty or the swap dealer or losses related to the recommended swap dealer that acts as an advisor to a
Special Entity shall make reasonable §§ 23.441–23.449 [Reserved] contributions imposed by the
efforts to obtain such information as is Commission, the Securities and
§ 23.450 Requirements for swap dealers
necessary to make a reasonable and major swap participants acting as
Exchange Commission or a self-
determination that any swap or trading counterparties to special entities. regulatory organization subject to the
strategy involving a swap recommended jurisdiction of the Commission or the
(a) Definitions. For purposes of this
by the swap dealer is in the best Securities and Exchange Commission,
section:
interests of the Special Entity. This (1) The term ‘‘material business provided that, this paragraph shall not
information shall include information relationship’’ means any relationship apply if the representative is an
relating to: with a swap dealer or major swap employee of the Special Entity.
(i) The authority of the Special Entity participant, whether compensatory or (c) For purposes of paragraph (b)(3) of
to enter into a swap; otherwise, that reasonably could affect this section, a representative of a
(ii) The financial status of the Special the independent judgment or decision Special Entity will be deemed to be
Entity, as well as future funding needs; making of the representative, provided independent of the swap dealer or major
(iii) The tax status of the Special however, that material business swap participant if:
Entity; relationship does not include payment (1) The representative is not and,
(iv) The investment or financing of fees by the swap dealer or major swap within one year, was not an associated
objectives of the Special Entity participant to the representative at the person of the swap dealer or major swap
(including review of any written written direction of the Special Entity participant, within the meaning of
derivatives, financing and investment for services provided by the Section 1a(4) of the Act;
policies, plans or similar documents); representative in connection with the (2) There is no principal relationship
(v) The experience of the Special swap executed between the Special between the representative of the
Entity with respect to entering into Entity and the swap dealer or major Special Entity and the swap dealer or
swaps, generally, and swaps of the type swap participant. The term ‘‘material major swap participant; and
and complexity being recommended; business relationship’’ shall be subject to (3) The representative does not have
(vi) Whether the Special Entity has an a one-year look back; and a material business relationship with
independent representative that meets (2) The term ‘‘principal relationship’’ the swap dealer or major swap
the criteria enumerated in § 23.450(b); means where a swap dealer or major participant, provided however, that if
(vii) Whether the Special Entity has swap participant is a principal of the the representative received any
the financial capability to withstand representative of a Special Entity or the compensation from the swap dealer or
potential market-related changes in the representative of a Special Entity is a major swap participant, the swap dealer
value of the swap during the term of the principal of the swap dealer or major or major swap participant must ensure
swap; and swap participant, as the term ‘‘principal’’ that the Special Entity is informed of the
(viii) Such other information as is is defined in § 3.1(a) of this chapter; compensation and the Special Entity
relevant to the particular facts and (3) The term ‘‘statutory agrees in writing, in consultation with
circumstances of the Special Entity, disqualification’’ means grounds for the representative, that the
market conditions and the type of swap refusal to register or to revoke, condition compensation does not constitute a
recommended. or restrict the registration of any material business relationship.
(c) Reasonable reliance on registrant or applicant for registration as (d) Reasonable reliance on
representations of the Special Entity. set forth in Sections 8a(2) and 8a(3) of representations of the Special Entity. A
The swap dealer may rely on written the Act. swap dealer may rely on written
representations of the Special Entity to (b) Any swap dealer or major swap representations of a Special Entity to
satisfy its requirement in paragraph (b) participant that offers to or enters into satisfy its obligation to have a
of this section to make ‘‘reasonable a swap with a Special Entity shall have reasonable basis to believe that the
efforts’’ to obtain necessary information, a reasonable basis to believe that the Special Entity has a representative that
provided that: Special Entity has a representative that: satisfies the criteria in paragraph (b) of
(1) The swap dealer has a reasonable (1) Has sufficient knowledge to this section provided that:
basis to believe that the representations evaluate the transaction and risks; (1) The swap dealer has a reasonable
are reliable taking into consideration the (2) Is not subject to a statutory basis to believe that the representations
facts and circumstances of a particular disqualification; are reliable taking into consideration the
swap dealer-Special Entity relationship, (3) Is independent of the swap dealer facts and circumstances of a particular
assessed in the context of a particular or major swap participant; Special Entity-representative
transaction; and (4) Undertakes a duty to act in the relationship, assessed in the context of
(2) The representations include best interests of the Special Entity it a particular transaction;
information sufficiently detailed for the represents; (2) The representations include
swap dealer to reasonably conclude that (5) Makes appropriate and timely information sufficiently detailed for the
the Special Entity is: disclosures to the Special Entity; swap dealer reasonably to conclude that
(i) Capable of evaluating (6) Evaluates, consistent with any the representative satisfies the criteria in
independently the material risks guidelines provided by the Special paragraph (b) of this section. Relevant
inherent in the recommendation; Entity, fair pricing and the considerations would include:
(ii) Exercising independent judgment appropriateness of the swap; (i) The nature of the relationship
in evaluating the recommendation; and (7) In the case of employee benefit between the Special Entity and the
(iii) Capable of absorbing potential plans subject to the Employee representative and the duties of the
losses related to the recommended Retirement Income Security Act of 1974, representative, including the obligation
swap; and is a fiduciary as defined in Section 3 of of the representative to act in the best
(3) The swap dealer has a reasonable that Act (29 U.S.C. 1002); and interests of the Special Entity;
basis to believe that the Special Entity (8) In the case of a municipal entity (ii) The representative’s capability to
has a representative that meets the as defined in § 23.451, is subject to make hedging or trading decisions, and
criteria enumerated in § 23.450(b). restrictions on certain political the resources available to the
representative to make informed (2) The term ‘‘covered associate’’ (7) The term ‘‘solicit’’ means a direct
decisions; means: or indirect communication by any
(iii) The use by the representative of (i) Any general partner, managing person with a municipal entity for the
one or more consultants; member or executive officer, or other purpose of obtaining or retaining an
(iv) The general level of experience of person with a similar status or function; engagement related to a swap.
the representative in financial markets (ii) Any employee who solicits a (b) Prohibitions and Exceptions.
and specific experience with the type of municipal entity for the swap dealer or (1) As a means reasonably designed to
instruments, including the specific asset major swap participant and any person prevent fraud, no swap dealer or major
class, under consideration; who supervises, directly or indirectly, swap participant shall offer to enter into
(v) The representative’s ability to such employee; and or enter into a swap or a trading strategy
understand the economic features of the (iii) Any political action committee involving a swap with a municipal
swap involved; controlled by the swap dealer or major entity within two years after any
(vi) The representative’s ability to swap participant or by any person contribution to an official of such
evaluate how market developments described in paragraphs (a)(2)(i) and municipal entity was made by the swap
would affect the swap; and (a)(2)(ii) of this section. dealer or major swap participant, or by
(vii) The complexity of the swap or (3) The term ‘‘municipal entity’’ means
any covered associate of the swap dealer
swaps involved. any State, political subdivision of a
or major swap participant, provided
(e) Unqualified representative. If a State, or municipal corporate
however, that:
swap dealer or major swap participant instrumentality of a State, including—
(i) Any agency, authority, or (2) This prohibition does not apply:
determines that the representative of a
Special Entity does not meet the criteria instrumentality of the State, political (i) If the only contributions made by
established in this section, the swap subdivision, or municipal corporate the swap dealer or major swap
dealer or major swap participant shall instrumentality; participant to an official of such
make a written record of the basis for (ii) Any plan, program, or pool of municipal entity were made by a
such determination and submit such assets sponsored or established by the covered associate:
determination to its Chief Compliance State, political subdivision, or (A) To officials for whom the covered
Officer for review to ensure that the municipal corporate instrumentality or associate was entitled to vote at the time
swap dealer or major swap participant any agency, authority, or of the contributions, provided that the
has a substantial, unbiased basis for the instrumentality thereof; and any other contributions in the aggregate do not
determination. issuer of municipal securities. exceed $350 to any one official per
(f) Before the initiation of a swap, a (4) The term ‘‘official’’ of a municipal election; or
swap dealer or major swap participant entity means any person (including any (B) To officials for whom the covered
shall disclose to the Special Entity in election committee for such person) associate was not entitled to vote at the
writing: who was, at the time of the contribution, time of the contributions, provided that
(1) The capacity in which it is acting an incumbent, candidate or successful the contributions in the aggregate do not
in connection with the swap; and candidate for elective office of a exceed $150 to any one official, per
(2) If the swap dealer or major swap municipal entity, if the office: election;
participant engages in business with the (i) Is directly or indirectly responsible (ii) To a swap dealer or major swap
Special Entity in more than one for, or can influence the outcome of, the participant as a result of a contribution
capacity, the swap dealer or major swap selection of a swap dealer or major swap made by a natural person more than six
participant shall disclose the material participant by a municipal entity; or months prior to becoming a covered
differences between such capacities in (ii) Has authority to appoint any associate of the swap dealer or major
connection with the swap and any other person who is directly or indirectly swap participant, provided that this
financial transaction or service responsible for, or can influence the exclusion shall not apply if the natural
involving the Special Entity. outcome of, the selection of a swap person, after becoming a covered
(g) This section shall not apply with dealer or major swap participant by a associate, solicits the municipal entity
respect to a transaction that is: municipal entity. on behalf of the swap dealer or major
(1) Initiated on a designated contract (5) The term ‘‘payment’’ means any swap participant to offer to enter into or
market or swap execution facility; and gift, subscription, loan, advance, or to enter into a swap or trading strategy
(2) One in which the swap dealer or deposit of money or anything of value. involving; or
major swap participant does not know (6) The term ‘‘regulated person’’
means: (iii) With respect to a swap that is
the identity of the counterparty to the initiated on a designated contract
transaction. (i) A person that is subject to
restrictions on certain political market or swap execution facility if the
§ 23.451 Political contributions by certain contributions imposed by the swap dealer or major swap participant
swap dealers and major swap participants. Commission, the Securities and does not know the identity of the
(a) Definitions. For the purposes of Exchange Commission or a self- counterparty to the transaction at the
this section: regulatory agency subject to the time of the transaction.
(1) The term ‘‘contribution’’ means any jurisdiction of the Commission or the (3) No swap dealer or major swap
gift, subscription, loan, advance, or Securities and Exchange Commission; participant or any covered associate of
deposit of money or anything of value (ii) A general partner, managing the swap dealer or major swap
made: member or executive officer of such participant shall:
(i) For the purpose of influencing any person, or other individual with a (i) Provide or agree to provide,
election for state or local office; similar status or function; or directly or indirectly, payment to any
(ii) For payment of debt incurred in (iii) An employee of such person who person to solicit a municipal entity to
connection with any such election; or solicits a municipal entity for the swap offer to enter into, or to enter into, a
(iii) For transition or inaugural dealer or major swap participant and swap with that swap dealer or major
expenses incurred by the successful any person who supervises, directly or swap participant unless such person is
candidate for state or local office. indirectly, such employee. a regulated person; or
(ii) Coordinate, or solicit any person circumstances surrounding the (1) The character of the market for the
or political action committee to make, contribution. swap, including price, volatility, speed,
any: (e) Prohibitions Inapplicable. (1) The certainty of execution, and liquidity;
(A) Contribution to an official of a prohibitions under paragraph (b) of this (2) The size and type of transaction;
municipal entity with which the swap section shall not apply to a contribution
dealer or major swap participant is made by a covered associate of the swap (3) The number of markets checked;
offering to enter into, or has entered dealer or major swap participant if: (4) Accessibility of quotations; and
into, a swap; or (i) The swap dealer or major swap (5) The terms and conditions of the
(B) Payment to a political party of a participant discovered the contribution order which results in the transaction,
state or locality with which the swap within 120 calendar days of the date of as communicated to the Commission
dealer or major swap participant is such contribution; registrant.
offering to enter into or has entered into (ii) The contribution did not exceed
a swap or a trading strategy involving a the amounts permitted by paragraphs By the Commission, this 9th day of
swap. (b)(2)(i)(A) or (B) of this section; and December 2010.
(c) Circumvention of Rule. No swap (iii) The covered associate obtained a David A. Stawick,
dealer or major swap participant shall, return of the contribution within 60 Secretary.
directly or indirectly, through or by any calendar days of the date of discovery of
Appendices to Business Conduct
other person or means, do any act that the contribution by the swap dealer or
Standards for Swap Dealers and Major
would result in a violation of paragraph major swap participant.
Swap Participants With
(b) of this section. (2) A swap dealer or major swap
Counterparties—Commission Voting
(d) Requests for Exemption. The participant may not rely on paragraph
Summary and Statements of
Commission, upon application, may (e)(1) of this section more than twice in
Commissioners
conditionally or unconditionally any 12-month period.
exempt a swap dealer or major swap (3) A swap dealer or major swap Note: The following appendices will not
participant from the prohibition under participant may not rely on paragraph appear in the Code of Federal Regulations.
paragraph (b) of this section. In (e)(1) of this section more than once for
determining whether to grant an any covered associate, regardless of the Appendix 1—Commission Voting
exemption, the Commission will time between contributions. Summary
consider, among other factors:
(1) Whether the exemption is PART 155—TRADING STANDARDS On this matter, Chairman Gensler and
Commissioners Dunn, Sommers, Chilton and
necessary or appropriate in the public Authority and Issuance O’Malia voted in the affirmative; no
interest and consistent with the Commissioner voted in the negative.
protection of investors and the purposes 3. The authority citation for part 155
of the Act; shall be revised to read as follows: Appendix 2—Statement of Chairman
(2) Whether the swap dealer or major Authority: 7 U.S.C. 6b, 6c, 6g, 6j, 6s, and Gary Gensler
swap participant: 12a as amended by Title VII of the Dodd-
I support the proposed rulemaking to
(i) Before the contribution resulting in Frank Wall Street Reform and Consumer
establish business conduct standards for
the prohibition was made, adopted and Protection Act, Pub. L. 111–203, 124 Stat.
swap dealers and major swap participants in
implemented policies and procedures 1376 (Jul. 21, 2010).
their dealings with counterparties. Today’s
reasonably designed to prevent 4. Add § 155.7 to read as follows: proposal implements important new
violations of this section; authorities that Congress granted the
(ii) Prior to or at the time the § 155.7 Execution standards. Commission to establish and enforce robust
contribution which resulted in such (a) In connection with any customer sales practices in the swap markets. The
prohibition was made, had no actual order to enter into a swap where such proposed rule will level the playing field and
knowledge of the contribution; and swap is available for trading on one or bring needed transparency. It will strengthen
(iii) After learning of the contribution: more designated contract markets or confidence in the market to benefit hedgers
(A) Has taken all available steps to swap execution facilities, a Commission and other market participants.
cause the contributor involved in registrant shall: The proposed rule would prohibit fraud
(1) Prior to execution of the swap, and certain abusive practices. It also would
making the contribution which resulted
implement requirements for swap dealers
in such prohibition to obtain a return of disclose to the customer:
and major swap participants to deal fairly
the contribution; and (i) The designated contract markets with customers, provide balanced
(B) Has taken such other remedial or and swap execution facilities on which communications and disclose conflicts of
preventive measures as may be the swap is available for trading; and interest and material incentives before
appropriate under the circumstances; (ii) The designated contract markets entering into a swap. The rule also would
(3) Whether, at the time of the and swap execution facilities on which implement the Dodd-Frank heightened duties
contribution, the contributor was a the registrant has trading privileges. on swap dealers and major swap participants
covered associate or otherwise an (2) Execute the order on terms that when they deal with certain entities, such as
employee of the swap dealer or major have a reasonable relationship to the pension plans, governmental entities and
swap participant, or was seeking such best terms available for such swap on endowments.
employment; designated contract markets or swap The proposed rule is intended to ensure
(4) The timing and amount of the execution facilities trading such swap. that swaps customers get fair treatment in the
contribution which resulted in the (b) As part of the execution execution of their transactions. It would
requirements in paragraph (a) of this require swap dealers to disclose what access
prohibition; they have to swap execution facilities and
(5) The nature of the election (e.g., section, the registrant shall use designated contract markets. These rules also
Federal, State or local); and reasonable diligence to ascertain the prohibit a swap dealer from defrauding a
(6) The contributor’s apparent intent best terms available. Among the factors customer by executing a transaction on terms
or motive in making the contribution that will be considered in determining that have no ‘‘reasonable relationship’’ to the
that resulted in the prohibition, as whether a Commission registrant has market. The proposed rule provides
evidenced by the facts and used ‘‘reasonable diligence’’ are: flexibility to accommodate developments in
the swaps markets while also protecting

customers.
[FR Doc. 2010–31588 Filed 12–21–10; 8:45 am]
BILLING CODE 6351–01–P

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8 Id. (proposed § 23.601 imposing requirements

Finally, as set forth in proposed financial condition resulting from adverse

significantly increase counterparty risk exposure in volatilities.

FINRA Proposed Suitability Rule, 75 FR 52562,

101) for purposes of ERISA).

131 See ‘‘Political Contributions by Certain

Investment Advisers,’’ Release No. IA–3043 (Jul. 1,

Request for Comment: The political subdivision or any agency, authority or

the swaps markets while also protecting

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