BCS Adopting Release - 81 FR 29959 (May 13, 2016)

Vol. 81

Friday,

No. 93

May 13, 2016

Part II

Securities and Exchange Commission

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17 CFR Part 240
Business Conduct Standards for Security-Based Swap Dealers and Major
Security-Based Swap Participants; Final Rule

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations

SECURITIES AND EXCHANGE
COMMISSION
17 CFR Part 240
[Release No. 34–77617; File No. S7–25–11]
RIN 3235–AL10

Business Conduct Standards for
Security-Based Swap Dealers and
Major Security-Based Swap
Participants
Securities and Exchange
Commission.
ACTION: Final rule.
AGENCY:

In accordance with Section
764 of Title VII (‘‘Title VII’’) of the
Dodd-Frank Wall Street Reform and
Consumer Protection Act (the ‘‘DoddFrank Act’’), the Securities and
Exchange Commission (‘‘SEC’’ or
‘‘Commission’’) is adopting new rules
under the Securities Exchange Act of
1934 (‘‘Exchange Act’’) that are intended
to implement provisions of Title VII
relating to business conduct standards
and the designation of a chief
compliance officer for security-based
swap dealers and major security-based
swap participants. The final rules also
address the cross-border application of
the rules and the availability of
substituted compliance.
DATES: Effective Date: July 12, 2016.
Compliance Date: The compliance
dates are discussed in Section IV.B of
this release.
FOR FURTHER INFORMATION CONTACT:
Lourdes Gonzalez, Assistant Chief
Counsel—Sales Practices, Joanne
Rutkowski, Senior Special Counsel,
Cindy Oh, Special Counsel, Lindsay
Kidwell, Special Counsel, Stacy Puente,
Special Counsel, Devin Ryan, Special
Counsel, Office of Chief Counsel,
Division of Trading and Markets, at
(202) 551–5550, at the Securities and
Exchange Commission, 100 F Street NE.,
Washington, DC 20549. For further
information on cross-border application
of the rules, contact: Carol McGee,
Assistant Director, Richard Gabbert,
Senior Special Counsel, Joshua Kans,
Senior Special Counsel, and Margaret
Rubin, Special Counsel, Office of
Derivatives Policy, Division of Trading
and Markets, at (202) 551–5550, at the
Securities and Exchange Commission,
100 F Street NE., Washington, DC
20549.

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SUMMARY:

SUPPLEMENTARY INFORMATION:

Table of Contents
I. Introduction
A. Summary of Final Rules
B. Cross-Border Application of the Final
Rules

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C. Consistency With CFTC Rules
D. Department of Labor ERISA Fiduciary
Regulations
E. Investment Adviser and Municipal
Advisor Status
F. Intersection With SRO Rules
II. Discussion of Rules Governing Business
Conduct
A. Scope, Generally
B. Exceptions for Anonymous SEF or
Exchange-Traded Transactions
C. Application of the Rules to SBS Dealers
and Major SBS Participants
D. Reliance on Representations
E. Policies and Procedures Alternative
F. Definitions
G. Business Conduct Requirements
1. Counterparty Status
2. Disclosure
a. Disclosure Not Required When the
Counterparty Is an SBS Entity or a Swap
Entity
b. Timing and Manner of Certain
Disclosures and Scope of Disclosure
Rules
c. Material Risks and Characteristics of the
Security-Based Swap
d. Material Incentives or Conflicts of
Interest
e. Daily Mark
f. Clearing Rights
3. Know Your Counterparty
4. Recommendations by SBS Dealers
5. Fair and Balanced Communications
6. Obligation Regarding Diligent
Supervision
H. Rules Applicable to Dealings With
Special Entities
1. Scope of Definition of ‘‘Special Entity’’
2. ‘‘Acts as an Advisor’’ to a Special Entity
3. Definition of ‘‘Best Interests’’
4. Antifraud Provisions
5. SBS Entities Acting as Counterparties to
Special Entities
6. Qualifications of the Independent
Representative
a. Written or Other Representations
Regarding Qualifications
b. Sufficient Knowledge To Evaluate
Transaction and Risks
c. No Statutory Disqualification
d. Undertakes a Duty To Act in the Best
Interests of the Special Entity
e. Makes Appropriate and Timely
Disclosures to Special Entity
f. Pricing and Appropriateness
g. Subject to ‘‘Pay To Play’’ Prohibitions
h. ERISA Fiduciary
i. Safe Harbor
7. Disclosure of Capacity
8. Exceptions for Anonymous, Special
Entity Transactions on an Exchange or
SEF
9. Certain Political Contributions by SBS
Dealers
I. Chief Compliance Officer
J. Prime Brokerage Transactions
K. Other Comments
III. Cross-Border Application and Availability
of Substituted Compliance
IV. Explanation of Dates
A. Effective Date
B. Compliance Date
C. Application to Substituted Compliance
V. Paperwork Reduction Act
VI. Economic Analysis

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A. Introduction and Broad Economic
Considerations
B. Baseline
1. Available Data Regarding Security-Based
Swap Activity
2. Security-Based Swap Market: Market
Participants and Dealing Structures
a. Security-Based Swap Market
Participants
b. Participant Domiciles
c. Market Centers
d. Common Business Structures for Firms
Engaged in Security-Based Swap Dealing
Activity
e. Current Estimates of Number of SBS
Dealers and Major SBS Participants
3. Security-Based Swap Market: Levels of
Security-Based Swap Trading Activity
4. Global Regulatory Efforts
5. Dually Registered Entities
6. Cross-Market Participation
7. Pay To Play Prohibitions
C. Costs and Benefits of Business Conduct
Rules
1. Verification of Status and Know Your
Counterparty Rules
2. Disclosures and Communications
a. Risks, Characteristics, and Conflicts of
Interest
b. Daily Mark
c. Clearing Rights
3. Suitability
a. Costs and Benefits
b. Institutional Suitability Alternative
4. Special Entities
a. Scope and Verification
b. SBS Entities as Counterparties to Special
Entities
c. SBS Dealers as Advisors to Special
Entities
d. Independent Representation:
Alternatives
e. Reliance on Representations
f. Magnitude of the Economic Effects
5. Fraud, Fair and Balanced
Communications, Supervision
a. Antifraud
b. Fair and Balanced Communications
c. Supervision
6. CCO Rules
a. Annual Compliance Report, Conflicts of
Interest, Policies and Procedures
b. CCO Removal and Compensation
7. Pay To Play
8. Scope
a. Inter-Affiliate Transactions
b. Opt Out
9. Cross-Border Application
a. Scope of Application to SBS Entities
b. Substituted Compliance
D. Effects on Efficiency, Competition and
Capital Formation
VII. Regulatory Flexibility Act Certification
Statutory Basis and Text of Final Rules

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

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Dealers, ‘‘SBS Entities’’) as set forth in
Title VII of the Dodd-Frank Act.1 The
Commission is also amending Rules
3a67–10 and 3a71–3 and adopting Rule
3a71–6 with respect to the cross-border
application of the rules and the
availability of substituted compliance.
The Dodd-Frank Act was enacted,
among other reasons, to promote the
financial stability of the United States
by improving accountability and
transparency in the financial system.2
The 2008 financial crisis highlighted
significant issues in the over-thecounter derivatives markets, which
experienced dramatic growth in the
years leading up to the financial crisis
and are capable of affecting significant
sectors of the U.S. economy. Title VII of
the Dodd-Frank Act provides for a
comprehensive new regulatory
framework for swaps and security-based
swaps by, among other things: (1)
Providing for the registration and
comprehensive regulation of SBS
Entities, swap dealers (‘‘Swap Dealers’’),
and major swap participants (‘‘Major
Swap Participants’’ and, together with
Swap Dealers, ‘‘Swap Entities’’); (2)
imposing clearing and trade execution
requirements for swaps and securitybased swaps, subject to certain
exceptions; (3) creating recordkeeping,
regulatory reporting, and public
dissemination requirements for swaps
and security-based swaps; and (4)
enhancing the rulemaking and
enforcement authorities of the
Commission and the Commodity
Futures Trading Commission (‘‘CFTC’’).
The Commission initially proposed
Rules 15Fh–1 through 15Fh–6 and Rule
15Fk–1 in June 2011.3 In May 2013, the
Commission re-opened the comment
period for all of its outstanding Title VII
rulemakings, including the external
business conduct rulemaking.4
The Commission received 40
comments on the Proposing Release, of
which 9 were comments submitted in
response to the Reopening Release.5 Of
1 Dodd-Frank Wall Street Reform and Consumer
Protection Act, Public Law 111–203, 124 Stat. 1376
(2010).
2 See Public Law 111–203, Preamble.
3 See Business Conduct Standards for SecurityBased Swap Dealers and Major Security-Based
Swap Participants, Exchange Act Release No. 64766
(Jun. 29, 2011), 76 FR 42396 (Jul. 18, 2011)
(‘‘Proposing Release’’).
4 See Reopening of Comment Periods for Certain
Rulemaking Releases and Policy Statement
Applicable to Security-Based Swaps Proposed
Pursuant to the Securities Exchange Act of 1934
and the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Exchange Act Release No.
69491 (May 1, 2013), 78 FR 30800 (May 23, 2013)
(‘‘Reopening Release’’).
5 See letters from Kenneth M. Fisher, Senior Vice
President and Chief Financial Officer, Noble
Energy, dated July 7, 2011 (‘‘Noble’’); Chris Barnard,

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dated Aug. 10, 2011 (‘‘Barnard’’); R. Glenn Hubbard,
Co-Chair, Committee on Capital Markets
Regulation, John L. Thornton, Co-Chair, Committee
on Capital Markets Regulation, and Hal S. Scott,
Director, Committee on Capital Markets Regulation,
dated Aug. 26, 2011 (‘‘CCMR’’); John F. Damgard,
President, Futures Industry Association, Robert
Pickel, Executive Chairman, International Swaps
and Derivatives Association, Inc., and Kenneth E.
Bentsen, Jr., Executive Vice President, Public Policy
and Advocacy, Securities Industry and Financial
Markets Association, dated Aug. 26, 2011 (‘‘FIA/
ISDA/SIFMA’’); Gerald W. McEntee, President,
American Federation of State, County and
Municipal Employees, dated Aug. 29, 2011
(‘‘AFSCME’’); Mark Hepsworth, President,
Institutional Business, Interactive Data Corporation,
dated Aug. 29, 2011 (‘‘IDC’’); Sen. Carl Levin, U.S.
Senate, dated Aug. 29, 2011 (‘‘Levin’’); Susan N.
Kelly, Senior Vice President of Policy Analysis and
General Counsel, American Public Power
Association, and Noreen Roche-Carter, Chair, Tax
and Finance Task Force, Large Public Power
Council, dated Aug. 29, 2011 (‘‘APPA’’); Stuart J.
Kaswell, Executive Vice President & Managing
Director, General Counsel, Managed Funds
Association, dated Aug. 29, 2011 (‘‘MFA’’); Dennis
M. Kelleher, President & CEO, and Stephen W. Hall,
Securities Specialist, Better Markets, Inc., dated
Aug. 29, 2011 (‘‘Better Markets (August 2011)’’);
Christopher A. Klem and Molly Moore, Ropes &
Gray LLP, dated Aug. 29, 2011 (‘‘Ropes & Gray’’);
Joanne T. Medero, BlackRock, Inc., dated Aug. 29,
2011 (‘‘BlackRock’’); Joseph Dear, Chief Investment
Officer, California Public Employees’ Retirement
System, Jennifer Paquette, Chief Investment Officer,
Colorado PERA, Keith Bozarth, Executive Director,
State of Wisconsin Investment Board, Brian
Guthrie, Executive Director, Teacher Retirement
System of Texas, and Rick Dahl, Chief Investment
Officer, Missouri State Employees’ Retirement
System, dated Aug. 29, 2011 (‘‘CalPERS (August
2011)’’); Barbara Roper, Director of Investor
Protection, Consumer Federation of America,
Marcus Stanley, Policy Director, Americans for
Financial Reform, and Michael Greenberger, Law
School Professor and Founder & Director,
University of Maryland Center for Health &
Homeland Security, dated Aug. 29, 2011 (‘‘CFA’’);
American Benefits Council, dated Aug. 29, 2011
(‘‘ABC’’); Jeff Gooch, Chief Executive Officer,
MarkitSERV, dated Aug. 29, 2011 (‘‘MarkitSERV’’);
Timothy W. Cameron, Esq. Managing Director,
Asset Management Group, Securities Industry and
Financial Markets Association, dated Aug. 29, 2011
(‘‘SIFMA (August 2011)’’); John D. Walda, President
and Chief Executive Officer, National Association of
College and University Business Officers, dated
Aug. 29, 2011 (‘‘NACUBO’’); Kevin Gould,
President, Markit North America, Inc., dated Aug.
29, 2011 (‘‘Markit’’); Daniel F. C. Crowley, Partner,
K&L Gates LLP, on behalf of the Church Alliance,
dated Aug. 29, 2011 (‘‘Church Alliance (August
2011)’’); Christopher J. Ailman, California State
Teachers’ Retirement System, dated Aug. 30, 2011
(‘‘CalSTRS’’); John M. McNally, National
Association of Bond Lawyers, dated Sept. 1, 2011
(‘‘NABL’’); Colette J. Irwin-Knott, National
Association of Independent Public Finance
Advisors, dated Sept. 6, 2011 (‘‘NAIPFA’’); ABA
Securities Association, American Council of Life
Insurers, Financial Services Roundtable, Futures
Industry Association, Institute of International
Bankers, International Swaps and Derivatives
Association, and Securities Industry and Financial
Markets Association, dated Sept. 8, 2011 (‘‘ABA
Securities Association’’); Kent A. Mason, Davis &
Harman LLP, dated Sept. 15, 2011 (‘‘Mason’’);
Senator Tim Johnson, Chairman, U.S. Senate
Committee on Banking, Housing, and Urban Affairs,
and Representative Barney Frank, U.S. House
Committee on Financial Services, dated Oct. 4,
2011 (‘‘Johnson’’); Lawrence B. Patent, K&L Gates
LLP, on behalf of the Church Alliance, dated Oct.

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the comments directed at the CrossBorder Proposing Release,6 five
referenced the proposed external
business conduct standards
specifically,7 while others addressed
cross-border issues generally, such as
the application of substituted
4, 2011 (‘‘Church Alliance (October 2011)’’); Joseph
Dear, Chief Investment Officer, California Public
Employees’ Retirement System et al., dated Oct. 4,
2011 (‘‘CalPERS (October 2011)’’); Susan Gaffney
Director, Federal Liaison Center, Government
Finance Officers Association, dated Oct. 31, 2011
(‘‘GFOA’’); Jeffery W. Rubin, Chair, Federal
Regulation of Securities Committee, American Bar
Association Business Law Section and Nir D.
Yarden, Chair, Institutional Investors Committee,
American Bar Association, dated Dec. 7, 2011
(‘‘ABA Committees’’); Bruce E. Stern, Chairman,
Association of Financial Guaranty Insurers, dated
Sept. 17, 2012 (‘‘AFGI (September 2012)’’);
Financial Services Roundtable, Future Industry
Association, Institute of International Bankers,
International Swaps and Derivatives Association,
Investment Company Institute, Securities Industry
and Financial Markets Association, dated May 21,
2013 (‘‘Financial Services Roundtable’’); Bruce E.
Stern, Chairman, Association of Financial Guaranty
Insurers, dated July 22, 2013 (‘‘AFGI (July 2013)’’);
Robert Pickel, Executive Vice Chairman,
International Swaps and Derivatives Association,
Inc., dated July 22, 2013 (‘‘ISDA (July 2013)’’);
Dennis M. Kelleher, President and CEO, and
Stephen W. Hall, Securities Specialist, Better
Markets, Inc., dated July 22, 2013 (‘‘Better Markets
(July 2013)’’); Dennis M. Kelleher, President and
CEO, Better Markets, Inc., dated Oct. 18, 2013
(‘‘Better Markets (October 2013)’’); Angie Karna,
Managing Director, Legal, Nomura Global Financial
Products Inc., dated Sept. 10, 2014 (‘‘Nomura’’);
Kyle Brandon, Managing Director, Securities
Industry and Financial Markets Association, dated
Aug. 7, 2015 (‘‘SIFMA (August 2015)’’); Kyle
Brandon, Managing Director, Securities Industry
and Financial Markets Association, dated Sept. 23,
2015 (‘‘SIFMA (September 2015)’’); Kyle Brandon,
Managing Director, Securities Industry and
Financial Markets Association, dated Nov. 3, 2015
(‘‘SIFMA (November 2015)’’). The comments that
the Commission received on the Proposing Release
and the Reopening Release are available on the
Commission’s Web site at http://www.sec.gov/
comments/s7-25-11/s72511.shtml.
6 Cross-Border Security-Based Swap Activities;
Re-Proposal of Regulation SBSR and Certain Rules
and Forms Relating to the Registration of SecurityBased Swap Dealers and Major Security-Based
Swap Participants, Exchange Act Release No. 69490
(May 1, 2013), 78 FR 30968 (May 23, 2013) (‘‘CrossBorder Proposing Release’’).
7 See letters from Robert Pickel, International
Swaps and Derivatives Association, Inc., dated Aug.
14, 2013 (‘‘ISDA (August 2013)’’); Karrie McMillan,
General Counsel, Investment Company Institute and
Dan Waters, Managing Director, ICI Global, dated
Aug. 21, 2013 (‘‘ICI’’); Dennis M. Kelleher,
President & CEO, Better Markets, Inc., Stephen W.
Hall, Securities Specialist, Better Markets, Inc., and
Katelynn O. Bradley, Attorney, Better Markets, Inc.,
dated Aug. 21, 2013 (‘‘Better Markets (August
2013)’’); Kenneth E. Bentsen, Jr., President,
Securities Industry and Financial Markets
Association, Walt Lukken, President & Chief
Executive Officer, Futures Industry Association;
and Richard M. Whiting, Executive Director and
General Counsel, The Financial Services
Roundtable, dated Aug. 21, 2013 (‘‘SIFMA (August
2013)’’); Matti Leppa¨la¨, Secretary General/CEO,
PensionsEurope, dated Sep. 3, 2013
(‘‘PensionsEurope’’). These comment letters are
available on the Commission’s Web site at https://
www.sec.gov/comments/s7-02-13/s70213.shtml.

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compliance,8 without specifically
referring to the Proposing Release. Of
the comments submitted in response to
the U.S. Activity Proposing Release,9
eight addressed the proposed crossborder application of the business
conduct standards.10
8 See letters from Stephen Maijoor, Chair,
European Securities and Markets Authority, dated
Aug. 21, 2013 (‘‘ESMA’’); Stuart J. Kaswell,
Executive Vice President & Managing Director,
General Counsel, Managed Funds Association and
Adam Jacobs, Director, Head of Markets Regulation,
Alternative Investment Management Association,
dated Aug. 19, 2013 (‘‘MFA/AIMA’’); Marcus
Stanley, Policy Director, Americans for Financial
Reform, dated Aug. 22, 2013 (‘‘AFR’’); Sarah A.
Miller, Chief Executive Officer, Institute of
International Bankers, dated Aug. 21, 2013 (‘‘IIB
(August 2013)’’); Catherine T. Dixon, Chair, Federal
Regulation of Securities Committee, American Bar
Association, Business Law Section, dated Oct. 2,
2013 (‘‘ABA (October 2013)’’); Agricultural Retailers
Association, Business Roundtable, Financial
Executives International, National Association of
Corporate Treasurers, National Association of
Manufacturers, U.S. Chamber of Commerce, dated
Aug. 21, 2013 (‘‘CDEU’’); Futures Options
Association, dated Aug. 21, 2013 (‘‘FOA’’); Kevin
Nixon, Managing Director, Institute of International
Finance, dated August 8, 2013 (‘‘IIF’’); Koichi
Ishikura, Executive Chief of Operations for
International Headquarters, Japan Securities Dealers
Association, dated Aug. 21, 2013 (‘‘JSDA’’); Patrick
Pearson, European Commission, dated Aug. 21,
2013 (‘‘EC’’); Jonathan Kindred and Shigesuke
Kashiwagi, Japan Financial Markets Council, dated
Aug. 15, 2013.
The SEC Chair and Commissioners were copied
on a comment letter to the CFTC in connection with
the CFTC’s own cross-border initiative. See letter
from Sherrod Brown, U.S. Senator, Tom Harkin,
U.S. Senator, Jeff Merkley, U.S. Senator, Carl Levin,
U.S. Senator, Elizabeth Warren, U.S. Senator,
Dianne Feinstein, U.S. Senator, to the Honorable
Gary Gensler, dated May 22, 2013 (‘‘U.S. Senators’’).
9 See Application of Certain Title VII
Requirements to Security-Based Swap Transactions
Connected with a Non-U.S. Person’s Dealing
Activity that are Arranged, Negotiated, or Executed
by Personnel Located in a U.S. Branch or Office or
in a U.S. Branch or Office of an Agent, Exchange
Act Release No. 74843 (Apr. 29, 2015), 80 FR 27443
(May 13, 2015) (‘‘U.S. Activity Proposing Release’’).
10 See letters from Kenneth E. Bentsen, Jr.,
President & CEO, Securities Industry and Financial
Markets Association and Financial Services
Roundtable and Rich Foster, Senior Vice President
& Senior Counsel for Regulatory and Legal Affairs,
Financial Services Roundtable, dated July 13, 2015
(‘‘SIFMA/FSR (July 2015)’’); Sarah A. Miller, Chief
Executive Officer, Institute of International Bankers,
dated July 13, 2015 (‘‘IIB (July 2015)’’); Dan Waters,
Managing Director, ICI Global, dated July 13, 2015
(‘‘ICI Global (July 2015)’’); Dennis M. Kelleher,
President and CEO, Stephen W. Hall, Securities
Specialist, Todd Phillips, Attorney, Better Markets,
Inc., dated July 13, 2015 (‘‘Better Markets (July
2015)’’); Timothy W. Cameron, Esq., Managing
Director and Laura Martin, Managing Director and
Associate General Counsel, Asset Management
Group, Securities Industry and Financial Markets
Association, dated July 13, 2015 (‘‘SIFMA–AMG
(July 2015)’’); David Geen, General Counsel,
International Swaps and Derivatives Association,
Inc. (‘‘ISDA (July 2015)’’); Chris Barnard, dated June
26, 2015 (‘‘Barnard (July 2015)’’); Stuart J. Kaswell,
Executive Vice President, Managing Director &
General Counsel, Managed Funds Association,
dated July 13, 2015 (‘‘MFA (July 2015)’’). These
comment letters are available on the Commission’s
Web site at http://www.sec.gov/comments/s7-06-15/
s70615.shtml.

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The Commission is now adopting
Rules 15Fh–1 through 15Fh–6 and Rule
15Fk–1, with certain revisions suggested
by commenters or designed to clarify
the rules and conform them to the rules
adopted by the CFTC. The principal
aspects of the rules are briefly described
immediately below. A detailed
discussion of each rule follows in
Sections II.A.–II.J, below.11
A. Summary of Final Rules
Rule 15Fh–1, as adopted, defines the
scope of Rules 15Fh–1 through 15Fh–6
and Rule 15Fk–1, and provides that an
SBS Entity can rely on the written
representations of a counterparty or its
representative to satisfy its due
diligence requirements under the rules,
unless it has information that would
cause a reasonable person to question
the accuracy of the representation.
Rule 15Fh–2, as adopted, sets forth
the definitions used throughout Rules
15Fh–1 through 15Fh–6. The defined
terms are discussed in connection with
the rules in which they appear.
Rule 15Fh–3, as adopted, defines the
business conduct requirements
generally applicable to SBS Entities
with respect to: (1) Verification of
counterparty status as an eligible
contract participant (‘‘ECP’’) or special
entity; (2) disclosure to the counterparty
of material information about the
security-based swap, including material
risks, characteristics, incentives, and
conflicts of interest; (3) disclosure of
information concerning the daily mark
of the security-based swap; (4)
disclosure regarding the ability of the
counterparty to require clearing of the
security-based swap; (5) communication
with counterparties in a fair and
balanced manner based on principles of
fair dealing and good faith; and (6) the
establishment of a supervisory and
compliance infrastructure. Rule 15Fh–3,
as adopted, additionally requires an SBS
Dealer to: (1) Establish, maintain and
enforce written policies and procedures
reasonably designed to obtain and retain
a record of the essential facts concerning
each known counterparty that are
necessary to conduct business with that
counterparty; and (2) comply with
certain suitability obligations when
recommending a security-based swap,
or trading strategy involving a securitybased swap, to a counterparty.
Rule 15Fh–4(a), as adopted, provides
that it shall be unlawful for an SBS
Entity to: (i) Employ any device,
11 If any of the provisions of these rules, or the
application thereof to any person or circumstance,
is held to be invalid, such invalidity shall not affect
other provisions or application of such provisions
to other persons or circumstances that can be given
effect without the invalid provision or application.

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scheme, or artifice to defraud any
special entity or prospective customer
who is a special entity; (ii) engage in
any transaction, practice, or course of
business that operates as a fraud or
deceit on any special entity or
prospective customer who is a special
entity; or (iii) to engage in any act,
practice, or course of business that is
fraudulent, deceptive, or manipulative.
Rule 15Fh–4(b), as adopted, sets forth
particular requirements for SBS Dealers
acting as advisors to special entities.12
Specifically, an SBS Dealer that acts as
an advisor to a special entity must act
in the ‘‘best interests’’ of the special
entity, and make reasonable efforts to
obtain information that it needs to
determine that the recommendation is
in the ‘‘best interests’’ of the special
entity.13
Rule 15Fh–5, as adopted, sets forth
particular requirements for SBS Entities
acting as counterparties to special
entities. Under the rule, those SBS
Entities must have a reasonable basis to
believe that the counterparty has a
qualified representative who: (1) Has
sufficient knowledge to evaluate the
transaction and risks; (2) is not subject
to a statutory disqualification; (3) is
independent of the SBS Entity; (4)
undertakes a duty to act in the best
interests of the special entity; (5) makes
appropriate and timely disclosures to
the special entity of material
information concerning the securitybased swap; and (6) provides written
representations regarding fair pricing
and the appropriateness of the securitybased swap. If the special entity is an
employee benefit plan that is subject to
regulation under Title I of ERISA
(‘‘ERISA plan’’), these requirements are
satisfied if the independent
representative is a ‘‘fiduciary’’ under
ERISA. In addition, the independent
representative must be subject to pay-toplay regulation if the special entity is a
‘‘municipal entity’’ or a ‘‘governmental
plan’’ as defined in Section 3 of ERISA.
Rule 15Fh–6, as adopted, imposes
certain pay-to-play restrictions on SBS
Dealers. The rule generally prohibits an
SBS Dealer from engaging in security12 The statutory definition of ‘‘special entity’’
includes federal agencies, states and political
subdivisions, employee benefit plans as defined
under the Employee Retirement Income Security
Act of 1974 (‘‘ERISA’’), governmental plans as
defined under ERISA, and endowments. See Rule
15Fh–2(d) (defining ‘‘special entity’’ to include
employee benefit plans that are defined in Title I
of ERISA but permitting employee benefit plans
that are not subject to regulation under Title I of
ERISA to elect not to be special entities).
13 Rule 15Fh–2(a), as adopted, defines what it
means to ‘‘act as an advisor’’ to a special entity, and
provides a safe harbor under which the parties can
establish that the SBS Dealer is not acting as an
advisor to the special entity.

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based swap transactions with a
‘‘municipal entity’’ within two years
after certain political contributions have
been made to officials of the municipal
entity. As with other pay-to-play rules,
Rule 15Fh–6 does not prohibit political
contributions.
Rule 15k–1, as adopted, requires an
SBS Entity to designate a CCO and
imposes certain duties and
responsibilities on that CCO.
B. Cross-Border Application of the Final
Rules
Rule 3a71–3(c) and related
amendments to Rule 3a71–3(a), as
adopted, define the scope of application
of the business conduct standards
described in Section 15F(h) of the
Exchange Act, and the rules and
regulations thereunder (other than the
rules and regulations prescribed by the
Commission pursuant to Section
15F(h)(1)(B)) to SBS Dealers. As
adopted, these rules require a registered
U.S. SBS Dealer to comply with
transaction-level business conduct
requirements with respect to all of its
transactions, except for certain
transactions conducted through such
dealer’s foreign branch. The rules
further require a registered foreign SBS
Dealer to comply with transaction-level
business conduct requirements with
respect to any transaction with a U.S.
person (except for a transaction
conducted through a foreign branch of
the U.S. person) and any transaction
that the SBS Dealer arranges, negotiates,
or executes using personnel located in
the United States.
Rule 3a67–10(d) and related
amendments to Rule 3a67–10(a), as
adopted, define the scope of application
of the business conduct standards
described in Section 15F(h) of the
Exchange Act, and the rules and
regulations thereunder (other than the
rules and regulations prescribed by the
Commission pursuant to Section
15F(h)(1)(B)) to registered Major SBS
Participants. As adopted, these rules,
like those applicable to registered SBS
Dealers, require a registered U.S. Major
SBS Participant to comply with
transaction-level business conduct
requirements with respect to all of its
transactions, except for certain
transactions conducted through such
participant’s foreign branch. The rules
further require a registered foreign
Major SBS Participant to comply with
transaction-level business conduct
requirements with respect to any
transaction with a U.S. person (except
for a transaction conducted through a
foreign branch of the U.S. person) but
not any transaction with a non-U.S.
person.

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Finally, Rule 3a71–6, as adopted,
provides a framework under which
foreign SBS Dealers and foreign Major
SBS Participants may seek to satisfy
certain business conduct requirements
under Title VII by means of substituted
compliance.
In developing these final rules,
including their cross-border application,
we have consulted and coordinated
with the CFTC and the prudential
regulators 14 in accordance with the
consultation mandate of the Dodd-Frank
Act.15 The Commission also has
consulted and coordinated with foreign
regulatory authorities through
Commission staff participation in
numerous bilateral and multilateral
discussions with foreign regulatory
authorities addressing the regulation of
OTC (over-the-counter) derivatives.16
Through these discussions and the
Commission staff’s participation in
various international task forces and
working groups,17 we have gathered
information about foreign regulatory
reform efforts and their impact on and
relationship with the U.S. regulatory
regime. The Commission has taken and
will continue to take these discussions
14 The term ‘‘prudential regulator’’ is defined in
section 1a(39) of the Commodity Exchange Act, 7
U.S.C. 1a(39), and that definition is incorporated by
reference in section 3(a)(74) of the Exchange Act,
15 U.S.C. 78c(a)(74). Pursuant to the definition, the
Board of Governors of the Federal Reserve System,
the Office of the Comptroller of the Currency, the
Federal Deposit Insurance Corporation, the Farm
Credit Administration, or the Federal Housing
Finance Agency (collectively, the ‘‘prudential
regulators’’) is the ‘‘prudential regulator’’ of a
security-based swap dealer or major security-based
swap participant if the entity is directly supervised
by that regulator.
15 Section 712(a)(2) of the Dodd-Frank Act
provides in part that the Commission shall ‘‘consult
and coordinate to the extent possible with the
Commodity Futures Trading Commission and the
prudential regulators for the purposes of assuring
regulatory consistency and comparability, to the
extent possible.’’
16 For example, senior representatives of
authorities with responsibility for regulation of OTC
derivatives have met on a number of occasions to
discuss international coordination of OTC
derivatives regulations. See, e.g., Report of the OTC
Derivatives Regulators Group to G20 Leaders on
Cross-Border Implementation Issues November
2015 (Nov. 2015), available at: http://www.cftc.gov/
idc/groups/public/@internationalaffairs/
documents/file/odrgreportg20_1115.pdf.
17 Commission representatives participate in the
Financial Stability Board’s Working Group on OTC
Derivatives Regulation (‘‘ODWG’’), both on the
Commission’s behalf and as the representative of
the International Organization of Securities
Commissions (‘‘IOSCO’’), which is co-chair of the
ODWG. See Security-Based Swap Transactions
Connected with a Non-U.S. Person’s Dealing
Activity That Are Arranged, Negotiated, or
Executed By Personnel Located in a U.S. Branch or
Office or in a U.S. Branch or Office of an Agent;
Security-Based Swap Dealer De Minimis Exception,
Exchange Act Release No. 77104 (February 10,
2016), 81 FR 8597 n.15 (Feb. 19, 2016) (‘‘U.S.
Activity Adopting Release’’), (describing the
Commission representative’s role).

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into consideration in developing rules,
forms, and interpretations for
implementing Title VII of the DoddFrank Act.18
C. Consistency With CFTC Rules
The Commission and CFTC staffs,
prior to the proposal of rules by their
respective agency, held approximately
30 joint meetings with interested parties
regarding the agencies’ respective
business conduct rules to solicit a
variety of views.19 As discussed in
Section I.D. below, the agencies’ staffs
also consulted with Department of
Labor (‘‘DOL’’) representatives on this
rulemaking. In the Proposing Release,
the Commission solicited comment on
the impact of any differences between
the Commission’s and CFTC’s
approaches to business conduct
regulations, and whether the
Commission’s proposed business
conduct regulations should be modified
to conform to the proposals made by the
CFTC.20 Subsequently, in February
2012, the CFTC adopted final rules with
respect to the external business conduct
standards of Swap Entities that are
generally consistent with the
Commission’s proposed rules.21 In
addition, in April 2013, the CFTC
adopted final rules with respect to
internal business conduct standards
regarding, among other things, the
obligation of a Swap Entity to diligently
supervise its business.22 These rules
also require each Swap Entity to
designate a CCO, prescribe
qualifications and duties of the CCO,
and require that the CCO prepare, sign,
and furnish the annual report
containing an assessment of the
18 See Section 752(a) of the Dodd-Frank Act
(providing in part that ‘‘[i]n order to promote
effective and consistent global regulation of swaps
and security-based swaps, the Commodity Futures
Trading Commission, the Securities and Exchange
Commission, and the prudential regulators . . . as
appropriate, shall consult and coordinate with
foreign regulatory authorities on the establishment
of consistent international standards with respect to
the regulation (including fees) of swaps.’’).
19 A list of Commission staff meetings in
connection with this rulemaking is available on the
Commission’s Web site under ‘‘Meetings with SEC
Officials’’ at http://www.sec.gov/comments/df-titlevii/swap/swap.shtml and at http://www.sec.gov/
comments/s7-25-11/s72511.shtml.
20 See Proposing Release, 76 FR at 42438, supra
note 3.
21 See Business Conduct Standards for Swap
Dealers and Major Swap Participants With
Counterparties, 77 FR 9734 (Feb. 17, 2012) (‘‘CFTC
Adopting Release’’).
22 See Swap Dealer and Major Swap Participant
Recordkeeping, Reporting, and Duties Rules;
Futures Commission Merchant and Introducing
Broker Conflicts of Interest Rules; and Chief
Compliance Officer Rules for Swap Dealers, Major
Swap Participants, and Futures Commission
Merchants, 77 FR 20128 (Apr. 3, 2013) (‘‘CFTC CCO
Release’’).

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registrant’s compliance activities to
either the board of directors or the
senior officer.23 The rules further
require the annual report to be
furnished to the CFTC.24
In May 2013, in the Reopening
Release, the Commission sought
comment on certain specific issues,
including: (1) The relationship of the
proposed rules to any parallel
requirements of other authorities,
including the CFTC and relevant foreign
regulatory authorities; and (2) with
respect to the CFTC rules, whether and
to what extent the Commission, in
adopting its own rules, should
emphasize consistency with the CFTC
rules versus adopting rules that are
more tailored to the security-based swap
market, including any specific examples
where consistency or tailoring of a
particular rule or rule set is more
critically important.25
The Commission received numerous
comments regarding consistency with
the CFTC’s external business conduct
rules both before and after the CFTC
adopted its final rules.26 Comments
specific to individual rules are
addressed in the discussions of the
respective rules below. As a general
matter, these comments had, as an
overarching theme, that the Commission
should coordinate with the CFTC to
achieve consistent regulations.27
Commenters stressed that differences
between the regulatory regimes would,
among other things, increase regulatory
burdens and costs for market
participants, delay execution of
transactions, and lead to confusion.28
Before the CFTC adopted its final
external business conduct rules,
commenters were divided as to whether
they preferred the Commission’s 29 or
24 Id.
25 See

Reopening Release, supra note 4.
e.g., Barnard, supra note 5; FIA/ISDA/
SIFMA, supra note 5; AFSCME, supra note 5;
Levin, supra note 5; APPA, supra note 5; Ropes &
Gray, supra note 5; BlackRock, supra note 5;
Nomura, supra note 5; GFOA, supra note 5; NABL,
supra note 5; ISDA (July 2013), supra note 5; AFGI
(July 2013), supra note 5; CFA, supra note 5; SIFMA
(August 2015), supra note 5; SIFMA (September
2015), supra note 5; SIFMA (November 2015), supra
note 5.
27 See, e.g., Barnard, supra note 5; FIA/ISDA/
SIFMA, supra note 5; AFSCME, supra note 5;
Levin, supra note 5; APPA, supra note 5; Ropes &
Gray, supra note 5; BlackRock, supra note 5;
Nomura, supra note 5; GFOA, supra note 5; NABL,
supra note 5; ISDA (July 2013), supra note 5; AFGI
(July 2013), supra note 5; SIFMA (August 2015),
supra note 5; SIFMA, supra note 5 (September
2015); SIFMA (November 2015), supra note 5.
28 See, e.g., Barnard, supra note 5; Levin, supra
note 5; BlackRock, supra note 5; NABL, supra note
5; GFOA, supra note 5.
29 See, e.g., SIFMA (August 2011), supra note 5;
GFOA, supra note 5; NABL, supra note 5.
26 See,

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D. Department of Labor ERISA
Fiduciary Regulations
Section 15F(h)(2)(C) of the Exchange
Act defines the term ‘‘special entity’’ to
include ‘‘an employee benefit plan, as
defined in section 3 of the Employee
Retirement Income Security Act of
1974.’’ 33
Prior to proposing the business
conduct standards rules, the
Commission received submissions from
commenters concerning the interaction
with ERISA, DOL’s proposed fiduciary
rule, and current regulation regarding
the definition of ERISA fiduciaries.34 As
30 See,

e.g., CFA, supra note 5.
e.g., Nomura, supra note 5; GFOA, supra
note 5; ISDA (July 2013), supra note 5; SIFMA
(August 2015), supra note 5; SIFMA (September
2015), supra note 5; SIFMA (November 2015), supra
note 5.
Commenters also urged, with respect to
supervision and CCO obligations (‘‘internal’’
business conduct standards), that our final rules be
informed by industry experience complying with
the analogous Financial Industry Regulatory
Authority, Inc. (‘‘FINRA’’) supervision and CCO
rules, as well as the CFTC internal business conduct
standards. See SIFMA (September 2015), supra note
5, at 2 (urging the Commission to harmonize its
rules with, among other things, ‘‘the FINRA
Supervision Rules, [and] the FINRA CCO Rule’’).
32 One commenter noted that more than 17,000
entities have already adhered to a multilateral
protocol that had been developed in response to the
CFTC rules. See SIFMA (November 2015), supra
note 5.
33 29 U.S.C. 1001 et seq. See History of EBSA and
ERISA, available at http://www.dol.gov/ebsa/
aboutebsa/history.html.
34 See, e.g., letter from Kenneth E. Bentsen, Jr.,
Executive Vice President, Public Policy and
Advocacy, Securities Industry and Financial
Markets Association and Robert G. Pickel,
31 See,

23 Id.

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the CFTC’s 30 proposed approach to
specific issues, in instances in which
the CFTC’s proposed approach differed
from the Commission’s proposed rules.
However, the comments received by the
Commission in response to the
Reopening Release, which was issued
after the CFTC adopted its final rules,
overwhelmingly urged the Commission
to harmonize its external business
conduct rules with those of the CFTC
because the CFTC’s rules have already
been implemented by the industry.31 A
number of these comments have
suggested specific and detailed
modifications. Where we believe the
external business conduct rules, if
modified in accordance with these
suggestions, will continue to provide
the protections (as explained in the
context of the particular rule) that the
rules are intended to accomplish, we
have modified the proposed rules to
harmonize with CFTC requirements to
create efficiencies for entities that have
already established infrastructure for
compliance with analogous CFTC
requirements.32

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noted above, the Commission, CFTC
and DOL staffs consulted on issues
regarding the intersection of ERISA
fiduciary status with the Dodd-Frank
Act business conduct provisions, prior
to the Commission’s proposing rules in
this area.35
The Commission received numerous
comments concerning the interaction of
ERISA and existing fiduciary regulation
with the business conduct standards
under the Exchange Act and the
Commission’s proposed rules.36
Commenters, including ERISA plan
sponsors, dealers and institutional asset
managers, stated that although ERISA
plans currently use security-based
swaps as part of their overall hedging or
investment strategy, the statutory and
regulatory intersections of ERISA and
the external business conduct standards
under Title VII of the Dodd-Frank Act
could prevent ERISA plans from
participating in security-based swap
markets in the future, and the proposed
business conduct standards rules, if
adopted without clarification, could
have unintended consequences for SBS
Entities dealing with ERISA plans.37
Commenters were primarily
concerned that compliance with the
business conduct standards under the
Exchange Act or the Commission’s
proposed rules would cause an SBS
Entity to be an ERISA fiduciary to an
ERISA plan and thus, subject to ERISA’s
prohibited transaction provisions.38 If
an SBS Entity were to become an ERISA
fiduciary to an ERISA plan, it would be
prohibited from entering into a securitybased swap with that ERISA plan absent
an exemption.39 One commenter
Executive Vice Chairman, International Swaps and
Derivatives Association, Inc. to Elizabeth M.
Murphy, Secretary, Commission and David A.
Stawick, Secretary, CFTC (Oct. 22, 2010) (‘‘SIFMA/
ISDA 2010 Letter’’), at 8 n.19. This comment letter
is available on the Commission’s Web site at http://
www.sec.gov/comments/df-title-vii/swap/
swap.shtml.
35 See Proposing Release, 76 FR at 42398, supra
note 3.
36 See, e.g., ABC, supra note 5; CFA, supra note
5; FIA/ISDA/SIFMA, supra note 5; IDC, supra note
5; MFA, supra note 5; BlackRock, supra note 5;
Johnson, supra note 5.
37 See, e.g., ABC, supra note 5; FIA/ISDA/SIFMA,
supra note 5; IDC, supra note 5; MFA, supra note
5; BlackRock, supra note 5; Johnson, supra note 5.
38 Section 406(b) of ERISA (29 U.S.C. 1106(b))
states that an ERISA fiduciary with respect to an
ERISA plan shall not (1) deal with the assets of the
plan in his own interest or for his own account, (2)
in his individual or in any other capacity act in any
transaction involving the plan on behalf of a party
(or represent a party) whose interests are adverse to
the interests of the plan or the interests of its
participants or beneficiaries, or (3) receive any
consideration for his own personal account from
any party dealing with such plan in connection
with a transaction involving the assets of the plan.
39 In addition to other statutory exemptions,
Section 408(a) of ERISA (29 U.S.C. 1108(a)) gives

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
asserted that the penalties for violating
ERISA’s prohibited transaction
provisions would discourage SBS
Entities from dealing with ERISA
plans.40 Other commenters asserted that
compliance by SBS Entities with the
following obligations could cause an
SBS Entity to be an ERISA fiduciary: (1)
Providing information regarding the
risks of the security-based swap; (2)
providing the daily mark; (3) reviewing
the ability of the special entity’s advisor
to advise the special entity with respect
to the security-based swap; and (4)
acting in the best interests of the special
entity.41 Accordingly, commenters
requested that the Commission and DOL
coordinate the respective rules to clarify
that compliance with the business
conduct standards rules will not make
an SBS Entity an ERISA fiduciary.42
DOL staff reviewed the CFTC’s final
business conduct standards rules for
Swap Entities and provided the CFTC
with the following statement:
The Department of Labor has reviewed
these final business conduct standards and
concluded that they do not require swap
dealers or major swap participants to engage
in activities that would make them
fiduciaries under the Department of Labor’s
current five-part test defining fiduciary
advice 29 CFR 2510.3–21(c). In the
Department’s view, the CFTC’s final business
conduct standards neither conflict with the
Department’s existing regulations, nor
compel swap dealers or major swap
participants to engage in fiduciary conduct.
Moreover, the Department states that it is
fully committed to ensuring that any changes
to the current ERISA fiduciary advice
regulation are carefully harmonized with the
final business conduct standards, as adopted
by the CFTC and the SEC, so that there are
no unintended consequences for swap
dealers and major swap participants who
comply with these business conduct
standards.43

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Thereafter, in April 2015, the DOL
reproposed a change to the definition of
fiduciary under ERISA.44 The DOL
DOL authority to grant administrative exemptions
from prohibited transactions prescribed in Section
406 of ERISA.
40 See ABC, supra note 5.
41 See, e.g., ABC, supra note 5; FIA/ISDA/SIFMA,
supra note 5; IDC, supra note 5; MFA, supra note
5; BlackRock, supra note 5; Johnson, supra note 5.
42 See, e.g., ABC, supra note 5; FIA/ISDA/SIFMA,
supra note 5; IDC, supra note 5; MFA, supra note
5; BlackRock, supra note 5; Johnson, supra note 5.
43 See Letter from Phyllis C. Borzi, Assistant
Secretary, Employee Benefits Security
Administration, U.S. Department of Labor to The
Hon. Gary Gensler et al., CFTC (Jan. 17, 2012),
CFTC Adopting Release, Appendix 2—Statement of
the Department of Labor, 77 FR 9835, supra note
21.
44 See Definition of the Term ‘‘Fiduciary’’;
Conflict of Interest Rule—Retirement Investment
Advice, 80 FR 21927 (Proposed Rule, Apr. 20,
2015).

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noted that its staff had ‘‘consulted with
staff of the SEC.’’ 45
On April 6, 2016, DOL issued its final
rule.46 We understand that DOL’s
revised definition of ‘‘fiduciary’’ in its
final rule is intended to allow SBS
Entities to avoid becoming ERISA
fiduciaries when acting as
counterparties to a swap or securitybased swap transaction. For example,
DOL makes the following statement in
the preamble to its final rule:
The Department has provided assurances
to the CFTC and the SEC that the Department
is fully committed to ensuring that any
changes to the current ERISA fiduciary
advice regulation are carefully harmonized
with the final business conduct standards, as
adopted by the CFTC and the SEC, so that
there are no unintended consequences for
swap and security-based swap dealers and
major swap and security-based swap
participants who comply with the business
conduct standards. See, e.g., Letter from
Phyllis C. Borzi, Assistant Secretary,
Employee Benefits Security Administration,
U.S. Department of Labor, to The Hon. Gary
Gensler et al., CFTC (Jan. 17, 2012). In this
regard, we note that the disclosures required
under the business conduct standards,
including those regarding material
information about a swap or security-based
swap concerning material risks,
characteristics, incentives and conflicts of
interest; disclosures regarding the daily mark
of a swap or security-based swap and a
counterparty’s clearing rights; disclosures
necessary to ensure fair and balanced
communications; and disclosures regarding
the capacity in which a swap or securitybased swap dealer or major swap participant
is acting when a counterparty to a special
entity, do not in the Department’s view
compel counterparties to ERISA-covered
employee benefit plans, other plans or IRAs
to make a recommendation for purposes of
paragraph (a) of the final rule or otherwise
compel them to act as fiduciaries in swap
and security-based swap transactions
conducted pursuant to section 4s of the
Commodity Exchange Act and section 15F of
the Securities Exchange Act. This section of
this Notice discusses these issues in the
context of the express provisions in the final
rule on swap and security-based swap
transactions and on transactions with
independent fiduciaries with financial
expertise.47

Furthermore, DOL’s final rule
establishes a ‘‘swap and security-based
swap transactions’’ exclusion 48 which,
in DOL’s view, is intended to establish
conditions under which persons acting
as SBS Entities, among others, ‘‘do not
become investment advice fiduciaries as
45 Id.

at 21937.
Definition of the Term ‘‘Fiduciary’’;
Conflict of Interest Rule—Retirement Investment
Advice, 81 FR 20946 (Final Rule, Apr. 8, 2016).
47 Id. at 20985, n. 36.
48 See id. at 20984–86 (discussing the swap and
security-based swap transactions exception).
46 See

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29965

a result of communications and
activities conducted during the course
of swap or security-based swap
transactions regulated under the DoddFrank Act provisions in the Commodity
Exchange Act or the Securities
Exchange Act of 1934 and applicable
CFTC and SEC implementing rules and
regulations.’’ 49 In addition, DOL has
stated that its exclusion for
‘‘transactions with independent plan
fiduciaries with financial expertise’’ has
been significantly adjusted and
expanded in the final rule and gives an
alternative avenue for parties involved
in swap, security-based swap, or other
investment transactions to conduct the
transaction in a way that would ensure
they do not become investment advice
fiduciaries under the final rule.50
The Commission staff has continued
to coordinate with DOL staff to ensure
that the final business conduct
standards rules are appropriately
harmonized with ERISA and DOL
regulations. DOL staff has provided the
Commission with a statement that:
It is the Department’s view that the draft
final business conduct standards do not
require security-based swap dealers or major
security-based swap participants to engage in
activities that would make them fiduciaries
under the Department’s current five-part test
defining fiduciary investment advice. 29 CFR
2510.3–21(c). The standards neither conflict
with the Department’s existing regulations,
nor compel security-based swap dealers or
major security-based swap participants to
engage in fiduciary conduct. Moreover, the
Department’s recently published final rule
amending ERISA’s fiduciary investment
advice regulation was carefully harmonized
with the SEC’s business conduct standards so
that there are no unintended consequences
for security-based swap dealers and major
security-based swap participants who
comply with the business conduct standards.
As explained in the preamble to the
Department’s final rule, the disclosures
required under the SEC’s business conduct
rules do not, in the Department’s view,
compel counterparties to ERISA-covered
employee benefit plans to make investment
advice recommendations within the meaning
of the Department’s final rule or otherwise
compel them to act as ERISA fiduciaries in
49 Id. at 20985. See also id. (explaining that in
DOL’s view, ‘‘when Congress enacted the swap and
security based swap provisions in the Dodd-Frank
Act, including those expressly applicable to ERISA
covered plans, Congress did not intend that
engaging in regulated conduct as part of a swap or
security-based swap transaction with an employee
benefit plan would give rise to additional fiduciary
obligations or restrictions under Title I of ERISA’’).
50 See id. at 20986 (noting that DOL ‘‘does not
believe extending the swap and security-based
swap provisions to IRA investors is appropriate’’
and, rather, concluding ‘‘that it was more
appropriate to address this issue in the context of
the ‘independent plan fiduciary with financial
expertise’ provision described elsewhere in this
Notice’’).

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swap and security-based swap transactions
conducted pursuant to section 4s(h) of the
Commodity Exchange Act and section 15F of
the Securities Exchange Act of 1934.51

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

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E. Investment Adviser and Municipal
Advisor Status
In addition to questions about ERISA
fiduciary status, commenters also
questioned whether compliance with
the business conduct standards might
cause an SBS Entity to be deemed an
investment adviser or, when transacting
with a special entity that meets the
definition of municipal entity, a
municipal advisor.52 Two commenters
expressed concern more generally that
compliance with the daily mark
requirement (in Rule 15Fh–3(c)) might
raise questions as to whether an SBS
Entity has advisory or fiduciary
responsibilities under applicable
common law, state law or federal law
(e.g., DOL regulations, provisions of the
Investment Advisers Act of 1940
(‘‘Advisers Act’’), or the Dodd-Frank
Act’s municipal advisor provisions).53
As we noted in the Proposing Release,
the duties imposed on an SBS Dealer (or
Major SBS Participant) under the
business conduct rules are specific to
this context, and are in addition to any
duties that may be imposed under other
applicable law.54 Thus, an SBS Entity
must separately determine whether it is
subject to regulation as a broker-dealer,
an investment adviser, a municipal
advisor or other regulated entity.55 For
51 See Letter from Phyllis C. Borzi, Assistant
Secretary, Employee Benefits Security
Administration, U.S. Department of Labor to The
Hon. Mary Jo White et al., SEC (Apr. 12, 2016).
52 See, e.g., FIA/ISDA/SIFMA, supra note 5;
SIFMA (August 2011), supra note 5.
53 See FIA/ISDA/SIFMA, supra note 5; SIFMA
(August 2011), supra note 5.
54 See Proposing Release, supra note 3, 76 FR at
42424.
55 The Dodd-Frank Act amended the Exchange
Act definition of ‘‘dealer’’ so that a person would
not be deemed to be a dealer as a result of engaging
in security-based swaps with eligible contract
participants. See Section 3(a)(5) of the Exchange
Act, 15 U.S.C. 78c(a)(5), as amended by section
761(a)(1) of the Dodd-Frank Act. The Dodd-Frank
Act does not include comparable amendments for
persons who act as brokers in swaps and securitybased swaps. Because security-based swaps, as
defined in Section 3(a)(68) of the Exchange Act, are
included in the Exchange Act Section 3(a)(10)
definition of ‘‘security,’’ persons who act as brokers
in connection with security-based swaps must,

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example, an SBS Dealer that acts as an
advisor to a special entity may fall
within the definition of ‘‘investment
adviser’’ under Section 202(a)(11) of the
Advisers Act.56
We further stated in the Proposing
Release that an SBS Dealer that acts as
an advisor to a municipal entity also
may be a ‘‘municipal advisor’’ under
Section 15B(e) of the Exchange Act.57
We note, however, that we subsequently
adopted rules in 2013 that interpret the
statutorily defined term ‘‘municipal
advisor’’ and provide a regulatory
exemption for persons engaging in
municipal advisory activities in
circumstances in which a municipal
entity or obligated person is otherwise
represented by an independent
registered municipal advisor with
respect to the same aspects of a
municipal financial product or an
issuance of municipal securities so long
as the following requirements are
satisfied: (1) The independent registered
municipal advisor is registered pursuant
to Section 15B of the Exchange Act and
the rules and regulations thereunder,
and is not, and within at least the past
two years was not, associated with the
person seeking to rely on the exemption;
(2) the person seeking to use the
exemption receives from the municipal
entity or obligated person a
representation in writing that it is
represented by, and will rely on the
advice of, the independent registered
municipal advisor, and such person has
a reasonable basis for relying on the
representation; and (3) the person
seeking to use the exemption provides
written disclosure to the municipal
entity or obligated person, with a copy
to the independent registered municipal
advisor, stating that such person is not
a municipal advisor and is not subject
to the fiduciary duty to municipal
entities that the Exchange Act imposes
on municipal advisors, and such
disclosure is made at a time and in a
manner reasonably designed to allow
the municipal entity or obligated person
to assess the material incentives and
conflicts of interest that such person
may have in connection with the
absent an exception or exemption, register with the
SEC as a broker pursuant to Exchange Act Section
15(a), and comply with the Exchange Act’s
requirements applicable to brokers.
As discussed in Section I.F, infra, the
Commission has issued temporary exemptions
under the Exchange Act in connection with the
revision of the ‘‘security’’ definition to encompass
security-based swaps. Among other aspects, these
temporary exemptions extended to certain broker
activities involving security-based swaps.
56 See 15 U.S.C. 80b–2(a)(11).
57 See 15 U.S.C. 78o–4(e)(4).

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municipal advisory activities.58 We
explained that if a municipal entity or
obligated person is represented by a
registered municipal advisor, parties to
the municipal securities transaction and
others who are not registered municipal
advisors should be able to provide
advice to the municipal entity or
obligated person without being deemed
themselves to be municipal advisors, so
long as the responsibilities of each
person are clear.59
F. Intersection With SRO Rules
Under the framework established in
the Dodd-Frank Act, SBS Entities are
not required to be members of selfregulatory organizations (‘‘SROs’’).
Some commenters have, however, urged
us to harmonize Title VII business
conduct requirements applicable to SBS
Entities with relevant SRO requirements
applicable to the SRO’s members to
avoid unnecessary differences, which
they argue could create duplication and
conflicts when an SBS Entity is also
registered as a broker-dealer, or when an
SBS Entity uses a registered brokerdealer to intermediate its transactions.60
The rules we proposed were designed
to implement the business conduct
requirements enacted by Congress
regarding security-based swap activity
of SBS Entities. At the same time, in
proposing these rules, we were mindful
that an SBS Entity also may engage in
activity that will require it to register as
a broker-dealer, and thus become
subject to SRO rules applicable to
registered broker-dealers that may
impose similar business conduct
requirements.61 As we noted in the
Proposing Release, the existing rules of
various SROs served as an important
point of reference for our proposed
58 See Registration of Municipal Advisors,
Exchange Act Release No. 70462 (Sept. 20, 2013),
78 FR 67468, 67509–11 (Nov. 12, 2013) (‘‘Municipal
Advisor Registration Release’’).
59 Id. at 67471.
60 See IIB (July 2015), supra note 10, at 13;
SIFMA/FSR (July 2015), supra note 10, at 9–10 (due
to the possibility of dually registered firms, the
Commission and FINRA, ‘‘must work to harmonize
existing sales practice requirements’’ because, to the
extent requirements differ, ‘‘there may be
unnecessary duplication and conflicts that cause a
disparate impact on security-based swap dealers
acting through broker-dealers as compared to other
security-based swap dealers.’’); SIFMA (September
2015), supra note 5, at 2 (urging the Commission
to harmonize its rules with, among other things,
‘‘the FINRA Supervision Rules, [and] the FINRA
CCO Rule’’).
61 See Exchange Act Section 15(b)(8) (generally
making it illegal for a registered broker-dealer to
effect a transaction in, or induce or attempt to
induce the purchase or sale of, any security unless
it is a member of a registered securities association
or effects transactions in securities solely on a
national securities exchange of which it is a
member). 15 U.S.C. 78o(b)(8).

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business conduct rules.62 For example,
a number of the proposed rules,
including those regarding ‘‘know your
counterparty,’’ 63 suitability,64 fair and
balanced communications,65
supervision,66 and designation of a
CCO,67 were patterned on standards that
have been established by SROs for their
members. However, we tailored the
proposed rules to the specifics of the
regulatory scheme for security-based
swaps under Title VII.68
We recognize, as the commenters
noted, that the security-based swap and
other securities activities of certain
entities may require them to register
both as broker-dealers and as SBS
Dealers or Major SBS Participants.69 To
the extent an entity will be subject to
regulation both as a broker-dealer and as
an SBS Entity, there may be overlapping
regulatory requirements applicable to
the same activity. The Commission is
mindful of potential regulatory conflicts
or redundancies and has sought in
adopting these final rules to avoid such
conflicts and minimize redundancies,
consistent with the statutory business
conduct requirements for SBS Entities.
As discussed throughout this release,
the rules we are adopting today take
into account the comments received,
62 We looked, in particular, to the requirements
imposed by FINRA, the Municipal Securities
Rulemaking Board (‘‘MSRB’’), and the National
Futures Association (‘‘NFA’’), in addition to the
business conduct standards, both internal and
external, adopted by the CFTC.
63 Proposed Rule 15Fh–3(e). Cf. FINRA Rule
2090.
64 Proposed Rule 15Fh–3(f). Cf. FINRA Rules
2090 and 2111.
65 Proposed Rule 15Fh–3(g). See Exchange Act
Section 15F(h)(3)C), 15 U.S.C. 78o–10(h)(3)(C). Cf.
NASD Rule 2210(d)(1)(A).
66 Proposed Rule 15Fh–3(h). See Exchange Act
Section 15F(h)(1)(B), 15 U.S.C. 78o–10(h)(1)(B). Cf.
NASD Rules 3010 and 3012.
67 Proposed Rule 15Fk–1. See Exchange Act
Section 15F(k), 15 U.S.C. 78o–10(k). Cf. FINRA Rule
3130.
68 For example, we provided in the proposed
rules for an institutional suitability alternative,
which was modeled on FINRA’s institutional
suitability rule (Rule 2111(b)) but tailored to take
into account the definition of eligible contract
participant included in Title VII, which includes,
among other persons, individuals with aggregate
amounts of more than $10 million invested on a
discretionary basis (or $5 million if hedging), and
entities with a net worth of at least $1 million that
are hedging commercial risk. See discussion in
Section II.G.4, infra. In addition, proposed Rule
15Fh–3(g) would impose obligations regarding fair
and balanced communications that are consistent
with, but less detailed than, the obligations
imposed on registered broker-dealers under FINRA
Rule 2210. See Section II.G.5, infra.
69 See, e.g., IIB (July 2015), supra note 10. In
addition, as noted above, there may instances in
which a registered broker-dealer acts on behalf of
an SBS Entity, and so both our rules and the SRO
business conduct rules may apply to the activity of
the broker-dealer in its capacity as agent of the SBS
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both comments specific to the
application of the proposed rules to the
security-based swap market and the role
that the SBS Entities play in that
market, and comments asking us to
modify the proposed rules to more
closely align with the similar SRO rules
applicable to broker-dealers.70 Overall,
we believe that the business conduct
rules we are adopting today are
generally designed to be consistent with
the relevant SRO requirements, taking
into account the nature of the securitybased swap market and the statutory
requirements for SBS Entities.71
On July 1, 2011, the Commission
issued a separate order granting
temporary exemptive relief (the
‘‘Temporary Exemptions’’) from
compliance with certain provisions of
the Exchange Act in connection with
the revision, pursuant to Title VII of the
Dodd-Frank Act, of the Exchange Act
definition of ‘‘security’’ to encompass
security-based swaps.72 Consistent with
the Commission’s action, on July 8,
2011, FINRA filed for immediate
effectiveness FINRA Rule 0180, which,
with certain exceptions, is intended to
temporarily limit the application of
FINRA rules with respect to securitybased swaps, thereby helping to avoid
undue market disruptions resulting
from the change to the definition of
‘‘security’’ under the Act.73
70 One commenter urged harmonization with SRO
(as well as CFTC) rules to allow SBS Entities ‘‘to
leverage existing processes and speed
implementation.’’ SIFMA (September 2015), supra
note 5, at 2.
71 Generally, when a business conduct standard
in these proposed rules is based on a similar SRO
standard, we would expect—at least as an initial
matter—to take into account the SRO’s
interpretation and enforcement of its standard when
we interpret and enforce our rule. At the same time,
we are not bound by an SRO’s interpretation and
enforcement of an SRO rule, and our policy
objectives and judgments may diverge from those of
a particular SRO. Accordingly, we would also
expect to take into account such differences in
interpreting and enforcing our rules. Proposing
Release, 76 FR at 42399, supra note 3.
72 See Order Granting Temporary Exemptions
Under the Securities Exchange Act of 1934 in
Connection With the Pending Revision of the
Definition of ‘‘Security’’ Encompass Security-based
Swaps, and Request for Comment, Exchange Act
Release No. 64795 (Jul. 1, 2011), 76 FR 39927 (Jul.
7, 2011) (the ‘‘Exemptive Release’’). The term
‘‘security-based swap’’ is defined in Section 761 of
the Dodd-Frank Act. 15 U.S.C. 78c(a)(68). See also
Further Definition of ‘‘Swap,’’ ‘‘Security-Based
Swap,’’ and ‘‘Security-Based Swap Agreement’’;
Mixed Swaps; Security-Based Swap Agreement
Recordkeeping, Exchange Act Release No. 67453
(Jul. 18, 2012), 77 FR 48208 (Aug. 13, 2012)
(‘‘Products Definitions Adopting Release’’) for
further discussion regarding the meaning of the
term security-based swap.
73 FINRA Rule 0180 temporarily limits the
application of certain FINRA rules with respect to
security-based swaps. See Notice of Filing and
Immediate Effectiveness of Proposed Rule Change
to Adopt FINRA Rule 0180 (Application of Rules

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29967

The Commission, noting the need to
avoid a potential unnecessary
disruption to the security-based swap
market in the absence of an extension of
the Temporary Exemptions, and the
need for additional time to consider the
potential impact of the revision of the
Exchange Act definition of ‘‘security’’ in
light of recent Commission rulemaking
efforts under Title VII of the Dodd-Frank
Act, issued an order that extended and
refined the applicable expiration dates
of the previously granted Temporary
Exemptions.74 In the Temporary
Exemptions Extension Release, the
Commission extended the expiration
date of the expiring Temporary
Exemptions that are not directly linked
to pending security-based swap
rulemakings until the earlier of such
time as the Commission issues an order
or rule determining whether any
continuing exemptive relief is
appropriate for security-based swap
activities with respect to any of these
Exchange Act provisions or until three
years following the effective date of the
to Security-Based Swaps); File No. SR–FINRA–
2011–033, Exchange Act Release No. 64884 (Jul. 14,
2011), 76 FR 42755 (July 19, 2011) (‘‘FINRA Rule
0180 Notice of Filing’’). See also Notice of Filing
and Immediate Effectiveness of a Proposed Rule
Change to Extend the Expiration Date of FINRA
Rule 0180 (Application of Rules to Security-Based
Swaps); File No. SR–FINRA–2016–001, Exchange
Act Release No. 76850 (Jan. 7, 2016), 81 FR 1666
(Jan. 13, 2016) (extending until February 11, 2017
the expiration date of the exemptions under FINRA
Rule 0180) (‘‘FINRA Rule 0180 Extension Notice’’).
In its Exemptive Release, the Commission noted
that the relief is targeted and does not include, for
instance, relief from the Exchange Act’s antifraud
and anti-manipulation provisions. FINRA has noted
that FINRA Rule 0180 is similarly targeted. For
instance, paragraph (a) of FINRA Rule 0180
provides that FINRA rules shall not apply to
members’ activities and positions with respect to
security-based swaps, except for FINRA Rules 2010
(Standards of Commercial Honor and Principles of
Trade), 2020 (Use of Manipulative, Deceptive or
Other Fraudulent Devices), 3310 (Anti-Money
Laundering Compliance Program) and 4240 (Margin
Requirements for Credit Default Swaps). See also
paragraphs (b) and (c) of FINRA Rule 0180
(addressing the applicability of additional rules);
FINRA Rule 0180 Notice of Filing; FINRA Rule
0180 Extension Notice.
74 See Order Extending Temporary Exemptions
Under the Securities Exchange Act of 1934 in
Connection With the Revision of the Definition of
‘‘Security’’ to Encompass Security-Based Swaps,
and Request for Comment, Exchange Act Release
No. 71485 (Feb. 5, 2014), 79 FR 7731 (Feb. 10, 2014)
(‘‘Temporary Exemptions Extension Release’’). See
also Extension of Exemptions for Security-Based
Swaps, Securities Act of 1933 (‘‘Securities Act’’)
Release No. 9545, Exchange Act Release No. 71482
(Feb. 5, 2014), 79 FR 7570 (Feb. 10, 2014)
(extending the expiration dates in interim final
rules that provide exemptions under the Securities
Act, the Exchange Act, and the Trust Indenture Act
of 1939 for those security-based swaps that prior to
July 16, 2011 were security-based swap agreements
and are defined as ‘‘securities’’ under the Securities
Act and the Exchange Act as of July 16, 2011 due
solely to the provisions of Title VII of the DoddFrank Act).

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Temporary Exemptions Extension
Release.75 The Commission further
extended the expiration date for many
expiring Temporary Exemptions
directly related to pending securitybased swap rulemakings until the
compliance date for the related securitybased swap-specific rulemaking.76
In establishing Rule 0180, and in
extending the rule’s expiration date,77
FINRA noted its intent, pending the
implementation of any Commission
rules and guidance that would provide
greater regulatory clarity in relation to
security-based swap activities, to align
the expiration date of FINRA Rule 0180
with the termination of relevant
provisions of the Temporary
Exemptions provided by the
Commission, so as to avoid undue
market disruptions resulting from the
change to the definition of ‘‘security’’
under the Exchange Act.
II. Discussion of Rules Governing
Business Conduct
A. Scope, Generally
1. Proposed Rule
Proposed Rule 15Fh–1 would provide
that Rules 15Fh–1 through 15Fh–6
(governing business conduct) and Rule
15Fk–1 (requiring designation of a CCO)
are not intended to limit, or restrict, the
applicability of other provisions of the
federal securities laws, including but
not limited to Section 17(a) of the
Securities Act, Sections 9 and 10(b) of
the Exchange Act, and the rules and
regulations thereunder. Additionally, it
would provide that Rules 15Fh–1
through 15Fh–6 and Rule 15Fk–1 would
not only apply in connection with
entering into security-based swaps but
also would continue to apply, as
appropriate, over the term of executed
security-based swaps.
In the Proposing Release, the
Commission solicited comment on the
scope of the business conduct rules,

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75 See

Temporary Exemptions Extension Release,
79 FR at 7734, supra note 74. These Temporary
Exemptions are currently scheduled to expire in
February 2017.
76 Id. at 7731. The Commission extended a subset
of the Temporary Exemptions until they are
addressed within relevant rulemakings relating to:
(i) Capital, margin, and segregation requirements for
security-based swap dealers and major securitybased swap participants, (ii) recordkeeping and
reporting requirements for security-based swap
dealers and major security-based swap participants,
(iii) security-based swap trade acknowledgement
rules, and/or (iv) registration requirements for
security-based swap execution facilities.
77 As noted in the FINRA Rule 0180 Extension
Notice, FINRA has indicated that it intends to
amend the expiration date of Rule 0180 in
subsequent filings as necessary such that the
expiration date will be coterminous with the
termination of relevant provisions of the Temporary
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including whether the rules should
apply to transactions between an SBS
Entity and its affiliates, whether any of
the rules should apply to security-based
swaps that were entered into prior to the
effective date of the rules, and to the
extent that any of the rules were
intended to provide additional
protections for a particular
counterparty, whether the counterparty
should be able to opt out of those
protections.78
2. Comments on the Proposed Rule
a. General
Eleven commenters addressed the
general scope of the proposed business
conduct standards.79 One commenter
recommended that the Commission
apply the proposed rules to securitybased swaps that are offered as well as
those that are executed.80 The other
commenters addressed: The application
of the rules to inter-affiliate
transactions, the application of the rules
to security-based swaps entered into
prior to the effective date, and whether
counterparties should be able to opt out
of the protections provided by the rules.
b. Application to Security-Based Swaps
Entered Into Prior to the Effective Date
Seven commenters addressed the
application of the rules to securitybased swaps that were entered into prior
to the compliance date of the rules, and
all seven recommended that the rules
not apply to such transactions.81 Three
further indicated that the rules should
not generally apply to amendments to,
or other lifecycle events arising under,
a security-based swap that was executed
before the compliance date of the
rules.82 Another commenter also
specifically argued that the rules should
not apply to either partial or full
terminations of security-based swaps
executed prior to the compliance date,
or the exercise of an option on a
security-based swap where the option
was executed prior to the compliance
date.83
78 See

Proposing Release, 76 FR at 42401–42402,
supra note 3.
79 See CFA, supra note 5; ABA Securities
Association, supra note 5; FIA/ISDA/SIFMA, supra
note 5; SIFMA (August 2011), supra note 5; NABL,
supra note 5; AFGI (September 2012), supra note
5; AFGI (July 2013), supra note 5; CalPERS (August
2011), supra note 5; ABC, supra note 5; MFA, supra
note 5; CalSTRS, supra note 5; SIFMA (August
2015), supra note 5.
80 See CFA, supra note 5.
81 See SIFMA (August 2011), supra note 5; FIA/
ISDA/SIFMA, supra note 5; NABL, supra note 5;
AFGI (September 2012), supra note 5; AFGI (July
2013), supra note 5; ABC, supra note 5; SIFMA
(August 2015), supra note 5.
82 See FIA/ISDA/SIFMA, supra note 5; NABL,
supra note 5; SIFMA (August 2011), supra note 5.
83 See SIFMA (August 2015), supra note 5.

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One commenter argued that
amendments to existing transactions
typically do not alter the risk and other
characteristics of a transaction
sufficiently to merit application of the
rules and that application of the rules in
these cases may frustrate their
purpose.84 Others believed that any
potential retroactive application would
be burdensome, noting that it would
undermine the expectations that the
parties had when entering into the
security-based swap.85
c. Application to Inter-Affiliate
Transactions
Three commenters discussed the
application of the rules to inter-affiliate
transactions.86 All three recommended
that the rules generally not apply to
security-based swap transactions
between affiliates,87 but one recognized
that entity-level requirements (such as
CCO and supervision responsibilities)
will necessarily apply.88 One
commenter asserted that the rules are
intended to protect investors in arm’s
length transactions and therefore, would
be irrelevant in inter-affiliate
transactions.89 The second commenter
similarly argued that because affiliates
are not ‘‘external clients’’ of the SBS
Entity, the protections afforded by the
rules are inapposite.90 The second
commenter also suggested that the
Commission define ‘‘affiliate’’ to mean
an entity that is ‘‘under common control
and that reports information or prepares
its financial statements on a
consolidated basis’’ with another entity,
and opined that the definition should be
consistently applied across Title VII
rulemakings.91 The third commenter
also advocated for a common control
standard, arguing that the rules should
not apply to transactions between an
SBS Entity and ‘‘a person controlling,
controlled by, or under common control
with the [SBS Entity].’’ 92
d. Counterparty Opt-Out
Nine commenters addressed whether
to permit counterparties to opt out of
certain protections provided by the
84 See

FIA/ISDA/SIFMA, supra note 5.
AFGI (September 2012), supra note 5; AFGI
(July 2013), supra note 5; SIFMA (August 2011),
supra note 5.
86 See ABA Securities Association, supra note 5;
FIA/ISDA/SIFMA, supra note 5; SIFMA (August
2015), supra note 5.
87 See ABA Securities Association, supra note 5;
FIA/ISDA/SIFMA, supra note 5; SIFMA (August
2015), supra note 5.
88 See ABA Securities Association, supra note 5.
89 See FIA/ISDA/SIFMA, supra note 5.
90 See ABA Securities Association, supra note 5.
91 Id.
92 See SIFMA (August 2015), supra note 5.
85 See

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rules.93 Six commenters were in favor of
allowing an opt out in at least some
circumstances,94 and three were against
it.95
Three commenters suggested that the
Commission permit institutional or
‘‘sophisticated investors’’ to opt out of
provisions intended to protect
counterparties.96 Specifically, one
endorsed allowing ‘‘qualified
institutional buyers’’ as defined in Rule
144A under the Securities Act and
institutions with total assets of $100
million or more to opt out, asserting that
the costs, delays in execution, and
requirements to make detailed
representations and disclosure to the
SBS Entity may outweigh the benefits
that such counterparties would
receive.97 Another asserted that
‘‘sophisticated’’ counterparties should
be able to opt out of receiving ‘‘material
information’’ disclosures and the
written disclosures related to clearing
rights to lower their hedging costs and
avoid potential trading delays and
inefficiencies.98
Three other commenters suggested an
opt out for specific types of
counterparties.99 One suggested that an
ERISA plan should be permitted to opt
out because SBS Entities might use the
information they receive as a result of
compliance with the business conduct
standards to disadvantage the ERISA
plan.100 A second asserted that pension
funds acting as end users should be
allowed to opt out of any rules that
impose ‘‘heightened fiduciary duties’’
on SBS Dealers because pension funds
do not need extra protection, and
compliance with the fiduciary duties
would only increase costs for SBS
Dealers, leading them to either pass the
costs along or refrain from entering into
transactions with pension funds.101 A
third suggested that any entity advised
by a qualified independent
representative should be able to waive
the protections of the rules to avoid
93 See FIA/ISDA/SIFMA, supra note 5; CalPERS
(August 2011), supra note 5; SIFMA (August 2011),
supra note 5; ABC, supra note 5; MFA, supra note
5; CalSTRS, supra note 5; CFA, supra note 5; Better
Markets (August 2011), supra note 5; Levin, supra
note 5.
94 See FIA/ISDA/SIFMA, supra note 5; CalPERS
(August 2011), supra note 5; SIFMA (August 2011),
supra note 5; ABC, supra note 5; MFA, supra note
5; CalSTRS, supra note 5.
95 See CFA, supra note 5; Better Markets (August
2011), supra note 5; Levin, supra note 5.
96 See FIA/ISDA/SIFMA, supra note 5; CalPERS
(August 2011), supra note 5; MFA, supra note 5.
97 See FIA/ISDA/SIFMA, supra note 5.
98 See MFA, supra note 5.
99 See ABC, supra note 5; CalSTRS, supra note 5;
SIFMA (August 2011), supra note 5.
100 See ABC, supra note 5.
101 See CalSTRS, supra note 5.

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execution delays and administrative
costs.102
Three commenters opposed allowing
counterparties to opt out of the special
protections in the rules.103 One
commenter noted that a ‘‘theoretically
optional opt out would likely become
mandatory’’ because SBS Dealers would
make it a condition of doing business,
and that an opt-out approach could be
used to perpetuate abuses the rules are
intended to prevent.104 Another
commented that an opt-out would ‘‘only
add confusion to an already complex
regulatory framework and create
opportunities for market participants to
evade compliance with the muchneeded business conduct standards.’’ 105
A third specifically opposed allowing
counterparties to opt out of the
disclosure requirements, noting that
even sophisticated investors may be
misled.106
3. Response to Comments and Final
Rule
After considering the comments, the
Commission is adopting Rule 15Fh–1,
predesignated as Rule 15Fh–1(a), with
certain modifications.
a. General
The Commission is adopting, as
proposed, the provision in final Rule
15Fh–1(a) specifying that Rules 15Fh–1
through 15Fh–6 and Rule 15Fk–1 apply
‘‘in connection with entering into
security-based swaps’’ and also will
continue to apply, as appropriate, over
the term of executed security-based
swaps. Many of the rules impose
obligations on an SBS Entity with
respect to its ‘‘counterparty’’ that must
be satisfied before the SBS Entity has
actually entered into a security-based
swap with that counterparty (e.g., Rule
15Fh–3(a) (verification of counterparty
status) and Rule 15Fh–3(b) (disclosure
of material risks and characteristics, and
material incentives or conflicts of
interest)). This is consistent with the
language specifying that the rules apply
‘‘in connection with entering into
security-based swaps’’ in Rule 15Fh–
1(a). Accordingly, when the rules refer
to a ‘‘counterparty’’ of the SBS Entity,
the term ‘‘counterparty’’ includes a
potential counterparty where
compliance with the obligation is
required before the SBS Entity and the
102 See

SIFMA (August 2011), supra note 5.
CFA, supra note 5; Better Markets (August
2011), supra note 5; Levin, supra note 5.
104 See CFA, supra note 5.
105 See Better Markets (August 2011), supra
note 5.
106 See Levin, supra note 5.
103 See

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‘‘counterparty’’ has actually entered into
the security-based swap.107
b. Application to Security-Based Swaps
Entered Into Prior to the Effective Date
To address concerns raised by
commenters,108 the Commission is
clarifying that the business conduct
rules generally will not apply to any
security-based swap entered into prior
to the compliance date of the rules, and
generally will apply to any securitybased swap entered into after the
compliance date of these rules,
including a new security-based swap
that results from an amendment or
modification to a pre-existing securitybased swap.109
In response to commenters’ concerns
about applying the business conduct
rules to amendments to and other
lifecycle events of a security-based swap
entered into before the compliance date
of these rules,110 the Commission is
clarifying that the business conduct
rules generally will not apply to
amendments or modifications to a preexisting security-based swap unless the
amendment or modification results in a
new security-based swap (and occurs
after the compliance date of these rules).
The Commission has previously
determined that if the material terms of
a security-based swap are amended or
modified during its life based on an
exercise of discretion and not through
predetermined criteria or a
predetermined self-executing formula,
the amended or modified security-based
swap is viewed as a new security-based
swap.111 Thus, if there is such a
material amendment or modification,
which could include a change in the
economic terms of the transaction that
the parties would not have provided for
when entering into the security-based
swap contract, the Commission will
consider the amended or modified
security-based swap to be a new
107 We believe that our reading of the term
‘‘counterparty’’ to include a potential counterparty
addresses the concerns raised by the commenter
that requested that the Commission apply the rules
to security-based swaps that are offered as well as
those that are executed. See CFA, supra note 5.
108 See SIFMA (August 2011), supra note 5; FIA/
ISDA/SIFMA, supra note 5; NABL, supra note 5;
AFGI (September 2012), supra note 5; AFGI (July
2013), supra note 5; ABC, supra note 5; SIFMA
(August 2015), supra note 5.
109 See infra Sections IV.B and C (discussing the
compliance dates of these rules).
110 See FIA/ISDA/SIFMA, supra note 5; NABL,
supra note 5; SIFMA (August 2015), supra note 5.
111 See Products Definitions Adopting Release,
supra note 72, 77 FR at 48286 (‘‘If the material
terms of a Title VII instrument are amended or
modified during its life based on an exercise of
discretion and not through predetermined criteria
or a predetermined self-executing formula, the
Commissions view the amended or modified Title
VII instrument as a new Title VII instrument.’’).

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security-based swap for purposes of the
business conduct rules. If that material
amendment or modification occurs after
the compliance date of these rules, these
rules will apply to the resulting new
security-based swap.
In response to concerns raised by a
commenter, the Commission also is
clarifying that the rules generally will
not apply to either a partial or full
termination of a pre-existing securitybased swap.112 In these instances we
anticipate that the expectations of the
parties will be governed by the preexisting terms of the original securitybased swap, and so the business
conduct requirements generally will not
apply. If, however, the partial
termination involves a change in the
material terms of the original securitybased swap ‘‘based on an exercise of
discretion and not through
predetermined criteria or a
predetermined self-executing formula’’
the business conduct rules will apply.
As requested by a commenter,113 we
are clarifying that the business conduct
rules generally will not apply to a new
security-based swap that results from
the exercise of an option on a securitybased swap (whether or not the exercise
occurs before or after the compliance
date of these rules), as long as the terms
upon which a party can exercise the
option and the terms of the underlying
security-based swap that will result
upon the exercise of the option are
governed by the terms of the preexisting option. If, however, the material
terms of either the option or the
resulting security-based swap are
amended or modified based on an
exercise of discretion and not through
predetermined criteria or a
predetermined self-executing formula,
our business conduct rules will apply to
the amended or modified option or
security-based swap resulting from the
exercise of the option (assuming that
such amendment or modification occurs
after the compliance date of these rules).
We believe it appropriate to apply the
rules in this manner to help to ensure
that counterparties receive the benefits
of the rules in circumstances where they
are warranted, while providing firms
adequate time to review the business
conduct rules being adopted today and
make appropriate changes to their
operations before they have to begin
complying with those rules.
The Commission emphasizes that the
above clarifications relate to the
business conduct rules that by their
terms apply when an SBS Entity offers
to enter into or enters into a security112 See

SIFMA (August 2015), supra note 5.

113 Id.

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based swap, such as verification of
status (Rule 15Fh–3(a)), certain
disclosures (Rule 15Fh–3(b) and (d)),
requirements for special entities as
counterparties (Rule 15Fh–5), and payto-play (Rule 15Fh–6)). Other rules
being adopted today are broader in their
application, such as those relating to
know your counterparty (Rule 15Fh–
3(e)), recommendations of securitybased swaps or trading strategies (Rule
15Fh–3(f)), fair and balanced
communications (Rule 15Fh–3(g)),
supervision (Rule 15Fh–3(h)), antifraud
(Rule 15Fh–4(a)), requirements when an
SBS Dealer is acting as an advisor to a
special entity (Rule 15Fh–4(b)), and the
CCO (Rule 15Fk–1). Thus, if an SBS
Entity takes an action after the
compliance date that independently
implicates one of the business conduct
rules, it will need to comply with the
applicable requirements. For example, if
an SBS Dealer makes a recommendation
of a trading strategy that involves
termination of a pre-existing securitybased swap, the SBS Dealer would need
to comply with the suitability
requirements of Rule 15Fh–3(f)
regarding such recommendation. In
addition, an SBS Entity will need to
comply with ‘‘entity level’’ rules
relating to supervision and CCO after
the compliance date of those rules for
all of its security-based swap business.
c. Application to Inter-Affiliate
Transactions
The Commission agrees with the
concerns raised by commenters
regarding the treatment of inter-affiliate
transactions.114 As the Commission
noted in the Definitions Adopting
Release (defined below), market
participants may enter into interaffiliate security-based swaps for a
variety of purposes, such as to allocate
risk within a corporate group or to
transfer risks within a corporate group
to a central hedging or treasury
entity.115 As discussed below, we
believe that transactions by SBS Entities
with certain of their affiliated persons
do not implicate the concerns that the
business conduct requirements
regarding verification of counterparty
status (Rule 15Fh–3(a)), disclosures
regarding the product and potential
conflicts of interest, daily mark and
114 See ABA Securities Association, supra note 5;
FIA/ISDA/SIFMA, supra note 5; SIFMA (August
2015), supra note 5.
115 See Further Definition of ‘‘Swap Dealer,’’
‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap
Participant,’’ ‘‘Major Security-Based Swap
Participant’’ and ‘‘Eligible Contract Participant,’’
Exchange Act Release No. 66868 (Apr. 27, 2012), 77
FR 30596, 30624–30625 (May 23, 2012)
(‘‘Definitions Adopting Release’’).

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clearing rights (Rule 15Fh–3(b), (c) and
(d)), ‘‘know your counterparty’’ and
suitability obligations (Rules 15Fh–3(e)
and (f)), and obligations when advising
or acting as counterparty to a special
entity (Rules 15Fh–4(b) and 15Fh–5) are
intended to address (referred to as
‘‘transaction specific obligations’’).116
We therefore are providing in Rule
15Fh–1(a) as adopted that Rules 15Fh–
3(a) through (f), 15Fh–4(b) and 15Fh–5
are not applicable to security-based
swaps that SBS Entities enter into with
certain affiliates.
We are not, however, extending the
exception to transactions with all
affiliates, as requested by some
commenters.117 Rather, the Commission
is limiting the exception from the
business conduct requirements to
security-based swap transactions
between majority-owned affiliates. The
rule defines ‘‘majority-owned affiliates’’
consistent with the Definitions
Adopting Release such that, for these
purposes, the counterparties to a
security-based swap are majority-owned
affiliates if one counterparty directly or
indirectly owns a majority interest in
the other, or if a third party directly or
indirectly owns a majority interest in
both counterparties to the securitybased swap, where ‘‘majority interest’’ is
the right to vote or direct the vote of a
majority of a class of voting securities of
an entity, the power to sell or direct the
sale of a majority of a class of voting
securities of an entity, or the right to
receive upon dissolution or the
contribution of a majority of the capital
of a partnership.118
The transaction-specific obligations
outlined above and included in Rule
15Fh–1(a) generally are designed to
provide an SBS Entity counterparty
with certain information in connection
with the security-based swap
transaction that would help reduce
potential information asymmetries, and
to help ensure that the SBS Entity
knows its counterparty and acts in a fair
manner towards that counterparty, even
in the face of potential conflicts of
interest. The Commission does not
believe that these objectives and
116 As one commenter suggested, because
affiliates are not ‘‘external clients’’ of the SBS
Entity, the protections afforded by these rules may
be inapposite. See ABA Securities Association,
supra note 5.
117 See SIFMA (August 2015), supra note 5; FIA/
ISDA/SIFMA, supra note 5. See also ABA
Securities Association, supra note 5 (suggesting an
‘‘affiliated group’’ definition that was considered
but not adopted in the Definitions Adopting
Release). As noted above, the Commissions instead
adopted the exception for ‘‘majority-owned
affiliates’’ that we are providing here. See
Definitions Adopting Release, supra note 115.
118 See Exchange Act Rules 3a71–1(d)(1) and
15Fh–1(a).

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concerns are implicated in the same
manner or to the same extent when
there is an alignment of economic
interests between the SBS Entity and a
counterparty, such as is the case when
the counterparty is a majority-owned
affiliate. However, absent majority
ownership, we cannot be confident that
there would be an alignment of
economic interests that is sufficient to
eliminate the concerns that underpin
the need for regulation in this area.119
Accordingly, the Commission is
modifying Rule 15Fh–1(a) to provide
that Rules 15Fh–3(a)–(f), 15Fh–4(b) and
15Fh–5 are not applicable to securitybased swaps that SBS Entities enter into
with their majority-owned affiliates.
These generally are the transaction
specific exceptions requested by a
commenter.120
Further, consistent with the
commenter’s request, we are not
granting an exception for transactions
with affiliates with respect to the
antifraud requirements of Rule 15Fh–
4(a) or the requirements of Rule 15Fh–
3(g) (fair and balanced
communications).121 The exception for
inter-affiliate transactions from the
transaction specific obligations
discussed above is generally predicated
on the assumption that entities with
aligned economic interests have an
incentive to act fairly when dealing with
each other. However, we believe it
important to continue to provide the
protections of the antifraud and fair and
balanced communication rules in
situations where an SBS Entity acts in
a manner contrary to this assumption.
We also are not granting exceptions to
the entity-level requirements regarding
supervision (Rule 15Fh–3(h)) and CCO
obligations (Rule 15Fk–1), which are
intended to help to ensure the
compliance of SBS Entities in their
security-based swap transactions.
d. Counterparty Opt-Out
The Commission has considered the
concerns raised by commenters 122 and
determined, on balance, not to permit
counterparties generally to opt out of

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119 See

Definitions Adopting Release, 77 FR at
30625, supra note 115 (declining to adopt a
‘‘common control’’ standard, noting that, ‘‘[a]bsent
majority ownership, we cannot be confident that
there would be an alignment of economic interests
that is sufficient to eliminate the concerns that
underpin dealer regulation.’’).
120 See SIFMA (August 2015), supra note 5
(requesting exceptions with respect to Rules 15Fh–
3(a) through (f), 15Fh–4(b) and 15Fh–5).
121 See id.
122 See FIA/ISDA/SIFMA, supra note 5; CalPERS
(August 2011), supra note 5; SIFMA (August 2011),
supra note 5; ABC, supra note 5; MFA, supra note
5; CalSTRS, supra note 5; CFA, supra note 5; Better
Markets (August 2011), supra note 5; Levin, supra
note 5.

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the protections provided by the business
conduct rules. As discussed throughout
the release in the context of specific
rules, the rules being adopted today are
intended to provide certain protections
for counterparties, including certain
heightened protections for special
entities. We think it is appropriate to
apply the rules so that counterparties
receive the benefits of those protections
and so do not think it appropriate to
permit parties generally to elect to ‘‘opt
out’’ of the benefits of those
provisions.123
While we are not adopting a general
opt-out provision, as discussed below in
connection with the relevant rules, the
Commission has determined to permit
means of compliance with the final
rules that should promote efficiency and
reduce costs (e.g., Rule 15Fh–1(b)
(reliance on representations)) and,
where appropriate, allow SBS Entities to
take into account the sophistication of
the counterparty (e.g., Rule 15Fh–3(f)
(regarding recommendations of securitybased swaps or trading strategies)).
B. Exceptions for Anonymous SEF or
Exchange-Traded Transactions
Section 15F(h)(7) of the Exchange Act
provides a statutory exception ‘‘from the
requirements of this subsection’’ for
security-based swap transactions that
are: ‘‘(A) initiated by a special entity on
an exchange or security-based swaps
execution facility; and (B) the securitybased swap dealer or major securitybased swap participant does not know
the identity of the counterparty to the
transaction.’’ 124 More generally,
commenters have asked the Commission
to provide exceptions to the application
of our rules in situations in which an
SBS Entity does not know the identity
of its counterparty, or where a securitybased swap transaction is executed on a
registered national securities exchange
or security-based swap execution
facility (‘‘SEF’’), without regard to
whether the counterparty is a special
entity.125
1. Proposal
Noting that there may be
circumstances in which it may be
unclear which party ‘‘initiated’’ the
communications that resulted in the
parties entering into a security-based
swap transaction on a registered SEF or
123 However, as discussed in Section II.H.1.c.iii
below, in order to resolve any tension between
Exchange Act Sections 15F(h)(2)(C)(iii) and (iv), we
are allowing employee benefit plans that are
defined in Section 3 of ERISA but not subject to
Title I of ERISA to opt out of special entity status.
124 15 U.S.C. 78o–10(h)(7).
125 See, e.g., SIFMA (August 2011), supra note 5;
BlackRock, supra note 5; FIA/ISDA/SIFMA, supra
note 5.

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29971

registered national securities exchange,
the Commission proposed to interpret
Section 15F(h)(7) to apply to any
transaction with a special entity on a
registered SEF or registered national
securities exchange, where the SBS
Entity does not know the identity of its
counterparty at any time up to and
including execution of a transaction.
The Commission further proposed to
interpret Section 15F(h)(7) to apply with
respect to requirements specific to
dealings with special entities. Proposed
Rule 15Fh–4(b)(3) would provide an
exception from the special requirements
for SBS Dealers acting as advisors to
special entities, including the
requirement that an SBS Dealer act in
the best interests of a special entity for
whom it acts as an advisor, if the
transaction is executed on a registered
exchange or SEF and the SBS Dealer
does not know the identity of the
counterparty at any time up to and
including execution of the transaction.
Under the same circumstances,
proposed Rule 15Fh–5(c) would
similarly provide an exception from the
special requirements for SBS Entities
acting as counterparties to special
entities, including the qualified
independent representative and
disclosure requirements of proposed
Rule 15Fh–5.126 Proposed Rule 15Fh–
6(b)(2)(iii) would provide an exception
from the pay to play rules with respect
to transactions on a registered exchange
or SEF where the SBS Dealer does not
know the identity of the counterparty at
any time up to and including execution
of the transaction.127
Consistent with Section 15F(h)(7), we
also proposed to limit the application of
certain other requirements to situations
in which the identity of a counterparty
(whether a special entity or not) is
known to the SBS Entity. The rules as
proposed would limit the verification of
counterparty status obligations
(proposed Rule 15Fh–3(a)),128 and know
your counterparty obligations (proposed
Rule 15Fh–3(e)) to transactions with
126 See Section II.H.8, infra for a discussion of the
proposed exceptions from the requirements of Rules
15Fh–4(b) and 15Fh–5.
127 Rule 15Fh–6, as proposed, would apply only
with respect to transactions ‘‘initiated’’ by a
municipal entity. The Commission is modifying the
exception under Rule 15Fh–6(b)(2)(iii) to apply to
all security-based swap transactions that are
executed on a registered national securities
exchange or registered or exempt SEF, rather than
just with respect to transactions ‘‘initiated by a
municipal entity’’ on such exchange or registered
SEF (as long as the other conditions of Rule 15Fh–
6(b)(2)(iii) are met). These revisions are consistent
with the exceptions to Rules 15Fh–4 and 15Fh–5
for anonymous, exchange-traded or SEF
transactions. See Section II.H.9, infra.
128 See Section II.G.1, infra.

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counterparties whose identity is known
to the SBS Entity.129
2. Comments on the Proposal
The Commission received five
comment letters that addressed the
exception for anonymous, exchange or
SEF-traded security-based swaps in the
context of special entity-specific
requirements,130 and four comment
letters that addressed more broadly the
issue of an exception for anonymous or
SEF and exchange-traded security-based
swaps.131 The comment letters that
address the exception in the context of
the special entity requirements are
discussed infra in Sections II.H.8 and
II.H.9. The comment letters that address
the broader issue of an exception from
business conduct requirements for
anonymous or SEF and exchange-traded
security-based swaps are discussed
below.
Two commenters asserted that, where
a security-based swap is cleared
(through registered clearing
organizations) and SEF or exchangetraded, the transaction should not be
subject to the requirements of the
proposed rules—regardless of whether
the identity of the counterparty is
known at the time of execution.132 The
commenters argued that knowledge or
identification of a counterparty’s
identity should not compel compliance
with the business conduct standards.133
The commenters further argued that the
concerns addressed by business conduct
standards were largely inapplicable to
security-based swaps entered into
through registered SEFs, swap execution
facilities or registered national securities
exchanges.134 The commenters asserted
that compliance with the proposed rules
would result in delay, additional
complexity, individual negotiation and
potentially less transparency, which the
129 See

Sections II.G.1 and II.G.3, infra.
ABC, supra note 5; CFA, supra note 5;
SIFMA (August 2015), supra note 5; Better Markets
(August 2011), supra note 5; FIA/ISDA/SIFMA,
supra note 5.
131 See SIFMA (August 2011), supra note 5; MFA,
supra note 5; BlackRock, supra note 5; SIFMA
(August 2015), supra note 5
132 See SIFMA (August 2011), supra note 5
(arguing that parties to exchange-traded securitybased swaps likely know the identity of their
counterparty before the transaction, either because
the exchange uses a request for quote system (where
the participants can seek quotes from specific
counterparties) or a single-dealer platform, or
because information about the counterparties to the
trade is necessary to complete the execution
process); BlackRock, supra note 5.
133 See SIFMA (August 2011), supra note 5
(‘‘mere knowledge’’); BlackRock, supra note 5
(‘‘mere identification’’).
134 See SIFMA (August 2011), supra note 5
(‘‘largely inapplicable’’); BlackRock, supra note 5
(‘‘simply will not be an issue’’).

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130 See

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trading and clearing requirements of the
Dodd-Frank Act sought to avoid.135
However, one of the commenters
acknowledged that some security-based
swaps executed on a SEF or exchange
might be bilaterally negotiated, and the
SEF or exchange subsequently used to
process the trade, in which case it might
be appropriate to apply the business
conduct standards.136
After adoption of the CFTC’s business
conduct standards, one commenter
urged the Commission to adopt an
exception for exchange-traded securitybased swaps that are intended to be
cleared if: (1)(a) The transaction is
executed on a registered or exempt SEF
or registered national securities
exchange; and (b) is of a type that is, as
of the date of execution, required to be
cleared pursuant to Section 3C of the
Exchange Act; or (2) the SBS Entity does
not know the identity of the
counterparty, at any time up to and
including execution of the
transaction.137 The commenter argued
that these changes would harmonize the
scope of the Commission’s requirements
with the scope of the parallel
requirements under the relief provided
by CFTC No-Action Letter 13–70.138 The
commenter argued that the
considerations on which the CFTC staff
based its no-action relief would also
apply to the security-based swap
market, namely: ‘‘(i) the impossibility or
impracticability of compliance with
certain rules by a Swap Entity when the
identity of the counterparty is not
known prior to execution; (ii) the
likelihood that swaps initiated
anonymously on a designated contract
market or swap execution facility will
be standardized and, thus, information
about the material risks and
characteristics of such swaps is likely to
be available from the designated
contract market or swap execution
facility or other widely available source
(including the product specifications of
a derivatives clearing organization
where the swaps are accepted for
clearing); and (iii) the likelihood that
such relief would provide an incentive
to transact on designated contract
markets and swap execution facilities,
135 See SIFMA (August 2011), supra note 5;
BlackRock, supra note 5.
136 See BlackRock, supra note 5 (also noting that,
conversely, generally ‘‘when a swap or a securitybased swap is cleared and exchange-traded, the
counterparty to the trade should be viewed as
fungible, rendering compliance with the specific
requirements of [the proposed rules] unnecessary’’).
137 See SIFMA (August 2015), supra note 5.
138 Id. See Swaps Intended to Be Cleared, CFTC
Letter No. 13–70 (Nov. 15, 2013), available at http://
www.cftc.gov/idc/groups/public/@lrlettergeneral/
documents/letter/13-70.pdf.

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thus enhancing transparency in the
swaps market.’’ 139
3. Response to Comments and Final
Rules
After considering the comments, the
Commission has determined to adopt
two sets of exceptions from the business
conduct requirements. As discussed in
Sections II.H.8 and II.H.9, infra, we are
adopting exceptions from the
requirements of Rules 15Fh–4(b), 15Fh–
5 and 15Fh–6 (collectively, ‘‘special
entity exceptions’’) for anonymous
transactions executed on a registered
national securities exchange or a
registered or exempt SEF, where the
identity of the special entity is not
known to the SBS Entity at a reasonably
sufficient time prior to execution of the
transaction to permit the SBS Entity to
comply with the obligations of the
rule.140
In addition to the special entity
exceptions, the Commission is adopting
a second set of exceptions that are not
limited to transactions with special
entities, under which certain of the
business conduct standards rules will
apply only where the SBS Entity knows
the identity of the counterparty at a
reasonably sufficient time prior to
execution of the transaction to permit
the SBS Entity to comply with the
obligations of the rule.141 These
exceptions are intended to address the
impracticalities and potential business
disruption that could result if an SBS
Entity were required to comply with the
disclosure requirements in Rule 15Fh–
3(b) (requiring an SBS Entity to disclose
material risks and characteristics of a
security-based swap and material
incentives or conflicts in connection
with a security-based swap, prior to
entering into that security-based swap
with a counterparty) and Rule 15Fh–
3(d) (requiring certain pre-transaction
disclosures to counterparties regarding
clearing rights), before learning the
identity of its counterparty.142 By only
applying these rules’ requirements to
situations where the counterparty’s
identity is known ‘‘at a reasonably
sufficient time prior to’’ the execution of
a transaction, the rules’ requirements
are limited to situations where an SBS
139 Id.
140 See Rules 15Fh–4(b)(3)(ii), 15Fh–5(d)(2) and
15Fh–6(b)(3)(iii). We have similarly modified the
verification of special entity counterparty status
requirements in Rule 15Fh–3(a)(2), as discussed
infra in Section II.G.1.
141 See ABC, supra note 5; FIA/ISDA/SIFMA,
supra note 5.
142 As discussed in Section II.G.3, infra, we are
adopting as proposed the exception in Rule 15Fh–
3(e), which limits SBS Dealers’ counterparty
obligations under the rule to transactions with
‘‘known’’ counterparties.

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Entity has sufficient time before the
execution of the transaction to comply
with its obligations under the rules. For
this reason, we decline to adopt
language, suggested by a commenter,
which would apply the exception to
circumstances where the identity of the
counterparty ‘‘is not known at any time
up to and including execution of the
transaction.’’ 143
We are not, however, accepting the
commenter’s suggestion that we revise
our exceptions to provide an exception
for transactions intended to be cleared
so long as the transaction is either
executed on a registered national
securities exchange or registered or
exempt SEF and required to be cleared
pursuant to Section 3C of the Exchange
Act, regardless of whether or not the
transaction is anonymous.144 Similarly,
we reject commenters’ more general
assertions that the exceptions should
apply to all SEF or exchange-traded
transactions, even where the identity of
the counterparty is known,145 and that
the protections provided by the business
conduct standards are unnecessary for
security-based swaps that are entered
into through registered SEFs, swap
execution facilities or registered
national securities exchanges.146 The
rules being adopted today are intended
to provide certain protections for
counterparties, and we think it is
appropriate to apply the rules, to the
extent practicable, so that counterparties
receive the benefits of those protections.
We have determined not to apply those
rules where it may not be possible or
practical to do so, specifically where a
transaction is executed on a registered
exchange or SEF and the identity of the
counterparty is not known to the SBS
Entity at a reasonably sufficient time
prior to execution of the transaction to
permit the SBS Entity to comply with
the obligations of the rule. However,
where the identity of the counterparty is
known in a timely manner, we believe
that it is appropriate to apply the rules
so that the counterparty receives the
benefits of the protections provided by
the rules, including the assistance of an
advisor or qualified independent
representative acting in the best
interests of a counterparty that is special
entity.

143 See

SIFMA (August 2015), supra note 5.

144 Id.
145 See SIFMA (August 2011), supra note 5;
BlackRock, supra note 5.
146 See SIFMA (August 2011), supra note 5.

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C. Application of the Rules to SBS
Dealers and Major SBS Participants
1. Proposal
As noted in the Proposing Release, in
general, where the Dodd-Frank Act
imposes a business conduct requirement
on both SBS Dealers and Major SBS
Participants, we proposed rules that
would apply to SBS Dealers and Major
SBS Participants.147 Where, however, a
business conduct requirement is not
expressly addressed by the Dodd-Frank
Act, the proposed rules generally
applied only to SBS Dealers.148 We
solicited comment on whether this
approach was appropriate. Specifically,
where the Dodd-Frank Act requires that
a business conduct rule apply to all SBS
Entities, we asked if the rule should
impose the same requirements on Major
SBS Participants as on SBS Dealers, and
where we proposed rules for SBS
Dealers that are not expressly addressed
by the Dodd-Frank Act, we asked if any
of those rules should also apply to
Major SBS Participants.
2. Comments on the Proposal
Three commenters addressed the
general application of the rules to SBS
Dealers and Major SBS Participants.149
One commenter agreed it may be
appropriate, ‘‘in light of their somewhat
different roles,’’ to adopt different
approaches to rules governing SBS
Dealers and Major SBS Participants in
certain areas.150 The commenter
asserted that absent an affirmative
reason to adopt a different approach for
SBS Dealers and Major SBS
Participants, the Commission should
seek to promote consistency and adopt
uniformly strong rules.151 The
commenter argued that the determining
factor should be whether Major SBS
Participants are likely to be engaged in
conduct that would appropriately be
regulated under the relevant
standard.152
In contrast, another commenter urged
the Commission to consider separate
147 See Proposing Release, 76 FR at 42400–42401,
supra note 3.
148 As noted in the Proposing Release, there are
exceptions to this principle. We proposed that all
SBS Entities be required to determine if a
counterparty is a special entity. In addition, Section
3C(g)(5) of the Exchange Act creates certain rights
with respect to clearing for counterparties entering
into security-based swaps with SBS Entities but
does not require disclosure. We proposed a rule that
would require an SBS Entity to disclose to a
counterparty certain information relating to these
rights. See 15 U.S.C. 78c–3(g)(5); Proposing Release,
76 FR at 42401 n.39, supra note 3.
149 See CFA, supra note 5; MFA, supra note 5;
BlackRock, supra note 5.
150 See CFA, supra note 5.
151 Id.
152 Id.

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29973

regulatory regimes for SBS Dealers and
Major SBS Participants, arguing that
they are different, and there are
‘‘different reasons why the Dodd-Frank
Act requires additional oversight of
each.’’ 153 The commenter
recommended that the Commission
focus regulation of Major SBS
Participants on reducing default risk,
and focus regulation of SBS Dealers on
market making and pricing and sales
practices in addition to reducing default
risk.154 The commenter argued that to
the extent Major SBS Participants
transact at arm’s-length, they will not be
advising counterparties and therefore,
neither fiduciary duties nor ‘‘dealer-like
obligations’’ (regarding ‘‘know your
counterparty,’’ suitability and ‘‘pay-toplay’’ restrictions, for example) should
be imposed on them.155
A third commenter generally
supported our proposed approach in not
applying certain business conduct
requirements to Major SBS Participants
where the Dodd-Frank Act does not
expressly impose such standards.156 In
the alternative, if the Commission
determines to require Major SBS
Participants to disclose ‘‘material
information’’ and to provide daily marks
to their counterparties, the commenter
asked that we make these requirements
inapplicable to transactions between a
Major SBS Participant and an SBS
Dealer, and to allow all other parties to
opt out of receiving such disclosures in
their dealings with a Major SBS
Participant.157
3. Response to Comments and Final
Rules
After considering the comments, the
Commission has determined to apply
the rules to SBS Dealers and Major SBS
Participants as proposed. To that end, as
discussed below, where a statutory
provision encompasses both SBS
Dealers and Major SBS Participants,158
153 See

MFA, supra note 5.

154 Id.
155 Id.
156 See

BlackRock, supra note 5.

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

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we are adopting rules that would apply
equally to SBS Dealers and Major SBS
Participants.159 We think this is
important to ensure that counterparties
of Major SBS Participants, as well as
counterparties of SBS Dealers, receive
the protections the rules are intended to
provide. For example, to the extent that
Major SBS Participants may be better
informed about the risks and valuations
of security-based swaps due to
information asymmetries, disclosures
may help inform counterparties
concerning the material risks and
characteristics of security-based swaps,
and material conflicts of interest of
Major SBS Participants entering into
security-based swaps.160
Where, however, a business conduct
requirement is not expressly addressed
by the Dodd-Frank Act or we read the
statute to apply a requirement only to
SBS Dealers,161 the adopted rules
generally would not apply to Major SBS
Participants.162 Thus, the obligations
under Rules 15Fh–3(e) (know your
counterparty), 15Fh–3(f)
(recommendations of security-based
swaps or trading strategies), 15Fh–4(b)
(special obligations when acting as an
advisor to a special entity) and 15Fh–6
(pay to play rules) do not apply to a
Major SBS Participant. In addition, our
rules provide exceptions to Major SBS
Participants, as discussed in Section
II.G.2.a, from certain disclosure
requirements when entering into
security-based swaps with an SBS
Dealer, another Major SBS Participant, a
swap dealer or a swap participant.
In determining whether or not to
apply certain requirements to Major SBS
Participants, as explained in the
Proposing Release, we have considered
how the differences between the
for SBS Dealers and Major SBS Participants that
enter into a security-based swap with a special
entity); and Section 15F(k) (imposing CCO
obligations).
159 See Rules 15Fh–3(a) (verification of
counterparty status), 15Fh–3(b) (pre-trade
disclosures), 15Fh–3(c) (daily mark), 15Fh–3(h)
(supervision), 15Fh–5 (special requirements for SBS
Entities acting as counterparties to special entities)
and 15Fk–1 (CCO requirements).
160 See discussion infra in Section VI.B.
161 See Section II.H.2 (regarding application of
‘‘act as an advisor’’ obligations under Rule 15Fh–
4(b) to SBS Dealers but not Major SBS Participants).
162 As noted in the Proposing Release, there are
exceptions to this principle. Because an SBS Entity
must comply with the requirements of Rule 15Fh–
5 if it is acting as a counterparty to a special entity,
the obligation to verify special entity status under
Rule 15Fh–3(a)(2) applies to all SBS Entities. See
Section II.G.1. In addition, Section 3C(g)(5) of the
Exchange Act creates certain rights with respect to
clearing for counterparties entering into securitybased swaps with SBS Entities but does not require
disclosure. As discussed in Section II.G.2.f, infra,
Rule 15Fh–3(d) would require all SBS Entities to
disclose to a counterparty certain information
relating to these clearing rights.

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definitions of SBS Dealer and Major SBS
Participant may be relevant in
formulating the business conduct
standards applicable to these entities.
The Dodd-Frank Act and our rules
define ‘‘security-based swap dealer’’ in
a functional manner, by reference to the
way a person holds itself out in the
market and the nature of the conduct
engaged in by that person, and how the
market perceives the person’s
activities.163 Unlike the definition of
‘‘security-based swap dealer,’’ which
focuses on those persons whose
function is to serve as the points of
connection in those markets, the
definition of ‘‘major security-based
swap participant’’ focuses on the market
impacts and risks associated with an
entity’s security-based swap
positions.164 Despite the differences in
focus, however, the Dodd-Frank Act
applies substantially the same statutory
standards to SBS Dealers and Major SBS
Participants.165 We explained in the
Proposing Release that, in this way, the
statute applies comprehensive
regulation to entities (i.e., Major SBS
Participants) whose security-based swap
activities do not cause them to be
dealers, but nonetheless could pose a
high degree of risk to the U.S. financial
system generally.
We are mindful, as noted by a
commenter, that there are ‘‘different
reasons why the Dodd-Frank Act
requires additional oversight of
each.’’ 166 We have attempted to take
into account these differing definitions
and regulatory concerns in considering
whether the business conduct
requirements that we proposed, and that
we are adopting, for SBS Dealers should
or should not apply to Major SBS
Participants as well. Accordingly, as
noted, in general, where the Dodd-Frank
Act imposes a business conduct
requirement on both SBS Dealers and
Major SBS Participants, the rules will
apply equally to SBS Dealers and Major
SBS Participants, and where a business
conduct requirement is not expressly
addressed by the Dodd-Frank Act, the
rules generally will not apply to Major
SBS Participants. We believe this
approach addresses the concern of the
commenter who argued that the
determining factor should be the
163 See Exchange Act Section 3(a)(71), 15 U.S.C.
78c(a)(71), and Rule 3a–71, 17 CFR 240.3a71.
164 See Exchange Act Section 3(a)(67), 15 U.S.C.
78c(a)(67), and Rule 3a–67, 17 CFR 240.3a67.
165 In particular, under Section 15F of the
Exchange Act, SBS Dealers and Major SBS
Participants generally are subject to the same types
of margin, capital, business conduct and certain
other requirements, unless an exclusion applies.
See 15 U.S.C. 78o–10.
166 See MFA, supra note 5.

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conduct in which a Major SBS
Participant is likely to be engaged.167
The external business conduct
requirements promulgated under
Section 15F(h) are intended to provide
certain protections for counterparties,
and we believe the rules we are
adopting today appropriately apply
those requirements to SBS Dealers and
Major SBS Participants so that
counterparties receive the benefit of
those protections. At the same time,
mindful of the different role to be
played by Major SBS Participants
(which, by definition, are not SBS
Dealers), we have not sought to impose
the full range of business conduct
requirements on Major SBS Participants.
We note that our approach in this regard
largely mirrors that of the CFTC, under
whose rules Swap Dealers and Major
Swap Participants have operated for
some time. We believe that this
consistency will result in efficiencies for
entities that have already established
infrastructure to comply with the CFTC
standard.
We proposed and are adopting limited
exceptions (as discussed in connection
with the applicable rules) from the
disclosure requirements in Rules 15Fh–
3(b), 15Fh–3(c) and 15Fh–3(d) for
transactions with an SBS Entity or a
Swap Entity.168 We are not, however,
adopting the suggestion that we broaden
the exceptions to permit other types of
counterparties to opt out of the
disclosures and other protections
provided under the rules when entering
into a transaction with a Major SBS
Participant. As noted above, the external
business conduct requirements
promulgated under Section 15F(h) are
intended to provide certain protections
for counterparties, and we believe the
rules we are adopting today
appropriately tailor those requirements
so that counterparties receive the benefit
of those protections.
D. Reliance on Representations
1. Proposal
The Proposing Release solicited input
on whether the rules adopted by the
Commission should include a standard
addressing the circumstances in which
an SBS Entity may rely on
representations to establish compliance
with the business conduct rules.169 We
sought comment on two alternative
approaches.170 One approach would
permit an SBS Entity to rely on a
representation from a counterparty
167 See

CFA, supra note 5.
BlackRock, supra note 5.
169 See Proposing Release, 76 FR at 42404, supra
note 3.
170 Id.
168 See

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
unless it knows that the representation
is not accurate (‘‘actual knowledge
standard’’).171 The other would permit
an SBS Entity to rely on a representation
unless the SBS Entity has information
that would cause a reasonable person to
question the accuracy of the
representation (‘‘reasonable person
standard’’).172 After the Commission
issued its proposed rules, the CFTC in
its final rules adopted a ‘‘reasonable
person standard’’ that generally permits
a Swap Entity to rely on written
representations to satisfy its due
diligence obligations unless it has
information that would cause a
reasonable person to question the
accuracy of the representation.173
2. Comments on the Proposal
Twelve commenters generally
addressed the proposed standards for
reliance on counterparty
representations.174 With one
exception,175 these comments predate
the 2012 adoption of the CFTC rules.
In 2011, seven commenters supported
the actual knowledge standard.176 One
asserted its view that the actual
knowledge standard would offer greater
legal certainty to SBS Entities when
making required subjective judgments
under the rules (for example, judgments
regarding the qualifications of a special
entity’s independent representative).177
Another commenter argued that the
actual knowledge standard is preferable
because the reasonable person standard
would require an assessment of what a
reasonable person would conclude if
such person had the same information
as the SBS Entity, which could cause
uncertainty and additional cost for
market participants.178
One commenter, writing after the
CFTC rules were adopted, asked the
Commission to adopt a ‘‘reasonable
person standard’’ that is ‘‘consistent
with the parallel CFTC EBC Rules,’’
171 Id.

which generally permit a Swap Entity to
rely on written representations to satisfy
its due diligence obligations unless it
has information that would cause a
reasonable person to question the
accuracy of the representations.179
Additionally, two other commenters
supported the reasonable person
standard in 2011.180 One commenter
asserted that the reasonable person
standard would help to ensure that SBS
Entities are acting on reliable
information because of the duty it
would impose to verify the accuracy of
a representation if the SBS Entity had
some reason to question it.181 The
commenter also argued that the
reasonable person standard would be
easier to monitor and enforce because it
would be objective rather than
subjective.182
Some commenters suggested that the
Commission require detailed
representations.183 One commenter
asked the Commission to clarify that, for
purposes of ‘‘red flags,’’ the knowledge
test should apply only to individuals
with knowledge of the security-based
swap transaction; information that may
be available to other parts of the SBS
Entity organization should not be
imputed to those individuals.184
Another commenter requested that the
Commission clarify that any
representations made by a special entity
or its representative to satisfy the rules
do not give any party any additional
rights, such as rescission or monetary
compensation (e.g., if the
representations turn out to be
incorrect).185 Additionally, the
commenter asserted that an SBS Dealer
should be permitted to rely on a single
set of representations made by a special
entity at the beginning of a trading
relationship, rather than requiring the
SBS Dealer to obtain a new
representation with each transaction, if
the special entity represents that it will
notify the SBS Dealer when the
representations become inaccurate.186

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More generally, another commenter
recommended allowing representations
to be contained in counterparty
relationship documentation if agreed to
by the counterparties, and requiring
counterparties to undertake to update
such representations with any material
changes.187 The commenter also
suggested that an SBS Entity that is also
registered with the CFTC as a Swap
Entity should be permitted to rely on a
counterparty’s written representations
with respect to the CFTC’s business
conduct rules to satisfy its due diligence
requirements under the Commission’s
business conduct rules provided that
the SBS Entity provides notice of such
reliance to the counterparty and the
counterparty does not object.188 The
commenter argued that this would
speed implementation and lower costs
without reducing counterparty
protections.189 Finally, the commenter
recommended including both a general
reliance on representations provision
and also specific reliance on
representations safe harbors in the
individual rules that specify what
representations the SBS Entity should
obtain to satisfy the safe harbor.190
3. Response to Comments and Final
Rule
The Commission is adopting new
Rule 15Fh–1(b), which provides that an
SBS Entity may rely on written
representations to satisfy its due
diligence requirements under the
business conduct rules unless it has
information that would cause a
reasonable person to question the
accuracy of the representation. Under
this standard, if an SBS Entity has in its
possession information that would
cause a reasonable person to question
the accuracy of the representation, it
will need to make further reasonable
inquiry to verify the accuracy of the
representation.191
187 See

SIFMA (August 2015), supra note 5.
In a subsequent letter, the commenter
explained that there is a multilateral protocol that
has been adopted by most market participants as a
means of complying with the CFTC rules. See
SIFMA (November 2015), supra note 5. The
commenter noted that the representations contained
in this protocol only expressly address market
participants’ trading in swaps, but asserted that
‘‘the factual matters addressed by those
representations typically do not vary as between
trading in swaps and trading in [security-based
swaps]. As a result, requiring SBS Entities to obtain
separate representations specifically addressing
[security-based swaps] would impose additional
costs with few, if any, additional benefits.’’ Id.
189 SIFMA (November 2015), supra note 5.
190 Id.
191 See Proposing Release, 76 FR at 42404, supra
note 3. As described infra in Section II.G.0, Rule
15Fh–3(e) will require an SBS Dealer to have
policies and procedures reasonably designed to
188 Id.

172 Id.
173 See CFTC Adopting Release, 77 FR at 9749,
supra note 21.
174 See CCMR, supra note 5; FIA/ISDA/SIFMA,
supra note 5; APPA, supra note 5; BlackRock, supra
note 5; SIFMA (August 2011), supra note 5; ABC,
supra note 5; ABA Committees, supra note 5;
NABL, supra note 5; Better Markets (August 2011),
supra note 5; AFSCME, supra note 5; CFA, supra
note 5; SIFMA (August 2015), supra note 5.
175 See SIFMA (August 2015), supra note 5
(asking the Commission to adopt a reasonable
person standard consistent with the standard under
the parallel CFTC rules).
176 See FIA/ISDA/SIFMA, supra note 5; APPA,
supra note 5; BlackRock, supra note 5; SIFMA
(August 2011), supra note 5; ABC, supra note 5;
ABA Committees, supra note 5; NABL, supra note
5.
177 See FIA/ISDA/SIFMA, supra note 5.
178 See NABL, supra note 5.

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179 See

SIFMA (August 2015), supra note 5.
Better Markets (August 2011), supra note
5; CCMR, supra note 5. See also CFA, supra note
5 (opposing both proposed standards but noting a
preference for the reasonable person standard over
the actual knowledge standard).
181 See Better Markets (August 2011), supra note
5.
182 Id.
183 See AFSCME, supra note 5 (recommending
requiring written representations that are
‘‘sufficiently detailed and informative to permit
reliance,’’ and requiring SBS Entities to have a
reasonable basis for believing the representations to
be true); CFA, supra note 5 (recommending
requiring that the written representations be
sufficiently detailed to allow such an assessment).
184 See FIA/ISDA/SIFMA, supra note 5.
185 See ABC, supra note 5.
186 Id.
180 See

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We understand that this is a market in
which parties rely heavily on
representations both with respect to
relationship documentation and the
transactions themselves. While both
standards we proposed for comment
could be workable in this context, we
recognize that neither provides the
absolute certainty sought by some
commenters. As we explained in the
Proposing Release, under either
approach an SBS Entity could not
ignore information in its possession as
a result of which the SBS Entity would
know that a representation is
inaccurate.192 Under an ‘‘actual
knowledge’’ standard, however, an SBS
Entity can rely on a representation
unless it knows that the representation
is inaccurate. This alternative could
allow SBS Entities to rely on
questionable representations insofar as
they do not have actual knowledge that
the representation is inaccurate, even if
they have information that would cause
reasonable persons to question their
accuracy. As a result, this alternative
could potentially reduce the benefits of
the verification of status, know your
counterparty, suitability and special
entity requirements and result in weaker
protections for counterparties to SBS
Entities. In contrast, the ‘‘reasonable
person’’ standard under the rule as
adopted should help ensure that SBS
Entities do not disregard facts that call
into question the validity of the
representation.193
Further, this standard also is
consistent with the standard adopted by
the CFTC under which a Swap Entity
cannot rely on a representation if the
Swap Entity has information that would
obtain and retain certain essential facts regarding a
known counterparty. As a result, information in the
SBS Entity’s possession will include information
gathered by an SBS Dealer through compliance with
the ‘‘know your counterparty’’ provisions of Rule
15Fh–3(e), as well as any other information the SBS
Entity has acquired through its interactions with the
counterparty, including other representations
obtained from the counterparty by the SBS Entity.
192 See Proposing Release, 76 FR at 42404, supra
note 3.
193 Cf. Exchange Act Rule 3a71–3(4) (permitting
reliance on a counterparty representation unless the
party seeking to rely on the representation ‘‘knows
or has reason to know that the representation is not
accurate; . . . a person would have reason to know
that the representation is not accurate if a
reasonable person should know, under all of the
facts of which the person is aware, that it is not
accurate’’). See also Application of ‘‘Security-Based
Swap Dealer’’ and ‘‘Major Security-Based Swap
Participant’’ Definitions to Cross-Border SecurityBased Swap Activities; Final Rule; Republication,
Exchange Act Release No. 72472 (Jun. 25, 2014), 79
FR 47277, 47313 (Aug. 12, 2014 (republication))
(‘‘Cross-Border Adopting Release’’) (noting that
‘‘this ‘known or have reason to know’ standard
should help ensure that potential [SBS Entities] do
not disregard facts that call into question the
validity of the representation’’).

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cause a reasonable person to question
the accuracy of the representation.194
This consistency will result in
efficiencies for entities that have already
established infrastructure to comply
with the CFTC standard.
The rule as adopted would permit an
SBS Entity to reasonably rely on the
representations of a counterparty or its
representative to satisfy its due
diligence obligations under the business
conduct rules, including Rules 15Fh–
2(a) and (d), 15Fh–3(a), (e) and (f),
15Fh–4 and 15Fh–5. We are not
requiring a specified level of detail for
these representations but note that they
should be detailed enough to permit the
SBS Entity to form a reasonable basis for
believing that the applicable
requirement is satisfied.195
Nothing in our rules would prohibit
an arrangement under which the parties
agree that representations will be
provided in counterparty relationship
documentation, and that they will
update such representations with any
material changes, as suggested by
commenters.196
We are not accepting the commenter’s
suggestion that we provide that in every
instance an SBS Entity that is also
registered with the CFTC as a Swap
Entity will be permitted to rely on a
counterparty’s pre-existing written
representations with respect to the
CFTC’s business conduct rules to satisfy
its due diligence requirements under the
Commission’s business conduct rules,
provided that the SBS Entity provides
notice of such reliance to the
counterparty and the counterparty does
not object.197 Rule 15Fh–1(b) as adopted
sets out the standard pursuant to which
an SBS Entity can rely on
representations to satisfy its due
diligence obligations, and does not
194 See CFTC Adopting Release, 77 FR at 9749,
supra note 21.
195 See AFSCME, supra note 5 (recommending
requiring written representations that are
‘‘sufficiently detailed and informative to permit
reliance,’’ and requiring SBS Entities to have a
reasonable basis for believing the representations to
be true); CFA, supra note 5 (recommending
requiring that the written representations be
sufficiently detailed to allow such an assessment).
196 See FIA/ISDA/SIFMA, supra note 5; SIFMA
(August 2015), supra note 5.
197 Id. In a subsequent letter, the commenter
explained that there is a multilateral protocol that
has been adopted by most market participants as a
means of complying with the CFTC rules. See
SIFMA (November 2015), supra note 5. The
commenter noted that the representations contained
in this protocol only expressly address market
participants’ trading in swaps, but asserted that
‘‘the factual matters addressed by those
representations typically do not vary as between
trading in swaps and trading in [security-based
swaps]. As a result, requiring SBS Entities to obtain
separate representations specifically addressing
[security-based swaps] would impose additional
costs with few, if any, additional benefits.’’ Id.

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speak to the process the SBS Entity will
need to undertake to meet the standard.
The question of whether reliance on the
representations that had been obtained
with respect to the CFTC business
conduct rules, including the process by
which the SBS Entity makes that
determination, would satisfy an SBS
Entity’s obligations under our business
conduct rules will depend on the facts
and circumstances of the particular
matter.198
We are not adopting the suggestion of
one commenter that ‘‘the knowledge test
should be applied only to individuals
with knowledge of the SBS
transaction.’’ 199 In some instances it
may be appropriate to look only to the
knowledge of persons involved in a
security-based swap transaction for
purposes of determining whether an
SBS Entity reasonably relied on
representations. However, the
determination whether to impute to the
individuals that are involved in a
securities-based swap transaction
knowledge that may be available in
other parts of the SBS Entity will
depend on the facts and circumstances
of the particular matter. At a minimum,
an SBS Entity seeking to rely on
representations cannot ignore
information that would cause a
reasonable person to question the
accuracy of those representations.
E. Policies and Procedures Alternative
1. Proposal
The Commission solicited comment
on whether an SBS Entity should be
deemed to have complied with a
requirement under the proposed rules if
it has: (1) Established and maintained
written policies and procedures, and a
documented system for applying those
policies and procedures, that are
reasonably designed to achieve
compliance with the requirement; and
(2) reasonably discharged the duties and
obligations required by the written
policies and procedures and
documented system, and did not have a
reasonable basis to believe that the
written policies and procedures and
documented system were not being
followed.200
198 See SIFMA (August 2015), supra note 5;
SIFMA (November 2015), supra note 5.
199 See FIA/ISDA/SIFMA, supra note 5 (arguing
that information that may be available to other parts
of the SBS Entity organization should not be
imputed to those individuals involved in the SBS
transaction).
200 See Proposing Release, 76 FR at 42402, supra
note 3.

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2. Comments on the Proposal
One commenter addressed the
policies and procedures alternative.201
The commenter opposed the alternative,
arguing that it would reward the process
of achieving compliance more than
actually achieving compliance.202
However, the commenter asserted that
SBS Entities should be required to
establish, maintain, document and
enforce appropriate policies and
procedures, and that the Commission
should take them into account when
determining the sanctions for
violations.203 The commenter argued
that the requirement regarding policies
and procedures should supplement the
requirements or prohibitions in the
rules, not supplant them.204
3. Response to Comments and Final
Rule

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After taking into consideration the
comment, the Commission is not
adopting a general policies and
procedures safe harbor. The
Commission acknowledges the
importance of policies and procedures
as a tool to achieving compliance with
applicable regulatory and other
requirements but agrees with the
commenter that a general policies and
procedures safe harbor could have the
unintended effect of rewarding the
process towards achieving compliance
more than the result of actually
achieving compliance.205
As discussed more fully herein, Rule
15Fh–3(h) requires that an SBS Entity
establish, maintain and enforce written
policies and procedures that are
reasonably designed to prevent
violations of applicable securities laws,
and rules and regulations thereunder.
Rule 15Fh–3(h) also provides an
affirmative defense to a charge of failure
to supervise diligently based, in part, on
the establishment and maintenance of
these policies and procedures, where
the entity has reasonably discharged the
duties and obligations required by the
written policies and procedures and
documented system, and did not have a
reasonable basis to believe that the
written policies and procedures and
documented system were not being
followed. In addition, consistent with
the approach of the CFTC, we are
providing targeted representationsbased safe harbors,206 which should
201 See

CFA, supra note 5.

202 Id.
203 Id.
204 Id.
205 See

CFA, supra note 5.
e.g., Rule 15Fh–3(f)(3), discussed in
Section II.G.3, infra, under which an SBS Dealer
can generally satisfy its obligations by obtaining
206 See,

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result in efficiencies for entities that
have already established infrastructure
to comply with the CFTC rules.
F. Definitions
1. Proposed Rule
Proposed Rules 15Fh–2(a), (c), (e) and
(f), which would define ‘‘act as an
advisor to a special entity,’’
‘‘independent representative of a special
entity,’’ ‘‘special entity,’’ and ‘‘subject to
a statutory disqualification,’’
respectively are discussed in Section
II.H below in the context of the special
entity requirements.
Proposed Rule 15Fh–2(b) would
define ‘‘eligible contract participant’’ to
mean any person defined in Section
3(a)(66) of the Exchange Act.
Proposed Rule 15Fh–2(d) would
provide that ‘‘security-based swap
dealer or major security-based swap
participant’’ would include, where
relevant, an associated person of the
SBS Dealer or Major SBS Participant.
2. Comments on the Proposed Rule
a. Definitions Relating to the Rules
Applicable to Dealings With Special
Entities
Comments on paragraphs (a), (c), (e)
and (f) of proposed Rule 15Fh–2
defining ‘‘act as an advisor,’’
‘‘independent representative of a special
entity,’’ ‘‘special entity’’ and ‘‘subject to
a statutory disqualification,’’
respectively are addressed below in
Section II.H.
b. Eligible Contract Participant
One commenter addressed proposed
Rule 15Fh–2(b) defining ‘‘eligible
contract participant.’’ 207 The
commenter pointed out an error in the
cross-reference in the rule to the
Exchange Act definition and
recommended adding a reference to
applicable rules and interpretations of
the Commission and the CFTC.208
c. SBS Dealer or Major SBS Participant
Three commenters addressed
proposed Rule 15Fh–2(d) defining SBS
Dealer or Major SBS Participant.209 Two
commenters suggested that the
Commission adopt a broader definition
that would apply the business conduct
rules to any person acting on behalf of
representations with respect to certain suitability
requirements, and Rule 15Fh–5(b), discussed in
Section II.H.6, infra, under which an SBS Entity can
generally satisfy its obligations with respect to
having a reasonable basis to believe that a special
entity counterparty has a qualified independent
representative.
207 See SIFMA (August 2015), supra note 5.
208 Id.
209 See CFA, supra note 5; FIA/ISDA/SIFMA,
supra note 5; SIFMA (August 2015), supra note 5.

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the SBS Entity, including an associated
person, consistent with the CFTC
business conduct rules.210 One
commenter asserted that this would
prevent SBS Entities from ‘‘evad[ing]
the business conduct rules by doing
through third parties what they would
not be permitted to do directly.’’ 211 The
commenter also discouraged the
Commission from seeking to identify all
of the requirements that would apply to
an associated person of an SBS Entity,
suggesting that the rules should apply in
any circumstance where an SBS Entity
acts through or by means of an
associated person or other party.212
A third commenter recommended that
the Commission clarify that associated
persons of an SBS Entity should only be
directly responsible for complying with
the disclosure rules and rules involving
interactions with counterparties, and
should not be responsible for complying
with internal business conduct
standards, such as the rules relating to
supervision and requiring designation of
a CCO.213 The commenter also
suggested that the Commission define
‘‘associated person’’ as ‘‘an associated
person of an [SBS Dealer] or [Major SBS
Participant] through whom the [SBS
Dealer] or [Major SBS Participant]
acts.’’ 214
3. Response to Comments and Final
Rule
The Commission is moving the
definition of ‘‘independent
representative of a special entity’’ from
Rule 15Fh–2 to Rule 15Fh–5 and
accordingly, re-designating paragraphs
(d) through (f) of Rule 15Fh–2 as
paragraphs (c) through (e). The
definition of ‘‘independent
representative of a special entity’’ and
paragraphs (a), (d) and (e) of Rule 15Fh–
2 (defining ‘‘act as an advisor,’’ ‘‘special
entity’’ and ‘‘subject to a statutory
disqualification,’’ respectively) are
addressed below in Section II.H.
The Commission is adopting Rule
15Fh–2(b) with two modifications. In
response to a suggestion from a
commenter,215 the Commission is
correcting a typographical error in the
cross-reference to the Exchange Act
definition of ‘‘eligible contract
participant’’ in the proposed rule. The
proposed rule referenced ‘‘Section
3(a)(66)’’ of the Exchange Act, but
should have referenced Section 3(a)(65)
of the Exchange Act, which defines an
210 See CFA, supra note 5; SIFMA (August 2015),
supra note 5.
211 See CFA, supra note 5.
212 Id.
213 See FIA/ISDA/SIFMA, supra note 5.
214 Id.
215 See SIFMA (August 2015), supra note 5.

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eligible contract participant. Section
3(a)(65) of the Exchange Act, in turn,
provides that the term eligible contract
participant ‘‘has the same meaning as in
section 1a of the Commodity Exchange
Act.’’ We have also revised the
definition in response to the same
commenter’s request that we add a
reference to applicable rules and
interpretations of the Commission and
the CFTC to incorporate the joint SEC–
CFTC rulemaking adopted in May
2012.216 In this regard, we note that the
Commission and the CFTC jointly
further defined the term eligible
contract participant by adopting rules
and regulations under the Commodity
Exchange Act.217 Thus, as adopted, the
definition of ‘‘eligible contract
participant’’ in Rule 15Fh-2(b) refers to:
‘‘any person as defined in Section
3(a)(65) of the Act and the rules and
regulations thereunder and in Section
1a of the Commodity Exchange Act and
the rules and regulations thereunder.’’
After considering the comments, the
Commission is adopting Rule 15Fh–2(d)
as proposed, re-designated as Rule
15Fh–2(c). The statute defines the term
‘‘associated person of a security-based
swap dealer or major security-based
swap participant’’ to include ‘‘any
person directly or indirectly controlling,
controlled by, or under common control
with’’ an SBS Dealer or Major SBS
Participant.218 While the SBS Entity
remains ultimately responsible for
compliance with the business conduct
standards, to the extent that an SBS
Entity acts through, or by means of, an
associated person of that SBS Entity, the
associated person must comply as well
with the applicable business conduct
standards.
The Commission declines to modify
the definition, as requested by some
commenters, to apply to persons acting
on behalf of the SBS Entity.219 We
believe it unnecessary to expand the
definition because, as noted above, the
SBS Entity remains ultimately
responsible for compliance with the

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216 Section

712(d)(1)(A) of the Dodd-Frank Act
provides, among other things, that the CFTC and
the Commission, in consultation with the Board of
Governors, shall further define the term ‘‘eligible
contract participant.’’ Public Law 111–203, 124
Stat. 1376 (2010). Moreover, Section 712(d)(4)
provides that any interpretation of, or guidance by
either Commission regarding, a provision of Title
VII of the Dodd Frank Act shall be effective only
if issued jointly by the CFTC and the Commission,
after consultation with the Board of Governors, if
this title requires the Commissions to issue joint
regulations to implement the provision. Id.
217 See Definitions Adopting Release, supra note
115.
218 Section 3(a)(70)(A)(ii) of the Exchange Act, 15
U.S.C. 78c(a)(70)(A)(ii).
219 See CFA, supra note 5; SIFMA (August 2015),
supra note 5.

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business conduct standards, whether
the SBS Entity is acting through, or by
means of, an associated person or other
person.
In response to the commenter that
raised concerns that associated persons
should not be responsible for complying
with ‘‘internal’’ business conduct
standards,220 the Commission notes that
Rule 15Fh–2(c) provides that the
definition of an SBS Entity includes
associated persons of the SBS Entity
‘‘where relevant.’’ Certain rules,
including the so-called ‘‘internal’’
business conduct rules (e.g., Rule 15Fh–
3(h) (supervision) and Rule 15Fk–1
(designation of CCO)) may apply to
some but not all associated persons of
an SBS Entity, and the registrant
remains ultimately responsible for
compliance with all of the business
conduct rules that are the subject of this
rulemaking.
G. Business Conduct Requirements
1. Counterparty Status
a. Proposed Rule
Section 15F(h)(3)(A) of the Exchange
Act directs that business conduct
requirements adopted by the
Commission shall establish a duty for an
SBS Entity to verify that any
counterparty meets the eligibility
standards for an ECP.221
Proposed Rule 15Fh–3(a)(1) would
require an SBS Entity to verify that a
counterparty whose identity is known to
an SBS Entity prior to the execution of
the transaction meets the eligibility
standards for an ECP, before entering
into a security-based swap with that
counterparty other than on a registered
national securities exchange or SEF.222
Proposed Rule 15Fh–3(a)(2) would
require an SBS Entity to verify whether
a counterparty whose identity is known
to the SBS Entity prior to the execution
of the transaction is a special entity
before entering into a security-based
220 See

FIA/ISDA/SIFMA, supra note 5.
U.S.C. 78o–10(h)(3)(A).
222 Proposed Rule 15Fh–3(a)(1). See Section 6(l)
of the Exchange Act (making it unlawful to effect
a security-based swap transaction with or for a
person that is not an ECP unless such transaction
is effected on a registered national securities
exchange). See also Section 5(e) of the Securities
Act of 1933, 15 U.S.C. 77e(e)) (‘‘unless a registration
statement meeting the requirements of section 10(a)
[of the Securities Act] is in effect as to a securitybased swap, it shall be unlawful for any person . . .
to offer to sell, offer to buy or purchase or sell a
security-based swap to any person who is not an
eligible contract participant’’). See also Registration
and Regulation of Security-Based Swap Execution
Facilities, Exchange Act Release No. 63825 (Feb. 2,
2011), 76 FR 10948 (Feb. 28, 2011) (‘‘SEF
Registration Proposing Release’’) (proposed Rule
809 would limit SEF participation to registered SBS
Dealers, Major SBS Participants, brokers and ECPs).
221 15

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swap with that counterparty, no matter
where the transaction is executed.223
b. Comments on the Proposed Rule
Three commenters addressed
proposed Rule 15Fh–3(a).224 One
opposed limiting the application of the
rule to known counterparties, noting
that this would invite SBS Entities to
promote anonymous off-exchange
transactions that would allow them to
avoid obligations otherwise owed to
special entities.225 The commenter
asserted that the only exemption from
the verification requirement should be
for transactions on a registered exchange
or SEF, and that for such transactions,
if the SBS Entity knows the identity of
the counterparty prior to the transaction
and has reason to believe it may not be
an ECP, the SBS Entity should be
required to undertake an additional
inquiry to verify the counterparty’s
status.226 The commenter also
recommended that verification take
place before the SBS Entity offers to
enter into a transaction, rather than
before execution.227
Two commenters recommended that
the exception for transactions on a
registered exchange or SEF be
broadened to apply to the verification of
special entity status in addition to the
verification of ECP status.228 One
commenter also recommended
expanding the exception to include
exempt SEFs, such as a foreign SEF that
the Commission determines to be
subject to a comparable home country
regime.229 Additionally, as part of a
series of recommendations to harmonize
with the CFTC’s treatment of employee
benefit plans defined in Section 3 of
ERISA, the commenter suggested
requiring an SBS Entity to verify
whether a counterparty is eligible to
223 Proposed Rule 15Fh–3(a)(2). See generally
Section 15F(h)(1)(D) of the Exchange Act, 15 U.S.C.
78o–10(h)(1)(D) (authorizing the Commission to
prescribe business conduct standards that relate to
‘‘such other matters as the Commission determines
to be appropriate’’).
224 See CFA, supra note 5; FIA/ISDA/SIFMA,
supra note 5; SIFMA (August 2015), supra note 5.
225 See CFA, supra note 5.
226 Id. The commenter also recommended that the
Commission conform to the CFTC’s then-pending
proposal, which would have required counterparty
status verification in any transaction other than
anonymous transactions on a swap execution
facility. We note, however, that the CFTC
subsequently adopted a rule that clarified that the
exemption from verification applies to all
transactions on a designated contract market
(‘‘DCM’’) and to anonymous transactions on a swap
execution facility. See CFTC Adopting Release, 77
FR at 9757, supra note 21.
227 See CFA, supra note 5.
228 See FIA/ISDA/SIFMA, supra note 5; SIFMA
(August 2015), supra note 5.
229 SIFMA (August 2015), supra note 5.

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elect to be a special entity, and if so, to
notify such counterparty.230
The other commenter also
recommended further narrowing the
application of the rule by excluding
transactions in which the identity of the
counterparty is known just prior to
execution, arguing that an SBS Entity
would have insufficient time to
exchange representations with the
counterparty or otherwise verify the
counterparty’s status in those
situations.231 Alternatively, the
commenter requested that the
Commission require SEFs to adopt rules
that would permit verification of the
counterparty’s status.232 The commenter
also opposed establishing specific
documentation requirements regarding
counterparty status, asserting that it
would not allow for flexible risk
management and investment decisions
through private contractual
negotiation.233
c. Response to Comments and Final
Rule
After considering the comments, the
Commission is adopting Rule 15Fh–3(a)
with certain modifications.
Rule 15Fh–3(a)(1), as adopted,
requires an SBS Entity to verify the ECP
status of a counterparty before entering
into a security-based swap with that
counterparty other than a transaction
executed on a registered national
securities exchange. We are not
adopting the further provision of the
proposed rule that would have limited
the application of the verification
requirement to a counterparty ‘‘whose
identity is known to the SBS Entity
prior to the execution of the
transaction.’’ We also are not adopting
the provision of the proposed rule that
would have provided that the
verification requirement does not apply
to transactions executed on a SEF.
These changes reflect the Commission’s
further consideration of the regulatory
framework provided by the Dodd-Frank
Act.
In particular, Section 6(l) of the
Exchange Act makes it unlawful to
effect a transaction in a security-based
swap with or for a person that is not an
ECP, unless the transaction is effected
on a registered national securities
exchange.234 Section 6(l) of the

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230 Id.

See also discussion in Section III.H.1, infra.
supra note 5.

231 FIA/ISDA/SIFMA,
232 Id.
233 Id.

234 See Proposing Release, 76 FR at 42403, supra
note 5. 15 U.S.C. 78f(l) (‘‘[i]t shall be unlawful for
any person to effect a transaction in a securitybased swap with or for a person that is not an
eligible contract participant, unless such
transaction is effected on a [registered] national
securities exchange’’).

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Exchange Act does not provide an
exception for transactions effected on
SEFs, or for transactions where the
identity of a counterparty is not known
to the SBS Entity prior to the execution
of the transaction. Thus, upon further
consideration of the proposed rule in
the context of the statute, we are not
providing an exception for transactions
executed other than on a registered
national securities exchange, and we are
not limiting the requirement to known
counterparties because Section 6(l) of
the Exchange Act does not contain a
similar exception or limitation, and we
do not wish to suggest to SBS Entities
that Section 6(l) is similarly limited. In
this regard, we note that, even with
these modifications, the scope of
Section 6(l) of the Exchange Act
(‘‘unlawful to effect a transaction in a
security-based swap’’) is broader than
the activity covered by Rule 15Fh–
3(a)(1) (‘‘before entering into a securitybased swap’’), and that SBS Entities,
and other market participants, have an
independent obligation under Section
6(l) for any action covered by that
section.235
As noted in the Proposing Release, an
SBS Entity that has complied with the
requirements of Rule 15Fh–3(a)(1)
concerning a counterparty’s eligibility to
enter into a particular security-based
swap fulfills its obligations under the
rule for that security-based swap, even
if the counterparty subsequently ceases
to meet the eligibility standards for an
ECP during the term of that securitybased swap.236 However, an SBS Entity
will need to verify the counterparty’s
status for any subsequent action covered
by Rule 15Fh–3(a)(1), (which it could do
by relying on written representations
from the counterparty, as described
above). An SBS Entity could satisfy this
obligation by relying on a representation
in a master or other agreement that is
renewed or ‘‘brought down’’ as of the
date of the subsequent action covered by
15Fh–3(a)(1). In this manner,
counterparties will be able to make
representations about their status at the
outset of a relationship, and can
undertake to ‘‘bring down’’ that
representation for each relevant action
involving a security-based swap. In
235 See also Section 5(e) of the Securities Act, 15
U.S.C. 77e(e) (‘‘unless a registration statement
meeting the requirements of [section 10(a) of the
Securities Act] is in effect as to a security-based
swap, it shall be unlawful for any person . . . to
offer to sell, offer to buy or purchase or sell a
security-based swap to any person who is not an
eligible contract participant’’). This rulemaking
does not address and has no applicability with
respect to the requirements under the Securities Act
applicable to security-based swap transactions.
236 See Proposing Release, 76 FR at 42404, supra
note 5.

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addition, as noted above, market
participants have an independent
obligation under Section 6(l) of the
Exchange Act for any action covered by
that section.
Rule 15Fh–3(a)(2), as adopted,
requires an SBS Entity to verify whether
a counterparty is a special entity before
entering into a security-based swap
transaction with that counterparty,
unless the transaction is executed on a
registered or exempt SEF or registered
national securities exchange and the
SBS Entity does not know the identity
of the counterparty at a reasonably
sufficient time prior to execution of the
transaction to permit the SBS Entity to
comply with the obligations of the rule.
The rule as proposed would have
limited the verification of special entity
status to counterparties whose identity
is known to the SBS Entity prior to the
execution of the security-based swap
transaction. Because the question of
special entity status figures most
significantly in connection with the
application of the special entity rules
(Rules 15Fh–4, 15Fh–5 and 15Fh–6), we
have modified the special entity
verification rule to track the exceptions
to those rules.237 Accordingly, the
verification of special entity status
requirements will not apply where the
transaction is executed on a registered
or exempt SEF or registered national
securities exchange, and the SBS Entity
does not know the identity of the
counterparty at a reasonably sufficient
time prior to execution of the
transaction to permit the SBS Entity to
comply with the obligations of the rule.
An SBS Entity that has complied with
the requirements of Rule 15Fh–3(a)(2)
concerning verification whether a
counterparty is a special entity before
entering into a particular security-based
swap with that counterparty fulfills its
obligations under the rule for that
security-based swap.238 However, an
SBS Entity will need to verify the
counterparty’s status for any subsequent
action covered by Rule 15Fh–3(a)(2)
(which it could do by relying on written
representations from the counterparty,
as described above). An SBS Entity
could satisfy this obligation by relying
on a representation in a master or other
agreement that is renewed or ‘‘brought
down’’ as of the date of the subsequent
action covered by 15Fh–3(a)(2). In this
manner, counterparties will be able to
make representations about their status
at the outset of a relationship, and can
undertake to ‘‘bring down’’ that
237 See
238 See

Section II.B.
Proposing Release, 76 FR at 42404, supra

note 5.

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representation for each relevant action
involving a security-based swap.
Additionally, the Commission is
adding a new paragraph (a)(3), special
entity election, which requires an SBS
Entity, in verifying the special entity
status of a counterparty pursuant to
Rule 15Fh–3(a)(2), to verify whether a
counterparty is eligible to elect not to be
a special entity as provided for in the
adopted special entity definition in Rule
15Fh–2(d)(4), and if so, notify such
counterparty. This change is intended to
provide the greatest protections to the
broadest categories of special entities,
while still allowing them the flexibility
to elect not to avail themselves of
special entity protections.239
Although the Dodd-Frank Act does
not specifically require an SBS Entity to
verify whether a counterparty is a
special entity or is eligible to elect not
to be a special entity, the Commission
believes that such verification will help
to ensure the proper application of the
business conduct rules that apply to
SBS Entities dealing with special
entities.240
The Commission is not revising the
rule, as suggested by a commenter,241 to
require that verification of special entity
counterparty status take place before an
SBS Entity ‘‘offers’’ to enter into a
transaction. We agree with the
commenter that it is important for an
SBS Entity to verify special entity status
‘‘as soon as possible . . . to ensure
timely compliance with the other
obligations that accompany transactions
with these entities.’’ As explained in
Section II.A, when the rules refer to a
‘‘counterparty’’ of the SBS Entity, the
term ‘‘counterparty’’ includes a
potential counterparty where
compliance with the obligation is
required before the SBS Entity and the
‘‘counterparty’’ have actually entered
into the security-based swap.
The Commission is not specifying the
manner of documentation or procedures
required for compliance with Rule
15Fh–3(a).242 Among other things, an
239 As explained in Section II.H.1, we are
interpreting the definition of ‘‘special entity’’ to
distinguish entities that are ‘‘defined in’’ section 3
of ERISA but not ‘‘subject to’’ regulation under Title
I of ERISA. Our rules as adopted would include
within the ‘‘special entity’’ definition entities such
as church plans and plans maintained solely for the
purpose of complying with applicable workmen’s
compensation laws, unemployment compensation,
or disability insurance laws but allow them to elect
not to be treated as ‘‘special entities.’’
240 See Section II.H, infra.
241 See CFA, supra note 5.
242 See Proposing Release, 76 FR at 42403, supra
note 3. The Commission separately has proposed
rules regarding recordkeeping and reporting
requirements for SBS Entities that would require an
SBS Entity to keep records of its verification. See
Recordkeeping and Reporting Requirements for

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SBS Entity could rely on representations
in accordance with Rule 15Fh–1(b). For
example, an SBS Entity could verify that
a counterparty is an ECP by obtaining a
written representation from the
counterparty as to specific facts about
the counterparty (e.g., that it has $100
million in assets) to conclude that the
counterparty is an ECP, unless the SBS
Entity has information that would cause
a reasonable person to question the
accuracy of the representation.
Similarly, an SBS Entity could seek to
verify that a counterparty is not a
special entity by obtaining a written
representation from the counterparty
that it does not fall within any of the
enumerated categories of persons that
are ‘‘special entities’’ for purposes of
Section 15F of the Exchange Act. The
SBS Entity also could seek to obtain a
representation in writing from the
counterparty if it elects not to be a
special entity, as provided for in the
special entity definition in Rule 15Fh–
2(d)(4). Consistent with Rule 15Fh–1(b),
however, an SBS Entity cannot
disregard information that would cause
a reasonable person to question the
accuracy of the representation.
2. Disclosure
Section 15F(h)(3)(B) of the Exchange
Act broadly requires that business
conduct requirements adopted by the
Commission require disclosures by SBS
Entities to counterparties of information
related to ‘‘material risks and
characteristics’’ of the security-based
swap, ‘‘material incentives or conflicts
of interest’’ that an SBS Entity may have
in connection with the security-based
swap, and the ‘‘daily mark’’ of a
security-based swap.243
a. Disclosure Not Required When the
Counterparty is an SBS Entity or a Swap
Entity
i. Proposed Rules
Section 15F(h)(3)(B) provides that
disclosures under that section are not
required when the counterparty is ‘‘a
security-based swap dealer, major
security-based swap participant,
security-based swap dealer, or major
security-based swap participant.’’ 244 As
explained in the Proposing Release, the
Commission believes that the repetition
of the terms ‘‘security-based swap dealer
and major security-based swap
Security-Based Swap Dealers, Major Security-Based
Swap Participants, and Broker-Dealers; Capital Rule
for Certain Security-Based Swap Dealers, Exchange
Act Release No. 71958 (Apr. 17, 2014), 79 FR 25193,
25208 and 25217–25218 (May 2, 2014)
(‘‘Recordkeeping Release’’) (proposed Rules 18a–
5(a)(17) and 18a–5(b)(13)).
243 15 U.S.C. 78o–10(h)(3)(B).
244 15 U.S.C. 78o–10(h)(3)(B).

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participant’’ in this Exchange Act
provision is a drafting error, and that
Congress instead intended an exclusion
identical to that found in the
Commodity Exchange Act, which
provides that these general disclosures
are not required when the counterparty
is ‘‘a swap dealer, major swap
participant, security-based swap dealer,
or major security-based swap
participant.’’ 245 Accordingly, proposed
Rule 15Fh–3(b) (information about
material risks and characteristics, and
material incentives or conflicts of
interests), proposed Rule 15Fh–3(c) (the
daily mark), and proposed Rule 15Fh–
3(d) (clearing rights) would not apply
whenever the counterparty is an SBS
Entity or Swap Entity.
ii. Comments on the Proposal
Two commenters submitted
comments on the application of the
disclosure requirements when the
counterparty is an SBS Entity or Swap
Entity.246 One commenter asserted that
the disclosure requirements should
apply even when the counterparty is
also an SBS Entity.247 Another
commenter agreed with the
Commission’s interpretation that
Congress intended the exclusion to
apply to transactions with other SBS
Entities and Swap Entities.248 However,
in response to a specific request for
comment, the commenter asserted that
the Commission should not exempt
transactions with other entities (such as
banks or broker-dealers) from the
disclosure requirements, or otherwise
subject them to different disclosure
standards, because while more
sophisticated banks or brokers may
benefit, less sophisticated parties would
be left without adequate protections.249
Additionally, as discussed in Section
II.B, a commenter advocated for adding
exceptions to the disclosure
requirements in Rules 15Fh–3(b) and (d)
to cover security-based swaps that are
intended to be cleared and that are
either (1) executed on a registered
national securities exchange or
registered or exempt SEF and required
to be cleared pursuant to Section 3C of
the Exchange Act, or (2) anonymous.250
The commenter argued that this would
harmonize the scope of the
Commission’s disclosure requirements
with no-action relief provided by the
245 7 U.S.C. 6s(h)(3)(B). See Proposing Release, 76
FR at 42405, supra note 3.
246 See Better Markets (August 2011), supra note
5; CFA, supra note 5.
247 See Better Markets (August 2011), supra note
5.
248 See CFA, supra note 5.
249 Id.
250 See SIFMA (August 2015), supra note 5.

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
CFTC with respect to its parallel
requirements.251
iii. Response to Comments and Final
Rules
After considering the comments, the
Commission is adopting, as proposed,
the exceptions from the disclosure
requirements under Rule 15Fh–3(b)
(information about material risks and
characteristics, and material incentives
or conflicts of interests), Rule 15Fh–3(c)
(the daily mark), and Rule 15Fh–3(d)
(clearing rights) for transactions in
which the counterparty is an SBS Entity
or Swap Entity. We are not adopting the
suggestion that disclosure requirements
apply even when the counterparty is an
SBS Entity or Swap Entity. We believe
that an SBS Entity would be wellpositioned to negotiate with another
SBS Entity, and nothing in our rules
precludes an SBS Entity from requesting
such disclosures.
In addition, the exceptions under the
rules as adopted parallel the exceptions
in the analogous CFTC rules. This
consistency will result in efficiencies for
entities that have already established
infrastructure to comply with the CFTC
standard.
For the reasons discussed in Section
II.B, we are not providing additional
exceptions for transactions that are
intended to be cleared.252
b. Timing and Manner of Certain
Disclosures and Scope of Disclosure
Rules

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i. Proposed Rules
Proposed Rule 15Fh–3(b) would
require that disclosures regarding
material risks and characteristics and
material incentives or conflicts of
interest be made to potential
counterparties before entering into a
security-based swap, but would not
mandate the specific manner in which
those disclosures are made as long as
they are made ‘‘in a manner reasonably
designed to allow the counterparty to
assess’’ the information being
provided.253 Proposed Rule 15Fh–3(d)
similarly would require that disclosures
regarding certain clearing rights be
made before entering into a securitybased swap, but would not mandate the
manner of disclosure. To the extent
such disclosures were not otherwise
provided to the counterparty in writing
prior to entering into a security-based
251 Id.
252 Id. See Swaps Intended to Be Cleared, CFTC
Letter No. 13–70 (Nov. 15, 2013), available at http://
www.cftc.gov/idc/groups/public/@lrlettergeneral/
documents/letter/13-70.pdf.
253 Section 15F(h)(3)(B) of the Exchange Act is
silent regarding both form and timing of disclosure.
See 15 U.S.C. 78o–10(h)(3)(B).

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swap, proposed Rules 15Fh–3(b)(3) and
15Fh–3(d)(3) would require an SBS
Entity to make a written record of the
non-written disclosures made pursuant
to proposed Rules 15Fh–3(b) and 15Fh–
3(d), respectively, and provide a written
version of these disclosures to the
counterparty in a timely manner, but in
any case no later than the delivery of the
trade acknowledgement of the particular
transaction.
ii. Comments on Proposed Rules
Timing and Manner of Certain
Disclosures
Five commenters addressed the
timing and manner of required
disclosures.254 One commenter
recommended allowing disclosure
requirements to be satisfied by the
execution of a master agreement and
provision of a trade acknowledgment.255
Similarly, another commenter urged the
Commission to permit all required
disclosures to be made upfront at the
beginning of a trading relationship,
rather than on a transaction-bytransaction basis.256
Alternatively, if the Commission
requires disclosure beyond the master
agreement and trade acknowledgment,
the first commenter encouraged the
Commission to permit the use of
standardized disclosures.257 The
commenter also recommended that the
Commission not dictate the timing of
required disclosures and permit SBS
Entities to make required disclosures in
advance, as opposed to immediately
prior to the execution of a trade, so as
not to interfere with the parties’ desired
timing.258 However, the commenter
noted that advance disclosure
requirements would be infeasible for
transactions executed on a SEF or
exchange, or where the counterparty is
known only immediately prior to or
after execution.259
In contrast, two commenters
advocated for more specific
requirements with respect to the timing
and manner of disclosure.260 Both
recommended that disclosure be
required in writing and at a ‘‘reasonably
sufficient time’’ prior to the execution of
the transaction to allow counterparties
to evaluate the information before
deciding whether to enter the
254 See ABC, supra note 5; CFA, supra note 5;
FIA/ISDA/SIFMA, supra note 5; Better Markets
(August 2011), supra note 5; SIFMA (August 2015),
supra note 5.
255 See FIA/ISDA/SIFMA, supra note 5.
256 See ABC, supra note 5.
257 See FIA/ISDA/SIFMA, supra note 5.
258 Id.
259 Id.
260 See Better Markets (August 2011), supra note
5; CFA, supra note 5.

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29981

transaction.261 One commenter also
asserted that disclosure should be in a
clear and intelligible format that permits
comparison between derivatives offered
by different market participants.262 The
other commenter opposed allowing SBS
Entities to satisfy disclosure
requirements through entry into a
master agreement and provision of a
trade acknowledgement, arguing that
key information could be lost in the fine
print of legal documents.263 At a
minimum, if a master agreement is used,
the commenter recommended that the
required disclosures regarding material
risks and characteristics and material
incentives or conflicts of interest be
provided in a clearly labeled, separate
narrative incorporated into the overall
document, and that all key issues be
disclosed before the trade is executed
and not in a post-trade
acknowledgement.264
Another commenter also
recommended that disclosure regarding
material risks and characteristics and
material incentives or conflicts of
interest be required at a ‘‘reasonably
sufficient time’’ prior to the execution of
the transaction to harmonize with the
CFTC’s disclosure requirements.265
Additionally, as discussed in Section
II.B, the commenter advocated for
adding exceptions to the disclosure
requirements in Rules 15Fh–3(b) and (d)
to cover security-based swaps that are
intended to be cleared and that are
either: (1) Executed on a registered
national securities exchange or
registered or exempt SEF and required
to be cleared pursuant to Section 3C of
the Exchange Act, or (2) anonymous.266
Written Records of Non-Written
Disclosure
One commenter addressed the written
record requirements in proposed Rules
15Fh–3(b)(3) and 15Fh–3(d)(3).267 The
commenter opposed permitting SBS
Entities to make required disclosures
orally, asserting that oral disclosure fails
to promote pre-trade transparency and
makes enforcement more difficult, and
that SBS Entities may minimize
disclosure of conflicts of interest when
making them orally.268 The commenter
also argued that the Commission’s
approach to permitting oral disclosure
‘‘doesn’t even have the benefit of saving
261 See Better Markets (August 2011), supra note
5; CFA, supra note 5.
262 See Better Markets (August 2011), supra note
5.
263 See CFA, supra note 5.
264 Id.
265 See SIFMA (August 2015), supra note 5.
266 Id.
267 See CFA, supra note 5.
268 See CFA, supra note 5.

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labor, since the Commission proposes to
require after-the-fact written disclosures
of any information not made in writing
prior to the transaction.’’ 269
Scope of Disclosure Rules
If the Commission requires disclosure
beyond the master agreement and trade
acknowledgment, one commenter
encouraged the Commission to exclude
from such requirements counterparties
that are regulated entities such as banks,
broker-dealers, and investment
advisers.270 Two other commenters
argued that Major SBS Participants
should not be subject to the disclosure
requirements because they will be
transacting with counterparties at arm’s
length.271 Alternatively, one commenter
suggested exempting transactions
between Major SBS Participants and
SBS Dealers from the disclosure
requirements, and allowing all other
counterparties to opt out of certain
disclosure requirements, in particular
receiving written records of non-written
disclosure.272 Similarly, another
commenter suggested that ECPs should
have the option of opting-out of
disclosures.273

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iii. Response to Comments and Final
Rules
After considering the comments, the
Commission is adopting the rules
substantially as proposed, with certain
modifications. In response to
commenters’ concerns, the Commission
is requiring that an SBS Entity make the
disclosures required by Rule 15Fh–3(b)
regarding material risks and
characteristics and material incentives
or conflicts of interest at a reasonably
sufficient time prior to entering into a
security-based swap to allow the
counterparty to assess the disclosures.
This will also be consistent with the
CFTC’s timing requirement for its
parallel disclosures rules, resulting in
efficiencies for entities that have already
established infrastructure to comply
with the CFTC standard.
With respect to the manner of
disclosure, we are not adopting the
commenters’ suggestion that we impose
more specific requirements with respect
to the timing and manner of
disclosure.274 Instead, the Commission
continues to believe it is appropriate to
require only that disclosures regarding
material risks and characteristics and
269 Id.
270 See
271 See

FIA/ISDA/SIFMA, supra note 5.
BlackRock, supra note 5; MFA, supra note

5.
272 See

BlackRock, supra note 5.
273 See MFA, supra note 5.
274 See Better Markets (August 2011), supra note
5; CFA, supra note 5.

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material incentives or conflicts of
interest be made ‘‘in a manner
reasonably designed to allow the
counterparty to assess’’ the information
being provided pursuant to Rule 15Fh–
3(b). As noted in the Proposing Release,
this provision is intended to require that
disclosures be reasonably clear and
informative as to the relevant material
risks or conflicts that are the subject of
the disclosure, and is not intended to
impose a requirement that disclosures
be tailored to a particular counterparty
or to the financial, commercial or other
status of that counterparty.275
After considering the comments, the
Commission is also adopting as
proposed the requirements in Rules
15Fh–3(b)(3) and 15Fh–3(d)(3) that an
SBS Entity make a written record of any
non-written disclosures made pursuant
to Rules15Fh–3(b) and 15Fh–3(d),
respectively, and provide a written
version of these disclosures to the
counterparty in a timely manner, but in
any case no later than the delivery of the
trade acknowledgement 276 of the
particular transaction. As noted in the
Proposing Release and suggested by
commenters, the Commission
understands that security-based swaps
generally are executed under master
agreements, with much of the
transaction-specific disclosure provided
over the telephone, in instant messages
or in confirmations.277 The Commission
believes that parties should have the
flexibility to make disclosures by
various means, including master
agreements and related documentation,
telephone calls, emails, instant
messages, and electronic platforms.278
Similarly, while we acknowledge the
commenter’s concern that SBS Entities
may minimize disclosure of conflicts of
275 See Proposing Release, 76 FR at 42406, supra
note 3.
276 See Trade Acknowledgement and Verification
of Security-Based Swap Transactions, Exchange Act
Release No. 63727 (Jan. 14, 2011), 76 FR 3859 (Jan.
21, 2011) (proposing Rule 15Fi–1(c)(1), which
would require a trade acknowledgement to be
provided within 15 minutes of execution for a
transaction that has been executed and processed
electronically; within 30 minutes of execution for
a transaction that is not electronically executed, but
that will be processed electronically; and within 24
hours of execution for a transaction that the SBS
Entity cannot process electronically).
277 See Proposing Release, 76 FR at 42406, supra
note 3; FIA/ISDA/SIFMA, supra note 5.
278 When SBS Entities rely on electronic media,
their counterparties generally should have the
capability to effectively access all of the information
required by Rule 15Fh–3(b)(3) in a format that is
understandable but not unduly burdensome for the
counterparty. See generally Use of Electronic Media
by Broker-Dealers, Transfer Agents and Investment
Advisers for Delivery of Electronic Information,
Securities Act Release No. 7288 (May 9, 1996), 61
FR 24644 (May 15, 1996). See also Use of Electronic
Media, Exchange Act Release No. 42728 (Apr. 28,
2000), 65 FR 25843 (May 4, 2000).

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interest when making them orally, we
are not persuaded that requiring all
disclosures be provided in writing prior
to the parties’ entering into a securitybased swap would be necessary to
provide protections under the rule as
adopted. We further note that Rule
15Fh–3(b)(3), discussed in Section
II.G.2.c, separately requires that an SBS
Entity provide a written record of nonwritten disclosures no later than the
delivery of the trade acknowledgement
of the particular transaction.
Accordingly, the Commission
anticipates that SBS Entities may elect
to make certain required disclosures of
material information to their
counterparties in a master agreement or
other written document accompanying
such agreement. While certain forms of
disclosure may be highly standardized,
certain provisions may need to be
tailored to the particular transaction,
most notably pricing and other
transaction-specific commercial terms.
As noted in the Proposing Release, the
Commission believes this approach is
generally consistent with the use of
standardized disclosures suggested by
industry groups and commenters.279
We do believe, however, that is it is
important that the required disclosures
be made at a reasonably sufficient time
before the execution of the transaction
to allow the counterparty to assess the
disclosures. While this time may vary
depending on the product and the
counterparty, we do not believe, as
suggested by some commenters, that
SBS Entities should be able to rely on
trade acknowledgements alone to satisfy
certain disclosure requirements.280 As
noted in the Proposing Release,
however, SBS Entities could rely on
trade acknowledgements to memorialize
non-written disclosures they made prior
to entering into the proposed
transaction.281
As discussed in Section II.B above,
the Commission is limiting the
disclosure requirements in Rules 15Fh–
3(b) and (d) to circumstances where the
identity of the counterparty is known to
the SBS Entity at a reasonably sufficient
time prior to execution of the
transaction to permit the SBS Entity to
comply with the obligations of the rule.
The disclosure requirements in Rules
15Fh–3(b) and (d) will not apply where
the identity of the counterparty is not
discovered until after the execution of
the transaction, or where the SBS Entity
learns the identity of the counterparty
279 See Proposing Release, 76 FR at 42406, supra
note 3.
280 See FIA/ISDA/SIFMA, supra note 5.
281 See Proposing Release, 76 FR at 42406, supra
note 3.

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
with insufficient time to be able to
provide the necessary disclosures to
satisfy its obligations under the rule
without disrupting or delaying the
execution of the transaction. Similarly,
for the reasons discussed in Section
II.A.3.d, we are not providing additional
exceptions or ‘‘opt-out’’ rights.
Finally, we are not adopting the
suggestion of one commenter that the
Commission exclude from the
disclosure requirements transactions
with counterparties that are regulated
entities such as banks, broker-dealers,
and investment advisers.282 Because
information asymmetries exist in a
market for opaque and complex
products, even for regulated entities,
such disclosures may help inform
counterparties concerning the
valuations and material risks and
characteristics of security-based swaps
in the sometimes rapidly changing
market environment.283 In this regard,
the external business conduct
requirements promulgated under
Section 15F(h) are intended to provide
certain protections for counterparties,
including information regarding the
material risks and characteristics of the
security-based swap, any material
incentives or conflicts of interest that
the SBS Entity may have, and the daily
mark of the security-based swap. We
believe the rules we are adopting today
appropriately apply those requirements
so that counterparties receive the benefit
of those protections, and so are not
providing counterparty exclusions
beyond the exception for transactions
with SBS Entities and Swap Entities
discussed in Section II.G.2.a, infra.
c. Material Risks and Characteristics of
the Security-Based Swap

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i. Proposed Rule
Proposed Rule 15Fh–3(b)(1) would
require an SBS Entity to disclose the
material risks and characteristics of the
particular security-based swap,
including, but not limited to, the
material factors that influence the dayto-day changes in valuation, the factors
or events that might lead to significant
losses, the sensitivities of the securitybased swap to those factors and
conditions, and the approximate
magnitude of the gains or losses the
security-based swap would experience
under specified circumstances. In the
Proposing Release, the Commission also
solicited comment regarding whether
SBS Entities should be specifically
282 See
283 See

FIA/ISDA/SIFMA, supra note 5.
Section VI.C, infra.

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required to provide scenario analysis
disclosure.284
ii. Comments on the Proposed Rule
General
Seven commenters addressed the
disclosure of material risks and
characteristics of security-based
swaps.285 One commenter expressed
support for the proposed disclosure
requirements, agreeing that the
disclosure should include any
information for which there is a
substantial likelihood that a reasonable
investor would consider the information
to be important in making an
investment decision.286
Two commenters argued that the
Commission should adopt different or
modified disclosure requirements.287
One commenter requested that the
Commission clarify in the rule that: (1)
The rule only requires disclosure about
the material risks and characteristics of
the security-based swap itself and not
with respect to the underlying reference
security or index, and (2) the rule does
not require disclosure in relation to any
particular counterparty.288 The
commenter also asked the Commission
to eliminate the proposed requirement
that risk disclosures set forth the
approximate magnitude of the gains or
losses the security-based swap will
experience under specified
circumstances because this is the
functional equivalent of a requirement
to provide a scenario analysis, which
the commenter does not support
(discussed below).289 Additionally, the
commenter noted its view that the
Commission should not require an SBS
Entity to disclose the absence of certain
material provisions typically contained
in master agreements for security-based
swap transactions because master
agreements differ and what is ‘‘typical’’
is not clear.290 A second commenter
requested a clarification that only
material information is required to be
disclosed.291
Three commenters argued for
additional or modified requirements.292
One asserted that the proposed
284 See Proposing Release, 76 FR at 42409, supra
note 3.
285 See Barnard, supra note 5; Better Markets
(August 2011), supra note 5; CFA, supra note 5;
Levin, supra note 5; FIA/ISDA/SIFMA, supra note
5; SIFMA (August 2011), supra note 5; SIFMA
(August 2015), supra note 5.
286 See Barnard, supra note 5.
287 See FIA/ISDA/SIFMA, supra note 5; SIFMA
(August 2015), supra note 5.
288 See FIA/ISDA/SIFMA, supra note 5.
289 Id.
290 Id.
291 See SIFMA (August 2015), supra note 5.
292 See Better Markets (August 2011), supra note
5; CFA, supra note 5; Levin, supra note 5.

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29983

disclosure obligations are too limited in
terms of scope, form, and content.293
The commenter suggested that the
disclosure provisions should require
‘‘more complete, timely, and intelligible
disclosure of all the risks, costs, and
other material information relating to
[security-based swap] transactions,’’
including disaggregated prices and
risks, listed hedge equivalents, scenario
analysis (discussed below), and
embedded financing costs.294 Similarly,
another commenter requested
clarification regarding what material
risks and characteristics must be
disclosed, arguing that the disclosure
should include liquidity risks, the
details of (and separate prices for) the
standardized component parts of any
customized security-based swap, any
features of the security-based swap that
could disadvantage the counterparty
(such as differences in interest rates
paid versus those received), and where
credit arrangements are built into
security-based swaps through
forbearance of collateral posting, the
embedded credit and its price.295 A
third commenter also suggested that the
Commission clarify what material risks
and characteristics must be disclosed,
proposing that SBS Entities be required
to disclose any material risk related to
the source of a security-based swap’s
assets and any negative view by the SBS
Entity itself of the assets’ riskiness.296
The commenter also recommended that
SBS Entities be required to disclose the
material risks and characteristics not
just of the security-based swap itself,
but also of any reference securities,
indices, or other assets, noting that this
disclosure would be particularly
important when the security-based swap
references unique pools of assets
arranged by the SBS Entity.297
Another commenter, writing after the
CFTC adopted its final rules,
recommended that the Commission
harmonize with the CFTC’s requirement
to disclose material risks and
characteristics.298 Specifically, the
commenter requested that, like the
CFTC, the Commission describe the
material risks and characteristics to be
disclosed as including ‘‘market, credit,
liquidity, foreign currency, legal,
operational, and any other applicable
risks,’’ and ‘‘the material economic
terms of the security-based swap, the
terms relating to the operation of the
293 See

Better Markets (August 2011), supra note

5.
294 Id.
295 See
296 See

CFA, supra note 5.
Levin, supra note 5.

297 Id.
298 See

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security-based swap, and the rights and
obligations of the parties during the
term of the security-based swap.’’ 299
The commenter argued that
harmonization with the CFTC would
help support the continued
development of standard disclosures,
reducing compliance costs and
preventing undue delays in execution,
and would reduce the likelihood of
inconsistent disclosures for similar
products and resulting counterparty
confusion.300
Scenario Analysis
We sought comment on whether we
should require scenario analysis and, if
so, what standards should apply. Eight
commenters addressed the disclosure of
scenario analysis.301 Four commenters
supported requiring scenario analysis
disclosure to some degree.302 Of these
commenters, one suggested that the
analysis include specific information
about the security-based swap’s
liquidity and volatility.303 Another
recommended only requiring scenario
analysis disclosure for ‘‘high-risk
complex security-based swaps,’’ and
suggested that the Commission provide
additional clarification or a definition
for determining what security-based
swaps are high-risk and complex.304 A
third commenter advocated requiring
SBS Entities to notify counterparties of
their right to receive a scenario analysis
and to provide a scenario analysis at the
request of a non-SBS Entity
counterparty.305 To reduce the costs
associated with providing scenario
analyses and to mitigate the disclosure
of SBS Entities’ proprietary information,
the commenter suggested that the
Commission permit SBS Entities to
delegate the provision of scenario
analyses to qualified third-parties.306
The commenter explained that requiring
scenario analysis disclosure on a
transaction-by-transaction basis would
not be necessary because SBS Entity
counterparties are generally
sophisticated enough to create their
own, more meaningful, portfolio-based
analyses, but that scenario analyses
could help a less sophisticated
299 Id.
300 Id.

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301 See

Barnard, supra note 5; Better Markets
(August 2011), supra note 5; CFA, supra note 5;
Markit, supra note 5; FIA/ISDA/SIFMA, supra note
5; SIFMA (August 2011), supra note 5; MFA, supra
note 5; SIFMA (August 2015), supra note 5.
302 See Barnard, supra note 5; Better Markets
(August 2011), supra note 5; CFA, supra note 5;
Markit, supra note 5.
303 See Better Markets (August 2011), supra note
5.
304 See Barnard, supra note 5.
305 See Markit, supra note 5.
306 Id.

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counterparty understand the dynamics
and potential exposure of security-based
swaps on a portfolio-level.307 The
commenter also noted that the
Commission should encourage all
market participants to create or obtain a
portfolio-level scenario analysis, in
keeping with industry best practices.308
Four commenters opposed requiring
disclosure of scenario analysis.309 One
noted that requiring scenario analysis
disclosure would have potentially
significant adverse consequences for
special entities and other
counterparties, and urged the
Commission to refrain from requiring
it.310 Specifically, the commenter
explained that requiring scenario
analysis would likely delay execution of
transactions and expose counterparties
to market risk for potentially extended
periods of time (including at critical
times when the counterparty is seeking
to hedge its positions in volatile
markets) because the development of
scenario analyses depends upon the
specific terms agreed by the parties and
therefore, cannot be performed until full
agreement on the material terms is
reached.311 Additionally, the
commenter noted that the development
of such analyses would cause SBS
Entities to incur substantial costs, which
ultimately would be passed on to
counterparties.312 Another commenter
opposed a requirement to provide
scenario analysis and asserted that, if a
scenario analysis is required, it should
only be at the request of the
counterparty and only with respect to
scenarios based on parameters selected
by the counterparty.313 The commenter
also expressed concern that providing a
scenario analysis could be viewed as a
‘‘recommendation’’ that triggers other
requirements under the proposed rules
(e.g., suitability requirements).314
A third commenter, writing after the
CFTC adopted final rules,315 stated that,
307 Id.
308 Id.
309 See FIA/ISDA/SIFMA, supra note 5; SIFMA
(August 2011), supra note 5; MFA, supra note 5;
SIFMA (August 2015), supra note 5.
310 See SIFMA (August 2011), supra note 5.
311 Id.
312 Id.
313 See FIA/ISDA/SIFMA, supra note 5.
314 Id.
315 The CFTC had proposed to require scenario
analysis for ‘‘high-risk complex bilateral swaps’’ but
in its final rules determined instead to require
scenario analysis only when requested by the
counterparty for any swap not ‘‘made available for
trading’’ on a designated contract market or swap
execution facility. To comply with the CFTC rule,
swap dealers must disclose to counterparties their
right to receive scenario analysis and consult with
counterparties regarding design. See CFTC
Adopting Release, 77 FR at 9762–9763, supra note
21. See also 17 CFR 23.431(b).

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in its experience, the CFTC’s scenario
analysis requirement has complicated
the ability of SBS Dealers to provide
different pricing scenarios, either
voluntarily or at the request of a
counterparty, because it creates
‘‘uncertainty as to when those scenarios
must satisfy the requirements for
scenario analysis set forth in the CFTC
EBC rules.’’ 316
A fourth commenter recommended
that, to the extent a Major SBS
Participant is transacting with an ECP at
arm’s-length, the Commission should
explicitly exclude scenario analysis
from the information that the Major SBS
Participant is required to disclose
pursuant to Rule 15Fh–3(b).317 The
commenter asserted that scenario
analysis disclosure would be costly and
redundant since the rule would already
require Major SBS Participants to
undertake a transaction-specific
analysis, and prepare tailored
disclosures of a transaction’s loss
sensitivities to market factors and
conditions, and the magnitude of gains
and losses the transaction may
experience under specified
circumstances.318
iii. Response to Comments and Final
Rule
After considering the comments, the
Commission is adopting Rule 15Fh–
3(b)(1) with some modifications
requested by commenters to more
closely align the requirements of our
rules with those of the CFTC.
We have revised the descriptions in
Rule 15Fh–3(b)(1) of the required
disclosures of material risks and
characteristics of a security-based swap
to harmonize with the descriptions in
the parallel CFTC disclosure
requirement. As adopted, Rule 15Fh–
3(b)(1) requires an SBS Entity to
disclose material information in a
manner reasonably designed to allow
the counterparty to assess the material
risks and characteristics of the
particular security-based swap, which
may include (1) market risk,319 credit
risk,320 liquidity risk,321 foreign
316 See
317 See

SIFMA (August 2015), supra note 5.
MFA, supra note 5.

318 Id.
319 By ‘‘market risk,’’ we mean the risk to the
value of a security-based swap ‘‘resulting from
adverse movements in the level or volatility of
market prices.’’ See Proposing Release, 76 FR at
42408 n.82, supra note 3.
320 By ‘‘credit risk,’’ we mean the risk that a
counterparty to a security-based swap ‘‘will fail to
perform on an obligation’’ under the security-based
swap. See Proposing Release, 76 FR at 42408 n.80,
supra note 3.
321 By ‘‘liquidity risk,’’ we mean the risk that a
counterparty to a security-based swap ‘‘may not be
able to, or cannot easily, unwind or offset a

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currency risk, legal risk,322 operational
risk323 and any other applicable risks,
and (2) the material economic terms of
the security-based swap, and the rights
and obligations of the parties during the
term of the security-based swap. These
changes are intended to provide an
illustrative list of material risks and
characteristics. In addition, these
changes will harmonize our rule with
the requirements of the CFTC rule,
which should result in efficiencies for
SBS Entities that have already
established infrastructure to comply
with the CFTC rules, while still
achieving the objectives of the rule to
provide information to a counterparty to
help them assess whether, and under
what terms, they want to enter into the
transaction.
The rule as adopted requires
disclosure of ‘‘material’’ information
regarding material risks and
characteristics and material incentives
or conflicts of interests. We believe that
this modification will provide for an
appropriate level of disclosure by
requiring disclosure of ‘‘material’’
information, that is, the information
most relevant to a counterparty’s
assessment of whether and under what
terms to enter into a security-based
swap. In addition, it will harmonize
with the CFTC approach, promoting
regulatory consistency across the swap
and security-based swap markets,
particularly among entities that transact
in both markets and have already
established infrastructure to comply
with existing CFTC regulations. In
response to comment, the Commission
believes that for purposes of evaluating
the material risks and characteristics of
the particular security-based swap,
including its economic terms, material
information about the referenced
security, index, asset or issuer should be
disclosed.324 As one commenter
suggested, this disclosure would be
particularly important when, for
example, the security-based swap
particular position at or near the previous market
price because of inadequate market depth or
because of disruptions in the marketplace.’’ See
Proposing Release, 76 FR at 42408 n.83, supra note
3.
322 By ‘‘legal risk,’’ we mean the risk that
agreements are unenforceable or incorrectly or
inadequately documented. See Proposing Release,
76 FR at 42408 n.85, supra note 3.
323 By ‘‘operational risk,’’ we mean the risk that
‘‘deficiencies in information systems or internal
controls, [including human error,] will result in
unexpected loss.’’ See Proposing Release, 76 FR at
42408 n.84, supra note 3.
324 The manner in which and extent of
information about the referenced security, index,
asset or issuer is disclosed would depend on the
particular facts and circumstances, including the
public availability of the information.

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references unique pools of assets
arranged by the SBS Entity.325
The Commission anticipates that SBS
Entities may provide these disclosures
through various means, including by
providing a scenario analysis, as noted
in the Proposing Release.326 We are not,
however, adopting any requirements
that would require an SBS Entity to
provide scenario analysis. Although
scenario analysis may prove a valuable
analytic tool, it is one means by which
information may be conveyed, and we
acknowledge the concerns of
commenters that a scenario analysis
may not be necessary or appropriate in
every situation to ensure that
appropriate disclosures are made. We
note, however, that nothing in our rules
would preclude parties from requesting
such analysis, even if a security-based
swap is ‘‘made available for trading.’’ In
this regard, our approach differs from
that of the CFTC which requires a Swap
Dealer to provide scenario analysis
when requested by a counterparty for
any swap that is not ‘‘made available for
trading’’ on a designated contract
market or swap execution facility. We
believe, however, that the approaches
are consistent because, as noted above,
the Commission is not prohibiting
counterparties from requesting scenario
analysis disclosure.
As noted in the Proposing Release,
these disclosures are intended to pertain
to the material risks and characteristics
of the security-based swap, and not the
material risks and characteristics of the
security-based swap with respect to a
particular counterparty.327
d. Material Incentives or Conflicts of
Interest
i. Proposed Rule
Proposed Rule 15Fh–3(b)(2) would
require the SBS Entity to disclose any
material incentives or conflicts of
interest that it may have in connection
with the security-based swap, including
any compensation or other incentives
from any source other than the
counterparty in connection with the
security-based swap to be entered into
with the counterparty.328 We explained
325 See

Levin, supra note 5.
Proposing Release, 76 FR at 42408 n.88,
supra note 3.
327 See Proposing Release, 76 FR at 42408 n.87,
supra note 3. However, if an SBS Dealer
recommends a security-based swap or trading
strategy involving a security-based swap, or acts as
an advisor to a special entity, for example, Rules
15Fh–3(f) and 15Fh–4, respectively, impose certain
counterparty-specific requirements. See Rules
15Fh–3(f) and 15Fh–4, discussed infra in Sections
II.G.0 and II.H.3.
328 See Section 15F(h)(3)(B)(ii) of the Exchange
Act, 15 U.S.C. 78o–10(h)(3)(B)(ii) (providing that
business conduct requirements adopted by the
326 See

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29985

in the Proposing Release that we
preliminarily believed that the term
‘‘incentives’’—which is used in Section
15F(h)(3)(b)(ii) of the Dodd-Frank Act—
refers not to any profit or return that the
SBS Entity would expect to earn from
the security-based swap itself, or from
any related hedging or trading activities
of the SBS Entity, but rather to any other
financial arrangements pursuant to
which an SBS Entity may have an
incentive to encourage the counterparty
to enter into the transaction. This
disclosure would include, among other
things, information concerning any
compensation (e.g., under revenuesharing arrangements) or other
incentives the SBS Entity receives from
any source other than the counterparty
in connection with the security-based
swap to be entered into with the
counterparty, but would not include, for
example, expected cash flows received
from a transaction to hedge the securitybased swap or that the security-based
swap is intended to hedge.329
ii. Comments on the Proposed Rule
Seven commenters addressed the
disclosure of material incentives or
conflicts of interest.330 One commenter
expressed strong support for the
proposed rule.331 A second commenter
also supported the proposed rule, noting
that it is consistent with the CFTC’s
parallel requirement, except for the
CFTC’s requirement to disclose a pretrade mid-market mark, which the
commenter argued is of limited benefit
and delays execution of transactions.332
Three other commenters expressed
support for the proposed rule but also
suggested certain revisions to the
rule.333 One recommended modifying
the rule to include specific disclosures
by SBS Entities of any affiliations or
material business relationships they
may have with any provider of securitybased swap valuation services.334
Another noted that an SBS Entity’s
biggest conflict of interest would likely
be the difference in compensation
between selling a security-based swap
(and in particular, a customized
security-based swap) versus another
Commission shall require disclosure by an SBS
Entity of ‘‘any material incentives or conflicts of
interest’’ that the SBS Entity may have in
connection with the security-based swap).
329 See Proposing Release, 76 FR at 42409, supra
note 3.
330 See Barnard, supra note 5; IDC, supra note 5;
CFA, supra note 5; Levin, supra note 5; FIA/ISDA/
SIFMA, supra note 5; SIFMA (August 2015), supra
note 5.
331 See Barnard, supra note 5.
332 See SIFMA (August 2015), supra note 5.
333 See IDC, supra note 5; CFA, supra note 5;
Levin, supra note 5.
334 See IDC, supra note 5.

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product with similar economic terms.335
Accordingly, the commenter
recommended that SBS Entities be
required to include any differential
compensation in their disclosure.336
Additionally, the commenter asserted
that if an SBS Entity is entering a trade
as part of a trading strategy to move a
position off its books, the SBS Entity
should be required to disclose that
particular conflict of interest and that
the security-based swap is
recommended to effect that strategy.337
A third commenter suggested
coordinating the proposed rule with the
conflict of interest prohibitions in
Sections 619 and 621 of the Dodd-Frank
Act to clarify that those prohibitions
cannot be circumvented through
application of the business conduct
disclosure requirements.338 The
commenter also recommended
including in these required disclosures
any otherwise hidden profits or returns
that the SBS Entity expects to make
from a security-based swap, related
agreement or arrangement, or related
hedging or trading activity.339
One commenter objected to any
requirement that an SBS Entity disclose
its anticipated profit for the securitybased swap.340 The commenter asserted
that the best protection for a
counterparty is reviewing and selecting
the best available pricing.341

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iii. Response to Comments and Final
Rule
After considering the comments, the
Commission is adopting Rule 15Fh–
3(b)(2) as proposed.
As noted in the Proposing Release, the
Commission believes that the term
‘‘incentives’’—which is used in Section
15F(h)(3)(b)(ii) of the Dodd-Frank Act—
refers not to any profit or return that the
SBS Entity would expect to earn from
the security-based swap itself, or from
any related hedging or trading activities
of the SBS Entity, but rather to any other
financial arrangements pursuant to
which an SBS Entity may have an
incentive to encourage the counterparty
to enter into the transaction.342
Accordingly, the disclosure required
pursuant to Rule 15Fh–3(b)(2) generally
should include information concerning
any compensation (for example, under
revenue-sharing arrangements) or other
incentives the SBS Entity receives from
335 See

CFA, supra note 5.

336 Id.
337 Id.
338 See

Levin, supra note 5.

339 Id.
340 See

FIA/ISDA/SIFMA, supra note 5.

341 Id.
342 See Proposing Release, 76 FR at 42409, supra
note 3.

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any source other than the counterparty
in connection with the security-based
swap to be entered into with the
counterparty but will not include, for
example, expected cash flows received
from a transaction to hedge the securitybased swap or that the security-based
swap is intended to hedge.
As discussed above, whether a
conflict or incentive is material depends
on the facts and circumstances of the
particular matter. Although we are not
expressly requiring disclosure of
differential compensation as requested
by the commenter, the difference in
compensation an SBS Entity may
receive for selling a security-based swap
versus another product with similar
economic terms may create a material
incentive or conflict of interest that
would need to be disclosed under the
framework discussed above. Similarly,
an SBS Entity would need to disclose
material information concerning
affiliations or material business
relationships it may have with any
provider of security-based swap
valuation providers if those
relationships create a material incentive
or conflict of interest. Regarding the
commenter’s concern that the conflict of
interest prohibitions in Sections 619
and 621 of the Dodd-Frank Act might be
circumvented through application of the
business conduct disclosure
requirements,343 nothing in our rules
limits or restricts the applicability of
other relevant laws.344
e. Daily Mark
Exchange Act Section 15F(h)(3)(B)(iii)
directs that business conduct
requirements adopted by the
Commission require an SBS Entity to
disclose to a counterparty (other than to
another SBS Entity or Swap Entity): (i)
For cleared security-based swaps, upon
request of the counterparty, the daily
mark from the appropriate derivatives
clearing organization;345 and (ii) for
343 See

Levin, supra note 5.
instance, depending on the facts and
circumstances, failure to disclose material conflicts
of interest when there is a recommendation by a
broker-dealer can be a violation of the antifraud
rules. See, e.g., Chasins v. Smith, Barney & Co., 438
F.2d 1167, 1172 (2d Cir. 1970) (explaining that
failure to inform a customer fully of a possible
conflict of interest in the securities which the
broker recommended for purchase was an omission
of material fact in violation of Rule 10b–5). See also
In the Matter of Richmark Capital Corp., Exchange
Act Release No. 48758 (Nov. 7, 2003) (Commission
opinion) (‘‘When a securities dealer recommends
stock to a customer, it is not only obligated to avoid
affirmative misstatements, but also must disclose
material adverse facts of which it is aware. That
includes disclosure of ‘adverse interests’ such as
‘economic self-interest’ that could have influenced
its recommendation.’’) (citations omitted).
345 As noted in the Proposing Release, although
Section 15F(h)(3)(B)(iii) of the Exchange Act refers
344 For

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uncleared security-based swaps, the
daily mark of the transaction.
i. Proposed Rule
Proposed Rule 15Fh–3(c) would
require an SBS Entity to disclose to its
counterparty (other than to another SBS
Entity or Swap Entity): (1) For a cleared
security-based swap, upon the request
of the counterparty, the daily end-of-day
settlement price that the SBS Entity
receives from the appropriate clearing
agency, and (2) for an uncleared
security-based swap, the midpoint
between the bid and offer, or the
calculated equivalent thereof, as of the
close of business, unless the parties
agree in writing to a different time, on
each business day during the term of the
security-based swap. Proposed Rule
15Fh–3(c)(2) would specify that the
daily mark for an uncleared securitybased swap may be based on market
quotations for comparable securitybased swaps, mathematical models or a
combination thereof. Proposed Rule
15Fh–3(c)(2) also would require
disclosure of the data sources and a
description of the methodology and
assumptions used to prepare the daily
mark for an uncleared security-based
swap, as well as any material changes to
such data sources, methodology or
assumptions during the term of the
security-based swap.
ii. Comments on Proposed Rule
Ten comment letters addressed the
requirement for SBS Entities to provide
a daily mark.346
One commenter suggested
modifications to the daily mark
requirement to harmonize with the
CFTC’s parallel requirement.347
Specifically, for cleared security-based
swaps, the commenter recommended
that an SBS Entity simply be required to
notify a counterparty of its right to
receive the daily mark from the
appropriate clearing agency upon
request.348 The commenter also argued
that the CFTC’s description of the
clearinghouse’s mark is less
to a ‘‘derivatives clearing organization,’’ the
Commission believes that this was a drafting error
and that Congress intended to refer to a ‘‘clearing
agency’’ because the Dodd-Frank Act elsewhere
requires security-based swaps to be cleared at
registered clearing agencies, not derivatives clearing
organizations. See Proposing Release, 76 FR at
42410 n.98, supra note 3; Section 17A(g) of the
Exchange Act, 15 U.S.C. 78q–1(g).
346 See Barnard, supra note 5; Levin, supra note
5; IDC, supra note 5; AFGI (September 2012), supra
note 5; AFGI (July 2013), supra note 5; FIA/ISDA/
SIFMA, supra note 5; MFA, supra note 5;
BlackRock, supra note 5; SIFMA (August 2011);
SIFMA (August 2015), supra note 5.
347 See SIFMA (August 2015), supra note 5.
348 Id.

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prescriptive.349 Additionally, the
commenter recommended that the
Commission provide guidance clarifying
that an SBS Entity will be deemed to
satisfy the daily mark requirement for
cleared security-based swaps if the
counterparty has agreed to receive its
daily mark from its clearing member.350
One commenter asserted that
requiring SBS Entities to provide daily
marks would not further the goal of
providing helpful transparency because
in most transactions marks are typically
either based on internal models or
derived from indices with which the
transactions are not perfectly
matched.351 Another commenter asked
the Commission to carefully review and
consider the costs of such a requirement
before imposing any obligation to
provide daily marks, other than those
agreed upon for collateral purposes or
for which midmarket quotations are
observable.352 The commenter also
requested that ‘‘sophisticated
counterparties’’ be permitted to opt out
of this requirement, and recommended
that the Commission clarify that where
parties have agreed upon a basis for
margining uncleared security-based
swaps, providing the daily mark used to
make the related margin calculation
should satisfy the SBS Entity’s daily
mark disclosure obligations.353
One commenter suggested that the
data sources, methodology and
assumptions used to prepare the daily
mark should be required to constitute a
complete and independently verifiable
methodology for valuing each securitybased swap entered into between the
parties, noting that this would promote
objectivity and transparency, and aid in
the resolution of disputes.354 In this
regard, a second commenter also
expressed support for requiring the
provision of a daily mark and
specifically for requiring disclosure of
any material changes to the data
sources, methodology and assumptions
used to prepare the daily mark, noting
that this should include disclosing if the
data sources become unreliable or
unavailable and any resulting changes
to the valuations.355
A third commenter recommended
requiring disclosure as to how the daily
mark is calculated, including such
information as whether the daily mark
was calculated based on inputs related
to actual trade activity, using

mathematical models, quotes and prices
of other comparable securities, and
whether those inputs came from thirdparty valuation service providers.356
The commenter added, however, that
the proposed disclosure of the data
sources and the description of the
methodology and assumptions used
were not likely to require the disclosure
of proprietary information and that a
general description of key valuation
inputs should be sufficient.357 Likewise,
another commenter also recommended
that the Commission clarify in rule text
that an SBS Entity is not required to
disclose confidential, proprietary
information about any model it may use
to prepare the daily mark.358
This commenter also recommended
that an SBS Entity should disclose
additional information concerning its
daily mark to ensure a fair and balanced
communication, including that: (1) The
daily mark may not necessarily be a
price at which the SBS Entity or
counterparty would agree to replace or
terminate the security-based swap; (2)
calls for margin may be based on
considerations other than the daily
mark; and (3) the daily mark may not
necessarily be the value of the securitybased swap that is marked on the books
of the SBS Entity.359 Additionally, this
commenter advocated for eliminating
the proposed requirement for the SBS
Entity to disclose its data sources used
to prepare the daily mark to harmonize
more closely with the CFTC rule, which
requires disclosure of assumptions and
methodologies but not data sources.360
One commenter noted that Major SBS
Participants, unlike SBS Dealers, will
not always have access to sufficient
market information to provide a daily
mark, particularly if the security-based
swap is not actively traded or if there
are no current bid and offer quotes.361
The commenter expressed concern that
this could cause Major SBS Participants
to have to reveal proprietary
information about their trading book
positions, particularly when providing
the methodology and inputs that they
used to prepare the daily mark.362 The
commenter suggested permitting
sophisticated counterparties to opt out
of receiving daily marks.363 Another
commenter suggested either not
requiring Major SBS Participants to
provide the daily mark to its

counterparties or in the alternative, to
exempt transactions between Major SBS
Participants and SBS Dealers and allow
all other counterparties to opt out of
receiving such disclosures.364
Several commenters raised potential
conflicts of interest concerns in
connection with providing the daily
mark for uncleared security-based
swaps. Two commenters recommended
requiring SBS Entities to use third-party
quotations whenever possible to
calculate the daily mark for uncleared
security-based swaps.365 One
commenter suggested allowing use of
the midpoint between an SBS Entity’s
bid and offer prices only when the SBS
Entity’s internal book value falls within
the same price range.366 Additionally,
this commenter suggested that the
Commission consider requiring the SBS
Entity to provide clients with actionable
quotes or prices at which the SBS Entity
would terminate the swap or allow the
client to buy more, and with actionable
quotes at a significant size as a means
to ensure accuracy.367 Another
commenter noted its view that defining
the daily mark for uncleared securitybased swaps as the midpoint between
the bid and offer prices, or the
calculated equivalent thereof, could be
problematic because it may present a
conflict of interest for SBS Entities,
particularly when the security-based
swaps are not actively traded or do not
have consistent or up-to-date bid and
offer quotes.368 This commenter also
suggested requiring SBS Entities and
their counterparties to have a clearly
defined process for resolving any
potential valuation disputes. 369
Two commenters addressed the
communication of daily marks,
supporting the use of web-based
methods of communication.370 One
commenter advocated for web-based
systems to be the preferred method of
communication, but noted that since
some market participants prefer more
traditional methods of communication,
web-based systems should not be
required.371 The commenter
recommended requiring SBS Entities to
have policies and procedures in place
that reasonably ensure that any nonelectronic means of communication is
safe and secure and is otherwise
364 See

356 See

349 Id.
351 See

AFGI (September 2012), supra note 5;
AFGI (July 2013), supra note 5.
352 See FIA/ISDA/SIFMA, supra note 5.
353 Id.
354 See Barnard, supra note 5.
355 See Levin, supra note 5.

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IDC, supra note 5.

357 Id.

350 Id.

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358 See

BlackRock, supra note 5.
Levin, supra note 5; and IDC, supra note

366 See

Levin, supra note 5.

367 Id.

360 Id.

368 See

MFA, supra note 5.

362 Id.
363 Id.

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365 See

5.
SIFMA (August 2015), supra note 5.

359 Id.
361 See

29987

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IDC, supra note 5.
IDC, supra note 5.
370 See Markit, supra note 5; IDC, supra note 5.
371 See Markit, supra note 5.
369 See

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comparable to web-based systems.372
Additionally, the commenter generally
requested that the Commission provide
greater clarity on permissible methods
for delivering daily mark disclosures,
establish minimum requirements for the
communication of daily marks (for
instance, that the interfaces used
provide counterparties with appropriate
tools to initiate, track and close
valuation disputes), and require SBS
Entities to ensure that the method of
communication is designed to protect
the confidentiality of the data and
prevent any unintentional or fraudulent
addition, modification or deletion of a
valuation record.373 The second
commenter suggested that the use of a
secure Web site or electronic platform
should be required to enhance data
security.374 The commenter noted that
such a platform could also be used to
provide transparency into the inputs
used to determine the daily mark and to
initiate inquiries or challenges to the
daily mark.375 The commenter also
recommended that the Commission
require daily mark information to be
provided without charge.376
iii. Response to Comments and Final
Rule
After considering the comments, the
Commission is adopting Rule 15Fh–3(c)
as proposed, with modifications.

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Cleared Security-Based Swaps
In response to concerns raised by a
commenter,377 the Commission is
modifying the requirement in Rule
15Fh–3(c)(1) concerning delivery of the
daily mark for cleared security-based
swaps. For cleared security-based
swaps, the proposed rule would have
required the SBS Entity upon the
request of the counterparty to provide
the counterparty with the end-of-day
settlement price the SBS Entity received
from the clearing agency. As adopted,
for cleared security-based swaps, Rule
15Fh–3(c)(1) requires an SBS Entity
upon the request of the counterparty to
provide to the counterparty the daily
mark that the SBS Entity receives from
the appropriate clearing agency.
In response to comments, the
Commission is clarifying that to fulfill
its obligation to provide the daily mark
upon request, the SBS Entity may agree
with the clearing agency, a clearing
member or another agent, for such
clearing agency, clearing member or
372 Id.
373 Id.
374 See

IDC, supra note 5.

375 Id.
376 Id.
377 SIFMA

(August 2015), supra note 5.

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other agent to provide the daily mark
directly to the counterparty.378 The SBS
Entity, however, would retain the
regulatory responsibility to provide the
daily mark upon request. We
understand that current market practice
is for a clearing agency to provide access
to end-of-day settlement prices to the
counterparty. We believe that this
flexibility is appropriate, as we believe
errors in transmission are less likely to
occur if the counterparty receives the
information directly from the
appropriate clearing agency, which is
the source of the daily mark for cleared
security-based swaps. In addition, these
changes will align our rule more closely
with the comparable CFTC rule, which
allows for the counterparty to receive
the daily mark for a cleared swap from
access to the derivatives clearing
organization or futures commodities
merchant or from the Swap Entity,
which should result in efficiencies for
SBS Entities that have already
established infrastructure to comply
with the CFTC rule.379 We note that an
SBS Entity’s obligation to provide the
daily mark, if requested by the
counterparty, exists for the life of the
security-based swap between the SBS
Entity and the counterparty. Depending
on the form of clearing that is used to
clear the security-based swap, the
security-based swap between the SBS
Entity and the counterparty may be
terminated upon clearing by the clearing
agency.380
Rule 15Fh–3(c)(1), as adopted, also
requires that the SBS Entity provide the
daily mark (as opposed to the end-ofday settlement price) upon request to
the counterparty to allow clearing
agencies the flexibility to provide a
different calculation of the mark in the
future. As noted above, we understand
that current market practice is for the
clearing agency to provide an end-ofday settlement price as its mark. In
addition, this change will conform our
rule more closely to the parallel CFTC
rule described above.
Uncleared Security-Based Swaps
The Commission is adopting Rule
15Fh–3(c)(2) as proposed. The
Commission agrees with commenters 381
378 See

SIFMA (August 2015), supra note 5.
17 CFR 23.431(d); and CFTC Adopting
Release, supra note 21.
380 If, for example, the security-based swap
between the SBS Entity and counterparty is
terminated upon novation by the clearing agency,
the SBS Entity would no longer have any obligation
to provide a daily mark to the original counterparty
because a security-based swap no longer exists
between them.
381 See Barnard, supra note 5; Levin, supra note
5; IDC, supra note 5; SIFMA (August 2015), supra
note 5.

that the daily mark for uncleared
security-based swaps will provide
helpful transparency to counterparties
during the lifecycle of a security-based
swap by providing a useful and
meaningful reference point against
which to assess, among other things, the
calculation of variation margin for a
security-based swap or portfolio of
security-based swaps, and otherwise
inform the counterparty’s understanding
of its financial relationship with the
SBS Entity.382 We continue to believe
that even if the mark is calculated based
on internal models or such indices, its
provision by the SBS Entity will further
the goal of providing helpful
transparency into the SBS Entity’s
pricing and valuation of the securitybased swap by providing a helpful
reference point that the SBS Entity’s
counterparty can take into account
when evaluating the pricing and
valuation of the SBS. Thus, we disagree
with the commenter 383 who believes
that providing the daily mark will not
enhance transparency.
As noted in the Proposing Release,
though the daily mark may be used as
an input to compute the variation
margin between an SBS Entity and its
counterparty, it is not necessarily the
sole determinant of how such margin is
computed. Differences between the
daily mark and computations for
variation margin may result from
adjustments for position size, position
direction, credit reserve, hedging,
funding, liquidity, counterparty credit
quality, portfolio concentration, bid-ask
spreads, or other costs. Moreover, we
understand that the actual computations
may be highly negotiated between the
parties. Therefore, we decline to
implement the commenter’s suggestion
that the basis for margining uncleared
security-based swaps would satisfy the
daily mark disclosure obligations.
For uncleared security-based swaps,
Rule 15Fh–3(c)(2) as adopted defines
the daily mark as the midpoint between
the bid and offer prices for a particular
uncleared security-based swap, or the
calculated equivalent thereof, as of the
close of business unless the parties
otherwise agree in writing to a different
time.384 The Commission continues to
believe that, absent specific agreement
by the parties otherwise, the rule will

379 See

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382 See Proposing Release, 76 FR at 42410, supra
note 3.
383 See AFGI (September 2012), supra note 5;
AFGI (July 2013), supra note 5.
384 As noted in the Proposing Release, parties
could agree that the daily mark would be computed
as of a time other than the close of business but
could not agree to waive the requirement that the
daily mark be provided on a daily basis, as required
by the statute. See Proposing Release, 76 FR at
42411 n.103, supra note 3.

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result in a daily mark that reflects daily
changes in valuation and that is: (a) The
same for all counterparties of the SBS
Entity that have a position in the
uncleared security-based swap, (b) not
adjusted to account for holding-specific
attributes such as position direction,
size, or liquidity, and (c) not adjusted to
account for counterparty-specific
attributes such as credit quality, other
counterparty portfolio holdings, or
concentration of positions.385
As noted in the Proposing Release, for
actively traded security-based swaps
that have sufficient liquidity, computing
a daily mark as the midpoint between
the bid and offer prices for a particular
security-based swap, known as a
‘‘midmarket value,’’ would be consistent
with Rule 15Fh–3(c)(2).386 For securitybased swaps that are not actively traded,
or do not have up-to-date bid and offer
quotes, the SBS Entity may calculate an
equivalent to a midmarket value using
mathematical models, quotes and prices
of other comparable securities, securitybased swaps, or derivatives, or any
combination thereof. In this regard, the
rule as adopted requires that the SBS
Entity disclose its data sources and a
description of the methodology and
assumptions used to prepare the daily
mark, and promptly disclose any
material changes to such data sources,
methodology and assumptions during
the term of the security-based swap.
One commenter suggested that the
disclosures should include how the
daily mark is calculated, including
whether the daily mark is calculated
based on inputs related to actual trade
activity or using mathematical models,
quotes and prices of other comparable
securities, and whether those inputs
came from third-party valuation service
providers.387 We believe that the
requirement in the rule to disclose data
sources, methodologies and
assumptions encompasses this
commenter’s suggestion. On the other
hand, another commenter has expressed
concern that disclosure of data sources,
methodology and assumptions would
require the SBS Entity to disclose
confidential, proprietary information
about its models.388 We believe
achieving the benefits underlying the
385 See Proposing Release, 76 FR at 42411, supra
note 3.
386 See Proposing Release, 76 FR at 42411, supra
note 3. See also Improving Counterparty Risk
Management Practices, Counterparty Risk
Management Policy Group (June 1999) at 7 (for use
of the term ‘‘mid-market value’’). For a discussion
of mid-market value and costs, see also ISDA
Research Notes, The Value of a New Swap, Issue
3 (2010), available at http://www.isda.org/
researchnotes/pdf/NewSwapRN.pdf.
387 See IDC, supra note 5.
388 See SIFMA (August 2015), supra note 5.

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statutory daily mark requirement
require that each counterparty knows
the data sources, methodology and
assumptions used to calculate the mark.
This information is critical for a
counterparty to properly understand
how the daily mark was calculated. The
Commission believes that such
disclosures will provide the
counterparty useful context with which
it can assess the quality of the mark
received.389 The Commission further
agrees with the commenter that these
disclosures would promote objectivity
and transparency.390 This commenter
also suggested that this description of
data sources, methodologies and
assumptions should be required to
constitute a complete and
independently verifiable methodology
for valuing each security.391 To satisfy
the duty to disclose the data sources,
methodology and assumptions used to
prepare the daily mark, SBS Entities
may choose to provide to counterparties
methodologies and assumptions
sufficient to independently validate the
output from a model generating the
daily mark. The Commission does not
foresee that these disclosures would
require SBS Entities to disclose
confidential, proprietary information
about any model it may use to prepare
the daily mark.392 With these
disclosures, counterparties should not
be misled or unduly rely on the daily
mark provided by the SBS Entities.
Therefore, the Commission’s final rule
requires disclosure of the data sources,
methodology and assumptions
389 The Commission recognizes that different SBS
Entities may produce somewhat different marks for
similar security-based swaps, depending on the
respective data sources, methodologies and
assumptions used to calculate the marks. Thus, the
data sources, methodologies and assumptions
would provide a context in which the quality of the
mark could be evaluated. See Disclosure of
Accounting Policies for Derivative Financial
Instruments and Derivative Commodity Instruments
and Disclosure of Quantitative and Qualitative
Information about Market Risk Inherent in
Derivative Financial Instruments, Other Financial
Instruments and Derivative Commodity
Instruments, Securities Act Release No. 7386 (Jan.
31, 1997), 62 FR 6044 (Feb. 10, 1997). The
Commission understands that industry practice is
often to include similar disclosures for margin calls
in swap documentation, such as a credit support
annex. See Proposing Release, 76 FR at 42411
n.109, supra note 3.
390 See Barnard, supra note 5.
391 See Barnard, supra note 5.
392 We also note that methodologies and
assumptions with respect to various models are
disclosed in the context of financial statement
reporting in footnotes to publicly available financial
statements and Management’s Discussion and
Analysis in periodic reports under the Exchange
Act without disclosing confidential proprietary
information about models. See FASB Accounting
Standards Codification Topic 820, Fair Value
Measurements and Disclosures; 17 CFR 229.303;
and 17 CFR 229.305.

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29989

underlying the daily mark for uncleared
security-based swaps.
A commenter suggested that the daily
mark disclosures would assist in
resolving valuation disputes during the
term of the security-based swap.393
Another commenter suggested requiring
SBS Entities and their counterparties to
have a clearly defined process for
resolving any potential valuation
disputes about daily marks for both
cleared and uncleared security-based
swaps.394 The Commission notes that
many market participants separately
negotiate a dispute resolution
mechanism for disagreements regarding
valuations or include standardized
language regarding dispute resolution in
their agreements. At this time, the
Commission declines to require parties
to have a process for resolving valuation
disputes and leaves the parties the
flexibility to include such dispute
resolution mechanisms in their
negotiations if desired.
Two commenters suggested that Major
SBS Participants should not be required
to provide the daily mark for uncleared
security-based swaps.395 We believe that
the benefits of Rule 15Fh–3(c), as
discussed above, would inure equally to
counterparties that transact with SBS
Dealers as well as those that transact
with Major SBS Participants. As we
have noted above, even with the use of
proprietary models to calculate the daily
mark, we do not believe that the level
of detail required to be disclosed would
require an SBS Entity to disclose
confidential proprietary information,
whether the SBS Entity is an SBS Dealer
or a Major SBS Participant. The
commenter that expressed concerns
regarding the reliability of the daily
mark illustrates the necessity of the
disclosure of the data sources,
methodologies and assumptions
underlying the calculation.
Counterparties may evaluate the
393 See

Barnard, supra note 5.
IDC, supra note 5.
395 See MFA, supra note 5 (suggesting that Major
SBS Participants will have to use proprietary
models, which will force the Major SBS
Participants to reveal proprietary information about
their trading book positions and that such
calculations would be sufficient to calculate a
fund’s total asset value but should not be relied
upon by other market participants) and BlackRock,
supra note 5 (arguing that the security-based swaps
are arms-length transactions so the Major SBS
Participant should not be required to develop
systems to deliver the daily mark information,
particularly since most transactions will be with an
SBS Dealer). As an alternative to eliminating the
daily mark requirement for Major SBS Participants,
these commenters suggest that sophisticated
counterparties should be permitted to opt out of
receiving the daily mark. See discussion above
regarding the Commission’s reasons for not
permitting counterparties to opt out of receiving the
daily mark disclosure.
394 See

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations

calculation and reliability of the daily
mark calculation and determine for
themselves whether or not to rely on the
calculation. Furthermore, we do not
find the arms-length nature of
relationships with counterparties to be a
persuasive argument to eliminate the
daily mark requirement. To the extent
that Major SBS Participants may be
better informed about the valuations of
security-based swaps due to significant
information asymmetries in a market for
opaque and complex products,
disclosures may help inform
counterparties concerning the
valuations and material risks and
characteristics of security-based swaps
in the sometimes rapidly changing
market environment.396 The commenter
also states that the vast majority of
transactions by a Major SBS Participant
would be with an SBS Dealer, in which
circumstance, the disclosure is not
required. As a result, we are not
adopting the commenters’ suggestions to
exclude Major SBS Participants from the
requirement of providing the daily mark
disclosure at this time.
The Commission has considered the
rationale raised by commenters and
decided not to allow counterparties,
even ‘‘sophisticated counterparties,’’ to
opt-out of the protections afforded by
the daily mark disclosures. It is our
understanding that counterparties have
a range of sophistication and some are
unlikely to have their own modeling
capabilities or access to relevant data to
calculate a daily mark themselves. We
think it is appropriate to apply the rule
so that counterparties receive the
benefits of the daily mark and related
disclosures, and do not think it
appropriate to permit parties to ‘‘opt
out’’ of the benefits of those provisions.
A commenter suggested modifying the
rule text for uncleared security-based
swaps to require that the SBS Entity
disclose additional information
concerning the daily mark to ensure a
fair and balanced communication,
including, as appropriate, that: (A) The
daily mark may not necessarily be a
price at which either the counterparty or
the SBS Entity would agree to replace or
terminate the security-based swap; (B)
depending upon the agreement of the
parties, calls for margin may be based
on considerations other than the daily
mark provided to the counterparty; and
(C) the daily mark may not necessarily
be the value of the security-based swap
that is marked on the books of the SBS
Entity.397 While the Commission
396 See

Section II.C., supra.
SIFMA (August 2015), supra note 5
(requesting that the Commission insert additional
397 See

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declines to modify the rule text in this
way, it does note that Rule 15Fh–3(g) as
adopted requires an SBS Entity to
communicate with its counterparty in a
fair and balanced manner.398 As a
result, an SBS Entity may generally
wish to consider disclosing this
information.
Against this background, the
Commission is not prescribing the
means by which an SBS Entity
determines the daily mark for an
uncleared security-based swap.
Commenters have made various
suggestions as to additional
requirements as to the inputs used for
the daily mark calculation, such as
requiring independent third-party
quotes or limiting the context in which
an SBS Entity can use its own bid and
offer prices or requiring the daily mark
to be an actionable quote.399 At this
time, the Commission declines to adopt
these additional requirements. We
believe that the rule as adopted will
provide appropriate flexibility for SBS
Entities to determine how to calculate
the daily mark while providing
disclosure of sufficient information—
data sources, methodologies and
assumptions, which are designed to
allow the counterparty to assess the
quality of the marks it receives from the
SBS Entity. One of these commenters
also suggested that using its own bid
and offer prices for the calculation of
the daily mark may present a conflict of
interest for the SBS Entity.400 If the SBS
Entity is presented with a conflict of
interest, we believe that the SBS Entity
likely would disclose the conflict to the
counterparty pursuant to Rule 15Fh–
3(b)(2) if the conflict is material. After
receiving such disclosures, the
counterparty will be able to factor that
information into its assessment of the
quality of the marks it receives.
Consistent with the considerations
outlined above, an SBS Entity may
choose to do these calculations in-house
or to use independent third-party
valuation services, as suggested by a
commenter.401
As noted above, Rule 15Fh–3(c)(2)
requires an SBS Entity to disclose to the
counterparty its data sources and a
description of the methodology and
assumptions used to prepare the daily
mark for an uncleared security-based
swap. Additionally, Rule 15Fh–3(c)(2)
requires an SBS Entity to promptly
disclose any material changes to the
required disclosures into Rule 15h–3(c) to ensure a
fair and balanced communication).
398 See Section II.G.5, infra.
399 See Levin, supra note 5; and IDC, supra note
5.
400 Id.
401 See IDC, supra note 5.

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data sources, methodology, or
assumptions during the term of the
security-based swap. As noted in the
Proposing Release, an SBS Entity is not
required to disclose the data sources or
a description of the methodology and
assumptions more than once unless it
materially changes the data sources,
methodology or assumptions used to
calculate the daily mark.402 For the
purposes of this rule, a material change
would generally include any change
that has a material impact on the daily
mark provided, such as if the data
sources become unreliable or
unavailable, as requested by one
commenter.403
A commenter has requested that we
eliminate the requirement to disclose
data sources to harmonize more closely
with the CFTC.404 We believe that the
requirement to disclose data sources is
important for the counterparty to
understand and assess the mark being
provided. Therefore, we decline to
eliminate this requirement.
Applicable to Both Cleared and
Uncleared Security-Based Swaps
Rule 15Fh–3(c) as adopted, does not
mandate the means by which an SBS
Entity must make the required
disclosures and the Commission
declines to mandate any particular
means at this time. The Commission
believes that SBS Entities are best
positioned to determine the most
appropriate means of communication of
the disclosures. Commenters have made
several specific suggestions for
additional requirements regarding the
means of communication of the daily
mark.405 One commenter suggested that
we require the use of a secure Web site
or electronic platform.406 Another
commenter requested web-based
systems to be the preferred method of
communication, but noted that since
some market participants prefer more
traditional methods of communication,
web-based systems should not be
required.407 The commenter
recommended requiring SBS Entities to
have policies and procedures in place
that reasonably ensure that any non402 See Proposing Release, 76 FR at 42412, supra
note 3.
403 See Levin, supra note 5.
404 See SIFMA (August 2015), supra note 5.
405 Suggestions include: Requiring interfaces that
allow the counterparty to initiate, track and close
valuation disputes; a method of communication
designed to protect the confidentiality of the data
and prevent any unintentional or fraudulent
addition, modification or deletion of a valuation
record; or require the use of a secure Web site or
electronic platform. See Markit, supra note 5; IDC,
supra note 5.
406 See IDC, supra note 5.
407 See Markit, supra note 5.

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electronic means of communication is
safe and secure and is otherwise
comparable to web-based systems.408
Additionally, the commenter generally
requested that the Commission provide
greater clarity on permissible methods
for delivering daily mark disclosures,
establish minimum requirements for the
communication of daily marks (for
instance, that the interfaces used
provide counterparties with appropriate
tools to initiate, track and close
valuation disputes), and require SBS
Entities to ensure that the method of
communication is designed to protect
the confidentiality of the data and
prevent any unintentional or fraudulent
addition, modification or deletion of a
valuation record.409 The Commission
continues to believe that such a method
of communication would be an
appropriate way for SBS Entities to
discharge their obligations with respect
to daily marks.410
One commenter suggested that we
require an SBS Entity to have policies
and procedures to reasonably ensure the
safety and security of non-electronic
means of communication.411 To provide
SBS Entities with flexibility in the
manner of disclosure, we have not
specified requirements with respect to
the safety and security of either
electronic or non-electronic
communication of the daily mark.412
In the Proposing Release, the
Commission stated that the daily mark
for both cleared and uncleared securitybased swaps should be provided
without charge and with no restrictions
on internal use by the counterparty,
although restrictions on dissemination
to third parties are permissible.413 One
commenter supported the requirement
that the daily mark disclosure be
provided free of charge.414 The daily
mark disclosures are relevant to a
counterparty’s ongoing understanding
and management of its security-based
swap positions. We believe that
counterparties to whom the SBS Entity
provides the daily mark should have the
opportunity to effectively use, retain,
408 Id.

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409 Id.
410 See Proposing Release, 76 FR at 42412, supra
note 3.
411 See Markit, supra note 5.
412 See the discussion of Timing and Manner of
Certain Disclosures above in Section II.G.2.b. SBS
Entities have to comply with their obligations under
Section 15F(j) and Rule 15Fh–3(h). In addition, as
a practical matter, we believe SBS Entities are likely
to have such policies and procedures with respect
to both electronic and non-electronic means of
communication in the course of prudent business
practices.
413 See Proposing Release, 76 FR at 42412, supra
note 3.
414 See IDC, supra note 5.

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and analyze the information with
respect to such management. Therefore,
the Commission continues to believe
that effective access to the daily mark
information is necessary to ensure a
counterparty’s ability to manage its
security-based swap positions over the
life of the security-based swaps.
Charging for provision of the daily
mark, or allowing restrictions on the
internal use of the daily mark by the
counterparty with respect to managing
their security-based swap positions,
could undermine this objective. Thus,
the Commission continues to believe
that the daily mark for both cleared and
uncleared security-based swaps should
be provided without charge and with no
restrictions on internal use by the
counterparty, although restrictions on
dissemination to third parties are
permissible.415 Accordingly, the
Commission has included these
requirements in a new paragraph (3) to
Rule 15Fh–3(c), as adopted.
f. Clearing Rights
Section 15F(h)(1)(D) of the Exchange
Act authorizes the Commission to
prescribe business conduct standards
that relate to ‘‘such other matters as the
Commission determines to be
appropriate.’’ 416 When an SBS Entity
enters into a security-based swap with
a counterparty that is not an SBS Entity
or a Swap Entity, Section 3C(g) of the
Exchange Act establishes a right for the
counterparty: (i) To select the clearing
agency at which the security-based
swap will be cleared, if the securitybased swap is subject to the mandatory
clearing requirement under Section
3C(a); 417 and (ii) to elect to require the
clearing of the security-based swap, and
to select the clearing agency at which
the security-based swap will be cleared,
if the security-based swap is not subject
to the mandatory clearing
requirement.418
415 For these purposes, providing the daily mark
to a third party that is the agent of the counterparty,
such as the independent representative of a special
entity, for use consistent with its duties to the
client, generally should be considered internal use.
416 15 U.S.C. 78o–10(h)(1)(D).
417 See Exchange Act 3C(g)(5)(A), 15 U.S.C. 78c–
3(g)(5)(A): With respect to any security-based swap
that is subject to the mandatory clearing
requirement under subsection (a) and entered into
by a security-based swap dealer or a major securitybased swap participant with a counterparty that is
not a swap dealer, major swap participant, securitybased swap dealer, or major security-based swap
participant, the counterparty shall have the sole
right to select the clearing agency at which the
security-based swap will be cleared.
418 See Exchange Act Section 3C(g)(5)(B), 15
U.S.C. 78c–3(g)(5)(B): With respect to any securitybased swap that is not subject to the mandatory
clearing requirement under subsection (a) and
entered into by a security-based swap dealer or a
major security-based swap participant with a

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i. Proposed Rule
Proposed Rule 15Fh–3(d) would
require an SBS Entity, before entering
into a security-based swap with a
counterparty, other than an SBS Entity
or Swap Entity, to disclose to the
counterparty its rights under Section
3C(g) of the Exchange Act concerning
submission of a security-based swap to
a clearing agency for clearing. The
counterparty’s rights, and thus the
proposed disclosure obligations, would
differ depending on whether the
clearing requirement of Section 3C(a)
applies to the relevant transaction.419
When the clearing requirements of
Section 3C(a) apply to a security-based
swap, proposed Rule 15Fh–3(d)(1)(i)
would require the SBS Entity to disclose
to the counterparty the clearing agencies
that accept the security-based swap for
clearing and through which of those
clearing agencies the SBS Entity is
authorized or permitted, directly or
through a designated clearing member,
to clear the security-based swap. Under
proposed Rule 15Fh–3(d)(1)(ii), the SBS
Entity would also be required to notify
the counterparty of the counterparty’s
sole right to select which clearing
agency is to be used to clear the
security-based swap, provided it is a
clearing agency at which the SBS Entity
is authorized or permitted, directly or
through a designated clearing member,
to clear the security-based swap.
For security-based swaps that are not
subject to the clearing requirement
under Exchange Act Section 3C(a),
proposed Rule 15Fh–3(d)(2) would
require the SBS Entity to determine
whether the security-based swap is
accepted for clearing by one or more
clearing agencies and, if so, to disclose
to the counterparty the counterparty’s
right to elect clearing of the securitybased swap. Proposed Rule 15Fh–
3(d)(2)(ii) would require the SBS Entity
to disclose to the counterparty the
clearing agencies that accept the
security-based swap for clearing and
whether the SBS Entity is authorized or
permitted, directly or through a
designated clearing member, to clear the
security-based swap through such
counterparty that is not a swap dealer, major swap
participant, security-based swap dealer, or major
security-based swap participant, the counterparty—
(i) may elect to require clearing of the securitybased swap; and (ii) shall have the sole right to
select the clearing agency at which the securitybased swap will be cleared.
419 Section 3C(a)(1) of the Exchange Act provides
that: ‘‘[i]t shall be unlawful for any person to engage
in a security-based swap unless that person submits
such security-based swap for clearing to a clearing
agency that is registered under this Act or a clearing
agency that is exempt from registration under this
Act if the security-based swap is required to be
cleared.’’ 15 U.S.C. 78c–3(a)(1).

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clearing agencies. Proposed Rule 15Fh–
3(d)(2)(iii) would require the SBS Entity
to notify the counterparty of the
counterparty’s sole right to select the
clearing agency at which the securitybased swap would be cleared, provided
it is a clearing agency at which the SBS
Entity is authorized or permitted,
directly or through a designated clearing
member, to clear the security-based
swap.

to be cleared pursuant to Section 3C of
the Exchange Act, or (2) anonymous.427

iii. Response to Comments and Final
Rule
After considering the comments, the
Commission is adopting Rule 15Fh–3(d)
largely as proposed, but with
modifications. First, as discussed above
in Section II.B, we are limiting an SBS
Entity’s disclosure obligations regarding
clearing rights pursuant to Rule 15Fh–
ii. Comments on Proposed Rule
3(d) to counterparties whose identity is
known to the SBS Entity at a reasonably
Four commenters addressed the
sufficient time prior to the execution of
required disclosure regarding clearing
the transaction.
420
rights.
One commenter requested
The Commission is also making a
confirmation that a counterparty’s
second
modification to the proposed
clearing elections could affect the price
rule. We also added the phrase ‘‘subject
of the security-based swap so long as
to Section 3C(g)(5) of the Act,’’ to Rule
this is disclosed to the counterparty at
15Fh–3(d)(1)(ii) to clarify the source of
the time of the other disclosures
the counterparty’s right to select which
421
regarding clearing.
Additionally, the
of the clearing agencies described in
commenter asked for clarification that
paragraph (d)(1)(i) shall be used to clear
standardized disclosure could be used
the security-based swap.
to satisfy this requirement.422 Another
A commenter suggested that, due to
commenter recommended that the
the limited number of security-based
Commission not impose the clearing
swap clearing agencies, disclosure of
rights disclosure requirement on Major
clearing agencies by name was
SBS Participants transacting with
unnecessary.428 Regardless of the
counterparties at arm’s length, or
current limited number of clearing
alternatively, that the Commission allow agencies for security-based swaps, not
ECP counterparties to opt out of
every security-based swap will be
receiving such disclosures.423
accepted for clearing at every clearing
An additional commenter advocated
agency, so the Commission believes that
for harmonizing the clearing rights
it is still useful for the counterparty to
disclosure requirement with the CFTC’s know whether the particular securityparallel requirement.424 Specifically, the based swap is able to be cleared at a
commenter recommended eliminating
particular clearing agency.
the proposed requirements to disclose
Rule 15Fh–3(d) requires that
the names of the clearing agencies that
disclosure be made before a transaction
accept the security-based swap for
occurs. As noted in the Proposing
clearing, and through which the SBS
Release, the Commission believes that it
Entity is authorized to clear the
would be appropriate for a counterparty
security-based swap.425 The commenter to exercise its statutory right to select
argued that given the limited number of the clearing agency at which its
security-based swap clearing agencies,
security-based swaps will be cleared on
such additional disclosure is unlikely to a transaction-by-transaction basis, on an
be necessary, and that the Commission
asset-class-by-asset-class basis, or in
could always require it at a future date
terms of all potential transactions the
if the number increases.426
counterparty may execute with the SBS
Additionally, as discussed in Section
Entity.429 While Rule 15Fh–3(d) does
II.B, the commenter advocated for
not require an SBS Entity to become a
adding an exception to the requirements member or participant of a specific
clearing agency, an SBS Entity could not
regarding the disclosure of clearing
enter into security-based swaps that are
rights to include security-based swaps
subject to a mandatory clearing
that are intended to be cleared and that
requirement without having some
are either (1) executed on a registered
arrangement in place to clear the
national securities exchange or
transaction.430
registered or exempt SEF and required
Consistent with the discussion
regarding manner of disclosures above
420 See CFA, supra note 5; FIA/ISDA/SIFMA,
in Section II.G.2.b, the Commission
supra note 5; MFA, supra note 5; SIFMA (August
2015), supra note 5.
421 See FIA/ISDA/SIFMA, supra note 5.
422 Id.
423 See MFA, supra note 5.
424 See SIFMA (August 2015), supra note 5.
425 Id.
426 Id.

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427 Id.
428 See
429 See

SIFMA (August 2015), supra note 5.
Proposing Release, 76 FR at 42413, supra

note 3.
430 See Section 3C(a)(1) of the Exchange Act, 15
U.S.C. 78c–3(a)(1).

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agrees with the commenter that SBS
Entities could use standardized
disclosure to satisfy Rule 15Fh–3(d).
The Commission also recognizes that
a counterparty’s clearing elections could
affect the price of the security-based
swap and recognizes that counterparties
may wish to receive disclosures about
the effect of clearing on the price.
Although the rule does not explicitly
require that the SBS Entity provide
specific disclosures regarding the effect
of clearing on the price of the securitybased swap, the SBS Entity may wish to
consider whether their obligations
under Rule 15Fh–3(b)(1) to disclose the
material risks and characteristics of the
particular security-based swap, as well
as their obligation pursuant to Rule
15Fh–3(g) to communicate with
counterparties in a fair and balanced
manner based on principles of fair
dealing and good faith (including
providing a sound basis for evaluating
the facts with regard to any particular
security-based swap or trading strategy
involving a security-based swap) may
require such disclosure given their
particular facts and circumstances.
One commenter recommended that
the Commission not impose the clearing
rights disclosure requirement on Major
SBS Participants transacting with
counterparties at arm’s length or as an
alternative allow ECP counterparties to
opt out of receiving the clearing rights
disclosure.431 As explained in the
Proposing Release, the required
disclosure is intended to promote that,
wherever possible and appropriate,
derivatives contracts formerly traded
exclusively in the OTC market are
cleared through a regulated clearing
agency.432 The Commission has
considered the concerns raised by
commenters and determined that it is
appropriate to require Major SBS
Participants to provide such disclosures,
and to not to permit counterparties to
opt out of the protections provided by
the business conduct rules. We believe
that the benefits of Rule 15Fh–3(d), as
discussed above, would inure equally to
counterparties that transact with SBS
Dealers as well as those that transact
with Major SBS Participants.433 We
further believe that allowing
counterparties to effectively opt out of
the rule would deprive them of the
express protections that the rules were
intended to provide. As a result, we are
not adopting the commenters’
suggestions to allow counterparties to
opt out of the clearing rights disclosure
431 See

MFA, supra note 5.
MFA, supra note 5; Proposing Release 76
FR at 42413, supra note 3.
433 See Section II.C above.
432 See

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
requirement when transacting with a
Major SBS Participant nor to exclude
Major SBS Participants from the
requirement of providing the clearing
rights disclosure at this time.
3. Know Your Counterparty
Section 15F(h)(1)(D) of the Exchange
Act authorizes the Commission to
prescribe business conduct standards
that relate to ‘‘such other matters as the
Commission determines to be
appropriate.’’ 434
a. Proposed Rule
Proposed Rule 15Fh–3(e) would
establish a ‘‘know your counterparty’’
requirement under which an SBS Dealer
would be required to establish, maintain
and enforce policies and procedures
reasonably designed to obtain and retain
a record of the essential facts that are
necessary for conducting business with
each counterparty that is known to the
SBS Dealer. For purposes of the
proposed rule, ‘‘essential facts’’ would
be defined as: (i) Facts required to
comply with applicable laws,
regulations and rules; (ii) facts required
to implement the SBS Dealer’s credit
and operational risk management
policies in connection with transactions
entered into with such counterparty;
(iii) information regarding the authority
of any person acting for such
counterparty; and (iv) if the
counterparty is a special entity, such
background information regarding the
independent representative as the SBS
Dealer reasonably deems appropriate.435
b. Comments on the Proposed Rule

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Four commenters addressed the
proposed know your counterparty
requirement.436 Two commenters
generally supported the proposed
rule.437 However, one requested
clarification that since the requirement
only applies to ‘‘known’’ counterparties,
it would not apply to an SBS Dealer
transacting on a SEF or other electronic
execution platform where such SBS
Dealer only learns the identity of the
counterparty immediately before the
execution and must execute the
transaction within a limited time frame
after learning the counterparty’s
identity.438 The other commenter
asserted that the requirement should

apply to Major SBS Participants in
addition to SBS Dealers.439
A third commenter expressed concern
that the proposed rule would
inappropriately empower SBS Dealers
to adopt and enforce rules and to collect
information about independent
representatives.440 The commenter
asserted that the use of the word
‘‘enforce’’ in the proposed rule suggests
that the rule would improperly
empower SBS Dealers to adopt policies
and procedures that have the force of
law with respect to their
counterparties.441 Specifically, the
commenter asserted that the proposed
rule authorizes SBS Dealers to collect
unlimited information about the
representatives of special entities, as
well as proprietary information, which
would give dealers an unfair
competitive advantage.442 The
commenter argued that SBS Dealers
should be required to adopt policies that
comply with the law, and that these
policies should not be binding to the
extent they require more than the law
requires.443
A fourth commenter recommended
eliminating the proposed requirement to
collect background information
regarding the independent
representative of a special entity.444
First, the commenter asserted that this
change would harmonize the
Commission’s rule with the parallel
CFTC requirement.445 Second, the
commenter stated that the proposed
requirement would be duplicative of the
requirements imposed on SBS Entities
acting as counterparties to special
entities pursuant to Rule 15Fh–5.446
Additionally, as discussed in Section
II.B, the commenter advocated for
adding an exception to the know your
counterparty requirement to cover
security-based swaps that are intended
to be cleared, executed on a registered
national securities exchange or
registered or exempt SEF, and of a type
that is, as of the date of execution,
required to be cleared pursuant to
Section 3C of the Exchange Act.447
c. Response to Comments and Final
Rule
After considering the comments, the
Commission is adopting Rule 15Fh–3(e)
with two modifications. First, in
response to a specific suggestion from a
439 See

434 15

U.S.C. 78o–10(h)(1)(D).
435 Proposed Rule 15Fh–3(e)(1)–(4).
436 See CFA, supra note 5; FIA/ISDA/SIFMA,
supra note 5; ABC, supra note 5; SIFMA (August
2015), supra note 5.
437 See CFA, supra note 5; FIA/ISDA/SIFMA,
supra note 5.
438 See FIA/ISDA/SIFMA, supra note 5.

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440 See

CFA, supra note 5.
ABC, supra note 5.

441 Id.
442 Id.
443 Id.
444 See

commenter,448 the Commission is
eliminating the proposed requirement
that an SBS Dealer obtain background
information regarding the independent
representative of a special entity
counterparty, as the SBS Dealer
reasonably deems appropriate. The
Commission agrees with the commenter
that the proposed requirement would
have been duplicative of the
requirements imposed on SBS Entities
acting as counterparties to special
entities pursuant to Rule 15Fh–5
(discussed below in Section II.H).
Second, the Commission is adding the
word ‘‘written’’ before policies and
procedures in the rule text to clarify that
the policies and procedures required by
the rule must be written. The
Commission believes that this change
clarifies the proposal and reflects the
requirement in Rule 15Fh–3(h),
discussed in Section II.G.6 below, that
an SBS Dealer establish, maintain and
enforce written policies and procedures
that are reasonably designed to prevent
violations of the applicable federal
securities laws and rules and
regulations thereunder. Thus, as
adopted, Rule 15Fh–3(e) requires SBS
Dealers to ‘‘establish, maintain and
enforce written policies and procedures
reasonably designed to obtain and retain
a record of the essential facts concerning
each counterparty.’’
In response to concerns raised by a
commenter,449 the Commission is
clarifying that the provision stating that
an SBS Dealer shall ‘‘establish, maintain
and enforce’’ policies and procedures
does not vest such policies and
procedures with force of law with
respect to their counterparties. An SBS
Dealer would, however, have an
obligation to enforce (i.e., follow) its
internal policies and procedures.
We have determined, as proposed, not
to apply the rule where an SBS Dealer
does not know the identity of its
counterparty. We are not adopting the
suggestion of one commenter that we
provide an additional exception to cover
security-based swaps that are intended
to be cleared, executed on a registered
national securities exchange or
registered or exempt SEF, and of a type
that is, as of the date of execution,
required to be cleared pursuant to
Section 3C of the Exchange Act, even if
not anonymous.450 However, we note
that Rule 15Fh–3(e) requires SBS
Dealers to establish policies and
procedures that are ‘‘reasonably
designed to obtain and retain a record
of the essential facts concerning each

SIFMA (August 2015), supra note 5.

445 Id.

448 See

446 Id.

449 See

SIFMA (August 2015), supra note 5.
ABC, supra note 5.
450 See SIFMA (August 2015), supra note 5.

447 Id.

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[known counterparty] that are necessary
for conducting business with such
counterparty.’’ Reasonably designed
policies and procedures established
pursuant to Rule 15Fh–3(e) may address
situations in which there are few, if any,
essential facts that are necessary for
conducting business with a
counterparty. For example, if the only
security-based swaps that an SBS Dealer
enters into with a counterparty are
intended to be cleared security-based
swaps that are executed on a registered
exchange or SEF and of a type that is,
as of the date of execution, required to
be cleared pursuant to Section 3C of the
Exchange Act, then there may be few, if
any, essential facts that the SBS Dealer
needs to know about such counterparty
in that circumstance.
In response to a commenter’s request
for clarification that since the
requirement only applies to ‘‘known’’
counterparties, it would not apply to an
SBS Dealer transacting on a SEF or other
electronic execution platform where
such SBS Dealer only learns the identity
of the counterparty immediately before
the execution and must execute the
transaction within a limited time frame
after learning the counterparty’s
identity,451 the Commission notes that
Rule 15Fh–3(e) does not contain a
specific timing requirement. Rule 15Fh–
3(e) requires SBS Dealers to establish
policies and procedures that are
‘‘reasonably designed to obtain and
retain a record of the essential facts
concerning each [known counterparty]
that are necessary for conducting
business with such counterparty.’’ To be
‘‘reasonably designed’’ such policies
and procedures generally should
provide for the collection of
counterparty information prior to
execution of a transaction with that
counterparty. However, if the SBS
Dealer does not learn a counterparty’s
identity until immediately prior to or
subsequent to execution, then it would
be reasonable for collection to occur
within a reasonable time after the SBS
Dealer learns the identity of the
counterparty.452
As noted in the Proposing Release, the
‘‘know your counterparty’’ obligations
under Rule 15Fh–3(e) are a modified
451 See

FIA/ISDA/SIFMA, supra note 5.
application of the know your counterparty
requirement in these circumstances does not affect
the application of the other business conduct
obligations in Rules 15Fh–3(b) and (d), 15Fh–4(b),
15Fh–5, and 15Fh–6, including the exceptions to
the application of those rules where the identity of
the counterparty is not known to the SBS Entity at
a reasonably sufficient time prior to execution of
the transaction, and, in the case of Rules 15Fh–4(b),
15Fh–5 and 15Fh–6, executed on a registered
national securities exchange or registered or exempt
SEF.

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452 The

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version of the ‘‘know your customer’’
obligations imposed on other market
professionals, such as broker-dealers,
when dealing with customers.453
Although the statute does not require
the Commission to adopt a ‘‘know your
counterparty’’ standard, the
Commission continues to believe that
such a standard is consistent with basic
principles of legal and regulatory
compliance, and operational and credit
risk management.454 Further, the
Commission continues to believe that
entities that currently operate as SBS
Dealers typically would already have in
place, as a matter of their normal
business practices, policies and
procedures that could potentially satisfy
the requirements of the rule.455
The Commission is applying the
requirements in Rule 15Fh–3(e) to SBS
Dealers but declines to apply them to
Major SBS Participants, as suggested by
a commenter.456 As discussed above in
Section II.C, the Commission has
determined that where a business
conduct requirement is not expressly
addressed by the Dodd-Frank Act, the
rules generally will not apply to Major
SBS Participants.
4. Recommendations by SBS Dealers
Section 15F(h)(1)(D) of the Exchange
Act authorizes the Commission to
prescribe business conduct standards
that relate to ‘‘such other matters as the
Commission determines to be
appropriate.’’ 457 Additionally, Section
15F(h)(3)(D) of the Exchange authorizes
the Commission to establish ‘‘such other
standards and requirements as the
Commission may determine are
appropriate in the public interest, for
the protection of investors, or otherwise
in furtherance of the purposes of this
Act.’’ 458
453 See Proposing Release, 76 FR at 42414, supra
note 3. Cf. FINRA Rule 2090 (‘‘[e]very member shall
use reasonable diligence, in regard to the opening
and maintenance of every account, to know (and
retain) the essential facts concerning every
customer and concerning the authority of each
person acting on behalf of such customer’’).
Supplementary Material .01 to FINRA Rule 2090
defines the ‘‘essential facts’’ for purposes of the
FINRA rule to include certain information not
required by Rule 15Fh–3(e). For purposes of FINRA
Rule 2090, facts ‘‘essential’’ to ‘‘knowing the
customer’’ are those required to (a) effectively
service the customer’s account, (b) act in
accordance with any special handling instructions
for the account, (c) understand the authority of each
person acting on behalf of the customer, and (d)
comply with applicable laws, regulations, and
rules.
454 See Proposing Release, 76 FR at 42414, supra
note 3.
455 Id.
456 See CFA, supra note 5.
457 15 U.S.C. 78o–10(h)(1)(D).
458 15 U.S.C. 78o–10(h)(3)(D).

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a. Proposed Rule
i. General
Proposed Rule 15Fh–3(f) generally
would require an SBS Dealer that
recommends a security-based swap or
trading strategy involving a securitybased swap to a counterparty, other than
an SBS Entity or Swap Entity, to have
a reasonable basis for believing that the
recommended security-based swap or
trading strategy is suitable. Specifically,
proposed Rule 15Fh–3(f)(1)(i) would
require an SBS Dealer to have a
reasonable basis to believe, based on
reasonable diligence, that the
recommended security-based swap or
trading strategy is suitable for at least
some counterparties. Additionally,
proposed Rule 15Fh–3(f)(1)(ii) would
require an SBS Dealer to have a
reasonable basis to believe that the
recommended security-based swap or
trading strategy is suitable for the
particular counterparty that is the
recipient of the SBS Dealer’s
recommendation (‘‘customer-specific
suitability’’). Under proposed Rule
15Fh–3(f)(1)(ii), to establish a
reasonable basis to believe that a
recommendation is suitable for a
particular counterparty, an SBS Dealer
would need to have or obtain relevant
information regarding the counterparty,
including the counterparty’s investment
profile, trading objectives, and its ability
to absorb potential losses associated
with the recommended security-based
swap or trading strategy.
ii. Institutional Suitability Alternative
Proposed Rule 15Fh–3(f)(2) would
provide an alternative to the general
suitability requirements, under which
an SBS Dealer could fulfill its suitability
obligations with respect to a particular
counterparty if: (1) The SBS Dealer
reasonably determines that the
counterparty (or its agent) is capable of
independently evaluating investment
risks with regard to the relevant
security-based swap or trading strategy
involving a security-based swap; (2) the
counterparty (or its agent) affirmatively
represents in writing that it is exercising
independent judgment in evaluating the
recommendations by the SBS Dealer;
and (3) the SBS Dealer discloses that it
is acting in the capacity of a
counterparty, and is not undertaking to
assess the suitability of the securitybased swap or trading strategy for the
counterparty.
The Commission sought comment on
whether different categories of ECPs
should be treated differently for
purposes of suitability

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
determinations.459 The Proposing
Release noted that, under our proposed
rules, an SBS Dealer could rely on the
institutional suitability alternative when
entering into security-based swaps with
any person that qualified as an ECP, a
category that includes persons with $5
million or more invested on a
discretionary basis that enter into the
security-based swap ‘‘to manage
risks.’’ 460 In contrast, under FINRA
rules, in order to apply an analogous
institutional suitability alternative, a
broker-dealer must be dealing with a
person (whether a natural person,
corporation, partnership, trust, or
otherwise) with total assets of at least
$50 million.461 The Proposing Release
asked whether the Commission should
apply a different standard of suitability
depending on whether the counterparty
would be protected as a retail investor
under FINRA rules when the SBS Dealer
is also a registered broker-dealer.462
More generally, the Commission sought
comment on whether the institutional
suitability alternative available under
proposed Rule 15Fh–3(f)(2) should be
limited to counterparties that would not
be protected as retail investors under
FINRA rules or another category of
counterparties.

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iii. Special Entity Suitability Alternative
Proposed Rule 15Fh–3(f)(3) would
provide another alternative to the
general suitability requirements for SBS
Dealers transacting with special entity
counterparties. Under proposed Rule
15Fh–3(f)(3), an SBS Dealer would be
deemed to satisfy its suitability
obligations with respect to a special
entity counterparty if the SBS Dealer
either is acting as an advisor to the
special entity and complies with
proposed Rule 15Fh–4(b),463 or is
459 See Proposing Release, 76 FR at 42417, supra
note 3.
460 See Section 1a(18)(A)(xi) of the Commodity
Exchange Act, 7 U.S.C. 1a(18)(A)(xi).
461 See FINRA Rule 2111(b) (referring to FINRA
Rule 4512(c)).
462 Under FINRA rules, institutional suitability is
limited to transactions with so-called
‘‘institutional’’ investors:
(1) A bank, savings and loan association,
insurance company or registered investment
company;
(2) an investment adviser registered either with
the SEC under Section 203 of the Investment
Advisers Act or with a state securities commission
(or any agency or office performing like functions);
or
(3) any other person (whether a natural person,
corporation, partnership, trust or otherwise) with
total assets of at least $50 million.
See FINRA Rule 4512(c) (regarding definition of
‘‘institutional account’’).
463 As discussed below in Section II.H.2,
proposed Rule 15Fh–4(b) would impose certain
requirements on SBS Dealers acting as advisors to
special entities.

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deemed not to be acting as an advisor
to the special entity pursuant to
proposed Rule 15Fh–2(a).
b. Comments on the Proposed Rule
i. General
Six commenters addressed the
suitability requirements.464 Three
commenters recommended expanding
the suitability requirements.465 One
commenter suggested two changes to
the rule: (1) Clarifying that SBS Dealers
would be prohibited from
recommending to investors financial
products that the dealers believe will
fail; and (2) requiring that an SBS Dealer
making recommendations regarding a
certain product or type of product have
the background necessary to understand
the product.466 Another commenter
urged the Commission to consider
developing suitability standards for the
types of financial products that can be
sold to state and local governments,
including those products in the swaps
arena.467 A third commenter suggested
that the Commission conform its
requirements to the CFTC’s proposal,
noting that the CFTC proposal would
have required the dealer to obtain
information through reasonable due
diligence concerning the counterparty’s
financial situation and needs,
objectives, tax status, ability to evaluate
the recommendation, liquidity needs,
risk tolerance or other relevant
information.468 The commenter also
recommended explicitly requiring SBS
Dealers to: (1) Gather information
sufficient to make the suitability
assessment; and (2) maintain sufficient
documents to allow the Commission to
effectively enforce compliance.469
Additionally, the commenter asserted
that the suitability requirement should
apply to all SBS Entities, not just SBS
Dealers, noting that the suitability
obligation would only be imposed on a
Major SBS Participant if the Major SBS
Participant makes a recommendation to
a non-SBS Entity.470 While the
commenter supported the exclusion
from the suitability requirement for
recommendations to other SBS Entities,
it strongly opposed any additional
464 See Levin, supra note 5; GFOA, supra note 5;
CFA, supra note 5; Barnard, supra note 5; FIA/
ISDA/SIFMA, supra note 5; SIFMA (August 2015),
supra note 5.
465 See Levin, supra note 5; GFOA, supra note 5;
CFA, supra note 5.
466 See Levin, supra note 5.
467 See GFOA, supra note 5.
468 See CFA, supra note 5. The CFTC
subsequently adopted a rule that is similar to
proposed Rule 15Fh–3(f). See CFTC Adopting
Release, 77 FR at 9771–9774, supra note 21.
469 See CFA, supra note 5.
470 Id.

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exclusions (e.g., for recommendations to
broker-dealers or other market
intermediaries who are not SBS
Entities). Finally, the commenter also
strongly opposed limiting the
requirement to recommendations to
retail investors.471
Two other commenters recommended
narrowing the suitability
requirements.472 One commenter
suggested that any suitability standard
for SBS Dealers be applied at the least
granular level (e.g., on a transaction-bytransaction basis, on an asset-class-byasset-class basis, or in terms of all
potential transactions between the
parties, as appropriate).473 The second
commenter opposed the suitability
requirement more broadly, stating that
Congress did not impose such a
requirement.474 The commenter
suggested, as an alternative to the
proposed rule, that any suitability
requirement for recommendations to
counterparties other than special
entities be imposed through a
requirement to adopt and enforce
policies and procedures reasonably
designed to assess the suitability of
recommendations, and that the
proposed rule be incorporated as
guidance establishing a safe harbor for
whether an SBS Dealer’s policies are
reasonable.475 The commenter also
asserted that the proposed rule could
conflict with the specific suitability
rules of other (unidentified) regulators,
and accordingly, urged the Commission
to clarify that an SBS Dealer that
complies with suitability requirements
of another qualifying regulator will also
be deemed to have adopted and
enforced reasonable suitability policies
under the Commission’s rule.476 Finally,
the commenter recommended allowing
sophisticated counterparties to opt out
of suitability protection, noting that
some counterparties will find the
suitability analysis burdensome and
intrusive, and that the costs of the
471 Id. The commenter explained that, under the
institutional suitability alternative, ‘‘the SBS Dealer
wouldn’t even have to have a reasonable basis to
believe that the swap was suitable . . . for the
particular counterparty to the transaction.’’ The
commenter expressed its concern that:
Given the profits at stake, SBS Dealer will have
strong incentives to conclude that the counterparty
is capable of evaluating the transaction.
Counterparties who turn to the derivatives markets
out of questionable motives will have equally strong
incentives to assert their capacity to independently
evaluate investment risk. And even those with
purer motives may be reluctant to confess to a lack
of expertise.
472 See Barnard, supra note 5; FIA/ISDA/SIFMA,
supra note 5.
473 See Barnard, supra note 5.
474 See FIA/ISDA/SIFMA, supra note 5.
475 Id.
476 Id.

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proposed suitability rule for those
counterparties will likely outweigh any
benefits.477
Finally, a sixth commenter advocated
for harmonizing the suitability
requirement in proposed Rule 15Fh–
3(f)(1)(i) with the CFTC’s parallel
requirement.478 Specifically, the
commenter recommended changing the
wording of the suitability requirement
in proposed Rule 15Fh–3(f)(1)(i) to
‘‘undertake reasonable diligence to
understand the potential risks and
rewards associated with the
recommended security-based swap or
trading strategy involving a securitybased swap.’’ 479
ii. Institutional Suitability Alternative
Three commenters submitted
comments regarding the institutional
suitability alternative in proposed Rule
15Fh–3(f)(2).480 Two commenters
expressed concerns regarding the
proposed alternative.481 One commenter
expressed concern that the counterparty
representations upon which the SBS
Dealer would rely may become outdated
or boilerplate language that is
inappropriate for the counterparty to
which it is directed.482 Accordingly, the
commenter suggested requiring SBS
Dealers to conduct routine audits to
ensure that these institutional level
suitability determinations are not overutilized, that they are appropriate for
the particular counterparties involved,
and that the appropriate written
documentation was provided and
signed in applicable transactions.483
Additionally, the commenter
recommended that as part of that audit
process, and to prevent inaccurate
determinations, SBS Dealers should be
required to test, perhaps on an annual
basis, whether counterparties continue
to have the personnel and expertise
needed to conduct independent
evaluations of the security-based swap
products being marketed.484
The second commenter strongly
opposed the institutional suitability
alternative, asserting that the
complexity and opacity of structured
finance products has made them
impenetrable to all but the most
sophisticated industry experts.485 At a
minimum, the commenter
recommended that if the Commission

adopts the institutional suitability
alternative, it should require an SBS
Dealer to have a reasonable basis to
believe its counterparty has the capacity
to absorb potential losses related to the
security-based swap or trading strategy
being recommended.486
A third commenter advocated for
harmonizing the institutional suitability
alternative with the CFTC’s parallel
provision, citing potential counterparty
confusion.487 Specifically, the
commenter recommended that the
Commission: (1) Clarify that the
institutional suitability alternative only
satisfies an SBS Dealer’s customerspecific suitability obligation in
proposed Rule 15Fh–3(f)(1)(ii), not its
suitability obligation in proposed Rule
15Fh–3(f)(1)(i); and (2) add a safe harbor
providing that an SBS Dealer can satisfy
its requirement to make a reasonable
determination that the counterparty is
capable of independently evaluating
investment risks with regard to the
security-based swap if the SBS Dealer
receives written representations from
the counterparty regarding the
counterparty’s compliance with
appropriate policies and procedures.488
iii. Special Entity Suitability Alternative
Four commenters submitted
comments regarding the suitability
alternative for special entity
counterparties in proposed Rule 15Fh–
3(f)(3).489 Three commenters supported
the proposed rule.490 Another
commenter recommended adding a
requirement to the institutional
suitability alternative, in lieu of the
special entity suitability alternative, that
the SBS Dealer comply with the
requirements of Rule 15Fh–4(b)
(regarding acting as an advisor to a
special entity) if the SBS Dealer’s
recommendation to a special entity
would cause it to be acting as an advisor
to the special entity.491
c. Response to Comments and Final
Rule
i. General
After considering the comments, the
Commission is adopting Rule 15Fh–
3(f)(1) with two modifications. The first
modification is to rephrase the
suitability obligation in proposed Rule
15Fh–3(f)(1)(i), in response to a specific

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477 Id.
478 See

SIFMA (August 2015), supra note 5.

486 Id.

479 Id.

487 See

480 See

488 Id.

Levin, supra note 5; CFA, supra note 5;
SIFMA (August 2015), supra note 5.
481 See Levin, supra note 5; CFA, supra note 5.
482 See Levin, supra note 5.
483 Id.
484 Id.
485 See CFA, supra note 5.

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SIFMA (August 2015), supra note 5.

489 See BlackRock, supra note 5; GFOA, supra
note 5; ABC, supra note 5; SIFMA (August 2015),
supra note 5.
490 See BlackRock, supra note 5; GFOA, supra
note 5; ABC, supra note 5.
491 See SIFMA (August 2015), supra note 5.

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suggestion from a commenter,492 to
make it consistent with the CFTC’s
parallel suitability requirement in
Commodity Exchange Act Rule
23.434(a)(1), which explicitly requires
SBS Dealers to understand the riskreward tradeoff of their
recommendations. We believe that our
proposed formulation and the CFTC’s
formulation would have achieved the
same purpose. However, to alleviate
concerns among commenters that
compliance with the two rules would
require anything different, we are
harmonizing the wording of our rule
with the CFTC’s parallel suitability
obligation.493 As adopted, Rule 15Fh–
3(f)(1)(i) requires an SBS Dealer that
recommends a security-based swap or
trading strategy involving a securitybased swap to a counterparty, other than
an SBS Entity or Swap Entity, to
‘‘undertake reasonable diligence to
understand the potential risks and
rewards associated with the
recommended security-based swap or
trading strategy involving a securitybased swap.’’ Consistency with the
CFTC standard will result in efficiencies
for entities that have already established
infrastructure to comply with the CFTC
standard. Consistent wording will also
allow SBS Entities to more easily
analyze compliance with the
Commission’s rule against their existing
activities to comply with the CFTC’s
parallel suitability rule for Swap
Entities.
The second modification the
Commission is making is to add the
phrase ‘‘involving a security-based
swap’’ to the final line of the customerspecific suitability obligation in
proposed Rule 15Fh–3(f)(1)(ii) to modify
‘‘trading strategy.’’ Accordingly, Rule
15Fh–3(f)(1)(ii), as adopted, requires an
SBS Dealer that recommends a securitybased swap or trading strategy involving
a security-based swap to a counterparty,
other than an SBS Entity or Swap
Entity, to have a reasonable basis to
believe that a recommended securitybased swap or trading strategy involving
a security-based swap is suitable for the
counterparty, and to establish a
492 See SIFMA (August 2015), supra note 5. The
Commission believes this change also responds to
another commenter’s concern that the proposed
rules could conflict with the CFTC’s suitability rule.
See FIA/ISDA/SIFMA, supra note 5.
493 See CFTC Adopting Release, 77 FR at 9771–
9774, supra note 21. The new formulation is also
consistent with FINRA’s approach to this aspect of
suitability. See Supplementary Material .05(a) to
FINRA Rule 2111 (effective July 9, 2012) (‘‘[a]
member’s or associated person’s reasonable
diligence must provide the member or associated
person with an understanding of the potential risks
and rewards associated with the recommended
security or strategy’’).

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reasonable basis for a recommendation,
to have or obtain relevant information
regarding the counterparty, including
the counterparty’s investment profile,
trading objectives, and its ability to
absorb potential losses associated with
the recommended security-based swap
or trading strategy ‘‘involving a securitybased swap.’’ The Commission does not
believe that this is a substantive change.
It simply clarifies that the term trading
strategy as used in the final line of the
rule is the same as recommended
trading strategy involving a securitybased swap that is referenced earlier in
the rule.
As noted in the Proposing Release,
although suitability is not expressly
addressed in Section 15F(h) of the
Exchange Act, the obligation to make
only suitable recommendations is a core
business conduct requirement for
broker-dealers and other financial
intermediaries.494 Municipal securities
dealers also have a suitability obligation
when recommending municipal
securities transactions to a customer.495
Depending on the scope of its activities,
an SBS Dealer may be subject to one of
these other suitability obligations, in
addition to those under Rule 15Fh–3(f).
In particular, an SBS Dealer that also is
a registered broker-dealer and a FINRA
member, would be subject to FINRA’s
suitability requirements in connection
with the recommendation of a securitybased swap or trading strategy involving
a security-based swap.496 Rule 15Fh–
3(f) is intended to ensure that all SBS
Dealers that make recommendations are
subject to this obligation, tailored as
appropriate in light of the nature of the
security-based swap markets.497
494 See Proposing Release, 76 FR at 42415, supra
note 3. See also, e.g., FINRA Rules 2090 and 2111
(effective Jul. 9, 2012); Charles Hughes & Co. v.
SEC, 139 F.2d 434 (2d Cir. 1943) (enforcing
suitability obligations under the antifraud
provisions of the Exchange Act).
495 MSRB Rule G–19(c) provides that:
In recommending to a customer any municipal
security transaction, a broker, dealer, or municipal
securities dealer shall have reasonable grounds: (i)
Based upon information available from the issuer of
the security or otherwise, and (ii) based upon the
facts disclosed by such customer or otherwise
known about such customer, for believing that the
recommendation is suitable.
496 See FINRA Rule 2111. Under FINRA rules,
unless a customer is an ‘‘institutional account’’ that
meets the requirements of the institutional account
exemption, he or she would be entitled to the
protections provided by retail suitability obligations
in the broker-dealer context. An ‘‘institutional
account’’ means the account of a bank, savings and
loan association, insurance company, registered
investment company, registered investment adviser
or any other person (whether a natural person,
corporation, partnership, trust, or otherwise) with
total assets of at least $50 million. See FINRA Rule
2111(b) (referring to FINRA Rule 4512(c)).
497 Some dealers have indicated that they already
apply ‘‘institutional suitability’’ principles to their

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The Commission continues to believe
that the determination of whether an
SBS Dealer has made a recommendation
that triggers suitability obligations
should turn on the facts and
circumstances of the particular situation
and, therefore, whether a
recommendation has taken place is not
susceptible to a bright line definition.498
This follows the FINRA approach to
what constitutes a recommendation for
purposes of FINRA’s suitability rule.499
In the context of the FINRA suitability
rule, factors considered in determining
whether a recommendation has taken
place include whether the
communication ‘‘reasonably could be
viewed as a ‘call to action’ ’’ and
‘‘reasonably would influence an
investor to trade a particular security or
group of securities.’’ 500 We note that
this could include a call to action
regarding buying, selling, materially
amending or early termination of a
security-based swap. The more
individually tailored the
communication to a specific customer
or a targeted group of customers about
a security or group of securities, the
greater the likelihood that the
communication may be viewed as a
‘‘recommendation.’’ The Commission
continues to believe that this approach
to determining whether a
recommendation has taken place should
apply in the context of Rule 15Fh–3(f)
as well.501
As noted in the Proposing Release, an
SBS Dealer typically would not be
deemed to be making a recommendation
solely by reason of providing general
financial or market information, or
transaction terms in response to a
request for competitive bids.502 Again,
this follows the FINRA approach to
swap business. See, e.g., Letter from Richard
Ostrander, Managing Director and Counsel, Morgan
Stanley, to Elizabeth M. Murphy, Secretary,
Securities and Exchange Commission, and David A.
Stawick, Secretary, Commodity Futures Trading
Commission (Dec. 3, 2010) at 5; Report of the
Business Standards Committee, Goldman Sachs
(Jan. 2011), http://www2.goldmansachs.com/ourfirm/business-standards-committee/report.pdf.
498 See Proposing Release, 76 FR at 42415, supra
note 3.
499 See FINRA Regulatory Notice 12–25 (May
2012) Q.2 and Q.3 (regarding the scope of
‘‘recommendation’’).
500 See FINRA Notice to Members 01–23 (Mar. 19,
2001), and Notice of Filing of Proposed Rule
Change to Adopt FINRA Rules 2090 (Know Your
Customer) and 2111 (Suitability) in the
Consolidated FINRA Rulebook, Exchange Act
Release No. 62718 (Aug. 13, 2010), 75 FR 51310
(Aug. 19, 2010), as amended, Exchange Act Release
No. 62718A (Aug. 20, 2010), 75 FR 52562 (Aug. 26,
2010) (discussing what it means to make a
‘‘recommendation’’).
501 See Proposing Release, 76 FR at 42415, supra
note 3.
502 See Proposing Release, 76 FR at 42415, supra
note 3.

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29997

determining whether a recommendation
has occurred.503 Furthermore,
compliance with the requirements of the
other business conduct rules, in
particular, Rules 15Fh–3(a) (verification
of counterparty status), 15Fh–3(b)
(disclosures of material risks and
characteristics, and material incentives
or conflicts of interest), 15Fh–3(c)
(disclosures of daily mark), and 15Fh–
3(d) (disclosures regarding clearing
rights) would not, in and of itself, result
in an SBS Dealer being deemed to be
making a ‘‘recommendation.’’ 504
We believe that the suitability
obligation in Rule 15Fh–3(f)(1)(i) should
address one commenter’s concerns
about the possibility that an SBS Dealer
will recommend a financial product that
it believes will fail or that it does not
have the necessary background to
understand.505 When making
recommendations, SBS Dealers are
always required to meet their suitability
obligation in Rule 15Fh–3(f)(1)(i),
regardless of whether they avail
themselves of the institutional
suitability alternative to meet their
customer-specific suitability obligations.
In that respect, SBS Dealers will always
be required to undertake reasonable
diligence to understand the risks and
rewards behind any recommended
security-based swap.
With respect to another commenter’s
concerns about SBS Dealers’ gathering
sufficient information to make the
customer-specific suitability
assessment,506 the Commission notes
that Rule 15Fh–3(f)(1)(ii) requires an
SBS Dealer to ‘‘have a reasonable basis
to believe’’ that a recommended
security-based swap or trading strategy
is suitable for the counterparty. To
establish that reasonable basis, the rule
requires the SBS Dealer to ‘‘have or
obtain relevant information regarding
the counterparty, including the
counterparty’s investment profile,
trading objectives, and its ability to
503 See Supplementary Material .03 to FINRA
Rule 2090.
504 Additionally, as discussed in Section I.E,
supra, the duties imposed on an SBS Dealer under
the business conduct rules are specific to this
context, and are in addition to any duties that may
be imposed under other applicable law. Thus, an
SBS Dealer must separately determine whether it is
subject to regulation as a broker-dealer, an
investment adviser, a municipal advisor or other
regulated entity.
505 See Levin, supra note 5.
506 See CFA, supra note 5. In response to the
commenter’s other concern regarding the
Commission requiring SBS Dealers to maintain
sufficient documentation to effectively enforce
compliance with the suitability rule, we note that
the Commission has separately proposed
recordkeeping requirements for SBS Dealers. See
Recordkeeping Release, 79 FR at 25135, supra note
242.

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absorb potential losses associated with
the recommended security-based swap
or trading strategy.’’ The list of ‘‘relevant
information’’ in the rule is exemplary,
not exhaustive. Whether an SBS Dealer
has a reasonable basis to believe that a
recommended security-based swap or
trading strategy is suitable for the
counterparty is a determination that
depends on the facts and circumstances
of the particular situation.
The Commission declines to apply
Rule 15Fh–3(f) to Major SBS
Participants, as suggested by one
commenter.507 As discussed above in
Section II.C, where a business conduct
requirement is not expressly addressed
by the Dodd-Frank Act, the Commission
is generally not applying such a rule to
Major SBS Participants. The
Commission continues to believe that it
is appropriate not to impose suitability
obligations on Major SBS Participants,
given that, by definition, Major SBS
Participants are not engaged in securitybased swap dealing activity at levels
above the de minimis threshold.508
However, if a Major SBS Participant is,
in fact, recommending security-based
swaps or trading strategies involving
security-based swaps to a counterparty,
this would indicate that the Major SBS
Participant is actually engaged in
security-based swap dealing activity.509
If a Major SBS Participant engages in
such activity above the de minimis
threshold in Exchange Act Rule 3a71–2,
it would need to register as an SBS
Dealer and, as such, would need to
comply with the suitability obligations
imposed by Rule 15Fh–3(f).
Further, Rule 15Fh–3(f) will not
impose suitability obligations on an SBS
Dealer transacting with an SBS Entity or
Swap Entity. The Commission
continues to believe that these types of
counterparties, which are professional
intermediaries or major participants in
the swaps or security-based swaps
markets, would not need the protections
that would be afforded by this rule.
However, taking into account the
concerns of one commenter,510 the
Commission is not adopting any
additional exclusions to the rule at this
time, nor is the Commission applying
507 See

CFA, supra note 5.
Exchange Act Rule 3a61–1(a)(1) (limiting
the definition of ‘‘major security-based swap
participant’’ to persons that are not security-based
swap dealers).
509 See Proposing Release, 76 FR at 42416 n.140,
supra note 3. See also Definitions Adopting Release,
77 FR at 30618, supra note 115 (‘‘Advising a
counterparty as to how to use security-based swaps
to meet the counterparty’s hedging goals, or
structuring security-based swaps on behalf of a
counterparty, also would indicate security-based
swap dealing activity.’’).
510 See CFA, supra note 5.

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508 See

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the suitability obligations at the least
granular level (e.g., on a transaction-bytransaction basis, on an asset-class-byasset-class basis, or in terms of all
potential transactions between the
parties), as suggested by another
commenter.511 The Commission is also
not, as suggested by one commenter,512
providing an opt out from the rule or a
policies and procedures alternative. As
discussed above in Sections II.A.3.d and
II.E, the Commission believes that it is
appropriate to apply the suitability rule
so that counterparties receive the
benefits of the protections provided by
the rule; permitting parties to ‘‘opt out’’
of the benefits of the rule or providing
a policies and procedures alternative
would undermine its core purpose of
protecting counterparties. However,
while we are not adopting an opt out
provision or a policies and procedures
alternative, the Commission has
determined to permit means of
compliance with Rule 15Fh–3(f) that
should promote efficiency and reduce
costs (e.g., reliance on representations
pursuant to Rule 15Fh–1(b)) and
allowing SBS Dealers to take into
account the sophistication of the
counterparty by way of the institutional
suitability alternative in Rule 15Fh–
3(f)(2) (described below).
The Commission is not adopting one
commenter’s suggestion to impose
additional standards for the types of
financial products that can be sold to
state and local governments, including
security-based swaps.513 We have
determined that additional standards
are not needed and that the rules we are
adopting appropriately regulate the
business conduct of the professional
market intermediaries selling these
products. We also note that the MSRB
is developing a regulatory framework for
municipal advisors, including detailed
standards of conduct that municipal
advisors owe to municipal entities.514
511 See

Barnard, supra note 5.
FIA/ISDA/SIFMA, supra note 5.
513 See GFOA, supra note 5.
514 See, e.g., Order Granting Approval of a
Proposed Rule Change, as Modified by Amendment
No. 1 and Amendment No. 2, Consisting of
Proposed New Rule G–42, on Duties of NonSolicitor Municipal Advisors, and Proposed
Amendments to Rule G–8, on Books and Records
to be Made by Brokers, Dealers, Municipal
Securities Dealers, and Municipal Advisors,
Exchange Act Release No. 76753 (Dec. 23, 2015), 80
FR 81614 (Dec. 30, 2015); Order Granting Approval
of a Proposed Rule Change Consisting of Proposed
Amendments to Rule G–20, on Gifts, Gratuities and
Non-Cash Compensation, and Rule G–8, on Books
and Records to be Made by Brokers, Dealers,
Municipal Securities Dealers, and Municipal
Advisors, and the Deletion of Prior Interpretive
Guidance, Exchange Act Release No. 76381 (Nov. 6,
2015), 80 FR 70271 (Nov. 13, 2015); see also Notice
of Filing of a Proposed Rule Change Consisting of
Proposed Amendments to Rule G–37, on Political
512 See

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ii. Institutional Suitability Alternative
and Special Entity Suitability
Alternative
After considering the comments, the
Commission is adopting Rules 15Fh–
3(f)(2)–(4) with a number of
modifications. First, in response to a
specific suggestion from a
commenter,515 the Commission is
correcting a typographical error in
proposed Rule 15Fh–3(f)(2). The
institutional suitability alternative in
proposed Rule 15Fh–3(f)(2) was
intended to provide SBS Dealers with
an alternative method to fulfill their
customer-specific suitability obligations
described in proposed Rule 15Fh–
3(f)(1)(ii), not their suitability
obligations described in proposed Rule
15Fh–3(f)(1)(i). Accordingly, the crossreference in the proposed rule should
have been to ‘‘paragraph (f)(1)(ii),’’ not
to ‘‘paragraph (f)(1).’’ The Commission
is correcting this cross-reference in the
final rules.
Second, in response to concerns
raised by a commenter,516 the
Commission is also limiting the
availability of the institutional
suitability alternative to
recommendations made to ‘‘institutional
counterparties.’’ This is a change from
the proposed rule under which the
institutional suitability alternative
would have been available with respect
to recommendations made to any
counterparty. Rule 15Fh–3(f)(4), as
adopted, defines the term ‘‘institutional
counterparty’’ for these purposes to
mean a counterparty that is an eligible
contract participant as defined in
clauses (A)(i), (ii), (iii), (iv), (viii), (ix) or
(x), or clause (B)(ii) (other than a person
described in clause (A)(v)) of Section
1a(18) of the Commodity Exchange Act
and the rules and regulations
thereunder, or any person (whether a
natural person, corporation,
partnership, trust or otherwise) with
total assets of at least $50 million. This
more closely aligns the treatment of the
persons who may most need the
protections of the suitability
requirements with their treatment under
FINRA rules, which limit the
application of FINRA’s analogous
institutional suitability alternative to
recommendations to persons (whether a
natural person, corporation,
partnership, trust or otherwise) with
Contributions and Prohibitions on Municipal
Securities Business, Rule G–8, on Books and
Records, Rule G–9, on Preservation of Records, and
Forms G–37 and G–37x, Exchange Act Release No.
76763 (Dec. 23, 2015), 80 FR 81709 (Dec. 30, 2015).
515 See SIFMA (August 2015), supra note 5.
516 See CFA, supra note 5.

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total assets of at least $50 million.517
Rule 15Fh–3(f)(2), as adopted, generally
provides that an SBS Dealer may rely on
the institutional suitability alternative
when making recommendations to
institutional counterparties. For a
counterparty that is not an institutional
counterparty, an SBS Dealer will need
to have or obtain relevant information
regarding the counterparty to establish a
reasonable basis to believe that a
recommended security-based swap or
trading strategy involving a securitybased swap is suitable for the
counterparty.518
Third, in response to specific
suggestions from a commenter, the
Commission is making changes to
harmonize the institutional and special
entity suitability alternatives with the
CFTC’s parallel provisions.519
Specifically, the Commission is
eliminating the separate special entity
suitability alternative. Accordingly, an
SBS Dealer may satisfy its customerspecific suitability obligations in Rule
15Fh–3(f)(1)(ii) with respect to any
institutional counterparty, including a
special entity counterparty that meets
the $50 million asset threshold
described above, by complying with the
requirements of the institutional
suitability alternative in Rule 15Fh–
3(f)(2). Having a single institutional
suitability alternative will result in
greater consistency with the CFTC’s
parallel rule, which will result in
efficiencies for entities that have already
established infrastructure to comply
with the CFTC standard.520 However,
the Commission is not adopting the
commenter’s suggestion to add a new
fourth prong to Rule 15Fh–3(f)(2) that
requires an SBS Dealer to comply, in
addition to the requirements of the first
three prongs (as outlined below), with
the requirements of Rule 15Fh–4(b) if
the SBS Dealer’s recommendation to a
special entity would cause it to be
acting as an advisor to the special
entity.521 The Commission is not
517 See FINRA Rule 2111(b) (referring to FINRA
Rule 4512(c)).
518 See Rule 15Fh–3(f)(1)(ii).
519 See SIFMA (August 2015), supra note 5. See
also CFTC Adopting Release, 77 FR at 9771–9774,
supra note 21.
520 See SIFMA (August 2015), supra note 5
(noting that ‘‘[a]lthough conforming to the [parallel
CFTC suitability rule] would impose additional
diligence and compliance requirements on the [SBS
Dealer], these requirements would not result in
material costs because [SBS Dealers] are already
complying with the same requirements under the
[parallel CFTC rule]’’). However, we note that the
CFTC does not limit the availability of its
institutional suitability alternative to
recommendations to ‘‘institutional counterparties.’’
See Commodity Exchange Act Rule 23.434(b).
521 See SIFMA (August 2015), supra note 5. As
discussed in Section II.H.2 below, Rule 15Fh–4(b)

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making this change because the rules
impose independent requirements, and
the Commission believes that SBS
Dealers should comply with each rule to
the extent applicable.
The proposed special entity
suitability alternative would have
provided that an SBS Dealer would be
deemed to satisfy its suitability
obligations with respect to a special
entity counterparty if the SBS Dealer
either (1) is acting as an advisor to the
special entity and complies with
proposed Rule 15Fh–4(b), or (2) is
deemed not to be acting as an advisor
to the special entity pursuant to
proposed Rule 15Fh–2(a).522 With
respect to the former, the Commission
believes that when an SBS Dealer is
acting as an advisor to a special entity,
it is appropriate for both the best
interests requirements of Rule 15Fh–
4(b) and the suitability requirements of
Rule 15Fh–3(f) to apply. As discussed in
Section II.H.3 below, there is some
overlap between the requirements, so an
SBS Dealer’s efforts to satisfy one set of
requirements may result in satisfaction
of the other. With respect to the latter,
the Commission continues to believe, as
noted in the Proposing Release, that the
standards for determining that an SBS
Dealer is not acting as an advisor under
Rule 15Fh–2(a) are substantially the
same as the standards that an SBS
Dealer must satisfy to qualify for the
institutional suitability alternative
under Rule 15Fh–3(f)(2) (with the
exception of the new institutional
counterparty limitation described
above).523 However, the Commission
agrees with the commenter that having
a single institutional suitability
alternative more consistent with the
CFTC’s rule will result in efficiencies
and a lower likelihood of counterparty
confusion.524 Additionally, as we note
above, the rules being adopted today are
intended to provide certain protections
for counterparties, including certain
heightened protections for special
entities. In this regard, we believe it is
important that the rules impose both
sets of requirements on SBS Dealers that
generally requires an SBS Dealer that acts as an
advisor to a special entity to make a reasonable
determination that any recommended securitybased swap or trading strategy involving a securitybased swap is in the best interests of the special
entity.
522 See proposed Rule 15Fh–3(f)(3).
523 See Proposing Release, 76 FR at 42416 n.137,
supra note 3.
524 See SIFMA (August 2015), supra note 5.
However, as noted above, the CFTC does not limit
the availability of its alternative to
recommendations to ‘‘institutional counterparties.’’
See Commodity Exchange Act Rule 23.434(b). The
‘‘institutional counterparty’’ limitation is discussed
above.

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make recommendations to special
entities so that special entities receive
the full range of benefits that the rules
are intended to provide.
Fourth, the Commission is adding the
words ‘‘with regard to the relevant
security-based swap or trading strategy
involving a security-based swap’’ to
modify ‘‘recommendations of the [SBS
Dealer]’’ in the second prong of the
institutional suitability alternative to
match the language used in the first
prong and clarify that those are the only
recommendations to which the rule
refers. The Commission is adopting the
other two prongs of the institutional
suitability alternative as proposed.
Accordingly, as adopted, Rule 15Fh–
3(f)(2) provides that when an SBS
Dealer makes a recommendation, it may
fulfill its customer-specific suitability
obligations under Rule 15Fh–3(f)(1)(ii)
with respect to an institutional
counterparty, if: (1) The SBS Dealer
reasonably determines that the
counterparty (or its agent) is capable of
independently evaluating investment
risks with regard to the relevant
security-based swap or trading strategy
involving a security-based swap; (2) the
counterparty (or its agent) affirmatively
represents in writing that it is exercising
independent judgment in evaluating the
recommendations of the SBS Dealer
with regard to the relevant securitybased swap or trading strategy involving
a security-based swap; and (3) the SBS
Dealer discloses that it is acting in the
capacity of a counterparty, and is not
undertaking to assess the suitability of
the security-based swap or trading
strategy for the counterparty. If an SBS
Dealer cannot rely on the institutional
suitability alternative provided by
Rule15Fh–3(f)(2), it would need to make
an independent determination that the
recommended security-based swap or
trading strategy involving security-based
swaps is suitable for the counterparty.
The Commission believes that the
SBS Dealer reasonably could determine
that the counterparty (or its agent) is
capable of independently evaluating
investment risks with regard to the
relevant security-based swap or trading
strategy for purposes of Rule 15Fh–
3(f)(2)(i) through a variety of means.
However, in response to specific
suggestions from a commenter 525 and to
provide additional clarity, the
Commission is adding a safe harbor in
Rule 15Fh–3(f)(3) providing that an SBS
Dealer can satisfy its requirement under
the first prong of the institutional
suitability alternative in Rule 15Fh–
3(f)(2) to make a reasonable
determination that the counterparty (or
525 See

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its agent) is capable of independently
evaluating investment risks with regard
to the relevant security-based swap or
trading strategy if the SBS Dealer
receives appropriate written
representations from its counterparty.
As discussed above in Section II.D, an
SBS Dealer can rely on a counterparty’s
written representations unless the SBS
Dealer has information that would cause
a reasonable person to question the
accuracy of the representation. Under
Rule 15Fh–3(f)(3)(i),if the counterparty
is not a special entity, the
representations must provide that the
counterparty has complied in good faith
with written policies and procedures
reasonably designed to ensure that the
persons evaluating the recommendation
and making trading decisions on behalf
of the counterparty are capable of doing
so. Under Rule 15Fh–3(f)(3)(ii), if the
counterparty is a special entity, the
representations must satisfy the terms of
the safe harbor in Rule 15Fh–5(b).526 If
an SBS Dealer chooses not to take
advantage of the safe harbor provided by
Rule 15Fh–3(f)(3), the Commission
believes that the SBS Dealer reasonably
could determine that the counterparty
(or its agent) is capable of
independently evaluating investment
risks with regard to the relevant
security-based swap or trading strategy
for purposes of Rule 15Fh–3(f)(2)(i)
through a variety of means. For
example, an SBS Dealer could comply
with this requirement by having a
counterparty indicate in a signed
agreement or other document that the
counterparty is capable of
independently evaluating investment
risks with respect to recommendations
or an SBS Dealer could call its
counterparty, have that discussion, and
(if it chooses or circumstances require)
document the conversation to evidence
the counterparty’s affirmative
indication.
The Commission continues to believe
that parties should be able to make the
disclosures and representations required
by Rules 15Fh–3(f)(2) and (3) on a
transaction-by-transaction basis, on an
asset-class-by-asset-class basis, or
broadly in terms of all potential
526 As discussed in Section II.H.6.i below, Rule
15Fh–5(b) provides a safe harbor under which an
SBS Entity can comply with its obligation to have
a reasonable basis to believe that its special entity
counterparty has a qualified independent
representative that, among other things, has
sufficient knowledge to evaluate the transaction and
risks and undertakes to act in the best interests of
the special entity. Rule 15Fh–5(b) specifies the
representations that the SBS Entity must obtain
from its special entity counterparty and, in some
cases, from such counterparty’s representative, to
satisfy the safe harbor.

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transactions between the parties.527
However, where there is an indication
that a counterparty is not capable of
independently evaluating investment
risks, or does not intend to exercise
independent judgment regarding, all of
an SBS Dealer’s recommendations, the
SBS Dealer necessarily will have to be
more specific in its approach to
complying with the institutional
suitability alternative. For instance, in
some cases an SBS Dealer may be
unable to determine that a counterparty
is capable of independently evaluating
investment risks with respect to any
security-based swap. In other cases, the
SBS Dealer may determine that a
counterparty is generally capable of
evaluating investment risks with respect
to some categories or types of securitybased swaps, but that the counterparty
may not be able to understand a
particular type of security-based swap
or its risk. Additionally, the
requirements of Rule 15Fh–1(b) will
apply when an SBS Dealer is relying on
representations from a counterparty or
its representative.528
We are not adopting one commenter’s
suggestions to require SBS Dealers to
conduct routine audits to ensure that
the institutional suitability alternative is
used appropriately.529 The Commission
does not believe that routine audits are
the sole means through which an SBS
Dealer could supervise its associated
persons’ use of the institutional
suitability alternative. The Commission
thinks that the totality of the
supervisory requirements in Rule 15Fh–
3(h) (discussed below) are appropriate
to promote effective supervisory
systems and believes that SBS Dealers
should have the flexibility to determine
what means they will use to supervise
their associated persons’ use of the
institutional suitability alternative. The
Commission notes that in supervising
the use of the institutional suitability
alternative, SBS Dealers should
generally consider whether their
associated persons’ reliance on
representations from counterparties is
reasonable. As discussed above and in
Section II.D, an SBS Dealer (or its
associated person) can rely on a
counterparty’s written representations
unless the SBS Dealer has information
that would cause a reasonable person to
question the accuracy of the
representation. In this context,
information that might be relevant to
this determination includes whether the
counterparty has previously invested in
527 See Proposing Release, 76 FR at 42416, supra
note 3.
528 See discussion in Section II.D, supra.
529 See Levin, supra note 5.

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the type of security-based swap or been
involved in the type of trading strategy
that the SBS Dealer is now
recommending, and whether the
counterparty (or its representative)
appreciates what differentiates the
recommended security-based swap from
a less complex alternative. If the
associated person knows that the
recommended security-based swap or
trading strategy represents a significant
change from the counterparty’s prior
investment strategy or knows that the
counterparty (or its representative) lacks
an appreciation of what differentiates
the recommended security-based swap
from a less complex alternative, the
associated person should generally
consider whether it can reasonably rely
on the counterparty’s representation
that it is capable of independently
evaluating the investment risks.530
The Commission is also not adopting
another commenter’s suggestion to add
a requirement to the institutional
suitability alternative that an SBS Dealer
have a reasonable basis to believe its
counterparty has the capacity to absorb
potential losses related to the
recommended security-based swap or
trading strategy.531 The Commission
believes that the requirement in Rule
15Fh–3(f)(2)(i) that an SBS Dealer ‘‘have
a reasonable basis to believe’’ that the
counterparty is capable of evaluating
investment risks independently is
appropriate to support the objectives of
the institutional suitability alternative,
and does not believe it is necessary to
specifically require an SBS Dealer to
have a reasonable basis to believe its
counterparty has the capacity to absorb
potential losses related to the
recommended security-based swap or
trading strategy.
5. Fair and Balanced Communications
Section 15F(h)(3)(C) of the Exchange
Act requires the Commission to adopt
rules establishing a duty for SBS
Entities to communicate in a fair and
balanced manner based on principles of
fair dealing and good faith.532
530 As discussed in Section II.D, under Rule
15Fh–1(b), an SBS Dealer can reasonably rely on
written representations from a counterparty or its
representative to satisfy its due diligence
obligations. Because reliance must be reasonable,
the question of whether reliance on representations
would satisfy an SBS Dealer’s obligations under our
business conduct rules will depend on the facts and
circumstances of the particular matter. At a
minimum, an SBS Dealer seeking to rely on
representations cannot ignore information that
would cause a reasonable person to question the
accuracy of those representations.
531 See CFA, supra note 5.
532 15 U.S.C. 78o–10(h)(3)(C).

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a. Proposed Rule
Proposed Rule 15Fh–3(g) would
require SBS Entities to communicate
with counterparties in a fair and
balanced manner based upon principles
of fair dealing and good faith. In
particular, the rule would require: (1)
Communications to provide a sound
basis for evaluating the facts with regard
to any particular security-based swap or
trading strategy involving a securitybased swap; (2) communications not to
imply that past performance will recur
or make any exaggerated or unwarranted
claim, opinion or forecast; and (3) any
statement referring to the potential
opportunities or advantages presented
by a security-based swap to be balanced
by an equally detailed statement of the
corresponding risks.533
b. Comments on the Proposed Rule
Three commenters addressed the fair
and balanced communications
requirement.534 Two commenters
expressed support for the proposed
rule,535 and one was opposed.536 One of
the commenters supporting the
proposed rule stated that there should
not be any exceptions to the proposed
fair and balanced communications
requirement.537 The other commenter
asserted that to be fair and balanced,
communications must inform investors
of both the potential rewards and risks
of their investments, and also the SBS
Entity’s involvement and interests in the
investments, in specific terms.538
Specifically, the commenter noted that
all material adverse interests should be
disclosed, and that the rule should
clarify that it is not enough to inform a
customer that the SBS Entity ‘‘may’’
have an adverse interest if that adverse
interest already exists.539
The commenter in opposition to the
proposed rule asserted that a fair and
balanced communications requirement
is unnecessary.540 The commenter
explained that the proposed rule is not
relevant in the context of SBS Entities’
legacy portfolios since the proposed rule
would generally prohibit puffery used to
induce a counterparty to enter into new
transactions.541 Additionally, the
533 Proposed

Rule 15Fh–3(g)(1)–(3).
CFA, supra note 5; Levin, supra note 5;
AFGI (September 2012), supra note 5; AFGI (July
2013), supra note 5.
535 See CFA, supra note 5; Levin, supra note 5.
536 See AFGI (September 2012), supra note 5;
AFGI (July 2013), supra note 5.
537 See CFA, supra note 5.
538 See Levin, supra note 5.
539 Id.
540 See AFGI (September 2012), supra note 5;
AFGI (July 2013), supra note 5.
541 See AFGI (September 2012), supra note 5;
AFGI (July 2013), supra note 5.

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534 See

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commenter noted that due to the
sophisticated nature of counterparties in
the security-based swaps market, the
fair and balanced communications
requirement is not critical, particularly
where all SBS Entities’ communications
are already subject to the antifraud
provisions of the Dodd-Frank Act and
the Exchange Act.542
c. Response to Comments and Final
Rule
After considering the comments, the
Commission is adopting Rule 15Fh–3(g)
as proposed. The rule applies in
connection with entering into securitybased swaps, and will continue to apply
over the term of a security-based
swap.543
The Commission does not believe any
changes to the rule are necessary to
address a commenter’s concern that to
be fair and balanced, communications
must inform investors of both the
potential rewards and risks of their
investments because Rule 15Fh–3(g)(3)
already provides that ‘‘[a]ny statement
referring to the potential opportunities
or advantages presented by a securitybased swap shall be balanced by an
equally detailed statement of the
corresponding risks.’’ 544 With respect to
the commenter’s assertion that fair and
balanced communications should also
include information regarding the SBS
Entity’s involvement and interests in the
investments,545 the Commission notes
that although specific disclosure
regarding conflicts of interest is not
required by Rule 15Fh–3(g), it is
required by Rule 15Fh–3(b)(2)
(disclosure of material incentives or
conflicts of interest).
The standard set forth in Rule 15Fh–
3(g) is consistent with the similarly
worded requirement in the FINRA rule
on communications.546 Rule 15Fh–3(g)
also includes three specific standards,
drawn from the FINRA rule, which
should clarify the rule requirement. The
standards are: (1) Communications must
provide a sound basis for evaluating the
facts with respect to any security-based
542 See AFGI (September 2012), supra note 5;
AFGI (July 2013), supra note 5.
543 See Rule 15Fh–1(a). In response to concerns
expressed by a commenter, the Commission notes
that there are no exceptions to Rule 15Fh–3(g). See
CFA, supra note 5.
544 See Levin, supra note 5.
545 Id.
546 FINRA Rule 2210(d). See NASD IM–2210–
1(1), Guidelines to Ensure That Communications
with the Public Are Not Misleading (‘‘Members
must ensure that statements are not misleading
within the context in which they are made. A
statement made in one context may be misleading
even though such a statement could be appropriate
in another context. An essential test in this regard
is the balanced treatment of risks and potential
benefits.’’).

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swap or trading strategy involving a
security-based swap; 547 (2)
communications may not imply that
past performance will recur, or make
any exaggerated or unwarranted claim,
opinion, or forecast; 548 and (3) any
statement referring to the potential
opportunities or advantages presented
by a security-based swap or trading
strategy involving a security-based swap
shall be balanced by an equally detailed
statement of the corresponding risks.549
As noted in the Proposing Release, these
standards do not represent an exclusive
list of considerations that an SBS Entity
must take into account in determining
whether a communication with a
counterparty is fair and balanced.550 In
addition to complying with Rule 15Fh–
3(g), SBS Entities should also keep in
mind that all their communications
with counterparties will be subject to
the specific antifraud provisions added
to the Exchange Act under Title VII of
the Dodd-Frank Act,551 as well as
general antifraud provisions under the
federal securities laws.552 The
Commission declines to eliminate the
fair and balanced communications
requirement, as suggested by a
commenter,553 because we believe the
requirement promotes investor
protection by prohibiting SBS Entities
from overstating the benefits or
understating the risks to inappropriately
547 Cf. FINRA Rule 2210(d)(1)(A) (‘‘All member
communications with the public shall be based on
principles of fair dealing and good faith, must be
fair and balanced, and must provide a sound basis
for evaluating the facts in regard to any particular
security or type of security, industry, or service.’’).
548 Cf. FINRA Rule 2210(d)(1)(F)
(‘‘Communications may not predict or project
performance, imply that past performance will
recur or make any exaggerated or unwarranted
claim, opinion or forecast.’’).
549 Cf. FINRA Rule 2210(d)(1)(D) (‘‘Members must
ensure that statements are clear and not misleading
within the context in which they are made, and that
they provide balanced treatment of risks and
potential benefits. Communications must be
consistent with the risks of fluctuating prices and
the uncertainty of dividends, rates of return and
yield inherent to investments.’’) The Commission
believes that this requirement addresses concerns
raised by a commenter that to be fair and balanced,
communications must inform investors of both the
potential rewards and risks of their investments.
See Levin, supra note 5.
550 See Proposing Release, 76 FR at 42418, supra
note 3.
551 See Sections 9(j) and 15F(h)(4)(A) of the
Exchange Act, 15 U.S.C. 78i(j) and 15 U.S.C. 78o–
10(h)(4)(A)). See also Prohibition Against Fraud,
Manipulation, and Deception in Connection with
Security-Based Swaps, Exchange Act Release No.
63236 (Nov. 3, 2010), 75 FR 68560 (Nov. 8, 2010)
(proposing Rule 9j–1 to implement the antifraud
prohibitions of Section 9(j) of the Exchange Act).
552 See, e.g., 15 U.S.C. 77q and 78i, and, if the
SBS Entity is registered as a broker-dealer, 15 U.S.C.
78o.
553 See AFGI (September 2012), supra note 5;
AFGI (July 2013), supra note 5.

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decisions.

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6. Obligation Regarding Diligent
Supervision
Section 15F(h)(1)(B) of the Exchange
Act authorizes the Commission to adopt
rules for the diligent supervision of the
business of SBS Entities.554
a. Proposed Rule
Proposed Rule 15Fh–3(h)(1) would
require an SBS Entity to establish,
maintain and enforce a system to
supervise, and to diligently supervise,
its business and associated persons,
with a view to preventing violations of
applicable federal securities laws, rules
and regulations relating to its business
as an SBS Entity. Proposed Rule 15Fh–
3(h)(2) would require an SBS Entity’s
supervisory system to be reasonably
designed to achieve compliance with
applicable securities laws, rules and
regulations, and would establish
minimum requirements for the
supervisory system. Specifically,
proposed Rule 15Fh–3(h)(2)(i) would
require an SBS Entity to designate at
least one person with authority to carry
out the supervisory responsibilities of
the SBS Entity for each type of business
in which it engages for which
registration as an SBS Entity is required.
Proposed Rule 15Fh–3(h)(2)(ii) would
require an SBS Entity to use reasonable
efforts to determine that all supervisors
are qualified and meet standards of
training, experience, and competence
necessary to effectively supervise the
security-based swap activities of the
persons associated with the SBS Entity.
Proposed Rule 15Fh–3(h)(2)(iii)
would require an SBS Entity to
establish, maintain and enforce written
policies and procedures addressing the
supervision of the types of securitybased swap business in which the SBS
Entity is engaged. The policies and
procedures would need to be reasonably
designed to achieve compliance with
applicable securities laws, rules and
regulations,555 and include, at a
minimum: (1) Procedures for the review
by a supervisor of transactions for
which registration as an SBS Entity is
required; 556 (2) procedures for the
review by a supervisor of incoming and
outgoing written (including electronic)
correspondence with counterparties or
potential counterparties and internal
written communications relating to the
SBS Entity’s business involving
security-based swaps; 557 (3) procedures
554 15

U.S.C. 78o–10(h)(1)(B).
Rule 15Fh–3(h)(2)(iii).
556 Proposed Rule 15Fh–3(h)(2)(iii)(A).
557 Proposed Rule 15Fh–3(h)(2)(iii)(B).
555 Proposed

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for a periodic review, at least annually,
of the security-based swap business in
which the SBS Entity engages that is
reasonably designed to assist in
detecting and preventing violations of,
and achieving compliance with,
applicable federal securities laws and
regulations; 558 (4) procedures to
conduct a reasonable investigation
regarding the character, business repute,
qualifications, and experience of any
person prior to that person’s association
with the SBS Entity; 559 (5) procedures
to consider whether to permit an
associated person to establish or
maintain a securities or commodities
account in the name of, or for the
benefit of such associated person, at
another SBS Dealer, broker, dealer,
investment adviser, or other financial
institution, and if permitted, procedures
to supervise the trading in such account,
including the receipt of duplicate
confirmations and statements related to
such account; 560 (6) a description of the
supervisory system, including the titles,
qualifications and locations of
supervisory persons and the specific
responsibilities of each person with
respect to the types of business in which
the SBS Entity is engaged; 561 (7)
procedures prohibiting supervisors from
supervising their own activities or
reporting to, or having their
compensation or continued employment
determined by, a person or persons they
are supervising; 562 and (8) procedures
preventing the standards of supervision
from being reduced due to any conflicts
of interest of a supervisor with respect
to the associated person being
supervised.563 Additionally, proposed
Rule 15Fh–3(h)(2)(iv) would require an
SBS Entity to include written policies
and procedures reasonably designed,
taking into consideration the nature of
the SBS Entity’s business, to comply
with the duties set forth in Section
15F(j) of the Exchange Act.564
Under proposed Rule 15Fh–3(h)(3),
the Commission proposed two
mechanisms under which an SBS Entity
or associated person would not be
deemed to have failed to diligently
supervise any other person. The SBS
Entity or associated person could
demonstrate that: (1) Such person is not
subject to his or her supervision, or (2)
it meets the terms of a safe harbor. The
safe harbor would require the SBS
Entity or associated person to satisfy

two conditions. The first condition
would be that the SBS Entity has
established and maintained written
policies and procedures, and a
documented system for applying those
policies and procedures, that would
reasonably be expected to prevent and
detect, insofar as practicable, any
violation of the federal securities laws
and the rules and regulations
thereunder relating to security-based
swaps.565 The second condition would
be that the SBS Entity or associated
person has reasonably discharged the
duties and obligations required by such
written policies and procedures and
documented system and did not have a
reasonable basis to believe that such
written policies and procedures and
documented system were not being
followed.566
Finally, proposed Rule 15Fh–3(h)(4)
would require an SBS Entity to
promptly amend its written supervisory
procedures as appropriate when
material changes occur in either
applicable securities laws, rules or
regulations, or in the SBS Entity’s
business or supervisory system, and to
promptly communicate any material
amendments to its supervisory
procedures throughout the relevant
parts of its organization.
b. Comments on the Proposed Rule
Five commenters addressed the
proposed supervision rule.567 One
commenter supported the requirement
in proposed Rule 15Fh–3(h)(2)(iv) that
SBS Entities adopt written policies and
procedures reasonably designed to
ensure compliance with the duties set
forth in Section 15F(j) of the Exchange
Act.568 The commenter noted that this
approach, which does not mandate the
inclusion of specific elements or
prohibitions, will provide SBS Entities
flexibility in establishing compliance
policies appropriate for their
management and organizational
structure.569
Another commenter argued for
additional diligent supervision
requirements.570 The commenter
recommended requiring supervisory
personnel to report to upper
management or the board, as
appropriate, if they have reason to
believe the SBS Entity’s supervisory
procedures are not proving effective in
565 Proposed

558 Proposed

Rule 15Fh–3(h)(2)(iii)(C).
559 Proposed Rule 15Fh–3(h)(2)(iii)(D).
560 Proposed Rule 15Fh–3(h)(2)(iii)(E).
561 Proposed Rule 15Fh–3(h)(2)(iii)(F).
562 Proposed Rule 15Fh–3(h)(2)(iii)(G).
563 Proposed Rule 15Fh–3(h)(2)(iii)(H).
564 See 15 U.S.C. 78o–10(j).

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Rule 15Fh–3(h)(3)(i).
Rule 15Fh–3(h)(3)(ii).
567 See CFA, supra note 5; FIA/ISDA/SIFMA,
supra note 5; MFA, supra note 5; NABL, supra note
5; SIFMA (September 2015), supra note 5.
568 See NABL, supra note 5.
569 Id.
570 See CFA, supra note 5.
566 Proposed

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preventing violations.571 The
commenter also suggested requiring SBS
Entities to reevaluate their supervisory
procedures when they fail to detect or
deter significant violations, and
determine whether revisions are
needed.572
In contrast, a third commenter
requested that the Commission narrow
the proposed supervision
requirements.573 The commenter
suggested that the Commission clarify
that when an SBS Entity is already
subject to, and complies with,
comparable requirements of another
‘‘qualifying regulator’’ (such as risk
management standards imposed by a
prudential regulator), the SBS Entity’s
supervisory policies and procedures
will be deemed to be reasonably
designed for purposes of the proposed
rule.574 The commenter also requested
that the Commission clarify that a
person committing a violation will not
be viewed as being subject to the
supervision of another person unless the
putative supervisor knew or should
have known that he or she had the
authority and responsibility to exercise
control over the other person that could
have prevented the violation.575
A fourth commenter opposed the
application of the proposed rule to
Major SBS Participants.576 The
commenter asserted that the proposed
rule imposes burdensome and costly
supervisory procedures on Major SBS
Participants that are not appropriate
given their non-dealer role in the
marketplace, and that the potential costs
of compliance would be without any
meaningful offsetting benefit for other
market participants or the financial
markets as a whole.577
A fifth commenter recommended
harmonizing the Commission’s
supervision requirements with FINRA
Rule 3110 to enable SBS Entities that
are also broker-dealers to make use of
their existing supervisory systems and
to minimize confusion.578 Specifically,
571 Id.
572 Id.
573 See

FIA/ISDA/SIFMA, supra note 5.

574 Id.
575 Id.
576 See

MFA, supra note 5.

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577 Id.
578 See SIFMA (September 2015), supra note 5.
Although the Commission modeled proposed Rule
15Fh–3(h) in part on NASD Rules 3010
(Supervision) and 3012 (Supervisory Control
System), the Commission subsequently approved
new consolidated FINRA Rules 3110 (Supervision)
and 3120 (Supervisory Control System), which are
largely based on and replace NASD Rules 3010 and
3012, and corresponding provisions of the NYSE
Rules and Interpretations. See Order Approving
Proposed Rule Change as Modified by Amendment
No. 1, Exchange Act Release No. 71179 (Dec. 23,
2013), 78 FR 79542 (Dec. 30, 2013).

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the commenter suggested eliminating
the proposed requirements in proposed
Rule 15Fh–3(h)(1) to ‘‘enforce’’ a system
to supervise and to diligently supervise
‘‘the business’’ (as opposed to the
associated persons) of the SBS Entity,
and changing the description of the
supervisory system from ‘‘with a view to
preventing violations of’’ to ‘‘reasonably
designed to ensure compliance with’’
the provisions of applicable federal
securities laws and the rules and
regulations thereunder relating to its
business as an SBS Entity.579 The
commenter also recommended
eliminating the redundant description
of the supervisory system in proposed
Rule 15Fh–3(h)(2), and making a
number of changes to the wording of the
minimum requirements listed in subsection (h)(2) to align them with FINRA
Rule 3110.580 The commenter also asked
that the Commission modify the rule
text to reflect that security-based swaps
are not necessarily traded in an
‘‘account’’ but rather pursuant to a
bilateral trading relationship.581
Additionally, the commenter
recommended adding a provision
allowing an SBS Entity that cannot
comply with the requirement in
proposed Rule 15Fh–3(h)(2)(iii)(G)
(preventing a supervisor from
supervising his or her own activities or
reporting to a person he or she is
supervising) to document its
determination that compliance is not
possible because of the firm’s size or a
supervisory person’s position within the
firm and document how the supervisory
arrangement otherwise complies with
proposed Rule 15Fh–3(h)(1).582 The
commenter also requested that the
Commission provide guidance regarding
risk-based reviews that is consistent
with FINRA supplementary material on
the topic.583 Finally, the commenter
recommended wording changes to the
maintenance of written supervisory
procedures requirement in proposed
Rule 15Fh–3(h)(4) to harmonize with
FINRA Rule 3110, including eliminating
the proposed requirement to update the
written supervisory procedures when
material changes occur to the
‘‘business,’’ as opposed to the
supervisory system.584
c. Response to Comments and Final
Rule
After considering the comments, the
Commission is adopting Rule 15Fh–3(h)
579 Id.
580 Id.
581 Id.
582 Id.
583 Id.
584 Id.

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30003

With certain modifications. In response
to commenters’ concerns regarding SBS
Entities that will also be registered as
broker-dealers or Swap Entities being
subject to overlapping requirements
with respect to their supervisory
systems,585 the modifications (discussed
below) are primarily intended to make
the final rule more consistent with
FINRA Rule 3110 and the CFTC’s
supervision rule for Swap Entities while
continuing to provide protections
intended to help ensure that SBS
Entities have effective supervisory
systems.586 While, as discussed
throughout this release, we are making
changes to many of the business
conduct rules that are intended to make
the final rules more consistent with the
parallel CFTC requirements, for the
supervision and CCO rules, in
particular, we agree with a commenter
that consistency with the parallel
FINRA rules is also important because
many SBS Entities have already
established infrastructure to comply
with those rules in the context of
broader supervisory and compliance
programs across their security-based
swap and related securities and swaps
businesses.587 This consistency will
result in efficiencies for SBS Entities
that have already established
supervisory systems to comply with the
FINRA and/or CFTC standards.
Consistent wording will also allow SBS
Entities to more easily analyze
compliance with the Commission’s rule
against their existing activities to
comply with FINRA Rule 3110 and the
CFTC’s supervision rule for Swap
Entities.
First, in response to a specific
suggestion made by a commenter,588 the
585 See SIFMA (September 2015), supra note 5;
FIA/ISDA/SIFMA, supra note 5.
586 As noted above, although the Commission
modeled proposed Rule 15Fh–3(h) in part on NASD
Rules 3010 (Supervision) and 3012 (Supervisory
Control System), the Commission subsequently
approved new consolidated FINRA Rules 3110
(Supervision) and 3120 (Supervisory Control
System), which are largely based on and replace
NASD Rules 3010 and 3012, and corresponding
provisions of the NYSE Rules and Interpretations.
Among other changes to the rules, the new FINRA
rules contain new or modified requirements with
respect to: (i) Which personnel can supervise other
personnel; (ii) which personnel are permitted to
perform office inspections; (iii) review of certain
internal communications; and (iv) obligations to
monitor for insider trading, conduct internal
investigations and provide reports to FINRA
regarding such investigations. The new FINRA rule
also codified guidance regarding the permissible
use of risk-based systems for review of transactions
and correspondence. See Order Approving
Proposed Rule Change as Modified by Amendment
No. 1, Exchange Act Release No. 71179 (Dec. 23,
2013), 78 FR 79542 (Dec. 30, 2013).
587 See SIFMA (September 2015), supra note 5.
588 See SIFMA (September 2015), supra note 5.

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Commission is making several wording
changes to the description of the general
requirement to establish a supervisory
system in Rule 15Fh–3(h)(1). The
Commission is deleting the words ‘‘and
enforce’’ from the description and
adding the modifying language ‘‘the
activities of’’ before associated persons
so that it requires an SBS Entity to
‘‘establish and maintain a system to
supervise, and [to] diligently supervise,
its business and the activities of its
associated persons.’’ 589 Rule 15Fh–
3(h)(2)(iii) (discussed below) includes
an express requirement to enforce
supervisory policies and procedures,
making the additional language
regarding enforcing the system to
supervise unnecessary. Accordingly, the
Commission believes that the rule, as
adopted with these wording changes,
will continue to establish requirements
to help ensure that SBS Entities have
effective supervisory systems, consistent
with the proposed rule. At the same
time, the changes will make the wording
of the rule more consistent with the
corresponding FINRA and CFTC
requirements, as requested by a
commenter. This consistency will result
in efficiencies for SBS Entities that have
already established supervisory systems
to comply with the FINRA and/or CFTC
standards, as discussed above.
Second, the Commission is making
further wording changes to the
descriptions of the required supervisory
system in Rule 15Fh–3(h)(1) and (2) in
response to concerns raised by a
commenter regarding the redundancy of
the descriptions.590 Proposed Rule
15Fh–3(h)(1) would require SBS Entities
to ‘‘establish . . . a system to
supervise . . . with a view to
preventing violations of the provisions
of applicable federal securities laws and
the rules and regulations thereunder
relating to its business [as an SBS
Entity],’’ and proposed Rule 15Fh–
3(h)(2) would specify that the required
system be ‘‘reasonably designed to
achieve compliance with applicable
securities laws and the rules and
regulations thereunder.’’ The
Commission does not believe that the
two descriptions (‘‘prevent violations’’
and ‘‘achieve compliance’’) are
substantively different, nor did we
intend to give the appearance of creating
589 Cf. FINRA Rule 3110(a) (‘‘Each member shall
establish and maintain a system to supervise the
activities of each associated person. . .’’);
Commodity Exchange Act Rule 23.602(a) (‘‘Each
[Swap Entity] shall establish and maintain a system
to supervise, and shall diligently supervise, all
activities relating to its business performed by its
partners, members, officers, employees, and agents
(or persons occupying a similar status or performing
a similar function) . . .’’).
590 See SIFMA (September 2015), supra note 5.

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two different standards for what is
essentially the same requirement.
Accordingly, the Commission is
changing and consolidating the
description of the supervisory system in
Rule 15Fh–3(h)(1) to state that an SBS
Entity’s supervisory system ‘‘shall be
reasonably designed to prevent
violations of applicable federal
securities laws and the rules and
regulations thereunder relating to its
business [as an SBS Entity],’’ and
eliminating the redundant description
in Rule 15Fh–3(h)(2).591 Additionally,
the Commission is making parallel
changes to Rules 15Fh–3(h)(2)(iii) and
15Fh–3(h)(2)(iii)(C). Specifically, the
Commission is changing the
requirement in Rule 15Fh–3(h)(2)(iii)
that the supervisory system provide for
the establishment, maintenance and
enforcement of certain written policies
and procedures from policies and
procedures that are ‘‘reasonably
designed to achieve compliance with’’
to policies and procedures that are
‘‘reasonably designed to prevent
violations of applicable federal
securities laws and the rules and
regulations thereunder.’’ The
Commission is also changing the
requirement in Rule 15Fh–3(h)(2)(iii)(C)
that an SBS Entity’s supervisory policies
and procedures include procedures for
a periodic review of the SBS Entity’s
security-based swap business by
eliminating the redundant requirement
that the review be reasonably designed
to assist in ‘‘achieving compliance
with’’ applicable federal securities laws
and regulations and conforming the
remaining language. Accordingly, as
adopted, Rule 15Fh–3(h)(2)(iii)(C)
requires an SBS Entity’s written
supervisory policies and procedures to
include ‘‘[p]rocedures for a periodic
review, at least annually, of the securitybased swap business in which the [SBS
Entity] engages that is reasonably
designed to assist in detecting and
preventing violations of applicable
591 This formulation tracks the requirement in
Exchange Act Rule 15Fb2–1(b) that a senior officer
of the SBS Entity certify on Form SBSE–C that
‘‘[a]fter due inquiry, he or she has reasonably
determined that the [SBS Entity] has developed and
implemented written policies and procedures
reasonably designed to prevent violation of federal
securities laws and the rules thereunder.’’ Cf.
FINRA Rule 3110(a) (‘‘Each member shall establish
and maintain a system to supervise the activities of
each associated person that is reasonably designed
to achieve compliance with applicable securities
laws and regulations, and with applicable FINRA
rules.’’); Commodity Exchange Act Rule 23.602(a)
(‘‘Each [Swap Entity] shall establish and maintain
a system to supervise . . . Such system shall be
reasonably designed to achieve compliance with the
requirements of the Commodity Exchange Act and
[CFTC] regulations.’’).

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federal securities laws and the rules and
regulations thereunder.’’
Third, in response to concerns raised
by a commenter,592 the Commission is
changing the wording of the minimum
requirements for a supervisory system
listed in Rule 15Fh–3(h)(2) to more
closely align the requirements of our
rule with those of FINRA Rule 3110,
and to reflect the fact that security-based
swaps are not necessarily traded in an
‘‘account’’ but rather pursuant to a
bilateral trading relationship.
Specifically, the Commission is: (1)
Changing the description of the
requirement that supervisors be
qualified in Rule 15Fh–3(h)(2)(ii) from
‘‘qualified and meet standards of
training, experience, and competence
necessary to effectively supervise the
security-based swap activities of the
persons associated with the [SBS
Entity]’’ to ‘‘qualified, either by virtue of
experience or training, to carry out their
assigned responsibilities;’’ 593 (2) adding
‘‘and the activities of its associated
persons’’ to the policies and procedures
requirement in Rule 15Fh–3(h)(2)(iii) so
that it requires ‘‘written policies and
procedures addressing the supervision
of the types of security-based swap
business in which the [SBS Entity] is
engaged and the activities of its
associated persons;’’ 594 (3) adding
‘‘good’’ to the description of the
requirement to have procedures for
background investigations on associated
persons in Rule 15Fh–3(h)(2)(iii)(D) so
that it requires ‘‘procedures to conduct
a reasonable investigation regarding the
good character’’ of an associated
person; 595 (4) adding ‘‘or a trading
relationship’’ to the description of the
requirement to have procedures for
considering whether to allow an
associated person to conduct trading for
his or her own benefit at another
financial institution in Rule 15Fh–
3(h)(2)(iii)(E) so that it requires
‘‘procedures to consider whether to
permit an associated person to establish
or maintain a securities or commodities
account or a trading relationship;’’ and
(5) changing the description of the
592 See

SIFMA (September 2015), supra note 5.
FINRA Rule 3110(a)(6) (‘‘A member’s
supervisory system shall provide . . . for . . .
[t]he use of reasonable efforts to determine that all
supervisory personnel are qualified, either by virtue
of experience or training, to carry out their assigned
responsibilities.’’).
594 Cf. FINRA Rule 3110(b)(1) (‘‘Each member
shall establish, maintain, and enforce written
procedures to supervise the types of business in
which it engages and the activities of its associated
persons . . .’’).
595 Cf. FINRA Rule 3110(e) (‘‘Each member shall
ascertain by investigation the good
character . . . of an applicant before the member
applies to register that applicant with FINRA
. . .’’).
593 Cf.

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requirement to have conflicts of interest
procedures in Rule 15Fh–3(h)(2)(iii)(H)
from ‘‘procedures preventing the
standards of supervision from being
reduced due to any conflicts of interest
of a supervisor with respect to the
associated person being supervised’’ to
‘‘procedures reasonably designed to
prevent the supervisory system required
by paragraph (h)(1) from being
compromised due to the conflicts of
interest that may be present with respect
to the associated person being
supervised, including the position of
such person, the revenue such person
generates for the [SBS Entity], or any
compensation that the associated person
conducting the supervision may derive
from the associated person being
supervised.’’ 596 The Commission
believes that the rule, as adopted with
these changes, will continue to provide
protections intended to help ensure that
SBS Entities have effective supervisory
systems, consistent with the proposed
rule. At the same time, the changes will
make the wording of the rule more
consistent with the parallel FINRA
requirement, resulting in efficiencies for
SBS Entities that have already
established supervisory systems to
comply with the FINRA standard, as
discussed above.
In addition to the wording changes
described above, the Commission is
making two other sets of changes to the
minimum requirements for a
supervisory system listed in Rule 15Fh–
3(h)(2). First, the Commission is
eliminating the specific requirement in
proposed Rule 15Fh–3(h)(2)(iii)(E) that
the supervision of trading in an
associated person’s securities or
commodities account at another
financial institution ‘‘includ[e] the
receipt of duplicate confirmations and
statements related to such accounts.’’
This change is intended to more closely
align our requirement with the
analogous FINRA rule, which was
amended after our proposal.597 The
596 Cf. FINRA Rule 3110(b)(6)(D) (‘‘The
supervisory procedures . . . shall
include . . . procedures reasonably designed to
prevent the supervisory system required pursuant
to paragraph (a) of this Rule from being
compromised due to the conflicts of interest that
may be present with respect to the associated
person being supervised, including the position of
such person, the revenue such person generates for
the firm, or any compensation that the associated
person conducting the supervision may derive from
the associated person being supervised, including
the position of such person, the revenue such
person generates for the firm, or any compensation
that the associated person conducting the
supervision may derive from the associated person
being supervised.’’).
597 See Order Approving Proposed Rule Change to
Adopt FINRA Rule 3210 (Accounts at Other BrokerDealers and Financial Institutions), as Modified by

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amended FINRA rule replaced the
requirement to receive duplicate
confirmation and statements with a
more flexible standard by which firms
can determine the data source(s) that are
the most effective means to review
trading activity. Likewise, this change is
also intended to provide SBS Entities
reasonable flexibility to craft
appropriate supervisory policies and
procedures relevant to their business
model and to ascertain the means to
obtain the necessary data for effective
supervision. The Commission notes that
the rule, in permitting flexibility, does
not limit the SBS Entity’s discretion to
request from the associated person such
transaction and account information as
the SBS Entity deems necessary to fulfill
its supervisory obligations (including
confirmations and statements related to
the account or trading relationship), and
SBS Entities may consider the
availability of such information and
whether activity in the account can be
properly monitored when determining
whether to provide consent to an
associated person to open or maintain
an account or trading relationship at
another financial institution.
Second, in response to concerns
raised by a commenter,598 the
Commission is modifying Rule 15Fh–
3(h)(2)(iii)(G) to address circumstances
where an SBS Entity is unable to
comply with the supervisory
requirements due to the SBS Entity’s
size or supervisor’s position within the
SBS Entity. Pursuant to final Rule
15Fh–3(h)(2)(iii)(G), an SBS Entity that
cannot comply with the requirement in
Rule 15Fh–3(h)(2)(iii)(G) (preventing a
supervisor from supervising his or her
own activities or reporting to a person
he or she is supervising) will be
required to document its determination
that compliance is not possible because
of the firm’s size or a supervisory
person’s position within the firm,
document how the supervisory
arrangement otherwise complies with
Rule 15Fh–3(h)(1), and include a
summary of such determination in the
annual compliance report prepared by
the SBS Entity’s CCO pursuant to Rule
15Fk–1(c). This change is designed to
address concerns raised by a commenter
that due to the size or structure of some
SBS Entities, it may not always be
Partial Amendment No. 1 and Partial Amendment
No. 2, in the Consolidated FINRA Rulebook,
Exchange Act Release No. 77550 (Apr. 7, 2016), 81
FR 21924 (Apr. 13, 2016) (‘‘Proposed FINRA Rule
3210(c) would require an executing member, upon
written request by the employer member, to
transmit duplicate copies of confirmations and
statements, or the transactional data contained
therein, with respect to an account subject to the
rule.’’).
598 See SIFMA (September 2015), supra note 5.

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30005

possible to prohibit an associated
person who performs a supervisory
function at an SBS Entity from
supervising his or her own activities or
reporting to a person whom he or she
is supervising.599 The Commission
believes adding the provision described
above will make the supervisory
requirements more operationally
workable by providing flexibility, in
particular for supervision of very senior
SBS Entity personnel, while still
maintaining appropriate investor
protection through the requirement to
document how the supervisory
arrangement otherwise complies with
Rule 15Fh–3(h)(1). The Commission
notes that SBS Entities relying on this
provision will also be subject to the
other requirements of Rule 15Fh–3(h),
including the requirement in Rule
15Fh–3(h)(2)(iii)(H) to have procedures
reasonably designed to prevent the
supervisory system from being
compromised due to the conflicts of
interest that may be present with respect
to the associated person being
supervised, including the position of
such person, the revenue such person
generates for the SBS Entity, or any
compensation that the associated person
conducting the supervision may derive
from the associated person being
supervised.
The Commission notes that the
minimum requirements for a
supervisory system listed in Rule 15Fh–
3(h)(2) are not an exhaustive list. SBS
Entities should keep in mind their
overarching obligation in Rule 15Fh–
3(h)(1) to establish and maintain a
supervisory system that is reasonably
designed to prevent violations of
applicable federal securities laws and
the rules and regulations thereunder
relating to the SBS Entity’s business as
an SBS Entity. For instance, although
Rule 15Fh–3(h)(2)(iii)(B) only requires
procedures ‘‘for the review by a
supervisor of incoming and outgoing
written (including electronic)
correspondence with counterparties or
potential counterparties and internal
written communications relating to the
[SBS Entity’s] business involving
security-based swaps,’’ if an SBS Entity
records oral communications with
counterparties or potential
counterparties, the SBS Entity generally
should consider providing for the
supervisory review of such
communications.600 Similarly, if an SBS
599 See

SIFMA (September 2015), supra note 5.
15F(g)(1) of the Exchange Act provides
that each SBS Entity shall maintain daily trading
records of the security-based swaps of the SBS
Entity and all related records (including related
cash or forward transactions) and recorded
600 Section

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Entity chooses to provide certain
disclosures required by Rule 15Fh–3(b)
orally, the SBS Entity should consider
how it will supervise these oral
communications.
In response to a specific suggestion
made by a commenter,601 the
Commission is modifying the
maintenance of written supervisory
procedures requirement in Rule 15Fh–
3(h)(4) to harmonize with FINRA Rule
3110. Specifically, we are changing the
requirement to promptly communicate
material amendments to an SBS Entity’s
supervisory procedures from
‘‘throughout the relevant parts of its
organization’’ to ‘‘to all associated
persons to whom such amendments are
relevant based on their activities and
responsibilities.’’ 602 We believe that the
new formulation will be more effective
at achieving its intended result by
targeting the communications to the
associated persons to whom such
amendments are relevant. The
Commission believes that under the
proposed formulation, potential
interpretations of the phrase ‘‘relevant
parts of its organization’’ may have
resulted in communications to a broader
than necessary group. The Commission
declines to adopt the commenter’s
suggestion to eliminate the proposed
requirement in Rule 15Fh–3(h)(4)(i) for
an SBS Entity to update its written
supervisory procedures when material
changes occur to its ‘‘business,’’ in
addition to its supervisory system.603
Rule 15Fh–3(h)(1) requires an SBS
Entity to diligently supervise its
business. Implicit in that obligation is a
requirement that the SBS Entity update
communications, including electronic mail, instant
messages, and recordings of telephone calls, for
such period as may be required by the Commission
by rule or regulation. See 15 U.S.C. 78o–10(g)(1). To
implement Section 15F(g)(1) of the Exchange Act,
the Commission has proposed to amend the
preservation requirement in paragraph (b)(4) of
Exchange Act Rule 17a–4 to include ‘‘recordings of
telephone calls required to be maintained pursuant
to [Section 15F(g)(1) of the Exchange Act].’’ Under
this proposed requirement, a broker-dealer SBS
Entity would be required to preserve for three years
telephone calls that it chooses to record to the
extent the calls are required to be maintained
pursuant to Section 15F(g)(1) of the Exchange Act.
The Commission has also proposed a parallel
requirement for stand-alone SBS Entities. See
Recordkeeping Release, 79 FR at 25213–25214,
supra note 242.
601 See SIFMA (September 2015), supra note 5.
602 Cf. FINRA Rule 3110(b)(7) (‘‘Each member
shall promptly amend its written supervisory
procedures to reflect changes in applicable
securities laws or regulations, including FINRA
rules, and as changes occur in its supervisory
system. Each member is responsible for promptly
communicating its written supervisory procedures
and amendments to all associated persons to whom
such written supervisory procedures and
amendments are relevant based on their activities
and responsibilities.’’).
603 See SIFMA (September 2015), supra note 5.

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its supervisory system as necessary to
accommodate changes to its business.
The Commission does not want to create
confusion regarding this obligation by
eliminating the explicit requirement in
Rule 15Fh–3(h)(4)(i) for an SBS Entity to
update its supervisory procedures when
material changes occur to its business.
In addition to the modifications
discussed above, the Commission is
making several clarifying changes to the
rule. First, the Commission is correcting
a typographical error in Rule 15Fh–
3(h)(2). The cross-reference in the
proposed rule should have been to
‘‘paragraph (h)(1),’’ not to ‘‘paragraph
(g)(1).’’ The Commission is correcting
this cross-reference in the final rule.
Second, the Commission also is
making two other changes to the rule to
clarify that Rule 15Fh–3(h) does not
require multiple sets of written
supervisory policies and procedures.
Specifically, the Commission is: (1) Redesignating proposed Rule 15Fh–
3(h)(2)(iv) as Rule 15Fh–3(h)(2)(iii)(I);
and (2) clarifying that the written
policies and procedures referred to in
Rule 15Fh–3(h)(3) are those required by
Rule 15Fh–3(h)(2)(iii) by adding the
modifying language ‘‘as required in
§ 240.15Fh–3(h)(2)(iii)’’ after ‘‘written
policies and procedures’’ in Rule 15Fh–
3(h)(3)(i), and by changing the
references in Rule 15Fh–3(h)(3)(ii) from
‘‘the written policies and procedures’’ to
‘‘such written policies and procedures.’’
Rule 15Fh–3(h) establishes
supervisory obligations that incorporate
principles from both Exchange Act
Section 15(b) and existing SRO rules.
The concept of diligent supervision in
these rules is consistent with business
conduct standards for broker-dealers
that have historically been established
by SROs for their members, subject to
Commission approval. As with diligent
supervision by a broker-dealer, the
Commission believes that it generally
would be appropriate for an SBS Entity
to use a risk-based review system to
satisfy its supervisory obligations under
Rule 15Fh–3(h) instead of conducting
detailed reviews of every transaction or
every communication, so long as the
SBS Entity uses a risk-based review
system that is reasonably designed to
provide the entity with sufficient
information to allow it to focus on the
areas that pose the greatest risks of
federal securities law violations.604 Use
of a risk-based system allows SBS
Entities the flexibility to establish their
supervisory systems in a manner that
604 This guidance is intended to respond to a
request from a commenter to provide guidance
regarding risk-based reviews that is consistent with
Supplementary Material .05 and .06 to FINRA Rule
3110. See SIFMA (September 2015), supra note 5.

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reflects their business models, and
based on those models, focus on areas
where heightened concern may be
warranted.
Rule 15Fh–3(h)(2)(iii)(I), as adopted,
requires an SBS Entity to adopt written
policies and procedures reasonably
designed, taking into consideration the
nature of such SBS Entity’s business, to
comply with the duties set forth in
Section 15F(j) of the Exchange Act.
Section 15F(j) of the Exchange Act
requires an SBS Entity to comply with
obligations concerning: (1) Monitoring
of trading to prevent violations of
applicable position limits; (2)
establishing sound and professional risk
management systems; (3) disclosing to
regulators information concerning its
trading in security-based swaps; (4)
establishing and enforcing internal
systems and procedures to obtain any
necessary information to perform any of
the functions described in Section 15F
of the Exchange Act, and providing the
information to regulators, on request; (5)
implementing conflict-of-interest
systems and procedures; and (6)
addressing antitrust considerations such
that the SBS Entity does not adopt any
process or take any action that results in
any unreasonable restraint of trade or
impose any material anticompetitive
burden on trading or clearing.605 While
the requirements of Section 15F(j) are
self-executing, we highlight in
particular the duty of an SBS Entity
under Section 15F(j)(2) to ‘‘establish
robust and professional risk
management systems adequate for
managing the day-to-day business’’ of
the SBS Entity. Any risk management
system established by an SBS Entity
should be effective to manage the risks
of the SBS Entity within the risk
tolerance limits to be determined for
each type of risk. We have separately
proposed a rule regarding the
requirement for an SBS Entity for which
there is not a prudential regulator to
establish, document, and maintain
controls to assist it in managing the
risks associated with its business
activities, including market, credit,
leverage, liquidity, legal, and
operational risks.606
605 15

U.S.C. 78o–10(j).
Commission has separately proposed to
require every SBS Entity for which there is not a
prudential regulator (‘‘Non-bank SBS Dealers’’) to
comply, with certain exceptions, with the
requirements of Rule 15c3–4 under the Exchange
Act ‘‘as if it were an OTC derivatives dealer with
respect to all of its business activities.’’ See
Exchange Act Rule 18a–1(g). See also Capital,
Margin, and Segregation Requirements for SecurityBased Swap Dealers and Major Security-Based
Swap Participants and Capital Requirements for
Broker-Dealers, Capital, Margin, and Segregation
Requirements for Security-Based Swap Dealers and
606 The

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We are not adopting a commenter’s 607
suggestion that when an SBS Entity is
already subject to, and complies with,
comparable requirements of another
‘‘qualifying regulator’’ (such as risk
management standards imposed by a
prudential regulator), the SBS Entity’s
supervisory policies and procedures
will be deemed to be reasonably
designed for purposes of Rule 15Fh–
3(h). Exchange Act Section 15F(h)(1)(B)
directs the Commission to adopt rules
relating to the diligent supervision of
SBS Entities’ business. Although we
have closely conformed our supervision
rule to parallel SRO requirements and
believe it is also consistent with parallel
CFTC requirements, we do not believe
it is appropriate to defer to other
regulators’ rules, other than as discussed
below in Section III. In addition, we are
not excluding Major SBS Participants
from the scope of the rule, as one
commenter suggested.608 We note that
Exchange Act Section 15Fh(1)(B)
explicitly contemplates that Major SBS
Participants, as well as SBS Dealers,
will have obligations to supervise
diligently their security-based swap
business. As discussed above in Section
II.C, where the Dodd-Frank Act imposes
a business conduct requirement on both
SBS Dealers and Major SBS
Participants, the rules will apply to both
entities.
Rule 15Fh–3(h)(3), as adopted,
provides that SBS Entities and
associated persons will not be liable for
failure to supervise another person if
either the other person is not subject to
the SBS Entity’s or associated person’s
supervision, or if the safe harbor
described in the rule is satisfied.609 The
Major Security-Based Swap Participants and Capital
Requirements for Broker-Dealers, Exchange Act
Release No. 68071 (Oct. 18, 2012), 77 FR 70214,
70250–70251 (Nov. 23, 2012), explaining that
application of Rule 15c3–4 would require a Nonbank SBS Entity to ‘‘establish, document, and
maintain a system of internal risk management
controls to assist in managing the risks associated
with its business activities, including market,
credit, leverage, liquidity, legal, and operational
risks.’’ Rule 15c3–4 identifies a number of elements
that must be part of the risk management system
including, among other things: A risk control unit
that reports directly to senior management and is
independent from business trading units; separation
of duties between persons responsible for entering
into a transaction and those responsible for
recording the transaction on the dealer’s books; and
periodic reviews (which may be performed by
internal audit staff) and annual reviews (which
must be conducted by independent certified public
accountants) of the dealer’s risk management
systems. Id.
607 See FIA/ISDA/SIFMA, supra note 5.
608 See MFA, supra note 5.
609 One commenter requested clarification that a
person committing a violation will not be viewed
as subject to the supervision of another person
unless such other person knew or should have
known that he or she had authority and

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safe harbor contains two conditions.
First, the SBS Entity must have
established policies and procedures,
and a system for applying those policies
and procedures, which would
reasonably be expected to prevent and
detect, to the extent practicable, any
violation of the federal securities laws
and the rules and regulations
thereunder relating to security-based
swaps. Second, the SBS Entity or
associated person must have reasonably
discharged the duties and obligations
incumbent on it by reason of such
procedures and system without a
reasonable basis to believe that such
procedures were not being followed.610
Both conditions must be met in order
for an SBS Entity to satisfy the safe
harbor. However, as noted in the
Proposing Release, the inability to rely
on the safe harbor would not necessarily
mean that an SBS Entity or associated
person failed to diligently supervise any
other person.611
responsibility to exercise control over the violator
that could have prevented the violation. See FIA/
ISDA/SIFMA, supra note 5. The Commission notes
that if the conditions of the safe harbor in Rule
15Fh–3(h)(3) are not met, liability for failure to
supervise would be a facts and circumstances
determination, which would take into account the
factors described by the commenter.
610 We are not adopting a commenter’s
recommendation that our rules expressly require
supervisory personnel to ‘‘report up’’ to upper
management of the board, and require an SBS
Entity to reevaluate its supervisory procedures if
they fail to detect or deter significant violations. See
CFA, supra note 5. We note that Rule 15Fh–3(h)
provides a baseline for an effective supervisory
system, but, as noted in the Proposing Release, a
particular system may need additional elements to
be effective. See Proposing Release, 76 FR at 42419,
supra note 3. For that reason, Rule 15Fh–3(h)(2)
states that it establishes only minimum
requirements. Id.
611 See Proposing Release, 76 FR at 42420, supra
note 3. With respect to broker-dealers, the
Commission’s policy regarding failure to supervise
is well established. See 15 U.S.C. 78o(b)(4)(E) and
15 U.S.C. 78o(b)(6)(A). As the Commission has
explained in other contexts:
The Commission has long emphasized that the
responsibility of broker-dealers to supervise their
employees is a critical component of the federal
regulatory scheme . . . In large organizations it is
especially imperative that those in authority
exercise particular vigilance when indications of
irregularity reach their attention. The supervisory
obligations imposed by the federal securities laws
require a vigorous response even to indications of
wrongdoing. Many of the Commission’s cases
involving a failure to supervise arise from situations
where supervisors were aware only of ‘‘red flags’’
or ‘‘suggestions’’ of irregularity, rather than
situations where, as here, supervisors were
explicitly informed of an illegal act. Even where the
knowledge of supervisors is limited to ‘‘red flags’’
or ‘‘suggestions’’ of irregularity, they cannot
discharge their supervisory obligations simply by
relying on the unverified representations of
employees. Instead, as the Commission has
repeatedly emphasized, ‘‘[t]here must be adequate
follow-up and review when a firm’s own
procedures detect irregularities or unusual trading
activity. . . .’’ Moreover, if more than one
supervisor is involved in considering the actions to

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30007

H. Rules Applicable to Dealings With
Special Entities
Sections 15F(h)(4) and (5) of the
Exchange Act provide certain additional
protections for ‘‘special entities’’—such
as municipalities, federal and state
agencies, pension plans, and
endowments 612—in connection with
security-based swaps.613
Special entities, like other market
participants, may use swaps and
security-based swaps for a variety of
purposes, including risk management
and portfolio adjustment. In adopting
the special entity provisions of the
Exchange Act, the Commission seeks to
implement the statute, while not
impeding special entities’ access to
security-based swaps.
1. Scope of Definition of ‘‘Special
Entity’’
a. Proposed Rule
Exchange Act Section 15F(h)(2)(C)
defines a ‘‘special entity’’ as: (i) A
Federal agency; (ii) a State, State agency,
city, county, municipality, or other
political subdivision of a State; (iii) any
employee benefit plan, as defined in
Section 3 of ERISA; (iv) any
governmental plan, as defined in
Section 3 of ERISA; or (v) any
endowment, including an endowment
that is an organization described in
Section 501(c)(3) of the Internal
Revenue Code of 1986.614 Proposed
Rule 15Fh–2(e) defines a ‘‘special
entity’’ as: (i) A Federal agency; (ii) a
State, State agency, city, county,
municipality, or other political
be taken in response to possible misconduct, there
must be a clear definition of the efforts to be taken
and a clear assignment of those responsibilities to
specific individuals within the firm.
John H. Gutfreund, Exchange Act Release No.
31554 (Dec. 3, 1992) (report pursuant to Section
21(a) of the Exchange Act) (footnotes omitted). See
Proposing Release, 76 FR at 42419 n.158, supra note
3.
612 See Section II.D.2.a, infra.
613 15 U.S.C. 78o–10(h)(4)–(5).
614 Section 501(c)(3) of the Internal Revenue Code
of 1986 includes, in its list of ‘‘exempt
organizations’’:
Corporations, and any community chest, fund, or
foundation, organized and operated exclusively for
religious, charitable, scientific, testing for public
safety, literary, or educational purposes, or to foster
national or international amateur sports
competition (but only if no part of its activities
involve the provision of athletic facilities or
equipment), or for the prevention of cruelty to
children or animals, no part of the net earnings of
which inures to the benefit of any private
shareholder or individual, no substantial part of the
activities of which is carrying on propaganda, or
otherwise attempting, to influence legislation
(except as otherwise provided in subsection (h)),
and which does not participate in, or intervene in
(including the publishing or distributing of
statements), any political campaign on behalf of (or
in opposition to) any candidate for public office.
26 U.S.C. 501(c)(3).

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subdivision of a State; (iii) any
employee benefit plan, as defined in
Section 3 of ERISA; (iv) any
governmental plan, as defined in
Section 3(32) of ERISA; or (v) any
endowment, including an endowment
that is an organization described in
Section 501(c)(3) of the Internal
Revenue Code of 1986.
The Proposing Release noted that
commenters had raised questions about
the scope of the ‘‘special entity’’
definition. The Commission requested
comment regarding: (1) Whether to
interpret the phrase ‘‘employee benefit
plan, as defined in Section 3’’ of ERISA
to mean a plan that is subject to
regulation under ERISA; (2) whether the
phrase ‘‘governmental plan’’ should
include government investment pools or
other plans, programs or pools of assets;
(3) the definition of the term
‘‘endowment;’’ (4) the treatment of
collective investment vehicles in which
one or more special entities are
invested; (5) the treatment of foreign
entities; and (6) the treatment of master
trusts holding the assets of one or more
funded plans of a single employer and
its affiliates.
b. Comments on the Proposed Rule
One commenter argued that the term
‘‘special entity’’ was adequately defined
in the Exchange Act, and that it ‘‘should
not require extensive clarification.’’ 615
However, most commenters requested
that the Commission exclude or include
specific groups from the ‘‘special entity’’
designation. These comments are
addressed below.

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i. Federal Agency
We received no comments regarding
the inclusion of federal agencies within
the special entity definition. In the
Proposing Release, we noted that the
definition of ‘‘security-based swap’’
excludes an ‘‘agreement, contract or
transaction a counterparty of which is a
Federal Reserve bank, the Federal
Government, or a Federal agency that is
expressly backed by the full faith and
credit of the United States.’’ 616
ii. State and Municipal Entities
One commenter suggested that we
modify the description of state and
municipal entities to include ‘‘any
instrumentality, department, or a
corporation of or established by a State
or political subdivision of a State.’’ 617
According to the commenter, this
modification would harmonize the
615 See CFA, supra note 5. See also Exchange Act
Section 15F(h)(2)(C).
616 Proposing Release, 76 FR 42421, n. 176, supra
note 3 (citing Section 3(a)(68) of the Exchange Act).
617 See SIFMA (August 2015), supra note 5.

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SEC’s definition of ‘‘special entity’’ with
that of the CFTC.618
iii. Employee Benefit Plans and
Governmental Plans
As stated above, Exchange Act
Section 15F(h)(2)(C)(iii) defines ‘‘special
entity’’ to include ‘‘any employee
benefit plan, as defined in Section 3 of
[ERISA].’’ 619 Section 15F(h)(2)(C)(iv)
separately adds ‘‘any governmental
plan, as defined in Section 3 [ERISA]’’
to the special entity definition. Section
3 of ERISA defines the term ‘‘employee
benefit plan’’ to include plans, such as
most private sector employee benefit
plans, that are subject to regulation
under Title I of ERISA.620 However,
Section 3 of ERISA also defines the
following additional categories of
employee benefit plans that are not
subject to’’ ERISA regulation: (1)
Governmental plans; (2) church plans;
(3) plans maintained solely for the
purpose of complying with applicable
workmen’s compensation laws or
unemployment compensation or
disability insurance laws; (4) plans
maintained outside the U.S. primarily
for the benefit of persons substantially
all of whom are nonresident aliens; or
(5) unfunded excess benefit plans. 621
These latter categories of employee
benefit plans, including governmental
plans, are therefore ‘‘defined in’’ ERISA,
but not ‘‘subject to’’ regulation under
ERISA.
Commenters asked the Commission at
the proposing stage to limit the scope of
Section 15F(h)(2)(C)(iii) to employee
benefit plans that are subject to
regulation under ERISA, and not to
extend the definition of ‘‘special entity’’
to plans that are merely ‘‘defined in’’
ERISA, ‘‘unless they are covered by
another applicable prong of the ‘‘special
entity’’ definition (e.g., governmental
plans).’’ 622 As the commenters noted,
Exchange Act Section 15F(h)(2)(C)(iv)
separately defines ‘‘special entity’’ to
include any governmental plan, as
defined in Section 3 of ERISA. Mindful
of the redundancy that would result if
the statute were interpreted to include
governmental plans twice in the
definition of ‘‘special entity,’’ the
Commission therefore requested
comment regarding whether to interpret
the phrase ‘‘employee benefit plan, as
defined in Section 3 of [ERISA]’’ in
Exchange Act Section 15F(h)(2)(C)(iii),
618 Id.
619 15

U.S.C. 78o–10(h)(2)(C)(iii).
generally 29 U.S.C. 1002(1)–(2).
621 See 29 U.S.C. 1003(b).
622 SIFMA/ISDA 2010 Letter at 2, supra note 34.
620 See

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or to mean a plan that is ‘‘subject to’’
regulation under ERISA.623
Seven comment letters addressed this
issue. One commenter argued that the
expansive language of the statute
suggested that any employee benefit
plan ‘‘defined in’’ ERISA, including a
church plan, should be treated as a
special entity, and that, as a matter of
policy, church plans should not be
treated differently than ERISA or
governmental plans when entering into
security-based swaps with SBS
Entities.624 This commenter
recommended that the Commission
revise the proposed special entity
definition to clarify that church plans
are special entities, or that the
Commission permit church plans to
‘‘opt in’’ to special entity status, since
opting in would provide potential
counterparties greater certainty
regarding whether a church plan was, in
fact, a special entity.625 Another
commenter recommended that the
Commission cover plans ‘‘defined in’’
ERISA.626
A collective group of three
commenters argued that the definition
of special entity should include only
employee benefit plans that are ‘‘subject
to’’ ERISA.627 This group asserted that,
‘‘[s]ince Congress included a separate
‘governmental plans’ prong in the
definition of special entity, the
‘employee benefit plan’ prong
necessarily excludes governmental
plans (both domestic and foreign) and
should be read narrowly to include only
employee benefit plans ‘‘subject to’’
ERISA.’’ 628 However, one of these
commenters later independently
submitted a comment after the CFTC
adopted business conduct rules, and
expressed its support for an ‘‘opt in’’
approach.629 This commenter asserted
that the special entity definition should
be limited to employee benefit plans
that are ‘‘subject to’’ ERISA, although
other employee benefit plans defined in
ERISA, such as church plans, should be
allowed to opt in to special entity status.
According to this commenter, these
modifications would harmonize the SEC
and CFTC special entity definitions.
One commenter suggested treating
plans subject to ERISA and government
plans subject to ERISA similarly, so long
as both are acting as end-users and are
623 Proposing Release, 76 FR at 42422 n.182,
supra note 3.
624 See Church Alliance (August 2011), supra
note 5. See also Church Alliance (October 2011),
supra note 5.
625 Id.
626 See CalPERS (August 2011), supra note 5.
627 See FIA/ISDA/SIFMA, supra note 5.
628 Id.
629 See SIFMA (August 2015), supra note 5.

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otherwise complying with their
fiduciary obligations.630 Another
commenter suggested including
governmental plans as special entities,
arguing that ‘‘the taxpayers and
government workers who stand behind
government pensions are precisely the
sort of constituents Congress sought to
protect through the heightened
protections of special entities.’’ 631
More broadly, one commenter
recommended that the business conduct
standards should only apply to certain
governmental special entities, and that
they should not apply to ERISA plans—
since these plans already have similar or
greater protections under ERISA.632 The
commenter argued that, by applying
these standards to all special entities,
the SEC ‘‘has extended its regulatory
reach significantly beyond the scope of
the statute,’’ resulting in ‘‘redundant’’ or
‘‘overlapping’’ regulations.633 The
commenter recommended that the
proposed rules be modified to exclude
ERISA plans with security-based swap
advisors that are ‘‘already sufficiently
regulated.’’ 634
iv. Master Trusts
The Commission additionally
requested comment regarding whether
to include a master trust that holds the
assets of one or more funded plans of a
single employer and its affiliates within
the special entity definition. Three
commenters supported the treatment of
master trusts as special entities.635
One comment letter suggested that the
term ‘‘special entity’’ should be
modified to include master trusts
holding the assets of one or more
funded plans of a single employer.636
Another comment letter urged the
Commission to clarify that master trusts
would be treated as special entities,
noting that, by making this clarification,
the SEC would harmonize the
interpretation of its rules with that of
the CFTC.637
One commenter urged the
Commission to include church benefit
boards that hold the assets of multiple
church plans, church endowments, and
other church-related funds on a
commingled basis within the special
entity definition, arguing that the
functions of church benefit boards are
similar to those of tax-exempt trusts, or

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630 See

CalSTRS, supra note 5.
631 See CFA, supra note 5.
632 See ABC, supra note 5.
633 Id.
634 Id.
635 See FIA/ISDA/SIFMA, supra note 5; Church
Alliance (August 2011), supra note 5; SIFMA
(August 2015), supra note 5.
636 See FIA/ISDA/SIFMA, supra note 5.
637 See SIFMA (August 2015), supra note 5.

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master trusts established by several
multiple-employer pension plans, and
that such a definition would reflect the
close relationship—recognized in
ERISA—between church benefit boards
and their constituent church plans.638
v. Collective Investment Vehicles
The Commission requested comment
regarding whether to interpret ‘‘special
entity’’ to include a collective
investment vehicle in which one or
more special entities had invested. All
eight commenters that commented on
this question opposed the designation of
collective investment vehicles as special
entities, even where such collective
investment vehicles have special entity
investors.639
Commenters generally argued that
requiring SBS Entities to investigate or
‘‘look through’’ their collective
investment vehicle counterparties to
determine whether they held special
entity investments would create
uncertainty in the market, increase
compliance costs, disrupt the gains of
special entity investors, and restrict
special entities’ access to security-based
swaps—since collective investment
vehicle managers may either limit or
reject investments by special entities to
avoid limitations on their security-based
swap trading activities.640
One commenter asked the
Commission to clarify that it would not
‘‘look through’’ collective investment
vehicles to align its interpretation of the
special entity definition with that of the
CFTC.641
Two commenters argued to exclude
collective investment vehicles because
these vehicles are almost always passive
investors, and that including them
within the adopted rules would serve no
regulatory purpose, since Congress’
intent was to protect special entities as
defined within the statute.642
Lastly, two commenters urged the
Commission to exclude hedge funds,
even where a special entity invests in
that hedge fund.643
vi. Endowments
The Commission requested comment
regarding how to apply the special
entity definition to endowments, and
638 See

Church Alliance (August 2011), supra

note 5.
639 See ABC, supra note 5; SIFMA (August 2011),
supra note 5; ABA Committees, supra note 5; FIA/
ISDA/SIFMA, supra note 5; BlackRock, supra note
5; MFA, supra note 5; NACUBO, supra note 5;
SIFMA (August 2015), supra note 5.
640 Id.
641 See SIFMA (August 2015), supra note 5.
642 See ABA Committees, supra note 5; NACUBO,
supra note 5.
643 See FIA/ISDA/SIFMA, supra note 5;
BlackRock, supra note 5.

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30009

whether certain organizations that
qualify as endowments should be
included in that definition. The five
commenters addressing this issue
suggested that the Commission limit the
definition of endowments in the special
entity context, with various caveats.644
Three commenters suggested limiting
the definition of ‘‘endowments’’ to
endowments that, themselves, enter into
swaps.645 Two of these commenters
urged the Commission to clarify that the
term ‘‘endowments’’ would not include
non-profit organizations whose assets
might include funds designated as an
endowment,646 while another asked that
the Commission exclude organizations
that use endowment assets to pledge,
maintain, enhance or support the
organization’s collateral obligations.647
Another commenter similarly requested
that the Commission interpret the
definition of endowment to exclude
charitable organizations that enter into
security-based swaps for which their
counterparties have recourse to the
organizations’ endowment.648 The
commenter noted that, by making this
clarification, the SEC would bring its
interpretation of the rules into harmony
with that of the CFTC.649
The last commenter requested
clarification that private foundations
would not be included within the
special entity definition.650 The
commenter argued that these
foundations are, by statute, non-profit
organizations that are not publicly
supported, and that ‘‘no evidence’’
exists that Congress intended to treat
private foundations as ‘‘endowments’’
under Dodd-Frank.651
Similarly, this same commenter
suggested that ‘‘institutional investor
organizations’’ (such as large non-profits
and ‘‘sophisticated’’ endowments) with
over $1 billion of net assets under
management should be excluded from
the special entity definition, since large
‘‘sophisticated’’ endowments employ
professional money managers already
subject to oversight and review.652 The
commenter argued that a special entity
designation for these organizations
could reduce the number of SBS Entities
willing to trade in security-based swaps,
644 See FIA/ISDA/SIFMA, supra note 5; NABL,
supra note 5; NACUBO, supra note 5; ABA
Committees, supra note 5; SIFMA (August 2015),
supra note 5.
645 See FIA/ISDA/SIFMA, supra note 5; NABL,
supra note 5; NACUBO, supra note 5.
646 See FIA/ISDA/SIFMA, supra note 5; NABL,
supra note 5.
647 See NACUBO, supra note 5.
648 See SIFMA (August 2015), supra note 5.
649 Id.
650 See ABA Committees, supra note 5.
651 Id.
652 See ABA Committees, supra note 5.

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given the increased compliance costs
associated with evaluating the
qualifications of an independent
representative.

within the special entity definition, and
is therefore adopting Rule 15Fh–2(e)(1)
as proposed, renumbered as Rule 15Fh–
2(d)(1).

vii. Foreign Plans, Foreign Entities
The Commission requested comment
on whether to exclude from the
definition of ‘‘special entity’’ any
foreign entity. Six commenters
responded to this issue.653 All six
commenters asserted that foreign
entities should not be deemed special
entities, although one commenter
recommended that the U.S. reserve the
right to extend application of its
business conduct standards to foreign
entities if international regulatory efforts
fail.654
Four other commenters objected to
the inclusion of foreign pension and
employee benefit plans within the
special entity definition on the grounds
that the statutory language reflected a
lack of Congressional intent to provide
special protection for such plans under
Dodd-Frank, and that extending the
SEC’s authority outside the United
States would create the potential for
conflict with other nations’ regulatory
regimes.655 These commenters
requested that the Commission revise
the proposed definition of ‘‘special
entity’’ to specifically exclude foreign
entities.656

ii. State and Municipal Special Entities
After further consideration and in
light of the comment received, the
Commission is modifying proposed
Rule 15Fh–2(e)(2), adopted as Rule
15Fh–2(d)(2), to further define state and
municipal entities to include ‘‘any
instrumentality, department, or a
corporation of or established by a State
or political subdivision of a State.’’ 657
As the Commission explained in
another context, states may delegate
powers to their political subdivisions,
including the power to create corporate
instrumentalities.658 Similarly, the
Commission believes a department or a
corporation organized as a municipal
corporate instrumentality of a state’s
political subdivision should be
considered a municipal corporate
instrumentality of a state. Corporate
instrumentalities, departments, or
corporations created by states or their
political subdivisions are therefore
taxpayer-backed institutions.
Consequently, the Commission believes
it is important to include ‘‘any
instrumentality, department, or a
corporation of or established by a State
or political subdivision of a State’’
within the special entity definition to
provide heightened protections for
taxpayer-backed institutions that
transact in security-based swaps.
In addition, the inclusion of this
language will conform the special entity
definition to that of a ‘‘municipal
entity’’ in the Exchange Act, as well as
to the CFTC’s definition of State and
municipal special entities, thereby
providing all categories of municipal
entities with heightened protections,659
as well as addressing the commenter’s
concern regarding the need for a
consistent definition across the securitybased swaps and swaps markets.660 This

c. Response to Comments and Final
Rule
After consideration of all comments,
the Commission has determined to
modify the scope of the special entity
definition as described below.

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i. Federal Agency
As noted above, the Commission did
not receive any comments on the
inclusion of federal agencies within the
special entity definition. The
Commission continues to believe it is
appropriate to include federal agencies
653 See ABC, supra note 5; SIFMA (August 2011),
supra note 5; Johnson, supra note 5; BlackRock,
supra note 5; CFA, supra note 5; PensionsEurope,
supra note 7.
654 See Johnson, supra note 5. This same
commenter argued that Congress limited the
territorial scope of Title VII to activities within the
United States, and that extraterritorial application
of these laws should only apply when international
activities of U.S. firms have a ‘‘direct and
significant connection with or effect on U.S.
commerce,’’ or are designed to evade U.S. rules. Id.
For further discussion, see Cross Border
Application and Availability of Substituted
Compliance, Section III.
655 See ABC, supra note 5; BlackRock, supra note
5; SIFMA (August 2011), supra note 5.
656 One commenter urged the Commission to only
apply the business conduct standards to securitybased swap transactions involving U.S.
counterparties. See PensionsEurope, supra note 7,
discussed in Section III below.

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657 See SIFMA (August 2015), supra note 5; and
SIFMA (November 2015), supra note 5 (asking the
Commission to clarify that an instrumentality,
department, or a corporation of, or established by,
a State or political subdivision of a State is a special
entity). This is consistent as well with the ECP
definition for governmental entities, which includes
‘‘an instrumentality, agency, or department’’ of a
State or political subdivision of a State. See Section
3(a)(65) of the Exchange Act, referring to Section
1a(18)(A)(vii)(III) of the CEA.
658 See Municipal Advisor Registration Release,
78 FR at 67483, supra note 5.
659 See Exchange Act Section 15B(e)(8), 15 U.S.C.
78o–4(e)(8) (defining ‘‘municipal entity’’ to include
‘‘any agency, authority, or instrumentality of the
States, political subdivision, or municipal corporate
entity’’).
660 See SIFMA (August 2015), supra note 5; and
SIFMA (November 2015), supra note 5.

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consistency should result in efficiencies
for entities that transact in securitybased swaps, particularly where such
entities have already established a
compliance infrastructure that satisfies
the requirements of the existing CFTC
business conduct standards.
iii. Employee Benefit Plans and
Governmental Plans
Upon further consideration and in
light of the comments received, the
Commission is modifying proposed
Rule 15Fh–2(e)(3), which stated ‘‘any
employee benefit plan defined in
Section 3 of [ERISA]’’ to state in
adopted Rule 15Fh–2(d)(3) ‘‘any
employee benefit plan subject to Title I
of [ERISA].’’ Under this modification,
Rule 15Fh(2)(d)(3) only includes
employee benefit plans that are subject
to regulation under Title I of ERISA.
Furthermore, proposed Rule 15Fh–
2(e)(4), renumbered as Rule 15Fh–
2(d)(5), is being adopted as proposed, to
include ‘‘any governmental plan, as
defined in section 3(32) of [ERISA].’’
In reaching this determination, we
believe that Exchange Act Sections
15F(h)(2)(C)(iii) (employee benefit plans
defined in Section 3 of ERISA) and
15F(h)(2)(C)(iv) (governmental plans
defined in Section 3 of ERISA) should
be read together ‘‘to avoid rendering
superfluous’’ any statutory language of
the Exchange Act.661 As discussed
above in Section II.H.1.b.3, Exchange
Act Section 15F(h)(2)(C)(iii), read
literally as any employee benefit plan
‘‘defined in’’ Section 3 of ERISA, would
render Section 15F(h)(2)(C)(iv)
superfluous, since governmental plans
‘‘defined in’’ ERISA are specifically
designated as special entities under
Section 15F(h)(2)(C)(iv). The
Commission therefore agrees with the
commenter that Congress’ separate
inclusion of governmental plans within
the special entity definition supports a
narrower reading of Section
15F(h)(2)(C)(iii), such that the definition
only includes employee benefit plans
‘‘subject to’’ regulation under ERISA.662
We recognize that this interpretation
of ‘‘special entity’’ would exclude other
types of employee benefit plans
‘‘defined in’’ Section 4(b) of ERISA,
including church plans and workmen’s
compensation plans. Therefore, upon
further consideration, and in response
to commenters who support a broader
interpretation of the term ‘‘special
entity,’’ including those commenters
who assert that a church plan should be
treated as a special entity, the
661 Astoria Fed. Sav. & Loan Assn. v. Solimino,
501 U.S. 104, 112 (1991).
662 See FIA/ISDA/SIFMA, supra note 5.

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Commission has determined to include
an additional prong to the special entity
definition.663 Specifically, Rule 15Fh–
2(d)(4), as adopted, defines a special
entity to include ‘‘[a]ny employee
benefit plan defined in Section 3 of
[ERISA] and not otherwise defined as a
special entity, unless such employee
benefit plan elects not to be a special
entity by notifying a security-based
swap dealer or major security-based
swap participant of its election prior to
entering into a security-based swap with
the particular security-based swap
dealer or major security-based swap
participant.’’ The Commission believes
that the inclusion of this additional
provision appropriately resolves any
tension between Exchange Act Sections
15F(h)(2)(C)(iii) and (iv), while granting
broad coverage under the enhanced
business conduct protections for special
entities provided by the Dodd Frank
Act.
Under Rule 15Fh–2(d)(4), as adopted,
an employee benefit plan that is
‘‘defined in’’ Section 3 of ERISA but not
‘‘subject to’’ regulation under ERISA is
included within the special entity
definition, although it may elect to opt
out of special entity status by notifying
an SBS Entity counterparty of its
election to opt out prior to entering into
a security-based swap. Therefore, for
example, under Rule 15Fh–2(d)(4), any
church plan, as defined in Section 3(33)
of ERISA, would be considered a special
entity unless it elected to opt out of
special entity status.664 It is also
consistent with Rule 15Fh–3(a)(3),
which requires an SBS Entity to verify
whether a counterparty is eligible to
elect not to be a special entity, and if so,
to notify the counterparty of its right to
make such an election.665 Further, by
requiring employee benefit plans to
notify SBS Entities of their decision to
opt out, the provision will provide SBS
Entities greater clarity regarding their
counterparty’s election to be treated as
a special entity, as requested by a
commenter.666
We note that the special entity
definition the Commission is adopting
today differs from the CFTC’s special
entity definition, which instead
includes an opt-in provision for plans
‘‘defined in’’ ERISA.667 While we agree
663 See Church Alliance (August 2011), supra
note 5; CalPERS (August 2011), supra note 5;
Church Alliance (October 2011), supra note 5;
SIFMA (August 2015), supra note 5.
664 See Church Alliance (August 2011), supra
note 5.
665 See Section II.G.1.b, supra.
666 See Church Alliance (August 2011), supra
note 5.
667 See CFTC Adopting Release, 77 FR at 9774,
supra note 21.

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with the CFTC’s objective of ‘‘providing
protections broadly,’’ 668 we have
determined that inclusion of an opt-out
provision will afford the maximum
protections to the broadest categories of
special entities, while still allowing
them the flexibility to elect not to be
special entities when they do not wish
to avail themselves of those protections.
In making this determination, we
acknowledge the commenter’s request
that we conform our special entity
definition to that of the CFTC.669
However, we believe that the practical
effect of an opt-out versus an opt-in
regime should be minimal since, in
either case, the SBS Entity will need to
advise the counterparty of its option to
be treated as a special entity. The result
should be greater clarity for SBS Entities
regarding the regulatory status of their
counterparties.
Lastly, we disagree with the
commenter’s assertions that the SEC
‘‘has extended its regulatory reach’’
beyond the statute by applying the
business conduct rules to ERISA plans,
and that the resulting regulations would
overlap with the preexisting regulations
established under ERISA.670 As noted
above, the plain language of Exchange
Act Section 15F(h)(2)(C)(iii) includes
ERISA plans within the special entity
definition, and we continue to believe
that such plans are deserving of the
heightened protections of the business
conduct rules specific to special
entities. Moreover, wherever practical,
we have adopted bifurcated rules that
acknowledge the existing federal
regulatory framework for ERISA plans,
thereby minimizing the tension that
may arise between that framework and
the business conduct standards adopted
today.671
iv. Master Trusts
The Commission agrees with
commenters that master trusts should be
treated as special entities, where a
master trust holds the assets of more
than one ERISA plan, sponsored by a
single employer or by a group of
employers under common control.672 In
668 77

FR at 9776.
SIFMA (August 2015), supra note 5.
670 See ABC, supra note 5.
671 See, e.g., Section II.H.2.c.ii, infra.
672 See FIA/ISDA/SIFMA, supra note 5; Church
Alliance (August 2011), supra note 5; SIFMA
(August 2015), supra note 5. See also Section 403(a)
of ERISA (in general, ‘‘assets of an employee benefit
plan shall be held in trust by one or more trustees’’)
(29 U.S.C. 1103(a)); DOL Regulation 29 CFR
2520.103–1(e) (requiring the plan administrator of
a Plan which participates in a master trust to file
an annual report on IRS Form 5500 in accordance
with the instructions for the form relating to master
trusts); see also IRS Form 5500 Instructions, at 9
(‘‘For reporting purposes, a ‘master trust’ is a trust
669 See

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30011

this regard, the Commission clarifies
that, if a master trust holds the assets of
an ERISA plan, the SBS Entity may
satisfy the business conduct
requirements being adopted today by
treating the master trust as a special
entity, rather than applying the business
conduct rules to each underlying ERISA
plan in a master trust. The Commission
understands that a single employer or a
group of employers under common
control may sponsor multiple ERISA
plans that are combined into a master
trust to achieve economies of scale and
other efficiencies. In such cases, the
Commission does not believe that any
individual ERISA plan within the
master trust would receive any
additional protection if the SBS Dealer
or Major SBS Participant had to
separately comply with the final rules
with respect to each ERISA plan whose
assets are held in the master trust.
The Commission similarly agrees with
the commenter that, where a church
benefit board holds the assets of
multiple church plans as defined in
Section 3(33) of ERISA, the function of
the church benefit board is similar to
that of a master trust.673 Because church
plans are recognized in ERISA, and a
church benefit board holds only the
assets of constituent church plans,674 a
church benefit board that holds the
assets of church plans will be deemed
a special entity under final Rule 15Fh2(d)(4), although it will have the ability
to opt out of special entity protections.
Lastly, this clarification addresses the
commenter’s request that the
Commission interpret the special entity
definition in harmony with the CFTC, as
the CFTC also includes master trusts as
special entities where a master trust
holds the assets of more than one ERISA
plan, sponsored by a single employer or
by a group of employers under common
control.675 Such uniformity will help
establish regulatory consistency across
the security-based swap and swap
markets, thereby creating efficiencies for
SBS entities that transact in securitybased swaps and swaps.
v. Collective Investment Vehicles
The Commission requested comment
on whether to interpret ‘‘special entity’’
to include collective investment
vehicles in which one or more special
entities had invested. After
. . . in which the assets of more than one plan
sponsored by a single employer or by a group of
employers under common control are held.’’).
673 See Church Alliance (August 2011), supra
note 5.
674 See generally 29 U.S.C. 1003(b).
675 See SIFMA (August 2015), supra note 5. See
also CFTC Adopting Release, 77 FR at 9776, supra
note 21.

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consideration of the comments, the
Commission has determined not to
interpret ‘‘special entity’’ in that way.
The Commission agrees with
commenters that uniformly urged the
Commission not to treat a collective
investment vehicle as a special entity,
solely because the collective investment
vehicle may have one or more special
entity investors.676
Unlike master trusts, formed for the
purpose of holding assets of ERISA
plans, a collective investment vehicle
may be formed for a variety of reasons
and only incidentally accept
investments from special entities. We
share the concerns of commenters that
requiring SBS Entities to investigate or
‘‘look through’’ their collective
investment vehicle counterparties to
determine whether they held special
entity investments could create
uncertainty in the market, and could
potentially increase compliance costs,
disrupt the gains of special entity
investors, and restrict special entities’
access to security-based swaps—since
collective investment vehicle managers
may either limit or reject investments by
special entities to avoid application of
the special entity requirements.677
At the same time, we recognize the
potential benefits of applying
heightened protections to special
entities that have invested in collective
investment vehicles, either by applying
those protections to the collective
investment vehicle itself or requiring
the SBS Entity to ‘‘look through’’ the
collective investment vehicle. After
further consideration, we have
determined that it would neither be
appropriate to treat the entire collective
investment vehicle as a special entity,
nor to require an SBS Dealer to ‘‘look
through’’ the collective investment
vehicle to determine whether any of its
investors qualify as special entities.
While the special entity has made the
decision to invest in the collective
investment vehicle, it is the collective
investment vehicle that enters into the
security-based swap—not the special
entity. In light of the foregoing, we do
not believe that collective investment
676 See ABC, supra note 5; SIFMA (August 2011),
supra note 5; ABA Committees, supra note 5; FIA/
ISDA/SIFMA, supra note 5; BlackRock, supra note
5; MFA, supra note 5; NACUBO, supra note 5;
SIFMA (August 2015), supra note 5. See ABC, supra
note 5; SIFMA (August 2011), supra note 5; ABA
Committees, supra note 5; FIA/ISDA/SIFMA, supra
note 5; BlackRock, supra note 5; MFA, supra note
5; NACUBO, supra note 5; SIFMA (August 2015),
supra note 5. For clarification, and in response to
commenters, the term ‘‘collective investment
vehicle’’ in our discussion includes, but is not
limited to, hedge funds that hold the assets of
special entity investors. See FIA/ISDA/SIFMA,
supra note 5; BlackRock, supra note 5.
677 Id.

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vehicles should be included within the
special entity definition.
Lastly, our decision not to include
collective investment vehicles in the
special entity definition will address the
commenter’s suggestion that we
harmonize the Commission’s special
entity definition with that of the CFTC
to increase regulatory consistency across
the security-based swap and swap
markets.678
vi. Endowments, Non-Profit
Organizations, and Private Foundations
The Commission requested comment
regarding application of the special
entity definition to endowments. After
taking into consideration the comments,
the Commission has determined to
interpret the term ‘‘endowment,’’ as
used in Section 15F(h)(2)(C)(v) of the
Exchange Act, not to include entities or
persons other than the endowment
itself. The Commission therefore agrees
with commenters that special entity
status should be limited to endowments
that are, themselves, counterparties to
security-based swaps.679 Accordingly,
the Commission does not interpret the
term ‘‘endowment’’ to include
organizations that use endowment
assets to pledge, maintain, enhance or
support the organization’s collateral
obligations, or situations where a
counterparty has recourse to the
organization’s endowment.680
For clarification, and in response to
comment,681 a private foundation will
be subject to special entity protections
where the private foundation qualifies
as an endowment under applicable state
laws, rules, or regulations, including the
Uniform Prudent Management of
Institutional Funds Act. Although we
acknowledge the commenter’s assertion
that private foundations typically derive
their financial support through private
donations,682 we do not agree that
public funding is a prerequisite to
special entity status, or that private
funding should necessarily exclude a
foundation from qualifying for special
entity status.
As noted above in Section II.G.1.b,
Rule 15Fh–3(a)(2) generally requires an
SBS Entity to verify whether its
counterparty is a special entity before
entering into the security-based swap
with that counterparty. Such
verification should generally include a
determination whether the counterparty
may be deemed an endowment under
678 See

SIFMA (August 2015), supra note 5.
FIA/ISDA/SIFMA, supra note 5; NABL,
supra note 5; NACUBO, supra note 5.
680 See NACUBO, supra note 5; SIFMA (August
2015), supra note 5.
681 See ABA Committees, supra note 5.
682 Id.
679 See

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applicable state law, as described above.
However, as discussed in Section
II.G.1.b, supra, counterparties may make
representations about their status as
special entities at the outset of a
relationship with an SBS Entity, and
can ‘‘bring down’’ that representation
for each relevant action involving a
security-based swap.
Also, as with collective investment
vehicles, we believe that a more
expansive interpretation of the special
entity definition would require a
burdensome ‘‘look through’’ process to
determine whether endowment funds
had, for instance, been invested or used
as collateral in a particular securitybased swap, and could ultimately
restrict the ability of entities that are
neither themselves endowments nor
special entities (such as organizations
described in section 501(c)(3) of the
Internal Revenue Code of 1986 whose
assets merely include funds designated
as an endowment) to transact in
security-based swaps.
By making the foregoing
clarifications, the Commission more
closely aligns its interpretation of the
term ‘‘endowment’’ with that of the
CFTC.683 This consistency in the
definition will address the commenter’s
concern regarding the need to promote
regulatory clarity, and result in
operational efficiencies for entities that
have been operating under the CFTC’s
business conduct regime since 2012.684
Lastly, as discussed in more detail
above in Section II.A.2.d., we decline
the commenter’s suggestion to permit
endowments to opt out of special entity
status.685 As stated in the Proposing
Release, Congress created heightened
protections to mitigate the potential for
abuse in SBS transactions with special
entities, as the financial sophistication
of special entities varies greatly.686 As
discussed above in Section II.A, the
rules being adopted today are intended
to provide certain protections for
counterparties, including certain
683 See CFTC Adopting Release, 77 FR at 9776,
supra note 21 (‘‘The Commission agrees with
commenters that the Special Entity prong with
respect to endowments is limited to the endowment
itself. Therefore, the endowment prong of the
Special Entity definition under Section
4s(h)(2)(C)(v) and § 23.401(c)(5) applies with
respect to an endowment that is the counterparty
to a swap with respect to its investment funds. The
definition would not extend to charitable
organizations generally. Additionally, where a
charitable organization enters into a swap as a
counterparty, the Special Entity definition would
not apply where the organization’s endowment is
contractually or otherwise legally obligations to
make payments on the swap . . . .’’).
684 See SIFMA (August 2015), supra note 5.
685 Id.
686 See Proposing Release, 76 FR at 42401, supra
note 3.

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heightened protections for special
entities. We think it is appropriate to
apply the rules so that counterparties
receive the benefits of those protections
and do not think it is appropriate to
permit parties to ‘‘opt out’’ of those
provisions. Furthermore, we note that
the CFTC’s adopted rules do not contain
such an opt-out provision, and that
Swap Entities and their special entity
counterparties have been operating
under this regime since 2012. For all of
the foregoing reasons, and to achieve
regulatory consistency across the
security-based swap and swap markets,
we decline to adopt an opt-out
provision for endowments in the final
rules.
vii. Foreign Plans and Foreign Entities
The Commission requested comment
on whether to exclude from the
definition of ‘‘special entity’’ any
foreign entity. After considering the
comments, all of which asserted that
foreign entities should not be deemed
special entities, the Commission is
declining to include foreign entities
within the definition of ‘‘special entity.’’
The Commission believes that, as stated
in the Cross-Border Adopting Release,
the term ‘‘special entity’’ applies to
‘‘legal persons organized under the laws
of the United States.’’ 687 This reading
addresses the concerns raised by
commenters regarding the need for
clarification concerning the application
of the rules as they relate to special
entity-specific provisions.688
2. ‘‘Acts as an Advisor’’ to a Special
Entity
a. Proposed Rule

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As discussed below in Section II.H.3,
Section 15F(h)(4)(B) of the Exchange
Act imposes a duty on an SBS Dealer
acting ‘‘as an advisor’’ to a special entity
to act in the best interests of the special
entity.689 The Dodd-Frank Act does not
687 See Application of ‘‘Security-Based Swap
Dealer’’ and ‘‘Major Security-Based Swap
Participant’’ Definitions to Cross-Border SecurityBased Swap Activities; Final Rule; Republication,
79 FR 47278, 47306 n.234 (Aug. 12, 2014)
(‘‘Consistent with the proposal, ‘special entities,’ as
defined in Section 15F(h)(2)(C) of the Exchange Act,
are U.S. persons because they are legal persons
organized under the laws of the United States’’).
688 See ABC, supra note 5; SIFMA (August 2011),
supra note 5; BlackRock, supra note 5. For a more
detailed discussion on the cross-border application
of U.S. business conduct standards, see Section III,
infra.
689 Under proposed Rule 15Fh–4(b), an SBS
Dealer that ‘‘acts as an advisor’’ to a special entity
regarding a security-based swap must: (1) Act in the
best interests of the special entity; and (2) make
reasonable efforts to obtain such information that
the SBS Dealer considers necessary to make a
reasonable determination that a security-based
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define the term ‘‘advisor,’’ nor does it
establish specific criteria for
determining when an SBS Dealer is
acting as an advisor within the meaning
of Section 15F(h)(4).
The Commission proposed Rule
15Fh–2(a), which states that an SBS
Dealer ‘‘acts as an advisor to a special
entity when it recommends a securitybased swap or a trading strategy that
involves the use of a security-based
swap to the special entity.’’ We
explained in the Proposing Release that,
for these purposes, to ‘‘recommend’’ has
the same meaning as that discussed in
connection with Rule 15Fh–3(f).690
While the Dodd-Frank Act does not
preclude an SBS Dealer from acting as
both advisor and counterparty, the
Commission recognized in the
Proposing Release that it could be
impracticable for an SBS Dealer acting
as a counterparty to a special entity to
meet the ‘‘best interests’’ standard
imposed by Section 15F(h)(4) if it were
deemed to be acting as an advisor to the
special entity.691 Proposed Rule 15Fh–
2(a) would therefore provide a threepronged safe harbor for an SBS Dealer
to establish that it is not acting as an
advisor. To qualify for the safe harbor,
the SBS Dealer’s special entity
counterparty must first represent in
writing that it will not rely on the SBS
Dealer’s recommendations, but that it
will instead rely on advice from a
‘‘qualified independent
representative.’’ 692 Second, the SBS
Dealer must have a ‘‘reasonable basis’’
to conclude that the special entity is
being advised by a qualified
independent representative.693 Toward
this end, the SBS Dealer could rely on
the special entity’s written
representations unless the SBS Dealer
has information that would cause a
reasonable person to question the
accuracy of the representation.694 Third,
the SBS Dealer must disclose that it is
not undertaking to act in the special
entity’s best interests, as would
otherwise be required under Section
15F(h)(4).695
b. Comments on the Proposed Rule
The Commission received numerous
comments in response to the definition
of ‘‘acts as an advisor’’ to a special
swap is in the best interests of the special entity.
See Section II.H.3, infra.
690 See Proposing Release, 76 FR at 42424, supra
note 3.
691 Id.
692 Proposed Rule 15Fh–2(a)(1).
693 Proposed Rule 15Fh–2(a)(2).
694 See also discussion on SBS Entities acting as
counterparties to special entities, Section II.H.5,
infra.
695 Proposed Rule 15Fh–2(a)(3).

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entity in proposed Rule 15Fh–2(a). One
commenter asserted that the meaning of
the phrase ‘‘acts as an advisor to a
special entity’’ was critical to several
regulatory rulemakings, and that this
term should be applied as consistently
as possible.696 That commenter and
another recommended that, in
developing recommendations for the
final rules, the Commission staff
coordinate with the Commission staff
working on rules regarding municipal
advisors, as well as the MSRB and the
CFTC.697 The commenter urged the
Commission to work with the CFTC and
the MSRB to make the definition as
consistent as possible across regulatory
regimes.
However, the majority of comment
letters addressing proposed Rule 15Fh–
2(a) related to: (1) The use of the term
‘‘recommends’’ when defining the
phrase ‘‘acts as an advisor to a special
entity;’’ and (2) the safe harbor from
acting as an advisor to a special entity
set forth in proposed Rule 15Fh–2(a)(1)–
(3). These comments are summarized
below.
i. ‘‘Recommends’’ an SBS or Related
Trading Strategy to a Special Entity
Eight comment letters addressed
whether an SBS Dealer should be
deemed to act as an advisor if it
‘‘recommends’’ a security-based swap or
trading strategy to a special entity.698
One commenter argued that the
definition of ‘‘acting as an advisor’’ was
too narrow, and should be expanded to
include not only making
recommendations, but also providing
‘‘more general information and
opinions.’’ 699 That commenter and
another recommended that the
definition of ‘‘act as an advisor’’ should
parallel that of an ‘‘investment adviser,’’
such that the definition would
encompass advising special entities as
to the value of a security-based swap or
as to the advisability of a security-based
swap or trading strategies involving
security-based swaps.700 The second
commenter asserted that this definition
would more closely conform the
definition of ‘‘act as an advisor’’ to the
definition of ‘‘investment adviser’’
under the Advisers Act, as well as to the
definition of ‘‘commodity trading
696 See

NABL, supra note 5.
Better Markets (August 2011), supra note
5; CFA, supra note 5; Ropes & Gray, supra note 5;
APPA, supra note 5; FIA/ISDA/SIFMA, supra note
5; NACUBO, supra note 5; SIFMA (August 2011),
supra note 5; SIFMA (August 2015), supra note 5.
699 See Better Markets (August 2011), supra note
5.
700 Id. Under the commenter’s approach, the SBS
Dealer need not receive compensation for the
advice to be deemed acting as an advisor. See also
FIA/ISDA/SIFMA, supra note 5.
698 See

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advisor’’ under the CEA, while
preserving the benefits of the
Commission’s proposed safe harbor.701
A third commenter generally
supported our proposed approach,
noting that ‘‘defining recommendations
as advice is consistent . . . with
congressional intent.’’ 702 The
commenter, however, would narrow the
definition of advice to
‘‘recommendations related to a securitybased swap or a security-based swap
trading strategy that are made to meet
the objectives or needs of a specific
counterparty after taking into account
the counterparty’s specific
circumstances.’’ 703 Another commenter
suggested that the term
‘‘recommendation’’ exclude
communications to groups of customers
or to investment managers with
multiple clients, unless the
communication was tailored to a
member of the group or to a specific
client known to the SBS Dealer.704
According to the commenter, the
Commission should clarify that a
recommendation must be tailored to the
circumstances of a known special-entity
counterparty before giving rise to
advisor status, because, without this
clarification, general communications to
investment advisers (that potentially
have special entity clients) might result
in the SBS Dealer unknowingly ‘‘acting
as an advisor.’’ 705 In 2015, after the
CFTC adopted its final business conduct
rules, a commenter similarly proposed
that the Commission narrow the scope
of the definition of ‘‘act as an advisor to
a special entity’’ to include only
recommendations that are ‘‘tailored to
the particular needs or characteristics of
the special entity.’’ 706
Another commenter argued that a
definition premised on an SBS Dealer’s
‘‘recommend[ing]’’ a security-based
swap or related trading strategy was
‘‘overly broad and unwise,’’ and that
acting as an advisor ‘‘requires a more
formal, acknowledged agency, as part of
a relationship of trust and
confidence.’’ 707 This commenter
expressed concern that a definition
based on recommendations could chill
communications, including informal
701 See
702 See

FIA/ISDA/SIFMA, supra note 5.
CFA, supra note 5.

703 Id.

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704 See

FIA/ISDA/SIFMA, supra note 5.

705 Id.
706 See SIFMA (August 2015), supra note 5. As
the commenter stated, these modifications would
harmonize the SEC and CFTC standards for
determining when a Swap Dealer or SBS Dealer is
acting as an advisor to a special entity. In addition,
the commenter argued that this modification would
align the definition with applicable guidance under
the Advisers Act.
707 See Ropes & Gray, supra note 5.

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‘‘market chatter.’’ 708 Two other
commenters similarly urged the
Commission to adopt a bright line,
objective standard, where an explicit
agreement by the parties would
determine whether the SBS Dealer acts
as advisor to the special entity.709 Under
this approach, unless the special entity
and SBS Dealer agree that information
provided by the SBS Dealer would form
the primary basis for an investment
decision, the SBS Dealer’s
communications would not be
considered a ‘‘recommendation’’ under
proposed Rule 15Fh–2(a).710
Several commenters requested that
the Commission clarify whether certain
communications constitute ‘‘acting as
an advisor.’’ One commenter was
concerned that an SBS Dealer could
provide a counterparty with data,
analysis, and opinions that constituted
recommendations in fact, but were not
labeled or characterized as such.711 A
second commenter suggested the
Commission clarify that the phrase
‘‘acting as an advisor’’ does not include
providing general transaction, financial
or market information to the special
entity.712 A third commenter
recommended the final rule clarify that
an SBS Dealer’s ‘‘customary product
explanations and marketing activities,
provision of general market information,
quotes in response to requests, and
information pursuant to requirements in
the business conduct rules would not
constitute ‘acting as an advisor’ to a
special entity.’’ 713
ii. Safe Harbor
The Commission received a number
of comment letters on the proposed
rule’s safe harbor provisions. Ten
comment letters generally supported the
safe harbor, subject to various
suggestions or objections.714 Three
commenters objected to the safe
harbor.715
Commenters supporting the adoption
of safe harbor provisions that would
protect an SBS Dealer from being
708 Id.
709 See SIFMA (August 2011), supra note 5;
APPA, supra note 5 (arguing that special entities
would suffer the economic impact of the
uncertainty resulting from a ‘‘facts and
circumstances’’ test).
710 Id.
711 See Better Markets (August 2011), supra note
5.
712 See CFA, supra note 5.
713 See SIFMA (August 2011), supra note 5.
714 See ABC, supra note 5; GFOA, supra note 5;
NABL, supra note 5; NACUBO, supra note 5; APPA,
supra note 5; FIA/ISDA/SIFMA, supra note 5;
Ropes & Gray, supra note 5; Black Rock, supra note
5; SIFMA (August 2015), supra note 5; SIFMA
(November 2015), supra note 5.
715 See Better Markets (August 2011), supra note
5; CFA, supra note 5; AFSCME, supra note 5.

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deemed an advisor to a special entity,
argued that market participants would
benefit from greater certainty provided
by the safe harbor, which would enable
contracting parties to specify the nature
of their relationship.716
A number of commenters, however,
expressed concern about the possible
interaction of the proposed safe harbor
with ERISA. One commenter, for
example, generally agreed with the
proposed safe harbor but expressed
concern that requiring an SBS Dealer to
have a ‘‘reasonable basis’’ to believe a
special entity was being advised by a
qualified independent representative
could allow the SBS Dealer’s opinion of
an ERISA plan representative to
‘‘trump’’ that of the ERISA plan
fiduciary.717 For these reasons, the
commenter urged the Commission to
prohibit an SBS Dealer that acts as a
counterparty to an ERISA plan from
vetoing the plan’s choice of
representative.718
Another commenter suggested the
proposed safe harbor be revised to
provide that either: (1) The special
entity will rely on advice from a
qualified independent representative, or
(2) if the special entity or its
representative is relying on the
Qualified Professional Asset Manager
(‘‘QPAM’’) or In-House Asset Manager
(‘‘INHAM’’) Exemption, the decision to
enter into the transaction will be made
by a QPAM or INHAM.719 One
commenter expressed concern with the
proposed safe harbor’s requirement that
the special entity represent it is not
716 See NABL, supra note 5; APPA, supra note 5;
FIA/ISDA/SIFMA, supra note 5; NACUBO, supra
note 5.
717 See ABC, supra note 5. The commenter
expressed concern that such a veto power could
render the Department of Labor’s Prohibited
Transaction Class Exemption 84–14 for Qualified
Professional Asset Managers (‘‘QPAMs’’)
unavailable, and make ERISA plan representatives
hesitant to vigilantly represent the plan’s interests
for fear of a future veto. The commenter also argued
that, through this same provision, an SBS Dealer
acting as an ERISA plan counterparty could learn
confidential information regarding the plan or its
representative.
718 Id.
719 See BlackRock, supra note 5. Section 406(a) of
ERISA generally prohibits the fiduciary of a plan
from causing the plan to engage in various
transactions with a ‘‘party in interest’’ (as defined
in Section 3(14) of ERISA), unless a statutory or
administrative exemption applies to the transaction.
Prohibited Transaction Exemption 84–14 (the
‘‘QPAM Exemption’’), an administrative exemption,
permits certain parties in interest to engage in
transactions involving plan assets if, among other
conditions, the assets are managed by a ‘‘qualified
professional asset manager’’ (QPAM), which is
independent of the parties in interest. Prohibited
Transaction Exemption 96–23 (the ‘‘INHAM
Exemption’’) provides similar conditional
prohibited transaction relief for certain transactions
involving plan assets that are managed by an inhouse asset management affiliate of a plan sponsor.

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‘‘relying’’ on recommendations from the
SBS Dealer.720 As the commenter
explained, since reliance is one of the
essential elements of a securities fraud
action, an SBS Dealer could seek to rely
on the special entity’s representation
that it did not ‘‘rely’’ on the SBS
Dealer’s recommendation in defense of
a subsequent securities fraud action
against the SBS Dealer.721 Instead, the
commenter suggested ‘‘as a purely
technical matter’’ that the safe harbor
instead require a special entity to
acknowledge that the SBS Dealer is not
acting as advisor to the special entity.722
In August 2015, another commenter
suggested modifying the proposed rule
to harmonize with the CFTC’s approach
by creating a second separate safe
harbor for employee benefit plans
subject to Title I of ERISA that
‘‘recognizes the unique fiduciary regime
already applicable to such special
entities.’’ 723 In addition to
recommending a safe harbor for ERISA
plans, the commenter requested two
changes to the non-ERISA safe harbor:
(1) Adding a requirement that an SBS
Dealer may not express an opinion as to
whether a special entity should enter
into the recommended security-based
swap or related trading strategy; and (2)
eliminating the safe harbor condition
that an SBS Dealer have a reasonable
basis to believe that the special entity is
advised by a qualified independent
representative.724 The commenter noted
that the ‘‘reasonable basis’’ provision is
absent from the parallel CFTC business
conduct rule, and argued that the
provision is unnecessary in light of the
fact that the SBS Dealer will already
receive a written representation that the
special entity will rely on advice from
the independent representative.725 The
commenter explained that its suggested
modifications were generally intended
to bring the Commission’s safe harbor
provisions into conformity with those of
the CFTC.726 The same commenter
subsequently urged the Commission to
either (i) permit SBS Entities to
reasonably rely on written
representations that satisfy the CFTC’s
safe harbor, or (ii) adopt a parallel safe
harbor.727
Three commenters opposed the
proposed safe harbor, arguing that it
would erode the statutory protections
for special entities. For instance, one

commenter argued that the safe harbor
would effectively allow SBS Dealers to
give advice that might not be in the best
interests of the special entity.728 A
second commenter opposed the safe
harbor on the grounds that it would
cause special entities to waive their
right to ‘‘best interest’’
recommendations as a condition of
transacting with SBS Dealers, and force
them to rely solely on an independent
representative that might be ‘‘financially
beholden to the security-based swap
industry.’’ 729 The commenter also
expressed concern that ‘‘in any
transaction involving a customized
swap, the special entity will by
definition be relying on the swap
dealer’s assertion that the customization
was designed with the particular needs
of the special entity in mind,’’ and if the
SBS Dealer knows or has reason to
know that the swap is not in the best
interests of the special entity, the SBS
Dealer ‘‘should be precluded from doing
the transaction regardless of what
representations the special entity
provides about who it may be relying
on.’’ 730
Similarly, a third commenter
characterized the safe harbor as
permitting ‘‘an SBS Dealer to escape the
critical responsibilities associated with
‘acting as an advisor’ by having Special
Entities waive this right,’’ and expressed
concern that special entities would be
forced to sign ‘‘boilerplate’’ waivers to
enter into a security-based swap.731
c. Response to Comments and Final
Rule
As stated above, proposed Rule 15Fh–
2(a) defined what it means for an SBS
Dealer to act as an advisor to a special
entity, and proposed Rule 15Fh–4
imposed certain requirements on SBS
Dealers acting as advisors. Thus, the
proposed rules would not impose these
obligations on Major SBS
Participants.732 One commenter stated
its view that it is appropriate to impose
Rule 15Fh–4(b)’s heightened standards
of conduct on professional market
participants that are likely to be acting
as advisors to special entities,733 and
728 See

Better Markets (August 2011), supra note

729 See

CFA, supra note 5.

5.
730 Id.
731 See

720 See
721 Id.
722 Id.
723 See
724 See

SIFMA (August 2015), supra note 5.
SIFMA (November 2015), supra note 5.

725 Id.
726 Id.
727 Id.

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AFSCME, supra note 5.
Section 15F(h)(2)(A) of the Exchange
Act generally requires all SBS Entities to comply
with the requirements of Section 15F(h)(4), the
specific requirements of Sections 15F(h)(4)(B) and
(C), by their terms, apply only to SBS Dealers that
act as advisors to special entities.
733 See CFA, supra note 5 (arguing that the
determining factor in whether a rule should apply
to a Major SBS Participant is whether it is engaged
732 Although

Ropes & Gray, supra note 5.

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30015

another commenter stated that the
‘‘dealer-like obligations’’ of Rule 15Fh–
4(b) should not be imposed on Major
SBS Participants, transacting at arm’slength, as they will not likely advise
special entities with respect to securitybased swap transactions.734 The
Commission continues to believe that it
is appropriate not to impose the
heightened obligations when acting as
an advisor to a special entity on Major
SBS Participants, given the nature of
their participation in the security-based
swap markets.735 However, if a Major
SBS Participant is, in fact,
recommending security-based swaps or
trading strategies involving securitybased swaps to a special entity, this
could indicate that the Major SBS
Participant is actually engaged in
security-based swap dealing activity.736
A Major SBS Participant that engages in
such activity above the de minimis
threshold in Exchange Act Rule 3a71–2
would need to register as an SBS Dealer
and comply with the obligations
imposed on SBS Dealers, including the
obligations imposed by Rule 15Fh–4(b)
when an SBS Dealer is acting as an
advisor to a special entity.
Upon review and consideration of the
comments, the Commission is adopting
Rule 15Fh–2(a) as described below.
i. ‘‘Recommends’’ an SBS or Related
Trading Strategy to a Special Entity
We are adopting, as proposed, Rule
15Fh–2(a), under which an SBS Dealer
is defined to ‘‘act as an advisor to a
special entity’’ when it recommends a
security-based swap or a trading strategy
that involves a security-based swap to a
special entity.737 For these purposes, to
‘‘recommend’’ has the same meaning as
discussed in connection with Rule
15Fh–3(f).738 The determination of
whether an SBS Dealer has made a
‘‘recommendation’’ turns on the facts
and circumstances of the particular
situation and, therefore, whether a
in conduct that would appropriately be regulated
under the relevant standard).
734 See MFA, supra note 5.
735 See Section II.C.3 (discussing bases for
applying certain requirements to SBS Dealers but
not to Major SBS Participants).
736 See Proposing Release, 76 FR at 42416 n.140,
supra note 3. See also Definitions Adopting Release,
77 FR at 30618, supra note 108 (‘‘Advising a
counterparty as to how to use security-based swaps
to meet the counterparty’s hedging goals, or
structuring security-based swaps on behalf of a
counterparty, also would indicate security-based
swap dealing activity.’’).
737 Although we are adopting Rule 15Fh–2(a), as
proposed, we are adopting the safe harbor under
proposed rule 15Fh–2(a)(1)–(3) with various
modifications, as discussed in Section II.H.2.c.ii,
infra.
738 See Section II.G.4, infra.

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recommendation has taken place is not
susceptible to a bright line definition.739
The Commission is not expanding the
definition of ‘‘recommendation’’ to
encompass ‘‘more general information
and opinions,’’ as suggested by a
commenter.740 Such a broad definition
could have the unintended consequence
of chilling commercial communications,
restricting customary commercial
interactions, and generally reducing
market information shared with special
entities regarding security-based
swaps.741 As we discussed in Section
II.G.4, the Commission continues to
believe that the meaning of the term
‘‘recommendation’’ is well-established
and familiar to intermediaries in the
financial services industry, including
broker-dealers that rely on institutional
suitability determinations, and we
believe that the same meaning should be
ascribed to the term in this context.
As explained in Section II.G.4, the
factors considered in determining
whether a recommendation has taken
place include whether the
communication ‘‘reasonably could be
viewed as a ‘call to action’ ’’ and
‘‘reasonably would influence an
investor to trade a particular security or
group of securities.’’ 742 The more
individually tailored the
communication to a specific customer
or a targeted group of customers about
a security or group of securities, the
greater the likelihood that the
communication may be viewed as a
‘‘recommendation.’’ 743 Thus, in
response to commenters’ requests for
clarification, an SBS Dealer typically
would not be making a
recommendation—and would therefore
not be ‘‘acting as an advisor’’ to a
special entity with a duty to act in the
‘‘best interests’’ of a special entity—
solely by reason of providing general
financial or market information or
transaction terms in response to a
request for competitive bids.744
Furthermore, provision of information
pursuant to the requirements of the
business conduct rules will not, in and
of itself, result in an SBS Dealer being
viewed as making a ‘‘recommendation,’’
739 See Proposing Release, 76 FR at 42415, supra
note 3. As discussed in Section II.G.4, supra, this
is consistent with the FINRA approach as to what
constitutes a recommendation.
740 See Better Markets (August 2011), supra note
5.
741 See, e.g., Ropes & Gray, supra, note 5.
742 Our approach here is consistent with that of
the CFTC. See CFTC Adopting Release, 77 FR at
9783, n. 699, supra note 22.
743 Id. at n. 698.
744 See CFA, supra note 5; SIFMA (August 2011),
supra note 5. See also Proposing Release, 76 FR at
42415, supra note 3.

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as suggested by one commenter.745
Rather, as stated above, the
determination of whether providing
information about the valuation of a
security-based swap, or concerning the
advisability of a security-based swap or
a trading strategy, involving a securitybased swap constitutes a
‘‘recommendation’’ turns on the
particular facts and circumstances.
To avoid unnecessarily narrowing the
definition of ‘‘recommendation,’’ we
decline to limit the definition of ‘‘act as
an advisor’’ to recommendations that
are designed to meet the needs of a
specific counterparty after taking into
account the counterparty’s individual
circumstances.746 We also decline to
exclude from the definition of
‘‘recommendation’’ communications to
groups of customers or to investment
managers with multiple clients.747 We
believe that such an exclusion could
unnecessarily deprive groups or special
entity investors of the intended
protections of the rules when there are
communications regarding a particular
security-based swap or trading strategy
to a targeted group of special entities
that share common characteristics, e.g.,
school districts. As stated above, such
communications should be evaluated
based on whether, in light of all the
facts and circumstances, the
communications could ‘‘reasonably
could be viewed as a ‘call to action’ ’’
and ‘‘reasonably would influence an
investor to trade a particular security or
group of securities.’’ 748 We also note
that the number of recipients of a given
communication does not necessarily
change the characteristics of the
communication.
Furthermore, we are not limiting the
definition of ‘‘act as an advisor’’ to a
special entity to situations in which
parties affirmatively contract or
otherwise establish ‘‘more formal,
acknowledged agency relationships that
are part of a relationship of trust and
confidence’’ 749 We believe this could
limit the scope of the obligations and
corresponding protections for special
entities when an SBS Dealer ‘‘acts as an
advisor’’ in a manner that is not
consistent with the intended objectives
of the rule. In short, the rule could be
stripped of its intended protections if
those protections only applied when the
745 See

SIFMA (August 2011), supra note 5.
CFA, supra note 5.
747 See FIA/ISDA/SIFMA, supra note 5.
748 See Section II.G.4, supra.
749 See Ropes & Gray, supra note 5; SIFMA
(August 2011), supra note 5; APPA, supra note 5.
746 See

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regulated entity agreed to be
regulated.750
For the same reason, SBS Dealers may
not avoid making a ‘‘recommendation’’
as defined in this context through
disclaimer, or simply by not
characterizing or labeling a
recommendation as such.751 An
interpretation that would permit an SBS
Dealer to disclaim its ‘‘best interests’’
duty, irrespective of the SBS Dealer’s
conduct, could essentially relieve SBS
Dealers of their obligations and deprive
special entities of the corresponding
protections intended by Rule 15Fh–4.
Rather than require the affirmative
agreement of the parties to establish an
advisory relationship, we are providing
a safe harbor, as described in Section
II.H.2.c.ii, infra, by which the parties
can agree that an SBS Dealer is not
‘‘acting as an advisor’’ to a special entity
where certain conditions are met—
specifically, where the special entity
agrees to rely on the advice of an ERISA
fiduciary or other qualified,
independent representative with respect
to a security-based swap transaction.
We reject the commenters’ suggestion
that we conform the definition of an
SBS Dealer that ‘‘acts as an advisor’’ to
a special entity to the definition of
‘‘investment adviser’’ under the
Advisers Act, or to the definition of
‘‘commodity trading advisor’’ under the
CEA.752 We do not agree that either
definition is necessarily tailored to the
specific attributes of security-based
swap transactions or the unique
relationships between SBS Dealers and
their special entity counterparties;
therefore we believe that those
definitions would not necessarily
provide special entities that trade in
security-based swaps with the
protections the business conduct rules
are intended to provide.
The Commission continues to believe
that the duties imposed on an SBS
Dealer that ‘‘acts as an advisor’’ (as well
as the definition of ‘‘act as an advisor’’
under Rule 15Fh–2(a)) are supplemental
to any duties that may be imposed
under other applicable law.753 In
particular, we acknowledge the
commenter’s suggestion that the
Commission coordinate with the MSRB
regarding the definition of ‘‘acts as an
advisor.’’ 754 As explained in Section
750 The CFTC has taken the same approach in its
treatment of swap dealers. See CFTC Adopting
Release, 77 FR at 9785, supra note 22.
751 See Better Markets (August 2011), supra note
5.
752 See Better Markets (August 2011), supra note
5; FIA/ISDA/SIFMA, supra note 5.
753 See Proposing Release, 76 FR at 42424, supra
note 13.
754 See FIA/ISDA/SIFMA, supra note 5.

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I.E, supra, we have adopted rules that
provide an exemption from ‘‘municipal
advisor’’ status for persons providing
advice with respect to municipal
financial products or the issuance of
municipal securities where certain
conditions are met, such as where the
municipal entity is represented by an
independent registered municipal
advisor.755 More generally, as discussed
in Section I.E, supra, the duties imposed
on an SBS Dealer under the business
conduct rules are specific to this
context, and are in addition to any
duties that may be imposed under other
applicable law. Thus, an SBS Dealer
must separately determine whether it is
subject to regulation as a broker-dealer,
an investment adviser, a municipal
advisor or other regulated entity.
Lastly, the Commission considered
and agrees with the comment that the
definition of ‘‘acting as an advisor’’ to a
special entity should be applied as
consistently as possible across various
rulemakings, and that the Commission
should coordinate with the CFTC with
respect to this definition.756 As noted in
Section I.C, the staffs of the Commission
and the CFTC extensively coordinated
and consulted in connection with their
respective rulemakings in an effort to
establish a consistent rule regime across
the swap and security-based swap
markets. These efforts are reflected in
the rules adopted today.
We note that the Commission’s
definition of ‘‘acts as an advisor’’ to a
special entity under Rule 15Fh–2(a)
differs slightly from the CFTC’s parallel
rule, under which a swap dealer is
deemed to be an advisor when it
‘‘recommends a swap or trading strategy
involving a swap that is tailored to the
particular needs or characteristics of the
Special Entity.’’ 757 While we agree that
the more individually tailored the
communication to a specific
counterparty or a targeted group of
counterparties about a swap, group of
swaps or trading strategy involving the
use of a swap, the greater the likelihood
that the communication may be viewed
as a ‘‘recommendation,’’ we do not agree
that a security-based swap
communication must be so tailored to
constitute a recommendation for
purposes of Rule 15Fh–2(a). In adopting
this more expansive definition of ‘‘acts
as an advisor’’ to a special entity, the
Commission believes that it will better
provide the intended protections of the
statute to groups of special entity
755 See

Municipal Advisor Registration Release,
supra note 54.
756 See NABL, supra note 5; FIA/ISDA/SIFMA,
supra note 5.
757 17 CFR 23.440(a).

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investors that may be treated similarly
by SBS Dealers, such as school districts.
ii. Safe Harbor
After the Commission issued the
Proposing Release, the CFTC adopted
final rules that provide two safe harbors
from the definition of ‘‘acts as an
advisor to a special entity.’’ The first
provides a safe harbor for
communications between a swap dealer
and an ERISA plan that has an ERISA
fiduciary, and the second provides a
safe harbor for communications between
a swap dealer and any special entity
(including a special entity that is an
ERISA plan). Qualifying for either safe
harbor requires specified
representations in writing by the swap
dealer and special entity. In response to
requests from commenters, and upon
further consideration, we are adopting
an approach that similarly recognizes
the use of ERISA fiduciaries by ERISA
plans, thereby avoiding the potential
conflict or confusion that may result
where the existing ERISA rules intersect
with the business conduct rules adopted
today.758
In adopting a separate safe harbor for
ERISA plans, we recognize that
Congress has already established a
comprehensive federal regulatory
framework for ERISA plans. Such
recognition of the existing federal
regulatory framework for ERISA plans
maintains statutory protections for
ERISA plans, while addressing the
potential conflict, recognized by
commenters, between the ERISA rules
and the business conduct standards we
are adopting today.759 Lastly, in
adopting a bifurcated approach that
provides a safe harbor specifically for
ERISA plans and another that is
available with respect to all special
entities, we are responding to the
commenter’s request that we more
closely align the Commission’s rules
with those of the CFTC to promote
regulatory consistency and operational
efficiency for entities that have been
operating under the CFTC’s business
conduct regime since 2012.760
Under Rule 15Fh–2(a)(1), as adopted,
an SBS Dealer may establish that it is
not acting as an advisor to a special
entity that is an ERISA plan if the
special entity is represented by a
qualified independent representative
that meets the standard for an ERISA
fiduciary. Specifically, the rule provides
that an SBS Dealer will not be acting as
758 See ABC, supra note 5; BlackRock, supra note
5; SIFMA (August 2015), supra note 5.
759 Id.
760 See SIFMA (August 2015), supra note 5. See
also CFTC Adopting Release, 77 FR at 9784, n. 701,
supra note 22.

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an advisor to an ERISA special entity if:
(i) The ERISA plan represents in writing
that it has an ERISA fiduciary; (ii) the
ERISA fiduciary represents in writing
that it acknowledges that the SBS Dealer
is not acting as an advisor; and (iii) the
ERISA plan represents in writing that:
(A) It will comply in good faith with
written policies and procedures
reasonably designed to ensure that any
recommendation the special entity
receives from the SBS Dealer involving
a security-based swap transaction is
evaluated by an ERISA fiduciary before
the transaction is entered into; or (B)
any recommendation the special entity
receives from the SBS Dealer involving
a security-based swap transaction will
be evaluated by an ERISA fiduciary
before that transaction is entered into.
Allowing the ERISA plan to either
make written representations about its
policies and procedures or represent in
writing that the security-based swap
transaction will be evaluated by an
ERISA fiduciary provides the ERISA
plan greater flexibility in structuring its
relationship with the SBS Dealer.
Moreover, these requirements, taken
together, are designed to ensure that the
ERISA fiduciary, not the SBS Dealer, is
evaluating the security-based swap
transaction on behalf of the ERISA plan.
As an ERISA fiduciary is already
required by statute to, among other
things, act with prudence and loyalty
when evaluating a transaction for an
ERISA plan,761 the Commission believes
it is appropriate to provide the safe
harbor for when an SBS Dealer would
not be deemed to be acting as an advisor
to the ERISA plan for purposes of this
rule.
Under Rule 15Fh–2(a)(2), as adopted,
an SBS Dealer can establish it is not
acting as an advisor to any special entity
(including a special entity that is an
ERISA plan) when the special entity is
relying on advice from a qualified
independent representative that satisfies
specific criteria. An SBS Dealer will not
be ‘‘acting as an advisor’’ to any special
entity (including a special entity that is
an ERISA plan) if: (i) The special entity
represents in writing that it
acknowledges that the SBS Dealer is not
acting as an advisor, and that the special
entity will rely on advice from a
qualified independent representative;
and (ii) the SBS Dealer discloses that it
761 ERISA fiduciaries are required to act with both
loyalty (see Section 404(a)(1)(A)) and prudence (see
Section 404(a)(1)(B)) when evaluating a transaction
for an ERISA plan. In addition, ERISA fiduciaries
are subject to statutory prohibitions against entering
into certain categories of transactions between a
plan and a ‘‘party in interest’’ (see Section 406(a)),
and prohibitions against self-dealing and other
conflicts of interest (see Section 406(b)). See supra
note 38.

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is not undertaking to act in the best
interests of the special entity.762
In adopting the safe harbor, the
Commission agrees with commenters
that the provisions in Rule 15Fh–
2(a)(1)–(2) will reduce uncertainty
regarding the role of an SBS Dealer
when transacting with a special
entity.763 Requiring special entities (or
their fiduciaries) to affirm in writing
that they acknowledge the SBS Dealer is
not acting as an advisor, and that they
will instead obtain advice from a
qualified independent representative,
will help ensure that the parties are
aware of their respective rights and
obligations regarding a security-based
swap transaction. While our rules
would permit an SBS Dealer to rely on
the special entity’s (or its fiduciary’s)
written representations, the SBS
Dealer’s reliance must still be
reasonable, as required under Rule
15Fh–1(b). Specifically, the SBS Dealer
may not rely on a representation if the
SBS Dealer has information that would
cause a reasonable person to question
the accuracy of the representation.764
The requirement that a special entity or
its fiduciary represents in writing that it
acknowledges the SBS Dealer is not
acting as an advisor differs from the
proposed safe harbor, which would
have required the special entity to
represent that it would not rely on the
SBS Dealer’s recommendations. The
Commission is making this change in
response to a commenter’s concern.765
The Commission does not intend to
affect the rights of parties in private
actions.
The safe harbor under 15Fh–2(a)(2),
as adopted, also differs from the
proposed rule, which would have
required that an SBS Dealer must have
a reasonable basis to believe that the
special entity is advised by a qualified
independent representative. Rather,
under adopted Rule 15Fh–2(a)(2)(i), the
safe harbor requires written
representations from the special entity
that it will rely on advice from a
qualified independent representative.766
The Commission agrees with the
762 However, as noted above in Section II.G.4.c.ii,
an SBS Dealer that makes a recommendation to a
special entity will still need to have a reasonable
basis to believe that a recommended security-based
swap or trading strategy involving a security-based
swap is suitable for the special entity.
763 See NABL, supra note 5; APPA, supra note 5;
FIA/ISDA/SIFMA, supra note 5; NACUBO, supra
note 5.
764 Rule 15Fh–1(b).
765 See Ropes & Gray, supra note 5.
766 In addition, the safe harbor as adopted
continues to require that the SBS Dealer disclose to
the special entity that it is not undertaking to act
in the best interest of the special entity. See Rule
15Fh–2(a)(2)(ii).

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commenter that requiring special
entities to make representations to SBS
Dealers in writing that they are relying
on advice from a qualified independent
representatives addresses the proposed
rule’s underlying policy concern—i.e.,
that the special entity is represented by
a qualified independent
representative.767 Moreover, we believe
that requiring special entities to
effectively confirm that they have
qualified independent representatives
addresses the commenter’s concern that
the proposed rule would allow SBS
Dealers to evaluate the qualifications of
a special entity’s independent
representative and vest SBS Dealers
with the authority to ‘‘trump’’ the
special entity’s choice of
representative.768 An SBS Dealer could
rely on the special entity’s written
representations unless the SBS Dealer
has information that would cause a
reasonable person to question the
accuracy of the representation,
including the representation that the
special entity is relying on advice from
a qualified independent representative.
While we acknowledge commenters’
concerns that the safe harbor might
erode the statutory protections for
special entities,769 we also have
considered the inherent tensions that
arise where SBS Dealers have
concurrent, potentially conflicting roles
as advisor and counterparty to special
entities. On the one hand, the SBS
Dealer as advisor is subject to a duty to
act in the ‘‘best interests’’ of the special
entity. On the other hand, a broad
application of the ‘‘best interests’’
standard could have the unintended
consequences of chilling commercial
communications, restricting customary
commercial interactions, reducing
market information shared with special
entities, as well as reducing the ability
of special entities to engage in securitybased swaps. In adopting the safe
harbor, we acknowledge the tension
between the SBS Dealer’s potentially
conflicting roles as advisor and
counterparty by recognizing that the
special entity may be separately advised
by a fiduciary or other qualified
independent representative, who will
act in the special entity’s best interests.
We disagree with commenters that
adoption of the safe harbor could cause
special entities to waive their right to
‘‘best interests’’ standards or sign
‘‘boilerplate agreements’’ as a condition

of transacting with SBS Entities.770
Rather, the safe harbor reflects an
approach that is conditioned upon the
involvement of an ERISA fiduciary or
other qualified independent
representative that is otherwise required
to act in the best interests of the special
entity.
Although the safe harbor the
Commission is adopting today largely
aligns with that of the CFTC, it differs
from that of the CFTC in four respects:
(1) Rules 15Fh–2(a)(1)(ii) and 15Fh–
2(a)(2)(i)(A) require the special entity or
its fiduciary to represent in writing that
it acknowledges the SBS Dealer is not
acting as an advisor, whereas the CFTC
requires the special entity or its
fiduciary to represent it will not rely on
the SBS Dealer’s recommendations; 771
(2) Rules 15Fh–2(a)(1)(iii)(A) and (B)
apply to any recommendation the
special entity receives from the securitybased swap dealer ‘‘involving’’ a
security-based swap transaction, while
the parallel CFTC rules apply to
recommendations ‘‘materially affecting’’
a security-based swap transaction; 772 (3)
Rule 15Fh–2(a)(1)(iii) requires a
security-based swap transaction to be
evaluated by a fiduciary before the
transaction ‘‘is entered into,’’ whereas
the CFTC’s safe harbor requires a swap
transaction to be evaluated by fiduciary
before the transaction ‘‘occurs’’; 773 and
(4) the safe harbor in Rule 15Fh–2(a)
does not prohibit an SBS Dealer acting
as an advisor from expressing an
opinion as to whether a special entity
should enter into a recommended
security-based swap or trading
strategy.774 The Commission believes it
is appropriate to differ from the CFTC
in these three discrete areas for the
following reasons.
First, as discussed above, the
Commission believes that replacing the
requirement that the special entity or its
fiduciary represent it will not ‘‘rely’’ on
the SBS Dealer’s recommendations with
the requirement that the special entity
or its fiduciary represent in writing that
it acknowledges that the SBS Dealer is
not ‘‘acting as an advisor’’ will afford
special entities the same statutory
protections. As noted above, the
Commission is making this change in
response to a commenter’s concern.775
The Commission does not intend to
affect the rights of parties in private
actions.
770 See

CFA, supra note 5; AFSCME, supra note

5.
767 See
768 See

SIFMA (November 2015), supra note 5.
ABC, supra note 5. See also Section II.H.5,

infra.
769 See Better Markets (August 2011), supra note
5; CFA, supra note 5; AFSCME, supra note 5.

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771 See

17 CFR 23.440(b)(1)(ii), (b)(2)(ii)(A).
17 CFR 23.440(b)(1)(iii)(A)–(B).
773 See 17 CFR 23.440(b)(1)(iii).
774 Cf. 17 CFR 23.440(b)(2)(i).
775 See Ropes & Gray, supra note 5.
772 See

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Second, the Commission has
determined to replace the phrase
‘‘materially affecting’’ with the word
‘‘involving’’ in relation to the
recommendations that a special entity
receives from an SBS Dealer. We believe
that further clarification is needed in the
context of Rule 15Fh–2(a)(1) to make
clear that all recommendations made by
the SBS Dealer are covered by this
provision.
Third, the Commission has
determined to use the phrase ‘‘is entered
into,’’ as it is consistently used
throughout the business conduct rules
being adopted today.776 However,
because we also believe that the CFTC’s
usage of the word ‘‘occurs’’ was
intended to have the same meaning as
the phrase ‘‘is entered into,’’ we expect
the practical effect of CFTC Regulation
23.440(b)(1)(iii) to be substantially the
same as Rule 15Fh–2(a)(1)(iii).777
Fourth, the Commission declines to
adopt the provision in CFTC Regulation
23.440(b)(2)(i), under which Swap
Dealers seeking to avail themselves of
the safe harbor would be precluded
from ‘‘expressing an opinion’’ as to
whether the special entity should enter
into a recommended security-based
swap or trading strategy. Under the
rules adopted today, the determination
of whether an SBS Dealer has provided
advice to a special entity turns on
whether a communication is considered
a ‘‘recommendation,’’ not whether the
SBS Dealer has ‘‘expressed an opinion.’’
Unlike the word ‘‘recommendation,’’ the
phrase ‘‘express an opinion’’ is not
defined or described in the federal
securities laws in this context, and
therefore may have other meanings that
could cause confusion. Further, we also
believe the concern that underlies the
CFTC’s provision (i.e., that the special
entity obtain advice regarding a
security-based swap from an ERISA
fiduciary or other qualified independent
representative) is sufficiently addressed
by the requirement in Rules 15Fh–
2(a)(1)–(2) that the special entity or its
fiduciary represent that it acknowledges
that the SBS Dealer is not acting as an
advisor. It is therefore the Commission’s
view that prohibiting SBS Dealers from
‘‘expressing an opinion’’ would neither
776 See, e.g., Rule 15Fh–1 (‘‘Sections 240.15h–1
through 240.15Fh–6, and 240.15Fk–1 apply, as
relevant in connection with entering into securitybased swaps . . .’’); Rule 15Fh–3(a)(1), (2)
(‘‘. . . before entering into a security-based swap
. . .’’); Rule 15Fh–3(b) (‘‘At a reasonably sufficient
time prior to entering into a security-based swap
. . .’’); Rule 15Fh–6(b)(1) (‘‘It shall be unlawful for
a security-based swap dealer to offer to enter into,
or enter into, a security-based swap . . .’’)
(emphasis added).
777 See generally CFTC Adopting Release, 77 FR
at 9784, supra note 22.

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increase regulatory clarity regarding
whether an SBS Dealer’s conduct falls
within the safe harbor, nor provide a
corresponding increase in protection for
special entities.
3. Definition of ‘‘Best Interests’’
Exchange Act Section 15F(h)(4)(B)
imposes on an SBS Dealer that ‘‘acts as
an advisor’’ to a special entity a duty to
act in the ‘‘best interests’’ of the special
entity. In addition, Section 15F(h)(4)(C)
requires the SBS Dealer that ‘‘acts as an
advisor’’ to a special entity to make
‘‘reasonable efforts to obtain such
information as is necessary to make a
reasonable determination’’ that any
swap recommended by the SBS Dealer
is in the ‘‘best interests’’ of the special
entity.778 The term ‘‘best interests’’ is
not defined in the Dodd-Frank Act, and
the Commission did not propose to
define ‘‘best interests.’’ In the Proposing
Release, we noted that the ‘‘best
interests’’ duty for an SBS Dealer acting
as an advisor to a special entity ‘‘goes
beyond and encompasses the general
suitability requirement of proposed Rule
15Fh–3(f).’’ We sought comment on
whether we should define the term
‘‘best interests,’’ and if so, whether such
definition should use formulations
based on the standards applied to
investment advisers,779 municipal

778 Section 15F(h)(5) of the Exchange Act also
requires an SBS Entity that is a counterparty to a
special entity to have a ‘‘reasonable basis’’ to
believe the special entity has an independent
representative that undertakes to act in the best
interests of the special entity.
779 We have stated that an adviser must deal fairly
with clients and prospective clients, seek to avoid
conflicts with its clients and, at a minimum, make
full disclosure of any material conflict or potential
conflict. See Amendments to Form ADV,
Investment Advisers Act Release No. 3060 (Jul. 28,
2010), 75 FR 49234 (Aug. 12, 2010), citing SEC v.
Capital Gains Research Bureau, Inc., 375 U.S. 180,
191–194 (1963) (holding that investment advisers
have a fiduciary duty enforceable under Section 206
of the Advisers Act, that imposes upon investment
advisers the ‘‘affirmative duty of ‘utmost good faith,
and full and fair disclosure of all material facts,’ as
well as an affirmative obligation to ‘employ
reasonable care to avoid misleading’’’ their clients
and prospective clients).

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advisors,780 ERISA fiduciaries,781 or
some other formulation.
a. Proposed Rules
Proposed Rule 15Fh–4(b)(1) would
generally require an SBS Dealer that acts
as an advisor regarding a security-based
swap to a special entity to act in the
‘‘best interests’’ of the special entity.
Proposed Rule 15Fh–4(b)(2) would
require the SBS Dealer to make
‘‘reasonable efforts’’ to obtain the
information necessary to make a
reasonable determination that a
security-based swap or trading strategy
involving a security-based swap is in
the best interests of the special entity,
and that such information shall include
but not be limited to: (i) The authority
of the special entity to enter into a
security-based swap; (ii) the financial
status of the special entity, as well as
future funding needs; (iii) the tax status
of the special entity; (iv) the investment
or financing objectives of the special
entity; (v) the experience of the special
entity with respect to entering into
security-based swaps, generally, and
security-based swaps of the type and
complexity being recommended; (vi)
whether the special entity has the
financial capability to withstand
changes in market conditions during the
term of the security-based swap; and
(vii) such other information as is
relevant to the particular facts and
circumstances of the special entity,
market conditions and the type of
security-based swap or trading strategy
involving a security-based swap being
recommended.
780 See, e.g., Exchange Act Section 15B(b)(2)(L),
15 U.S.C. 78o–4(b)(2)(L) (requiring the MSRB to
prescribe means reasonably designed to prevent
acts, practices, and courses of conduct that are not
consistent with a municipal advisor’s fiduciary
duty to its municipal entity clients). In April 2015,
the MSRB filed proposed Rule G–42 with the
Commission for approval, which rule would
establish core standards of conduct for municipal
advisors when engaging in municipal advisory
activities, other than municipal advisory
solicitation activities. The rule was published in the
Federal Register on May 8, 2015. See Exchange Act
Release No. 74860 (May 4, 2015), 80 FR 26752. See
also Exchange Act Release Nos. 75628 (Aug. 6,
2015), 75737 (Aug. 19, 2015), and 76420 (Nov. 10,
2015). The rule was approved, with amendments,
on December 23, 2015. See Exchange Act Release
No. 76753 (Dec. 23, 2015).
781 See, e.g., 29 U.S.C. 1104(a)(1)(A) (‘‘a fiduciary
shall discharge his duties with respect to a plan
solely in the interest of the participants and
beneficiaries and for the exclusive purpose of: (i)
Providing benefits to participants and their
beneficiaries; and (ii) defraying reasonable expenses
of administering the plan’’) and 29 U.S.C.
1104(a)(1)(B) (a fiduciary must act ‘‘with the care,
skill, prudence, and diligence under the
circumstances then prevailing that a prudent man
acting in a like capacity and familiar with such
matters would use in the conduct of an enterprise
of a like character and with like aims’’).

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b. Comments on the Proposed Rules
The Commission received six
comment letters on the imposition of a
‘‘best interests’’ standard.782 One
commenter argued that the Commission
should define what it means to act in
the ‘‘best interests,’’ and proposed that
the definition must ‘‘be at least as strong
as the concept of ‘best interest’ [that] has
evolved under the fiduciary principles
applicable to investment [advisers].’’ 783
The commenter additionally requested
that the Commission acknowledge ‘‘that
the best interest standard intended by
Congress is a fiduciary concept that goes
well beyond suitability.’’ 784
Similarly, a second commenter
supporting a best interests standard
stated it did not believe it was
‘‘necessary, or even appropriate,’’ to
strictly define best interests.785 The
commenter asked the Commission to
provide guidance on how to apply the
standard in particular circumstances.
This commenter asserted that Congress
did not intend to apply the ERISA
fiduciary standard, and argued that the
intended model for the ‘‘heightened
standard’’ was the Advisers Act
fiduciary duty.786 The commenter stated
that Congress did not seek to eliminate
all conflicts of interest but to ensure that
such conflicts of interest would be
appropriately managed and fully
disclosed.787 The commenter urged that
in providing guidance in this area, it is
important for the Commission to clarify
that not all suitable recommendations
would satisfy a best interest standard
and that the best interest standard
would impose a ‘‘heightened duty
beyond mere suitability’’ and would
require SBS Dealers to ‘‘recommend
from among the various suitable options
the approach they believe to be best for
the special entity.’’ 788 In addition, the
commenter stated that the guidance
should ‘‘clarify that the best interest
standard is consistent with various
different methods of compensation and
with proprietary trades, but that it
requires the full disclosure of any
conflicts of interest.’’ In the context of
an SBS Dealer acting as an advisor and
serving as a counterparty, the
782 See Better Markets (August 2011), supra note
5; CFA, supra note 5; Johnson, supra note 5; ABC,
supra note 5; BlackRock, supra note 5; SIFMA
(August 2015), supra note 5.
783 See Better Markets (August 2011), supra note
5 (noting that Congress expressly described the
standard as ‘‘best interest’’ in Exchange Act
Sections 15F(h)(2)(A) and (B), 15F(h)(4) and
15F(h)(5)).
784 Id.
785 See CFA, supra note 5.
786 Id.
787 Id.
788 Id.

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commenter suggested that the
Commission clarify that it would not be
inconsistent with the SBS Dealer’s duty
to act in the best interests of the special
entity if the SBS Dealer, as principal,
earned a reasonable profit or fee from
transacting with the special entity.789
A third commenter asserted that
Congress rejected the imposition of a
fiduciary duty on SBS Dealers as
incompatible with their role as market
makers and asked the Commission to
‘‘respect Congressional intent’’ to
protect the ability of end users and
pension plans to transact in securitybased swaps in a cost-effective manner
by rejecting such a duty.790
Two additional commenters argued
that an SBS Dealer that ‘‘acts as an
advisor to a special entity’’ and
complies with the ‘‘best interest’’
requirements might become an ERISA
fiduciary under the DOL’s proposed
redefinition of the term ‘‘fiduciary.’’ 791
Accordingly, one of these commenters
requested that the Commission clarify
that compliance with the business
conduct standards would not transform
an SBS Dealer into a fiduciary under
ERISA or under the final DOL
regulation.792
One of these commenters also
opposed the best interest requirement,
and recommended that it be omitted
from the final rules.793 The commenter
expressed its concern that ‘‘[r]equiring
that an SBS Dealer act in the best
interests of a counterparty who is a
special entity would confuse the roles of
the parties and have an adverse impact
on the flow of information regarding
investment and trading strategies.’’ 794
Additionally, if the requirement is
retained, the commenter recommended
that the term ‘‘best interests’’ be defined
as complying with proposed Rule 15Fh–
3(g) (fair and balanced
communications),795 and NASD Rule
2010(d), which would require that
communications be based on principles
of fair dealing and good faith, be fair
and balanced, and provide a sound basis
for evaluating the transaction.796
After the CFTC adopted its rules in
2012, one commenter asserted that ‘‘to
promote legal certainty and the ability
of SBS dealers to continue to trade with
special entities, the SEC should provide
guidance clarifying the nature of an SBS
789 Id.
790 See
791 See

Johnson, supra note 5.
ABC, supra note 5; BlackRock, supra note

Dealer’s ‘best interests’ duty.’’ 797
Specifically, the commenter asserted
that, to harmonize with CFTC guidance,
the Commission should clarify that the
best interest duty is not a fiduciary duty,
but is rather a duty for the SBS Dealer
to: (1) Comply with the requirement to
make a reasonable effort to obtain
necessary information; (2) act in good
faith and make full and fair disclosure
of all material facts and conflicts of
interest with respect to the
recommended security-based swap or
related trading strategy; and (3) employ
reasonable care that any
recommendation made to the special
entity be designed to further the special
entity’s stated objectives.798 The
commenter also suggested that,
consistent with the CFTC’s guidance, a
recommendation need not represent the
best of all possible alternatives to meet
the best interest standard. Additionally,
the commenter stated that the
determination whether a
recommendation is in a special entity’s
best interest should be based on the
information known to the SBS Dealer at
the time a recommendation was
made.799 Furthermore, according to the
commenter, the best interest duty
should not impede an SBS Dealer from
negotiating the terms of a transaction in
its own interests, or from making a
reasonable profit in a transaction; nor
should it impose an ongoing obligation
on the SBS Dealer to act in the best
interest of the special entity.800 This
commenter also suggested deleting the
requirement under Rule 15Fh–4(b)(i)
that the SBS Dealer ‘‘make reasonable
efforts to obtain information regarding
‘the authority of the special entity to
enter into a security based swap.’ ’’ 801
Toward this end, the commenter argued
that the CFTC eliminated this
requirement as it was ‘‘duplicative’’ of
the know your customer requirement
under the CFTC’s business conduct
rules. As the commenter stated: ‘‘Since
proposed Rule 15Fh3(e)(3) would
require an SBS dealer to obtain this
information, we believe the same
considerations support eliminating that
requirement here.’’ 802 Moreover, the
commenter proposed a bifurcated
treatment of ERISA and non-ERISA
special entities under Rule 15Fh–5(a) to
recognize the ‘‘unique fiduciary regime’’
already applicable to ERISA special
entities, as well as to ‘‘reduce costs for
special entities since most of them have
797 See

5.
792 See

ABC, supra note 5.
793 See BlackRock, supra note 5.
794 Id.
795 See Section II.G.5, supra.
796 Id.

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SIFMA (August 2015), supra note 5.

798 Id.
799 Id.
800 Id.
801 Id.
802 Id.

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
already conformed their relationships
with their representatives to satisfy the
CFTC’s qualification criteria.’’ 803
c. Response to Comments and Final
Rules

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Upon consideration of commenters’
views, the Commission is adopting
Rules 15Fh–4(b)(1) and (2), regarding
the ‘‘best interests’’ obligation for an
SBS Dealer that acts as an advisor to a
special entity regarding a security-based
swap, with certain modifications.
Under Rule 15Fh–4(b)(1), as adopted,
an SBS Dealer that acts as an advisor to
a special entity will have a ‘‘duty to
make a reasonable determination that
any security-based swap or trading
strategy involving a security based swap
recommended by the security based
swap dealer is in the best interests of the
special entity.’’ We believe that this
language, suggested by a commenter,804
appropriately interprets the statutory
requirements imposed on an SBS Dealer
that is acting as an advisor to a special
entity.805 While the Commission is not
specifically defining the term ‘‘best
interests,’’ it is providing further
guidance below regarding how an SBS
Dealer that acts as an advisor to a
special entity can comply with the duty
to make a reasonable determination that
a security-based swap or security-based
swap trading strategy is in the ‘‘best
interests’’ of the special entity.
Under Rule 15Fh–4(b)(2), as adopted,
the advisor will be obligated to ‘‘make
reasonable efforts to obtain such
information that the security-based
swap dealer considers necessary to
make a reasonable determination that a
security-based swap or trading strategy
involving a security-based swap is in
the best interests of the special entity.’’
Whether a recommended security-based
swap or trading strategy is in the best
interests of the special entity is based on
information known to the advisor (after
it has employed its reasonable efforts
under Rule 15Fh–4(b)(2)) at the time the
recommendation is made.
Various commenters questioned
whether the ‘‘best interest’’ duty was
tantamount to, or would give rise to, a
‘‘fiduciary duty.’’ 806 The Commission
has considered commenters’ views and
the legislative history in regard to
whether Section 15Fh–4 imposes a
803 Id.
804 See

SIFMA (August 2015), supra note 5.
Rule 15Fh–4(b)(1) generally required
an SBS Dealer to ‘‘act in the best interests of the
special entity.’’
806 See, e.g., Better Markets (August 2011), supra
note 5; CFA, supra note 5; Johnson, supra note 5;
ABC, supra note 5; BlackRock, supra note 5.
805 Proposed

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fiduciary duty.807 As noted above, Rule
15Fh–4(b)(1), as adopted, requires that
an SBS Dealer ‘‘make a reasonable
determination that any security-based
swap or trading strategy involving a
security based swap recommended by
the security based swap dealer is in the
best interests of the special entity.’’ In
response to comments, and for
clarification, the determination whether
a recommended security-based swap or
trading strategy is in the ‘‘best interests’’
of the special entity will turn on the
facts and circumstances of the particular
recommendation and particular special
entity. In response to a commenter, and
as stated in the Proposing Release, we
continue to believe that the ‘‘best
interests’’ obligation for an SBS Dealer
acting as an advisor to a special entity
goes beyond and encompasses the
general suitability requirements of Rule
15Fh–3(f).808 The Commission generally
believes that it would be difficult for an
SBS Dealer acting as an advisor to a
special entity to fulfill its obligations
under Rule 15Fh–4(b)(1), as adopted,
unless the SBS Dealer, at a minimum:
(1) Complies with the requirement of
Rule 15Fh–4(b)(2) that it make a
reasonable effort to obtain necessary
information to make a reasonable
determination that a security-based
swap or related trading strategy is in the
best interests of the special entity; 809 (2)

acts in good faith and makes full and
fair disclosure of all material risks and
characteristics of and any material
incentives or conflicts of interest with
respect to the recommended securitybased swap; 810 and (3) employs
reasonable care that any
recommendation made to a special
entity is suitable taking into account the
information collected by the SBS Dealer
pursuant to Rules 15Fh–3(f)(1)(ii) and
15Fh–4(b)(2), including the special
entity’s objectives.811 In taking
reasonable care that any
recommendation made to a special
entity is suitable, an SBS Dealer acting
as an advisor to a special entity should
consider, among other things, the fair
pricing and appropriateness of the
security-based swap or trading strategy,
and must act without regard to its own
financial or other interests in the
security-based swap transaction or
trading strategy.812 As discussed below,
this does not prevent an SBS Dealer
from negotiating commercially
reasonable terms or earning a profit.
In response to commenters’ requests
for clarification, we do not believe that,
to act in the best interests of a special
entity, an SBS Dealer acting as an
advisor would be required to
recommend the ‘‘best’’ of all possible
alternatives that might exist.813 The

807 In the Senate bill, the business conduct
standards provision provided that ‘‘a security-based
swap dealer that provides advice regarding, or
offers to enter into, or enters into a security-based
swap with [a Special Entity] shall have a fiduciary
duty to the [Special Entity], as appropriate.’’
Restoring American Financial Stability Act of 2010,
H.R. 4173, Section 764 (May 20, 2010) (Public Print
version as passed in the Senate of the United States
May 27 (legislative day, May 26, 2010) (proposed
amendments to Section 15F(h)(2)(A) and (B) of the
Exchange Act), available at https://
www.congress.gov/bill/111th-congress/house-bill/
4173/text/pp). Instead, Congress adopted the
following best interests standard: ‘‘Duty.—Any
security-based swap dealer that acts as an advisor
to a Special Entity shall have a duty to act in the
best interests of the Special Entity.’’ H.R. Rep. No.
111–517, 111th Cong., 2d Sess., p. 423 (June 29,
2010) (Dodd-Frank Act Conference Report). See also
Section 15F(h)(4)(B) of the Exchange Act.
808 See Better Markets (August 2011), supra note
5; CFA, supra note 5. See also Proposing Release,
76 FR at 42417, supra note 3. This is the case even
if the SBS Dealer is not acting as counterparty to
the special entity for which it is acting as an
advisor.
809 Also, as stated above, to comply with its
customer-specific suitability obligations under Rule
15Fh–3(f)(1)(ii), an SBS Dealer must have a
reasonable basis to believe that a recommended
security-based swap or trading strategy involving a
security-based swap is suitable for the counterparty.
To establish a reasonable basis for a
recommendation, an SBS Dealer must have or
obtain relevant information regarding the special
entity, including its investment profile, trading
objectives, and its ability to absorb potential losses
associated with the recommended security-based
swap or trading strategy involving a security-based

swap. Furthermore, where an SBS Dealer’s
reasonable efforts to obtain necessary information
result in limited or incomplete information, the SBS
Dealer must assess whether it is able to make a
reasonable determination that a particular
recommendation is in the best interests of the
special entity.
810 The Commission believes that to ‘‘act in good
faith’’ in this context generally involves taking steps
to manage material conflicts of interest in addition
to disclosing them.
811 See note 809, supra and Rule 15Fh–4(b)(2). An
SBS Dealer generally should consider evaluating
‘‘best interests’’ in accordance with policies and
procedures that are reasonably designed to prevent
violations of the requirement that a recommended
swap is in the best interests of the special entity.
See Rule 15Fh–3(h)(2)(iii) (requiring SBS Entities to
have supervisory policies and procedures that are
reasonably designed to prevent violations of
applicable federal securities laws and the rules and
regulations thereunder). Furthermore, the
Commission has separately proposed that SBS
Dealers be required to make and keep current a
record that demonstrates their compliance with
Rule 15Fh–4, among others, as applicable. See
Recordkeeping and Reporting Requirements for
Security-Based Swap Dealers, Major Security-Based
Swap Participants, and Broker-Dealers; Capital Rule
for Certain Security-Based Swap Dealers; Proposed
Rules, Exchange Act Release No. 34–71958, 79 FR
25194 at 25208 (May 2, 2014).
812 Exercising reasonable care would also require,
among other things, undertaking reasonable
diligence to understand the potential risks and
rewards associated with the recommended securitybased swap or trading strategy. See Rule 15Fh–
3(f)(1)(i).
813 See CFA, supra note 5; SIFMA (August 2015),
supra note 5.

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determination whether a recommended
security-based swap is in the ‘‘best
interests’’ of the special entity must be
based on information known to the SBS
Dealer, acting as an advisor, (after it has
employed its reasonable efforts under
Rule 15Fh–4(b)(2)) at the time the
recommendation is made. We believe
that a broader requirement could
introduce legal uncertainty into the
determination of what an SBS Dealer
must do to fulfill its obligation under
the rule, given the broad range of
objectives for which a security-based
swap might be used, and how such
objectives may vary for different
transactions. The Commission believes,
however, that generally an SBS Dealer
should consider, based on the
information about existing alternatives
known to the SBS Dealer, any
reasonably available alternatives in
fulfilling its best interests obligations.
For further clarification in response to
comments, we believe that the ‘‘best
interests’’ duty would not necessarily
preclude an SBS Dealer from acting as
a counterparty.814 However, an SBS
Dealer acting in both capacities would
be required to comply with the full
range of requirements under Rules
15Fh–4 and 15Fh–5, applicable to SBS
Dealers acting as advisors and as
counterparties to special entities. In
addition to the substantive
requirements, Rule 15Fh–5(c) would
require that the SBS Dealer disclose to
the special entity in writing the
capacities in which is it acting, and the
material differences between its
capacities as advisor and counterparty
to the special entity.
We also do not believe that the ‘‘best
interests’’ duty would prevent an SBS
Dealer from negotiating commercially
reasonable security-based swap terms in
its own interest,815 or that it would
preclude an SBS Dealer from making a
reasonable profit or fee from a
transaction with a special entity.816 We
do not believe that the profit motive
inherent in any security-based swap
transaction necessarily precludes an
SBS Dealer, acting as an advisor, from
fulfilling its ‘‘best interests’’ duty to a
814 See

CFA, supra note 5.
SIFMA (August 2015), supra note 5. For
example, the SBS Dealer may negotiate appropriate
provisions relating to collateral and termination
rights to manage its risks related to the securitybased swap.
816 See CFA, supra note 5. Furthermore, as noted
throughout this release, the duties imposed on an
SBS Dealer under these business conduct rules are
specific to this context, and are in addition to any
duties that may be imposed under other applicable
law. Thus, an SBS Dealer must separately
determine whether it is subject to regulation as a
broker-dealer, an investment adviser, a municipal
advisor or other regulated entity.

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815 See

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special entity, although it raises the
potential for material conflicts that
would need to be disclosed—
particularly when the SBS Dealer is
acting as both an advisor and a
counterparty to the special entity. A
prohibition on receipt of reasonable
profits or fees would likely reduce SBS
Dealers’ willingness to act as advisors to
and transact with special entities at the
same time, and therefore could limit
special entities’ access to security-based
swap transactions that might be
necessary to their particular objectives.
As additional guidance in response to
comments,817 the ‘‘best interests’’ duty
would not require the SBS Dealer acting
as an advisor to undertake an ongoing
obligation to act in the ‘‘best interests’’
of the special entity, unless such
obligation is established through
contract or other arrangement or
understanding (e.g., a course of dealing).
As noted above, Rule 15Fh–4(b), as
adopted, requires an SBS Dealer to make
a reasonable determination, after
making reasonable efforts to obtain the
necessary information, that a
recommended security-based swap or
related trading strategy is in the best
interests of the special entity. Thus, the
‘‘best interests’’ duty applies only to
recommendations by the SBS Dealer.
For example, if an SBS Dealer makes a
recommendation in connection with a
material amendment to a security-based
swap or a recommendation to terminate
a security-based swap early, the ‘‘best
interests’’ duty would apply. However,
we note that an SBS Dealer would have
an ongoing ‘‘best interests’’ duty if it
were to assume the additional
responsibility of monitoring a special
entity’s security-based swap transaction
on an ongoing basis.
Commenters have suggested that we
apply principles applicable to
investment advisers under the Advisers
Act in the ‘‘best interests’’ standard of
Rule 15Fh–4(b).818 As noted above in
Section II.H.2.c.i., we believe that the
protections included in the business
conduct rules address the relationships
between SBS Dealers and their special
entity counterparties for which they act
as advisors, so long as their activities are
limited to those that would not, under
the facts and circumstances, implicate
other applicable law. However, as
discussed in Section I.E, supra, the
duties imposed on an SBS Dealer under
the business conduct rules are specific
to this context, and are in addition to
any duties that may be imposed under
other applicable law. Thus, an SBS
817 See

SIFMA (August 2015), supra note 5.
Better Markets (August 2011), supra note
5; CFA, supra note 5.
818 See

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Dealer must separately determine
whether it is subject to regulation as a
broker-dealer, an investment adviser, a
municipal advisor or other regulated
entity. We also decline to adopt a
commenter’s suggestion that we either
omit the term ‘‘best interests’’ from the
final rules, or state that ‘‘best interests’’
means complying with the fair and
balanced communications requirements
of Rule 15Fh–3(g) and FINRA Rule 2010
(Standards of Commercial Honor and
Principles of Trade).819 We do not
believe that either approach would be
consistent with the statute, which uses
the terms ‘‘fair and balanced
communications,’’ ‘‘fair dealing,’’ and
‘‘good faith’’ in separate provisions,
indicating that they impose duties
separate and apart from ‘‘best
interests.’’ 820
The Commission also has modified
the information that an SBS Dealer must
‘‘make reasonable efforts to obtain’’ and
consider in making its reasonable
determination that a security-based
swap or security-based swap strategy is
in the ‘‘best interests of the special
entity.’’ Specifically, Rule 15Fh–4(b)(2)
now includes the special entity’s
hedging, investment, financing, or other
stated objectives as information that
shall be considered by the SBS Dealer
in making this determination. The
addition of ‘‘hedging’’ and ‘‘other’’
objectives in Rule 15Fh–4(b)(2)(iii)
addresses a commenter’s suggestion that
these terms be included,821 and
recognizes that there may be a broader
set of objectives for a special entity to
enter into a security-based swap. The
added language expressly recognizes
special entities’ use of security-based
swaps to mitigate risk, as well as other
possible uses for security-based swaps
that might be necessary for a special
entity to achieve these objectives. We
believe that requiring an SBS Dealer to
make reasonable efforts to obtain
information about a wider array of
possible investment objectives of special
entities will allow SBS Dealers to more
accurately determine a special entity’s
819 See BlackRock, supra note 5. We interpret
BlackRock’s comment as referring to FINRA Rule
2010, (or its predecessors, NYSE Rule 2010 or
NASD Rule 2110) which states: ‘‘A member, in the
conduct of its business, shall observe high
standards of commercial honor and just and
equitable principles of trade.’’
820 Compare Exchange Act Section 15F(h)(3)(C)
(requiring business conduct requirements to
‘‘establish a duty for security-based swap dealer or
major security-based swap participant to
communicate in a fair and balanced manner based
on principles of fair dealing and good faith’’) with
Exchange Act Section 15F(h)(4)(B) (‘‘Any securitybased swap dealer that acts as an advisor to a
special entity shall have a duty to act in the best
interests of the special entity’’).
821 See SIFMA (August 2015), supra note 5.

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
objectives in entering into a securitybased swaps, which is one of the factors
it must consider when making a best
interest determination (as discussed
above). Furthermore, as requested by a
commenter, this change conforms the
obligation under our rules with that
under the rules of the CFTC.822 Such
conformity promotes regulatory
consistency across the swap and
security-based swap markets,
particularly among entities that transact
in both markets and have already
established infrastructure to comply
with existing CFTC regulations.
Furthermore, we reject the
commenter’s request to delete the
requirement under proposed Rule
15Fh–4(b)(2)(i) that an SBS Dealer make
reasonable efforts to obtain ‘‘information
regarding the authority of the special
entity to enter into a security-based
swap.’’ 823 In so doing, we disagree with
the commenter’s assertion that the
requirement under Rule 15Fh–4(b)(2)(i)
is ‘‘duplicative’’ of the ‘‘know your
counterparty’’ requirement of Rule
15Fh–3(e)(3), which, according to the
commenter, already imposes an
obligation on SBS Dealers to obtain
information about the authority of the
special entity to enter into a securitybased swap. To the contrary, the know
your customer requirements of Rule
15Fh–3(e)(3) require an SBS Dealer to
learn ‘‘information regarding the
authority of any person acting for such
counterparty.’’ A determination
regarding the authority of any person
acting for a counterparty (under Rule
15Fh–3(e)(3)) is different from a
determination regarding the authority of
the counterparty itself to enter into a
security-based swap itself (under Rule
15Fh–4(b)(2)(i)). The SBS Dealer’s duty
to act in the best interests of a special
entity would encompass the
requirement to ensure that a special
entity has the requisite authority to
enter into an SBS transaction. Moreover,
the ‘‘know your counterparty’’
requirements of Rule 15Fh–3(e)(3) only
apply to known counterparties.824 Also,
the ‘‘know your counterparty’’
requirements apply only to
counterparties, whereas the
requirements imposed on SBS Dealers

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822 Id.

CFTC Regulation § 23.440(c)(2)(iii) states
that: ‘‘Any swap dealer that acts as an advisor to
a Special Entity shall make reasonable efforts to
obtain such information as is necessary to make a
reasonable determination that any swap or trading
strategy involving a swap recommended by the
swap dealer is in the best interests of the Special
Entity, including . . . information relating to . . .
the hedging, investment, financing, or other
objectives of the Special Entity.’’ See CFTC
Adopting Release, 77 FR at 9825, supra note 22.
823 See SIFMA (August 2015), supra, note 5.
824 See Section II.G.3, supra.

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that ‘‘act as an advisor’’ to special
entities are not limited to special
entities that are counterparties.
Accordingly, we continue to believe that
requiring SBS Dealers to obtain
information regarding the authority of a
special entity to enter into a securitybased swap is not duplicative, but is
necessary to achieving the overarching
purpose of the rule: Determining
whether a recommended security-based
swap or related trading strategy is in the
best interests of the special entity.
Lastly, as noted above, commenters
requested that we clarify that an SBS
Dealer that ‘‘acts as an advisor to a
special entity’’ and complies with the
‘‘best interests’’ requirements of these
business conduct standards will not
necessarily become an ERISA fiduciary
under the DOL’s proposed (now final)
redefinition of the term ‘‘fiduciary.’’ 825
As discussed in Section I.D, supra, DOL
staff has provided the Commission with
a statement that:
It is the Department’s view that the draft
final business conduct standards do not
require security-based swap dealers or major
security-based swap participants to engage in
activities that would make them fiduciaries
under the Department’s current five-part test
defining fiduciary investment advice. 29 CFR
2510.3–21(c). The standards neither conflict
with the Department’s existing regulations,
nor compel security-based swap dealers or
major security-based swap participants to
engage in fiduciary conduct. Moreover, the
Department’s recently published final rule
amending ERISA’s fiduciary investment
advice regulation was carefully harmonized
with the SEC’s business conduct standards so
that there are no unintended consequences
for security-based swap dealers and major
security-based swap participants who
comply with the business conduct standards.
As explained in the preamble to the
Department’s final rule, the disclosures
required under the SEC’s business conduct
rules do not, in the Department’s view,
compel counterparties to ERISA-covered
employee benefit plans to make investment
advice recommendations within the meaning
of the Department’s final rule or otherwise
compel them to act as ERISA fiduciaries in
swap and security-based swap transactions
conducted pursuant to section 4s(h) of the
Commodity Exchange Act and section 15F of
the Securities Exchange Act of 1934.826

4. Antifraud Provisions
a. Proposed Rule 15Fh–4(a)
Proposed Rule 15Fh–4(a) would track
the language of Section 15F(h)(4)(A) of
the Exchange Act, and prohibit an SBS
Entity from: (1) Employing any device,
825 See ABC, supra note 5; BlackRock, supra note
5; CFA, supra note 5.
826 See Letter from Phyllis C. Borzi, Assistant
Secretary, Employee Benefits Security
Administration, U.S. Department of Labor to The
Hon. Mary Jo White et al., SEC (Apr. 12, 2016).

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30023

scheme, or artifice to defraud any
special entity or prospective customer
who is a special entity; (2) engaging in
any transaction, practice, or course of
business that operates as a fraud or
deceit on any special entity or
prospective customer who is a special
entity; or (3) engaging in any act,
practice, or course of business that is
fraudulent, deceptive, or manipulative.
The first two provisions are specific to
an SBS Entity’s interactions with special
entities, while the third applies more
generally.
b. Comments on the Proposed Rule
The Commission received two
comment letters on this issue.827 The
first commenter argued that the
antifraud provisions of proposed Rule
15Fh–4(a) would be duplicative in light
of the general antifraud and antimanipulation provisions of the existing
federal securities laws and proposed
Rule 9j–1.828
The second commenter argued that,
because the antifraud prohibitions of
proposed Rule 15Fh–4(a)(3) were
modeled on language in the Advisers
Act applicable to conduct by investment
advisers, and SBS Entities do not
typically act as advisers to their
counterparties, the SEC should include
an affirmative defense against alleged
violations of the antifraud prohibitions
in its final rules.829 Specifically, the
commenter suggested that the
Commission establish an affirmative
defense for an SBS Entity that: (1) Did
not act intentionally or recklessly in
connection with such alleged violation;
and (2) complied in good faith with
written policies and procedures
reasonably designed to meet the
particular requirement that is the basis
for the alleged violation.830 The
commenter noted that the CFTC
included such a provision in its parallel
business conduct rules, and urged the
Commission to rely on the same
considerations that led the CFTC to
adopt its affirmative defense.831
c. Response to Comments and Final
Rule
After considering the comments, the
Commission is adopting Rule 15Fh–4(a)
as proposed. However, we are re-titling
Rule 15Fh–4 ‘‘Antifraud provisions and
827 See Barnard, supra note 5; SIFMA (August
2015), supra note 5.
828 See Barnard, supra note 5. See also
Prohibition Against Fraud, Manipulation, and
Deception in Connection With Security-Based
Swaps, Exchange Act Release No. 34–63236, 75 FR
68560 (Nov. 8, 2011).
829 See SIFMA (August 2015), supra note 5.
830 Id.
831 Id.

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special requirements for security-based
swap dealers acting as advisors to
special entities. We also are re-titling
Rule 15Fh–4(a) ‘‘Antifraud provisions’’
and Rule 15Fh–4(b) ‘‘Special
requirements for security-based swap
dealers acting as advisors to special
entities.’’
Rule 15Fh–4(a) codifies the statutory
requirements of Exchange Act Section
15F(h)(4)(A).832 Inclusion of the rule in
the business conduct standards will
provide SBS Entities and their
counterparties with easy reference to the
antifraud provisions that Congress
expressly provided under Section
15F(h)(4) of the Exchange Act. These
requirements, which by their terms are
applicable to all SBS Entities, apply in
addition to those prohibitions imposed
by Section 9(j) of the Exchange Act—
along with any rules the Commission
may adopt thereunder, and any other
applicable provisions of the federal
securities laws and related rules and
regulations. The Commission is not
adopting the commenter’s
recommendation that the final rules
incorporate an affirmative ‘‘policies and
procedures defense.’’ We recognize that
the CFTC adopted an express,
affirmative defense in its parallel
antifraud rules, in part in response to
concerns that the statute may impose
non-scienter liability for fraud in private
rights of action.833 The Exchange Act,
however, does not contain a parallel
provision.834 Moreover, the Commission
832 This language mirrors the language in Sections
206(2) and 206(4) of the Advisers Act, which does
not require scienter to prove liability. See SEC v.
Steadman, 967 F.2d 636, 647 (D.C. Cir. 1992). The
court in Steadman analogized Section 206(4) of the
Advisers Act to Section 17(a)(3) of the Securities
Act, which the Supreme Court had held did not
require a finding of scienter. See id., citing Aaron
v. SEC, 446 U.S. 680 (1980). The Steadman court
concluded that: ‘‘[S]ection 206(4) uses the more
neutral ‘act, practice, or course or business’
language. This is similar to [Securities Act] section
17(a)(3)’s ‘transaction, practice, or course of
business,’ which ‘quite plainly focuses upon the
effect of particular conduct . . . rather than upon
the culpability of the person responsible.’
Accordingly, scienter is not required under section
206(4), and the SEC did not have to prove it in
order to establish the appellants’ liability . . . .’’
SEC v. Steadman, 967 F.2d at 647 (internal citations
omitted). The Steadman court observed that,
similarly, a violation of Section 206(2) of the
Adviser Act could rest on a finding of simple
negligence. Id. at 642 note 5.
833 See CFTC Adopting Release, 77 FR at 9752,
supra note 21 (‘‘Even if the Commission were to
limit the rule to require proof of scienter and apply
the rule only when a swap dealer is acting as an
advisor to a Special Entity, that would not restrict
a court from taking a plain meaning approach to the
language in Section 4s(h)(4) in a private action
under Section 22 of the CEA’’).
834 See also Proposing Release, 76 FR 42401, fn.
44, supra note 3 (‘‘Section 15F(h) of the Exchange
Act does not, by its terms, create a new private right
of action or right of rescission, nor do we anticipate

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has considered the concerns raised by
commenters and determined not to
provide a similar safe harbor from
liability for fraud on behalf of SBS
Entities. As discussed throughout the
release in the context of specific rules,
the rules being adopted today are
intended to provide certain protections
for counterparties, including certain
heightened protections for special
entities. We think it is appropriate to
apply the rules so that counterparties
receive the benefits of those protections,
and therefore we do not think it would
be appropriate to provide the safe
harbor requested by the commenter
from liability for fraud. While we are
not adopting a safe harbor from liability
for fraud, as discussed below in
connection with the relevant rules, the
Commission has adopted rules that
permit reasonable reliance on
representations (e.g., Rule 15Fh–1(b))
and, where appropriate, allow SBS
Entities to take into account the
sophistication of the counterparty (e.g.,
Rule 15Fh–3(f) (regarding
recommendations of security-based
swaps or trading strategies)).
5. SBS Entities Acting as Counterparties
to Special Entities
a. Scope of Qualified Independent
Representative Requirement
i. Proposed Rules
Under Exchange Act Section
15F(h)(5)(A), an SBS Entity that offers to
enter into or enters into a security-based
swap with a special entity must comply
with any duty established by the
Commission requiring the SBS Entity to
have a ‘‘reasonable basis’’ to believe the
special entity has an ‘‘independent
representative’’ that meets certain
qualifications. Proposed Rules 15Fh–
2(c) and 15Fh–5(a) would implement
this provision. In particular, proposed
Rule 15Fh–2(c) would define an
‘‘independent representative,’’ and
proposed Rule 15Fh–5(a) would require
an SBS Entity that ‘‘offers to enter into’’
or enters into a security-based swap
with a special entity to have a
‘‘reasonable basis’’ to believe that the
special entity has a ‘‘qualified
independent representative.’’
ii. Comments on the Proposed Rule
Application to SBS Dealers and Major
SBS Participants
Under proposed Rule 15Fh–5(a), an
SBS Dealer or a Major SBS Participant
that offers to enter into or enters into an
SBS with a special entity must have a
reasonable basis to believe that the

special entity has a qualified
independent representative. Although
Exchange Act Section 15F(h)(2)(B) only
imposes an express obligation on SBS
Dealers to comply with the
requirements of Section 15F(h)(5), we
proposed to apply the qualified
independent representative requirement
to Major SBS Participants as well as SBS
Dealers because the specific
requirements under Section
15F(h)(5)(A) apply by their terms to
both a ‘‘security-based swap dealer and
major security-based swap participant
that offers to or enters into a securitybased swap with a special entity.’’ 835
The sole commenter on this issue
supported the proposed Rule, and
agreed that it should apply to both SBS
Dealers and Major SBS Participants.836
Application to Any Special Entity
In proposed Rule 15Fh–5(a), we
proposed to apply the qualified
independent representative
requirements to transactions with all
special entities. In the Proposing
Release, we explained that while
Exchange Act Section 15F(h)(5)(A)
provides broadly that an SBS Entity that
offers to or enters into a security-based
swap with a special entity must comply
with the requirements of that section,
Section 15F(h)(5)(A)(i) on its face would
apply these requirements only to
dealings only with ‘‘a counterparty that
is an eligible contract participant within
the meaning of subclause (I) or (II) of
clause (vii) of section 1a(18) of the
Commodity Exchange Act.’’ A reliance
on Section 15Fh(5)(A)(i) read in
isolation would lead to an anomalous
result in which special entity
obligations could apply with respect to
entities such as multinational and
supranational government entities,
which are ECPs ‘‘within the meaning of
subclause (I) or (II) of clause (vii) of
section 1a(18) of the Commodity
Exchange Act,’’ but that do not fall
within the definition of special entity in
Section 15F(h)(2)(C). Conversely,
Section 15Fh(5)(A)(i) read in isolation
could lead to special entity obligations
not being applied with respect to
dealings with state agencies, which are
special entities as defined in Section
15Fh(2)(C) but are not ECPs as defined
in Section 1a(18)(A)(vii)(I) and (II) of the
CEA.837
To resolve the ambiguity in the
statutory language, we proposed to
apply the qualified independent
requirement under Section 15F(h)(5) to
835 See

15 U.S.C. 78o–10(h)(5)(A).
NAIPFA, supra note 5.
837 See Proposing Release, 76 FR at 42426, supra
note 3.
836 See

that the proposed rules would create any new
private right of action or right of rescission’’).

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
security-based swap transactions or
offers to enter into security-based swap
transactions between an SBS Entity and
any counterparty that is a ‘‘special
entity’’ as defined in Section
15F(h)(1)(C). This approach would
address the statutory ambiguity by
including dealings with a special entity
that is an ECP within the meaning of
subclause (I) or (II) of clause (vii) of
Commodity Exchange Act Section
1a(18).838 The Proposing Release noted
that this reading would be consistent
with the categories of special entities
mentioned in the legislative history.839
It also would give meaning to the
requirement of Section
15F(h)(5)(A)(i)(VII) concerning
‘‘employee benefit plans subject to
ERISA,’’ that are not ECPs within the
meaning of subclause (I) or (II) of clause
(vii) of section 1a(18) of the Commodity
Exchange Act but are included in the
category of retirement plans identified
in the definition of special entity.840
The Commission received one
comment letter that addressed the
question of whether proposed Rule
15Fh–5(a) should apply to securitybased swap transactions with any
special entity.841 According to the
commenter, proposed Rule 15Fh–5(a)
was overly broad in scope and ignored
the limiting language of Section
15F(h)(5)(A). This commenter suggested
interpreting the requirement as applying
to only those referenced governmental
entities that are special entities.’’ 842
Application to ‘‘Offers’’
As stated above, proposed Rule 15Fh–
5(a) would apply to an SBS Dealer or
Major SBS Participant that ‘‘offers to
enter into’’ or enters into a securitybased swap with a special entity. The
Commission requested comment
regarding whether the phrase ‘‘offers to
enter into’’ a security-based swap was
sufficiently clear, and if not, how the
838 Id.

See also proposed Rule 15Fh–5(a).
H.R. Conf. Rep. 111–517 (June 29, 2010)
(‘‘When acting as counterparties to a pension fund,
endowment fund, or state or local government,
dealers are to have a reasonable basis to believe that
the fund or governmental entity has an independent
representative advising them.’’) (emphasis added).
840 See Section 15F(h)(1)(C)(iii) of the Exchange
Act.
841 See Ropes & Gray, supra note 5.
842 Id. The commenter suggested two other
possible alternatives for resolving the statutory
ambiguity: ‘‘(i) interpreting the de facto
independent representative requirements as
applying to both those referenced governmental
entities that are special entities and those that are
not, (ii) interpreting the independent representative
requirement to be generally inapplicable (as clearly
most special entities were not intended to be
covered in the reference)’’ but expressed a
preference for including governmental entities that
are special entities ‘‘absent clarification from
Congress.’’

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839 See

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requirement should be clarified.843
Three commenters responded to this
request.844
One commenter suggested that the
‘‘offer’’ stage of a security-based swap
transaction would often be too early for
the counterparty to ensure that the
independent representative requirement
was satisfied.845 Instead, the commenter
argued that the independent
representative requirement should be
satisfied if the counterparty had an
independent representative at the time
the transaction was executed.846 A
second commenter recommended that
the Commission exclude preliminary
negotiations from the definition of
‘‘offer,’’ and that the communication of
an interest in trading a security-based
swap should only be viewed as an
‘‘offer’’ when, based on the relevant
facts or circumstances, the
communication was ‘‘actionable’’ or
‘‘firm.’’ 847 A third commenter asked
that the Commission, like the CFTC,
clarify the term ‘‘offer’’ to mean an
‘‘offer to enter into an SBS that, if
accepted, would result in a binding
contract under applicable law.’’ 848
‘‘Reasonable Basis’’
The Commission additionally sought
comment regarding the degree of
inquiry required for an SBS Entity to
form a ‘‘reasonable basis’’ to believe the
special entity was represented by a
qualified independent representative.
Three commenters expressed concern
with the additional duties of inquiry
and diligence imposed on SBS Entities
under proposed Rule 15Fh–5(a).849 One
of these commenters argued that the
CFTC’s proposed requirement that a
Swap Dealer perform substantial
diligence to confirm a swap advisor’s
qualifications could pose a serious
conflict of interest, give the Swap Dealer
too much power, and ultimately
interfere with, prove more costly for,
and be problematic to state or local
governments.850 Another commenter
similarly argued that an inherent
conflict of interest existed in granting
one party to a transaction the authority
to effectively determine who has the
requisite qualifications to represent the
843 See Proposing Release, 76 FR at 42426, supra
note 3.
844 See APPA, supra note 5; FIA/ISDA/SIFMA,
supra note 5; SIFMA (August 2015), supra note 5.
845 See APPA, supra note 5.
846 Id.
847 See FIA/ISDA/SIFMA, supra note 5.
848 See SIFMA (August 2015), supra note 5.
849 See MFA, supra note 5; GFOA, supra note 5;
CalPERS, supra note 5.
850 See GFOA, supra note 5.

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30025

other party.851 The second commenter
would impose additional due diligence
obligations on SBS Entities before they
could rely on special entities’
representations regarding the
qualifications of representatives, even
where the SBS Entity does not have
information that would cause a
reasonable person to question the
accuracy of the representations.852 The
commenter conceded that requiring
such additional diligence might limit
the willingness or ability of SBS Entities
to provide special entities with access to
security-based swaps. However, it
argued that, in the absence of such
diligence, special entities’ access to
security-based swaps should be limited
to the extent suitability is in
question.853
Other commenters expressed a range
of views in response to our request for
comment on whether an SBS Entity
should be able to rely on representations
to form the necessary ‘‘reasonable basis’’
for believing that a special entity
counterparty is represented by a
qualified independent representative.
One commenter argued that no
particular level of specificity should be
required in the representations, and that
the SBS Dealer should not be required
to conduct further diligence before
relying on the special entity’s
representations, as ‘‘any such diligence
would interfere with the relationship
between the special entity and its
independent advisor and could result in
the SBS Dealer second-guessing the
special entity’s choice of
representative.’’ 854 Another commenter
argued that an SBS Dealer should be
required to rely on the representations
of a special entity concerning the
qualifications of its independent
representative, absent actual knowledge
of facts that clearly contradict material
aspects of the representative’s purported
qualifications.855
851 See CalPERS, supra note 5. This commenter
therefore recommended an approach that would
permit a special entity to choose between either
relying on the Commission’s proposed framework,
or relying on an alternative approach under which
it would be permitted to enter into off-exchange
security-based swap transactions with an SBS
Entity if the special entity had a representative,
whether internal or a third party, that had been
certified as able to evaluate security-based swap
transactions. The commenter contemplated that the
certification process would involve passage of a
proficiency examination to be developed by the
Commission or FINRA ‘‘or another recognized
testing organization.’’ A certified independent
representative would be required to complete
periodic continuing education. Id.
852 See NAIPFA, supra note 5.
853 Id.
854 See BlackRock, supra note 5.
855 See SIFMA (August 2011), supra note 5. The
commenter asserted that requiring an SBS Dealer to

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One commenter suggested adopting a
presumption that the special entity’s
selection of independent representative
was acceptable if the special entity
represents to the SBS Entity that the
representative satisfies the criteria in
Exchange Act Section 15F(h)(5)(A)(i).856
Two other commenters supported the
actual knowledge standard because they
believe the reasonable person standard
in practice could require an SBS Entity
to perform substantial due diligence to
rely on representations.857 One
commenter noted that this additional
due diligence could reduce the number
of SBS Entities willing to contract with
special entities, and could increase the
cost of security-based swaps for those
persons.858 The other expressed concern
that additional due diligence, in the
context of the qualifications of a special
entity’s independent representative,
would be intrusive, time consuming and
unnecessary, and would ‘‘come very
close to having the SBS Dealer ‘approve’
the special entity’s representative.’’ 859
A third commenter expressed similar
concerns, noting that absent actual
knowledge that a representation is
incorrect, SBS Dealers should not be
able to second-guess a special entity’s
selection of a representative.860
Another commenter supported
permitting an SBS Dealer to rely on a
special entity’s representation that its
independent representative met the
statutory and regulatory requirements,
unless the SBS Dealer had reason to
undertake an independent due diligence
investigation into representative’s qualifications
would impose upon the SBS Dealer a duty to
second-guess the special entity’s own assessment of
its representative and provide the SBS Dealer with
the ability to trump a special entity’s choice of asset
manager. According to the commenter, this could
result in a reduced number of security-based swap
counterparties for special entities, as SBS Dealers
would likely limit transactions with special entities
to avoid the potential liability, cost, delay, and
uncertainty arising from this added responsibility.
856 See ABA Committees, supra note 5. That
presumption would be voidable only if one or more
senior representatives of the SBS Entity with
expertise in security-based swap transactions
possessed actual knowledge that a representation
regarding the independent representative’s
qualifications was false. In that situation, the
Special Entity’s senior representative must present
his or her determination promptly in writing to the
special entity’s Chief Investment Officer and Chair
of the Board, or equivalent person.
857 See APPA, supra note 5; BlackRock, supra
note 5.
858 See APPA, supra note 5.
859 See BlackRock, supra note 5.
860 See ABC, supra note 5. According to the
commenter, without such a bright-line rule, SBS
Dealers might face litigation initiated by ERISA
plans for approving a representative who is
subsequently determined to lack needed expertise,
or by the representatives whom they have chosen
to disqualify. This potential liability would
ultimately discourage SBS Dealers from transacting
with ERISA plans altogether.

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believe that the special entity’s
representations with respect to its
independent representative were
inaccurate.861
After the adoption of the CFTC’s final
rules, one commenter urged the
Commission to adopt the CFTC’s
reasonable person approach, under
which an SBS Entity would be deemed
to have a reasonable basis to believe the
special entity has a qualified
independent representative when it
relies on written representations that the
special entity’s representative meets the
criteria for a qualified independent
representative.862 Alternatively, in the
ERISA context, the commenter
suggested that an SBS Entity be deemed
to have a reasonable basis to believe a
special entity subject to ERISA has a
representative that satisfies the
requirements for a qualified
independent representative when it
relies on written representations that the
representative is a fiduciary as defined
in Section 3 of ERISA.863 The
commenter’s suggested modifications
were intended to harmonize the SEC’s
standard with that adopted by the
CFTC.864
Another commenter requested that
the Commission clarify that any
representations made by a special entity
or its representative to satisfy the rules
do not give any party any additional
rights, such as rescission or monetary
compensation (e.g., if the
representations turn out to be
incorrect).865
iii. Response to Comments and Final
Rule
After consideration of the comments,
we are adopting Rule 15Fh–5(a), subject
to the modifications described below.
Application to SBS Dealers and Major
SBS Participants
As a preliminary matter, we continue
to believe and agree with the commenter
that Rule 15Fh–5(a) should apply to
both SBS Dealers and Major SBS
Participants.866 As discussed in Section
II.C. above, in making this
determination, the Commission
recognizes that the statutory language of
the business conduct standards
generally does not distinguish between
SBS Dealers and Major SBS
Participants. Where the statute does
make that distinction, the Commission
also makes that distinction in the
861 See

CCMR, supra note 5.

862 Id.
863 Id.
864 Id.
865 See
866 See

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NAIPFA, supra note 5.

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corresponding rule.867 Here, we believe
Congress intended to impose the
independent representative requirement
equally with respect to SBS Dealers and
Major SBS Participants, since the
specific requirements under Section
15F(h)(5)(A) of the Exchange Act apply
by their terms to both ‘‘security-based
swap dealer[s] and major security-based
swap participant[s] that offer[ ] to or
enter[ ] into a security-based swap with
a special entity.’’ 868 We also believe
that the protections of Rule 15Fh–5
should inure equally to those special
entities that transact with SBS Dealers
as well as those that transact with Major
SBS Participants.
Application to Any Special Entity
Moreover, the Commission continues
to believe that the qualified
independent representative
requirements in Rule 15Fh–5 should
apply whenever an SBS Entity acts as a
counterparty to any special entity. We
acknowledge the commenter’s
suggestion that the Commission ‘‘give
appropriate effect to the limiting
language in Exchange Act Section
15F(h)(5)(A)’’ regarding the types of
special entities to which the
independent representative requirement
applies.869 However, given the
ambiguity between the language of
Sections 15F(h)(2)(C) and
15F(h)(5)(A)(i), we believe that our
interpretation is appropriate and
promotes a more consistent reading of
both provisions of the statute, providing
protections to all special entities.870
This interpretation also gives meaning
to the requirement of Section
15F(h)(5)(A)(i)(VII) concerning
‘‘employee benefit plans subject to
ERISA.’’ Although these benefit plans
are not ECPs within the meaning of
subclause (I) or (II) of clause (vii) of
section 1a(18) of the Commodity
Exchange Act, they are included in the
category of plans identified as special
entities in Exchange Act section
15F(h)(2)(C). For these reasons, we
believe Rule 15Fh–5(a) should apply to
any special entity as counterparty.
867 For example, the requirements under
Exchange Act Section 15F(h)(4)(B) apply only to an
SBS Dealer that acts as an advisor to a special
entity, a distinction that is reflected in Rule 15Fh–
4(b).
868 See 15 U.S.C. 78o–10(h)(5)(A).
869 See Ropes & Gray, supra note 5.
870 See Proposing Release, 76 FR at 42426, supra
note 3. See also H.R. Conf. Rep. 111–517 (Jun. 29,
2010) (‘‘When acting as counterparties to a pension
fund, endowment fund, or state or local
government, dealers are to have a reasonable basis
to believe that the fund or governmental entity has
an independent representative advising them.’’)
(emphasis added).

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
Application to Offers
The Commission continues to believe
that, consistent with statutory language,
the independent representative
requirement of the business conduct
rules should be triggered when an
‘‘offer’’ to enter into a security-based
swap is made. We disagree with the
commenter that applying Rule 15Fh–
5(a) at the offer stage is premature.871
The rules are intended to provide
benefits to special entities by, among
other things, requiring that a special
entity has a qualified independent
representative that undertakes a duty to
act in its best interests in determining
whether to enter into a security-based
swap. The benefits of these protections
could be lost if the rule were to require
only that the special entity counterparty
have an independent representative at
the time the transaction is executed.872
Some commenters argued that the
appropriate definition of the term
‘‘offer’’ should be consistent with
contract law, and that a communication
should only be considered an offer
when, based on the relevant facts and
circumstances, it is ‘‘actionable’’ or
‘‘firm.’’ 873 The Commission agrees with
the commenter that the term ‘‘offer’’ for
purposes of the independent
representative requirement of these
business conduct rules means an ‘‘offer
to enter into a security-based swap that,
if accepted, would result in a binding
contract under applicable law.’’ 874
Given that the relationship between the
SBS Entity and the counterparty is
defined and shaped by contract (e.g.,
generally a master agreement and credit
documents), we believe that the
contractual interpretation is the
appropriate interpretation in this
context. This interpretation is also the
same as the CFTC’s interpretation of an
offer to enter into a swap and would
harmonize the scope of the term offer
for purposes of the independent
representative requirement of these
business conduct rules.875 We believe
that this harmonization will result in
efficiencies for entities that have already
established infrastructure to comply
with the CFTC standard.
Whether preliminary negotiations
would be deemed an ‘‘offer’’ will
depend upon the facts and
circumstances and details of the
communication.876 For example, if the
preliminary communication contains
871 See

APPA, supra note 5.

872 Id.
873 See

FIA/ISDA/SIFMA, supra, note 5. See also
SIFMA (August 2015), supra note 5.
874 See SIFMA (August 2015), supra note 5.
875 See CFTC Adopting Release at 9741.
876 See FIA/ISDA/SIFMA, supra, note 5.

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enough details (or if taken in the context
of several communications) that, if
accepted, would result in a binding
contract, it likely may be an ‘‘offer’’
under the rule.
Reasonable Basis
The Commission recognizes and
believes it appropriate that Rule 15Fh–
5(a) imposes on SBS Entities a duty of
inquiry to form a reasonable basis to
believe the special entity has a qualified
independent representative. The
amount of due diligence the SBS Entity
must perform to form a reasonable basis
to believe the independent
representative meets a particular
qualification will depend upon the
particular facts and circumstances. For
example, if the SBS Entity has no prior
dealings or familiarity with the
particular independent representative, it
will likely require more diligence on the
part of the SBS Entity than a transaction
with an independent representative that
the SBS Entity has had numerous recent
dealings in various different contexts.
Furthermore, if the SBS Entity has dealt
with the independent representative in
other contexts, but not necessarily in the
context of a security-based swap, it may
require some limited diligence to form
a reasonable basis regarding the
requisite qualifications.
The Commission agrees, however,
with the concerns of commenters that
requiring SBS Entities to perform
substantial due diligence regarding the
qualifications of independent
representatives may provide SBS
Entities with the ability to second guess
or negate the special entity’s choice of
independent representative, which may
generally increase transaction costs for
security-based swaps with special
entities, and allow SBS Entities to exert
undue influence over the special
entity’s selection of an independent
representative.877 To address these
concerns, final Rule 15Fh–1(b), as
discussed in Section II.D, allows SBS
Entities to reasonably rely on written
representations regarding the
qualifications and independence of
special entities’ representatives.878 This
generally comports with an SBS Entity’s
heightened standard of care when
transacting with special entities, while
avoiding the potential conflict of
interest and increased transaction costs
that could result if SBS Entities
effectively second-guessed special
entities’ choice of independent
representatives. In addition, we are
adopting safe harbors as discussed
below, pursuant to which an SBS Entity
877 See
878 See

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30027

will be deemed to have a reasonable
basis to believe that the special entity
has a representative that meets the
qualification and independence
requirements of Rule 15Fh–5(a). We
believe the availability of the safe harbor
also addresses the concerns of certain
commenters that SBS Entities not exert
undue influence on the special entity’s
selection of representative.879
The Commission acknowledges one
commenter’s recommended approach
that would permit a special entity to
choose between either: (1) Relying on
the Commission’s proposed framework
regarding a reasonable basis to believe
the qualifications of the independent
representative; or (2) relying on an
alternative approach under which it
would be permitted to enter into offexchange security-based swap
transactions with an SBS Entity if the
special entity had a representative,
whether internal or a third party, that
had been certified as able to evaluate
security-based swap transactions. The
commenter contemplated that the
certification process would involve the
development and implementation of a
proficiency examination by the
Commission or FINRA ‘‘or another
recognized testing organization,’’ and
that a certified independent
representative would be required to
complete periodic continuing
education.880 We do not believe that
this suggested alternative would
appropriately provide the protections to
special entities that the statute and our
proposed Rule 15Fh–5 were designed to
provide. First, we believe that this
alternative would effectively permit
special entities to opt out of the express
protections that the rules are intended
to provide. In addition, we are not
aware of the existence of a certification
process as described by the commenter,
and we did not propose and are not
adopting such a process.881
As with final Rule 15Fh–2(a), we have
determined to adopt Rule 15Fh–5(a) in
a bifurcated format to avoid potential
conflict with ERISA and DOL
regulations, as well as to more closely
harmonize with existing CFTC business
conduct rules. Rule 15Fh–5(a)(1), as
adopted, requires an SBS Entity that
offers to enter into or enters into a
security-based swap with a special
entity other than an ERISA special
entity to form a reasonable basis to
believe that the special entity has a
879 See

e.g., CalPERS (August 2011) supra note 5.
CalPERS, supra note 5.
881 However, to the extent that such a proficiency
examination were created, the results of the
examination could inform the SBS Entity’s
assessment of the qualifications of the independent
representative.
880 See

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qualified independent representative.
Rule 15Fh–5(a)(2), as adopted, requires
an SBS Entity that offers to enter into or
enters into a security-based swap with
an ERISA special entity to have a
reasonable basis to believe that the
special entity has a fiduciary, as defined
in Section 3 of ERISA. By adopting
separate criteria for the independent
representatives of ERISA and nonERISA special entities, the Commission
is addressing the concerns of numerous
commenters that the business conduct
standards, if adopted without regard for
the potential regulatory intersections of
ERISA, could cause confusion and
unintended consequences for SBS
Entities dealing with ERISA plans.882 In
addition, this change will provide
greater consistency with the parallel
CFTC rule, which will result in
efficiencies for SBS Entities that have
already established infrastructure to
comply with the CFTC rule.
The newly bifurcated rule, detailing
the requisite criteria for an SBS Entity
to form a reasonable basis to believe that
ERISA and non-ERISA special entities
have qualified independent
representatives, is discussed in greater
detail below.
b. Qualified Independent Representative
i. Proposed Rule

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Proposed Rule 15Fh–5(a)(6) would
require an SBS Entity to have a
reasonable basis to believe that, in the
case of a special entity that is an
employee benefit plan subject to ERISA,
the independent representative was a
‘‘fiduciary’’ as defined in section 3(21)
of that Act (29 U.S.C. 1002).883 The
proposed rule was not intended to limit,
restrict, or otherwise affect the
fiduciary’s duties and obligations under
ERISA.884
The Proposing Release solicited
feedback regarding any specific
requirements that should be imposed on
SBS Entities with respect to this
obligation, as well as what other
independent representative
qualifications might be deemed satisfied
if an independent representative of an
employee benefit plan subject to ERISA,
is a fiduciary as defined in section 3 of
ERISA.
882 See Section I.D., supra. See also ABC, supra
note 5; FIA/ISDA/SIFMA, supra note 5; IDC, supra
note 5; MFA, supra note 5; BlackRock, supra note
5; Johnson, supra note 5.
883 See Section 15F(h)(5)(A)(i)(VII) of the
Exchange Act, 15 U.S.C. 78o–10(h)(5)(A)(i)(VII). See
note 225, supra and related text regarding an SBS
Entity’s reliance on a representation from the
special entity to form this reasonable basis.
884 See notes 99, 198 and 189, supra regarding the
DOL’s proposal to amend definition of ‘‘fiduciary’’
for purposes of ERISA.

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ii. Comments on the Proposed Rule
The Commission received six
comment letters advocating a
presumption of qualification for ERISA
plan fiduciaries, since ERISA already
imposes fiduciary duties upon the
person who decides whether to enter
into a security-based swap on behalf of
an ERISA plan, and imposes on this
person a statutory duty to act in the best
interests of the plan and its participants,
thereby prohibiting certain self-dealing
transactions.885 According to these
commenters, the Commission’s
proposed standards would be
unnecessary, redundant, would overlap
with ERISA’s standards, and would only
serve to increase the administrative
burden and cost on SBS Entities without
any corresponding benefit.886
To address the potential conflict with
ERISA standards, one commenter
suggested that the Commission’s
definition of ‘‘independent
representative’’ should be inapplicable
to ERISA plans, and that the
Commission should merely crossreference the requirements under ERISA
for ERISA representatives.887
Another commenter supported the
presumptive qualification for ERISA
plan fiduciaries, provided that the plan
satisfied a minimum $1 billion net asset
requirement for institutional investor
organizations.888 The commenter
asserted that no public policy objective
would be achieved by permitting an
SBS Entity to reject a risk manager
fiduciary selected by a sophisticated
institutional investor organization with
over $1 billion in net assets, which did
not require the protections of the
rules.889
Since the adoption of the CFTC’s final
rules, another commenter recently
advocated for the separate treatment of
independent representatives of special
entities subject to ERISA.890 Under this
commenter’s proposal, an SBS Entity
that transacts with a special entity
subject to Title I of ERISA must have a
reasonable belief that the qualified
independent representative is a
fiduciary, as defined in Section 3 of
ERISA.891 An SBS Entity that transacts
with a non-ERISA special entity would
be required to form a reasonable belief
that the special entity has a qualified
885 See ABA Committees, supra note 5; ABC,
supra note 5; BlackRock, supra note 5; Mason,
supra note 5; SIFMA (August 2011), supra note 5;
SIFMA (August 2015), supra note 5.
886 See ABC, supra note 5; BlackRock, supra note
5; Mason, supra note 5.
887 See ABC, supra note 5.
888 See ABA Committees, supra note 5.
889 Id.
890 See SIFMA (August 2015), supra note 5.
891 Id.

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independent representative, defined by
specific criteria. The commenter’s
proposed modification recognizes ‘‘the
unique fiduciary regime already
applicable to such special entities,’’ and
harmonizes the Commission’s criteria
for qualified independent
representatives with those of the
CFTC.892
iii. Response to Comments and Final
Rule
After consideration of the comments,
the Commission is reformulating the
rules to reflect a separate treatment for
transactions with special entities subject
to ERISA, and transactions with special
entities other than those subject to
ERISA. Toward this end, we have
bifurcated Rule 15Fh–5(a) into parts
(a)(1) (applicable to dealings with
special entities other than those subject
to ERISA), and (a)(2) (applicable to
dealings with special entities subject to
ERISA).
Under Rule 15Fh–5(a)(1), as adopted,
an SBS Entity that transacts with a
special entity that is not subject to
ERISA must have a reasonable basis to
believe that the special entity has a
qualified independent representative.
As defined in the rule, a qualified
independent representative is a
representative who: Has sufficient
knowledge to evaluate the transaction
and risks; is not subject to a statutory
disqualification; undertakes a duty to
act in the best interests of the special
entity; makes appropriate and timely
disclosures to the special entity of
material information concerning the
security-based swap; will provide
written representations to the special
entity regarding fair pricing and the
appropriateness of the security-based
swap; in the case of a special entity
defined in 15Fh–2(2) or (5), is subject to
pay to play rules of the Commission, the
CFTC, or a SRO subject to the
jurisdiction of the Commission or the
CFTC; and is independent of the SBS
Entity. These qualifications are
addressed, separately, in Section II.H.7,
infra.
Under new Rule 15Fh–5(a)(2),
(formerly proposed Rule 15Fh–5(a)(6)),
an SBS Entity that transacts with a
special entity subject to ERISA must
have a reasonable basis to believe that
the special entity has a representative
that is a fiduciary, as defined in Section
3 of ERISA.893 In this regard, the SBS
Entity need not undertake further
inquiry into the ERISA fiduciary’s
qualifications. Such a presumption is
based on the pre-existing,
892 Id.
893 29

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comprehensive federal regulatory
regime governing ERISA fiduciaries.894
The Commission agrees with
commenters that ERISA fiduciaries
should be presumptively deemed
qualified as special entity
representatives,895 particularly because
an ERISA fiduciary is already required
by statute and regulations to, among
other things, act with prudence and
loyalty when evaluating a transaction
for an ERISA plan.896 Moreover, as
several commenters noted, to overlap
existing ERISA standards with the
business conduct standards would be
unnecessary, redundant, and would
unnecessarily increase administrative
costs for SBS Entities.897
This bifurcated rule is designed to
address the commenter’s concerns
regarding the need to align the
Commission’s treatment of ERISA plans
with that of the CFTC,898 and will
reflect the potential intersection of the
business conduct rules with the
comprehensive framework of regulation
under ERISA. Specifically, as discussed
above in Section I.D., supra, the
bifurcated format of the rule addresses
the concerns of numerous commenters
that the intersection between ERISA’s
existing fiduciary regulation and the
business conduct standards could lead
to conflict and unintended
consequences for SBS Entities
transacting with ERISA special entities,
up to and including the preclusion of
ERISA plans from participating in
security-based swap markets in the
future.899 By providing separate means
for SBS Entities to comply with the
rules when transacting with ERISA and
non-ERISA special entities, the final
rule will avoid the potential conflict
between the comprehensive framework
of regulation under ERISA and business
conduct rule regimes.
However, the Commission declines
the commenter’s suggestion to exclude
ERISA plans with a minimum net asset
requirement from the requirements of
the rule.900 Rule 15Fh–5 is designed to
ensure that special entities are
894 See 29 U.S.C. 1001 et seq.; History of EBSA
and ERISA, available at http://www.dol.gov/ebsa/
aboutebsa/history.html.
895 See ABA Committees, supra note 5; ABC,
supra note 5; BlackRock, supra note 5; Mason,
supra note 5; SIFMA (August 2011), supra note 5;
SIFMA (August 2015), supra note 5.
896 See supra notes 786 and 799 and
accompanying text.
897 See ABC, supra note 5; BlackRock, supra note
5; Mason, supra note 5.
898 See SIFMA (August 2015), supra note 5.
899 See, e.g., ABC, supra note 5; FIA/ISDA/
SIFMA, supra note 5; IDC, supra note 5; MFA,
supra note 5; BlackRock, supra note 5; Johnson,
supra note 5.
900 See ABA Committees, supra note 5.

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represented by a qualified independent
representative pursuant to the statutory
requirement. The Commission does not
believe that it is appropriate in this
context to provide an exception to
ERISA plans from the protections of
representation by a qualified and
independent representative based on a
net asset threshold. Different entities
will have differing levels of
understanding of the security-based
swap market, which may or may not be
impacted by the amount of their net
assets. More generally, the rules are
intended to provide certain protections
to special entities, and we think it
appropriate to apply the rules so that
special entities receive the benefits of
those rules.
c. Definition of ‘‘Independent
Representative’’
i. Proposed Rule
As noted above, an SBS Entity must
have a reasonable basis to believe that
a special entity has a ‘‘qualified
independent representative.’’ Proposed
Rule 15Fh–2(c) would establish
parameters for the term ‘‘independent
representative’’ of a special entity.
For instance, proposed Rule 15Fh–
2(c)(1) would generally require that a
representative of a special entity be
‘‘independent’’ of the SBS Entity that is
the counterparty to a proposed securitybased swap. Proposed Rule 15Fh–2(c)(2)
would provide that a representative of a
special entity is ‘‘independent’’ of an
SBS Entity if the representative does not
have a relationship with the SBS Entity,
whether compensatory or otherwise,
that reasonably could affect the
independent judgment or decisionmaking of the representative. In the
Proposing Release, the Commission
noted that the SBS Entity should obtain
the necessary information to determine
if, in fact, a relationship existed between
the SBS Entity and the independent
representative that could impair the
independence of the representative in
making decisions that affect the SBS
Entity.
Proposed Rule 15Fh–2(c)(3) would
deem a representative of a special entity
to be independent of an SBS Entity
where two conditions are satisfied: (i)
The representative is not and, within
one year, was not an associated person
of the SBS Entity; and (ii) the
representative had not received more
than ten percent of its gross revenues
over the past year, directly or indirectly,
from the SBS Entity. This latter
restriction would apply, for example,
with respect to revenues received as a
result of referrals by the SBS Entity. It
was intended to encompass situations

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30029

where a representative was hired by the
special entity as a result of a
recommendation by the SBS Entity. The
restriction would also apply to revenues
received, directly or indirectly, from
associated persons of the SBS Entity.
In order for an SBS Entity to
reasonably believe that the independent
representative received less than ten
percent of its gross revenue over the
past year from the SBS Entity, the
Commission noted that the SBS Entity
would likely need to obtain information
regarding the independent
representative’s gross revenues from
either the special entity or independent
representative.
ii. Comments on the Proposed Rule
Independence From the Special Entity
The Commission requested comment
on whether an independent
representative must be independent of
the special entity entering into the
security-based swap, or whether the
representative need only be
independent of the SBS Entity. All five
commenters agreed that the
independent representative need only
be independent from the SBS Entity,
and emphasized that the intent of the
proposed rule was to ensure a special
entity received advice from someone in
no way affiliated with an SBS Entity.901
One commenter, representing two
trade associations for municipal power
producers, argued that the intended
benefit of the proposed independent
representative requirement was to
ensure that a special entity receives
security-based swap advice from a
person other than the SBS Entity—not
to force special entities to hire thirdparties as independent
representatives.902 The commenter
noted that although many municipal
power producers rely on third-party
advisors when entering interest-rate
swaps, they have internal experts to
advise them on energy contracts.
Another commenter asserted that the
legislative history for Dodd-Frank
indicated that a representative’s
‘‘independence’’ referred to its
independence from the dealer or
broker—not its independence from the
special entity.903 The commenter
pointed out that Congress specifically
recognized the possibility that special
entities would use an in-house risk
specialist, and that the proposed rules
901 See APPA, supra note 5; Ropes & Gray, supra
note 5; BlackRock, supra note 5; GFOA, supra note
5; ABA Committees, supra note 5.
902 See APPA, supra note 5.
903 See ABA Committees, supra note 5.

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seemed to incorporate this
assumption.904
Standards for ‘‘Independence’’
The Commission solicited comment
regarding whether to adopt a different
test for a representative’s independence,
or whether the definition of
‘‘independent representative’’ should
exclude certain categories of associated
persons. Eleven comment letters
addressed the independence test in
proposed Rule 15Fh–2(c)(2)–(3).905
Four commenters argued that the
proposed rule would not sufficiently
ensure a representative’s
independence.906 For instance, one
commenter suggested that the one-year
prohibition on a representative being an
associated person of the SBS Entity be
extended to two years.907 This
commenter also recommended that
representatives who receive any
compensation of any kind, directly or
indirectly, from an SBS Entity during
the prior year be disqualified.908
According to this commenter,
representatives and associated persons
should be barred from, directly or
indirectly, working for or receiving
compensation from any SBS Entities for
one year to act as an independent
representative for any special entity.909
Another commenter argued that under
the proposed rule, a representative
might be deemed to be independent
even if he or she ‘‘worked with the SBS
Entity as recently as a year ago, was
recommended by the SBS Entity, has a
direct business relationship with the
SBS Entity that makes the representative
highly financially dependent on that
entity, and earns more of its revenues
from the SBS Entity than from the
Special Entity he or she purports to
represent.’’ 910 This commenter also
noted that, under the proposed rule, a
representative could earn virtually all of
its gross revenues from various SBS
Entities, so long as no more than ten
percent originated from the entity on the
other side of the transaction. For these
reasons, the commenter urged the
Commission to adopt instead the

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904 Id.
905 See ABC, supra note 5; NABL, supra note 5;
NAIPFA, supra note 5; AFSCME, supra note 5;
Better Markets (August 2011), supra note 5; CFA,
supra note 5; FIA/ISDA/SIFMA, supra note 5;
APPA, supra note 5; BlackRock, supra note 5;
SIFMA (August 2011), supra note 5; SIFMA (August
2015), supra note 5.
906 See AFSCME, supra note 5; Better Markets
(August 2011), supra note 5; CFA, supra note 5;
NAIPFA, supra note 5.
907 See Better Markets (August 2011), supra note
5.
908 Id.
909 Id.
910 See CFA, supra note 5.

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version of the independence standard
proposed by the CFTC, under which a
representative would be deemed to be
independent if: ‘‘(1) the representative is
not and, within one year, was not an
associated person of the swap dealer or
major swap participant, within the
meaning of Section 1a(4) of the Act; (2)
there is no principal relationship
between the representative of the
Special Entity and the swap dealer or
major swap participant; and (3) the
representative does not have a material
business relationship with the swap
dealer or major swap participant,
provided however, that if the
representative received any
compensation from the swap dealer or
major swap participant, the swap dealer
or major swap participant must ensure
that the Special Entity is informed of the
compensation and the Special Entity
agrees in writing, in consultation with
the representative, that the
compensation does not constitute a
material business relationship.’’ 911
Similarly, since the adoption of the
CFTC’s final business conduct rules,
one commenter has argued that the
Commission should harmonize its
standards of independence with those of
the CFTC, replacing the SEC’s
restriction on revenues received by the
independent representative from the
SBS Entity with the following
qualifications: (1) The representative is
not, and within one year of representing
the special entity in connection with the
security-based swap, was not an
associated person of the SBS Entity; (2)
there is no principal relationship
between the special entity’s
representative and the SBS Entity; (3)
the representative provides timely and
effective disclosures to the special entity
of all material conflicts of interest,
complies with policies and procedures
designed to mitigate conflicts of interest,
is not directly or indirectly controlled
by the SBS Entity, and does not receive
referrals, recommendations, or
introductions from the SBS Entity
within one year of representing the
special entity in connection with the
security-based swap.912 As the
commenter asserted, ‘‘the CFTC’s
standard has, in our members’
experiences, proved sufficient to ensure
the independence of special entity
representatives and mitigate possible
conflicts of interest, while also
establishing an objective standard that
special entities can apply in practice. As
911 See Business Conduct Standards for Swap
Dealers and Major Swap Participants With
Counterparties, 75 FR 80638, 80660 (Dec. 22, 2010)
(‘‘CFTC Proposing Release’’).
912 See SIFMA (August 2015), supra note 5.

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a result, we believe harmonization
would achieve the proposed rules’
intended objective while also
minimizing the extent to which SBS
Entities and special entities need to
incur significant additional costs.’’ 913
A third commenter suggested that the
Commission revise the independence
test for special entity representatives by:
(1) Using ERISA standards in assessing
the independence of a representative
(but rejecting the DOL’s fiduciary
standard, under which a fiduciary may
not derive more than 1% of its annual
income from a party in interest and its
affiliates); (2) considering a
representative’s relationships with an
SBS Entity on behalf of multiple special
entities, including the representative’s
relationships with an SBS Entity outside
of the security-based swap transaction at
issue; (3) including the revenues of an
independent representative’s affiliates
in applying the gross revenues test; (4)
decreasing the ten-percent gross revenue
threshold; and (5) adopting a two-year
timeframe (rather than one year) to
determine whether a representative is
independent of the SBS Entity.914 The
commenter argued that an independent
representative should be permitted to
receive compensation from the proceeds
of a security-based swap, so long as the
compensation was authorized by, and
paid at the written direction of, the
special entity.915 However, the
commenter did not believe that a special
entity should be allowed to consent to
an independent representative’s
conflicts of interest, even if fully
disclosed, as such conflicts might still
affect the independence of the
representative.916
The sole commenter that supported
the independence test as proposed did
so on the grounds that market
participants would benefit from the
certainty of its safe harbor.917
Another commenter argued that the
proposed rules’ definition of
‘‘independent representative’’ should
not apply to ERISA plans, as ERISA
already defines the criteria for
‘‘independence’’ of a representative.918
According to this commenter, if a plan’s
representative is not independent of the
plan’s counterparty, the transaction
violates the prohibited transaction rules
under ERISA section 406(b). Rather than
913 Id.
914 See

NAIPFA, supra note 5.

915 Id.
916 Id. Nor did the commenter believe that an SBS
Entity should be required to have a reasonable basis
to believe that the representative would make the
appropriate and timely disclosures of any potential
conflicts of interest.
917 See NABL, supra note 5.
918 See ABC, supra note 5.

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
adopt such overlapping regulations, the
commenter suggested cross-referencing
the independence requirements under
ERISA. Otherwise, the prohibition on
investment managers who receive
revenues from SBS Dealers from serving
as independent representatives could
cause plans to lose their best investment
managers and counterparties. Moreover,
the commenter argued that ‘‘the
administrative burden of applying the
gross revenue test could in many cases
be enormous at best and simply
unworkable at worst.’’ 919
However, the majority of commenters
urged the Commission to modify the
proposed independence standards. For
instance, while one commenter
supported the Commission’s one-year
prohibition on associated persons of
SBS Entities serving as special entity
representatives, the commenter
suggested four changes to the gross
revenues component of the proposed
rule: (1) Only payments by or on behalf
of the SBS Entity (not by or on behalf
of any affiliates or other associated
persons) should be taken into account;
(2) the revenue computations should be
based on the representative’s prior fiscal
year rather than a rolling twelve-month
look-back to simplify the calculations
and reduce compliance costs; (3)
payments to any affiliate (other than a
wholly-owned subsidiary) of the
representative should not be taken into
account for purposes of this test; and (4)
an SBS Entity should be able to rely on
representations from the representative
as to its gross revenues and whether
payments that have been made to the
representative equal or exceed the ten
percent threshold.920
Another commenter proposed
reducing the one year disqualification
period for association with the SBS
Entity to six months.921 This commenter
also suggested excluding from the gross
revenue test: (1) Income from referrals
from the gross revenue test, because
referrals ‘‘can be difficult to track;’’ and
(2) income paid by an SBS Entity on
behalf of the special entity.922
A third commenter generally opposed
the proposed rule on the basis that it
was unclear, would require costly
enhancements to compliance systems,
and ‘‘would be particularly problematic
in instances where a corporate
transaction changes the identity of
associated persons during the look-back
year.’’ 923 With respect to the first prong
of the proposed rule, this commenter

supported eliminating the one-year look
back period, as it believed the costs of
compliance with that provision would
outweigh any benefits. Instead, the
commenter argued that ‘‘independence’’
should be established if the
representative is not an associated
person of an SBS Entity at the time of
the transaction.924 With respect to the
gross revenue test, the commenter
argued that the term ‘‘indirect
compensation’’ was vague, and that
‘‘determining what would comprise
indirect compensation and establishing
a compliance system to track that
indirect compensation represents a
significant and time consuming
burden,’’ the expense of which would
likely be passed on to special entities.925
The commenter therefore suggested
limiting the gross revenue test to direct
revenue received by the representative
from the SBS Dealer—and not its
affiliates.926
A fourth commenter objected to the
compliance burdens raised by the
proposed rule, as well as various
implementation concerns on the
grounds that both prongs of the test
were ‘‘moving targets’’ that would
substantially complicate compliance
and impose additional burdens and
costs on advisors and special entities.927
The commenter recommended that the
Commission eliminate the twelvemonth ‘‘look-back’’ provision altogether,
but argued that if the Commission
retained this provision, it should apply
only where a continuing agreement
exists between the representative and
the SBS Entity (such as an ongoing
corporate services agreement), that the
one-year period be defined as a calendar
year rather than a rolling twelve-month
period, and that it should only be
triggered by the SBS Entity and the
representative—not by any associated
persons of the SBS Entity or the
representative.928 This commenter
additionally urged the Commission to
eliminate the gross revenue test on the
grounds that it was unduly restrictive
and difficult to apply. However, if the
Commission retained the gross revenue
test, the commenter requested that the
final rule clarify how gross revenues are
to be calculated.929
Another commenter argued that the
final version of proposed Rule 15Fh–
2(c) clarify that the ten percent gross
revenue test would not apply to any
independent representative employed
924 Id.

919 Id.

925 Id.

920 See

926 Id.

FIA/ISDA/SIFMA, supra note 5.
921 See APPA, supra note 5.
922 Id.
923 See BlackRock, supra note 5.

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927 See

by the special entity, as such a
prohibition would be inappropriate.930
The commenter also suggested that the
prohibition on independent
representatives who have worked for an
SBS Entity within the past year should
not apply if the independent
representative is an employee of the
special entity, who owes the special
entity a fiduciary duty.931 The
commenter asserted that if an
independent representative is an
employee of and owes a fiduciary duty
to an institutional investor organization,
an SBS Entity should have no authority
to assess the representative’s
qualifications. The commenter pointed
out that, as a fiduciary, the employee’s
prior employment by an SBS Entity
would be irrelevant—since any actual
breach of fiduciary duty would be
governed by the special entity’s charter,
state law or other applicable legal
requirements, rather than the DoddFrank Act.932
iii. Response to Comments and Final
Rule
After consideration of the comments,
the Commission is adopting Rule 15Fh–
2(c), with certain modifications. First,
we moved the rule defining the
‘‘independence’’ of a special entity’s
representative from Rule 15Fh–2 to Rule
15Fh–5 in an effort to minimize
confusion, and to consolidate the
requirements of the qualified
independent representative into Rule
15Fh–5. Specifically, the Commission is
renumbering proposed Rule 15Fh–2(c)
as Rule 15Fh–5(a)(1)(vii). In doing so,
we have subsumed the requirement that
a representative be independent of the
SBS Entity under the criteria for a
special entity’s qualified independent
representative.
Consistent with our proposal and
with comments received, we continue to
believe that a qualified independent
representative should be independent of
the SBS Entity, but need not be
independent of the special entity
itself.933 We do not believe that special
entities would receive any greater
protection by being required to incur the
cost of retaining a representative that
was independent of the special entity;
in fact, the special entity may be better
served by someone who has an ongoing
relationship with it and is more familiar
with the uses of the proceeds of the
swap and other needs of the special
entity. Although the Dodd-Frank Act is
930 See

ABA Committees, supra note 5.

931 Id.

SIFMA (August 2011), supra note 5.

928 Id.
929 Id.

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932 Id.
933 See Proposing Release, 76 FR at 42426, supra
note 3. See also APPA; Ropes & Gray, supra note
5; and BlackRock, supra note 5.

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silent concerning the question of
independence from the special entity,
nothing in the Dodd-Frank Act
precludes the use of a qualified
independent representative that is
affiliated with the special entity.
Accordingly, Rule 15Fh–5(a)(1) only
requires that the independent
representative be independent of the
SBS Entity to be a qualified
independent representative.
We are adopting Rule 15Fh–
5(a)(1)(vii) (formerly proposed Rules
15Fh–2(c)(1) and (2)) with one
modification. Proposed Rule 15Fh–
2(c)(1) defined an independent
representative of a special entity, in
part, as ‘‘independent of the securitybased swap dealer or major securitybased swap participant that is the
counterparty to a proposed securitybased swap.’’ Rule 15Fh–5(a)(1)(vii) as
adopted eliminates the phrase ‘‘that is
the counterparty to a proposed securitybased swap’’ from the definition. As
described immediately below, this
change is intended to reconcile the use
of the term ‘‘qualified independent
representative’’ in Rules 15Fh–5(a)(1)
and 15Fh–2(a)(2) as adopted.
Specifically, Rule 15Fh–2(a)(2) as
proposed and as adopted, under which
an SBS Dealer may seek to establish that
it is not acting as an advisor to a special
entity, refers to the definition of
‘‘qualified independent representative’’
as defined in Rule 15Fh–5(a).934
However, although the relevant part of
the definition of the term ‘‘independent
representative of a special entity’’ in
proposed Rule 15Fh–2(c)(1) included
the phrase ‘‘that is a counterparty to a
proposed security-based swap,’’ the
requirements in Rule 15Fh–2(a)(2) (as
proposed and as adopted) are not
limited to transactions in which the SBS
Dealer is a counterparty to the special
entity with respect to the security-based
swap. Thus, as noted, we are
eliminating the phrase ‘‘that is the
counterparty to a proposed securitybased swap’’ in Rule 15Fh–5(a)(1)(vii) as
adopted to reconcile the cross reference
to the term ‘‘qualified independent
representative’’ in Rule 15Fh–2(a)(2).
This change will not alter the scope
of Rule 15Fh–5(a) as adopted, because
that rule is only applicable to an SBS
Entity acting as counterparty to a special
entity. It will, however, align the
definition of qualified independent
representative with the scope of Rule
15Fh–2(a), which applies to
recommended transactions whether or
934 Specifically, Rule 15Fh–2(a)(2) requires,
among other things, a written representation by the
special entity that it ‘‘will rely on advice from a
qualified independent representative as defined in
[Rule] 15Fh–5(a)’’ (emphasis added).

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not the SBS Dealer is a counterparty to
the recommended security-based swap.
As a result, there must always be
someone independent of the SBS Dealer
reviewing any recommended securitybased swap transaction on behalf of the
special entity, whether or not the SBS
Dealer making the recommendation is
the counterparty to the transaction.
Furthermore, the elimination of the
phrase ‘‘that is the counterparty to a
proposed security-based swap’’ in the
rule as adopted will harmonize the rule
more closely with the parallel CFTC
requirement.
Under Rule 15Fh–5(a)(1)(vii)(A) as
adopted, a representative of a special
entity is independent of an SBS Entity
if the representative does not have a
relationship with the SBS Entity,
‘‘whether compensatory or otherwise,
that reasonably could affect the
independent judgment or decisionmaking of the representative.’’ Rule
15Fh–5(a)(1)(vii)(B) (as adopted)
modifies the criteria for determining the
independence of the representative that
was proposed in proposed Rule 15Fh–
2(c)(3) by replacing the ten percent gross
revenues test with requirements for
timely disclosures of all material
conflicts of interest and a prohibition
against referrals, recommendations or
introductions by the SBS Entity within
one year of the representative’s
representation of the special entity.
Under Rule 15Fh–5(a)(1)(vii)(B) as
adopted, a representative of a special
entity will be deemed to be independent
of an SBS Entity if three conditions are
met: (1) The representative is not and,
within one year of representing the
special entity in connection with the
security-based swap, was not an
associated person of the SBS Entity; (2)
the representative provides timely
disclosures to the special entity of all
material conflicts of interest that could
reasonably affect the judgment or
decision making of the representative
with respect to its obligations to the
special entity and complies with
policies and procedures reasonably
designed to manage and mitigate such
material conflicts of interest; and (3) the
SBS Entity did not refer, recommend, or
introduce the representative to the
special entity within one year of the
representative’s representation of the
special entity in connection with the
security-based swap.
Rule 15Fh–5(a)(1)(vii)(B)(1) (formerly
proposed Rule 15Fh–2(c)(2)) requires
that the independent representative is
not and was not an associated person of
the SBS Entity ‘‘within one year of
representing the special entity in
connection with the security-based
swap.’’ One commenter agreed with the

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one-year time frame in this provision.935
One commenter suggested that one year
was not long enough and suggested a
two-year look back 936 and another
commenter suggested that one year was
too long and suggested a six-month look
back.937 After consideration of the
comments, the Commission continues to
believe that an appropriate amount of
time is necessary to ‘‘cool off’’ any
association with an SBS Entity before
being considered independent of the
SBS Entity, and believes that a one-year
period between being an associated
person of an SBS Entity and functioning
as an independent representative is an
appropriate amount of time. We
disagree with the commenter that a
shorter six-month look back would be
appropriate, as we believe that a oneyear cooling off period provides greater
assurances of independence. At the
same time, we do not want to
unnecessarily place lengthy restrictions
on a representative’s ability to work as
an independent representative or
unnecessarily restrict a special entity’s
access to qualified independent
representatives. For this reason, we
believe that a one year restriction strikes
an appropriate balance. In addition to
the comments received, we note that
many market participants have
established compliance policies and
procedures to address a one-year lookback to comply with the CFTC rule that
requires that the independent
representative was not an associated
person of the Swap Entity within the
preceding twelve months or the
independent representative complied
with policies and procedures reasonably
designed to manage and mitigate the
conflict of being an associated person
within the last twelve months.938
Rule 15Fh–5(a)(1)(vii)(B)(2) adds the
new requirement that a representative
must provide timely disclosures to the
special entity of all material conflicts of
interest that could reasonably affect the
judgment or decision making of the
representative regarding its obligations
to the special entity, and the
representative must comply with
policies and procedures reasonably
designed to manage and mitigate such
material conflicts of interest. This
requirement establishes a standard that
is designed to support the development
of an SBS Entity’s reasonable belief
regarding the independence of the
representative advising a special entity.
One commenter recommended adopting
935 See

FIA/ISDA/SIFMA, supra note 5.
CFA, supra note 5.
937 See APPA, supra note 5.
938 See CFTC Adopting Release, 77 FR at 9795,
supra note 21.
936 See

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
such a requirement, asserting that the
CFTC standard, including the
requirement for timely disclosures has,
in their ‘‘members’ experiences proved
sufficient to ensure the independence of
special entity representatives and
mitigate possible conflicts of interest,
while also establishing an objective
standard that special entities can apply
in practice.’’ 939 In addition,
harmonization with the parallel CFTC
rule will result in efficiencies for SBS
Entities that have already established
infrastructure to comply with the CFTC
rule.
In the Commission’s view, to be
‘‘timely,’’ a representative’s disclosures
must allow the special entity sufficient
opportunity to assess the likelihood or
magnitude of a conflict of interest prior
to entering into the security-based swap.
To determine which conflicts of
interest disclosures are required, an SBS
Entity generally would need a
reasonable basis to believe that the
representative reviewed its relationships
with the SBS Entity and its affiliates,
including lines of business in which the
representative solicits business.
Additionally, where applicable, the SBS
Entity generally would also need a
reasonable basis to believe the
representative reviewed the
relationships of its principals and
employees, who could affect the
judgment or decision making of the
representative on behalf of the special
entity.
Lastly, Rule 15Fh–5(a)(1)(vii)(B)(3)
replaces the proposed ‘‘gross revenues’’
test with a standard under which a
representative will not be deemed
independent if the SBS Entity refers,
recommends, or introduces the
representative to the special entity
within one year of the representative’s
representation of the special entity in
connection with the security-based
swap. The change is intended to provide
a simpler standard for achieving the
policy goal that a special entity’s choice
of representative and the advice the
representative provides should be made
without any influence or input from the
SBS Entity.
In making this modification to the
rule as adopted, the Commission seeks
to address commenters’ concerns about
cost, clarity, and practicality.940
Commenters had expressed concerns
regarding the gross revenues test and an
SBS Entity’s ability to accurately track
939 See

SIFMA (August 2015), supra note 5.
SIFMA (August 2011), supra note 5; FIA/
ISDA/SIFMA, supra note 5; APPA, supra note 5;
BlackRock, supra note 5; and SIFMA (August 2015),
supra note 5.
940 See

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the revenues.941 One commenter
suggested eliminating the gross
revenues standard altogether.942 After
consideration of the comments, the
Commission believes that the
disclosures provided and the
prohibition against referrals,
recommendations or introductions
adequately addresses concerns
regarding independence more simply
and directly than the proposed ‘‘gross
revenues’’ test.943 Furthermore, this
prohibition harmonizes the
Commission’s standards for the
independence of the representative with
those of the CFTC.
6. Qualifications of the Independent
Representative
Proposed Rules 15Fh–5(a)(1)(i)–(vii)
would list the required qualifications of
a special entity’s independent
representative. The qualifications would
be that the independent representative:
(1) Has sufficient knowledge to evaluate
a security-based swap and its risks; (2)
is not subject to statutory
disqualification; (3) will undertake a
duty to act in the best interests of the
special entity; (4) makes appropriate
and timely disclosures to the special
entity of material information
941 See SIFMA (August 2011), supra note 5
(expressing concerns about calculating a rolling
twelve months of revenues and arguing that the ten
percent threshold would create a revenue ceiling
that is unduly restrictive and difficult to apply (e.g.,
a representative to multiple collective investment
vehicles would be required to consider each of its
multiple distributors for each collective investment
vehicle as a source of indirect revenue)); FIA/ISDA/
SIFMA, supra note 5 (arguing for clarification that
(1) payments to or from affiliates of the SBS Entity
or representative would not be taken into account;
(2) revenue computations should be determined as
of the end of the prior fiscal year; and (3) the SBS
Entity may rely on representations from the
representative as to its gross revenues and whether
payments equal or exceed the ten percent
threshold); APPA, supra note 5 (suggesting (1)
elimination of income from referrals from the gross
revenue test because referrals are difficult to track;
and (2) gross revenues test should not take into
account income paid by an SBS Entity on behalf of
the special entity); BlackRock, supra note 5
(expressing concerns regarding what would
comprise ‘‘indirect compensation’’ and the
compliance systems to track it and arguing that
revenue received from affiliates of the SBS Dealer
should not be considered); and SIFMA (August
2015), supra note 5 (arguing for the replacement of
the gross revenues test with the CFTC standard).
942 See SIFMA (August 2011), supra note 5; and
SIFMA (August 2015), supra note 5.
943 Although the independence safe harbor under
Rule 15Fh–5(a)(vii)(B) does not include a gross
revenues test, SBS Entities should consider whether
the sources of revenues of a representative create a
conflict of interest that must be disclosed pursuant
to Rule 15Fh–5(a)(vii)(B)(2) or 15Fh–5(b) or
otherwise impede the independence of the
representative. Depending on the facts and
circumstances, failure to disclose material conflicts
of interest when there is a recommendation by a
broker-dealer can be a violation of the antifraud
rules. See, e.g., Chasins, 438 F.2d at 1172.

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30033

concerning the security-based swap; (5)
will provide written representations to
the special entity regarding fair pricing
and the appropriateness of the securitybased swap; (6) (in the case of employee
benefit plans subject to ERISA) is a
fiduciary as defined in ERISA; and (7)
is subject to the pay to play prohibitions
of the Commission, the CFTC, or an
SRO that is subject to the jurisdiction of
the Commission or the CFTC. Each of
these proposed qualifications is
discussed in turn below.
As discussed above in Section
II.H.5.a.iii.B and more fully below, the
rules as adopted will distinguish
between transactions with special
entities subject to ERISA, and
transactions with special entities other
than those subject to ERISA.
Specifically, Rule 15Fh–5(a)(1) as
adopted addresses the qualifications for
the independent representatives of
special entities other than those subject
to regulation under ERISA, and Rule
15Fh–5(a)(2) as adopted addresses the
qualifications for independent
representatives of special entities
subject to regulation under ERISA.
a. Written or Other Representations
Regarding Qualifications
i. Proposal
In the Proposing Release, the
Commission also requested comment
regarding whether independent
representatives must furnish written
representations about their
qualifications, or whether the rules
should permit other means of
establishing that a special entity’s
independent representative possessed
the requisite qualifications.
ii. Comments on the Proposal
The Commission received three
comment letters on this point, all in
favor of a written representation
requirement.944 Although one such
commenter agreed that written
representations should be sufficient to
ensure that a qualified independent
swap advisor had been hired, the
commenter proposed that the written
representations include a verification
that the external swap advisor had
registered with and met professional
standards set by the appropriate
regulatory body overseeing swap
advisors.945 According to the
commenter, this would provide for
independent verification that was not
associated with the SBS Dealer or the
944 See NAIPFA, supra note 5; GFOA, supra note
5; APPA, supra note 5.
945 See GFOA, supra note 5.

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special entity, thereby minimizing any
potential conflict of interests.946
Another commenter suggested that, in
the case of an internal representative,
written representations should be
obtained either from the representative
or from the special entity, or a
combination of the two, depending on
the circumstances.947 In the case of
third-party representatives, the
commenter suggested that the thirdparty representative provide the
statement either directly to the SBS
Entity or to the special entity
acknowledging that the statement would
be relied on by SBS Entities for
purposes of the business conduct
rules.948
iii. Response to Comments and Final
Rule
After considering the comments, the
Commission has determined not to
mandate a manner of compliance with
the requirements of Rule 15Fh–5(a). As
discussed above, the obligation is on the
SBS Entity to have a reasonable basis for
believing that an independent
representative has the necessary
qualifications. An SBS Entity may use
various means, such as reliance on
representations from the special entity
or its representative or due diligence, to
form its reasonable basis to believe the
special entity’s independent
representative meets the qualifications
outlined in Rule 15Fh–5(a).
When an SBS Entity is relying on
representations from a special entity or
its representative to satisfy the
requirements of the rule, the
requirements of Rule 15Fh–1(b) will
apply.949 Consistent with our approach
to representations used to make
institutional suitability determinations,
we believe that parties should be able to
make representations regarding the
knowledge and qualifications of the
independent representative on a
transaction-by-transaction basis, on an
asset-class-by-asset-class basis, or
broadly in terms of all potential
transactions between the parties.
However, where there is an indication
that the independent representative is
not capable of independently evaluating
investment risks, or does not intend to
exercise independent judgment
regarding all of an SBS Entity’s

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946 Id.
947 See

APPA, supra note 5.
See also SIFMA (August 2015), supra note
5 (asserting that an SBS Entity should be deemed
to have formed a reasonable basis to believe that a
special entity has a qualified independent
representative by relying on written representations
that the representative is either an ERISA fiduciary,
or that the representative satisfies the criteria for a
qualified independent representative).
949 See discussion in Section II.D, supra.
948 Id.

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recommendations, the SBS Entity
necessarily will have to be more specific
in its approach. For instance, in some
cases, an SBS Entity may be unable to
determine that an independent
representative is capable of
independently evaluating investment
risks with respect to any security-based
swap. In other cases, the SBS Entity may
determine that the independent
representative is generally capable of
evaluating investment risks with respect
to some categories or types of securitybased swaps, but that the independent
representative may not be able to
understand a particular type of securitybased swap or its risk.
b. Sufficient Knowledge To Evaluate
Transaction and Risks
i. Proposed Rule
Proposed Rule 15Fh–5(a)(1) would
require an SBS Entity to have a
reasonable basis to believe that the
independent representative has
sufficient knowledge to evaluate the
security-based transaction and related
risks.
ii. Comments on the Proposed Rule
The Proposing Release solicited
comment regarding what circumstances,
if any, would give rise to a presumption
of qualification for certain independent
representatives other than ERISA
fiduciaries.
Presumptive Qualification
Two commenters supported a finding
of presumptive qualification for
sophisticated, professional advisers,
such as banks, Commission-registered
investment advisers, registered
municipal advisors, or other similarly
qualified professionals.950 The
commenter stated its view that
applicable federal and/or state
regulations governing these entities
already impose requirements that
ensure a minimum qualification level,
and any additional evaluation of such
representatives’ qualifications would
add little or no value to a special
entity’s representative selection
process.951
Other commenters supported the
presumption of qualification for inhouse representatives of a special entity,
since those representatives should
presumably act in the best interests of
the special entity by virtue of their
employment with the special entity.952
950 See ABC, supra note 5; SIFMA (August 2011),
supra note 5.
951 See SIFMA (August 2011), supra note 5.
952 See ABA Committees, supra note 5; NAIPFA,
supra note 5; CalPERS, supra note 5; Ropes & Gray,
supra note 5; APPA, supra note 5; GFOA, supra
note 5.

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More specifically, one commenter
supported this presumption on the
grounds that the representative had
been hired by the special entity to
perform a hedging and risk control
function, that he or she would be
subject to direct control by his or her
employer, and that he or she would be
subject to regular review.953 Another
commenter supported this presumption
so long as the in-house representative
met established requirements for
qualification, testing and continuing
education.954
Similarly, one commenter supported
the presumption of qualification for
independent representatives where a
governmental entity had verified the
qualifications of its independent
representative employee through the
hiring process.955
Registration of Representative as
Municipal Advisor or Investment
Adviser
In the Proposing Release, the
Commission asked whether to require
that an independent representative be
registered as a municipal advisor or an
investment adviser or otherwise subject
to regulation, such as banking
regulation.956 Three commenters
expressed some support for the
proposed registration requirement for
independent representatives,957 while
one commenter opposed it.958
The first commenter supporting the
registration requirement suggested that
the written representations regarding a
representative’s qualifications include a
verification that the external swap
advisor had registered with and met
professional standards set by the
appropriate regulatory body overseeing
swap advisors.959
Another commenter supported the
requirement that independent
representatives be registered with the
Commission as municipal advisors or
953 See

APPA, supra note 5.
NAIPFA, supra note 5. NAIPFA did not
support a presumption of qualification for ‘‘a
sophisticated, professional adviser such as a bank,
Commission-registered investment adviser,
insurance company or other qualifying QPAM or
INHAM for Special Entities subject to ERISA, a
registered municipal advisor, or a similar qualified
professional.’’
955 See GFOA, supra note 5.
956 See Proposing Release, 76 FR at 42429, supra
note 3. Such registration would subject
independent representatives to rules such as MSRB
rules (for example, Notice 2011–04 Pay to Play
Rules for Municipal Advisors) or other regulation
(for example, 17 CFR 275.206(4)–5). See also
Proposing Release, 76 FR at 42431 n.245–247, supra
note 3.
957 See NAIPFA, supra note 5; GFOA, supra note
5; FIA/ISDA/SIFMA, supra note 5.
958 See APPA, supra note 5.
959 See GFOA, supra note 5.
954 See

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investment advisers, or that they
otherwise be subject to regulation, such
as banking regulations, under which the
independent representative would be
bound by a fiduciary duty of loyalty and
care at all times.960
The third commenter requested that
the Commission establish a safe harbor
permitting an SBS Entity to conclude
that the special entity’s representative
was ‘‘qualified’’ (but not necessarily
‘‘independent’’) if the representative
was a registered municipal advisor or an
SEC-registered investment adviser that
provides investment advice with respect
to security-based swaps (or a foreign
entity having an equivalent status
abroad).961
As noted above, one commenter
opposed requiring employees of a
special entity to register in any capacity,
and suggested that any requirement to
register third-party representatives
should first be issued in the form of a
notice of proposed rulemaking.962
Proficiency Examination
In the Proposing Release, the
Commission requested comment
regarding whether a proficiency
examination should be developed to
assess the qualifications of independent
representatives. Four commenters
supported the development and usage of
a proficiency examination,963 while one
commenter opposed any proficiency
examination for in-house
representatives.964
One commenter, advocating for a
proficiency examination, argued that
such testing should be mandatory for
both in-house and third-party
representatives.965 Another commenter
suggested that the proficiency
examination could be developed by the
Commission, an SRO (e.g., FINRA), or
another recognized testing
organization.966 Furthermore, after
passing the examination, this
commenter suggested that an
independent representative be required
to complete periodic continuing
education.967
On the other hand, one commenter
opposed any proficiency examination
for in-house representatives, and argued
that a proficiency exam for third-party
representatives might provide a false

Periodic Re-Evaluation of Qualifications
In the Proposing Release, the
Commission asked whether an SBS
Entity should be required to reevaluate
(or, as applicable, require a new written
representation regarding) the
qualifications of the independent
representative on a periodic basis.
The Commission received three
comment letters in response to the
request for comment.970 The first
commenter viewed the reevaluation of a
representative’s qualifications as
unnecessary if independent
representatives were subject to
continuing education and periodic
testing requirements.971 Another
commenter suggested that the
Commission permit the representations
regarding a representative’s
qualifications to be set forth in a letter
that could be relied on for the duration
of a swap master agreement.972
However, this commenter
acknowledged a value in requiring
periodic re-certification for third-party
representatives, and recommended that
such re-certification occur every two
years.973 The third commenter was
concerned that trade-by-trade
documentation of the independent
representative criteria could reduce the
speed of trade execution for special
entities and add compliance burdens to
each transaction.974 This commenter
requested that the Commission clarify
that an SBS Dealer may meet its burden
of confirming the qualifications of an
independent representative through
appropriate representations provided by
the special entity no more frequently
than annually.975
iii. Response to Comments and Final
Rule
Upon consideration of the comments,
the Commission is adopting Rule 15Fh–
5(a)(1)(i) (formerly proposed Rule 15Fh–
5(a)(1)), as proposed.
Rule 15Fh–5(a)(1)(i) as adopted
requires that SBS Entities have a
reasonable basis to believe that the
independent representative has

960 See

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NAIPFA, supra note 5.
FIA/ISDA/SIFMA, supra note 5.
962 See APPA, supra note 5.
963 See CFA, supra note 5; CalPERS (August
2011), supra note 5; GFOA, supra note 5; NAIPFA,
supra note 5.
964 See APPA, supra note 5.
965 See NAIPFA, supra note 5.
966 See CalPERS (August 2011), supra note 5.
967 Id.

sense of expertise.968 This commenter
also expressed concern that an
examination requirement might, directly
or indirectly, impose additional costs or
burdens on special entities or SBS
Entities.969

961 See

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968 See

APPA, supra note 5.

969 Id.
970 See NAIPFA, supra note 5; APPA, supra note
5; Ropes & Gray, supra note 5.
971 See NAIPFA, supra note 5.
972 See APPA, supra note 5.
973 Id.
974 See Ropes & Gray, supra note 5.
975 Id.

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30035

sufficient knowledge to evaluate the
transaction and risks. The independent
representative may be required to
register by the statutes and rules of
another regulatory regime, such as
municipal advisor or investment
adviser, and nothing in the business
conduct standards modifies or
otherwise alters those registration
requirements. Whether or not an
independent representative is otherwise
registered under a different regulatory
regime may inform the SBS Entity’s
view of the independent
representative’s knowledge and
qualifications, but would not
automatically satisfy the qualification
requirements of the independent
representative. For example, an
independent representative registered as
an investment adviser may be very
knowledgeable with respect to a variety
of asset classes that do not include
security-based swaps.
While some commenters supported
the development of a proficiency
examination, we are neither developing
nor requiring that a proficiency
examination be developed to assess the
qualifications of independent
representatives.976 As noted above, an
SBS Entity may reasonably rely on
written representations about the
qualifications of the independent
representative to satisfy this obligation.
In this regard, the Commission believes
that the framework of Rule 15Fh–5(a)(1)
provides an appropriate criteria for
assessing the qualifications of special
entity representatives.977
As discussed below, we are separately
providing in new Rule 15Fh–5(a)(2) that
the qualified independent
representative requirement will be
satisfied if a special entity that is subject
to regulation under ERISA has a
representative that is a fiduciary as
defined in Section 3 of ERISA. We
recognize that Congress has established
a comprehensive federal regulatory
framework that applies to plans subject
to regulation under ERISA.978 Such
recognition of the federal regulatory
framework for ERISA plans maintains
statutory protections for ERISA plans,
while addressing the potential conflict,
recognized by commenters, between the
976 See CFA, supra note 5; CalPERS (August
2011), supra note 5; GFOA, supra note 5; NAIPFA,
supra note 5.
977 However, as noted above in Section II.H.5.,
supra, to the extent a proficiency examination or
certification process develops in the future, such
examination or certification may inform an SBS
Entity’s reasonable basis to believe the
qualifications of the independent representative.
978 See 29 U.S.C. 1104 and 1106.

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ERISA rules and business conduct
standards adopted today.979
Commenters have suggested various
time frames in which an independent
representative’s qualifications should be
confirmed or recertified.980 Whether or
not an independent representative’s
qualifications should be periodically reevaluated will likely be dependent on
whether it is reasonable for the SBS
Entity to continue to rely on the
representations regarding the
independent representative’s
qualifications. The Commission
recognizes the potential benefit of
requiring periodic re-evaluation, but is
also mindful of the costs of doing so.
The Commission has determined that it
is appropriate to allow the SBS Entity to
determine the necessity for a reevaluation based on the reasonableness
of its reliance on the representations it
receives from the special entity
regarding the qualifications of the
independent representatives, which will
provide the SBS Entities and the special
entities with flexibility to address their
particular facts and circumstances while
still affording the special entities the
protections of the rules.981
c. No Statutory Disqualification

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i. Proposed Rule
Proposed Rule 15Fh–5(a)(2) would
require an SBS Entity to have a
reasonable basis to believe that an
independent representative is not
subject to a statutory disqualification.
Although Exchange Act Section 15F(h)
979 See Section I.D. supra; see also CFTC
Adopting Release, supra note 21.
980 See Ropes & Gray, supra note 5 (no more
frequently than annually); and APPA, supra note 5
(recertified every two years).
981 As discussed above in Section II.D, the
question of whether reliance on representations
would satisfy an SBS Entity’s obligations under our
business conduct rules will depend on the facts and
circumstances of the particular matter. An SBS
Entity can rely on a counterparty’s written
representations unless the SBS Entity has
information that would cause a reasonable person
to question the accuracy of the representation.
Similar to our approach to the reasonableness of
reliance of representations with respect to
institutional suitability in Section II.G.4,
information that might be relevant to this
determination includes whether the independent
representative has previously advised with respect
to this type of security-based swap or been involved
in the type of trading strategy, and whether the
independent representative has a basic
understanding of what makes the security-based
swap distinguishable from a less complex
alternative. If the SBS Entity knows that the
security-based swap or trading strategy represents a
significant change from prior security-based swaps
that the independent representative has evaluated
or knows that the representative lacks a basic
understanding of what distinguishes the securitybased swap from a less complex alternative, the
SBS Entity generally should consider whether it can
reasonably rely on the representations regarding the
qualifications of the independent representative.

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does not define ‘‘subject to a statutory
disqualification,’’ the term has an
established meaning under Section
3(a)(39) of the Exchange Act,982 which
defines circumstances that would
subject a person to a statutory
disqualification with respect to
membership or participation in, or
association with a member of, an SRO.
While Section 3(a)(39) would not
literally apply here, the Commission
proposed to define ‘‘subject to a
statutory disqualification’’ for purposes
of proposed Rule 15Fh–5 by reference to
Section 3(a)(39) of the Exchange Act.
ii. Comments on the Proposed Rule
In the Proposing Release, the
Commission solicited comment
regarding whether it should require an
SBS Entity to check publicly available
databases, such as FINRA’s BrokerCheck
and the Commission’s Investment
Adviser Public Disclosure program, to
determine whether an independent
representative was subject to a statutory
disqualification.
The Commission received two
comment letters on this issue. To
minimize the degree of diligence
imposed on SBS Dealers, one
commenter suggested requiring thirdparty representatives to affirm that they
are not subject to statutory
disqualification, are not under
investigation, and are not listed on the
publicly available databases described
above.983
After the adoption of the CFTC’s final
rules, the Commission received one
comment letter addressing the
definition of ‘‘statutory disqualification
in the Proposing Release.’’ 984 This
commenter stated that, although the
statutory disqualification standards
under the Exchange Act and the CEA
differ somewhat, both cover comparable
types of disqualifying events.985
Therefore, requiring a dual registrant to
apply different standards for statutory
disqualification ‘‘would impose
substantial and duplicative diligence
documentation, without material
countervailing benefits.’’ 986 To avoid
this conflict, the commenter suggested
including language to accommodate
dually registered SBS Entities by
establishing a safe harbor where they are
deemed to have a reasonable basis to
believe that a person is not subject to
statutory disqualification under the
Exchange Act if the dually registered
SBS Entity has a reasonable basis to
982 15

U.S.C. 78c(a)(39).
APPA, supra note 5.
984 See SIFMA (August 2015), supra note 5.
985 Id.
986 Id.
983 See

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believe that the person is not subject to
statutory disqualification under the
CEA.987 According to the commenter,
this would allow dually registered SBS
Entities to determine whether a special
entity’s representative is subject to
statutory disqualification based on the
information it obtained to ensure
compliance with the parallel CFTC
business conduct rule.988
iii. Response to Comments and Final
Rule
The Commission is adopting
proposed Rule 15Fh–5(a)(2),
renumbered as Rule 15Fh–5(a)(1)(ii), as
proposed, with one modification. The
Commission is incorporating the
definition of ‘‘statutory disqualification’’
under Section 3(a)(39)(A)–(F) of the
Exchange Act, whereas the proposed
rule incorporated the definition under
Section 3(a)(39) of the Exchange Act.
Exchange Act Section 15F(h) does not
define ‘‘subject to a statutory
disqualification,’’ however Exchange
Act Section 3(a)(39) defines the term
‘‘statutory disqualification.’’ As
discussed in the SBS Entity Registration
Adopting Release, the definition in
Exchange Act Section 3(a)(39)
specifically relates to persons associated
with an SRO. In recognition of the fact
that an independent representative of a
special entity may not be associated
with an SRO, we have modified the text
of proposed Rule 15Fh–2(f) to reference
Sections 3(a)(39)(A)–(F) of the Securities
Exchange Act of 1934. This updated
cross-reference incorporates the
underlying issues that give rise to
statutory disqualification without
reference to SRO membership.989
In defining the phrase ‘‘subject to
statutory disqualification,’’ the
Commission declines to reference any
parallel provisions of the CEA.990 The
CFTC defines ‘‘statutory
disqualification’’ under relevant
sections of the CEA, without reference
to parallel provisions of the Exchange
Act. Therefore the inclusion of
references to the CEA might lead to
greater confusion and less certainty
among market participants regarding
987 Id.
988 Id.
989 See Registration Process for Security-Based
Swap Dealers and Major Security-Based Swap
Participants, Exchange Act Release No. 75611 (Aug.
5, 2015), 80 FR 48964 (Aug. 14, 2015) (‘‘Registration
Adopting Release’’).
990 In determining whether an SBS Entity has a
reasonable basis to believe an independent
representative is not subject to a statutory
disqualification, the SBS Entity may reasonably rely
on representations regarding the absence of a
statutory disqualification. See Sections II.D. and
II.H.6.a above.

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what persons would be subject to
statutory disqualification.
The Commission declines to adopt a
commenter’s suggestion to require thirdparty representatives to provide specific
affirmations that they are not subject to
statutory disqualifications, are not
under investigation, and are not listed
on publicly available databases as
subject to a statutory disqualification.
We do not believe that it is necessary or
appropriate to prescribe in Rule 15Fh–
5(a)(1)(ii) how an SBS Entity must form
its reasonable basis to believe that the
independent representative is not
subject to a statutory disqualification;
rather, the rule provides SBS Entities
the flexibility to determine how best to
meet their obligation. The SBS Entity
may reasonably rely on representations
regarding the qualifications of the
independent representative to form its
reasonable basis, but it is not required
to do so. Nor is it required to obtain any
specific representations or affirmations.
d. Undertakes a Duty To Act in the Best
Interests of the Special Entity
i. Proposed Rule
Proposed Rule 15Fh–5(a)(3) would
require an SBS Entity to have a
reasonable basis to believe that the
independent representative would
undertake a duty to act in the best
interests of the special entity.
ii. Comments on the Proposed Rule

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The Commission requested comment
regarding what circumstances, if any,
would give rise to a presumption that an
independent representative was acting
in the best interests of the special entity.
The Commission received seven
comment letters supporting the
presumption that certain representatives
would act in the best interests of the
special entity by virtue of their
employment with the special entity or
their status as fiduciaries.991 According
to these commenters, in-house
representatives of a special entity
should presumably act in the best
interests of their special entity
employer, particularly where their
performance would be subject to the
special entity’s review and
evaluation.992
991 See ABA Committees, supra note 5; NAIPFA,
supra note 5; CalPERS, supra note 5; Ropes & Gray,
supra note 5; APPA, supra note 5; GFOA, supra
note 5; SIFMA (August 2015), supra note 5.
992 See ABA Committees, supra note 5; NAIPFA,
supra note 5; CalPERS, supra note 5; Ropes & Gray,
supra note 5; APPA, supra note 5; GFOA, supra
note 5.

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iii. Response to Comments and Final
Rule
As discussed in Section I.D., supra,
the Commission has modified Rule
15Fh–5 to address the intersection of
Dodd-Frank and ERISA regulation by
distinguishing between non-ERISA
special entities and ERISA special
entities. With respect to non-ERISA
special entities, under Rule 15Fh–
5(a)(1), an SBS Entity must have a
reasonable basis for believing that a
non-ERISA special entity counterparty
has a qualified independent
representative that, among other things,
undertakes a duty to act in the ‘‘best
interests’’ of the special entity.993 With
respect to ERISA special entities, under
Rule 15Fh–5(b)(2), the SBS Entity must
have a reasonable basis to believe a
special entity counterparty that is
‘‘subject to’’ regulation under ERISA has
a representative that is a ‘‘fiduciary’’ as
defined in Section 3 of ERISA. This
bifurcated treatment of ERISA and nonERISA special entities under Rule
15Fh–5(a) addresses the commenter’s
recommendation that the business
conduct rules recognize the
comprehensive federal regulatory
framework that applies to plans that are
subject to regulation under ERISA, as
well as creates efficiencies for special
entities that have already conformed
their relationships with their
representatives to satisfy the CFTC’s
qualification criteria.994
The Commission is adopting
proposed Rule 15Fh–5(a)(3),
renumbered as Rule 15Fh–5(a)(1)(iii), as
proposed. The Commission agrees with
commenters that an SBS Entity may rely
on information about legal arrangements
between the special entity and its
representative to establish that the
representative is obligated to act in the
best interests of the special entity,
including by contract, employment
agreement, or other requirements under
state or federal law. In addition, Rule
15Fh–5(b) provides safe harbors for
forming a reasonable basis regarding the
qualifications of the independent
representative.995 Specifically, part of
the safe harbor is satisfied if the
independent representative provides a
written representation that it is legally
obligated to comply with the applicable
requirements in Rule 15Fh–5(a)(1) that
describe the qualifications of the
independent representative—including
that it undertakes to act in the best
interests of the special entity—by
agreement, condition of employment,
993 Rule

15Fh–5(a)(1)(iii).
SIFMA (August 2015), supra note 5.
995 See Section II.H.6.g. below for a more detailed
discussion of the safe harbor.
994 See

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30037

law, rule, or other enforceable duty.
Given the relief provided by the safe
harbor, at this time, the Commission
does not believe a presumption is
necessary regarding the reasonable
belief of the SBS Entity relating to the
undertaking of the independent
representative to act in the best interests
of the special entity.
e. Makes Appropriate and Timely
Disclosures to Special Entity
i. Proposed Rule
Proposed Rule 15Fh–5(a)(4) would
require an SBS Entity to have a
reasonable basis to believe that the
special entity’s independent
representative would make ‘‘appropriate
and timely’’ disclosures to the special
entity of material information
concerning the security-based swap.
ii. Comments on the Proposed Rule
The Proposing Release solicited
comment regarding whether to impose
specific requirements with respect to
the content of the disclosures in
proposed Rule 15Fh–5(a)(4). The
Commission received six letters
addressing this provision of the
proposed rule. Two commenters
supported the use of specific disclosures
to satisfy this requirement.996 In
contrast, two commenters argued that
the Commission should not require
specific content disclosures.997 One
commenter appeared to argue that the
standard of the proposed rule was too
low,998 and two commenters cautioned
against reading this portion of the
proposed rule as requiring the
disclosure of information before the
execution of each trade.999
A commenter recommended that the
final rules expressly state that the
appropriate and timely disclosure
requirement would be satisfied if the
SBS Entity received a written
representation affirming that the
representative is ‘‘obligated by law and/
or agreement or undertaking to provide
appropriate and timely disclosures to
the special entity.’’ 1000 However, this
commenter additionally believed that,
because this provision of the proposed
rule could be read to mandate preexecution disclosure on a transactionby-transaction basis, it could cause
delays in the execution of securitybased swaps, interfere with special
entities’ ability to hedge positions and
996 See ABC, supra note 5; SIFMA (August 2011),
supra note 5.
997 See APPA, supra note 5.
998 See NAIPFA, supra note 5.
999 See BlackRock, supra note 5; SIFMA (August
2011), supra note 5.
1000 See SIFMA (August 2011), supra note 5.

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portfolio risks, and deprive them of
trading opportunities.1001 Another
commenter requested that the
Commission clarify that proposed Rule
15Fh–5(a)(4) would not require the
disclosure of information before a trade
is executed.1002
A third commenter urged the
Commission not to impose specific
requirements regarding the content of
the disclosures.1003 According to this
commenter, there are too many types of
swaps and circumstances to allow for a
uniform set of mandated
disclosures.1004 After the adoption of
the CFTC’s final rules, a commenter
argued against the specific requirement
that the qualified independent
representative disclose ‘‘material
information concerning the securitybased swap.’’ 1005 The commenter
requested that the Commission instead
make the requirement a general
requirement to make appropriate and
timely disclosures to the special entity
to harmonize this provision with the
parallel CFTC requirement, ‘‘which
would reduce costs for special entities
since most of them have already
conformed their relationships with their
representatives to satisfy the CFTC’s
qualification criteria.’’ 1006
iii. Response to Comments and Final
Rule
As noted above, the SBS Entity may
reasonably rely on representations
regarding the independent
representative making appropriate and
timely disclosures to the special entity
to form its reasonable basis to believe
that the independent representative will
comply with Rule 15Fh–5(a)(1)(iv). As
with Rule 15Fh–5(a)(1)(iii), an SBS
Entity may rely on appropriate legal
arrangements between a special entity
and its representative to form a
reasonable basis to believe the
representative will make appropriate
and timely disclosures to the special
entity of material information regarding
the security-based swap—such as an
existing contract or employment
agreement.
In response to the comments arguing
that pre-trade disclosure should not be
required, we believe the necessity of
pre-trade disclosure will depend on the
facts and circumstances of the particular
security-based swap in the context of
the special entity and independent
representative. The SBS Entity is
1001 Id.
1002 See
1003 See

BlackRock, supra note 5.
APPA, supra note 5.

f. Pricing and Appropriateness
i. Proposed Rule
Proposed Rule 15Fh–5(a)(5) would
require an SBS Entity to form a
reasonable basis to believe that the
special entity’s independent
representative would provide written
representations to the special entity
regarding fair pricing and the
appropriateness of the security-based
swap.
ii. Comments on the Proposed Rule
Four commenters addressed this
proposed rule. Two commenters
supported the Commission’s proposal
that it ‘‘should be sufficient if the
representation states that the
representative is obligated, by law and/
or contract, to review pricing and
appropriateness with respect to any
swap transaction in which the
representative serves as such with
respect to the plan.’’ 1008 Both
commenters urged the Commission to
incorporate this approach into the
adopted rules.
The third commenter suggested that
an independent representative should
be required to disclose the basis on
which it determined that a particular
transaction was fairly priced, and that
the underlying documentation should
be sufficiently detailed to enable a third
party to evaluate the representative’s
conclusion.1009
After the adoption of the CFTC’s
business conduct rules, the fourth
commenter urged the Commission to
harmonize with the CFTC and require
1007 See

1004 Id.
1005 See

required to have a reasonable basis to
believe the independent representative
will provide the appropriate and timely
disclosures. To the extent that any
disclosures from the independent
representative are necessary for the
special entity to make an investment
decision with respect to the securitybased swap, the disclosure would not be
timely if it was given after the
investment decision was made.
Similarly, the CFTC rule also requires
that the Swap Entity have a reasonable
basis to believe that the independent
representative will make ‘‘appropriate
and timely’’ disclosures. Although the
language of the Commission’s rule
narrows the requirement found in the
parallel CFTC rule to appropriate and
timely disclosures of ‘‘material
information concerning the securitybased swap,’’ the timing requirement is
the same.1007

Section II.H.5., supra.
ABC, supra note 5; SIFMA (August 2011),
supra note 5.
1009 See CFA, supra note 5.

that the qualified independent
representative ‘‘evaluate[ ], consistent
with any guidelines provided by the
special entity, regarding fair pricing and
the appropriateness of the securitybased swap.’’ 1010 The commenter
asserted that this harmonization would
reduce compliance costs for special
entities that have already conformed
their relationships with their
representatives to satisfy the CFTC’s
qualification criteria.1011
iii. Response to Comments and Final
Rule
Upon consideration of the comments,
the Commission is modifying proposed
Rule 15Fh–5(a)(5), renumbered as Rule
15Fh–5(a)(1)(v). The Commission agrees
with the commenter’s suggestion that
the Commission should harmonize with
the language of the CFTC’s parallel
provision, which requires an SBS Entity
to form a reasonable basis that the
special entity’s independent
representative will ‘‘evaluate’’ fair
pricing and the appropriateness of the
security-based swap, ‘‘consistent with
any guidelines provided by the special
entity.’’ In the Commission’s view,
requiring an SBS Entity to form a
reasonable basis to believe that an
independent representative will
evaluate, consistent with any guidelines
provided by the special entity, fair
pricing and the appropriateness of the
security-based swap will achieve the
purpose of the proposed rule to ensure
the special entity receives advice
specifically with respect to pricing and
whether or not to enter into the securitybased swap. The rule will also provide
the special entity the flexibility to
provide parameters to its independent
representative regarding the pricing and
appropriateness of its security-based
swap. The Commission therefore agrees
with the commenter’s suggestion that
the special entity’s guidelines, to the
extent a special entity provides them,
should establish the criteria for
assessing the fair pricing and
appropriateness of a security-based
swap. In addition, this change will
harmonize the rule with the parallel
CFTC rule, thus creating efficiencies for
entities that have already established
infrastructure to comply with the CFTC
standard. In the absence of any
guidelines provided by the special
entity, Rule 15Fh–5(a)(1)(v) requires the
SBS Entity to form a reasonable basis to
believe that the independent
representative will evaluate the fair
pricing and appropriateness of the
security-based swap.

1008 See

SIFMA (August 2015), supra note 5.

1006 Id.

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1010 See

SIFMA (August 2015), supra note 5.

1011 Id.

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An SBS Entity also could form a
reasonable basis for its determination by
relying on a written representation that
the independent representative will
document the basis for its conclusion
that the transaction was fairly priced
and appropriate in accordance with any
guidelines provided by the plan, and
that the independent representative or
the special entity will maintain that
documentation in its records for an
appropriate period of time, and make
such records available to the special
entity upon request.1012 In response to
commenters’ concerns, the Commission
clarifies that this provision does not
necessarily require that a representative
provide the special entity transactionby-transaction documentation with
respect to fair pricing and
appropriateness of each security-based
swap. For example, where the
representative is given trading authority,
the representative could consider
undertaking in its agreement with the
special entity to ensure that the
representative will evaluate the pricing
and appropriateness of each swap
consistent with any guidelines provided
by the Special Entity prior to entering
into the swap. In such a situation, the
independent representative could
prepare and maintain adequate
documentation of its evaluation of
pricing and appropriateness to enable
both the representative and the special
entity to confirm compliance with any
such agreement.
g. Subject to ‘‘Pay to Play’’ Prohibitions

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i. Proposed Rule
Proposed Rule 15Fh–5(a)(7) would
require an SBS Entity to have a
reasonable basis to believe that a special
entity’s independent representative is
subject to rules of the Commission, the
CFTC, or an SRO subject to the
jurisdiction of the Commission or the
CFTC that prohibit it from engaging in
specified activities if certain political
contributions have been made, unless
the independent representative is an
employee of the special entity.
While not addressed in the DoddFrank Act, the Commission proposed to
include this ‘‘pay-to-play’’ provision
among the qualifications for
independent representatives.1013 As
discussed more fully in Section II.H.10,

infra, pay-to-play practices in
connection with security-based swap
transactions could result in significant
harm to special entities—particularly
where, as here, the independent
representative is intended to act in the
best interests of special entities.1014 The
pay-to-play provisions of the proposed
rules were intended to deter
independent representatives from
participating, even indirectly, in such
practices.
ii. Comments on the Proposed Rule
The Commission received one
comment letter addressing the inclusion
of a pay-to-play restriction among the
qualifications for independent
representatives. This commenter
supported the exception to the pay-toplay restrictions for advisors who are
employees of the special entity.1015
iii. Response to Comment and Final
Rule
The Commission is adopting
proposed Rule 15Fh–5(a)(7),
renumbered as Rule 15Fh–5(a)(1)(vi), as
proposed. Accordingly, an SBS Entity
must have a reasonable basis for
believing that the independent
representative is subject to rules of the
Commission, the CFTC or an SRO
subject to the jurisdiction of the
Commission or the CFTC that prohibit
it from engaging in specified activities if
certain political contributions have been
made, unless the independent
representative is an employee of the
special entity.1016 As stated in the
Proposing Release, the Commission
continues to believe that an
independent representative in these
circumstances would likely be either a
municipal advisor or an investment
adviser that is already subject to the
MSRB’s or the Commission’s pay-toplay prohibitions. The Commission does
not, however, intend to prohibit other
qualified persons from acting as
independent representatives, so long as
those persons are similarly subject to
pay-to-play restrictions. The
Commission believes that Rule 15Fh–
5(a)(1)(vi) will sufficiently deter SBS
Entities from participating, even
indirectly, in such unlawful practices.

1012 Id.
1013 See Exchange Act Section 15F(h)(1)(C)
(authorizing the Commission to prescribe business
conduct standards that relate to ‘‘such other matters
as the Commission determines to be appropriate’’).
For a discussion of abuses associated with pay to
play practices, see Section II.D.5, infra. See note
213, supra, and related text regarding an SBS
Entity’s reliance on a representation from the
special entity to form this reasonable basis.

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1014 See

note 32, supra.
APPA, supra note 5. See also ‘‘Certain
Political Contributions by SBS Dealers: Proposed
Rule 15Fh–6’’ at Section II.D.4.a., infra.
1016 See Exchange Act Section 15B(e)(4), 15 U.S.C
78o–4(e)(4) (defining ‘‘municipal advisor’’ as a
person ‘‘other than a municipal entity or an
employee of a municipal entity’’ that engages in the
specified activities).
1015 See

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h. ERISA Fiduciary
i. Proposed Rule
Proposed Rule 15Fh–5(a)(6) would
require an SBS Entity to have a
reasonable basis to believe that, in the
case of a special entity that is an
employee benefit plan subject to ERISA,
the independent representative was a
‘‘fiduciary’’ as defined in section 3(21)
of that Act (29 U.S.C. 1002).1017 The
proposed rule was not intended to limit,
restrict, or otherwise affect the
fiduciary’s duties and obligations under
ERISA.1018
The Proposing Release solicited
feedback regarding any specific
requirements that should be imposed on
SBS Entities with respect to this
obligation, as well as what other
independent representative
qualifications might be deemed satisfied
if an independent representative of an
employee benefit plan subject to ERISA,
is a fiduciary as defined in section 3 of
ERISA.
ii. Comments on the Proposed Rule
The Commission received six
comment letters advocating for a
presumption of qualification for ERISA
plan fiduciaries, since ERISA already
imposes fiduciary duties upon the
person who decides whether to enter
into a security-based swap on behalf of
an ERISA plan, and imposes on this
person a statutory duty to act in the best
interests of the plan and its participants,
thereby prohibiting certain self-dealing
transactions.1019 According to these
commenters, the Commission’s
proposed standards would be
unnecessary, redundant, would overlap
with ERISA’s standards, and would only
serve to increase the administrative
burden and cost on SBS Entities without
any corresponding benefit.1020
To address the potential conflict with
ERISA standards, one commenter
suggested that the Commission’s
definition of ‘‘independent
representative’’ should be inapplicable
to ERISA plans, and that the
Commission should merely cross1017 See Section 15F(h)(5)(A)(i)(VII) of the
Exchange Act, 15 U.S.C. 78o–10(h)(5)(A)(i)(VII). See
note 225, supra, and related text regarding an SBS
Entity’s reliance on a representation from the
special entity to form this reasonable basis.
1018 See notes 99, 198 and 189, supra, regarding
the DOL’s proposal to amend definition of
‘‘fiduciary’’ for purposes of ERISA.
1019 See ABA Committees, supra note 5; ABC,
supra note 5; BlackRock, supra note 5; Mason,
supra note 5; SIFMA (August 2011), supra note 5;
SIFMA (August 2015), supra note 5.
1020 See ABC, supra note 5; BlackRock, supra note
5; Mason, supra note 5.

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reference the requirements under
ERISA.1021
Another commenter supported the
presumptive qualification for ERISA
plan fiduciaries, provided that the plan
satisfied a minimum $1 billion net asset
requirement for institutional investor
organizations.1022 The commenter
asserted that no public policy objective
would be achieved by permitting an
SBS Entity to reject a risk manager
fiduciary selected by a sophisticated
institutional investor organization with
over $1 billion in net assets, which did
not require the protections of the
rules.1023 Another commenter
advocated for the separate treatment of
independent representatives of special
entities subject to ERISA.1024 Under this
commenter’s proposal, an SBS Entity
that transacts with a special entity
subject to Title I of ERISA must have a
reasonable belief that the qualified
independent representative is a
fiduciary, as defined in Section 3 of
ERISA.1025 The commenter’s proposed
modification for ERISA special entities
was intended to recognize ‘‘the unique
fiduciary regime already applicable to
such special entities,’’ and to harmonize
the Commission’s criteria for qualified
independent representatives with those
of the CFTC.1026
One commenter asserted that, for
ERISA plans, the determination whether
a disclosure was ‘‘appropriate’’ and
‘‘timely’’ should be made with reference
to ERISA.1027 However, in the event the
Commission imposed its own, separate
requirements on such disclosures, the
commenter requested that the
Commission allow the following
representations to satisfy this provision
of the proposed rule: (1) That the
representative shall provide the special
entity with such information, at such
times, as the special entity may
reasonably request regarding any swap
trade (either individually or in the
aggregate) entered into by such
representative on behalf of the special
entity; and (2) that, in the absence of
specific instruction to the contrary by
the special entity regarding swap trade
disclosure, the representative shall
comply with the disclosure
requirements imposed on the
representative under other applicable
law (e.g., ERISA) and by the special
entity under the special entity’s
1021 See
1022 See

ABC, supra note 5.
ABA Committees, supra note 5.

investment management agreement and
investment guidelines.1028
iii. Response to Comments and Final
Rule
As discussed in Section II.H.5.b.iii,
we are adopting a new Rule 15Fh–
5(a)(2) that expressly addresses dealings
with special entities subject to ERISA.
Under new Rule 15Fh–5(a)(2),
(formerly proposed Rule 15Fh–5(a)(6)),
an SBS Entity that acts as a counterparty
to an employee benefit plan subject to
Title I of ERISA must have a reasonable
basis to believe that the special entity
has a representative that is a fiduciary
as defined in Section 3 of ERISA. In this
regard, an ERISA fiduciary will be
presumed to be a qualified independent
representative, and the SBS Entity need
not undertake further inquiry into the
ERISA fiduciary’s qualifications. Such a
presumption acknowledges the preexisting, comprehensive federal
regulatory regime governing ERISA
fiduciaries and the importance of
harmonizing the Dodd-Frank Act
requirements with ERISA to avoid
unintended consequences.1029 This
formulation also will align the
Commission’s treatment of ERISA plans
with that of the CFTC.
i. Safe Harbor
i. Summary of Comments
Although not included in the
proposed rules, after adoption of the
CFTC’s final rules, one commenter
requested that the Commission adopt
separate safe harbors for transactions
with ERISA and non-ERISA special
entities regarding the requirement that
an SBS Entity form a reasonable basis to
believe that the special entity has a
qualified independent
representative.1030 According to this
commenter, the adoption of separate
safe harbors for ERISA and non-ERISA
special entities would align the
Commission’s requirements with those
of the CFTC by recognizing the ‘‘unique
fiduciary regime already applicable to’’
ERISA special entities, and, for
transactions with non-ERISA special
entities, the safe harbor would ‘‘help
speed implementation, reduce costs,
and mitigate counterparty confusion,
because most special entity
representatives have already taken steps
to ensure that they can provide the
representations contained in the CFTC’s
safe harbor.’’ 1031

1023 Id.
1024 See

SIFMA (August 2015), supra note 5.

1028 Id.

1025 Id.

1029 See

1026 Id.

1030 See

1027 See

ABC, supra note 5.

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Section I.D., supra.
SIFMA (August 2015), supra note 5.

1031 Id.

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ii. Response to Comments and Final
Rule
After consideration of the comments,
the Commission has determined to add
a new bifurcated safe harbor in Rule
15Fh–5(b), similar to that adopted by
the CFTC. The Commission believes the
safe harbor will provide SBS Entities an
efficient manner with which to comply
with the requirement to have a
reasonable basis to believe an
independent representative meets
certain enumerated qualifications while
meeting the purposes of the rule.
Under Rule 15Fh–5(b)(1) as adopted,
an SBS Entity shall be deemed to have
a reasonable basis to believe that a nonERISA special entity has a
representative that satisfies the
requirements of Rule 15Fh–5(a)(1) if: (i)
The special entity represents in writing
to the SBS Entity that it has complied
in good faith with written policies and
procedures reasonably designed to
ensure that it has selected a
representative that satisfies the
requirements of Rule 15Fh–5(a)(1), and
that such policies and procedures
provide for ongoing monitoring of the
performance of such representative
consistent with Rule 15Fh–5(a)(1); and
(ii) the representative represents in
writing to the special entity and the SBS
Entity that the representative: Has
policies and procedures reasonably
designed to ensure that it satisfies the
requirements of Rule 15Fh–5(a)(1);
meets the independence test of Rule
15Fh–f(a)(1)(vii); has the knowledge
required under paragraph (a)(1)(i) of this
section; is not subject to a statutory
disqualification under paragraph
(a)(1)(ii) of this section; undertakes a
duty to act in the best interests of the
special entity as required under
paragraph (a)(1)(iii) of this section; and
is subject to the requirements regarding
political contributions, as applicable,
under paragraph (a)(1)(vi) of this
section; and is legally obligated to
comply with the requirements of Rule
15Fh–5(a)(1) by agreement, condition of
employment, law, rule, regulation, or
other enforceable duty.1032
Under Rule 15Fh–5(b)(2) as adopted,
an SBS Entity shall be deemed to have
a reasonable basis to believe that an
ERISA special entity has a
representative that satisfies the
requirements of Rule 15Fh–5(a)(2),
provided that the special entity provides
in writing to the SBS Entity the
1032 SBS Entities should keep in mind that
reliance on these representation must be reasonable.
As discussed in Section II.D, supra, reliance on a
representation would not be reasonable if the SBS
Entity has information that would cause a
reasonable person to question the accuracy of the
representation.

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representative’s name and contact
information, and represents in writing
that the representative is a fiduciary as
defined in Section 3 of ERISA.
Obtaining the name and contact
information provides the SBS Entity
with basic information to investigate
further if it becomes questionable
whether it can reasonably rely on the
special entity’s representation or if the
need arises for it to further investigate
any of the representatives qualifications.
In addition, it is highly likely that the
SBS Entity will have the information in
the ordinary course of negotiating the
security-based swap if the independent
representative is advising or negotiating
the security-based swap on behalf of the
special entity.
The Commission believes that the safe
harbor will better enable an SBS Entity
to fulfill its obligations under Rule
15Fh–5(a), while at the same time
appropriately providing protections for
special entities. The Commission also
agrees with commenters that the safe
harbor will increase the efficiency of
SBS transactions, reduce costs, and
mitigate counterparty confusion. We
believe that although SBS Entities will
need to obtain additional
representations relating to meeting
certain of the standards in Rule 15Fh–
5(a)(1), most SBS Entities and special
entity representatives will still be able
to leverage any existing compliance
infrastructure established pursuant to
the CFTC’s safe harbor.1033
Additionally, as discussed above, the
bifurcated nature of the safe harbor
appropriately recognizes existing ERISA
regulations.1034
7. Disclosure of Capacity

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a. Proposed Rule
Proposed Rule 15Fh–5(b) would
require that, before initiation of a
security-based swap with a special
entity, an SBS Dealer must disclose in
writing the capacity or capacities in
which it is acting, and, if the SBS Dealer
engages in business or has engaged in
business within the last twelve months
with the counterparty in more than one
capacity, the SBS Dealer must disclose
the material differences between such
capacities in connection with the
security-based swap and any other
1033 See Section VI.C.4.iv., infra. However, the
CFTC safe harbor does not require the
representative to represent that it has the
knowledge required under paragraph (a)(1)(i) of this
section; is not subject to a statutory disqualification
under paragraph (a)(1)(ii) of this section; undertakes
a duty to act in the best interests of the special
entity as required under paragraph (a)(1)(iii) of this
section; and is subject to the requirements regarding
political contributions, as applicable, under
paragraph (a)(1)(vi) of this section.
1034 See Section II.H.6.g., supra.

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financial transaction or service
involving the counterparty.1035
Therefore, an SBS Dealer that is acting
as a counterparty but not an advisor to
a special entity would need to make
clear to the special entity the capacity
in which it is acting (i.e., that it is acting
as a counterparty, but not as an advisor).
As noted in the Proposing Release, a
firm might act in multiple capacities in
relation to a special entity. For example,
the firm might act as an underwriter in
a bond offering, as well as a
counterparty to a security-based swap
used to hedge the financing
transaction.1036 Because the SBS
Dealer’s duty to the special entity might
vary according to the capacity in which
it is acting, the special entity and its
independent representative should
understand the SBS Dealer’s roles in
any transaction.1037 The proposed rule
would therefore require an SBS Dealer
that engages in business, or has engaged
in business within the last twelve
months, with the counterparty in more
than one capacity to disclose the
material differences between such
capacities in connection with the
security-based swap and any other
financial transaction or service
involving the counterparty.1038 The
requirements of the proposed rule
would apply to SBS Dealers, but not
Major SBS Participants, because the
statutory requirement, by its terms,
requires disclosure in writing of ‘‘the
capacity in which the security-based
swap dealer is acting’’ (emphasis
added).
b. Comments on the Proposed Rule
The Commission received five
comment letters on this proposed rule.
Three commenters expressed concern
over the burden imposed on large
institutions, which would have to
identify and disclose a myriad of
possible relationships with special
entities.1039 Conversely, one commenter
suggested broadening the rule to apply
to Major SBS Participants in addition to
SBS Dealers.1040 The last commenter
suggested conforming the disclosure of
1035 See Section 15F(h)(5)(A)(2)(i) of the Exchange
Act, 15 U.S.C. 78o–10(h)(5)(A)(2)(i).
1036 See Swap Financial Group Presentation at 55.
1037 In the case of special entities that are
municipal entities, MSRB Rule G–23 generally
prohibits dealer-financial advisors from acting in
multiple capacities in the same municipal securities
transactions. See also MSRB Notice 2011–29 (May
31, 2011) (discussing rule amendment and
interpretive notice). Similarly, Section 206(3) of the
Investment Advisers Act of 1940 governs disclosure
to a client when acting in certain capacities.
1038 See proposed Rule 15Fh–5(b).
1039 See SIFMA (August 2011), supra note 5; ABC,
supra note 5; FIA/ISDA/SIFMA, supra note 5.
1040 See Better Markets (August 2011), supra note
5.

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capacity requirement to that of the
CFTC.1041
The first commenter argued that the
Commission’s proposed capacity
disclosure requirement was problematic
for two reasons.1042 First, it might
conflict with some SBS Dealers’
obligations to keep certain lines of
business separated from one another. In
this commenter’s view, to comply with
this requirement, large, multifaceted
SBS Dealers that have different
relationships with the same special
entity could be forced to review
activities throughout their entire
organizations—in some cases, across
informational walls that separate the
different business lines of the firm.
Second, the requirement might cause
execution delays for special entities,
since the SBS Dealer would need time
to determine the disclosures it must
make to the special entity. The
commenter asked the Commission to
clarify in the final rule that this
disclosure requirement applied only to
the SBS Dealer and the special entity,
and that it would not apply to any
associated persons of either the SBS
Dealer or the special entity. The
commenter additionally argued that the
twelve-month look back period
constituted a ‘‘moving target,’’ and
suggested that the Commission define
the period as a calendar year, rather
than a rolling twelve-month period.1043
Another commenter urged the
Commission to allow SBS Entities to
represent the capacity in which they
were acting with respect to an ERISA
plan in a schedule or amendment to an
ISDA Master Agreement, other
transactional document, or in an annual
disclosure document provided by the
SBS Entity to the special entity, which
could be changed if the SBS Entity were
to act in a different capacity.1044
Because ERISA plans generally deal
with SBS Entities as counterparties, the
commenter believed this would be an
effective and non-burdensome way to
make such representations. The
commenter additionally asserted that it
might be harmful to a special entity to
require an SBS Entity to disclose the
myriad different capacities in which the
SBS Entity has acted with respect to the
special entity—since requiring SBS
Dealers with diverse global operations
to disclose every relationship with a
plan (which often has multiple
investment managers and service
1041 See
1042 See

SIFMA (August 2015), supra note 5.
SIFMA (August 2011), supra note 5.

1043 Id.
1044 See ABC, supra note 5. Some commenters
referenced both SBS Dealers and Major SBS
Participants although the Commission only
proposed to apply the requirement to SBS Dealers.

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providers), then requiring the plan
manager to review such disclosures
would pose a significant administrative
burden and result in high costs and
delayed trades. These costs would likely
be passed on to special entities.
Another commenter argued that it
‘‘would be impossible for an SBS Entity
to ascertain and disclose every other
relationship it may have with its
counterparties’’ because large financial
institutions have multiple points of
contact with counterparties, making it
impossible to systematically collect and
disclose the required information.1045
This commenter argued that the
Proposing Release did not include an
analysis of the costs associated with the
requirement to disclose capacity. The
commenter recommended that the
Commission narrow this requirement to
cover only disclosure of the material
differences between the capacities in
which the SBS Entity itself (and not any
of its affiliates or other associated
persons) acted in connection with the
relevant security-based swap
transaction. In the alternative, the
commenter suggested that the
Commission require disclosure
regarding the capacities in which the
SBS Entity has acted with respect to the
counterparty other than in connection
with the relevant security-based swap
transaction, and that the SBS Entity
should be permitted to satisfy that
requirement with a generic disclosure of
the general types of capacities in which
it may act or have acted with respect to
the counterparty (along with a statement
distinguishing those capacities from the
capacity in which the SBS Entity is
acting with respect to the present
security-based swap).
One commenter suggested that the
capacity disclosure requirement be
applied equally to SBS Dealers and
Major SBS Participants, as it would
maximize the protection for special
entities.1046
After the adoption of the CFTC’s final
rules, a commenter subsequently
recommended deleting this twelvemonth ‘‘look back’’ period, as well as
the requirement that SBS Dealers
disclose the material differences
between such capacities ‘‘in connection
with the security-based swap and any
other financial transaction or service
involving the counterparty.’’ 1047
According to the commenter, these
modifications would harmonize the
Commission’s rule with the parallel
CFTC rule, and reduce confusion among
1045 See
1046 See

FIA/ISDA/SIFMA, supra note 5.
Better Markets (August 2011), supra

note 5.
1047 See SIFMA (August 2015), supra note 5.

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counterparties regarding the nature of
their relationship with an SBS
Dealer.1048
c. Response to Comments and Final
Rule
Upon consideration of the foregoing
comments, the Commission is adopting
proposed Rule 15Fh–5(b), renumbered
as Rule 15Fh–5(c), with several
modifications in response to comments.
Proposed Rule 15Fh–5(b) would require
that, before initiation of a security-based
swap with a special entity, an SBS
Dealer must disclose in writing the
capacity or capacities in which it is
acting, and, if the SBS Dealer engages in
business or has engaged in business
within the last twelve months with the
counterparty in more than one capacity,
the SBS Dealer must disclose the
material differences between such
capacities in connection with the
security-based swap and any other
financial transaction or service
involving the counterparty. As
discussed below, in response to
comments, the Commission is amending
the first part of the rule to clarify that
the disclosure of the capacity in which
the SBS Dealer is acting is ‘‘in
connection with the security-based
swap.’’ The Commission also is
amending the second part of the rule to
clarify the capacities between which
material differences must be disclosed.
In addition, we are deleting the 12
month look-back period. Specifically,
under the rule, as adopted (renumbered
as Rule 15Fh–5(c)), before initiation of
a security-based swap, an SBS Dealer
must disclose to the special entity in
writing the capacity in which the SBS
Dealer is acting ‘‘in connection with the
security-based swap,’’ and, if the SBS
Dealer engages in business 1049 with the
counterparty in more than one capacity,
the SBS Dealer must disclose the
material differences between the
capacity in which the SBS Dealer is
acting with respect to the security-based
swap and the capacities in which it is
acting with respect to any other
financial transaction or service
involving the counterparty to the special
entity.
Several commenters argued that the
proposed requirement that the SBS
Dealer disclose the capacity in which it
was acting was too broad and would
1048 Id.
1049 As discussed below, the rule is designed to
help ensure that the special entity understands the
SBS Dealer’s role in the security-based swap
transaction that is being initiated, and to
distinguish that role, if applicable, from its role
with respect to any other services the SBS Dealer
is providing or transactions in which it is involved
with the special entity. The term ‘‘engages in’’
should be interpreted broadly to achieve that goal.

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require the disclosure of a myriad of
possible relationships.1050 Some
commenters suggested that the relevant
disclosure should be the capacity in
which the SBS Dealer is acting ‘‘in
connection with the security-based
swap’’ and suggested the rule should be
narrowed accordingly.1051 A commenter
also suggested that the Commission
revise the disclosure of different
capacities to eliminate the language that
requires such disclosures to be ‘‘in
connection with the security-based
swap and any other financial
transaction or service involving the
counterparty.’’ 1052
The Commission agrees with
commenters that the disclosure of
capacity in the first part of the rule
should be limited to the capacity in
which the SBS Dealer is acting in
connection with the security-based
swap, and has amended the rule to
clarify this limitation. However, the
Commission declines the commenter’s
suggestion to eliminate the disclosure of
material differences between or among
the different capacities in which the
SBS Dealer is acting ‘‘in connection
with the security-based swap and any
other financial transaction or service
involving the counterparty.’’ 1053 The
proposed rule was designed to provide
the counterparty with sufficient
information about the capacity in which
the SBS Dealer is acting, and any
material differences between its
capacity in connection with the
security-based swap and any other
financial transaction or service
involving the counterparty, to help
ensure that the counterparty
understands the SBS Dealer’s role in the
security-based swap transaction that is
being initiated, and to distinguish that
role, if applicable, from its role with
respect to any other services it is
providing or transactions in which it is
involved with the counterparty.
Eliminating the requirement that the
SBS Dealer disclose the material
differences in the different capacities in
which it is acting would not address
potential counterparty confusion that
could arise when a SBS Dealer changes
status from transaction to transaction.
Some commenters expressed concerns
regarding the burden and practical
issues relating to having to apply this
disclosure requirement to the activities
of associated persons of the SBS
1050 SIFMA (August 2011), supra note 5; FIA/
ISDA/SIFMA, supra note 5; and ABC, supra note
5.
1051 See ABC, supra note 5; SIFMA (August 2011),
supra note 5.
1052 See SIFMA (August 2015), supra note 5.
1053 See FIA/ISDA/SIFMA, supra note 5; and
SIFMA (August 2015), supra note 5.

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Dealer 1054 and associated persons of the
special entity.1055 The Commission
recognizes the practical and operational
difficulties described in the comment
letters in determining the capacity in
which associated persons, including
affiliates, are acting or have acted with
respect to the special entity. The
Commission also recognizes the role of
the independent representative in
advising the special entity with respect
to these transactions. Given these
considerations, the Commission agrees
with the commenter it would be
appropriate for the SBS Dealer to use
generalized disclosures regarding the
other capacities in which the SBS
Dealer and its associated persons,
including affiliates, have acted or may
act with respect to the special entity and
its associated persons, along with a
statement distinguishing those
capacities from the capacity in which
the SBS Dealer is acting with respect to
the present security-based swap.1056
Such disclosure would require
consideration of the SBS Dealer’s
business and the types of capacities in
which it and its associated persons has
acted or may act with respect to the
particular special entity. We believe that
this generalized disclosure of other
capacities will help ensure that the
counterparty understands the SBS
Dealer’s role in the security-based swap
transaction that is being initiated, and to
distinguish that role, if applicable, from
its role with respect to any other
services it is providing or transactions
in which it is involved with the
counterparty.
After consideration of the comments,
the Commission also acknowledges the
commenters’ concerns regarding the
workability and potential delay in
execution of transactions and increased
costs the twelve month look back may
cause. Accordingly, the Commission has
also modified the adopted rule to
eliminate the 12-month look back
period for business in which the SBS
Dealer has engaged.
As discussed in Section II.G.2.b.
above, the Commission does not
prescribe the manner in which these
disclosure must be made. In response to
comments received,1057 the Commission
notes that the required disclosures
could be made in a transactional
document or an annual disclosure
document, depending on the number of
capacities in which the SBS Dealer is
acting and whether such capacities have
changed. In any event, the disclosure
1054 See

SIFMA (August 2011), supra note 5.
1055 See FIA/ISDA/SIFMA, supra note 5.
1056 Id.
1057 See ABC, supra note 5.

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must be sufficient to meet the
requirements of the rule, which is
designed to ensure that the special
entity understands the SBS Dealer’s role
in the security-based swap transaction
that is being initiated, and to distinguish
that role, if applicable, from its role with
respect to any other services the SBS
Dealer is providing or transactions in
which it is involved with the special
entity.
Finally, the Commission declines to
apply Rule 15Fh–5(c) to Major SBS
Participants, since the statutory
requirement, by its terms, requires
disclosure in writing of ‘‘the capacity in
which the security-based swap dealer is
acting.’’ Furthermore, as discussed in
Section II.C., supra, we have not sought
to impose the full range of business
conduct requirements on these Major
SBS Participants. We note that our
approach in this regard largely mirrors
that of the CFTC, under whose rules
Swap Entities have operated for some
time.
8. Exceptions for Anonymous, Special
Entity Transactions on an Exchange or
SEF
a. Proposed Rules
As previously discussed in Section
II.B, supra, Section 15F(h)(7) of the
Exchange Act provides that ‘‘[t]his
subsection shall not apply with respect
to a transaction that is (A) initiated by
a special entity on an exchange or
security-based swap execution facility;
and (B) one in which the security-based
swap dealer or major security-based
swap participant does not know the
identity of the counterparty to the
transaction.’’ 1058 We proposed to read
Section 15F(h)(7) to apply to any
transaction with a special entity on a
SEF or an exchange where the SBS
Entity does not know the identity of its
counterparty.1059 We further proposed
exceptions from the requirement of
proposed Rules 15Fh–4 (special
requirements for SBS Dealers acting as
advisors to special entities) and
15Fh–5 (special requirements for SBS
Entities acting as counterparties to
special entities) for such transactions.
b. Comments on the Proposed Rules
The Commission received five
comments that generally addressed the
exception for anonymous or SEF and
exchange-traded security-based
swaps,1060 and five comments that
1058 15

U.S.C. 78o–10(h)(7).
Proposing Release, 76 FR at 42421, supra

1059 See

note 3.
1060 See CFA, supra note 5; SIFMA (August 2011),
supra note 5; FIA/ISDA/SIFMA, supra note 5; MFA,
supra note 5; BlackRock, supra note 5.

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30043

specifically addressed the exception for
anonymous, exchange or SEF-traded
security-based swaps with special
entities.1061 The comment letters that
generally address this exception are
discussed above, in Section II.B, supra.
In the specific context of securitybased swap transactions with special
entities, one commenter suggested that
the business conduct standards should
only apply to non-SEF and nonexchange traded transactions, regardless
whether the transaction is
anonymous.1062 This commenter urged
the Commission to clarify that the
proposed rules would not apply to any
security-based swap transaction that is
entered into by a special entity on a
designated contract market or SEF.1063
Two commenters addressed the
Commission’s proposal to apply the
statutory exception to any anonymous
transaction with a special entity on a
registered exchange or SEF.1064 One
commenter supported this proposal as a
‘‘reasonable approach which is
consistent with Congressional intent
that the enhanced protections apply to
transactions where there is a degree of
reliance by the special entity on the
dealer or major swap participant.’’ 1065
The second commenter argued that the
exception in Section 15Fh(7) was
intended to apply to all external
business conduct requirements
promulgated under subsection (h), and
not merely those requirements relating
to SBS Dealers acting as advisors or
counterparties to special entities.1066
Another commenter argued that
Congress did not intend for the
exception to apply when SBS Entities
initiate transactions on a SEF or an
exchange.1067 According to this
commenter, SBS Entities seeking to
conduct business on a SEF or exchange
should bear the risk that their
counterparties are special entities, as the
risk would incentivize SBS Entities to
determine the identity of their
counterparties when they initiate
security-based swap transactions on an
SEF or exchange. The commenter
recommended that the Commission
adopt a ‘‘clear test’’ for determining
when a special entity ‘‘initiates’’ a
security-based swap transaction, and
that the test differentiate between
1061 See ABC, supra note 5; SIFMA (August 2015),
supra note 5; CFA, supra note 5; Better Markets
(August 2011), supra note 5; FIA/ISDA/SIFMA,
supra note 5.
1062 See ABC, supra note 5.
1063 Id.
1064 See CFA, supra note 5; FIA/ISDA/SIFMA,
supra note 5.
1065 See CFA, supra note 5.
1066 See FIA/ISDA/SIFMA, supra note 5.
1067 See Better Markets (Aug. 2011), supra note 5.

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initiating a negotiation and initiating a
transaction.1068 After adoption of the
CFTC’s business conduct standards,
another commenter urged the
Commission to adopt an exception for
exchange-traded security-based swaps
that are intended to be cleared if: (1)
The transaction is executed on a
registered or exempt security-based
swap execution facility or registered
national security exchange; and (2) is of
a type that is, as of the date of
execution, required to be cleared
pursuant to Section 3C of the Exchange
Act; or (3) the SBS Dealer does not
know the identity of the counterparty, at
any time up to and including execution
of the transaction.1069 The commenter
argued that these modifications would
harmonize the scope of the SEC’s
special entity requirements with the
parallel CFTC requirements set forth
under the relief provided by CFTC NoAction Letter 13–70.1070

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c. Response to Comments and Final
Rules
After consideration of the comments,
the Commission is adopting Rule 15Fh–
4(b)(3) and Rule 15Fh–5(c) (the latter
renumbered as 15Fh–5(d)) with several
modifications. Under the rules as
adopted, the business conduct
requirements of Rules 15Fh–4 and
15Fh–5 will not apply to a securitybased swap with a special entity if: (1)
The transaction is executed on a
registered SEF, exempt SEF, or
registered national securities exchange;
and (2) the SBS Dealer and/or Major
SBS Participant does not know the
identity of the counterparty at a
reasonably sufficient time prior to the
execution of the transaction to permit
the SBS Dealer and/or Major SBS
Participant to comply with the
obligations of the rule.1071 The language
of these exceptions, as adopted, differs
from the language of the proposed rules,
which would have applied the
exceptions where the SBS Dealer or
Major SBS Participant did not know the
identity of its counterparty ‘‘at any time
up to and including’’ execution of the
transaction, and only to transactions
executed on a registered SEF or national
exchange.
As discussed in Section II.B, by
limiting the scope of the business
conduct standards to situations where
the counterparty’s identity is known at
1068 Id.
1069 See

SIFMA (August 2015), supra note 5.

1070 Id.
1071 As noted above, Rule 15Fh–4 applies only to
SBS Dealers, whereas Rule 15Fh–5 applies to both
SBS Dealers and Major SBS Participants. See
Sections II.H.2 and II.H.5.a.iii.A, respectively,
supra.

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a reasonably sufficient time prior to the
execution of a transaction to permit the
SBS Dealer and/or Major SBS
Participant to comply with the
obligations of the rule, the Commission
seeks to relieve SBS Dealers and/or
Major SBS Participants of the duty to
comply with the rules’ requirements
where the counterparty’s identity is
learned immediately prior to the
execution of a transaction, so that the
SBS Entity would be able to comply
with the requirements of the rules in a
manner that would not be disruptive to
the counterparties to the transaction.
This change is intended to address
commenters’ concerns that compliance
with the rules might be unreasonable or
impractical where a counterparty’s
identity is learned immediately prior to
the transaction, and compliance could
result in the delay or disruption of the
transaction.1072 Such delay or
disruption would negate a primary
advantage of electronic trading and
discourage market participants from
executing security-based swaps on
electronic platforms. By only applying
the rules’ requirements to situations
where the counterparty’s identity is
known ‘‘at a reasonably sufficient time
prior to’’ the execution of a transaction,
the rules’ requirements are limited to
situations where an SBS Entity has
sufficient time before the execution of
the transaction to comply with its
obligations under the rules. For this
reason, we decline to adopt language,
suggested by a commenter, which
would apply the exception to
circumstances where the identity of the
counterparty ‘‘is not known at any time
up to and including execution of the
transaction.’’ 1073 For clarification, and
in response to commenters,1074 the
exception would encompass
transactions that are executed by an SBS
Entity on a registered or exempt SEF or
registered national securities exchange
via a request for quote method, as long
as the identity of the counterparty is not
known to the SBS Entity at a reasonably
sufficient time prior to the execution of
a transaction to permit the SBS Entity to
comply with the obligations of the
rules.1075
1072 See CFA, supra note 5; FIA/ISDA/SIFMA,
supra note 5.
1073 See SIFMA (August 2015), supra note 5.
1074 See FIA/ISDA/SIFMA, supra note 5; MFA,
supra note 5.
1075 The rule will apply to situations where an
SBS Entity negotiates or pre-arranges a securitybased swap transaction with a special entity and
routes such a pre-arranged transaction through a
SEF or registered national securities exchange. In
such instances, we believe the SBS Entity would
have known the identity of the counterparty at a
reasonably sufficient time prior to the execution of

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Also, as explained in Section II.B, the
exception would apply with respect to
transactions on exempt as well as
registered SEFs. We believe that
including transactions on exempt SEFs
is appropriate since, as discussed in
Section II.B, the practical considerations
that underlie the exception are not
affected by whether a SEF is registered
or not.
We believe that the exceptions under
Rule 15Fh–4(b)(3) and 15Fh–5(d), as
adopted, appropriately interpret the
intended statutory carve-outs for SBS
Entities engaged in anonymous,
registered exchange-traded, registered or
exempt SEF transactions with special
entities, while avoiding the ambiguity
inherent in determining which party
‘‘initiated’’ the security-based swap. The
final rule therefore obviates the need to
differentiate between initiating a
negotiation and initiating a transaction,
as one commenter had requested.1076
We acknowledge the commenter’s
suggestion that the exception should
apply irrespective of which party
initiates a transaction,1077 as well as
another commenter’s suggestion that
Congress may have intended to deny the
exception in situations in which an SBS
Entity initiates a transaction, so that
SBS Entities would be incentivized to
determine the identities of their
counterparties when they initiate
security-based swap transactions.1078 As
explained in Section II.B, we
understand there may be practical
difficulties in determining which
counterparty ‘‘initiates’’ a transaction on
a SEF or an exchange. However, we
believe the rules adopted today avoid
the ambiguity inherent in determining
which party ‘‘initiated’’ the securitybased swap, while appropriately
interpreting the intended statutory
carve-outs for SBS Entities that execute
anonymous, security-based swap
transactions with special entities on a
registered or exempt SEF or registered
national securities exchange.
We are not accepting the commenter’s
suggestion that we revise the exceptions
under 15Fh–4(b)(3) and 15Fh–5(d) to
include transactions that are intended or
required to be cleared, which are either
executed on a registered national
securities exchange or SEF, regardless of
whether the transaction is
anonymous.1079 Similarly, we reject
commenters’ more general assertion that
the transaction to permit the SBS Entity to comply
with the obligations of the rule.
1076 See Better Markets (August 2011), supra note
5.
1077 See CFA, supra, note 5.
1078 See Better Markets (August 2011), supra note
5.
1079 See SIFMA (August 2015), supra note 5.

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the exceptions should apply to all SEF
or exchange traded transactions, even
where the identity of the counterparty is
known.1080 Rather, we agree with the
commenter that it is appropriate to
apply the protections of the business
conduct rules to all security-based swap
transactions with special entities other
than anonymous transactions executed
on a registered national securities
exchange or SEF.1081 The rules adopted
today are intended to provide certain
protections for special entities, and we
think it is appropriate to apply the rules,
to the extent practicable, so that special
entities receive the benefits of those
protections. Where the identity of the
special entity is known, we believe that
it is appropriate to apply the rules so
that the special entity receives the
benefits of the protections provided by
the rules, including the assistance of an
advisor or qualified independent
representative acting in the best
interests of that special entity.
Lastly, we acknowledge the
improbability that an SBS Dealer who is
acting as an advisor to a special entity
and is therefore subject to the
requirements of Rule 15Fh–4 would not
know the identity of its special entity
counterparty. Consequently, we also
acknowledge that the circumstances
where the exception under Rule 15Fh–
4(b)(3) would apply are unlikely, and, in
any event, we would question the
appropriateness of an SBS Dealer
making a recommendation to an
unknown special entity. Nevertheless,
we believe there is value is providing
legal certainty for SBS Dealers that seek
to transact on a registered national
securities exchange or a registered or
exempt SEF without regard to the
regulatory status of their counterparty.

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9. Certain Political Contributions by
SBS Dealers
a. Proposed Rule
As proposed, Rule 15Fh–6(b)(1)
would generally make it unlawful for an
SBS Dealer to offer to enter into, or enter
into, a security-based swap, or a trading
strategy involving a security-based
swap, with a ‘‘municipal entity’’ within
two years after any ‘‘contribution’’ to an
‘‘official of such municipal entity’’ has
been made by the SBS Dealer or any of
its ‘‘covered associate[s].’’ Proposed
Rule 15Fh–6(b)(3)(i) would also prohibit
an SBS Dealer from paying a third party
to ‘‘solicit’’ municipal entities to offer to
enter into, or enter into, a security-based
swap, unless the third party is a
‘‘regulated person’’ that is itself subject
1080 See ABC, supra note 5; FIA/ISDA/SIFMA,
supra note 5.
1081 See CFA, supra note 5.

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to a pay to play restriction under
applicable law. Proposed Rule 15Fh–
6(b)(3)(ii) would prohibit an SBS Dealer
from coordinating or soliciting a third
party, including a political action
committee, to make any: (a)
Contribution to an official of a
municipal entity with which the SBS
Dealer is offering to enter into, or has
entered into, a security-based swap, or
(b) payment to a political party of a state
or locality with which the SBS Dealer is
offering to enter into, or has entered
into, a security-based swap. Finally,
proposed Rule 15Fh–6(c) would make it
unlawful for an SBS Dealer to do
indirectly or through another person or
means anything that would, if done
directly, result in a violation of the
prohibitions contained in the proposed
rule.
As proposed, Rule 15Fh–6(b)
included three main exceptions. First,
proposed Rule 15Fh–6(b)(2)(i) would
permit an individual who is a covered
associate to make aggregate
contributions without being subject to
the two-year time out period, of up to
$350 per election, to any one official for
whom the individual was entitled to
vote at the time of the contributions,
and up to $150 per election, to any one
official for whom the individual was not
entitled to vote at the time of the
contributions.1082 Second, proposed
Rule 15Fh–6(b)(2)(ii) would not apply
the proposed pay to play rules to
contributions made by an individual
more than six months prior to becoming
a covered associate of the SBS Dealer,
unless such individual solicits the
municipal entity after becoming a
covered associate. Third, proposed Rule
15Fh–6(b)(2)(iii) would not apply the
proposed pay to play rules to a securitybased swap that is initiated by a
municipal entity on a registered
national securities exchange or SEF, for
which the SBS Dealer does not know
the identity of the counterparty at any
time up to and including the time of
execution of the transaction.
In addition to the above exceptions,
proposed Rule 15Fh–6(e)(1) would
provide an automatic exception to allow
an SBS Dealer a limited ability to cure
the consequences of an inadvertent
political contribution where: (i) The
SBS Dealer discovered the contribution
within four months (120 calendar days)
1082 As discussed below, we are modifying the
text of this rule to clarify that the de minimis
contribution exception is limited to contributions
made by individuals so that the rule text tracks the
explanation of the exception that was outlined in
the Proposing Release and in the CFTC’s Adopting
Release for its analogous exception, as well as the
text of the Advisers Act Rule, upon which the
exception is modeled and is intended to
complement.

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30045

of the date of the contribution; (ii) the
contribution made did not exceed $350;
and (ii) the contribution was returned to
the contributor within 60 calendar days
of the date of discovery. However, an
SBS Dealer would not be able to rely on
this exception more than twice in any
12-month period, or more than once for
any covered associate, regardless of the
time between contributions.
Furthermore, under proposed Rule
15Fh–6(d) an SBS Dealer may apply to
the Commission for an exemption from
the two-year ban. In determining
whether to grant the exemption, the
Commission would consider, among
other factors: (i) Whether the exemption
is necessary or appropriate in the public
interest and consistent with the
protection of investors and the purposes
of the Exchange Act; (ii) whether the
SBS Dealer, (a) before the contribution
resulting in the prohibition was made,
had adopted and implemented policies
and procedures reasonably designed to
prevent violations of the proposed rule,
(b) prior to or at the time the
contribution was made, had any actual
knowledge of the contribution, and (c)
after learning of the contribution, had
taken all available steps to cause the
contributor to obtain return of the
contribution and such other remedial or
preventative measures as may be
appropriate under the circumstances;
(iii) whether, at the time of the
contribution, the contributor was a
covered associate or otherwise an
employee of the SBS Dealer, or was
seeking such employment; (iv) the
timing and amount of the contribution;
(v) the nature of the election (e.g., state
or local); and (vi) the contributor’s
intent or motive in making the
contribution, as evidenced by the facts
and circumstances surrounding the
contribution.
b. Comments on the Proposed Rule
Six commenters addressed proposed
Rule 15Fh–6.1083 One commenter, who
supported the proposal as applied to
SBS Dealers, stated that pay-to-play is
an appropriate area for the Commission
to exercise its authority and suggested
that this proposal ‘‘would help to
eliminate what would otherwise be a
serious gap in protections.’’ 1084
However, this same commenter does not
believe the Commission should exempt
Major SBS Participants from the
proposed pay-to-play rules based on
what this commenter claims ‘‘may turn
out to be a false ‘assumption’ that they
1083 See APPA, supra note 5; CFA, supra note 5;
FIA/ISDA/SIFMA, supra note 5; NAIPFA, supra
note 5; SIFMA (August 2011), supra note 5; SIFMA
(August 2015), supra note 5.
1084 CFA, supra note 5.

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will not be engaged in the type of
activity that would make them
appropriate.’’ 1085
Another commenter agreed that the
prohibition timeframe should be two
years, consistent with proposed Rule
15Fh–6(b)(1).1086 That same commenter
also believed that there are no
circumstances where an independent
representative that is advising a special
entity that is a State, State agency, city,
county, municipality, or other political
subdivision of a State, or a
governmental plan, as defined in
Section 3(32) of ERISA, other than an
employee of the special entity, would
not be subject to pay to play rules.1087
One commenter recommended that,
with respect to the proposal that
independent representatives be subject
to ‘‘pay to play’’ limitations, an
exception is needed ‘‘for advisors that
are employees of the special entity,
given the employer-employee
relationship.’’ 1088 That same
commenter also urged the Commission
to delay imposing the proposed pay to
play rule until after the ‘‘dealer’’
definitions are finalized.1089
Another commenter suggested, as a
general matter, that because the DoddFrank Act did not mandate any
restrictions on political contributions by
SBS Dealers it is not clear to that
commenter that the Commission needs
to impose such a requirement on a
discretionary basis.1090 This same
commenter, however, recommended
that the Commission revise the language
of the proposed rule to, at least in the
commenter’s view, parallel the
following aspects of MSRB’s
regulations: (1) Replace as the triggering
occasion for the application of the
proposed rule an ‘‘offer to enter into or
enter into a security-based swap or a
trading strategy involving a securitybased swap’’ with a term—‘‘engage in
municipal security-based swap
1085 CFA,

supra note 5.
NAIPFA, supra note 5.
1087 See NAIPFA, supra note 5.
1088 APPA, supra note 5.
1089 APPA, supra note 5 (stating in support of that
suggestion that ‘‘[w]hile financial institutions that
deal with municipal entities are more likely to have
compliance procedures in place to deal with payto-play rules, other entities that may ultimately be
considered SBS Dealers are much less likely to have
such systems in place or to be familiar with these
types of rules’’).
1090 See FIA/ISDA/SIFMA, supra note 5 (stating
that MSRB rules ‘‘on political contributions made
in connection with municipal securities business
will already cover most [SBS Dealers] doing
business with municipal entities, and, there may
not be much marginal benefit to imposing
additional restrictions on SBSDs generally’’). See
also id. (‘‘Because the Commission’s proposal is
nearly identical to the CFTC Proposal, our
comments generally track those we made in
response to the CFTC Proposal.’’).

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1086 See

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business’’—which they suggest is ‘‘more
akin to the terms used in the relevant
MSRB Rules’’; (2) define ‘‘municipal
security-based swap business’’ in the
proposed rule to mean ‘‘the execution of
a security-based swap with a municipal
entity’’; (3) narrow the definition of
‘‘solicit’’ in the proposed rule to include
only ‘‘any direct communication by any
person with a municipal entity for the
purpose of obtaining or retaining
municipal security-based swap
business,’’ so that the term ‘‘solicit’’
does not ‘‘implicate communication by
employees of a financial institution that
do not have a role in the security-based
swap business and who are already
regulated by the MSRB or the SEC’’; (4)
clarify the definition of ‘‘solicit’’ in the
proposed rule to ‘‘exclude[s] any
communication by any person with a
municipal entity for the sole purpose of
obtaining or retaining any other type of
business covered under pay to play
restrictions, such as municipal
securities business or municipal
advisory business’’; and (5) modify the
proposed rule to allow for up to three
exemptions for inadvertent
contributions, depending on the number
of SBS Dealer employees.1091 The same
commenter also recommended that the
Commission include a provision
specifying ‘‘an operative date of the rule
such that it only applies to
contributions made on or after its
effective date.’’ 1092
Finally, one commenter suggested
that the Commission create a safe harbor
from the pay to play rule for a special
entity that is represented by a qualified
independent representative that
affirmatively selects the SBS Dealer.1093
That commenter also suggests excluding
state-established plans that are managed
by a third-party, such as 529 college
savings plans, from the pay to play
provisions because otherwise, the
provisions would deter SBS Dealers
from transacting with the plans.
After the adoption of the CFTC’s rules
in 2015, this same commenter
subsequently proposed that the
Commission expressly except from the
prohibitions of Rule 15Fh–6(b)(1)
contributions that were ‘‘made before
the security-based swap dealer
registered with the Commission as
such.’’ 1094 According to the commenter,
these changes would be consistent with
CFTC No-Action relief, which clarified
that the ‘‘look back’’ period would not
include any time period before an SBS
Dealer is required to register as such,
1091 FIA/ISDA/SIFMA,

supra note 5.
supra note 5.
1093 See SIFMA (August 2011), supra note 5.
1094 See SIFMA (August 2015), supra note 5.
1092 FIA/ISDA/SIFMA,

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and would therefore prevent retroactive
application of the rule.1095 The
commenter further suggested that the
Commission modify the exception
under 15Fh–6(b)(2)(B)(iii), such that it
would apply to a security-based swap
that was ‘‘executed’’ by a municipal
entity on a registered national securities
exchange or registered or an ‘‘exempt’’
security-based swap execution facility,
and was of a ‘‘type that is, as of the date
of execution, required to be cleared
pursuant to Section 3C of the Act.’’ 1096
In the alternative, the commenter
suggested that the exception should
apply where the SBS Dealer does not
know the identity of the counterparty to
the transaction at any time up to and
including execution of the
transaction.1097
c. Response to Comments and Final
Rule
After considering the comments, the
Commission is adopting Rule 15Fh–6
with six modifications. First, after the
Proposing Release was published, an
inadvertent omission was identified in
the definition of ‘‘contribution’’ in
proposed Rule 15Fh–6(a)(1)(i). The
Proposing Release inadvertently omitted
the word ‘‘federal’’ in subsection (i) of
the proposed definition of
‘‘contribution’’ in Rule 15Fh–6(a)(1).
Although the Commission did not
receive any comments noting this
omission, we are modifying the rule text
to include the word ‘‘federal’’ in
subsection (i) of the final definition of
‘‘contribution’’ in Rule 15Fh–
6(a)(1)).1098 Furthermore, and as stated
in the Proposing Release, the
Commission explained that ‘‘Rule
15Fh–6 is modeled on, and intended to
complement, existing restrictions on
pay to play practices under Advisers
Act Rule 206(4)–5 . . . and under MSRB
Rules G–37 and G–38.’’ 1099 Importantly,
both Advisers Act Rule 206(4)–5(f)(1)(i)
and MSRB Rule G–37(g)(i)(A)(1) include
the word ‘‘federal’’ in their largely
identical definitions of the term
‘‘contribution.’’ The Commission is
correcting this inadvertent omission to
make the definition of ‘‘contribution’’ in
Rule 15Fh–6(a)(1)(i) consistent with the
1095 Id.
1096 Id.
1097 Id.
1098 As such, Final Rule 15Fh–6(a)(1)(i) will read
‘‘[f]or the purpose of influencing any election for
federal, state or local office.’’ In light of this
modification, and for purposes of internal
consistency with a parenthetical reference to this
rule text elsewhere in the rule, a parallel
modification is being made to Final Rule 15Fh–
6(d)(5), which will read: ‘‘The nature of the election
(e.g., federal, state or local).’’
1099 Proposing Release, 76 FR at 42433, supra
note 3.

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Commission’s existing definition of
‘‘contribution’’ under Advisers Act Rule
206(4)–5(f)(1)(i).1100 Correcting this
omission also will make the definition
of ‘‘contribution’’ in Rule 15Fh–6(a)(1)
consistent with the existing definition of
‘‘contribution’’ under CFTC Regulation
23.451(a)(1)(i) and, therefore, create a
harmonized regulatory framework that
complements and is comparable to
Advisers Act Rule 206(4)–5, MSRB
Rules G–37 and CFTC Regulation
23.451.1101 Based on the foregoing, the
Commission believes that correcting this
inadvertent omission in a rule that was,
as set forth in the Proposing Release,
‘‘modeled on, and intended to
complement, existing restrictions on
pay to play practices’’ 1102 will eliminate
an unintentional gap in pay to play
protections across regulatory regimes
that would otherwise be created. In light
of cross-market participation and
expected dual registration of some
entities, substantial consistency across
pay to play regulatory regimes,
including having largely consistent
definitions of ‘‘contribution,’’ will also
be helpful for those entities that have
already established a regulatory
infrastructure to comply with pay to
play standards under existing rules.
Second, the Commission is correcting
another inadvertent omission in the text
of Rule 15Fh–6(b)(2)(i). As outlined in
the Proposing Release, the de minimis
contribution exception found in Rule
15Fh–6(b)(2)(i) is intended to be limited
to contributions made by individuals
that are covered associates to track and
complement the similar de minimis
contribution exception found in
Advisers Act Rule 206(4)–5(b)(1), upon
1100 See Political Contributions by Certain
Investment Advisers, Advisers Act Release No.
3043 (Jul. 1, 2010), 75 FR 41018 (Jul. 14, 2010)
(‘‘Advisers Act Pay-to-Play Release’’) (adopting
Advisers Act Rule 206(4)–5 and stating, among
other things, that the definition of ‘‘contribution’’ in
Advisers Act Rule 206(4)–5 ‘‘is the same as . . . the
one used in MSRB rule G–37’’).
1101 Although subsection (iii) of CFTC Regulation
23.451(a)(1) also includes the term ‘‘federal’’ in the
definition of ‘‘contribution’’—‘‘[f]or transition or
inaugural expenses incurred by the successful
candidate for federal, state, or local office.’’—as
explained by the Commission in the Advisers Act
Pay-to-Play Release, neither Rule 206(4)–5 nor
MSRB Rule G–37 includes the transition or
inaugural expenses of a successful candidate for
federal office in the definition of ‘‘contribution.’’
See Advisers Act Pay-to-Play Release, 75 FR at
41030, n.154, supra note 1100. Therefore, because
this rule is modeled on, and intended to
complement, existing restrictions on pay to play
practices under Advisers Act Rule 206(4)–5 and
MSRB Rules G–37, we also do not include the term
‘‘federal’’ in subsection (iii) of Rule 15Fh–6(a)(1) for
the same reasons stated by the Commission when
adopting the Advisers Act pay-to-play rules.
1102 Proposing Release, 76 FR at 42433, supra
note 3.

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which this exception was modeled.1103
Because this exception is conditioned
on whether the covered associate was
entitled to vote for the official at the
time of the contribution, we believe it
was implicit in the proposed rule text
that this exception only applies to
contributions made by a natural person
since other legal persons are not entitled
to vote. However, we are modifying the
text of Rule 15Fh–6(b)(2)(i) to clarify
that this exception only applies to
contributions made by a natural person.
With that modification, the rule text as
adopted will track the explanation
behind this exception, as explained in
the Proposing Release, as well as the
text of Advisers Act Rule 206(4)–5(b)(1).
This modification will also make Rule
15Fh–6(b)(2)(i) consistent with the
CFTC’s analogous de minimis
contribution exception, which the CFTC
described as similarly intended to be
limited to individuals that are covered
associates.1104
Third, as discussed in Section II.B,
the Commission is modifying the
exception under Rule 15Fh–6(b)(2)(iii)
so as to apply when the SBS Dealer does
not know the identity of the
counterparty with reasonably sufficient
time prior to execution of the
transaction to permit the SBS Dealer to
comply with the obligations of the rule.
This language differs from the language
used in the proposal, which would
apply the exception when the dealer
does not know the identity of the
counterparty ‘‘at any time up to and
including execution of the transaction.’’
The adoption of this language will
comport with the language used in the
verification of counterparty status and
disclosure requirements of final Rule
15Fh–3, as well as the exceptions to the
special entity requirements under Rules
15Fh–4(b)(3) and 15Fh–5(d). As
discussed in those sections, this
language is intended to exclude
situations where the identity of the
counterparty is not discovered until
after execution of a transaction, or
where the SBS Dealer learns the identity
1103 See Proposing Release, 76 FR at 42434, supra
note 3 (‘‘The proposed rule would permit an
individual who is a covered associate to make
aggregate contributions without being subject to the
two-year time out period, of up to $350 per election,
for any one official for whom the individual is
entitled to vote, and up to $150 per election, to an
official for whom the individual is not entitled to
vote.’’) (emphases added).
1104 See CFTC Adopting Release, 77 FR at 9799,
supra note 21 (explaining that CFTC’s ‘‘proposed
rule permitted an individual that is a covered
associate to make aggregate contributions up to
$350 per election, without being subject to the twoyear time out period, to any one official for whom
the individual is entitled to vote, and up to $150
per election to an official for whom the individual
is not entitled to vote.’’) (emphases added).

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of the counterparty with insufficient
time to be able to satisfy its obligations
under the rule without delaying the
execution of the transaction.
Fourth, as discussed above in Section
II.H.8, the Commission is also
modifying the exception under Rule
15Fh–6(b)(2)(iii) to apply to all securitybased swap transactions executed on a
registered or exempt SEF or registered
national securities exchange, rather than
just with respect to transactions
‘‘initiated by a municipal entity’’ on
such exchange or SEF (as long as the
other conditions of Rule 15Fh–
6(b)(2)(iii) are met). We are revising the
rule to be consistent with the adopted
Rules 15Fh–4(b)(3) and 15Fh–5(d), and
avoid the ambiguity inherent in
determining which party ‘‘initiated’’ the
security-based swap.1105
Fifth, we are also modifying Rule
15Fh–6(e)(2), as one commenter
suggested,1106 to allow for up to three
exemptions for inadvertent
contributions per calendar year,
depending on the number of natural
person covered associates at the SBS
Dealer. Specifically, we are modifying
the text of Rule 15Fh–6(e)(2), as
suggested by this same commenter,1107
to provide that an SBS Dealers that has
more than 50 covered associates would
be able to rely on this exception no
more than three times per calendar year,
while an SBS Dealer that has 50 or
fewer covered associates would be able
to rely on this exception no more than
two times per calendar year. This
modification will parallel the provision
in Advisers Act Rule 206(4)–5, which
also allows ‘‘larger’’ investment advisers
to avail themselves of three automatic
exceptions, instead of two, in any
calendar year. As the Commission noted
when modifying its Advisers Act rule
proposal to include three automatic
exceptions for larger firms, we agree that
inadvertent violations of the rule are
more likely at firms with greater
numbers of covered associates, and we
believe that the twice per year limit is
appropriate for smaller firms and that
the three times per year limit is
appropriate for larger firms.1108
1105 See

supra Section II.H.8.
supra note 5 (suggesting
that the Commission modify proposed rule to allow
for up to three exemptions for inadvertent
contributions, depending on the number of SBS
Dealer employees).
1107 See id. (suggesting that the Commission
modify proposed rule to parallel the provisions in
SEC Rule 206(4)–5, relating to contributions from
certain covered associates of investment advisers).
1108 See Advisers Act Pay-to-Play Release, 75 FR
at 41035–36, n. 238, supra note 1100 (‘‘We do not
believe it is appropriate for there to be greater
variation in the number of times advisers may rely
1106 FIA/ISDA/SIFMA,

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Although we recognize that this
modification will create an additional
exception not found in the CFTC’s
analogous rule,1109 we believe that
harmonization across the Commission’s
regulatory regimes will help to create
regulatory efficiencies for entities that
have already established a regulatory
infrastructure based on the
Commission’s analogous exception.
Finally, the Commission is also
correcting in the final rule the following
typographical errors: (1) Revising an
internal cross-reference in Rule 15Fh–
6(a)(2)(iii) to cross-reference
‘‘paragraphs (a)(2)(i) and (a)(2)(ii) of this
section’’ rather than ‘‘paragraphs
(c)(2)(i) and (c)(2)(ii) of this section’’; (2)
revising an internal cross-reference in
Rule 15Fh–6(d) to cross-reference
‘‘paragraph (b) of this section’’ rather
than ‘‘paragraph (a)(1) of this section’’;
(3) revising Rule 15Fh–6(b)(3)(ii)(A) to
delete a phrase that was inadvertently
repeated ‘‘a security-based swap
security-based swap’’; and (4) revising
Rule 15Fh–6(b)(3)(ii)(B) to also delete a
phrase that was inadvertently repeated
‘‘a security-based swap security-based
swap.’’
With respect to the balance of Rule
15Fh–6, after considering the comments
submitted, the Commission is adopting
the Rule as proposed. The Commission
disagrees with certain commenters’
view that Rule 15Fh–6 is not an
appropriate area for the Commission to
exercise its authority to prescribe
business conduct standards.1110 The
Commission also disagrees with one
commenter’s suggestion that there may
not be much marginal benefit to
imposing additional restrictions on SBS
Dealers generally.1111 We proposed the
rule in the context of security-based
swaps because pay to play practices
may result in municipal entities
entering into transactions not because of
hedging needs or other legitimate
purposes, but rather because of
campaign contributions given to an
official with influence over the selection
process. Where pay to play exists, SBS
Dealers may compete for security-based
swap business based on their ability and
willingness to make political
contributions, rather than on their merit
or the merit of a proposed transaction.
on the exception than that based either on their size
or on other characteristics. We are seeking to
encourage robust monitoring and compliance.’’).
1109 See CFTC Adopting Release, 77 FR at 9828,
supra note 21.
1110 See, e.g., FIA/ISDA/SIFMA, supra note 5
(suggesting that because Dodd-Frank did not
mandate any restrictions on political contributions
by SBS Dealers it is not clear that the Commission
needs to impose such a requirement on a
discretionary basis). But see CFA, supra note 5.
1111 See FIA/ISDA/SIFMA, supra note 5.

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We believe these practices may result in
significant harm to municipalities and
others in connection with securitybased swap transactions, just as they do
in connection with other municipal
securities transactions.1112 We note that
SBS Dealers may have an incentive to
participate in pay to play practices out
of concern that they may be overlooked
if they fail to make such contributions.
These concerns, coupled with the
furtive nature of pay to play practices
and the inability of markets to properly
address them, strongly support the need
for prophylactic measures to address
them in the context of security-based
swaps.1113 Furthermore, and as the
same commenter concedes, there would
still be a regulatory gap as only ‘‘most’’
SBS Dealers would be covered and, as
another commenter observed, this rule
would help to eliminate that gap in
protection.1114 We made this same point
in the Proposing Release, noting that
while Rule 15Fh–6 is consistent with
and would complement the pay to play
prohibition adopted by the MRSB and
CFTC, there are no existing federal pay
to play rules that would apply to all SBS
Dealers in their dealings with municipal
entities.1115 Therefore, this rule was
proposed to help eliminate that
regulatory gap.
The Commission continues to believe
and a commenter also agrees that the
two-year time out provided for in Rule
15Fh–6 is appropriate.1116 As explained
in the Proposing Release, Rule 15Fh–
6(b)(1) would prohibit an SBS Dealer
from offering to enter into, or entering
into, a security-based swap or a trading
strategy involving a security-based
swap, with a municipal entity within
two years after a contribution to an
1112 See id. See SEC v. Larry P. Langford,
Litigation Release No. 20545 (Apr. 30, 2008) and
SEC v. Charles E. LeCroy, Litigation Release No.
21280 (Nov. 4, 2009) (charging Alabama local
government officials and J.P. Morgan employees
with undisclosed payments made to obtain
municipal bond offering and swap agreement
business from Jefferson County, Alabama). See also
J.P. Morgan Securities Inc., Securities Act Release
No. 9078 (Nov. 4, 2009) (settled order instituting
administrative and cease-and-desist proceedings
and imposing remedial sanctions against a brokerdealer that the Commission alleged was awarded
bond underwriting and interest rate swap
agreement business by Jefferson County in
connection with undisclosed payments by
employees of the firm).
1113 Cf. Blount v. SEC, 61 F.3d 938, 945 (D.C. Cir.
1995), cert. denied, 116 S. Ct. 1351 (1996) (‘‘no
smoking gun is needed where, as here, the conflict
of interest is apparent, the likelihood of stealth
great, and the legislative purpose prophylactic’’).
1114 CFA, supra note 5 (supporting the proposal
as applied to SBS Dealers and stating that this
proposal ‘‘would help to eliminate what would
otherwise be a serious gap in protections’’).
1115 Proposing Release, 76 FR at 42433, supra
note 3.
1116 See NAIPFA, supra note 5.

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official of such municipal entity has
been made by the SBS Dealer or any of
its covered associates. We believe the
two-year time out requirement strikes an
appropriate balance, as it is sufficiently
long to act as a deterrent but not so long
as to be unnecessarily onerous. The twoyear time out is generally consistent
with the time out provisions in Advisers
Act Rule 206(4)–5, MSRB Rule G–37
and CFTC Regulation 23.451.
As we also explained in the Proposing
Release, because the rule would
attribute to an SBS Dealer those
contributions made by a person even
prior to becoming a covered associate of
the SBS Dealer, SBS Dealers need to
‘‘look back’’ in time to determine
whether the two-year time out applies
when an employee becomes a covered
associate.1117 Given that one commenter
suggested further specificity as to
whether the rule applies only to
contributions made on or after the rules
effective date,1118 we are interpreting
the prohibition in Rule 15Fh–6(b)(1)
and its exceptions in Rule 15Fh–6(b)(2),
as well as the restrictions on soliciting
or coordinating contributions found in
Rule 15Fh–6(b)(3), to not be triggered
for an SBS Dealer or any of its covered
associates by contributions made before
the SBS Dealer registered with the
Commission as such. This interpretation
is, as one commenter noted, also
consistent with CFTC No-Action
relief.1119 However, such prohibitions
will apply to contributions made on or
after the SBS Dealer is required to
register with the Commission. We also
note that these prohibitions do not
apply to contributions made before the
compliance date of this rule by new
covered associates to which the rule’s
‘‘look back’’ applies (i.e., a person who
becomes a covered associate within two
years after the contribution is made).
1117 See Proposing Release, 76 FR at 42434, supra
note 3. In the Proposing Release, we explained, as
an example, that if the contribution at issue was
made less than two years (or six months, as
applicable under Rule 15Fh–6(b)(2)(ii)) before an
individual becomes a covered associate, the rule
would prohibit the firm from entering into a
security-based swap with the relevant municipal
entity until the two-year time out period has
expired. As noted above, Rule 15Fh–6(b)(2)(ii)
provides an exception to the prohibition in Rule
15Fh–6(b)(1) such that the prohibition would not
apply to contributions made by an individual more
than six months prior to becoming a covered
associate of the SBS Dealer, unless such individual
solicits the municipal entity after becoming a
covered associate.
1118 See FIA/ISDA/SIFMA, supra note 5
(requesting clarification that ‘‘the rule would not
unintentionally ban SBS activity as a result of
contributions made during the pre-effectiveness
period’’). See also SIFMA (August 2015), supra note
5.
1119 See SIFMA (August 2015), supra note 5. See
also CFTC Letter No. 12–33 (November 29, 2012).

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This interpretation is similar to the
approach taken by the Commission in
connection with Advisers Act Rule
206(4)–5.1120 For example, if an
individual who becomes a covered
associate on or after the effective date of
the rule made a contribution before the
effective date of the rule, that new
covered associate’s contribution would
not trigger the two-year time out. On the
other hand, if an individual who later
becomes a covered associate made the
contribution on or after the compliance
date of this rule, the contribution would
trigger the two-year time out if it were
made less than, as applicable, six
months or two years before the
individual became a covered
associate.1121
With respect to the comment
recommending amending the proposed
rule to include Major SBS Participants
in the prohibitions of Rule 15Fh–6,1122
the Commission does not believe that it
is necessary or appropriate to do so. We
have considered how the differences
between the definitions of SBS Dealer
and Major SBS Participant may be
relevant in formulating the business
conduct standards applicable to these
entities.1123 The Commission does not
believe it is necessary to revisit its
assumption, outlined in the Proposing
Release, that Major SBS Participants are
unlikely to give rise to the pay-to-play
concerns that this rule is intended to
address.1124 As discussed above, SBS
Dealers may have an incentive to
compete for security-based swap
business based on their ability and
willingness to participate in pay to play
activity, rather than on their merit or the
merit of a proposed transaction, out of
concern that they may be overlooked if
they fail to make such contributions.
However, we believe the incentives for
Major SBS Participants to engage in pay
to play activity are unlikely to be as
strong as the incentives for SBS Dealers
1120 See Advisers Act Pay-to-Play Release, 75 FR
at 41051, n.434, supra note 1100 (noting, similarly,
that the prohibitions in Rule 206(4)–5 also do not
apply to contributions made before the compliance
date established for Rule 206(4)–5 by new covered
associates to which the look back applies).
1121 See id. (providing similar examples in
connection with Rule 206(4)–5).
1122 CFA, supra note 5.
1123 See, e.g., Section II.B (explaining that, unlike
the definition of ‘‘security-based swap dealer,’’
which focuses on the way a person holds itself out
in the market and whose function is to serve as the
point of connection in those markets, the definition
of ‘‘major security-based swap participant,’’ focuses
on the market impacts and risks associated with an
entity’s security-based swap positions).
1124 See, e.g., MFA, supra note 5 (urging the
Commission to consider separate regulatory regimes
for SBS Dealers and Major SBS Participants, arguing
that they are different, and there are ‘‘different
reasons why the Dodd-Frank Act requires
additional oversight of each’’).

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given that, by definition, Major SBS
Participants are not engaged in securitybased swap dealing activity at levels
above the de minimis threshold.1125 As
such, Major SBS Participants are less
likely than SBS Dealers to be acting as
dealers in the security-based swap
market and, like any other person whose
dealing activity does not exceed the
dealer de minimis thresholds, should
therefore be less susceptible to the types
of competitive pressures that may create
an incentive to participate in pay to play
activity. We further note that, if a Major
SBS Participant is, in fact, engaged in
security-based swap dealing activity
above the de minimis threshold, it
would need to register as an SBS Dealer
and, as such, would need to comply
with the pay to play rules imposed by
Rule 15Fh–6.
Therefore, SBS Dealers, unlike Major
SBS Participants, may have an incentive
to participate in pay to play practices
out of concern that they may be
overlooked if they fail to make such
contributions which, in turn, would
necessitate application of pay to play
prohibitions. Furthermore, the
exclusion of Major SBS Participants
from Rule 15Fh–6 will also be
consistent with the pay to play
prohibition adopted by the CFTC.1126
Substantial consistency across pay to
play regulatory regimes will be helpful
for those entities that have already
established a regulatory infrastructure to
comply with existing rules. One
commenter suggested that, with respect
to the proposal that independent
representatives be subject to pay to play
limitations, an exception is needed ‘‘for
advisors that are employees of the
special entity, given the employeremployee relationship.’’ 1127 However,
the Commission notes that the rules
already include such an exception. As
explained previously, Rule 15Fh–
5(a)(1)(vi) as adopted requires an SBS
Entity to have a reasonable basis for
believing that the independent
representative is a person that is subject
to rules of the Commission, the CFTC or
an SRO subject to the jurisdiction of the
Commission or the CFTC prohibiting it
from engaging in specified activities if
certain political contributions have been
made, unless the independent
representative is an employee of the
special entity.
The same commenter also urged the
Commission, in a comment letter dated
1125 See Exchange Act rule 3a61–1(a)(1) (limiting
the definition of ‘‘major security-based swap
participant’’ to persons that are not security-based
swap dealers).
1126 See CFTC Adopting Release, 77 FR at 9800,
supra note 21.
1127 APPA, supra note 5.

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August 2011, to delay imposing the
proposed pay to play rule until after the
‘‘dealer’’ definitions are finalized.1128
As explained in Section IV.B below, the
Commission is adopting a compliance
date for final Rules 15Fh–1 through
15Fh–6 and Rule 15Fk–1 that is the
same as the compliance date of the SBS
Entity registration rules.1129
The Commission declines to revise
Rule 15Fh–6, as one commenter
suggested, by limiting the triggering
event for the application of the pay to
play rules to ‘‘engag[ing] in municipal
security-based swap business’’ or ‘‘the
execution of a security-based swap with
a municipal entity.’’ 1130 As explained
in the Proposing Release, pay to play
occurs when persons seeking to do
business with municipal entities make
political contributions, or are solicited
to make political contributions, to
elected officials or candidates to
influence the selection process.1131
Hence, pay to play could occur when an
SBS Dealer is merely offering to enter
into a security-based swap with a
municipal entity, before that SBS Dealer
has yet to actually enter into, engage in,
or execute any such transaction. Rather,
the SBS Dealer is seeking to influence
the selection process to generate
business. Therefore, the Commission
believes that further parsing of the
trigging event applicable to this rule, as
suggested by the commenter, would
create an unintended regulatory gap that
would not capture those who offer to
enter into a security-based swap
transaction with a municipal entity with
the hope that their contributions or
payments will influence the selection
process so that they may later enter into,
engage in, or execute security-based
swaps with that municipal entity. As
one court noted,’’[w]hile the risk of
corruption is obvious and substantial,
actors in this field are presumably
shrewd enough to structure their
relations rather indirectly.’’ 1132
Furthermore, this same suggestion was
1128 APPA,

supra note 5.
Commission explained in the
Registration Adopting Release that persons
determined to be SBS Dealers or Major SBS
Participants under those rules need not register as
such until the dates provided for in the
Commission’s final rules regarding SBS Entity
registration requirements, ‘‘and will not be subject
to the requirements applicable to those dealers and
major participants until the dates provided in the
applicable final rules.’’ Registration Adopting
Release, supra note 989.
1130 FIA/ISDA/SIFMA, supra note 5 (suggesting
that the Commission consider replacing the
proposed ‘‘triggering occasion for the application of
the rule’’).
1131 See Proposing Release, 76 FR at 42432, supra
note 3.
1132 Id. (citing Blount, 61 F.3d at 945).
1129 The

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raised to and declined by the CFTC.1133
As a result, the triggering event for the
application of Rule 15Fh–6 is consistent
with the CFTC’s rule and substantially
consistent with the trigging event for
certain prohibitions found in the
Commission’s Advisers Act Rule
206(4)–5.1134
One commenter that addressed the
definition of ‘‘solicit’’ in the proposed
rule generally urged us to adopt a
narrower definition.1135 However, the
Commission declines to revise Rule
15Fh–6 to further parse the definition of
‘‘solicit.’’ We believe that it is
unnecessary, as the commenter
suggested, for the definition to cover
only direct communications or to state
what communications are not covered
by the term ‘‘solicit.’’ 1136 The proposed
definition makes clear that to fall within
its scope the communication, whether
direct or indirect, must be ‘‘with a
municipal entity for the purpose of
obtaining or retaining an engagement
related to a security-based swap.’’
Further parsing and thus narrowing of
the definition of ‘‘solicit’’ is
unwarranted given the covert and
secretive nature of pay to play practices
where, as noted above, ‘‘actors in this
field are presumably shrewd enough to
structure their relations rather
indirectly.’’ 1137 Rule 15Fh–6 is
intended to deter SBS Dealers from
participating, even indirectly, in pay to
play practices. The Commission
believes that the definition of ‘‘solicit’’
is clear as to what communications are
covered by the pay to play rule, and the
definition is also consistent with the
CFTC’s rule and the Commission’s
definition of ‘‘solicit’’ in Advisers Act
Rule 206(4)–5 1138 which, as noted
1133 See CFTC Adopting Release, 77 FR at 9799–
800, supra note 21.
1134 See Advisers Act Rule 206(4)–5(2)(ii)
(including, among other triggering activities, when
the investment adviser is ‘‘providing or seeking to
provide investment advisory services to a
government entity’’).
1135 FIA/ISDA/SIFMA, supra note 5
(recommending that the Commission clarify the
definition of ‘‘solicit’’ include only ‘‘any direct
communication by any person with a municipal
entity for the purpose of obtaining or retaining
municipal security-based swap business’’).
1136 See id. (suggesting that the rule should
exclude any communication with a municipal
entity for the sole purpose of obtaining or retaining
any other type of business covered under pay-toplay restrictions because, in that commenter’s view,
such communications would already trigger pay-toplay restrictions under other regulations).
1137 Proposing Release, 76 FR at 42432, supra
note 3 (citing Blount, 61 F.3d at 945).
1138 17 CFR 275.206(4)–5(f)(10)(i) (defining
‘‘solicit,’’ in part, to mean ‘‘to communicate,
directly or indirectly, for the purpose of obtaining
or retaining a client for . . . an investment
adviser’’).

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above, Rule 15Fh–6 was modeled on
and intended to complement.
Another commenter suggested that
the Commission revise Rule 15Fh–6 to
create a safe harbor from the pay to play
rule for a special entity that is
represented by a ‘‘qualified independent
representative’’ that affirmatively selects
the SBS Dealer.1139 However, the
Commission declines to create a safe
harbor as the commenter suggested. For
one, the commenter’s argument that
such a safe harbor would ‘‘assist
municipal entities and their advisors by
preserving their ability to execute
security-based swap transactions’’ is not
persuasive to support this suggested
modification when, for example, one of
the purposes behind this rule is the
need for prophylactic measures to
address stealthy pay to play
practices.1140 As stated in the Proposing
Release and noted above, by its nature,
pay to play is covert and secretive
because participants do not broadcast
that contributions or payments are made
or accepted for the purpose of
influencing the selection of a financial
services provider. The Commission
believes that adopting such a safe
harbor, as suggested, could create a
means for would-be wrongdoers to
covertly and secretively engage in pay to
play practices by, among other things,
using situations where the special
entity, represented by a qualified
independent representative, selects the
SBS Dealer as a way to evade or
otherwise circumvent the rule’s
prohibitions. The commenter’s
suggestion would also create a material
difference between the regulatory
regimes established by the Commission
under the Advisers Act as well as the
CFTC’s rules and would decrease
regulatory efficiencies for market
participants.
Finally, we are not expressly
excluding, as one commenter suggested,
state-established plans that are managed
by a third-party, such as 529 college
savings plans, from the pay to play
provisions.1141 We do not find the
commenter’s unsupported claim that
pay to play provisions will deter SBS
Dealers from transacting business with
such plans persuasive. More
importantly, even if we were to accept
this argument, the same concerns,
outlined above, that we are attempting
to address with these pay to play
restrictions, including but not limited to
the furtive nature of pay to play
(August 2011), supra note 5.
Blount, 61 F.3d at 945 (noting that, with
respect to pay to play practices ‘‘the likelihood of
stealth great,’’ while ‘‘the legislative purpose
prophylactic’’).
1141 See SIFMA (August 2011), supra note 5.

practices, are also applicable for stateestablished plans that are managed by a
third-party. As noted above, we believe
that SBS Dealers may have an incentive
to participate in pay to play practices,
even in connection with stateestablished plans that are managed by a
third-party, out of concern that they
may be overlooked for business if they
fail to make such contributions. We
further believe these practices may
result in significant harm to
municipalities and others, including
state-established plans, in connection
with security-based swap transactions.
Rule 15Fh–6(b)(3)(i) is intended to deter
SBS Dealers from participating, even
indirectly, in such practices.
I. Chief Compliance Officer
Section 15F(k) of the Exchange Act
requires an SBS Entity to designate a
CCO, and imposes certain duties and
responsibilities on that CCO.1142
1. Proposed Rule
a. Designation, Reporting Line,
Compensation and Removal of the CCO
Proposed Rule 15Fk–1(a) would
require an SBS Entity to designate a
CCO on its registration form. Proposed
Rule 15Fk–1(b)(1) would require that
the CCO report directly to the board of
directors or to the senior officer of the
SBS Entity.1143 Proposed Rule 15Fk–
1(e)(1) would define ‘‘board of
directors’’ to include a body performing
a function similar to the board of
directors. Proposed Rule 15Fk–1(e)(2)
would define ‘‘senior officer’’ to mean
the chief executive officer or other
equivalent officer. Finally, proposed
Rule 15Fk–1(d) would require that the
compensation and removal of the CCO
be approved by a majority of the board
of directors of the SBS Entity.
b. Duties of the CCO
Proposed Rule 15Fk–1(b) would
impose certain duties on the CCO.
Proposed Rule 15Fk–1(b)(2) would
require the CCO to review the
compliance of the SBS Entity with
respect to the requirements in Section
15F of the Exchange Act and the rules
and regulations thereunder.1144
Proposed Rule 15Fk–1(b)(2) would
further require that, as part of the CCO’s
obligation to review compliance by the
SBS Entity, the CCO establish, maintain,
and review policies and procedures that
are reasonably designed to achieve
compliance by the SBS Entity with

1139 SIFMA
1140 Cf.

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1142 15

U.S.C. 78o–10(k).
Section 15F(k)(2)(A) of the Exchange Act,
15 U.S.C. 78o–10(k)(2)(A).
1144 See Section 15F(k)(2)(B) of the Exchange Act,
15 U.S.C. 78o–10(k)(2)(B).
1143 See

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
Section 15F of the Exchange Act and the
rules and regulations thereunder.
Proposed Rule 15Fk–1(b)(3) would
require that the CCO, in consultation
with the board of directors or the senior
officer of the organization, promptly
resolve conflicts of interest that may
arise.1145 Under proposed Rule 15Fk–
1(b)(4), the CCO would be responsible
for administering each policy and
procedure that is required to be
established pursuant to Section 15F of
the Exchange Act and the rules and
regulations thereunder.1146 Proposed
Rule 15Fk–1(b)(5) would require the
CCO to establish, maintain and review
policies and procedures reasonably
designed to ensure compliance with the
provisions of the Exchange Act and the
rules and regulations thereunder
relating to the SBS Entity’s business as
an SBS Entity.1147 Proposed Rule 15Fk–
1(b)(6) would require the CCO to
establish, maintain and review policies
and procedures reasonably designed to
remediate promptly non-compliance
issues identified by the CCO through
any compliance office review, lookback, internal or external audit finding,
self-reporting to the Commission and
other appropriate authorities, or
complaint that can be validated.1148
Proposed Rule 15Fk–1(e)(3) would
define ‘‘complaint that can be
validated’’ to mean any written
complaint by a counterparty involving
the SBS Entity or an associated person
that can be supported upon reasonable
investigation. Proposed Rule 15Fk–
1(b)(7) would require the CCO to
establish and follow procedures
reasonably designed for prompt
handling, management response,
remediation, retesting, and resolution of
non-compliance issues.1149

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c. Annual Compliance Report
Proposed Rule 15Fk–1(c)(1) would
require that the CCO annually prepare
and sign a report describing the SBS
Entity’s compliance policies and
procedures (including the code of ethics
and conflicts of interest policies) and
the compliance of the SBS Entity with
the Exchange Act and rules and
regulations thereunder relating to its
business as an SBS Entity.1150 Proposed
1145 See Section 15F(k)(2)(C) of the Exchange Act,
15 U.S.C. 78o–10(k)(2)(C).
1146 See Section 15F(k)(2)(D) of the Exchange Act,
15 U.S.C. 78o–10(k)(2)(D).
1147 See Section 15F(k)(2)(E) of the Exchange Act,
15 U.S.C. 78o–10(k)(2)(E).
1148 See Section 15F(k)(2)(F) of the Exchange Act,
15 U.S.C. 78o–10(k)(2)(F).
1149 See Section 15F(k)(2)(G) of the Exchange Act,
15 U.S.C. 78o–10(k)(2)(G).
1150 See Section 15F(k)(3)(A) of the Exchange Act,
15 U.S.C. 78o–10(k)(3)(A). As noted in the
Proposing Release, the Commission believes there

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Rule 15Fk–1(c)(2) would require that
each compliance report also contain, at
a minimum, a description of: (1) The
SBS Entity’s enforcement of its policies
and procedures relating to its business
as an SBS Entity; (2) any material
changes to the policies and procedures
since the date of the preceding
compliance report; (3) any
recommendation for material changes to
the policies and procedures as a result
of the annual review, the rationale for
such recommendation, and whether
such policies and procedures were or
will be modified by the SBS Entity to
incorporate such recommendation; and
(4) any material compliance matters
identified since the date of the
preceding compliance report. Proposed
Rule 15Fk–1(e)(4) would define
‘‘material compliance matter’’ to mean
any compliance matter about which the
board of directors of the SBS Entity
would reasonably need to know to
oversee the compliance of the SBS
Entity, and that involves, without
limitation: (1) A violation of the federal
securities laws relating to its business as
an SBS Entity by the SBS Entity or its
officers, directors, employees or agents;
(2) a violation of the policies and
procedures of the SBS Entity relating to
its business as an SBS Entity by the SBS
Entity or its officers, directors,
employees or agents; or (3) a weakness
in the design or implementation of the
policies and procedures of the SBS
Entity relating to its business as an SBS
Entity.
Proposed Rule 15Fk–1(c)(2)(ii)(D)
would require the compliance report to
include a certification, under penalty of
law, that the compliance report is
accurate and complete.1151 Proposed
Rule 15Fk–1(c)(2)(ii)(A) would require
that the compliance report accompany
each appropriate financial report of the
SBS Entity that is required to be
furnished or filed with the Commission
pursuant to Exchange Act Section 15F
and the rules and regulations
thereunder.1152 To allow the
compliance report to accompany each
appropriate financial report within the
required timeframe, proposed Rule
15Fk–1(c)(2)(ii)(B) would require the
compliance report to be submitted to the
board of directors, the audit committee
is a drafting error in the reference to compliance of
the ‘‘major swap participant’’ in Section
15F(k)(3)(A) of the Exchange Act, and accordingly,
proposed Rule 15Fk–1(c)(1) would apply the
requirement with respect to the compliance of the
‘‘major security-based swap participant.’’ See
Proposing Release, 76 FR at 42436 n.288, supra note
3.
1151 See Section 15F(k)(3)(B)(ii) of the Exchange
Act, 15 U.S.C. 78o–10(k)(3)(B)(ii).
1152 See Section 15F(k)(3)(B)(i) of the Exchange
Act, 15 U.S.C. 78o–10(k)(3)(B)(i).

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30051

and the senior officer of the SBS Entity
at the earlier of their next scheduled
meeting or within 45 days of the date of
execution of the certification.
Proposed Rule 15Fk–1(c)(2)(ii)(C)
would require the compliance report to
include a written representation that the
chief executive officer(s) (or equivalent
officer(s)) has/have conducted one or
more meetings with the CCO in the
preceding 12 months, the subject of
which addresses the SBS Entity’s
obligations as set forth in the proposed
rules and in Exchange Act Section 15F.
The subject of the meeting(s) must
include: (1) The matters that are the
subject of the compliance report; (2) the
SBS Entity’s compliance efforts as of the
date of such meeting; and (3) significant
compliance problems and plans in
emerging business areas relating to its
business as an SBS Entity.1153
Under proposed Rule 15Fk–
1(c)(2)(iii), if compliance reports are
separately bound from the financial
statements, the compliance reports shall
be accorded confidential treatment to
the extent permitted by law.
2. Comments on the Proposed Rule
a. Designation, Reporting Line, and
Compensation and Removal of the CCO
Five commenters addressed the
designation, reporting line and
compensation and removal of the
CCO.1154 Two commenters argued for
greater flexibility for SBS Entities with
respect to these requirements.1155 The
first commenter objected to the
mandated line of reporting of the CCO
in the proposed rule (which would
require the CCO to report directly to the
board of directors or to the senior officer
of the SBS Entity) and recommended
allowing SBS Entities greater flexibility
in determining the most effective
reporting framework in light of their
individual structure and
circumstances.1156 The commenter
noted that, particularly in large
institutions where security-based swap
transactions are one of many lines of
business, the proposed rule would
prohibit the CCO from reporting to other
senior management who may be more
familiar with the security-based swap
activities of the SBS Entity.1157
Accordingly, the commenter
recommended that the Commission
1153 Id.
1154 See FIA/ISDA/SIFMA, supra note 5; CFA,
supra note 5; Better Markets (August 2011), supra
note 5; Better Markets (October 2013), supra note
5; Barnard, supra note 5; SIFMA (September 2015),
supra note 5.
1155 See FIA/ISDA/SIFMA, supra note 5; SIFMA
(September 2015), supra note 5.
1156 See FIA/ISDA/SIFMA, supra note 5.
1157 Id.

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define the term ‘‘senior officer’’ to
include a more senior officer within the
SBS Entity’s compliance, risk, legal or
other control function as the SBS Entity
shall reasonably determine to be
appropriate.1158
Similarly, the second commenter
asked the Commission to provide
guidance specifying that if a division of
a larger company is an SBS Entity, then
the CCO of such entity could report to
the senior officer of that division.1159
Additionally, the commenter requested
guidance: (1) Regarding the supervisory
liability of compliance and legal
personnel employed by SBS Entities
that is consistent with the guidance it
has issued for broker-dealers’ legal and
compliance personnel; and (2) clarifying
that the CCO may share additional
executive responsibilities within the
SBS Entity.1160
Both commenters objected to the
proposed requirement that the
compensation and removal of the CCO
be approved by a majority of the SBS
Entity’s board of directors.1161 The first
commenter recommended eliminating
the requirement, noting that the
provision is not mandated by the DoddFrank Act, is not consistent with other
requirements applicable to similarly
situated employees, and would impose
organizational inefficiencies and other
unwarranted costs while offering
minimal benefits.1162 The second
commenter recommended allowing
either the board of directors or the
senior officer of the SBS Entity to
approve the compensation or removal of
the CCO to be consistent with the
parallel CFTC requirement, asserting
that this change would reasonably
ensure the independence and
effectiveness of the CCO while
providing for greater flexibility.1163
Three commenters argued for more
stringent requirements with respect to
the designation, reporting line and
compensation and removal of the
CCO.1164 The first commenter asserted
that ensuring market participants have
CCOs with real authority and autonomy
to police a firm from within is one of the
most efficient and effective tools
available to regulators, and accordingly,
recommended adopting additional
measures to protect the authority and
1158 Id.

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1159 See

independence of CCOs.1165 Specifically,
the commenter suggested: (1) Requiring
the CCO to meet competency standards,
including a lack of disciplinary history
and criteria demonstrating relevant
knowledge and experience; (2)
prohibiting the CCO from serving as
General Counsel or a member of the
legal department of the SBS Entity; (3)
appointing a senior CCO with overall
responsibility for compliance by a group
of affiliated or controlled entities; (4)
vesting authority in independent board
members to oversee the hiring,
compensation, and termination of the
CCO; (5) requiring the CCO to have
direct access to the board; and (6)
prohibiting attempts by officers,
directors, or employees to coerce,
mislead, or otherwise interfere with the
CCO.1166
Similarly, the second commenter
recommended that the authority and
responsibility to appoint or remove the
CCO, or to materially change its duties
and responsibilities, be vested only in
the independent directors and not the
full board.1167 Additionally, the
commenter suggested that the CCO have
only a compliance role and no other role
or responsibility that could create
conflicts of interest or threaten its
independence, and that the CCO’s
compensation be designed in a way that
avoids conflicts of interest.1168
The third commenter asserted that
firms should not be permitted to allow
the CCO to report to a senior officer of
the firm as a substitute for reporting to
the board.1169
b. Duties of the CCO
Three commenters addressed the
duties of the CCO.1170 The first
commenter supported the Commission’s
approach in the proposal regarding the
role and responsibilities of the CCO, but
recommended the following
modifications: (1) Changing the phrase
‘‘ensure compliance’’ in proposed Rule
15Fk–1(b)(5) to ‘‘achieve compliance,’’
(2) confirming that the relevant conflicts
of interest under proposed Rule 15Fk–
1(b)(3) would be those which are
reasonably identified by the SBS
Entity’s policies and procedures, taking
into consideration the nature of the SBS
Entity’s business, and (3) clarifying that
a CCO’s responsibility under proposed
Rule 15Fk–1(b)(4) to ‘‘administer’’ a

SIFMA (September 2015), supra note 5.
1165 See

1160 Id.
1161 See

FIA/ISDA/SIFMA, supra note 5; SIFMA
(September 2015), supra note 5.
1162 See FIA/ISDA/SIFMA, supra note 5.
1163 See SIFMA (September 2015), supra note 5.
1164 See CFA, supra note 5; Better Markets
(August 2011), supra note 5; Better Markets
(October 2013), supra note 5; Barnard, supra note
5.

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Better Markets (October 2013), supra note

5.
1166 See Better Markets (August 2011), supra note
5; Better Markets (October 2013), supra note 5.
1167 See Barnard, supra note 5.
1168 Id.
1169 See CFA, supra note 5.
1170 See FIA/ISDA/SIFMA, supra note 5; SIFMA
(September 2015), supra note 5; CFA, supra note 5.

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firm’s policies and procedures is limited
to coordinating supervisors’
administration of the relevant policies
and procedures.1171
The second commenter recommended
harmonizing the Commission’s CCO
requirements with FINRA Rule 3130
and the CFTC’s CCO requirements for
Swap Entities to enable SBS Entities
that are also broker-dealers and/or Swap
Entities to make use of their existing
infrastructure and to minimize
confusion.1172 Specifically, the
commenter recommended a number of
changes to proposed Rule 15Fk–1(b) to
align the description of the duties of an
SBS Entity’s CCO with those of a brokerdealer CCO, as described in applicable
FINRA and SEC guidance, and guidance
in the Proposing Release regarding the
supervisory responsibilities of an SBS
Entity’s CCO.1173 In particular, the
commenter sought clarification that the
SBS Entity has the responsibility, and
not the CCO in his or her personal
capacity, to establish, maintain and
review required policies and
procedures.1174 The recommended
changes include: (1) Replacing the
requirement in proposed Rule 15Fk–
1(b)(2) to ‘‘establish, maintain and
review’’ written policies and procedures
reasonably designed to achieve
compliance with Section 15F of the Act
and the rules and regulations
thereunder with a requirement to
‘‘prepare the registrant’s annual
assessment of’’ such policies and
procedures; (2) qualifying the
requirement in proposed Rule 15Fk–
1(b)(3) to promptly resolve conflicts of
interest in consultation with the board
of directors or the senior officer of the
SBS Entity with the qualifying language
‘‘take reasonable steps to’’ resolve; (3)
clarifying that the requirement in
proposed Rule 15Fk–1(b)(4) to
administer required policies and
procedures involves ‘‘advising on the
development of, and reviewing, the
registrant’s processes for (i) modifying
those policies and procedures as
business, regulatory and legislative
changes and events dictate, (ii)
evidencing supervision by the personnel
responsible for the execution of those
policies and procedures, and (iii) testing
the registrant’s compliance with those
policies and procedures;’’ (4) qualifying
the requirements in proposed Rules
15Fk–1(b)(5)–(7) to establish, maintain
and review certain policies and
procedures with the qualifying language
‘‘take reasonable steps to ensure that the
1171 See
1172 See

FIA/ISDA/SIFMA, supra note 5.
SIFMA (September 2015), supra note 5.

1173 Id.
1174 Id.

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registrant’’ establishes, maintains and
reviews such policies and procedures;
and (5) eliminating the timing
requirements in proposed Rules 15Fk–
1(b)(6) and (7) that the CCO ‘‘promptly’’
take the required actions.1175 Finally,
the commenter requested that the
Commission provide guidance
explaining that resolution of a conflict
of interest encompasses both
elimination and mitigation of the
conflict, and that the CCO’s role in
resolving conflicts may involve actions
other than making the ultimate decision
with regard to such conflict.1176
In contrast, the third commenter
recommended mandating that CCOs
have greater authority to resolve and
mitigate conflicts of interest that may
cause compliance problems.1177 At a
minimum, the commenter suggested
requiring the CCO to highlight in the
compliance report any
recommendations it made with regard to
resolution or mitigation of conflicts of
interest that were not adopted.1178
c. Annual Compliance Report
Four commenters addressed the
annual compliance report
requirements.1179 One commenter noted
several concerns with the annual
compliance report requirement.1180
First, the commenter requested that the
Commission permit the consolidation of
annual compliance reporting
requirements for SBS Entities under
common control (including those that
are also registered broker-dealers) to
avoid forcing a consolidated financial
institution to submit separate
compliance reports for each SBS Entity
and broker-dealer within the corporate
structure.1181 Second, the commenter
expressed concern regarding the
requirement in proposed Rule 15Fk–
1(c)(1)(i) that the compliance report
contain a description of the compliance
of the SBS Entity, as well as a
description of the SBS Entity’s
compliance policies and procedures, as
required under proposed Rule 15Fk–
1(c)(1)(ii).1182 The commenter requested
that the Commission clarify that
proposed Rule 15Fk–1(c)(1)(i) would be
satisfied by a description of the
particular matters set forth in proposed
Rule 15Fk–1(c)(2)(i), noting that a
1175 Id.

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1176 Id.
1177 See

CFA, supra note 5.

1178 Id.
1179 See FIA/ISDA/SIFMA, supra note 5; CFA,
supra note 5; Better Markets (August 2011), supra
note 5; Better Markets (October 2013), supra note
5; SIFMA (September 2015), supra note 5.
1180 See FIA/ISDA/SIFMA, supra note 5.
1181 Id.
1182 Id.

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requirement to describe an SBS Entity’s
‘‘compliance’’ in an absolute sense is so
broad and so vague as to be incapable
of being fulfilled in practice.1183 Third,
the commenter recommended that the
Commission amend its Freedom of
Information Act regulations in a manner
consistent with proposed Rule 15Fk–
1(c)(2)(iii), which would provide that
compliance reports bound separately
from financial statements shall be
accorded confidential treatment to the
extent permitted by law.1184
The commenter also had several
concerns regarding the required
certification of the compliance report in
proposed Rule 15Fk–1(c)(2)(ii)(D).1185
The commenter noted that the DoddFrank Act does not explicitly require the
CCO to be the individual responsible for
certifying the compliance report and
recommended that the CEO or other
relevant senior officer, not the CCO, be
responsible for the certification.1186
Alternatively, if the CCO is required to
certify, the commenter requested that
the CEO also be required to do so.1187
Additionally, the commenter requested
that the Commission clarify that the
liability standard for the certification is
the same as that which applies to other
documents filed with the Commission,
including liability under Section 32 of
the Exchange Act for willfully and
knowingly making false or misleading
material statements or omissions to the
Commission.1188 The commenter also
asserted that the certifier should, as in
other contexts, be responsible solely for
stating that the documents were
prepared under his or her direction or
supervision in accordance with a system
designed to ensure that qualified
personnel would properly gather and
evaluate the documents, and that based
on his or her inquiry of those persons
who were responsible for gathering the
documents, to the best of his or her
knowledge, the documents are accurate
in all material respects.1189
Similarly, the second commenter
requested that the Commission provide
guidance clarifying that if a certifying
officer has complied in good faith with
policies and procedures reasonably
designed to confirm the accuracy and
completeness of annual compliance
report, both the SBS Entity and the
certifying officer would have a basis for
defending accusations of false,
incomplete, or misleading statements or
1183 Id.
1184 Id.
1185 Id.

30053

representations made in the report.1190
The commenter also requested a number
of changes to the annual compliance
report requirements in proposed Rule
15Fk–1(c) to harmonize them with the
CFTC’s parallel requirements.1191 The
commenter argued that alignment of the
content requirements for annual
compliance reports ‘‘would allow SBS
Entities to leverage the extensive and
rigorous procedures they have adopted
to comply with the CFTC CCO Rule and
related guidance.’’ 1192 Specifically, the
recommended changes include: (1)
Eliminating the proposed requirement
to include a ‘‘description of
compliance’’ in the annual compliance
report, asserting that this requirement
would add unnecessary ambiguity; (2)
specifying that the report need only
contain a description of the ‘‘written’’
compliance policies and procedures of
the SBS Entity; (3) changing the
proposed description requirement in
proposed Rule 15Fk–1(c)(2)(i)(A) from
‘‘enforcement’’ of the SBS Entity’s
policies and procedures to an
‘‘assessment of the effectiveness’’ of
such policies and procedures; (4)
specifying that the requirement to
describe material changes to policies
and procedures in proposed Rule 15Fk–
1(c)(2)(i)(B) refers to the ‘‘registrant’s’’
policies and procedures; (5) changing
the proposed description requirement in
proposed Rule 15Fk–1(c)(2)(i)(C) from
‘‘any recommendation for material
changes to the policies and procedures’’
to ‘‘areas for improvement, and
recommended potential or prospective
changes or improvements to its
compliance program and resources
devoted to compliance;’’ (6) changing
the proposed description requirement in
proposed Rule 15F–1(c)(2)(i)(D) from
‘‘any material compliance matters’’ to
‘‘any material non-compliance matters’’
identified since the date of the
preceding report (and eliminating the
definition of material compliance
matter); (7) aligning the deadline for
filing of the compliance report with the
CFTC’s 90 day deadline; (8) allowing for
submission of the compliance report to
either the board of directors or the
senior officer, as opposed to requiring
submission to both the board of
directors (and audit committee) and the
senior officer, as proposed; (9)
eliminating the proposed requirement
that the report contain a written
representation regarding the required
annual meeting between the CEO and
the CCO; (10) eliminating the proposed
specifications for what topics such

1186 Id.
1187 Id.

1190 See

1188 Id.

1191 Id.

1189 Id.

1192 Id.

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meeting must cover; (11) allowing either
the CCO or the senior officer to certify
the annual compliance report to the best
of his or her knowledge; and (12)
providing for amendments to,
extensions of filing deadlines for, and
incorporation of other reports by
reference in the annual compliance
report.1193
The third commenter suggested: (1)
Requiring the CCO to meet quarterly
with the Audit Committee in addition to
annual meetings with the board of
directors and senior management; and
(2) requiring the board to review and
comment on, but not edit, the
compliance report.1194 Similarly, the
fourth commenter expressed support for
requiring the audit committee to review
and the CCO to certify the compliance
report, and argued that the CCO should
not be permitted to qualify its
report.1195
3. Response to Comments and Final
Rule
Rule 15Fk–1, as adopted, is designed
to be generally consistent with the
current compliance obligations
applicable to CCOs of other
Commission-regulated entities,1196 as
well as with the CFTC’s CCO rules
applicable to Swap Entities. As noted in
the Proposing Release, the requirements
of Rule 15Fk–1 underscore the central
role that sound compliance programs
play to help ensure compliance with the
Exchange Act and rules and regulations
thereunder applicable to security-based
swaps.1197 The Commission believes
that these requirements will help foster
sound compliance programs.1198
a. Designation, Reporting Line, and
Compensation and Removal of the CCO
After considering the comments, the
Commission is adopting Rule 15Fk–1(a)
(designation of the CCO), Rule 15Fk–
1(b)(1) (reporting line of the CCO), Rule
15Fk–1(d) (compensation and removal
of the CCO), and the associated
definitions of ‘‘board of directors’’ and
‘‘senior officer’’ in Rule 15Fk–1(e)(1)
and (2) as proposed. To address

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1193 Id.
1194 See Better Markets (August 2011), supra note
5; Better Markets (October 2013), supra note 5.
1195 See CFA, supra note 5.
1196 See, e.g., FINRA Rule 3130; Rule 38a–1(a)
under the Investment Company Act of 1940, 17 CFR
270.38a–1(a)(1); Rule 206(4)–7(a) under the
Advisers Act, 17 CFR 275.206(4)–7(a); Rule 13n–11
under the Exchange Act, 17 CFR 240.13n–11.
1197 See Proposing Release, 76 FR at 42435, supra
note 3.
1198 See Exchange Act Sections 15F(h)(1)(B)
(authorizing the Commission to prescribe duties for
diligent supervision), and 15F(h)(3)(D) (providing
authority to prescribe business conduct standards).
15 U.S.C. 78o–10(h)(1)(B) and 78o–10(h)(3)(D).

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concerns that an SBS Entity’s
commercial interests might have undue
influence on a CCO’s ability to make
forthright disclosure to the board of
directors or the senior officer about any
compliance failures, the rule is designed
to help promote CCO independence and
effectiveness by establishing a direct
reporting line to the board or senior
officer, and by requiring compensation
and removal decisions to be made by a
majority of the board of directors.
Accordingly, Rule 15Fk–1(b)(1) requires
the CCO to report directly to the board
or senior officer of the SBS Entity.1199
In addition, pursuant to Rule 15Fk–1(d)
any decision to remove the CCO from
his or her responsibilities or approve his
or her compensation must be made by
a majority of the board. The
Commission is not eliminating the
requirement that only a majority of the
board can approve the compensation or
removal of the CCO, as suggested by one
commenter,1200 nor is the Commission
broadening the rule to allow an SBS
Entity’s senior officer to approve the
compensation and removal of the CCO,
as suggested by another commenter.1201
The Commission believes that
eliminating the requirement that only a
majority of the board can approve the
compensation or removal of the CCO, or
allowing an SBS Entity’s senior officer
to approve the compensation and
removal of the CCO could undermine
the CCO’s independence and
effectiveness, particularly if the CCO is
responsible for reviewing the senior
officer’s compliance with the Exchange
Act and the rules and regulations
thereunder.1202
1199 One commenter recommended that the
Commission define the term ‘‘senior officer’’ to
include a more senior officer within the SBS
Entity’s compliance, risk, legal or other control
function as the SBS Entity shall reasonably
determine to be appropriate. See FIA/ISDA/SIFMA,
supra note 5. The Commission declines to make
this change because it could potentially undercut
the independence of the CCO, and as noted above,
the Commission believes it is important for the CCO
to be independent to mitigate potential conflicts for
the CCO in reporting or addressing compliance
failures. Another commenter requested that the
Commission provide guidance specifying that if a
division of a larger company is an SBS Entity, then
the CCO of such entity could report to the senior
officer of that division. See SIFMA (September
2015), supra note 5. The Commission has not yet
addressed a process through which firms could
submit an application for limited designation as an
SBS Entity, such as for a division within a larger
company. See Registration Adopting Release, 80 FR
at 48966 n.13, supra note 989 (addressing limited
designation and registration).
1200 See SIFMA (September 2015), supra note 5.
1201 See FIA/ISDA/SIFMA, supra note 5.
1202 This is consistent with the position the
Commission took in adopting CCO requirements for
security-based swap data repositories (‘‘SDRs’’). See
Security-Based Swap Data Repository Registration,
Duties, and Core Principles, Exchange Act Release

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In promoting a CCO’s independence
and effectiveness, the Commission does
not believe that it is necessary to adopt
additional requirements suggested by
commenters prohibiting a CCO from
having additional roles or
responsibilities outside of compliance,
such as being a member of the SBS
Entity’s legal department or from
serving as the SBS Entity’s general
counsel.1203 To the extent that this
poses a potential or existing conflict of
interest, the Commission believes that
an SBS Entity’s written policies and
procedures can be designed to
adequately identify and mitigate any
such conflict.1204
The Commission also is not adopting
rules requiring independent board
members to oversee the hiring,
compensation and termination of the
No. 74246 (Feb. 11, 2015), 80 FR 14438, 14507
(Mar. 19, 2015) (‘‘SDR Registration Release’’) (‘‘The
Commission is not extending the applicability of
this rule to an SDR’s senior officer because the
Commission believes that this may unnecessarily
create conflicts of interest for the CCO, particularly
if the CCO is subsequently responsible for
reviewing the senior officer’s compliance with the
Exchange Act and the rules and regulations
thereunder.’’). The Commission also declines to
narrow the reporting line requirement to specify
that the CCO must report only to the board of
directors (and not the senior officer), as suggested
by one commenter. See CFA, supra note 5.
Exchange Act Section 15F(k)(2)(A) gives SBS
Entities the flexibility of allowing the CCO to report
to either the board or senior officer, and the
Commission believes that requiring a majority of
the board to approve the compensation or removal
of the CCO is sufficient to promote the
independence of the CCO, allowing for greater
flexibility in the reporting line.
1203 See Better Markets (August 2011), supra note
5; Better Markets (October 2013), supra note 5;
Barnard, supra note 5. Cf. SIFMA (September 2015),
supra note 5 (requesting clarification that the CCO
may share additional executive responsibilities
within the SBS Entity). The Commission is also not
adopting a commenter’s suggestion to require the
appointment of a senior CCO with overall
responsibility for compliance by a group of
affiliated or controlled entities. See Better Markets
(August 2011), supra note 5; Better Markets
(October 2013), supra note 5. The Commission
believes entities should have the flexibility to
design their organizational structure to meet their
business needs.
1204 As discussed in Section II.G.6, supra, Rule
15Fh–3(h)(2)(iii)(H) requires SBS Entities to
establish, maintain, and enforce written policies
and procedures reasonably designed to prevent the
supervisory system from being compromised due to
the conflicts of interest that may be present with
respect to the associated person being supervised.
This is consistent with the position the Commission
took in adopting CCO requirements for SDRs. See
SDR Registration Release, 80 FR at 14507, supra
note 1202 (‘‘In promoting a CCO’s independence
and effectiveness, the Commission does not believe
that it is necessary to adopt, as two commenters
suggested, a rule prohibiting a CCO from being a
member of the SDR’s legal department or from
serving as the SDR’s general counsel. To the extent
that this poses a potential or existing conflict of
interest, the Commission believes that an SDR’s
written policies and procedures can be designed to
adequately identify and mitigate any associated
costs.’’).

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CCO or any material changes to the
CCO’s duties, requiring the CCO to have
direct access to the board, or expressly
prohibiting attempts by officers,
directors, or employees to coerce,
mislead or otherwise interfere with the
CCO, as suggested by commenters.1205
The Commission continues to believe
that requiring a majority of the board to
approve the compensation and removal
of the CCO is appropriate to promote the
CCO’s independence and effectiveness,
and believes that it is appropriate not to
provide for additional requirements
such as those suggested by the
commenters.1206 With this approach,
the Commission intends to promote the
independence and effectiveness of the
CCO while also providing SBS Entities
flexibility in structuring their businesses
and directing their compliance
resources.
One commenter suggested requiring
the CCO to meet certain competency
standards, including criteria
demonstrating relevant knowledge and
experience.1207 Given the critical role
that a CCO is intended to play in
helping to ensure an SBS Entity’s
compliance with the Exchange Act and
the rules and regulations thereunder,
the Commission believes that an SBS
Entity’s CCO generally should be
competent and knowledgeable regarding
the federal securities laws, empowered
with full responsibility and authority to
develop appropriate policies and
procedures for the SBS Entity, as
necessary, and responsible for
monitoring compliance with the SBS
Entity’s policies and procedures
adopted pursuant to rules under the
Exchange Act.1208 However, we believe
1205 See Better Markets (August 2011), supra note
5; Better Markets (October 2013), supra note 5;
Barnard, supra note 5.
1206 The Commission also believes that requiring
a majority of the board to approve the compensation
of the CCO will address a commenter’s concern
regarding designing the compensation of the CCO
in a way that avoids conflicts of interest. See
Barnard, supra note 5.
1207 See Better Markets (August 2011), supra note
5; Better Markets (October 2013), supra note 5.
1208 This is generally consistent with the position
the Commission took in adopting CCO requirements
for SDRs. See SDR Registration Release, 80 FR at
14510, supra note 1202 (‘‘Given the critical role that
a CCO is intended to play in ensuring an SDR’s
compliance with the Exchange Act and the rules
and regulations thereunder, the Commission
believes that an SDR’s CCO should be competent
and knowledgeable regarding the federal securities
laws, should be empowered with full responsibility
and authority to develop and enforce appropriate
policies and procedures for the SDR, as necessary,
and should be responsible for monitoring
compliance with the SDR’s policies and procedures
adopted pursuant to rules under the Exchange Act.
However, the Commission will not substantively
review a CCO’s competency, and is not requiring
any particular level of competency or business
experience for a CCO.’’).

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that such considerations are properly
vested in the SBS Entity, based on the
particulars of its business, and thus, the
Commission is not adopting specific
requirements concerning the
background, training or business
experience for a CCO.
Another commenter asked that the
Commission provide guidance regarding
the supervisory liability of compliance
and legal personnel employed by SBS
Entities to reflect the guidance
Commission staff has issued for brokerdealers’ legal and compliance
personnel.1209 The Commission
recognizes that compliance and legal
personnel play a critical role in efforts
by regulated entities to develop and
implement effective compliance
systems, including by providing advice
and counsel to business line personnel.
As noted in the Proposing Release, the
title of CCO does not, in and of itself,
carry supervisory responsibilities, and a
CCO does not become a ‘‘supervisor’’
solely because he or she has provided
advice or counsel concerning
compliance or legal issues to business
line personnel, or assisted in the
remediation of an issue. Consistent with
current industry practice, the
Commission generally would not expect
a CCO appointed in accordance with
Rule 15Fk–1 to have supervisory
responsibilities outside of the
compliance department.1210
Accordingly, absent facts and
circumstances that establish otherwise,
the Commission generally would not
expect that a CCO would be subject to
a sanction by the Commission for failure
to supervise other SBS Entity
personnel.1211 Moreover, a CCO with
supervisory responsibilities could rely
on the provisions of Rule 15Fh–3(h)(3),
under which a person associated with
an SBS Entity shall not be deemed to
have failed to reasonably supervise
another person if the conditions in the
rule are met.1212 The fact that the
Exchange Act does not presume that
compliance or legal personnel are
supervisors solely because of their
compliance or legal functions does not
1209 See SIFMA (September 2015), supra note 5
(referencing Division of Trading and Markets
Frequently Asked Questions about Liability of
Compliance and Legal Personnel at Broker-Dealers
under Sections 15(b)(4) and 15(b)(6) of the
Exchange Act (Sept. 30, 2013), available at: http://
www.sec.gov/divisions/marketreg/faq-ccosupervision-093013.htm).
1210 See Proposing Release, 76 FR at 42436, supra
note 3.
1211 Id. Regardless of their status as supervisors,
compliance and legal personnel who otherwise
violate the federal securities laws or aid and abet
or cause a violation may independently be held
liable for such violations.
1212 See Proposing Release, 76 FR at 42436, supra
note 3.

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30055

in any way diminish the compliance
duties of the CCO pursuant to Rule
15Fk–1(b), as discussed below.
b. Duties of the CCO
After considering the comments, the
Commission is adopting Rule 15Fk–
1(b)(2)–(4) (duties of the CCO) with a
number of modifications. In response to
a commenter’s concerns,1213 the
modifications (discussed below) are
primarily intended to provide certainty
regarding the CCO’s duties under the
final rule, consistent with the duties in
FINRA Rule 3130 and the CFTC’s CCO
requirements for Swap Entities, and to
clarify the role of the CCO generally. To
the extent our requirements are
consistent with FINRA and/or CFTC
standards, this consistency should
result in efficiencies for SBS Entities
that have already established
infrastructure to comply with the
FINRA and/or CFTC standards.
Consistent wording regarding
expectations for CCOs will also allow
such SBS Entities to more easily analyze
compliance with the Commission’s rule
against their existing activities to
comply with FINRA Rule 3130 and the
CFTC’s CCO rule for Swap Entities.
First, we are reorganizing Rule 15Fk–
1(b)(2) to provide additional clarity and
certainty as to the obligations of the
CCO. Specifically, our modifications are
designed to make clear that in taking
reasonable steps to ensure that the SBS
Entity establishes, maintains and
reviews written policies and procedures
reasonably designed to achieve
compliance with the Exchange Act and
the rules and regulations thereunder
relating to its business as an SBS Entity,
the CCO must satisfy the three specific
obligations enumerated in Rule 15Fk–
1(b)(2)(i)–(iii), discussed below.
Second, in addition to the
reorganization described above, we are
making some changes to the
descriptions of the duties listed in Rule
15Fk–1(b)(2). As described above, we
are making changes to the duty that now
appears in Rule 15Fk–1(b)(2).
Specifically, the Commission agrees
with a commenter that it is the
responsibility of the SBS Entity, not the
CCO in his or her personal capacity, to
establish and enforce required policies
and procedures.1214 Accordingly, to
reflect that, the Commission is
qualifying the proposed requirement to
establish, maintain and review policies
and procedures reasonably designed to
ensure compliance with the Exchange
Act and rules and regulations
thereunder with the qualifying language
1213 See
1214 See

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SIFMA (September 2015), supra note 5.
SIFMA (September 2015), supra note 5.

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‘‘take reasonable steps to ensure that the
registrant’’ establishes, maintains and
reviews such policies and procedures.
The Commission is also changing the
requirement in Rule 15Fk–1(b)(2) from a
requirement to ‘‘ensure compliance’’ to
a requirement to ‘‘achieve compliance’’
with the Exchange Act and rules and
regulations thereunder relating to the
SBS Entity’s business as an SBS Entity
in response to a specific suggestion from
a commenter,1215 and adding the word
‘‘written’’ before policies and
procedures to clarify that the policies
and procedures required by the rule
must be written. Similar to the
qualifying language with respect to the
registrant’s policies and procedures, the
Commission is making the change from
‘‘ensure compliance’’ to ‘‘achieve
compliance’’ to clarify that it is not the
role of the CCO to ‘‘ensure’’ compliance.
The Commission believes the
formulation ‘‘take reasonable steps to
ensure that the registrant establishes,
maintains and reviews written policies
and procedures reasonably designed to
achieve compliance’’ (as opposed to the
proposed formulation of ‘‘establish,
maintain and review policies and
procedures reasonably designed to
ensure compliance’’) more appropriately
describes the CCO’s role. The
Commission also notes that the policies
and procedures referred to in Rule
15Fk–1(b)(2) include those required by
Rules 15Fh–3(h)(2)(iii), 15Fk–1(b)(2)(ii)
and 15Fk–1(b)(2)(iii), and any other
policies and procedures the SBS Entity
deems necessary to achieve compliance
with the Exchange Act and the rules and
regulations thereunder relating to its
business as an SBS Entity.
We are also modifying the three
specific obligations of the CCO now
enumerated in Rule 15Fk–1(b)(2)(i)–(iii)
that the CCO must perform to satisfy his
or her duty to take reasonable steps to
ensure that the registrant establishes,
maintains and reviews policies and
procedures reasonably designed to
achieve compliance. As adopted, Rule
15Fk–1(b)(2)(i) requires the CCO to
‘‘revie[w] the compliance of the [SBS
Entity] with respect to the [SBS Entity]
requirements described in [S]ection 15F
of the [Exchange Act], and the rules and
regulations thereunder, where the
review shall involve preparing the
registrant’s annual assessment of its
written policies and procedures
reasonably designed to achieve
compliance with [S]ection 15F of the
[Exchange Act] and the rules and
regulations thereunder, by the [SBS
Entity].’’ The requirement that the CCO
‘‘prepare the registrant’s annual

assessment of its’’ written policies and
procedures reasonably designed to
achieve compliance with Section 15F of
the Exchange Act and the rules and
regulations thereunder represents a
change from the proposed requirement
that the CCO ‘‘establish, maintain and
review’’ such policies and procedures.
We are making this change in response
to a specific suggestion from a
commenter.1216 As discussed above, the
Commission agrees with the commenter
that it is the responsibility of the SBS
Entity, not the CCO in his or her
personal capacity, to establish and
enforce required policies and
procedures, and believes that this
change clarifies that point.
As adopted, Rule 15Fk–1(b)(2)(ii)
requires the CCO to ‘‘tak[e] reasonable
steps to ensure that the registrant
establishes, maintains and reviews
policies and procedures reasonably
designed to remediate non-compliance
issues identified by the [CCO] through
any means, including any: (A)
Compliance office review; (B) Lookback; (C) Internal or external audit
finding; (D) Self-reporting to the
Commission and other appropriate
authorities; or (E) Complaint that can be
validated.’’ This represents a change
from the proposed requirements: (1)
That the CCO ‘‘establish, maintain and
review’’ such policies and procedures,
and (2) that such policies and
procedures be reasonably designed to
remediate ‘‘promptly’’ non-compliance
issues. Additionally, as adopted, Rule
15Fk–1(b)(2)(iii) requires the CCO to
‘‘tak[e] reasonable steps to ensure that
the registrant establishes and follows
procedures reasonably designed for the
handling, management response,
remediation, retesting, and resolution of
non-compliance issues.’’ This also
represents a change from the proposed
requirements: (1) That the CCO
‘‘establish and follow’’ such procedures,
and (2) that such procedures be
reasonably designed for the ‘‘prompt’’
handling, management response,
remediation, retesting, and resolution of
non-compliance issues.’’ We are making
these changes in response to specific
suggestions from a commenter.1217 As
discussed above, the Commission agrees
with the commenter that it is the
responsibility of the SBS Entity, not the
CCO in his or her personal capacity, to
establish and enforce required policies
and procedures, and believes that the
first change to each provision clarifies
that point. Additionally, as discussed
above, eliminating the proposed timing
requirements with respect to the
1216 See

1215 See

FIA/ISDA/SIFMA, supra note 5.

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1217 See

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SIFMA (September 2015), supra note 5.
SIFMA (September 2015), supra note 5.

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‘‘prompt’’ remediation and handling of
non-compliance issues provides greater
consistency with the parallel CFTC
requirements. With this change, the
Commission intends to focus the CCO’s
efforts on the effective remediation and
handling of non-compliance issues,
without placing undue emphasis on
speed at the expense of other factors.
We believe, however, that the
remediation and handling of noncompliance issues generally should
occur within a reasonable timeframe.
In addition to the changes described
above, the Commission is making one
more modification to the duty to
remediate non-compliance issues in
final Rule 15Fk–1(b)(2)(ii). The
proposed rule referred only to noncompliance issues ‘‘identified by the
[CCO] through any: (A) Compliance
office review; (B) Look-back; (C) Internal
or external audit finding; (D) Selfreporting to the Commission and other
appropriate authorities; or (E)
Complaint that can be validated.’’
However, as noted above, Rule 15Fk–
1(b)(2)(iii) requires that the CCO ‘‘tak[e]
reasonable steps to ensure that the
registrant establishes and follows
procedures reasonably designed for the
handling, management response,
remediation, retesting, and resolution of
non-compliance issues’’ (emphasis
added). Because this requirement is not
limited to non-compliance issues
identified by the CCO through a specific
means, the Commission believes it is
appropriate to clarify that final Rule
15Fk–1(b)(2)(ii) covers non-compliance
issues identified by the CCO through
any means, including the means
specifically listed in sub-paragraphs
(A)–(E) of the rule.
Third, the Commission is modifying
the duties of the CCO now enumerated
in Rules 15Fk–1(b)(3) and (4). As
adopted, Rule 15Fk–1(b)(3) requires the
CCO to ‘‘[i]n consultation with the
board of directors or the senior officer
of the [SBS Entity], take reasonable
steps to resolve any material conflicts of
interest that may arise.’’ This represents
a change from the proposed
requirement, which would have
required the CCO to ‘‘[i]n consultation
with the board of directors or the senior
officer of the [SBS Entity], promptly
resolve any conflicts of interest that may
arise.’’ The Commission is adding the
‘‘take reasonable steps’’ language and
materiality qualifier to further clarify
and qualify the role of the CCO in
resolving conflicts of interest in
response to concerns raised by
commenters.1218 Such conflicts of
1218 See FIA/ISDA/SIFMA, supra note 5
(requesting confirmation that the relevant conflicts

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interest could include conflicts between
the commercial interests of an SBS
Entity and its statutory and regulatory
responsibilities, and conflicts between,
among, or with associated persons of the
SBS Entity. As noted in the Proposing
Release and consistent with the
discussions of the CCO’s role above, the
Commission understands that the
primary responsibility for the resolution
of conflicts generally lies with the
business units within SBS Entities
because the business line personnel are
those with the power to make decisions
regarding the business of the SBS
Entity.1219 As a result, the Commission
anticipates that the CCO’s role with
respect to such resolution and
mitigation of conflicts of interest would
include the recommendation of one or
more actions, as well as the appropriate
escalation and reporting with respect to
any issues related to the proposed
resolution of potential or actual
conflicts of interest, rather than
responsibility to execute the business
actions that may be associated with the
ultimate resolution of such conflicts.
Furthermore, the Commission
recognizes that a CCO typically will not
exercise the supervisory authority to
resolve conflicts of interest, and the
revisions to the rule are intended to
clarify that CCOs are not required to
actually resolve such conflicts.1220
of interest under proposed Rule 15Fk–1(b)(3) would
be those which are reasonably identified by the SBS
Entity’s policies and procedures, taking into
consideration the nature of the SBS Entity’s
business); SIFMA (September 2015), supra note 5
(recommending qualifying the requirement to
promptly resolve conflicts of interest in
consultation with the board or senior officer with
the qualifying language ‘‘take reasonable steps to’’
resolve, and requesting guidance explaining that
resolution of a conflict of interest encompasses both
elimination and mitigation of the conflict and that
the CCO’s role in resolving conflicts may involve
actions other than making the ultimate decision
with regard to such conflict).
1219 See Proposing Release, 76 FR at 42436, supra
note 3.
1220 This is consistent with the position the
Commission took in adopting a similar requirement
for CCOs of SDRs. See SDR Registration Release, 80
FR at 14510, supra note 1202. The Commission is
not, as suggested by one commenter, expressly
requiring the CCO to highlight in the annual
compliance report any recommendations he or she
made with regard to resolution or mitigation of
conflicts of interest that were not adopted. See CFA,
supra note 5. The Commission believes the
requirement in Rule 15Fk–1(c)(2)(i)(C) to include a
description in the annual compliance report of
areas for improvement, and recommended potential
or prospective changes or improvements to its
compliance program and resources, as discussed
below, will adequately cover such issues. The
requirement is broadly framed and will allow the
CCO the flexibility to include in the annual
compliance report a description of any areas where
the CCO thinks the compliance program needs to
be improved, including, as appropriate, any
recommendations the CCO made with regard to the
resolution or mitigation of conflicts of interest that
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Finally, in response to a specific
suggestion made by a commenter,1221
the Commission is eliminating the
proposed timing requirement with
respect to the ‘‘prompt’’ resolution of
conflicts of interest to harmonize with
the parallel CFTC requirement. With
this change, the Commission intends to
focus the CCO’s efforts on the effective
resolution of conflicts of interest,
without placing undue emphasis on
speed at the expense of other factors.
We believe, however, that the resolution
of conflicts of interest generally should
occur within a reasonable timeframe.
As adopted, Rule 15Fk–1(b)(4)
requires the CCO to ‘‘[a]dminister each
policy and procedure that is required to
be established pursuant to [S]ection 15F
of the [Exchange Act] and the rules and
regulations thereunder.’’ This represents
a change from the proposed requirement
that the CCO ‘‘be responsible for’’
administering such policies and
procedures. The Commission is
eliminating the words ‘‘be responsible
for’’ because we believe they are
unnecessary and could cause confusion.
The CCO is responsible for complying
with all of the duties listed in Rule
15Fk–1(b)(2)–(4). Commenters requested
clarifications as to what the CCO’s
administration of the required policies
and procedures would entail.1222 The
Commission recognizes that the CCO
cannot be a guarantor of the SBS
Entity’s conduct. The Commission
believes that such administration
generally should involve: (1) Reviewing,
evaluating, and advising the SBS Entity
and its risk management and
compliance personnel on the
development, implementation and
monitoring of the policies and
procedures of the SBS Entity, including
procedures reasonably designed for the
handling, management response,
remediation, retesting and resolution of
non-compliance issues as required by
Rule 15Fk–1(b)(2)(iii); and (2)
reviewing, evaluating, following and
reasonably responding to the
development, implementation and
monitoring of the SBS Entity’s processes
1221 See

SIFMA (September 2015), supra note 5.
SIFMA (September 2015), supra note 5
(requesting the addition of rule text explaining that
‘‘such administration shall involve advising on the
development of, and reviewing, the registrant’s
processes for (i) modifying those policies and
procedures as business, regulatory and legislative
changes and events dictate, (ii) evidencing
supervision by the personnel responsible for the
execution of those policies and procedures, and (iii)
testing the registrant’s compliance with those
policies and procedures’’); FIA/ISDA/SIFMA, supra
note 5 (requesting clarification that a CCO’s
responsibility to administer a firm’s policies and
procedures is limited to coordinating supervisors’
administration of the relevant policies and
procedures).
1222 See

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for (a) modifying its policies and
procedures as business, regulatory and
legislative changes dictate; (b)
evidencing supervision by the personnel
responsible for the execution of its
policies and procedures; (c) testing the
SBS Entity’s compliance with, and the
adequacy of, its policies and
procedures; and (d) resolving, escalating
and reporting issues or concerns. In
carrying out this administration, the
Commission believes that the CCO
generally should consult, as
appropriate, with business lines,
management and independent review
groups regarding resolution of
compliance issues.
c. Annual Compliance Report
After considering the comments, the
Commission is adopting Rule 15Fk–1(c)
(annual compliance report) with a
number of modifications, as discussed
below. In response to concerns raised by
a commenter,1223 these changes are
primarily intended to harmonize the
annual compliance report requirements
with the CFTC’s parallel requirements.
As discussed above, this consistency
will result in efficiencies for SBS
Entities that have already established
infrastructure to comply with the CFTC
requirements. Consistent wording
regarding expectations for the annual
compliance report will also allow such
SBS Entities to more easily analyze
compliance with the Commission’s rule
against their existing activities to
comply with the CFTC’s parallel rule for
Swap Entities.
First, the Commission is making a
clarifying change to Rule 15Fk–1(c)(1) to
consistently refer to the annual report
required by Rule 15Fk–1(c) as the
‘‘compliance report.’’ This wording
change will not alter the substantive
requirements of the rule. It is only
meant to clarify that the rule refers to a
single annual compliance report.
Second, the Commission is eliminating
the proposed requirement to include a
description of ‘‘the compliance’’ of the
SBS Entity in the annual compliance
report in response to concerns raised by
commenters,1224 and specifying that the
requirement to include a description of
the compliance policies and procedures
only requires a description of the
‘‘written’’ compliance policies and
procedures of the SBS Entity pursuant
to Rule 15Fk–1(c)(1), in response to a
specific suggestion from a
commenter.1225 The Commission agrees
1223 See

SIFMA (September 2015), supra note 5.
SIFMA (September 2015), supra note 5;
FIA/ISDA/SIFMA, supra note 5.
1225 See SIFMA (September 2015), supra note 5.
Cf. Commodity Exchange Act Rule 3.3(e)(1) (‘‘The
1224 See

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with commenters that the proposed
requirement to describe ‘‘the
compliance’’ of the SBS Entity was
vague and believes these clarifying
changes will facilitate SBS Entities’
compliance with the rule, which will
still require an SBS Entity to provide
information demonstrating how the SBS
Entity complies with the applicable
requirements of the Exchange Act and
the rules and regulations thereunder in
the form of the SBS Entity’s written
compliances policies and procedures.
As adopted, Rule 15Fk–1(c)(1) requires
the CCO to ‘‘annually prepare and sign
a compliance report that contains a
description of the written policies and
procedures of the [SBS Entity] described
in paragraph (b) (including the code of
ethics and conflict of interest policies).’’
The Commission believes that SBS
Entities can fulfill this requirement by
either providing copies or summaries of
their written compliance policies and
procedures in the annual compliance
report. These changes will also
harmonize the annual compliance
report requirements with the CFTC’s
parallel requirements, as discussed
above.
The Commission is also making
certain modifications to the required
content of the annual compliance report
in Rule 15Fk–1(c)(2) in response to
specific suggestions from a
commenter.1226 First, the Commission is
specifying that the requirement to
describe material changes to policies
and procedures since the date of the
preceding compliance report in Rule
15Fk–1(c)(2)(i)(B) refers to the
‘‘registrant’s’’ policies and procedures.
This is a clarification and does not
change the substance of the
requirement. The phrase ‘‘since the date
of the preceding compliance report’’ in
the rule refers to the coverage date of the
prior year’s compliance report, not the
date on which it was prepared.
Accordingly, pursuant to Rule 15Fk–
1(c)(2)(i)(B), as adopted, an SBS Entity
must describe in its annual compliance
report any material changes to the SBS
Entity’s policies and procedures for the
time period covered by the report.
Second, the Commission is making a
number of changes to harmonize the
content requirements for the annual
compliance report with the CFTC’s
parallel requirements for the annual
compliance reports of Swap Entities.
The Commission agrees with the
commenter that alignment of the
annual report shall, at a minimum . . . [c]ontain a
description of the written policies and procedures,
including the code of ethics and conflicts of interest
policies, of the futures commission merchant, swap
dealer, or major swap participant.’’).
1226 See SIFMA (September 2015), supra note 5.

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content requirements will allow SBS
Entities that are also registered as Swap
Entities to leverage the procedures they
have adopted to comply with the
CFTC’s parallel CCO rule.1227
Specifically, the Commission is
changing the proposed requirement in
Rule 15Fk–1(c)(2)(i)(A) that the annual
compliance report contain a description
of the ‘‘enforcement’’ of the SBS Entity’s
policies and procedures to an
‘‘assessment of the effectiveness’’ of
such policies and procedures.1228 The
Commission believes that an
‘‘assessment of the effectiveness’’ of the
SBS Entity’s policies and procedures is
a more appropriate description because
the Commission is looking for a selfevaluation in the annual compliance
report, not a detailed description of the
mechanisms through which the SBS
Entity’s policies and procedures are
enforced. Additionally, the Commission
believes that providing consistency with
the parallel CFTC requirement will
allow SBS Entities to leverage any
existing procedures, as discussed above.
The Commission is also changing the
proposed requirement in Rule 15Fk–
1(c)(2)(i)(C) that the annual compliance
report contain a description of ‘‘any
recommendation for material changes to
the policies and procedures’’ to a
requirement to describe ‘‘areas for
improvement, and recommended
potential or prospective changes or
improvements to its compliance
program and resources devoted to
compliance.’’ 1229 As discussed above,
this change is in response to a specific
suggestion from a commenter.1230 A
description of ‘‘areas for improvement,
and recommended potential or
prospective changes or improvements to
[an SBS Entity’s] compliance program
and resources devoted to compliance’’ is
broader and would include any
recommendations made by the CCO
with respect to material changes to the
SBS Entity’s compliance policies and
procedures. Accordingly, the
Commission does not believe this
wording change diminishes the scope of
SIFMA (September 2015), supra note 5.
Commodity Exchange Act Rule
3.3(e)(2)(ii) (‘‘The annual report shall, at a
minimum . . . [r]eview each applicable
requirement under the Act and Commission
regulations, and with respect to each . . . [p]rovide
an assessment as to the effectiveness of these
policies and procedures.’’).
1229 Cf. Commodity Exchange Act Rule
3.3(e)(2)(iii) (‘‘The annual report shall, at a
minimum . . . [r]eview each applicable
requirement under the Act and Commission
regulations, and with respect to each . . . [d]iscuss
areas for improvement, and recommend potential or
prospective changes or improvements to its
compliance program and resources devoted to
compliance.’’).
1230 See SIFMA (September 2015), supra note 5.

the required content of the annual
compliance report. At the same time,
however, this wording change makes
the rule consistent with the parallel
CFTC requirements and thus will allow
SBS Entities to leverage any existing
procedures, as discussed above.
Additionally, the Commission is
changing the proposed requirement that
the annual compliance report contain a
description of ‘‘any material compliance
matters identified since the date of the
preceding compliance report’’ to a
requirement to describe ‘‘any material
non-compliance matters identified’’ in
Rule 15Fk–1(c)(2)(i)(D).1231 The change
from ‘‘material compliance matter’’ to
‘‘material non-compliance matter’’ is in
response to a specific suggestion from a
commenter.1232 It is not a substantive
change and is simply intended to
provide consistency with the parallel
CFTC requirement to allow SBS Entities
to leverage any existing procedures, as
discussed above. The Commission is
also otherwise adopting the definition of
material non-compliance matter in Rule
15Fk–1(e)(4), as proposed.1233 The
elimination of the phrase ‘‘since the
date of the preceding compliance
report’’ in the final rule is also intended
to harmonize with the parallel CFTC
requirement and respond to
commenters’ general concerns regarding
consistency with parallel CFTC
requirements.1234 Additionally, with
this change, the Commission intends to
clarify that the annual compliance
report should describe both material
non-compliance matters that are newly
identified during the time period
covered by the report and previously
identified material non-compliance
matters that have not yet been resolved
as of the end of the time period covered
by the report.
Finally, the Commission is adding a
requirement in Rule 15Fk–1(c)(2)(i)(E)
for an SBS Entity to include a
description in its annual compliance
report of the ‘‘financial, managerial,
operational, and staffing resources set
aside for compliance with the [Exchange
Act] and the rules and regulations

1227 See
1228 Cf.

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1231 Cf. Commodity Exchange Act Rule 3.3(e)(5)
(‘‘The annual report shall, at a minimum . . .
[d]escribe any material non-compliance issues
identified, and the corresponding action taken.’’).
1232 See SIFMA (September 2015), supra note 5.
1233 The Commission declines to eliminate the
definition of material non-compliance matter to be
consistent with the CFTC’s parallel requirement
(which does not contain a definition), as suggested
by a commenter. See SIFMA (September 2015),
supra note 5. The Commission believes it is
important to provide an explanation in the rule of
what should be included in the annual compliance
report.
1234 See, e.g., Barnard, supra note 5; Levin, supra
note 5; BlackRock, supra note 5; Nomura, supra
note 5.

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thereunder relating to [the SBS Entity’s]
business as [an SBS Entity], including
any material deficiencies in such
resources.’’ 1235 The Commission is
adding this requirement to harmonize
with the CFTC’s parallel content
requirement for the annual compliance
reports of Swap Entities, and to respond
to commenters’ general concerns
regarding consistency with parallel
CFTC requirements.1236 The
Commission believes that a description
of an SBS Entity’s compliance resources
and any deficiencies in such resources
will be useful in assessing the
compliance of the SBS Entity.
The Commission is also making a
number of changes with respect to the
submission of the annual compliance
report. First, the Commission is aligning
the deadline for submitting the report
with the CFTC’s deadline of 90 days
after the end of the Swap Entity’s fiscal
year in response to concerns raised by
a commenter.1237 As adopted, Rule
15Fk–1(c)(2)(ii)(A) will require an SBS
Entity’s compliance report to ‘‘be
submitted to the Commission within 30
days following the deadline for filing
the [SBS Entity’s] annual financial
report with the Commission pursuant to
Section 15F of the Act and rules and
regulations thereunder.’’ 1238 This
represents a change from the proposed
requirement that the compliance report
‘‘[a]ccompany each appropriate
financial report of the [SBS Entity] that
is required to be furnished to or filed
with the Commission pursuant to
Section 15F of the Act and rules and
regulations thereunder.’’ In response to
concerns raised by a commenter, this
change will provide SBS Entities with
additional time to prepare their annual
compliance reports after they have filed
1235 Cf. Commodity Exchange Act Rule 3.3(e)(4)
(‘‘The annual report shall, at a minimum . . .
[d]escribe the financial, managerial, operational,
and staffing resources set aside for compliance with
respect to the [Commodity Exchange Act] and
[CFTC] regulations, including any material
deficiencies in such resources.’’).
1236 See, e.g., Barnard, supra note 5; Levin, supra
note 5; BlackRock, supra note 5; Nomura, supra
note 5.
1237 See SIFMA (September 2015), supra note 5;
No-Action Relief for Futures Commission
Merchants, Swap Dealers, and Major Swap
Participants from Compliance with the Timing
Requirements of Commission Regulation 3.3(f)(2)
Relating to Annual Reports by Chief Compliance
Officers, CFTC Letter No. 15–15 (Mar. 27, 2015),
available at http://www.cftc.gov/idc/groups/public/
@lrlettergeneral/documents/letter/15-15.pdf.
1238 Section 15F(k)(3)(B)(i) of the Exchange Act
provides that a compliance report shall
‘‘accompany each appropriate financial report of
the [SBS Entity] that is required to be furnished to
the Commission pursuant to this section.’’ 15 U.S.C.
78o–10(k)(3)(B)(i). The Commission is interpreting
‘‘accompany’’ in Section 15F(k)(3)(B)(i) to mean
follow within 30 days.

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their annual financials.1239 The
Commission proposed a 60 day deadline
from the end of the SBS Entity’s fiscal
year for the filing of an SBS Entity’s
annual financials, so to the extent the
Commission adopts its proposed
deadline for the annual financials, this
change should also result in consistency
with the CFTC’s 90 day deadline for
furnishing the annual compliance
report.1240
Second, in connection with the
change described above, the
Commission is eliminating the proposed
provision that ‘‘[i]f compliance reports
are separately bound from the financial
statements, the compliance reports shall
be accorded confidential treatment to
the extent permitted by law.’’ The
Commission believes this provision is
no longer necessary in light of the
changes we are making to Rule 15Fk–
1(c)(2)(ii)(A), discussed above, which
will no longer require the compliance
report to accompany the SBS Entity’s
financial report. SBS Entities may
request confidential treatment for their
annual compliance reports pursuant to
Exchange Act Rule 24b–2.1241
Third, in response to comment,1242
the Commission is adding a new Rule
15Fk–1(c)(2)(iii) allowing an SBS Entity
to request from the Commission an
extension of the deadline for submitting
its annual compliance report to the
Commission. The Commission agrees
with the commenter that it is
appropriate to establish a framework for
when an SBS Entity is unable to meet
the deadline. Pursuant to Rule 15Fk–
1(c)(2)(iii), an SBS Entity may request
an extension, provided that the SBS
Entity’s failure to timely submit the
report could not be eliminated without
unreasonable effort or expense.
Extensions of the deadline will be
granted at the discretion of the
Commission. Rule 15Fk–1(c)(2)(iii) will
also be consistent with CFTC rules
regarding extensions of deadlines for
compliance reports by Swap
Entities.1243
Fourth, the Commission is changing
the required timing of submission of the
1239 See

SIFMA (September 2015), supra note 5.
Recordkeeping Release, 79 FR at 25135,
supra note 242.
1241 See 17 CFR 240.24b–2. The change to the rule
renders moot a commenter’s request that the
Commission amend its FOIA regulations in a
manner consistent with proposed Rule 15Fk–
1(c)(2)(iii). See FIA/ISDA/SIFMA, supra note 5.
1242 See SIFMA (September 2015), supra note 5.
1243 See Swap Dealer and Major Swap Participant
Recordkeeping, Reporting, and Duties Rules;
Futures Commission Merchant and Introducing
Broker Conflicts of Interest Rules; and Chief
Compliance Officer Rules for Swap Dealers, Major
Swap Participants, and Futures Commission
Merchants, 77 FR 20128, 20201 (Apr. 3, 2012)
(‘‘CFTC CCO Adopting Release’’).
1240 See

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30059

compliance report to the board of
directors, audit committee and senior
officer of the SBS Entity. The timing
requirement in proposed Rule 15Fk–
1(c)(3)(ii)(B) (‘‘at the earlier of their next
scheduled meeting or within 45 days of
the date of execution of the required
certification’’) was based on the
timeframe provided in the FINRA rule
regarding annual certification of
compliance and supervisory
processes.1244 The FINRA rule allows
for submission of the compliance report
to the board of directors either before or
after execution of the required
certification.1245 The Commission
understands, however, that prudent
corporate governance generally would
require submission to the board of
directors and senior officer before the
execution of the certification.
Accordingly, as adopted, Rule 15Fk–
1(c)(2)(ii)(B) requires that the
compliance report be submitted to the
board of directors, audit committee and
senior officer of the SBS Entity ‘‘prior to
submission to the Commission.’’ This
timing requirement will be consistent
with both Commission rules regarding
compliance reports by SDRs and CFTC
rules regarding compliance reports by
Swap Entities.1246 This consistency
with CFTC requirements will allow SBS
Entities to leverage any existing
procedures, as discussed above.
The Commission declines to modify
this provision, as suggested by a
commenter, to allow for submission of
the compliance report to either the
board or the senior officer.1247 The
Commission believes that requiring
submission to the board, audit
committee and senior officer will
promote an effective compliance system
by ensuring that all of these groups, not
just the senior officer, have the
opportunity to review the report. The
Commission believes it is important for
the board, the audit committee and the
senior officer to all have the opportunity
to receive the compliance report so that
they remain informed regarding the SBS
Entity’s compliance system in the
context of their overall responsibility for
governance and internal controls of the
SBS Entity. However, the Commission
declines to explicitly require the board
to review and comment on the
compliance report, require the audit
committee to review the compliance
report, or require the CCO to meet
quarterly with the audit committee, as
1244 See

FINRA Rule 3130(c).

1245 Id.
1246 See SDR Registration Release, 80 FR at 14512,
supra note 1202; CFTC CCO Adopting Release, 77
FR at 20201, supra note 1243.
1247 See SIFMA (September 2015), supra note 5.

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suggested by other commenters.1248 The
Commission does not think it is
necessary to explicitly require the
board, audit committee or senior officer
to review or comment on the
compliance report that they receive, or
to require the CCO to meet with the
audit committee because we believe the
goals of the rule can be achieved
without such a requirement.
Additionally, in response to concerns
raised by a commenter 1249 and to
harmonize with the parallel CFTC
requirement and FINRA Rule 3130, the
Commission is eliminating: (1) The
proposed requirement that the report
contain a written representation
regarding the required annual meeting
between the senior officer and the CCO,
and (2) the proposed specifications for
what topics such meeting must cover.
The Commission agrees with the
commenter that since the purpose of the
required annual meeting between the
senior officer and CCO is to discuss the
annual compliance report and since the
contents of the annual compliance
report are already specified in Rule
15Fk–1(c)(2)(i), it is unnecessary to also
specify the topics that should be
discussed in the annual meeting.
Additionally, this consistency with
CFTC and FINRA requirements will
allow SBS Entities to leverage any
existing procedures, as discussed above.
To address concerns raised by
commenters,1250 we also are modifying
Rule15Fk–1(c)(2)(ii)(D) to provide that
either the senior officer or CCO can
execute the compliance report
certification and to add knowledge and
materiality qualifiers to the certification
requirement. The proposed rule would
have required the compliance report to
include a certification that, under
penalty of law, the compliance report is
accurate and complete, without
specifying who must execute the
certification. As adopted, Rule 15Fk–
1(c)(2)(ii)(D) requires the compliance
report to include a certification ‘‘from
the senior officer or Chief Compliance
Officer that, to the best of his or her
knowledge and reasonable belief, under
penalty of law, the compliance report is
accurate and complete in all material
1248 See Better Markets (August 2011), supra note
5; Better Markets (October 2013), supra note 5; CFA,
supra note 5.
1249 See SIFMA (September 2015), supra note 5.
1250 See FIA/ISDA/SIFMA, supra note 5
(requesting that the CEO or other relevant senior
officer be the individual responsible for executing
the certification, or in the alternative, if the CCO is
required to certify, that the CEO also be required to
do so); CFA, supra note 5 (requesting that the CCO
be the individual responsible for executing the
certification); SIFMA (September 2015), supra note
5 (requesting that either the senior officer or CCO
be permitted to execute the certification).

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respects.’’ The Commission believes that
allowing either the senior officer or CCO
to execute the certification is
appropriate because both the senior
officer and the CCO should be in a
position to certify the accuracy and
completeness of the compliance report.
As noted by a commenter,1251 Exchange
Act Section 15F(k)(3)(B)(ii) requires that
the compliance report include a
certification but does not specify who
must execute the certification.1252 The
FINRA rule regarding annual
certification of compliance and
supervisory processes requires the CEO
(or an equivalent officer) to execute the
certification.1253 In contrast,
Commission rules regarding compliance
reports by SDRs require the CCO to
execute the certification.1254 CFTC rules
regarding compliance reports by Swap
Entities allow either the CEO or the CCO
to execute the required certification.1255
Rule 15Fk–1(c)(2)(ii)(D) will be
consistent with the parallel CFTC rule
and will allow flexibility for SBS
Entities who might also be registered
broker-dealers and FINRA members,
and therefore, subject to the FINRA rule
regarding annual certification of
compliance and supervisory processes.
As discussed above, consistency with
CFTC requirements will allow SBS
Entities to leverage any existing
procedures.
Additionally, the Commission
believes it is appropriate to add the
knowledge and materiality qualifiers
described above to the required
certification to address commenters’
concerns regarding the liability standard
for the certification.1256 The
Commission believes that a certification
to the best of the knowledge and
reasonable belief of the certifying officer
that the compliance report is accurate
and complete in all material respects is
appropriate to ensure effective reporting
with respect to the compliance of the
SBS Entity.1257
1251 See

FIA/ISDA/SIFMA, supra note 5.
Section 15F(k)(3)(B)(ii) of the Exchange
Act, 15 U.S.C. 78o–10(k)(3)(B)(ii).
1253 See FINRA Rule 3130(c).
1254 See SDR Registration Release, 80 FR at
14511–14512, supra note 1202.
1255 See CFTC CCO Adopting Release, 77 FR at
20201, supra note 1243.
1256 See FIA/ISDA/SIFMA, supra note 5; SIFMA
(September 2015), supra note 5. Contra. CFA, supra
note 5 (arguing that the CCO should not be
permitted to qualify its report).
1257 Cf. General Rule of Practice 153(b)(1)(ii), 17
CFR 201.153(b)(1)(ii) (requiring an attorney who
signs a filing with the Commission to certify that
‘‘to the best of his or her knowledge, information,
and belief, formed after reasonable inquiry, the
filing is well grounded in fact and is warranted by
existing law or a good faith argument for the
extension, modification, or reversal of existing
law’’).
1252 See

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In response to a specific suggestion
from a commenter,1258 the Commission
is also adding a new Rule 15Fk–
1(c)(2)(iv) allowing an SBS Entity to
incorporate by reference sections of a
compliance report that have been
submitted within the current or
immediately preceding reporting period
to the Commission. The rule allows an
SBS Entity to: (1) Incorporate by
reference items from a previous year’s
compliance report, or (2) for an SBS
Entity that is registered in more than
one capacity with the Commission and
required to submit more than one
compliance report,1259 incorporate by
reference into its compliance report
required by Rule 15Fk–1(c) sections in
another compliance report submitted to
the Commission by it in its capacity as
another type of registered entity within
the current or immediately preceding
reporting period.1260 The Commission is
limiting incorporation by reference to
reports submitted within the current or
immediately preceding reporting period,
which will be the fiscal year of the SBS
Entity, because we want to ensure that
compliance reports do not simply
continue to refer back to prior year’s
reports. Rule 15Fk–1(c)(2)(iv) will also
be consistent with CFTC rules regarding
compliance reports by Swap
Entities.1261
Finally, in response to a specific
suggestion from a commenter,1262 the
Commission is adding a new Rule
15Fk–1(c)(2)(v) requiring an SBS Entity
to submit an amended compliance
report if material errors or omissions in
the report are identified. The amended
report must contain the required
certification by the CCO or senior
officer, described above. The
Commission is adding this rule to
promote accurate and complete
compliance reports. When an SBS
Entity discovers a material error or
omission in its annual compliance
report subsequent to submitting the
1258 See

SIFMA (September 2015), supra note 5.
SDR Registration Release, 80 FR at
14510–14512, supra note 1202.
1260 The Commission declines to permit the
consolidation of annual compliance reporting
requirements for SBS Entities under common
control, as suggested by one commenter. See FIA/
ISDA/SIFMA, supra note 5. The Commission
believes it is appropriate to require an SBS Entity
to submit a separate compliance report, as
contemplated by Section 15F(k)(3)(B) of the
Exchange Act. However, as discussed above, the
Commission has made a number of changes to Rule
15Fk–1 to further harmonize the requirements of
the rule with FINRA Rule 3130 and the CFTC’s CCO
requirements for Swap Entities so that SBS Entities
that are also registered broker-dealers that are
FINRA members and/or Swap Entities can leverage
their existing procedures to comply with the rule.
1261 See CFTC CCO Adopting Release, 77 FR at
20201, supra note 1243.
1262 See SIFMA (September 2015), supra note 5.
1259 See

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report to the Commission, we believe it
is appropriate for an SBS Entity to be
required to submit an amended report.
This does not include a situation where
an SBS Entity’s annual compliance
report becomes inaccurate or
incomplete due to events occurring after
the coverage date of the report. Material
errors or omissions should be judged as
of the coverage date of the report. Rule
15Fk–1(c)(2)(v) will also be consistent
with CFTC rules regarding amended
compliance reports by Swap
Entities.1263
J. Prime Brokerage Transactions
One commenter recommended that
the Commission adopt a new rule that
would, in connection with securitybased swaps executed under a prime
brokerage arrangement, permit the
executing dealer and prime broker to
allocate responsibility for compliance
with certain external business conduct
obligations in a manner consistent with
CFTC No-Action Letter 13–11.1264 The
commenter noted that the Commission
staff has previously addressed
circumstances in which the executing
broker and prime broker in a securities
prime brokerage arrangement allocate
certain responsibilities between
themselves in different contexts.1265
The commenter described a particular
situation in which a counterparty
(‘‘Prime Broker Client’’) enters into an
agreement with a registered SBS Dealer
(‘‘Prime Broker’’). That agreement
establishes parameters under which the
Prime Broker Client, acting as agent of
the Prime Broker, can negotiate and
enter into security-based swaps with
certain registered SBS Dealers
(collectively, the ‘‘Executing Dealer’’). If
a security-based swap negotiated by the
Prime Broker Client with the Executing
Dealer is accepted by the Prime Broker,
the Prime Broker will enter into a
corresponding security-based swap with
the Prime Broker Client, the terms of
which mirror the terms of the securitybased swap between the Executing
Dealer and the Prime Broker, subject to
associated prime brokerage fees agreed
by the parties.
In these circumstances, the Prime
Broker Client may have entered into a
security-based swap with the Prime
Broker based not only on
communications with the Prime Broker
but also on communications including
disclosure of material terms and other
1263 See CFTC CCO Adopting Release, 77 FR at
20201, supra note 1243.
1264 See SIFMA (August 2015), supra note 5.
1265 See Letter to Mr. Jeffrey C. Bernstein, Prime
Broker Committee, from Brandon Becker, Director,
Division of Market Regulation, Commission, dated
January 25, 1994.

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representations, and possibly on the
basis of a recommendation by the
Executing Dealer. According to this
commenter, in these circumstances, the
Prime Broker is in the best position to
take responsibility for compliance with
the external business conduct standards
that relate to the general relationship
between the Prime Broker and the Prime
Broker Client, whereas the Executing
Dealer is in the best position to take
responsibility for compliance with
business conduct standards that are
transaction-specific. The commenter
expressed the view that unless SBS
Dealers are permitted to allocate
compliance with the external business
conduct standards between the Prime
Broker and the Executing Dealer, it
would be impossible to continue
existing prime brokerage
arrangements.1266
The commenter proposed a rule under
which the Prime Broker and the
Executing Dealer would have the full
range of business conduct obligations
that they would allocate between
themselves. The commenter’s request is
beyond the scope of this rulemaking
although we acknowledge the concerns
raised by the commenter, and may
consider them in the future.
K. Other Comments
The CFTC proposed rules regarding
best execution and front running that it
did not ultimately adopt. One
commenter urged the Commission to
adopt a best execution requirement
similar to the CFTC’s proposal.1267
Another commenter urged the
Commission not to adopt a prohibition
on front running.1268 Although the
Commission is not adopting such rules,
we note that SBS Entities remain subject
to the antifraud provisions of the federal
securities laws, including the antifraud
provisions of Exchange Act Section
15H(h)(4)(A) and Rule 15Fh–4(a), as
discussed in Section II.H.4, with respect
to their dealings with counterparties.
The Commission did not propose
rules regarding portfolio reconciliation
and compression. Four commenters
generally supported portfolio
reconciliation and compression
requirements.1269 A fifth commenter
asserted that inter-affiliate swaps should
1266 We recognize that there may be other ways
that parties structure their prime brokerage
arrangements. The above discussion is based on the
description of the arrangement in the proposed rule
text provided by the commenter.
1267 See CFA, supra note 5.
1268 See SIFMA (August 2011), supra note 5.
Front running refers to an entity entering into a
transaction for its own benefit ahead of executing
a counterparty transaction.
1269 See Barnard, supra note 5; Levin, supra note
5; Markit, supra note 5; MarkitSERV, supra note 5.

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30061

not trigger portfolio reconciliation and
compression requirements.1270 The
Commission is not adopting rules
regarding portfolio reconciliation and
compression at this time.
III. Cross-Border Application and
Availability of Substituted Compliance
A. Cross-Border Application of Business
Conduct Requirements
1. Proposed Rule
The Commission proposed generally
to apply all requirements in Section 15F
of the Exchange Act, and the rules and
regulations thereunder, to all SBS
Entities, whether U.S. persons or nonU.S. persons.1271 The Commission also
proposed to classify each requirement
that applies to SBS Entities either as a
transaction-level requirement, which
applies to specific transactions, or as an
entity-level requirement, which applies
to the dealing entity as a whole.1272 In
this taxonomy, entity-level requirements
would include most requirements
applicable to SBS Entities, including
those relating to the CCO requirements
under Section 15F(k) of the Exchange
Act, the supervision requirement under
Section 15F(h)(1)(B) of the Exchange
Act, and the requirement to establish
procedures to comply with the duties
set forth in Section 15F(j) of the
Exchange Act, including conflict of
interest systems and procedures.1273
Transaction-level requirements would
include primarily business conduct
standards under Section 15F(h) of the
Exchange Act (except for the diligent
supervision requirement under Section
15F(h)(1)(B) of the Exchange Act).1274
Under the proposed approach, the
entity-level requirements would apply
to all transactions of an SBS Entity,
regardless of the U.S.-person status of
the SBS Entity or its counterparty to any
particular transaction.1275 With respect
to the business conduct standards under
Section 15F(h) of the Exchange Act
(except for the diligent supervision
requirement under Section 15F(h)(1)(B)
of the Exchange Act), however, the
1270 See

ABA Securities Association, supra note

5.
1271 See Cross-Border Proposing Release, 78 FR
31009, 31035, supra note 6. The Commission noted
in the Cross-Border Proposing Release its
longstanding ‘‘view that an entity that has
registered with the Commission subjects itself to the
entire regulatory system governing such registered
entities.’’ Id. at 30986.
1272 See Cross-Border Proposing Release, 78 FR
31009, 31035, supra note 6.
1273 See Cross-Border Proposing Release, 78 FR
31014–15, 31035, supra note 6.
1274 See Cross-Border Proposing Release, 78 FR
31010, 31035, supra note 6. See also U.S. Activity
Proposing Release, 80 FR 27473, supra note 9.
1275 See Cross-Border Proposing Release, 78 FR
31026–27, 31035, supra note 6.

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Commission proposed to provide an
exception from these requirements for
certain transactions of SBS Entities,
proposing slightly different approaches
for SBS Dealers and Major SBS
Participants.
With respect to SBS Dealers, the
Commission proposed a rule that would
have provided that registered foreign
SBS Dealers and registered U.S. SBS
Dealers, with respect to their foreign
business, would not be subject to the
requirements relating to business
conduct standards described in Section
15F(h) of the Exchange Act,1276 and the
rules and regulations thereunder, other
than the rules and regulations
prescribed by the Commission pursuant
to Section 15F(h)(1)(B).1277 The
proposed rule would define ‘‘foreign
business’’ for both foreign SBS Dealers
and U.S. SBS Dealers to mean any
security-based swap transactions
entered into, or offered to be entered
into, by or on behalf of the SBS Dealer
that do not include its U.S. business.1278
The proposed definition of ‘‘U.S.
business,’’ however, would differ for
foreign SBS Dealers and U.S. SBS
Dealers. For a foreign SBS Dealer, ‘‘U.S.
business’’ would mean (i) any
transaction entered into, or offered to be
entered into, by or on behalf of such
foreign SBS Dealer, with a U.S. person
(other than with a foreign branch), or (ii)
any transaction conducted within the
United States.1279 For a U.S. SBS Dealer,
‘‘U.S. business’’ would mean any
transaction by or on behalf of such U.S.
SBS Dealer, wherever entered into or
offered to be entered into, other than a
transaction conducted through a foreign
branch with a non-U.S. person or
1276 15 U.S.C. 78o–10(h). See proposed Rule
3a71–3(c) (providing a partial exception from
certain transaction-level business conduct
standards for foreign SBS Dealers in connection
with their foreign business); see also Cross-Border
Proposing Release, 78 FR 31016–18, supra note 6.
1277 See Cross-Border Proposing Release, 78 FR
31016, supra note 6. Section 15F(h)(1)(B) requires
registered SBS Dealers to conform with such
business conduct standards relating to diligent
supervision as the Commission shall prescribe. See
15 U.S.C. 78o–10(h)(1)(B).
1278 See Cross-Border Proposing Release, 78 FR
31016, supra note 6.
1279 See Cross-Border Proposing Release, 78 FR
31016, supra note 6. Whether the activity in a
transaction involving a registered foreign SBS
Dealer occurred within the United States or with a
U.S. person for purposes of identifying whether
security-based swap transactions are part of U.S.
business would have turned on the same factors
used in that proposal to determine whether a
foreign SBS Dealer is engaging in dealing activity
within the United States or with U.S. persons and
whether a U.S. person was conducting a transaction
through a foreign branch. See Cross-Border
Proposing Release, 78 FR 31016, supra note 6.

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another foreign branch of a U.S.
person.1280
In April 2015, the Commission reproposed the rule defining the
application of business conduct rules to
SBS Dealers to incorporate the modified
approach to U.S. activity proposed in
that release and to make certain
technical changes to the ‘‘foreign
business’’ definition relating to
transactions conducted through a
foreign branch.1281 Under the modified
approach, ‘‘U.S. business’’ of a foreign
SBS Dealer would have been defined to
mean (i) any transaction entered into, or
offered to be entered into, by or on
behalf of such foreign SBS Dealer, with
a U.S. person (other than a transaction
conducted through a foreign branch of
that person), or (ii) any security-based
swap transaction that is arranged,
negotiated, or executed by personnel of
the foreign SBS Dealer located in a U.S.
branch or office, or by personnel of its
agent located in a U.S. branch or
office.1282 With respect to a U.S. SBS
Dealer, ‘‘U.S. business’’ would have
been defined to mean ‘‘any transaction
by or on behalf of such U.S. SBS Dealer,
entered into or offered to be entered
into, other than a transaction conducted
through a foreign branch with a nonU.S. person or with a U.S.-person
counterparty that constitutes a
transaction conducted through a foreign
branch of the counterparty.’’ 1283 The
definitions of ‘‘U.S. security-based swap
dealer,’’ 1284 ‘‘foreign security-based
swap dealer,’’ 1285 and ‘‘foreign
business’’ 1286 remained unchanged
from the initial proposal, as did the text
of re-proposed Rule 3a71–3(c), which
would create the exception to the
business conduct requirements for the
1280 See Cross-Border Proposing Release, 78 FR
31016, supra note 6.
1281 U.S. Activity Proposing Release, 80 FR 27475,
supra note 9. See also proposed Rule 3a71–3(c) and
proposed Rules 3a71–3(a)(6), (7), (8), and (9).
1282 Proposed Rule 3a71–3(a)(8)(i). The
Commission explained in the U.S. Activity
Proposing Release that it intended the proposed
rule to indicate the same type of activity by
personnel located in the United States as it
proposed to use in the de minimis context.
Moreover, for purposes of proposed Rule 3a71–
3(a)(8)(i)(B), the Commission explained that it
would interpret the term ‘‘personnel’’ in a manner
consistent with the definition of ‘‘associated person
of a security-based swap dealer’’ contained in
section 3(a)(70) of the Exchange Act, 15 U.S.C.
78c(a)(70), regardless of whether such non-U.S.
person or such non-U.S. person’s agent is itself a
security-based swap dealer. See U.S. Activity
Proposing Release 80 FR at 27469 n.193, supra note
9.
1283 Proposed Rule 3a71–3(a)(8)(ii).
1284 See proposed Rule 3a71–3(a)(6).
1285 See proposed Rule 3a71–3(a)(7).
1286 See proposed Rule 3a71–3(a)(9).

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foreign business of registered securitybased swap dealers.
With respect to Major SBS
Participants, the Commission proposed
to provide an exception from the
business conduct standards as described
in Section 15F(h) of the Exchange Act,
and the rules and regulations
thereunder (other than the rules and
regulations prescribed by the
Commission pursuant to Section
15F(h)(1)(B)), only for foreign Major SBS
Participants, with respect to their
transactions with non-U.S. persons.1287
2. Comments on the Proposed
Application of Business Conduct
Requirements to SBS Entities
In response to the U.S. Activity
Proposing Release, commenters focused
on the proposal to impose business
conduct standards on a transaction of a
registered foreign SBS Dealer with other
non-U.S. persons when the SBS Dealer
uses personnel located in the United
States to arrange, negotiate, or execute
the transaction. Several commenters
expressed general support for the
Commission’s proposed test to
determine when various Title VII
requirements should apply to
transactions between two non-U.S.
persons based on U.S. activity.1288
Moreover, although these commenters
generally urged that the Commission not
impose business conduct requirements
(or impose only certain of the
requirements, as described below) on a
registered foreign SBS Dealer solely
based on U.S. activity, they indicated
that they support the tailoring of the
Commission’s test (‘‘U.S. Activity Test’’)
from the initial proposal, if the
Commission ultimately determines that
the business conduct requirements
should apply to such transactions.1289
One commenter urged the Commission
to return to its initially proposed
approach to the definition of
1287 See proposed Rule 3a67–10(b) (providing that
a Major SBS Participant ‘‘shall not be subject, with
respect to its security-based swap transactions with
counterparties that are not U.S. persons, to the
requirements relating to business conduct
standards’’ in Section 15F(h) of the Exchange Act
and the rules and regulations thereunder, other than
rules and regulations prescribed pursuant to
Section 15F(h)(1)(B) of the Exchange Act); proposed
Rule 3a67–10(a)(1) (defining ‘‘foreign major
security-based swap participant’’).
1288 See, e.g., SIFMA/FSR (July 2015), supra note
10; IIB (July 2015), supra note 10.
1289 See IIB (July 2015), supra note 10, at 2;
SIFMA/FSR (July 2015), supra note 10, at 3, 10. One
commenter supported the proposal’s use of the
same U.S. Activity Test for business conduct as for
de minimis calculations because applying the
business conduct standards solely based on the use
of a U.S. fund manager is not dealing activity,
would be inconsistent with investor expectations,
and is unnecessary to protect the U.S. markets. See
ICI Global (July 2015), supra note 10, at 2, 5.

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‘‘transactions conducted within the
United States,’’ which would have
looked to the location of relevant
activity of both counterparties.1290 Such
an approach would thus apply the
business conduct requirements fully to
any transactions involving activity in
the United States, not just dealing
activity in the United States but also
relevant activity carried out by a nondealing counterparty in the United
States.1291
Some commenters that objected to the
Commission’s proposed approach
argued that none of the business
conduct requirements should apply to
transactions between non-U.S. persons,
even if these transactions involve U.S.
activity and therefore constitute ‘‘U.S.
business’’ under the proposed
definition.1292 These commenters
explained that the non-U.S.
counterparties of foreign SBS Dealers do
not expect these protections; the dealer
is likely to be subject to similar
requirements in its home jurisdiction;
and application is unlikely to protect
the U.S. market and is inconsistent with
international comity.1293 In a related
comment, one commenter explained
that the business conduct requirements,
as well as other requirements related to
reporting and dealer registration, should
not apply to transactions that are
executed on an anonymous electronic
platform or other means that ‘‘involve[s]
no human contact within the United
States,’’ because the parties would have
no expectation that the rules would
apply to such a transaction.1294
1290 See Better Markets (July 2015), supra note 10,
at 3, 6.
1291 See id.
1292 See ICI Global (July 2015), supra note 10, at
2, 5–6; SIFMA–AMG (July 2015), supra note 10, at
2, 5 (stating that non-U.S. clients do not expect U.S.
protections to apply to transactions between two
non-U.S. persons). See also ISDA (July 2015), supra
note 10, at 2 (urging that the Commission not apply
the business conduct requirements to transactions
solely because the transaction involves U.S.
activity); ISDA (July 2015), supra note 10, at 8
(arguing that the Commission does not have a
supervisory interest in imposing entity-level
requirements in connection with security-based
swap transactions between two non-U.S. persons
that are cleared outside the United States, even if
they are arranged, negotiated, or executed by
personnel located in the United States).
1293 See ICI Global (July 2015), supra note 10, at
5–6; SIFMA–AMG (July 2015), supra note 10, at 2,
5; IIB (July 2015), supra note 10, at 11; SIFMA/FSR
(July 2015), supra note 10, at 9. See also ISDA (July
2015), supra note 10, at 2, n.7 (recommending that
the final business conduct rules be consistent with
the CFTC’s business conduct rules); Barnard (July
2015) at 2, supra note 10 (recommending that the
rules proposed in the U.S. Activity Proposing
Release be consistent with the rules proposed by
the CFTC); MFA (July 2015), supra note 10, at 4
(emphasizing need for Commission and its U.S.
counterparts to develop a single, harmonized
approach to cross-border derivatives regulation).
1294 See ISDA (July 2015), supra note 10, at 7.

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Some commenters taking this view
also explained that U.S. asset managers
may face challenges in servicing nonU.S. client accounts under the proposed
approach, noting that non-U.S. clients
may be reluctant to deal with DoddFrank-related documentation or to make
required representations and describing
the significant burdens these
requirements would impose on asset
managers.1295 One of these commenters
argued that the U.S. Activity Proposing
Release considered only the costs of the
SBS Dealers that would be directly
subject to the business conduct
requirements but not the costs borne by
buy-side market participants, such as
asset managers.1296
Some commenters that objected to the
Commission’s proposed application of
business conduct requirements to
transactions between two non-U.S.
persons solely on the basis of activity in
the United States urged the Commission
to limit the application to specific
requirements that, in the commenters’
views, address regulatory concerns
directly related to the relevant activity
in the United States. These commenters
supported dividing the business
conduct requirements into two separate
categories of ‘‘relationship-based’’
requirements and ‘‘transaction-specific’’
or ‘‘communication-based’’
requirements.1297 Commenters argued
that relationship-based requirements—
which they identified as requirements
related to counterparty status,
disclosure of daily marks, know your
counterparty, and counterparty
suitability—should not apply to
transactions between two non-U.S.
persons solely on the basis of U.S.
1295 Specifically, the commenters expressed
concern that, under the proposal, the U.S. asset
manager executing a trade on behalf of a non-U.S.
client would need to know whether the transaction
involved U.S. activity and would also need to verify
that the non-U.S. client satisfies the business
conduct requirements. See SIFMA–AMG (July
2015), supra note 10, at 4; ICI Global (July 2015),
supra note 10, at 6 (explaining that regulated fund
parties would need appropriate documentation and
representations in place to execute such trades and
would face interruptions in investment activities in
doing so).
1296 See SIFMA–AMG (July 2015), supra note 10,
at 4–5. This commenter specifically argued that the
proposed rules would effectively require asset
managers to verify the eligibility of a non-U.S.
client as having satisfied the Commission’s business
conduct requirements, imposing costs on asset
managers and, through impeding block trades on
behalf of U.S. persons and non-U.S. persons,
negatively affecting liquidity and execution price.
See SIFMA–AMG (July 2015), supra note 10, at 4.
The commenter also argued that the proposed
approach has ‘‘no ascertainable benefit’’ to non-U.S.
counterparties who would not expect the
protections and would instead look to the law of
the dealer’s jurisdiction or its own jurisdiction. See
SIFMA–AMG (July 2015), supra note 10, at 5.
1297 See SIFMA/FSR (July 2015), supra note 10,
at 8–10; IIB (July 2015), supra note 10, at 11–13.

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activity for reasons similar to those
described above.1298
On the other hand, commenters
explained that application of business
conduct requirements that are
‘‘communication-based’’ or transactionspecific—which they identified as
including disclosure of material risks
and characteristics and material
incentives or conflicts of interest and
related recordkeeping, disclosures
regarding clearing rights and related
recordkeeping, product suitability, and
fair and balanced communications and
supervision—to such transactions
would be simpler and less costly to
implement.1299 These commenters,
however, urged the Commission, if it
does apply the transaction-specific
requirements to these transactions, to
harmonize FINRA’s existing sales
practice requirements with the
‘‘communication-based’’ or transactionspecific rules applicable under Title VII
to avoid unnecessary duplication or
conflicts, as the U.S. activity in many of
these transactions may be carried out by
registered broker-dealers subject to
1298 For example, one commenter argued that
non-U.S. counterparties would not expect such
protections and that the requirements may
duplicate requirements in the counterparty’s home
jurisdiction. See SIFMA/FSR (July 2015), supra
note 10, at 8–9. Commenters also argued that the
non-U.S. counterparty would not expect to provide
any representations as to its status or to complete
questionnaires to comply with U.S. relationshiplevel requirements, particularly at the beginning of
a trading relationship when neither counterparty
may expect the relationship to involve U.S. activity
and that such burdens have no benefit. See SIFMA/
FSR (July 2015), supra note 10, at 8–9; IIB (July
2015), supra note 10, at 11–12 (arguing that nonU.S. counterparties would not expect the ‘‘traderelationship’’ requirements to apply in their trades
with non-U.S. persons and would be surprised to
be required to agree to covenants or fill out
questionnaires related to U.S. requirements);
SIFMA–AMG (July 2015), supra note 10, at 4
(explaining that non-U.S. clients of asset managers
would be surprised to need to verify eligibility
under the business conduct requirements after
instructing asset managers to trade only with nonU.S. dealers). See also ICI Global (July 2015), supra
note 10, at 6 (noting that, even though the registered
dealer (and not the non-U.S. person) is subject to
the business conduct requirements, the non-U.S.
fund counterparty would likely need to have in
place appropriate documentation and
representations if its dealer is subject to business
conduct requirements, which may cause
interruptions in their investment activities).
1299 See IIB (July 2015), supra note 10, at 12–13
(noting that compliance with these requirements
would not require ‘‘wholesale modifications’’ to the
relationship documentation or onboarding
processes as long as the non-U.S. security-based
swap dealer is able to satisfy the requirements
under the rules of the relevant non-U.S.
jurisdictions and that there may be benefits to
applying these rules uniformly to front office
personnel in the United States as a supplement to
generally applicable antifraud and antimanipulation rules); SIFMA/FSR (July 2015), supra
note 10, at 9–10 (explaining that the application of
these rules would be consistent with the parties’
expectations).

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FINRA requirements.1300 One
commenter requested that if the
Commission does apply relationshipbased requirements to transactions
involving U.S. activity, it make
substituted compliance available to
foreign registered SBS Dealers in such
transactions.1301
Two commenters suggested that, if the
Commission does apply the business
conduct requirements as proposed, it
offer an ‘‘opt-out’’ for sophisticated nonU.S. person counterparties that would
allow them to trade under their existing
documentation rather than develop new
documentation pursuant to U.S.
rules.1302 One commenter explained
that, because the requirements are for
the benefit of the non-U.S. counterparty,
that counterparty should be able to
waive them.1303
Two commenters argued that the
Commission should not allow concern
about special entity protections to
influence its consideration of whether
U.S. activity alone should trigger
business conduct requirements. These
commenters noted that the Commission
has previously explained that only U.S.
persons would be special entities and,
as such, a registered foreign SBS Dealer
would already be subject to the full
range of business conduct requirements
in transactions with special entities,
because such transactions would
constitute ‘‘U.S. business’’ under the
proposed approach even if the
Commission were to eliminate U.S.
Activity from the definition of ‘‘U.S.
business.’’ 1304

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3. Response to Comments and Final
Rule
After considering the comments, the
Commission is adopting final Rule
3a71–3(c) and amendments to the
definitions in Rule 3a71–3(a) largely
unchanged from the April 2015 re1300 See SIFMA/FSR (July 2015), supra note 10,
at 9–10; IIB (July 2015), supra note 10, at 13.
Commenters also urged the Commission to work
toward a harmonized approach to all the business
conduct rules with the CFTC and FINRA to ensure
that security-based swap dealers and swap dealers
are not subject to two different sets of business
conduct requirements. See ISDA (July 2015), supra
note 10, at 2, n.7; IIB (July 2015), supra note 10,
at 6, 7. See also ISDA (July 2015), supra note 10,
at 9 (asking the Commission to evaluate whether
imposing business conduct requirements adds
value if the intermediary is already subject to
broker-dealer regime).
1301 See IIB (July 2015), supra note 10, at 12.
1302 See IIB (July 2015), supra note 10, at 13;
SIFMA/FSR (July 2015), supra note 10, at 10–11
(requesting the non-U.S. counterparty have option
to opt-out of ‘‘transaction-specific’’ rules if they
apply solely as a result of U.S. activity).
1303 See SIFMA/FSR (July 2015), supra note 10,
at 10–11.
1304 See IIB (July 2015), supra note 10, at 12;
SIFMA/FSR (July 2015), supra note 10, at 9.

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proposal.1305 The Commission is also
adopting amendments to Rule 3a67–10
to incorporate an exception from these
requirements for registered Major SBS
Participants, modified slightly from the
initial proposal. Consistent with the
Cross-Border Proposing Release, the
Commission is not providing any
exception from the entity-level
requirements being adopted in this
release.1306
a. Entity-Level Requirements for SBS
Entities
The Commission continues to believe
that the rules and regulations prescribed
by the Commission relating to diligent
supervision pursuant to Section
15F(h)(1)(B), those relating to the CCO
under Section 15F(k) of the Exchange
Act, and those relating to requirements
under Section 15F(j) of the Exchange
Act should be treated as entity-level
requirements that apply to the entire
business of the registered foreign or U.S.
SBS Entity.1307 Accordingly, the
1305 The final rules incorporate minor conforming
edits. The definition of U.S. business for U.S.
security-based swap dealers (Rule 3a71–3(a)(8)(ii))
is modified for consistency with the surrounding
rules by moving the phrase ‘‘entered into or offered
to be entered into’’ and deleting the word
‘‘wherever’’ to further clarify that the definition of
U.S. business for a U.S. security-based swap dealer
does not depend on the location of personnel
arranging, negotiating, or executing the transaction.
Rule 3a71–3(a)(9) defining foreign business and
Rule 3a71–3(c) contain minor edits to simplify the
rule text primarily by eliminating unnecessary
separate references to U.S. and foreign securitybased swap dealers.
1306 The Commission does not believe that these
final rules apply Title VII to persons that are
‘‘transact[ing] a business in security-based swaps
without the jurisdiction of the United States,’’
within the meaning of section 30(c) of the Exchange
Act. A final rule that did not treat security-based
swaps that a registered foreign security-based swap
dealer has arranged, negotiated, or executed using
its personnel or personnel of its agent located in the
United States as the ‘‘U.S. business’’ of that dealer
for purposes of proposed Exchange Act rule 3a71–
3(c) would, in our view, reflect an understanding
of what it means to conduct a security-based swap
dealing business within the jurisdiction of the
United States that is divorced both from Title VII’s
statutory objectives and from the various structures
that non-U.S. persons use to engage in securitybased swap dealing activity. But in any event we
also believe that the final rule is necessary or
appropriate as a prophylactic measure to help
prevent the evasion of the provisions of the
Exchange Act that were added by the Dodd-Frank
Act, and thus help prevent the relevant purposes of
the Dodd-Frank Act from being undermined. See
Cross-Border Adopting Release, 79 FR 47291–92,
supra note 193 (interpreting anti-evasion provisions
of Exchange Act Section 30(c)). Without this rule,
non-U.S. persons could simply carry on a dealing
business within the United States with non-U.S.
persons. Permitting this activity could allow these
firms to retain full access to the benefits of
operating in the United States while avoiding
compliance with business conduct requirements,
which could increase the risk of misconduct. See
U.S. Activity Proposing Release, 80 FR 27477 n.255,
supra note 9.
1307 See Cross-Border Proposing Release, 78 FR
31013–15, supra note 6 (classifying these

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following requirements would apply to
all security-based swap transactions of
an SBS Entity, regardless of the U.S.person status of the SBS Entity or that
of its counterparty in any particular
transaction: 1308 Supervision
requirements under Rule 15Fh–3(h),
including the requirement in Rule
15Fh–3(h)(2)(iii)(I) that SBS Entities
establish procedures reasonably
designed to comply with the duties set
forth in Section 15F(j) of the Exchange
Act; and CCO requirements under Rule
15Fk–1. The Commission, however, is
adopting a rule that would potentially
make substituted compliance available
for these requirements for registered
foreign SBS Entities as discussed
below.1309
As the Commission has previously
stated, it is appropriate to subject a
registered SBS Entity to the diligent
supervision requirements regardless of
the status or location of its
counterparties to ensure that the SBS
Entity is adequately supervising its
business and its associated persons to
ensure compliance with the full range of
its obligations under the federal
securities laws.1310 Similarly, the
Commission continues to believe that
Rule 15Fh–3(h)(2)(iii)(I), which requires
SBS Entities to establish procedures to
comply with the duties set forth in
Section 15F(j) of the Exchange Act,
including conflict of interest systems
and procedures, should apply to all of
an SBS Entity’s security-based swap
transactions, as such systems and
procedures cannot be effective unless so
applied.1311 As we have previously
noted, to prevent conflicts of interest
from biasing the judgment or
supervision of these entities, application
to only a portion of an SBS Entity’s
security-based swap transactions would
not be effective at addressing conflicts
that may arise as a result of transactions
that arise out of an SBS Entity’s foreign
business.1312 Each of the remaining
duties under section 15F(j) 1313 would
requirements, among others, as entity-level). But see
ISDA (July 2015), supra note 10, at 8 (arguing that
the Commission does not have a supervisory
interest in imposing entity-level requirements in
connection with security-based swap transactions
between two non-U.S. persons that are cleared
outside the United States, even if they are arranged,
negotiated, or executed by personnel located in the
United States).
1308 See Cross-Border Proposing Release, 78 FR
31026–27, 31035, supra note 6.
1309 See Section III.B, infra.
1310 See Cross-Border Proposing Release, 78 FR
31014, 31017, supra note 6.
1311 See Cross-Border Proposing Release, 78 FR
31013–14, supra note 6.
1312 See Cross-Border Proposing Release, 78 FR
31014, supra note 6.
1313 Section 15F(j) of the Exchange Act requires
an SBS Entity to comply ‘‘at all times’’ with

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
not be effective if not applied at the
entity level.1314
The CCO requirements under Rule
15Fk–1 also raise entity-wide concerns.
CCO’s responsibilities include
establishing, maintaining, and
reviewing policies and procedures
reasonably designed to ensure
compliance with applicable Exchange
Act requirements.1315 Because such
responsibilities apply to the entity as a
whole and many of the requirements
that the CCO oversees are entity-level
requirements, the Commission believes
that it is necessary to treat the CCO
requirement as an entity-level
requirement applicable to all of an SBS
Entity’s security-based swap
business.1316

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b. Transaction-Level Requirements for
SBS Dealers
As noted above, the Commission is
adopting final Rule 3a71–3(c) and
amendments to the definitions in Rule
3a71–3(a) largely unchanged from the
proposal. Accordingly, the final rule
provides that registered SBS Dealers,
with respect to their foreign business,
shall not be subject to the requirements
relating to business conduct standards
described in Section 15F(h) of the
Exchange Act,1317 and the rules and
regulations thereunder,1318 other than
the rules and regulations prescribed by
the Commission pursuant to Section
obligations concerning: (1) Monitoring of trading to
prevent violations of applicable position limits; (2)
establishing sound and professional risk
management systems; (3) disclosing to regulators
information concerning its trading in security-based
swaps; (4) establishing and enforcing internal
systems and procedures to obtain any necessary
information to perform any of the functions
described in Section 15F of the Exchange Act, and
providing the information to regulators, on request;
(5) implementing conflict-of-interest systems and
procedures; and (6) addressing antitrust
considerations such that the SBS Entity does not
adopt any process or take any action that results in
any unreasonable restraint of trade or impose any
material anticompetitive burden on trading or
clearing. See 15 U.S.C. 78o–10(j).
1314 See Cross-Border Proposing Release, 78 FR
31014, supra note 6 (explaining that the purpose of
the diligent supervision requirements is to prevent
violations of applicable federal securities laws, and
the rules and regulations thereunder, relating to an
entity’s entire business as a security-based swap
dealer, which is not limited to either its foreign
business or its U.S. business, but rather is
comprised of its entire global security-based swap
dealing activity, and as such, to be effective, the
requirements should apply at the entity level).
1315 See Section II.I, supra.
1316 See Cross-Border Proposing Release, 78 FR
31014–15, supra note 6.
1317 15 U.S.C. 78o–10(h).
1318 These rules and regulations are Rules 15Fh–
1 through 15Fh–6. With the exception of Rule
15Fh–3(h), which prescribes certain entity-level
requirements pursuant to Exchange Act Section
15F(h)(1)(B), these rules are transaction-level
requirements, which is consistent with the
proposed approach. See, supra, Section III.0.

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15F(h)(1)(B).1319 The final rule defines
‘‘foreign business’’ for both foreign SBS
Dealers and U.S. SBS Dealers to mean
any security-based swap transactions
entered into, or offered to be entered
into, by or on behalf of the SBS Dealer
that do not include its U.S. business.1320
However, the final rule defines ‘‘U.S.
business’’ differently for foreign SBS
Dealers and U.S. SBS Dealers. The final
rule defines ‘‘U.S. business’’ of a foreign
SBS Dealer to mean (i) any transaction
entered into, or offered to be entered
into, by or on behalf of such foreign SBS
Dealer, with a U.S. person (other than a
transaction conducted through a foreign
branch of that person), or (ii) any
security-based swap transaction that is
arranged, negotiated, or executed by
personnel of the foreign SBS Dealer
located in a U.S. branch or office, or by
personnel of its agent located in a U.S.
branch or office.1321 For a U.S. SBS
Dealer, the final rule defines ‘‘U.S.
business’’ to mean ‘‘any transaction
entered into or offered to be entered into
by or on behalf of such U.S. securitybased swap dealer, other than a
transaction conducted through a foreign
branch with a non-U.S. person or with
a U.S.-person counterparty that
constitutes a transaction conducted
through a foreign branch of the
counterparty.’’ 1322 The Commission
also is adopting, unchanged from the
proposals, the definitions of ‘‘U.S.
security-based swap dealer,’’ 1323 and
‘‘foreign security-based swap
dealer.’’ 1324 The Commission also is
adopting the definition of ‘‘foreign
business,’’ 1325 with minor edits to
simplify the rule text primarily by
eliminating unnecessary separate
references to foreign SBS Dealers and
U.S. SBS Dealers. Finally, the
Commission is adopting Rule 3a71–3(c),
which creates the exception from the
application of the business conduct
1319 See

Rule 3a71–3(c).
Section 15F(h)(1)(B) requires registered securitybased swap dealers to conform with such business
conduct standards relating to diligent supervision
as the Commission shall prescribe. See 15 U.S.C.
78o–10(h)(1)(B). The rules being prescribed
pursuant to Exchange Act Section 15F(h)(1)(B) are
those in Rule 15F–3(h), which are entity-level
requirements, as discussed above. See, supra,
Section III.0. The exception as adopted applies to
Section 15F(h)(1)(A) of the Exchange Act, and any
rules and regulations thereunder. However, this
exception does not affect applicability of the
general antifraud provisions of the federal securities
laws to the activity of a foreign SBS Dealer. See
Cross-Border Proposing Release, 78 FR 31016 n.476,
supra note 6.
1320 See Rule 3a71–3(a)(9).
1321 See Rule 3a71–3(a)(8)(i).
1322 Rule 3a71–3(a)(8)(ii).
1323 See Rule 3a71–3(a)(6).
1324 See Rule 3a71–3(a)(7).
1325 See Rule 3a71–3(a)(9).

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30065

requirements to foreign business, again,
unchanged from the proposal except for
minor edits eliminating separate
references to foreign SBS Dealers and
U.S. SBS Dealers.
The final rule reflects the
Commission’s continuing view that all
registered SBS Dealers should be
required to comply with the transactionlevel elements of the business conduct
standards with respect to their U.S.
business.1326 The Dodd-Frank
counterparty protection mandate
focuses on the U.S. markets and
participants in those markets.1327 The
business conduct standards are
intended to bring professional standards
of conduct to, and increase transparency
in, the security-based swap market and
to require registered SBS Dealers to treat
parties to these transactions fairly.1328
Accordingly, with respect to both
foreign and U.S. SBS Dealers, we are
adopting a definition of ‘‘U.S. business’’
that encompasses those transactions that
appear particularly likely to affect the
integrity of the security-based swap
market in the United States and the U.S.
financial markets more generally or that
raise concerns about the protection of
participants in those markets.
With respect to foreign SBS Dealers,
the Commission continues to believe
that the final definition of ‘‘U.S.
business’’ should generally encompass
transactions with U.S. persons and
transactions that the foreign SBS Dealer
arranges, negotiates, or executes using
personnel located in a U.S. branch or
office.1329 As we have previously noted,
this approach would both preserve
customer protections for U.S.
counterparties that would expect to
benefit from the protection afforded to
them by Title VII of the Dodd-Frank Act
and help maintain market integrity by
subjecting the large number of
transactions that involve relevant
dealing activity in the United States to
these requirements, even if both
counterparties are non-U.S. persons.1330
1326 See U.S. Activity Proposing Release, 80 FR
27475, supra note 9.
1327 See Cross-Border Proposing Release, 78 FR
31017–018, supra note 6.
1328 See id. The rules require, among other things,
that registered SBS Dealers communicate in a fair
and balanced manner with potential counterparties
and that they disclose conflicts of interest and
material incentives to potential counterparties.
1329 We also note that relying on the same
approach to U.S. activity that is used in the de
minimis context should simplify implementation of
Title VII for market participants. See U.S. Activity
Proposing Release, 80 FR 27473, supra note 9.
1330 The exception from the definition for
transactions involving the foreign branch of a U.S.
person reflects our view that transactions between
the foreign branch of a U.S. person and a non-U.S.
person, in which the personnel arranging,

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With respect to U.S. SBS Dealers, the
Commission continues to believe that
the definition of ‘‘U.S. business’’ should
encompass all of their transactions,
regardless of the U.S.-person status of
the counterparty, except for transactions
that a U.S. SBS Dealer arranges,
negotiates, or executes through a foreign
branch with another foreign branch or
with a non-U.S. person. As noted above,
Title VII is concerned with the
protection of U.S. markets and
participants in those markets, and it
remains our view that imposing these
requirements on a U.S.-person dealer
when it arranges, negotiates, or executes
through its foreign branch with another
foreign branch or a non-U.S. person
would produce little or no benefit to
U.S. market participants.1331
One commenter urged the
Commission to return to its initially
proposed approach to the definition of
‘‘transactions conducted within the
United States,’’ which would have
looked to the location of relevant
activity of both counterparties.1332 Such
an approach would thus apply the
business conduct requirements fully to
any transactions involving activity in
the United States, not just dealing
activity in the United States but also
relevant activity carried out by a nondealing counterparty in the United
States. Given the structure of the
security-based swap market and the
concentration of security-based swap
dealing among a small group of firms,
the Commission believes the final rules
are appropriately tailored to apply the
business conduct requirements to
dealing activity, including dealing
activity in the United States, that is
likely to raise market integrity and
transparency concerns.1333 Further, as
the Commission discussed in the U.S.
Activity Adopting Release, the final
rules adopted in that release should
mitigate some commenters’ concerns
regarding the costs associated with the
initially proposed application of the de
minimis exception to ‘‘transactions
conducted within the United
States.’’ 1334 The initially proposed
negotiating, and executing the transaction are all
located outside the United States, are less likely to
affect the integrity of the U.S. market and reflects
our consideration of the role of foreign regulators
in non-U.S. markets. See Cross-Border Proposing
Release, 78 FR 31017, supra note 6.
1331 See Cross-Border Proposing Release, 78 FR
31018, supra note 6.
1332 See note 1291, supra (citing Better Markets
(July 2015), supra note 10).
1333 See U.S. Activity Adopting Release, 81 FR
8624, n.241 (explaining that the U.S. activity test is
appropriately tailored to capture dealing activity
that raises the types of concerns addressed by the
Title VII dealer regime).
1334 See U.S. Activity Adopting Release, 81 FR
8627.

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approach supported by the commenter
would have required a dealer engaged in
dealing activity to consider both the
location of its personnel and the
personnel of its counterparty in
determining whether to include
transactions in its de minimis
calculation thresholds.1335 The final
rules in the U.S. Activity Adopting
Release and the final rule being adopted
here focus on the location of relevant
personnel of only the dealer (or its
agent), which should impose lower
costs on market participants than the
initially proposed approach, while
applying the business conduct
requirements to dealing activity in the
United States that is likely to raise the
types of concerns addressed by the
business conduct requirements.1336
Moreover, given the Commission’s
action in the U.S. Activity Adopting
Release, taking a different approach in
the definition of ‘‘U.S. business’’ would
mean using a different test to identify
relevant U.S. activity from the test used
in the de minimis context. The
Commission believes that this would
present unnecessary implementation
and compliance challenges.1337
Some commenters have argued that
the business conduct standards should
not apply to any transactions between
two non-U.S. persons because the
foreign counterparties may not expect to
receive such protections, or to any such
transactions where expectations of
receiving such protections are likely to
be particularly low.1338 The
Commission has determined not to limit
the application of the business conduct
standards in this way. Counterparty
expectations are not particularly
relevant in determining whether a
1335 See Cross-Border Proposing Release, 78 FR
31000–01, supra note 6.
1336 See U.S. Activity Adopting Release, 81 FR
8627.
1337 See also U.S. Activity Proposing Release, 80
FR 27467, supra note 9 (discussing the change in
approach in the context of the de minimis
calculation from the Cross-Border Proposing
Release, which proposed to focus both on the
dealing and non-dealing counterparty, to the U.S.
Activity Proposing Release, which proposed to
focus only on the activity of personnel in the
United States of the dealing counterparty).
1338 See ICI Global (July 2015), supra note 10, at
2, 5–6; SIFMA–AMG (July 2015), supra note 10, at
2, 5 (stating that non-U.S. clients do not expect U.S.
protections to apply to transactions between two
non-U.S. persons). See also ISDA (July 2015), supra
note 10, at 2 (urging that the Commission not apply
the business conduct requirements to transactions
solely because the transaction involves U.S.
activity); ISDA (July 2015), supra note 10, at 7
(arguing that business conduct requirement, as well
as other requirements, should not apply to
transactions that are executed on an anonymous
electronic platform or other means that ‘‘involve[s]
no human contact within the United States,’’
because the parties would have no expectation that
the rules would apply to such a transaction).

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transaction that involves relevant
activity in the United States has the
potential to affect the integrity of the
U.S. markets, particularly given that all
of the registered foreign SBS Dealers
subject to these requirements will have,
by definition, a sufficient level of
activity in the U.S. security-based swap
market to exceed the de minimis
threshold, many by an order of
magnitude.1339 Given the significant
role registered SBS Dealers play in the
market, applying the business conduct
requirements to their U.S. business
should help protect the integrity of the
U.S. market.1340
Moreover, the approach to identifying
relevant dealing activity in the United
States reflects the Commission’s
determination that focusing solely on
the location of the personnel arranging,
negotiating, or executing the transaction
on behalf of the foreign SBS Dealer
appropriately balances the regulatory
objectives of the business conduct
standards with concerns about
workability of an activity-based test. To
create additional exceptions,
particularly for activity occurring in the
United States, based on the expectations
of the non-dealing counterparty or the
mode of its interaction with the foreign
SBS Dealer would unnecessarily
complicate this approach in a manner,
as noted above, that would not advance
the regulatory objectives served by these
standards.1341
Some commenters have urged the
Commission to harmonize any
standards that the Commission does
impose on these transactions with
requirements that may separately apply
to the foreign registered SBS Dealer’s
U.S.-person intermediary to avoid
unnecessary duplication or
conflicts.1342 The Commission
1339 See U.S. Activity Adopting Release, 81 FR
8623 (rejecting commenter concerns that
counterparties would not expect automated
electronic trades to be subject to de minimis
counting).
1340 See U.S. Activity Adopting Release, 81 FR
8616 and n.166 (explaining that overwhelming
majority of transactions captured by U.S. Activity
Test are likely to be inter-dealer transactions carried
out between non-U.S. persons whose dealing
activity likely exceeds the de minimis threshold by
at least an order of magnitude).
1341 To the extent that anonymously executed
transactions raise specific challenges or concerns,
these are not unique to transactions between two
non-U.S. persons involving relevant dealing activity
in the United States. The Commission has
separately addressed this issue above. See Section
II.B, supra.
1342 Commenters urged the Commission to
harmonize FINRA’s existing sales practice
requirements with the ‘‘communication-based’’ or
transaction-specific rules applicable under Title VII.
See SIFMA/FSR (July 2015), supra note 10, at 9–
10; IIB (July 2015), supra note 10, at 13.
Commenters also urged the Commission to work

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recognizes that business conduct
standards could apply to transactions
arising from relevant dealing activity in
the United States, including Title VII
and home jurisdiction requirements on
the registered SBS Dealer and SRO
requirements on the U.S. intermediary.
As discussed above, the rules being
adopted today are generally designed to
be consistent with the relevant SRO
requirements (and to harmonize with
CFTC requirements), taking into account
the nature of the security-based swap
market and the statutory requirements
for SBS Entities.1343 The Commission
does not believe that the commenters’
concerns warrant a complete or partial
exception from Title VII requirements
for the registered SBS Dealer.
First, as discussed below, the
Commission is adopting a rule that
potentially would make substituted
compliance available for the business
conduct requirements following a
substituted compliance determination
by the Commission.1344 Accordingly,
substituted compliance, if available,
could mitigate the commenters’
concerns regarding home country
regulation.1345 A person relying on
substituted compliance would remain
subject to the applicable Exchange Act
requirements, but could comply with
those requirements in an alternative
fashion.1346 In practice, however, we
recognize that there will be limits to the
availability of substituted compliance.
For example, it is possible that
substituted compliance may be
permitted with regard to some
requirements and not others with
respect to a particular jurisdiction. For
certain jurisdictions, moreover,
substituted compliance may not be
available with respect to any
requirements depending on our
assessment of the comparability of the
relevant foreign requirements, as well as
the availability of supervisory and
enforcement arrangements among the
Commission and relevant foreign
financial regulatory authorities.
Although comparability assessments
will focus on regulatory outcomes rather
toward a harmonized approach to all the business
conduct rules with the CFTC and FINRA to ensure
that security-based swap dealers and swap dealers
are not subject to two different sets of business
conduct requirements. See also ISDA (July 2015),
supra note 10, at 2, n.7; IIB (July 2015), supra note
10, at 6, 7.
1343 See Sections I.C and I.F, supra.
1344 See Rule 3a71–6. See also note 1301, supra
(citing IIB (July 2015), supra note 10, at 12).
1345 See note 1338, supra (citing ICI Global (July
2015), supra note 10, at 5–6; SIFMA–AMG (July
2015), supra note 10, at 2, 5; IIB (July 2015), supra
note 10, at 11; SIFMA/FSR (July 2015), supra note
10, at 9).
1346 See Cross-Border Proposing Release, 78 FR
31085, supra note 6.

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than rule-by-rule comparisons, the
assessments will require inquiry
regarding whether foreign regulatory
requirements adequately reflect the
interests and protections associated
with the particular Title VII
requirement. In some circumstances,
such a conclusion may be difficult to
achieve.
In the event that we are unable to
determine that an entity may satisfy
certain Title VII requirements via
substituted compliance, we recognize
that such persons may, as a result, be
subject to requirements that are
duplicative of particular Title VII
requirements. While we recognize the
significance of such a result, in our view
compliance with the Title VII
requirements is necessary to advance
the policy objectives of Title VII. This
would be undermined by permitting
foreign dealers to comply with their
Title VII obligations by satisfying
foreign requirements, unless the
alternative route provided by
substituted compliance has been made
available.
Second, although the Commission is
mindful that the U.S. intermediary of a
registered foreign SBS Dealer may be
subject to business conduct
requirements under the Exchange Act
and relevant SRO rules and that such
requirements may be similar in certain
respects to those in Title VII,1347 the
Commission continues to believe that
notwithstanding any requirements that
may apply to such intermediaries, it is
appropriate to impose the Title VII
business conduct standards directly on
registered foreign SBS Dealers when
they use personnel located in the United
States to arrange, negotiate, or execute
security-based swaps, even with
counterparties that are also non-U.S.
1347 See U.S. Activity Proposing Release, 80 FR
27476 n.249, supra note 9 (stating that the agent of
a foreign SBS Dealer would need to consider
whether it separately would need to register as a
security-based swap dealer (if, for example, the
agent acted as principal in a security-based swap
with the counterparty, and then entered into a backto-back transaction with the booking entity), a
broker (e.g., by soliciting or negotiating the terms
of security-based swap transactions), or other
regulated entity); Cross-Border Proposing Release,
78 FR 31027 n.574, supra note 6 (same).
Commenters urged the Commission to harmonize
FINRA’s existing sales practice requirements with
the ‘‘communication-based’’ or transaction-specific
rules applicable under Title VII. See SIFMA/FSR
(July 2015), supra note 10, at 9–10; IIB (July 2015),
supra note 10, at 13. Commenters also urged the
Commission to work toward a harmonized
approach to all the business conduct rules with the
CFTC and FINRA to ensure that security-based
swap dealers and swap dealers are not subject to
two different sets of business conduct requirements.
See ISDA (July 2015), supra note 10, at 9; IIB (July
2015), supra note 10, at 6, 7.

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persons.1348 The Commission continues
to believe that it is appropriate to
subject all registered SBS Dealers
engaged in U.S. business to the same
business conduct framework, rather
than encouraging a patchwork of
business conduct protections under U.S.
law that may offer counterparties
varying levels of protections and limit
the Commission’s ability to pursue
enforcement actions against the
registered SBS Dealer for violation of
Title VII depending on the business
model that the registered SBS Dealer has
chosen to use in its U.S. business.1349
Further, as we have previously
discussed, Congress established a
comprehensive framework of business
conduct standards in Title VII that
applies to registered SBS Dealers, and
we continue to believe that the
transactional requirements we adopt to
implement this framework should
govern their transactions with
counterparties when such transactions
raise market integrity, transparency, and
counterparty protection concerns that
are addressed by these requirements.1350
As we have already noted, SBS Dealers
are involved in an overwhelming
majority of SBS transactions in the U.S.,
meaning that business conduct
standards intended to achieve market
1348 See U.S. Activity Proposing Release, 80 FR
27476, supra note 9. Consistent with the
Commission’s position in the Cross-Border
Proposing Release, the dealer and its agent(s) may
choose to allocate the responsibility for compliance
with all U.S. business conduct requirements in a
manner consistent with its business structure,
although the foreign security-based swap dealer
would remain responsible for ensuring that all
relevant Title VII requirements applicable to a given
security-based swap transaction are fulfilled. See
U.S. Activity Proposing Release, 80 FR 27476 n.249,
supra note 9; Cross-Border Proposing Release, 78
FR 31026–27, supra note 6. This allocation,
however, would not affect the non-U.S. person’s
responsibilities with respect to performing the de
minimis calculations required under Rules 3a71–2
and 3a71–3(b). See U.S. Activity Proposing Release,
80 FR 27476 n.249, supra note 9; Cross-Border
Proposing Release, 78 FR 31026–27 n.574, supra
note 6.
1349 See U.S. Activity Proposing Release, 80 FR
27476, supra note 9.
1350 See U.S. Activity Adopting Release, Sections
IV.B.2, IV.B.3, and n.162 (describing regulatory
concerns raised by security-based swap dealing
activity carried out in the U.S., including risk,
market integrity and transparency, and counterparty
protection). See Section II.G.3, supra (explaining
that the ‘‘know your counterparty’’ standard would
be consistent with basic principles of legal and
regulatory compliance, and operational and credit
risk management); Section II.G.2.e, supra
(explaining that the daily mark disclosure
requirement is directly relevant to a counterparty’s
understanding of its financial relationship under a
security-based swap transaction and ensures a
counterparty’s ability to monitor the transaction
during the relationship); Section II.G.4, supra
(explaining that the suitability requirement enables
security-based swap dealers to understand the riskreward tradeoff of their security-based swap
transactions).

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integrity, transparency, and
counterparty protection across the U.S.
market in security-based swaps are more
likely to achieve these objectives if they
apply to all transactions that SBS
dealers arrange, negotiate, or execute
using personnel located in a U.S. branch
or office.1351
Some commenters supported dividing
the business conduct standards into two
categories, one of which they argued
should not apply to transactions
between two non-U.S. persons. These
commenters urged the Commission not
to impose ‘‘relationship-based’’
requirements (which they defined to
include rules relating to the
counterparty’s ECP status, ‘‘know your
counterparty’’ requirements, daily mark
disclosure, and suitability requirements)
on these transactions but suggested that
imposing ‘‘trade-specific’’ or
‘‘communication-based’’ requirements
(which they which they identified as
including disclosure of material risks
and characteristics and material
incentives or conflicts of interest and
related recordkeeping, disclosures
regarding clearing rights and related
recordkeeping, product suitability, and
fair and balanced communications and
supervision) could be a reasonable
approach, particularly if they were
made more consistent with similar
FINRA rules that may apply to the U.S.
intermediary.1352
The Commission does not agree with
commenters who argue that the foreign
SBS Dealers should be excepted from
the ‘‘relationship-based’’ requirements
when entering into transactions with
other non-U.S. persons.1353 The
Commission believes that applying each
of these requirements should improve
market integrity and enhance
transparency and counterparty
protections, even if that dealing activity
is entirely with non-U.S.-person
counterparties, particularly given that
the foreign SBS Dealers that engage in
the relevant dealing activity in the
United States at levels above the de
minimis threshold account for a
significant proportion of transactions in
the U.S. market. Moreover, certain

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1351 Firms

that act as dealers play a central role
in the security-based swap market. Based on an
analysis of 2014 single name CDS data in TIW,
dealer accounts of those firms that are likely to
exceed the de minimis thresholds and trigger
registration requirements intermediated
transactions with a gross notional amount of
approximately $8.5 trillion, over 60% of which was
intermediated by top 5 dealer accounts.
Commission staff analysis of TIW transaction
records indicates that approximately 99% of single
name CDS price-forming transactions in 2014
involved an ISDA-recognized dealer. See U.S.
Activity Adopting Release, 81 FR 8606 n.77.
1352 See notes 1297–1299, supra.
1353 See note 1298, supra.

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underlying substantive requirements
may require SBS Dealers to obtain
representations from counterparties (or
to otherwise confirm their status) even
absent these business conduct
requirements, meaning that, as a
practical matter, for example, we would
not expect that the requirement in Rule
15Fh–3(a)(1) to verify ECP status would
increase the burden on market
participants.1354 Accordingly, the
Commission does not believe it would
be appropriate to provide an exception
from these ‘‘relationship-based’’
requirements for foreign SBS Dealers
when they are required to comply with
the business conduct standards in a
security-based swap transaction with a
non-U.S.-person counterparty because
they have used personnel located in the
United States to arrange, negotiate, or
execute the transaction.
The Commission recognizes that some
non-U.S. person counterparties may
express reservations about making
certain representations or completing
questionnaires to comply with the
‘‘relationship-based’’ business conduct
requirements when they have no
intention of interacting with the dealer’s
personnel located in the United
States.1355 At the same time, nothing in
the rule requires a registered SBS Dealer
to comply with these requirements if it
intends to engage in transactions with a
counterparty solely as part of its foreign
business. If the relationship later
1354 The Exchange Act prohibits any person from
effecting a security-based swap with a non-ECP
unless the security-based swap is effected on a
national securities exchange and the Securities Act
makes it unlawful to offer to sell, offer to buy or
purchase or sell a security-based swap to any
person who is not an eligible contract participant
unless a registration is in effect. See Section II.G.1.c,
supra. See also Section 6(l) of the Exchange Act;
Section 5(e) of the Securities Act. Accordingly,
section 6(l) is broader than the activity covered by
Rule 15Fh–3(a)(1), and the SBS Dealer has an
independent obligation under section 6(l) even
absent the requirement in Rule 15Fh–3(a)(1), to
perform some due diligence in confirming that its
counterparty is an ECP. The requirement to verify
the ECP-status of a counterparty pursuant to Rule
15Fh–3(a)(1) simply provides a means for
complying with certain of the relevant substantive
statutory provisions. See id. See Section II.G.1.c,
supra.
1355 See SIFMA/FSR (July 2015), supra note 10,
at 8–9. See also ICI Global (July 2015), supra note
10, at 6 (noting that, even though the registered
dealer (and not the non-U.S. person) is subject to
the business conduct requirements, the non-U.S.
person counterparty would likely need to have in
place appropriate documentation and
representations if its dealer is subject to business
conduct requirements, which may cause
interruptions in their investment activities); IIB
(July 2015), supra note 10, at 11–12 (arguing that
non-U.S. counterparties would not expect the
‘‘trade-relationship’’ requirements to apply in their
trades with non-U.S. persons and would be
surprised to be required to agree to covenants or fill
out questionnaires related to U.S. requirements).
See note 1298, supra.

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develops in such a way that future
transactions may be expected to be part
of the SBS Dealer’s U.S. business, under
the final rules the SBS Dealer then
would be required to comply with these
business conduct standards, including
these ‘‘relationship-based’’
requirements.
As noted above, some commenters
acknowledged that the
‘‘communication-based’’ or ‘‘tradespecific’’ requirements likely would
advance regulatory objectives, such as
the prevention of fraud or manipulation,
even in connection with SBS
transactions between two non-U.S.
persons where one counterparty is using
personnel located in the United States
to arrange, negotiate, or execute
transactions.1356 They urged, however,
that the Commission harmonize its Title
VII business conduct standards to
existing FINRA rules to the extent that
it chooses to impose Title VII
requirements on these transactions.1357
As discussed above, the rules being
adopted today are generally designed to
be consistent with the relevant SRO
requirements (and to harmonize with
CFTC requirements), taking into account
the nature of the security-based swap
market and the statutory requirements
for SBS Entities.1358
The Commission recognizes that
application of these requirements may
impose costs on asset managers
servicing non-U.S. clients and impede
their ability to execute certain block
trades.1359 However, we believe that the
rules appropriately balance the
regulatory objectives of the business
conduct rules with concerns for a
workable approach. The rules adopted
here are generally applicable to
transactions of registered SBS Dealers;
the rules do not apply directly to asset
managers, and asset managers will incur
no liability under these rules. We
recognize that SBS Dealers may arrange
their business in a variety of ways and
may have certain expectations of asset
managers in connection with the
transactions involving funds. The
entities involved in the transaction may
1356 See

note 1299, supra.
note 1300, supra.
1358 See Sections I.C and I.F, supra.
1359 See notes 1295 and 1296, supra. Specifically,
the commenters expressed concern that, under the
proposal, the U.S. asset manager executing a trade
on behalf of a non-U.S. client, including in the
context of a block trade, would need to know
whether the transaction involved U.S. activity and
would also need to verify that the non-U.S. client
satisfies the business conduct requirements. See
SIFMA–AMG (July 2015), supra note 10, at 4; ICI
Global (July 2015), supra note 10, at 6 (explaining
that regulated fund parties would need appropriate
documentation and representations in place to
execute such trades and would face interruptions in
investment activities in doing so).
1357 See

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
allocate these costs in the manner most
efficient for the counterparties to the
transactions. Although the Commission
recognizes that, depending on how the
SBS Dealer and the asset manager
choose to allocate these responsibilities,
the asset manager may incur certain
costs, neither these private allocation
issues nor the potential liquidity or
execution price concerns change the
Commission’s view that the U.S.
business of SBS Dealers should be
subject to these business conduct
requirements.
The Commission also disagrees with
the commenters that urged the
Commission to permit sophisticated
counterparties to ‘‘opt-out’’ completely
from the business conduct standards
and with commenters that requested
that the U.S. Activity Test not be
applied to transactions with special
entities.1360 The Commission has
considered the concerns raised by
commenters and determined, on
balance, not to permit counterparties to
opt out of the protections provided by
the business conduct rules. The rules
are intended to provide certain
protections for counterparties, including
certain heightened protections for
special entities. We think it is
appropriate to apply the rules so that
counterparties receive the benefits of
those protections and so do not think it
appropriate to permit parties to ‘‘opt
out’’ of the benefits of those
provisions.1361
c. Transaction-Level Requirements for
Major SBS Participants

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As noted above, the Commission is
also adopting amendments to Rule
3a67–10 to incorporate a modified
exception from the business conduct
standards for registered foreign Major
SBS Participants.1362 The Commission
received no comments in response to
the proposed exception from the
business conduct requirement for
registered foreign Major SBS
1360 See IIB (July 2015), supra note 10, at 13;
SIFMA/FSR (July 2015), supra note 10, at 10–11
(requesting the non-U.S. counterparty have option
to opt-out of ‘‘transaction-specific’’ rules if they
apply solely as a result of U.S. activity). See note
1302, supra. See note 1304 (citing IIB (July 2015),
supra note 10, at 12; SIFMA/FSR (July 2015), supra
note 10, at 9–10).
1361 See Section II.A.3, supra. We also explained
above that, while we are not adopting an opt out
provision, as discussed in connection with the
relevant rules, the Commission has determined to
permit means of compliance with the final rules
that should promote efficiency and reduce costs
(e.g., Rule 15Fh–1(b) (reliance on representations))
and, where appropriate, allow SBS Entities to take
into account the sophistication of the counterparty
(e.g., Rule 15Fh–3(f) (regarding recommendations of
security-based swaps or trading strategies)).
1362 Rule 3a67–10(d).

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Participants in their transactions with
non-U.S. persons. However, the final
rule is slightly modified from the
proposal to address the concerns that
non-U.S. persons would limit or stop
trading with foreign branches of U.S.
banks that led us to adopt a similar
exception in the Cross-Border Adopting
Release for certain transactions from the
position threshold calculations to
determine whether one is a Major SBS
Participant.1363
As proposed, Exchange Act Rule
3a67–10(c), which addressed crossborder application of the definition of
‘‘major security-based swap
participant,’’ would require non-U.S.
persons to count toward the Major SBS
Participant thresholds only their
security-based swap transactions with
U.S. persons and would have permitted
no exception from that requirement. As
adopted, however, in the Cross-Border
Adopting Release, the relevant rule
(Exchange Act Rule 3a67–10(b))
provides that a non-U.S. person need
not include in these threshold
calculations its security-based swap
positions with a U.S. person to the
extent that the positions ‘‘arise from
transactions conducted through a
foreign branch of the counterparty,
when the counterparty is a registered
SBS Dealer.’’ 1364 This change to the
final rule made the Commission’s
approach to the threshold calculations
for Major SBS Participant consistent
with its final approach to the SBS
Dealer de minimis calculation
thresholds under Exchange Act rule
3a71–3(b)(1)(iii)(A)(1), which also
permitted non-U.S. persons to exclude
such transactions with U.S. persons
from their de minimis threshold
calculations.1365 The Commission noted
that this expanded exception from
counting certain security-based swap
positions towards a non-U.S. person’s
Major SBS Participant thresholds
should help mitigate concerns that nonU.S. persons will limit or stop trading
with foreign branches of U.S. banks.1366
The Commission believes similar
concerns about the ability of foreign
branches of U.S. banks to do business
with non-U.S. persons apply in the
context of application of the business
conduct requirement to these
1363 See Rule 3a67–10. See Cross-Border Adopting
Release, 79 FR 47343, supra note 193 (explaining
the Commission’s view that an exclusion from the
counting requirement for positions that arise from
transactions conducted through foreign branches of
registered security-based swap dealers
appropriately accounts for the risk in the U.S.
financial system created by such positions).
1364 See Exchange Act rule 3a67–10(b)(3)(i)(A).
1365 See Cross-Border Adopting Release, 79 FR
47343, supra note 193.
1366 See id.

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30069

transactions. This exception from the
application of the business conduct
requirements adopted in the final rules
today should address concerns that nonU.S. persons would limit or stop trading
with foreign branches of U.S. banks. The
Commission is therefore amending
Exchange Act rule 3a67–10 to
incorporate exceptions for transactions
through the foreign branch of a U.S.
person modeled on those that are
available in the final rule as it applies
to registered SBS Dealers.1367
Accordingly, the final rules except
registered foreign Major SBS
Participants from the business conduct
standards described in section 15F(h) of
the Exchange Act, and the rules and
regulations thereunder (other than the
rules and regulations prescribed by the
Commission pursuant to section
15F(h)(1)(B)) 1368 with respect to any
transaction with a non-U.S. person, as
proposed, or with a U.S. person in a
transaction conducted through the
foreign branch of the U.S. person.1369
The final rules also except a registered
U.S. Major SBS Participant from the
business conduct standards described in
section 15F(h) of the Exchange Act, and
the rules and regulations thereunder
(other than the rules and regulations
prescribed by the Commission pursuant
to section 15F(h)(1)(B)) 1370 with respect
to any transaction of the registered U.S.
Major SBS Participant that is a
transaction conducted through a foreign
branch with a non-U.S. person, or with
a U.S.-person counterparty that
constitutes a transaction conducted
through a foreign branch of the
counterparty.1371
1367 See Exchange Act rule 3a71–3(a)(8)(i)(A)
(excluding from the definition of ‘‘U.S. business’’ of
a foreign SBS Dealer any transaction with U.S.
persons that constitutes a transaction conducted
through a foreign branch of that U.S. person);
Exchange Act rule 3a71–3(a)(8)(ii) (excluding from
the definition of ‘‘U.S. business’’ of U.S. SBS
Dealers any transaction of the U.S. SBS Dealer that
is a transaction conducted through a foreign branch
with a non-U.S. person or with a U.S.-person
counterparty that constitutes a transaction
conducted through a foreign branch of the
counterparty).
1368 See, supra, notes 1318–1319.
1369 See Exchange Act rule 3a67–10(d)(1).
Consistent with the Cross-Border Proposing
Release, the Commission is also amending
Exchange Act rule 3a67–10(a) to define ‘‘foreign
major security-based swap participant.’’ See
Exchange Act rule 3a67–10(a)(6).
1370 See, supra, notes 1318–1319.
1371 See Exchange Act rule 3a67–10(d)(2). The
Commission is also amending Exchange Act rule
3a67–10(a) to define ‘‘U.S. major security-based
swap participant.’’ See Exchange Act rule 3a67–
10(a)(5).

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B. Availability of Substituted
Compliance
1. Proposed Substituted Compliance
Rule

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As part of the Cross-Border Proposing
Release, the Commission proposed to
make substituted compliance
potentially available in connection with
the requirements applicable to SBS
Dealers pursuant to Exchange Act
Section 15F, other than the registration
requirements applicable to dealers.1372
Because the business conduct
requirements being adopted today are
grounded in Section 15F, substituted
compliance generally would have been
available for those requirements under
the proposal.
The proposal would have specifically
provided that a foreign SBS Dealer 1373
could satisfy applicable requirements
under Section 15F by complying with
comparable regulatory requirements of a
foreign jurisdiction.1374 The
Commission explained that a person
relying on substituted compliance
would remain subject to the applicable
Exchange Act requirements, but could
comply with those requirements in an
alternative fashion. Failure to comply
with the applicable foreign requirement
would mean that the person would be
in violation of the requirement in the
Exchange Act.1375
The Commission further explained
that allowing substituted compliance for
the dealer requirements would have the
goal of increasing the efficiency of the
security-based swap market and
promoting competition ‘‘by helping to
avoid subjecting foreign security-based
swap dealers to potentially conflicting
or duplicative compliance obligations,
while still achieving the policy
objectives of Title VII.’’ The
Commission also stated that such an
approach would be consistent with the
global nature of the security-based swap
market, and may be less disruptive of
business relationships than not
permitting substituted compliance.1376
Under the proposal, the Commission
would not permit dealer requirements to
1372 See Cross-Border Proposing Release, 78 FR at
31088, 31207–08, supra note 6 (proposed Exchange
Act Rule 3a71–5).
1373 In the Cross-Border Proposing Release, the
Commission proposed to define a ‘‘foreign securitybased swap dealer’’ as a security-based swap dealer
that is not a U.S. person. See 78 FR at 31206, supra
note 6 (proposed Exchange Act Rule 3a71–3(a)(3)).
1374 See Cross-Border Proposing Release, 78 FR at
31207, supra note 6 (proposed Exchange Act Rule
3a71–5(b), providing that a security-based swap
dealer may comply with Section 15F requirements
by complying with certain corresponding foreign
requirements).
1375 See id. at 31085.
1376 See id. at 31089–90.

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be satisfied by substituted compliance
unless the Commission determined that
the foreign regime’s requirements were
comparable to the otherwise applicable
requirements, after taking into account
such factors as the Commission
determines are appropriate, including
the scope and objectives of the relevant
foreign regulatory requirements and the
effectiveness of the supervisory
compliance program administered, and
the enforcement authority exercised, by
the foreign financial regulatory
authority in support of its oversight.1377
The Commission also stated that in
making a substituted compliance
determination, it would focus on the
similarities in regulatory objectives,
rather than requiring that the foreign
jurisdiction’s rules be identical.
Moreover, depending on the assessment
of comparability, the Commission could
condition the substituted compliance
determination by limiting it to a
particular class or classes of registrants
in the foreign jurisdiction.1378
The proposal would have required
that, prior to making a substituted
compliance determination, the
Commission must have entered into a
supervisory and enforcement
memorandum of understanding
(‘‘MOU’’) or other arrangement with the
foreign authority addressing the
oversight and supervision of securitybased swap dealers subject to the
substituted compliance
determination.1379 The proposal further
provided for the potential withdrawal of
substituted compliance orders, after
notice and comment.1380 In addition,
the proposal would have required that
a foreign security-based swap dealer
could not submit a substituted
compliance request unless it is directly
supervised by the foreign financial
regulatory authority, and the securitybased swap dealer provides a
certification and opinion of counsel that
the security-based swap dealer can
provide the Commission with prompt
access to its books and records, and that
1377 See

id. at 31086–88.
id. at 31088. The Commission added that
it intended to take a category-by-category approach
toward substituted compliance under the proposal,
and that ‘‘certain requirements are interrelated such
that the Commission would expect to make a
substituted compliance determination for the entire
group of related requirements.’’ See id. at 31088–
89 (further stating that the Commission anticipated
considering substituted compliance related to
capital and margin requirements in connection with
requirements related to risk management,
recordkeeping and reporting, and diligent
supervision).
1379 See id. at 31088.
1380 See id. at 31089 (citing as an example
changes in the foreign regulatory regime or a foreign
regulator’s failure to exercise its supervisory or
enforcement authority in an effective manner).
1378 See

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the security-based swap dealer as a
matter of law can submit to onsite
inspection and examination by the
Commission.1381
Under the proposal, substituted
compliance would not have been
available to Major SBS Participants. In
this regard, the Commission particularly
noted ‘‘the limited information
currently available to us regarding what
types of foreign entities may become
major security-base swap participants, if
any, and the foreign regulation of such
entities.’’ 1382
2. Comments on the Proposal
Commenters raised issues in
connection with a variety of aspects
regarding the proposed substituted
compliance rule:
• Basis for substituted compliance.
One commenter to the Cross-Border
Proposing Release questioned the
Commission’s authority to grant
substituted compliance,1383 and
expressed skepticism regarding the
policy basis for permitting the use of
substituted compliance to satisfy Title
VII requirements.1384 That commenter
further suggested that any Commission
relief should be used sparingly, and
should be predicated on a finding that
1381 See

id. at 31089 & n.1126.
id. at 31035–36.
1383 See Better Markets (August 2013), supra note
7, at 24 (‘‘Nowhere does the SEC address its
authority for adopting such a framework, nor does
it explain how the possibility of ‘conflicting or
duplicative compliance obligations’ [justifies]
supplanting Congress’s determination that, to
protect the American taxpayer and economy, those
subject to the Commission’s jurisdiction must
comply with the actual provisions of the DoddFrank financial reform law.’’).
This commenter particularly described the use of
substituted compliance as constituting an
impermissible exemption from the Title VII
requirements, stating: ‘‘Had Congress intended the
SEC to permit compliance with foreign regulation
to suffice for all Title VII regulation of entities
under U.S. jurisdiction, directly or by way of antievasion regulations, it certainly could have done
so.’’ In support, the commenter cited Exchange Act
section 17A(k), 15 U.S.C. 78q–1(k), added by DoddFrank, which specifically permits the Commission
to exempt clearing agencies from registration when
they are subject to comparable and comprehensive
oversight by the CFTC or by foreign regulators. See
Better Markets (August 2013), supra note 7, at 25.
1384 See Better Markets (August 2013), supra note
7, at 24–25 (‘‘The SEC’s duty is to protect investors
and the public consistent with congressional policy,
not to minimize the costs, burdens, or
inconvenience that regulation imposes on industry.
This is particularly important when any claimed
industry burden is not only self-serving, but
without basis and entirely speculative.’’). The
commenter also alluded to potential loopholes
associated with opportunities for regulatory
arbitrage, encouraging ‘‘a race to the regulatory
bottom so that financial firms can increase profits
by avoiding regulations that protect the American
people and taxpayers,’’ and that the ‘‘financial
industry is among the most notorious business
sectors for searching the globe to exploit such
loopholes.’’ See id.
1382 See

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there is an actual conflict between Title
VII and foreign requirements.1385
• Availability to U.S. persons. One
commenter suggested that substituted
compliance for the dealer requirements
should be available to foreign branches
of U.S. persons,1386 while another
commenter opposed the availability of
substituted compliance to U.S.
persons.1387 One commenter expressed
the view that substituted compliance
should be made available to U.S.
persons in connection with transactions
with non-U.S. persons,1388 while
another stated that substituted
compliance should be made available to
U.S. persons in connection with all
transaction-level requirements.1389
• Availability in connection with U.S.
business. One commenter expressed the
view that substituted compliance
generally should not be available in
connection with transactions involving
U.S. counterparties, or in connection
with transactions that occur within the
U.S.1390
1385 See Better Markets (August 2013), supra note
7, at 26 (‘‘Rather than following a substituted
compliance approach, the SEC should use its
exemptive authority sparingly, and only upon a
finding of actual conflict with a particular foreign
regulation.’’).
1386 See SIFMA (August 2013), supra note 7, at
A–33 (stating that not allowing substituted
compliance for foreign branches in connection with
confirmation requirements and certain other
requirements would put foreign branches at a
competitive disadvantage to foreign dealers,
although foreign branches ‘‘are, in most cases,
subject to extensive supervision and oversight in
their host country’’; further noting that the
Commission proposed to allow substituted
compliance for foreign branches in connection with
regulatory reporting, public dissemination and
trade execution requirements).
1387 See Better Markets (August 2013), supra note
7, (generally opposing substituted compliance for
U.S. persons, including foreign branches, and
stating that allowing substituted compliance in
those circumstances would constitute ‘‘carve-outs’’
that would ‘‘essentially nullify U.S. law in favor of
foreign regulatory requirements’’).
1388 See ESMA, supra note 8, at 3–4 (expressing
the view that ‘‘substituted compliance should apply
when a counterparty to the derivative transaction is
established in an equivalent jurisdiction and is a
non-U.S. person. In such case, substituted
compliance should be possible whatever the status
of the other party is, including if it is a U.S. person,
and whatever the place out of which the transaction
is conducted or executed.’’).
1389 See MFA/AIMA, supra note 8 (stating the
Commission should extend substituted compliance
to ‘‘to all transaction-level requirements that apply
to U.S. and non-U.S. persons,’’ and that ‘‘by
extending the scope of substituted compliance to all
market participants, irrespective of their ‘U.S.
person’ status, and to all regulatory categories . . .
the Commission would mitigate the risk of
duplicative and/or conflicting regulatory
requirements, without curtailing the reasonable
application of Title VII of Dodd-Frank to relevant
market participants’’).
1390 See Better Markets (August 2013), supra note
7, at 26–27 (‘‘The SBS activities of a U.S. person
directly and immediately impact the United States
and endanger the U.S. taxpayer if improperly

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• Comparability criteria. Certain
commenters opposed the proposed
holistic approach toward assessing
comparability based on regulatory
outcomes, and instead expressed the
view that any assessments should be
done on a requirement-by-requirement
basis.1391 Conversely, a number of
commenters supported the proposed
approach.1392 Some commenters
requested further clarity regarding the
assessment criteria and regarding the
information that should be submitted in
support of applications,1393 while one
regulated . . . . Substituted compliance is simply
impermissible for transactions with U.S. persons or
for transactions that occur within the United States,
regardless of the status of the counterparty.’’).
1391 See AFR (stating that an ‘‘‘outcomes-based’
assessment of regulation is thus likely to be far
more subjective than a careful, point-by-point
comparison of the actual substance of the rules,’’
and that ‘‘a hypothesized similarity in outcomes for
sets of rules that are quite different in substance
should not suffice to certify comparability’’; further
stating that an outcomes-based assessment may not
be consistent with the need for different sets of
requirements to be standardized); Better Markets,
supra note 7, (August 2013) at 3, 30 (stating that the
SEC must abandon the regulatory outcomes test and
must ensure that foreign regulation is comparable
in substance, form, over time, and as enforced,’’ and
also questioning whether ‘‘one can ever predict
whether regulatory outcomes will be comparable’’).
A legislative comment letter to the CFTC in
connection with the CFTC’s own cross-border
initiative, on which the SEC Chair and
Commissioners were copied, also took the view that
there should be a presumption against
comparability for substituted compliance purposes
and that any assessment be made on a requirementby-requirement basis. See U.S. Senators, supra note
8 (‘‘However, the ‘substituted compliance’
determination must be made through a judicious
process, on a country-by-country and requirementby-requirement basis, and subject to a presumption
that other jurisdictions do not comply unless
proven otherwise.’’).
1392 See, e.g., SIFMA (August 2013), supra note 7,
at A–30 (the proposed approach ‘‘is consistent with
the goal of international comity and is preferable to
a rule-by-rule comparison’’); IIB (August 2013),
supra note 8, at 18 (‘‘We agree with the Commission
that requirements related to internal controls (such
as risk management, recordkeeping and reporting,
internal systems and controls, diligent supervision
and chief compliance officer requirements) should
generally be evaluated holistically. These
requirements are commonly overseen and
administered by a single prudential regulator.’’); EC,
supra note 8 (‘‘We support the consideration of
regulatory outcomes as the standard for permitting
substituted compliance, as well as the consideration
of particular market practices and characteristics in
individual jurisdictions. This flexible approach
recognises the differing approaches that regulators
and legislators may take to achieving the same
regulatory objectives in the derivatives markets.’’);
ABA (October 2013), supra note 8.
1393 See SIFMA (August 2013), supra note 7
(requesting that the Commission provide a ‘‘more
granular and detailed framework’’ for clarity
regarding the assessment process, including the
factors relevant to the determination and the
method and metrics for comparing regulatory
outcomes); CDEU, supra note 8 (addressing
vagueness in criteria); ISDA (August 2013), supra
note 7, at 3 (‘‘Without a more concrete definition
of the outcomes-based standard, applicants will
face uncertainty in determining what information

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commenter challenged the proposal’s
lack of particularized elements for
assessing comparability in connection
with certain requirements.1394 One
commenter questioned how the
Commission would be notified of
material changes to foreign law that
underpins a substituted compliance
determination.1395 Commenters also
expressed the views that regulatory
comparisons should focus on common
principles associated with shared G–20
Leaders goals,1396 urged the need for
consistency and coordination with the
work of other regulators and IOSCO,1397
and supported building on existing
cooperative initiatives.1398 Commenters
should be supplied in connection with an
application. ISDA proposes that the appropriate
‘outcomes’ to guide substituted compliance
determinations should be the common principles
based on the consensus G–20 goals as described
above, rather than details of domestic legislation; in
other words, a substituted compliance
determination should be an assessment that the
non-US regulatory approach under consideration
adheres to the common principles.’’); FOA, supra
note 8 (requesting additional detail regarding
relevant regulatory outcomes).
1394 See Better Markets (August 2013), supra note
7, at 30 (noting that the Commission proposed
particularized comparability elements in
connection with regulatory reporting and public
dissemination requirements, and stating that the
lack of such elements for other requirements would
be confusing and would create ‘‘the opportunity for
the Commission to approve much more relaxed
foreign regulations based on more vague
standards’’; further stating that it would be arbitrary
and capricious not to make use of ‘‘consistently
robust and publicly disclosed’’ standards to guide
substituted compliance determinations for each
requirement).
1395 See Better Markets (August 2013), supra note
7, at 29 (‘‘Any entity making use of substituted
compliance must be held responsible for
immediately informing the SEC if either the
relevant regulation or the factors that qualified the
entity for substituted compliance change in any
material way.’’).
1396 See ISDA (August 2013), supra note 7 (stating
that ‘‘the Commission could consider and adopt a
regime-based approach, whereby comparability
would exist if a jurisdiction has implemented
regulations to meet the G–20 commitments. The
Commission’s rejection of this approach based on
its ‘responsibility to implement the specific
statutory provisions . . . added by Title VII’
overlooks the principle that comity should inform
the extraterritorial application of statutory
directives’’; citation omitted).
1397 See II.F, supra note 8 (‘‘Nevertheless, the
proposed approach (and any similar approaches
used in other jurisdictions) will be even more
effective and beneficial if they are consistent with,
and coordinated with, the work and approaches of
other authorities in the same jurisdiction
(particularly in the case where multiple supervisors
have responsibility for swaps regulation), national
authorities in other jurisdictions and international
standard setters such as the International
Organization of Securities Commissions (IOSCO).’’).
1398 See JSDA, supra note 8 (noting that the CFTC
and the European Union had announced a ‘‘Path
Forward’’ regarding their joint understandings for
how to approach cross-border derivatives, and
stating ‘‘[w]e expect that the SEC and CFTC will
jointly adopt the same approach regarding
application of substituted compliance to Japan’’).

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also stated that the Commission should
coordinate substituted compliance
determinations with the CFTC.1399 One
commenter expressed concern regarding
operational complexities that may be
associated with ‘‘partial’’ substituted
compliance determinations, and
suggested that there be presumptions
against such partial determinations.1400
• Enforcement and supervisory
practices. One commenter expressed the
view that a substituted compliance
assessment must address a foreign
regime’s supervisory and enforcement
capabilities in practice.1401 Another
commenter expressed the view that
1399 See, e.g., CDEU, supra note 8 (‘‘The SEC
should also work closely with the CFTC when
determining whether substituted compliance is
applicable with respect to a particular jurisdiction.
With respect to substituted compliance, the
regulatory requirements of end-users operating
globally depend on whether the SEC has made a
comparability determination for the relevant nonU.S. jurisdiction. Conflicting regimes will lead to
increased costs and unnecessary duplicative
regulations which may be directly or indirectly
imposed on derivatives end users.’’); ISDA (August
2013), supra note 7 (‘‘Differences in the
Commission’s and CFTC’s approaches to
derivatives regulation produce uncertainties and
confusion for market participants. Moreover, the
lack of coordination severely limits potential
efficiencies in the substituted compliance process.
We note here some of the significant differences
between the Proposal and the CFTC July 2013
Guidance. We respectfully urge the agencies to
prioritize harmonization of their approaches to
substituted compliance.’’). But see ISDA (August
2013), supra note 7 (commending the Commission’s
proposal ‘‘to allow substituted compliance by bona
fide non-U.S. SBS dealers for external business
conduct standards and conflicts of interest duties in
transactions with U.S. persons,’’ in contrast to the
approach set forth in the CFTC’s cross-border
guidance).
1400 FOA, supra note 8 (urging the Commission to
be sensitive to ‘‘the possible consequences of
‘partial’ substituted compliance determination for
market participants and, wherever possible, to
presume that where a significant portion of a
jurisdiction’s regulatory regime is determined to be
comparable to Title VII of the Dodd-Frank Act, the
remainder of the jurisdiction’s regulatory regime
should also be deemed to be comparable’’).
1401 This commenter also highlighted particular
factors for analysis of foreign supervision and
enforcement. See Better Markets (August 2013),
supra note 7, at 29–31 (stating that the ‘‘foreign
regulatory regime must incorporate strong
investigative tools and meaningful penalty
provisions, and the foreign regulator must have a
demonstrable commitment to enforcement and the
resources to carry out such a commitment,’’ that the
Commission ‘‘must evaluate a host of factors
regarding the foreign regulatory system, including
staff expertise, agency funding, agency
independence, technological capacity, supervision
in fact, and enforcement in fact,’’ and that the
Commission ‘‘must determine that there is a track
record of robust enforcement by the foreign
jurisdiction before making or renewing any such
finding’’).
Another commenter more generally supported the
Commission’s ability to not grant substituted
compliance due to the substantive enforcement of
foreign regulatory regimes. See AFR, supra note 8
(also supporting withdrawal of substituted
compliance due to a foreign regulator’s failure to
exercise its supervisory or enforcement authority).

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differences among the supervisory and
enforcement regimes should not be
assumed to reflect flaws in one regime
or another.1402 One commenter
requested guidance regarding how the
Commission would consider such
enforcement and supervisory
practices.1403
• Multi-jurisdictional issues. One
commenter raised questions regarding
the application of substituted
compliance in connection with thirdcountry branches of non-U.S.
dealers,1404 while another commenter
raised issues regarding which sets of
rules apply to transactions between
parties in different markets, and
whether the parties to cross-jurisdiction
transactions may choose which rules
apply.1405 Commenters also raised
issues regarding the assessment of
substituted compliance in the context of
the European Union, stating that certain
rules are adopted at a European level
1402 See ISDA (August 2013), supra note 7
(‘‘While the G–20 commitments for the reform of
derivatives markets are globally shared, supervisory
practices vary significantly among jurisdictions.
Supervisory practices established in one
jurisdiction will be adapted to the facts of that
jurisdiction. This lack of commonality should not
be assumed to be a defect in supervisory standards;
common objectives may be reached through
differing means. Moreover, commonality may not
present meaningful benefits beyond those already
achieved by virtue of the Commission and its
counterpart regulators negotiating and entering into
memoranda of understanding, a process that is
separately a predicate for substituted compliance.’’).
1403 See ABA, supra note 8 (‘‘In addition, we
believe that the Commission’s comparability
analysis should extend to the existence and
effectiveness of the foreign jurisdiction’s
supervisory examination and enforcement
programs. However, we urge the Commission to
provide further guidance as to how these factors
will be analyzed in particular scenarios.’’).
1404 See FOA, supra note 8 (‘‘However, multijurisdictional scenarios are quite common and the
SEC must provide additional guidance on how it
intends to address substituted compliance when a
bank headquartered in one country (e.g., the UK)
may have a swap dealing branch that operates in
another country (e.g., Hong Kong). Any substituted
compliance determination by the SEC must account
for the interplay of the regulatory regimes in the
relevant non-U.S. jurisdictions.’’).
1405 See IIF, supra note 8 (‘‘A further general
observation is that while the rule proposal provides
for substituted compliance covering significant
aspects of entity-level and transaction-level
requirements, it does not seem to address the issue
of whose rules govern when the transaction is
between two or more parties in different markets.
It is important that the SEC provide guidance as to
how one determines the applicable requirements in
such cases. We suggest that the final rule should
clarify that if the SEC has concluded on the basis
of its outcomes-based assessment that the rules of
the host country where the counterparties are
located produce comparable outcomes to those in
the United States, then either the parties should be
free to choose which rules apply or the rules where
the [transaction] occurs should be the default
position.’’).

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and are applied directly in individual
member states.1406
• Deference and coordination. One
commenter suggested that the
Commission should defer to non-U.S.
oversight when possible.1407
Commenters further questioned the
proposed requirement that an applicant
for substituted compliance certify that
the Commission can access the firm’s
books and records and conduct onsite
inspections of the firm.1408 One
commenter expressed the view that the
Commission’s ability to access the books
and records of, and inspect, a dealer
relying on substituted compliance
should be subject to agreement with a
foreign jurisdiction.1409
1406 See ESMA, supra note 8 (‘‘ESMA considers
it is important that substituted compliance is
assessed at the level of the jurisdiction, i.e. at the
level of the Union, for Europe. EMIR rules are
adopted at European level and apply directly in
each Member State’’); FOA, supra note 8, at 5 (‘‘It
is not clear how the SEC intends to approach
situations where more than one non-U.S.
jurisdiction’s rules may be relevant. To some extent,
these risks may be mitigated in the European Union
to the extent that the SEC makes a substituted
compliance determination on an EU-wide basis.’’).
1407 See ISDA (August 2013), supra note 7, at 6–
7 (‘‘In order to minimize the burden of duplicative
inspection requests, the Commission should defer
to the maximum extent possible to oversight by the
non-U.S. regulatory authorities. Such an approach
would recognize the inherent limitations on the
Commission’s capability to interpret non-U.S.
regulation and determine whether conduct is
compliant.’’).
1408 See ISDA (August 2013), supra note 7, at 6
(‘‘ISDA requests that the Commission articulate a
clear rationale for the inspection powers stipulated
in footnote 1126 of the Proposal, as well as a set
of principles setting forth how such powers would
be used.’’); ESMA, supra note 8 (‘‘The objective of
substituted compliance and the necessary
cooperation of the non-U.S. authorities that
accompany such a determination should not be preempted by an invasive approach based on direct
access to all books and records and on-site
inspections which are not conducted in a
coordinated manner with the home jurisdiction
competent authority.’’). The underlying part of the
Cross-Border Proposing Release discussed how the
proposing release for the registration requirement
would require that nonresident security-based swap
dealers provide the Commission with an opinion of
counsel concurring that as a matter of law the firm
may provide the Commission with prompt access
to the firm’s books and records, and submit to
onsite inspection and examination by the
Commission. See Cross-Border Proposing Release,
78 FR at 31089 n.1126, supra note 6. The
Commission has since adopted that requirement.
See Registration Adopting Release, 80 FR at 48981,
supra note 989.
1409 See FOA, supra note 8 (‘‘The FOA believes
that the SEC’s access to the books and records of,
and the right to conduct on-site examinations and
inspections of, a non-U.S. security-based swap
dealer relying on a substituted compliance
determination should be subject to the terms of the
relevant Memorandum of Understanding (or other
agreement) governing such substituted compliance
arrangements. The FOA therefore urges the SEC to
clarify in its final cross-border rules that, as part of
a substituted compliance determination, the SEC
agrees to access books and records, and conduct onsite examinations and inspections, of non-U.S.

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
• Implementation and phase-in
periods. Some commenters suggested
that certain requirements be deferred
pending action on related substituted
compliance determinations.1410
Commenters also stated that any
withdrawal or modification of a
substituted compliance determination
by the Commission should also be
subject to a phase-in period.1411
• Availability to major participants.
Two commenters disagreed with the
proposal that substituted compliance
not be available to major security-based
swap participants.1412 In contrast, one

commenter expressed opposition to the
possibility of making substituted
compliance available to major
participants.1413
• Other. In response to questions
posed by the Cross-Border Proposing
Release, certain commenters opposed
certain potential limitations to the
availability of substituted
compliance.1414 One commenter
supported a standard timeframe for the
review of substituted compliance
applications.1415

security-based swap dealers through the
cooperative arrangements entered into with the
relevant non-U.S. regulator(s).’’).
1410 See, e.g., FOA, supra note 8 (suggesting that
the Commission consider ‘‘a phased
implementation process’’ for substituted
compliance, whereby the Commission would
‘‘consider delaying the effectiveness of the
compliance obligations applicable to non-U.S.
security-based swap dealers and major securitybased swap participants until such time as the SEC
has been able to make substituted compliance
determinations in respect of those jurisdictions that
are most active in the international derivatives
markets’’; also supporting a ‘‘temporary’’
substituted compliance regime whereby, following
submission of a substituted compliance request,
‘‘market participants from that jurisdiction would
be permitted to continue to comply with home
country regulations until such time as the SEC
determines that it will not permit substituted
compliance in respect of some, or all, of such home
country’s regulatory requirements’’); ABA, supra
note 8 (‘‘However, we recommend that the
Commission further clarify the details of its
proposed substituted compliance analysis; for
example, by indicating that it will consider
deferring the application of relevant entity-level
requirements pending final action on a particular
request.’’); SIFMA (August 2013), supra note 7
(‘‘[W]e believe that Foreign SBSDs should be
provided relief from compliance with Entity-Level
Requirements until the Commission has had the
opportunity to provide substituted compliance
determinations. We believe that this is preferable to
requiring Foreign SBSDs to have to build the
technological, operational and compliance systems
required to comply with U.S. law for a short,
interim period. This should be the case so long as
that period of time is anticipated to be reasonably
brief and the Commission anticipates a possibility
that the finalized regulations will be sufficiently
comparable.’’).
1411 See SIFMA (August 2013), supra note 7, at
A–36–37 (‘‘[M]arket participants are likely to design
systems and processes to comply with an approved
substituted regulatory regime after the Commission
has made such a determination. Withdrawal or
modification of such a determination could cause
significant operational difficulties for market
participants, that may have to realign their internal
infrastructure to be in compliance with the
Commission’s requirements.’’); FOA, supra note 8
(‘‘any decision by the SEC to modify or withdraw
a substituted compliance determination should be
subject to an appropriate phased timetable to permit
market participants sufficient time to adjust their
systems and operations to the new compliance
obligations’’).
1412 See SIFMA (August 2013), supra note 7, at
A–34 (‘‘Without this allowance, MSBSPs subject to
comparable regulation in their home jurisdiction
would be forced to comply with duplicative or
potentially conflicting regulatory regimes.’’); IIB
(August 2013), supra note 8, at 22 (‘‘We see no

After considering the comments
received, the Commission is adopting
Rule 3a71–6 to make substituted
compliance potentially available in
connection with the business conduct
requirements being adopted today.1416
The final rule has been modified from
the proposal in a number of ways,
including, as discussed below:
Consistent with the scope of the current
rulemaking, the final rule solely
addresses the use of substituted
compliance to satisfy those business
conduct requirements (rather than
addressing the availability of substituted
compliance more generally in
connection with section 15F
requirements other than registration

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3. Response to Comments and Final
Rule

reason why such institutions, if they exceed one of
the MSBSP thresholds, should be no less eligible for
substituted compliance than a foreign SBSD.’’).
1413 See Better Markets (August 2013), supra note
7, at 29 (supporting proposed approach, citing lack
of data and limited information, and adding that the
Commission should not consider substituted
compliance for major participants ‘‘until and unless
industry participants provide reliable and
comprehensive data proving that it would be
otherwise prudent to do so’’).
1414 See, e.g., ISDA (August 2013), supra note 7,
at 7 (opposing potential conditions requiring that
U.S. counterparties be qualified institutional buyers
or qualified investors, and opposing any use of a
threshold requirement that non-U.S. security-based
swap dealers predominantly engage in non-U.S.
business); ABA, supra note 8 (opposing limiting
substituted compliance to qualified institutional
buyers or qualified investors); see also Cross-Border
Proposing Release, 78 FR at 31091–92, supra note
6 (soliciting comment on those potential limitations
to the availability of substituted compliance).
1415 See FOA, supra note 8 (‘‘The FOA recognises
that the timeline for reviewing a request for
substituted compliance and reaching an informed
decision will likely vary, for example due to the
nature of the regulatory regime in a given
jurisdiction or the SEC staff’s lack of familiarity
with a particular jurisdiction’s approach.
Nevertheless, the FOA believes that it is essential
that there be a standard timeframe for the SEC to
reach a substituted compliance determination. Any
uncertainty regarding the timeline for compliance
with regulatory obligations creates a significant
amount of additional complexity for market
participants that are already faced with substantial
operational and compliance burdens in preparing
for the compliance dates of new regulations.’’).
1416 The final rule has been renumbered from the
proposal.

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requirements, as proposed); 1417 and the
final rule makes substituted compliance
potentially available to registered Major
SBS Participants (rather than limiting
the potential availability of substituted
compliance to registered SBS Dealers, as
proposed).1418
a. Basis for Availability of Substituted
Compliance in Connection With
Business Conduct Requirements
As discussed elsewhere, the securitybased swap market is global, with a
prevalence of cross-border transactions
within that market.1419 The cross-border
nature of this market poses special
regulatory challenges in connection
with the rules we are adopting today, in
that the Title VII business conduct
requirements applicable to SBS Dealers
or Major SBS Participants have the
potential to lead to requirements that
are duplicative of or in conflict with
applicable foreign business conduct
requirements, even when the two sets of
requirements implement similar goals
and lead to similar results. Such results
have the potential to disrupt existing
business relationships and, more
generally, to reduce competition and
market efficiency.
The Commission accordingly
proposed to implement a substituted
compliance framework ‘‘to address the
effect of conflicting or duplicative
regulations on competition and market
efficiency and to facilitate a wellfunctioning global security-based swap
market.’’ 1420 In the Commission’s view,
under certain circumstances it may be
appropriate to allow for substituted
compliance whereby market
participants may satisfy certain of the
Title VII business conduct requirements
by complying with comparable foreign
requirements. In this manner, registered
entities could comply with a single set
of requirements where substituted
compliance is deemed appropriate,
while remaining subject to robust
oversight. Accordingly, substituted
compliance may be expected to help
achieve the goals of Title VII in a way
that promotes market efficiency,
enhances competition and facilitates a
well-functioning global security-based
swap market.
In reaching this conclusion, the
Commission notes that one commenter
has questioned the Commission’s
authority to grant substituted
compliance and has expressed
skepticism regarding the policy basis for
1417 See

Section III.B.3.b, infra.
Section III.B.3.c, infra.
1419 See Section VI.B.3, infra.
1420 See Cross-Border Proposing Release, 78 FR at
31086, supra note 6.
1418 See

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permitting the use of substituted
compliance to satisfy Title VII
requirements.1421 In contrast to the
suggestion of that comment, however,
substituted compliance does not
constitute exemptive relief and does not
excuse registered SBS Entities from
having to comply with the Exchange Act
business conduct requirements. Instead,
substituted compliance provides an
alternative method of satisfying those
requirements under Title VII.
Moreover, the same commenter’s view
that substituted compliance would lead
to a lowering of regulatory standards is
addressed by the provision that any
grant of substituted compliance would
be predicated on there being comparable
requirements in the foreign jurisdiction.
Indeed, in the Commission’s view, the
potential for substituted compliance
will help to promote the effective
application of Title VII requirements, by
making it less likely that certain market
participants that are complying with
comparable foreign requirements will
determine that they need to choose
between modifying their business
conduct systems to reflect the
requirements of U.S. rules, or else
limiting or ceasing their participation in
the U.S. market.1422
This commenter also expressed the
view that any Commission action of this
nature at a minimum should be
predicated on a finding that there is an
actual conflict between Title VII and
foreign requirements.1423 In the
Commission’s view, however, requiring
a showing of actual conflict as a
condition to substituted compliance
should not be necessary as substituted
compliance is intended to promote
compliance efficiencies in connection
with potentially duplicative
requirements (as well as conflicting
requirements).1424
1421 See

notes 1383 and 1384, supra.
Commission further notes that section
752(a) of the Dodd-Frank Act in part requires that
the Commission consult with the foreign regulatory
authorities on the establishment of consistent
regulatory standards with respect to the regulation
of security-based swaps. The use of substituted
compliance to help mitigate the impacts of
inconsistent and duplicative requirements is
consistent with that statutory direction.
1423 See note 1385, supra.
1424 In light of the benefits associated with
substituted compliance, the final rule also does not
include potential limitations, for which the
proposing release solicited comment, that would
have conditioned substituted compliance on a nonU.S. entity not transacting with U.S. counterparties
that are not qualified institutional buyers or
qualified investors, or that would have required that
non-U.S. entities receiving substituted compliance
predominantly engage in non-U.S. business. See
note 1414, supra.

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b. Structure and Scope of the Final Rule
i. In General
As noted, the final rule has been
revised from the proposal to reflect that
until other Title VII rules are adopted,
substituted compliance will be available
only with respect to the business
conduct rules. The Commission expects
to assess the potential availability of
substituted compliance in connection
with other requirements when the
Commission considers final rules to
implement those requirements.
To implement this revised approach,
paragraph (a)(1) of Rule 3a71–6 as
adopted provides that the Commission
may, conditionally or unconditionally,
by order, make a determination with
respect to a foreign financial regulatory
system that compliance with specified
requirements under that foreign
financial regulatory system by a
registered SBS Dealer and/or by a
registered Major SBS Participant—each
a ‘‘security-based swap entity’’ under
the rule—or class thereof, may satisfy
the corresponding requirements
identified in paragraph (d) of rule 3a71–
6 that would otherwise apply.1425
Paragraph (d), discussed below, is an
addition from the proposal that specifies
the business conduct requirements that
the Commission is adopting.1426
Paragraph (a)(2) of the final rule
provides that the Commission will not
1425 See Exchange Act Rule 3a71–6(a)(1). The
proposed rule would have made substituted
compliance potentially available for all of the
section 15F dealer requirements other than
registration requirements. The structure of the final
rule implements a more targeted approach whereby
the Commission will assess the availability of
substituted compliance when the Commission
considers the applicable substantive rules.
Consistent with this approach, the final rule does
not include proposed paragraph (a)(3), which
would have specified that substituted compliance
would not be available in connection with the
registration requirements of section 15F. See
generally Registration Adopting Release, 80 FR at
48972–73, supra note 989 (determining that
substituted compliance would not be available in
connection with the registration requirements for
security-based swap dealers, and stating that
‘‘[p]ermitting a foreign SBS Dealer to satisfy these
requirements through compliance with the relevant
requirements in its home jurisdiction, even with
appropriate notice of such compliance to the
Commission, may deprive the Commission of the
necessary information, including information
resulting from inspection and examination of the
books and records of a firm engaged in dealing
activity at levels above the de minimis threshold.’’).
Paragraph (a)(1) of the final rule also has been
modified from the proposal to remove language
limiting substituted compliance to ‘‘foreign’’
entities. Substituted compliance for the business
conduct standards at issue here will be available
only to foreign security-based swap dealers and
foreign major security-based swap participants, and
the Commission expects to assess whether
substituted compliance should be limited to foreign
entities in connection with other section 15F
requirements.
1426 Exchange Act Rule 3a71–6(d).

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make a substituted compliance
determination unless it determines that
the foreign requirements applicable to
the SBS Entity (or class thereof), or to
the activities of such entity (or class
thereof), are comparable to the
otherwise applicable requirements, after
taking into account such factors as the
Commission determines are appropriate,
such as the scope and objectives of the
relevant foreign regulatory requirements
(taking into account applicable criteria
set forth in paragraph (d)), as well as the
effectiveness of the supervisory
compliance program administered, and
the enforcement authority exercised, by
the foreign authority to support its
oversight of the SBS Entity (or class
thereof) or of the activities of the entity
(or class thereof). This provision has
been revised from the proposal in part
to make the rule more flexible, by
permitting substituted compliance to be
predicated either on foreign regulation
of the entity (or class), or, alternatively,
on foreign regulation of the entity’s (or
class’s) activities. In this way, the rule
can account for situations in which a
foreign regulatory regime does not
specifically provide for the registration
of a particular category of market
participant, but nonetheless effectively
regulates the activities of members of
that category.1427
Paragraph (a)(2) of the rule further
provides that the Commission will not
make a substituted compliance
determination unless the Commission
has entered into a supervisory and
enforcement memorandum of
understanding and/or other arrangement
with the relevant foreign financial
regulatory authority addressing
supervisory and enforcement
cooperation and other matters arising
under the substituted compliance
determination.1428 This provision
1427 In other words, for example, under the final
rule the Commission may make substituted
compliance available in connection with a foreign
regulatory regime that does not make use of a
specific registration category for dealers in securitybased swaps, but that nonetheless regulates such
dealers in a manner that is comparable to the
section 15F requirements.
As proposed, paragraph (a)(2) made no mention
of particular criteria associated with a substituted
compliance determination. Paragraph (a)(2) of the
final rule, however, specifies that in considering the
scope and objectives of the relevant foreign
requirements, the Commission intends to consider
applicable criteria that are set forth in new
paragraph (d). See Section III.B.3.e, infra.
1428 See Exchange Act Rule 3a71–6(a)(2)(ii).
Paragraph (a)(2)’s reference to supervisory and
enforcement cooperation and other matters further
has been revised from the proposal, which
addressed the ‘‘oversight and supervision’’ of
applicable security-based swap dealers. This change
is to help ensure that enforcement cooperation is
encompassed within those arrangements, given the
importance of enforcement in promoting

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should help ensure that both regulators
will cooperate with each other within
the substituted compliance framework,
such that both regulators have
information that will assist them in
fulfilling their respective regulatory
mandates. Moreover, the Commission
may, on its own initiative, by order,
modify or withdraw a substituted
compliance determination after
appropriate notice and opportunity for
comment.1429
Paragraph (b) of the final rule
specifies that a registered SBS Entity
may satisfy the Exchange Act
requirements identified in paragraph (d)
of the rule by complying with
corresponding law, rules and
regulations under a foreign financial
regulatory system, provided that: (1)
The Commission has made a
determination providing that
compliance with specified requirements
under the foreign financial regulatory
system by such registered security-based
swap entity (or a class thereof) may
satisfy the corresponding requirements,
and (2) such entity satisfies any
conditions set forth in the Commission’s
determination.1430
Paragraph (c) of the final rule
addresses requests for substituted
compliance determinations. As
discussed below, those application
provisions have been revised from the
proposal in certain respects.1431
To implement the final rule’s targeted
approach toward substituted
compliance with applicable requirements. The
change parallels comparable language in the
substituted compliance rules applicable to
Regulation SBSR. See Regulation SBSR
908(c)(2)(iv).
1429 See Exchange Act Rule 3a71–6(a)(3).
Commenters stated that any withdrawal or
modification of a substituted compliance
determination by the Commission should also be
subject to a phase-in period. See note 1411, supra.
The final rule does not contain any such provision
for a phase-in period, however, given that
substituted compliance is predicated on the
relevant foreign requirements being comparable to
the Title VII requirements, and on the adequacy of
the relevant foreign authority’s supervision and
enforcement in connection with those foreign
requirements. Subject to that principle, the
Commission in practice would expect to consider
such timing and operational issues in the event that
it were to reconsider a previous grant of substituted
compliance. The particular facts and circumstances
surrounding such a reconsideration would be
relevant to how long substituted compliance would
remain available after Commission action.
1430 See Exchange Act Rule 3a71–6(b). This
paragraph has been changed from the proposal in
certain ways consistent with the changed scope of
the rule (i.e., deleting the word ‘‘foreign’’ and
replacing ‘‘dealer’’ with ‘‘entity’’) or for clarifying
purposes. This paragraph also has been changed
from the proposal, which referred to ‘‘legislative
requirements, rules and regulations,’’ to more
flexibly account for the variety of potential sources
of applicable requirements.
1431 See Section III.B.3.h, infra.

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compliance, paragraph (d) of rule 3a71–
6 states that substituted compliance will
be available in connection with the
business conduct and supervision
requirements of sections 15F(h) and
15F(j) and rules 15Fh–3 through 15Fh–
6, and the CCO requirements of section
15F(k) and rule 15Fk–1, subject to
exceptions discussed below.1432
As discussed below, moreover,
paragraph (d) specifies that prior to
making these substituted compliance
determinations, the Commission intends
to consider whether the information
required to be provided to
counterparties pursuant to the
requirements of the foreign jurisdiction,
the counterparty protections of the
foreign jurisdiction, the mandates for
supervisory systems under the
requirements of the foreign jurisdiction,
the duties imposed by the foreign
jurisdiction, and the CCO requirements
of the foreign jurisdiction, are
comparable to the Exchange Act
requirements.1433 Those factors are
relevant to the comparability analysis,
and their inclusion in the final rule also
responds to commenters that expressed
the view that the rules should provide
more guidance regarding comparability
criteria.1434 At the same time, as
discussed below, substituted
compliance does not require that there
be requirement-by-requirement
comparability between Exchange Act
requirements and foreign requirements,
as the operative question is whether
there is the comparability of the
associated regulatory outcomes.1435
Finally, the Commission is not
persuaded by commenter requests that
we provide phase-in periods or other
means to link the timing of the
substantive requirements under the
Exchange Act with the availability of
substituted compliance.1436 The
effective dates and compliance dates for
these business conduct requirements
reflect the need to implement those
requirements in a timely manner,
regardless of whether the alternative
1432 The business conduct requirements that are
the subject of this rulemaking in large part are
derived from Exchange Act section 15F(h). As
discussed above, however, Exchange Act section
15F(j) imposes on SBS Entities a series of selfexecuting duties with regard to trade monitoring,
risk management systems, regulatory disclosures,
information access systems and procedures,
conflict-of-interest systems and procedures, and
antitrust considerations. Rule 15h–3(h)(2)(iii)(I)
requires SBS Entities to adopt written policies and
procedures reasonably designed to comply with
those duties. See note 605, supra, and
accompanying text.
1433 See note 1458, infra, and accompanying text.
1434 See notes 1393 and 1394, supra.
1435 See Section III.B.3.e, infra.
1436 See note 1410, supra.

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30075

route provided by substituted
compliance is available.1437
ii. Unavailability in Connection With
Antifraud Prohibitions and Certain
Other Requirements
Paragraph (d)(1) of the final rule
provides that substituted compliance is
not available in connection with
Exchange Act section 15F(h)(4)(A),
which in relevant part prohibits SBS
Dealers from engaging in fraudulent
activities in connection with special
entities and more generally. The rule
also provides that substituted
compliance is not available in
connection with Exchange Act rule
15Fh–4(a), which implements that
statutory antifraud provision.
In the Commission’s view, substituted
compliance is not appropriate in
connection with those explicit statutory
prohibitions of fraudulent conduct,
given the central role of the antifraud
provisions of the securities laws in
protecting the integrity and reputation
of U.S. financial markets. The
Commission also notes that concerns
regarding regulatory duplication do not
arise in the context of such antifraud
prohibitions in the same way they may
arise with respect to other provisions.
Paragraph (d)(1) further provides that
substituted compliance is not available
in connection with Exchange Act
sections 15F(j)(3) and (j)(4)(B). Section
15F(j)(3) requires that SBS Entities
disclose, to the Commission and the
applicable prudential regulators,
information concerning: The terms and
conditions of the entity’s security-based
swaps; security-based swap trading
operations, mechanisms and practices;
financial integrity protections relating to
security-based swaps; and other
information relevant to the entity’s
trading in security-based swaps. Section
15F(j)(4)(B) provides that the SBS Entity
upon request shall provide the
Commission and any applicable
prudential regulator with information
necessary to perform statutory functions
under Section 15F. In our view, the
Commission’s oversight of SBS Entities
requires that the Commission be able to
directly access relevant information
from those entities. Accordingly, the
Commission does not believe that those
requirements that SBS Entities provide
information to the Commission are
reasonably amenable to being satisfied
1437 Given the facts and circumstances nature of
the substituted compliance assessment, the
Commission also does not believe that it would be
practicable to provide a standard timeframe for
reaching substituted compliance determinations.
See note 1415, supra.

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via compliance with the requirements of
a foreign jurisdiction.1438
iii. Application to Particular
Requirements

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It is possible that substituted
compliance may be granted with regard
to some of these requirements but not
others. As discussed below, the
Commission intends to assess the
comparability of foreign requirements
using a holistic approach that focuses
on regulatory outcomes rather than
predicating substituted compliance on
requirement-by-requirement
similarity.1439 At the same time,
however, the business conduct
requirements being adopted today
encompass a range of distinct categories
(e.g., supervision, counterparty
protection, special entity protection)
such that those individual categories
may be subject to differing conclusions
regarding the comparability of
regulatory outcomes and/or the
associated foreign enforcement and
supervisory practices. Thus, for
example, it may be possible that the
Commission would make substituted
compliance available with regard to a
particular foreign regulatory regime in
connection with certain counterparty
protections required by these rules but
not the supervision requirements, or
vice versa. Ultimately, this would
depend on the relevant facts and
circumstances, and their impact upon
specific assessments of
comparability,1440 and of supervision
and enforcement.
The Commission further anticipates
that certain categories of the
requirements we are adopting today—
related to ECP verification, special
entities and political contributions—
will raise special issues with regard to
comparability, and with regard to
whether adequate supervision and
enforcement is available under the
foreign regulatory regime. Such issues
are likely to arise with regard to those
particular requirements because each of
those requirements address protections
that may have no foreign law analogues,
as those requirements reflect heightened
1438 In addition, Exchange Act Section 15F(j)(7)
authorizes the Commission to prescribe rules
governing the duties of SBS Entities. While the
Commission is not excluding that provision from
the potential availability of substituted compliance,
the Commission expects to separately consider
whether substituted compliance may be available in
connection with any future rules promulgated
pursuant to that provision.
1439 See Section III.B.3.e, infra.
1440 As discussed below, substituted compliance
is predicated on the comparability of regulatory
outcomes, and does not mandate rule-by-rule
equivalence between specific requirements under
Title VII and analogous foreign requirements.

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concerns under U.S. law regarding
potential abuses involving particular
categories of persons. Indeed, those
categories and the protections afforded
to them under U.S. law may not
correspond with any specified
categories of persons or protections
under relevant foreign law. As a result,
substituted compliance assessments in
connection with those categories will
require inquiry regarding whether
foreign regulatory requirements
adequately reflect the same particular
interests and protections.
c. Availability to Major SBS Participants
Under the proposed rule, substituted
compliance would have been available
only to registered SBS Dealers, and
would not have been available to
registered Major SBS Participants. In
taking that proposed position, the
Commission noted a lack of information
regarding the types of entities that may
become Major SBS Participants, and the
foreign regulation of those entities.1441
Two commenters disagreed with that
aspect of the proposal, with one
commenter expressing concern
regarding major participants being
forced to comply with duplicative or
potentially conflicting regulatory
regimes, and the other commenter
suggesting there would be no reason to
distinguish between SBS Dealers and
Major SBS Participants in this
regard.1442 One commenter, in contrast,
opposed the possibility of substituted
compliance for Major SBS Participants
by citing the lack of relevant
information, and stated that the
Commission should not consider
substituted compliance for Major SBS
Participants unless the industry
provided data proving that this step
would be prudent.1443
After further consideration of the
issues, the final rule provides that
substituted compliance is potentially
available in connection with these
business conduct requirements for
registered Major SBS Participants as
well as for registered SBS Dealers. This
decision reflects the fact that the
business conduct standards apply to
registered Major SBS Participants as
well as to registered SBS Dealers, and
recognizes that the market efficiency
goals that underpin substituted
compliance also can apply when
substituted compliance is granted to
registered Major SBS Participants.
To implement this approach, the final
rule has been revised from the proposal
to specify that the Commission may
note 1382, supra.
note 1412, supra.
1443 See note 1413, supra.
1442 See

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d. Availability of Substituted
Compliance With Regard to U.S. and
Foreign Entities, Counterparties and
Activity
Under the final rule, substituted
compliance in connection with the
business conduct requirements is not
available to entities that are U.S.
persons.1446 On the other hand, entities
that are not U.S. persons may rely on
substituted compliance to satisfy the
business conduct requirements with
regard to the entirety of their securitybased swap business, regardless of
whether their counterparty for a
particular transaction is a U.S. person,
or whether any of the associated activity
occurs in the U.S.
i. No Availability to U.S. Security-Based
Swap Dealers or U.S. Major SecurityBased Swap Participants
Consistent with the proposal, the final
rule does not make substituted
compliance available to U.S. securitybased swap dealers or U.S. major
1444 See

Exchange Act rule 3a71–6(a)(1).
note 1413, supra, and accompanying text.
1446 See Exchange Act rule 3a71–6(d). For these
purposes, the term ‘‘U.S. person’’ has the meaning
set forth in Exchange Act rule 3a71–3(a)(4).
1445 See

1441 See

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determine that compliance by a
registered SBS Dealer and/or by a
registered Major SBS Participants—each
a ‘‘security-based swap entity’’ under
the rule—may satisfy the business
conduct requirements through
substituted compliance.1444 The
remainder of the final rule refers to a
security-based swap ‘‘entity’’ rather than
a security-based swap ‘‘dealer.’’
One commenter had expressed the
view that more information is needed
before substituted compliance is made
available to Major SBS Participants.1445
In the Commission’s view, however,
those concerns are adequately addressed
by the fact that any grant of substituted
compliance in connection with the
business conduct requirements
applicable to Major SBS Participants
would be predicated on a determination
that the Major SBS Participants is
subject to comparable regulation in a
foreign jurisdiction. Absent such a
determination—and consistent with the
Commission’s previously noted
concerns regarding the need for
information regarding the types of
entities that may become Major SBS
Participants, and the foreign regulation
of those entities—the Commission
would not grant substituted compliance
in connection with registered Major SBS
Participants, even if the Commission
were to grant substituted compliance in
connection with registered SBS Dealers
in the same jurisdiction.

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security-based swap participants in
connection with these business conduct
requirements.
Certain commenters had suggested
that substituted compliance for these
dealer requirements should be available
to foreign branches of U.S. persons,1447
or to U.S. persons in certain
circumstances in connection with
transaction-level requirements.1448 One
commenter further expressed the view
that foreign branches of U.S. banks may
be subject to extensive host country
supervision, and that concerns
regarding duplicative or inconsistent
regulation may arise in connection with
the security-based swap activities of
U.S. entities. Conversely, one
commenter argued that such an
extension of the proposed scope of
substituted compliance would be
inconsistent with the application of U.S.
law.1449
The Commission concludes on
balance that it is appropriate to limit the
availability of substituted compliance
such that only entities that are not U.S.
persons may take advantage of that
alternative route for satisfying the Title
VII business conduct requirements. In
part, this conclusion accounts for the
fact that concerns regarding duplication
and inconsistency in connection with
transaction-level business conduct
requirements should be mitigated by the
amendment we are adopting to
Exchange Act rule 3a71–3, to provide an
exception from the business conduct
requirements under Exchange Act
section 15F(h)—other than supervision
requirements pursuant to Exchange Act
section 15F(h)(1)(B)—for registered U.S.
SBS Dealers in connection with foreign
business conducted through their
foreign branches.1450
The Commission recognizes that the
above exception would not mitigate the
possibility that U.S. entities may face
duplication or inconsistency in certain
circumstances. For example, for nonU.S. business that U.S. SBS Dealers and
U.S. Major SBS Participants conduct
through their foreign branches, such
1447 See

note 1386, supra.
notes 1388 and 1389, supra.
1449 See note 1387, supra.
1450 See Exchange Act rule 3a71–3(c); see also
Section III.A.3.b, supra. There is a similar exception
from the section 15F(h) business conduct
requirements (other than supervision) for registered
U.S. Major SBS Participants with respect to
security-based swap transactions that constitute
transactions through a foreign branch of the
registered U.S. Major SBS Participant, that are
either with a non-U.S. person or with a U.S.-person
counterparty that constitutes a transaction
conducted through a foreign branch of that
counterparty. See Exchange Act rule 3a67–10(d)(2).
These exceptions are not available in connection
with the CCO requirements, which are promulgated
pursuant to Exchange Act section 15F(k).

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1448 See

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duplication or inconsistency may still
arise in connection with the entity-level
supervision and CCO regulations being
adopted today. For the other securitybased swap business of those U.S. SBS
Entities, such duplication or
inconsistency potentially may arise in
connection with any of the business
conduct requirements being adopted
today.
The Commission nonetheless believes
that substituted compliance should not
be available to registered entities that
are U.S. persons. This conclusion
reflects a number of policy
considerations. Fundamentally, this
approach acknowledges that dealers and
major participants that fall within the
‘‘U.S. person’’ definition have a
heightened connection to the U.S.
market.1451 As a result of that
heightened connection, it is the
Commission’s judgment that a U.S. SBS
Entity’s compliance with the business
conduct requirements of Title VII, and
the Commission’s associated oversight
of that entity’s security-based swap
business, should occur without the
potential availability of substituted
compliance. Although substituted
compliance is predicated on there being
comparability with Title VII
requirements, and does not exempt or
otherwise excuse compliance with Title
VII, in the Commission’s view direct
compliance with the Title VII business
1451 The definition of ‘‘U.S. person’’ is designed
to encompass persons that have a significant
portion of their financial and legal relationships
within the U.S. ‘‘[T]he definition of ‘U.S. person’ in
[17 CFR 240.3a71–3] is intended, in part, to identify
those persons for whom it is reasonable to infer that
a significant portion of their financial and legal
relationships are likely to exist within the United
States and that it is therefore reasonable to conclude
that risk arising from their security-based swap
activities could manifest itself within the United
States, regardless of the location of their
counterparties, given the ongoing nature of the
obligations that result from security-based swap
transactions.’’ ‘‘Application of ‘Security-Based
Swap Dealer’ and ‘Major Security-Based Swap
Participant’ Definitions to Cross-Border SecurityBased Swap Activities,’’ Exchange Act Release No.
72472 (Jun. 25, 2014), 79 FR 47278, 47289 (Aug. 12,
2014) (‘‘SBS Entity Definitions Adopting Release’’).
Moreover, the definition of ‘‘U.S. person’’ does
not carve out the foreign branches of U.S. persons.
In part this reflects the fact that ‘‘a person does not
hold itself out as a security-based swap dealer as
anything other than a single person even when it
enters into transactions through its foreign branch
or office.’’ See id.
Based on the direct nature of this link between
the U.S. market and those persons that fall within
the ‘‘U.S. person’’ definition, Title VII applies to the
security-based swap activities of U.S. persons in a
manner that is more comprehensive than its
application to the activities of other persons. See
generally id. at 47288–91 (addressing how dealer
and major participant definitions account for all
security-based swap activity of U.S. persons
because all such activity occurs in the U.S., but
account for a more limited subset of the activity of
foreign entities).

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conduct requirements by U.S. SBS
Entities will efficiently facilitate the
Commission’s regulatory oversight of
entities that have a heightened
connection to the U.S. market. That
warrants such limits to substituted
compliance in our view,
notwithstanding the general
considerations that support the
availability of substituted compliance in
connection with the business conduct
requirements.
This conclusion also reflects our view
that U.S. market participants generally
would have a reasonable expectation
that the business conduct requirements
of Title VII would apply directly, and
that the activities of such U.S. persons
would be subject to Commission
oversight with a degree of directness
that may not be present in connection
with substituted compliance.
ii. Availability in Connection With U.S.
Counterparties and U.S. Activity
Consistent with the proposal, the final
rule does not contain any provisions
that would limit the ability of foreign
registered entities to use substituted
compliance to satisfy the business
conduct requirements in connection
with transactions involving U.S.
counterparties or U.S. activity.
One commenter had expressed the
view that substituted compliance
should not be available in connection
with activities involving U.S. persons or
U.S. activity, arguing that the securitybased swap activity of U.S. persons
directly and immediately impacts the
U.S., and would endanger U.S.
taxpayers if improperly regulated.1452
We concur with that commenter
regarding the need for proper regulation
of SBS Entities in connection with their
security-based swap business involving
U.S. counterparties and activity (as well
as more generally). At the same time,
however, we note that substituted
compliance is not an alternative to
rigorous regulation, but instead is
predicated on there being business
conduct regulation comparable with the
rules we are adopting today. So long as
the Commission determines that
corresponding foreign requirements are
comparable with those Title VII
business conduct requirements, the use
of substituted compliance accordingly
would uphold the interests associated
with those Title VII requirements.
Also, following alternative
approaches—such as an approach
whereby substituted compliance would
not be available to a foreign SBS Entity
in connection with transactions
involving U.S. counterparties or U.S.
1452 See

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activity, but would be available in
connection with other transactions—in
practice may have the effect of forcing
the foreign SBS Entity to choose
between modifying its business conduct
systems, including its supervisory and
CCO arrangements to reflect the
requirements of U.S. rules, or else
exiting the U.S. market and thereby
generally reducing competition and
market efficiency.1453

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e. Comparability Criteria
As discussed in the Cross-Border
Proposing Release, the Commission will
endeavor to take a holistic approach in
considering whether regulatory
requirements are comparable for
purposes of substituted compliance, and
will focus on the comparability of
regulatory outcomes rather than
predicating substituted compliance on
requirement-by-requirement similarity.
The Commission also continues to
recognize that foreign regulatory
systems differ in their approaches to
achieving particular regulatory
outcomes, and that foreign requirements
that differ from those adopted by the
Commission nonetheless may achieve
regulatory outcomes comparable with
those of Title VII. The Commission
further continues to recognize that
different regulatory systems may be able
to achieve some or all of those
regulatory outcomes by using more or
fewer specific requirements than the
Commission, and that in assessing
comparability the Commission may
need to take into account the manner in
which other regulatory systems are
informed by business and market
practices in those jurisdictions.1454
Accordingly, in considering whether
the requirements of a foreign regulatory
regime are comparable with the various
categories of requirements being
adopted today (such as the supervision
and counterparty protection
requirements we are adopting) the
Commission will evaluate whether the
foreign requirements provide for
regulatory outcomes that are consistent
with the regulatory outcomes of the
applicable category of requirements.
Moreover, as noted above, in
1453 Other alternative approaches for addressing
the application of substituted compliance could be,
for example, to permit substituted compliance in
connection with U.S. activity that does not involve
U.S. counterparties, or allowing substituted
compliance for transaction with U.S. counterparties
only so long as no U.S. activity is involved.
Reducing the availability of substituted compliance
in such a manner, however, would be expected to
be accompanied by a corresponding reduction to
the competition and market efficiency benefits
associated with substituted compliance.
1454 See Cross-Border Proposing Release, 78 FR at
31085–86, supra note 6.

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application the Commission may
determine that for a particular
jurisdiction, the prerequisites for
substituted compliance have been met
in connection with certain categories of
requirements but not others.
In reaching this conclusion, the
Commission notes that certain
commenters opposed the proposed
holistic approach toward assessing
comparability based on regulatory
outcomes, and that instead expressed
the views that any assessments should
be done on a requirement-byrequirement basis. Those views at least
in part reflected the reasoning that an
outcomes-based approach would be
subjective and would lead to a
‘‘hypothesized similarity in outcomes
for sets of rules that are quite different
in substance.’’ 1455 In this regard, the
Commission recognizes that a
requirement-by-requirement approach
would be easier to implement and
simpler to translate into objective
criteria than an alternative approach
that focuses on regulatory outcomes.
Such a requirement-by-requirement
approach, however, could foreclose any
grants of substituted compliance,
because even highly similar regulatory
regimes are likely to have technical
differences in the implementing rules.
More generally, the Commission
believes that the proper focus for
analyzing substituted compliance
should address regulatory outcomes,
because a standard that turns upon the
comparability of regulatory outcomes
can promote regulatory efficiency in a
way that preserves the key protections
associated with the business conduct
rules, and in a manner that reflects the
cross-border nature of the market and
helps to curb fragmentation, while
facilitating the ability of U.S. persons to
participate in the global security-based
swap market.1456
As noted above, the Commission
foresees that there will be difficult
questions connected with comparability
assessments for Dodd-Frank
requirements related to ECP verification,
special entities and political
contributions, given that those
particular requirements all address
activities involving certain classes of
U.S. persons, and reflect heightened
concerns regarding potential abuses
involving such persons.1457 Recognizing
that the comparability assessments will
focus on regulatory outcomes rather
1455 See

note 1391, supra.
requirement-by-requirement standard, in
contrast, similarly would promote key protections,
but would not adequately address the cross-border
nature of the market and the ability of U.S. persons
to participate in the global market.
1457 See Section III.B.3.b.iii, supra.
1456 A

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than rule-by-rule comparisons, the
assessments will require inquiry
regarding whether foreign regulatory
requirements adequately reflect those
particular interests and protections.
Moreover, paragraph (d) of the final
rule (which as discussed above has been
added to the rule to specify the
requirements for which substituted
compliance potentially is available),
provides that prior to making these
substituted compliance determinations,
the Commission intends to consider
whether the information required to be
provided to counterparties pursuant to
the requirements of the foreign
jurisdiction, the counterparty
protections of the foreign jurisdiction,
the mandates for supervisory systems
under the requirements of the foreign
jurisdiction, the duties imposed by the
foreign jurisdiction, and the CCO
requirements of the foreign jurisdiction,
are comparable to the Exchange Act
requirements.1458 Those provisions have
been included as part of new paragraph
(d) in response to commenters to the
Cross-Border Proposing Release that
requested specific guidance regarding
the criteria the Commission will
consider in making comparability
assessments,1459 or that challenged the
rule’s lack of particularized elements for
assessing comparability.1460 While
recognizing those commenters’ wish for
additional guidance to assist in making
applications for substituted compliance,
and for assessment criteria that are as
specific and objective as possible, in
this circumstance the Commission
believes that the comparability
assessments will turn upon relevant
facts and circumstances in a manner
such that it would not be practicable to
include more specific criteria in the
rule.
One commenter questioned how the
Commission would be notified of
material changes to foreign law that
underpins a substituted compliance
determination.1461 The Commission
expects to address those issues in
connection with considering specific
applications for substituted compliance,
and notes that, potentially, the
requirement that the Commission be
notified of material changes in foreign
law could be incorporated as conditions
1458 See Exchange Act rule 3a71–6(d)(1). The rule
further provides that prior to making a substituted
compliance determination in connection with the
CCO requirements of section 15F(k), the
Commission intends to consider whether the
requirements of the foreign jurisdiction regarding
CCO requirements are comparable to those required
pursuant to the applicable Exchange Act
requirements. See Exchange Act rule 3a71–6(d)(2).
1459 See note 1393, supra.
1460 See note 1394, supra.
1461 See note 1395, supra.

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to substituted compliance orders, or as
part of memoranda of understanding or
other arrangements between the
Commission and the relevant foreign
financial regulators.1462
Commenters also expressed the views
that regulatory comparisons should
focus on common principles associated
with shared G–20 Leaders goals,1463
urged the need for consistency and
coordination with the work of other
regulators and IOSCO,1464 and with the
CFTC,1465 and also supported building
on existing cooperative initiatives,1466
and supported deference to non-U.S.
oversight when possible.1467 While the
Commission intends to be mindful of
those various goals and principles as
part of its comparability analyses, the
decision whether to grant substituted
compliance ultimately must focus on
whether a foreign regime produces
regulatory outcomes consistent with the
applicable provisions of the Exchange
Act. That type of assessment necessarily
must focus on Exchange Act
requirements.
Finally, one commenter argued that to
help manage operational complexities,
the entirety of a regulatory regime
should be deemed comparable with the
Exchange Act requirements if a
significant portion of that regime is
found to be comparable.1468 In the
Commission’s view, however, such an
approach would be inconsistent with
the predicate for substituted compliance
that there be the comparability of
regulatory outcomes. If a foreign
regulatory regime does not achieve a
regulatory outcome that is comparable
to the regulatory outcome associated
with particular Exchange Act
requirements, then the basis for
substituted compliance will not have
been satisfied. In that case, substituted
compliance would not be appropriate
with regard to such requirements,
notwithstanding its potential
1462 Substituted compliance orders further may be
conditioned on security-based swap dealers and
major security-based swap participants that rely on
substituted compliance notifying the Commission
of that reliance. In that respect, the forms that the
Commission has adopted for use by applicants for
registration as security-based swap dealers or major
security-based swap participants provides for
applicants to notify the Commission regarding
intended reliance on substituted compliance. See
Registration Adopting Release, 80 FR at 49049,
supra note 989 (questions 3A, B and C of Form
SBSE–A, addressing potential reliance on
substituted compliance determinations).
1463 See note 1396, supra.
1464 See note 1397, supra.
1465 See note 1399, supra.
1466 See note 1398, supra.
1467 See note 1407, supra.
1468 See note 1400, supra.

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availability in connection with other
requirements.
f. Consideration of Supervision and
Enforcement Practices
Assessment of a foreign regulatory
regime’s supervisory and enforcement
practices is expected to be a critical
component of any Commission decision
to permit substituted compliance. As
discussed in the Cross-Border Proposing
Release, when the Commission assesses
a foreign regulatory regime’s oversight
for purposes of making a substituted
compliance determination, the
Commission expects to consider not
only overall oversight activities, but also
oversight specifically directed at
conduct and activity that would be
relevant to the substituted compliance
determination.1469 For example, it
would be difficult for the Commission
to make a comparability determination
in support of substituted compliance if
oversight is directed solely at the local
activities of foreign security-based swap
dealers, as opposed to the cross-border
activities of such dealers.
In making this consideration a
prerequisite for substituted compliance,
the Commission in no way should be
interpreted as minimizing the
significance of the Commission’s own
independent obligation to supervise the
compliance of registered entities with
Title VII requirements, even when
requirements may be satisfied via
substituted compliance. Registered
entities are subject to the requirements
of Title VII, and the Commission retains
its full authority to inspect, examine
and supervise those entities’ compliance
with Title VII, and take enforcement
action as appropriate, regardless of the
availability of substituted compliance.
One comment emphasized that the
assessment must address a foreign
regulatory regime’s supervisory and
enforcement capabilities in practice, not
merely on paper.1470 Another comment
stated that differences among the
supervisory and enforcement regimes
should not be assumed to reflect flaws
in one regime or another.1471 The
Commission expects that its
consideration of the effectiveness of a
foreign regulatory regime’s practices
will account for those factors in
conjunction with other relevant
factors.1472
1469 See Cross-Border Proposing Release, 78 FR at
31088 n.1117, supra note 6.
1470 See note 1401, supra.
1471 See note 1402, supra.
1472 In this regard, the Commission notes that one
commenter requested further guidance regarding
the Commission’s consideration of the effectiveness
of foreign supervision and enforcement. See note
1403, supra. In the Commission’s view, however,

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30079

Applying those principles here, the
Commission notes that the difficult
questions noted above with respect to
requirements regarding ECP verification,
special entities and political
contributions also can be expected to
manifest themselves in connection with
our consideration of a foreign regulatory
regime’s supervisory and enforcement
practices. That is, as the Commission
evaluates the foreign regulatory regime’s
supervisory and enforcement practices
in connection with substituted
compliance, the Commission
necessarily will seek to evaluate
whether those supervisory and
enforcement practices will adequately
support regulatory outcomes consistent
with those particular requirements (as
well as the other business conduct
requirements).
More generally, the scope of any grant
of substituted compliance may be linked
to the scope of foreign regulatory
regime’s supervision and enforcement
practices. For example, if a foreign
regulatory regime closely oversees the
security-based swap business that an
SBS Entity conducts through an office
located in that non-U.S. jurisdiction, but
does not exercise the same degree of
regulatory oversight over a branch of
that entity that is located in the U.S., it
is possible that any grant of substituted
compliance would not extend to
activities conducted through the entity’s
U.S. branch.
g. Multi-Jurisdictional Issues
Commenters further have raised
certain issues—that were not addressed
in the Cross-Border Proposing Release—
regarding how the substituted
compliance rule would apply to certain
special circumstances involving multijurisdictional activities of foreign
security-based swap dealers. While
recognizing the facts-and-circumstances
nature of the application of substituted
compliance under the final rule, the
Commission anticipates that the final
rule would apply generally to such
circumstances in the following manner:
i. Third-Country Branches
One commenter particularly raised
questions regarding the application of
substituted compliance in connection
with third-country branches of foreign
security-based swap dealers, and
requested further guidance regarding
how substituted compliance would
apply to circumstances where an entity
consideration of foreign supervisory and
enforcement effectiveness will turn upon relevant
facts and circumstances in a manner such that it
would not be practicable to provide more specific
guidance regarding specific factors that may be
included within that analysis.

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located in one country has a branch
located in another country that engages
in dealing activity.1473 The potential
availability of substituted compliance
under the final rule will reflect the
scope of any relevant substituted
compliance order, including, for
instance, whether an order for a
particular jurisdiction extends to thirdcountry branches of entities domiciled
within that jurisdiction. The scope of
any such order—and hence the potential
availability of substituted compliance
for a third-country branch—necessarily
will turn upon the applicable facts and
circumstances.

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ii. Substituted Compliance and the
European Union
Commenters also raised issues
regarding the assessment of substituted
compliance in the context of the
European Union, stating that certain
rules are adopted at a European level
and are applied directly by individual
member states.1474 In the Commission’s
view, such issues may be expected to
affect analyses of substantive
comparability in a manner that differs
from the way they may apply to
consideration of the adequacy of a
foreign regulatory regime’s enforcement
and supervisory system. In particular, to
the extent that substantive requirements
are promulgated at a multi-state level,
the Commission’s analysis may consider
whether those multi-state requirements
are comparable to the corresponding
Exchange Act requirements. In contrast,
to the extent that the enforcement and
supervision of those requirements is
conducted at the member state level,
then the Commission necessarily would
assess the adequacy of a foreign
regulatory regime’s enforcement and
supervisory system at the member state
level. Any grant of substituted
compliance necessarily would take into
account both the substantive
requirements and the adequacy of the
relevant enforcement and supervisory
system.
iii. Additional Cross-Jurisdictional
Issues
Another commenter raised issues
regarding which sets of requirements
would apply to transactions between
parties in different markets, and
whether the parties to cross-jurisdiction
transactions may choose which rules
apply.1475 As discussed above,
substituted compliance is intended to
help promote efficiency, enhance
competition and facilitate a well1473 See

note 1404, supra.
note 1406, supra.
1475 See note 1405, supra.
1474 See

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functioning market by helping SBS
Entities avoid regulatory conflicts or
duplication. Substituted compliance is
not mandatory, moreover, so when it is
available a non-U.S. SBS Entity may
elect whether to rely on comparable
foreign requirements with regard to its
security-based swap business or some
discrete portion of that business.
However, the policies and procedures of
non-U.S. SBS Entities generally should
address with particularity when the
entity will rely on substituted
compliance with regard to particular
requirements (e.g., with regard to
particular portions of their securitybased swap business and/or particular
counterparties).
h. Applications for Substituted
Compliance and Related Prerequisites
Paragraph (c)(1) of the final rule
provides that a party or group of parties
that potentially would rely on
substituted compliance, or any foreign
financial regulatory authority or
authorities supervising such a party or
its security-based swap activities, may
file an application, pursuant to the
procedures set forth in Exchange Act
Rule 0–13 requesting that the
Commission make a substituted
compliance determination.1476
Exchange Act Rule 0–13 is a procedural
rule that the Commission has adopted
regarding the submission of substituted
compliance applications, and provides
for the opportunity for public comment
on completed applications.1477
Paragraph (c)(1) has been revised from
the proposal (which only referred to
applications by security-based swap
dealers) to reflect the fact that Rule 0–
13 provides for applications by foreign
financial authorities.1478 Also, to avoid
1476 See Exchange Act rule 3a71–6(c)(1). The final
rule accordingly provides that a foreign financial
regulatory authority may submit a substituted
compliance application if that authority supervises
a party that would rely on substituted compliance,
or supervises that party’s activities. A regulatory
authority that does not possess such supervisory
responsibilities would not be eligible to submit a
substituted compliance application, even if that
authority promulgates rules or other requirements
applicable to such parties’ security-based swap
activities.
1477 Among other respects, Rule 0–13 provides
that applications must include any supporting
documents necessary to make the application
complete, ‘‘including information regarding
applicable requirements established by the foreign
financial regulatory authority or authorities, as well
as the methods used by the foreign financial
regulatory authority or authorities to monitor and
enforce compliance with such rules.’’ Rule 0–13
further provides that Commission staff will review
the application after the filing is complete, and that
completed applications will be published for public
comment.
1478 See Cross-Border Adopting Release, 79 FR at
47358, supra note 193 (concluding, in adopting
Rule 0–13, that ‘‘allowing foreign regulators to

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duplicating the requirements of Rule 0–
13, paragraph (c)(1) also has been
revised from the proposal by removing
references to the need for the applicant
to provide the reasons for the request
and provide supporting documentation
as the Commission may request.
In addition, paragraph (c)(1) has been
revised from the proposal to provide
that applications may be made by
parties or groups of parties that
potentially would rely on substituted
compliance, in lieu of the proposed
reference to applications by foreign
security-based swap dealers or groups of
dealers ‘‘of the same class.’’ This change
in part accommodates the possibility
that market participants may seek
approval to rely on substituted
compliance prior to their being deemed
to be ‘‘security-based swap dealers’’ or
‘‘major security-based swap
participants’’ under the applicable
definitions. The final rule also does not
limit joint applications to those that
come from persons ‘‘of the same class,’’
to facilitate the Commission’s ability to
consider applications jointly submitted
by multiple entities notwithstanding
differences in their businesses.1479
In connection with applications
submitted by such parties, Rule 3a71–
6(c)(2)(i) states that such a party (or
group of parties) may make a substituted
compliance request only if the party or
the party’s activities are ‘‘directly
supervised by the foreign financial
regulatory authority or authorities with
respect to the foreign regulatory
requirements relating to the applicable
requirements.’’ 1480 This condition
should help promote the principles that
condition substituted compliance on the
effectiveness of the supervision and
enforcement exercised by the foreign
authority, by reflecting the fact that
substituted compliance will not be
allowed for entities that are not subject
to foreign oversight in connection with
their security-based swap business.
The final rule further provides that to
make a request for substituted
submit such requests would promote the
completeness of requests and promote efficiency in
the process for considering such requests’’).
1479 Paragraphs (c)(1) and (c)(2) also have been
changed to reflect the possibility that the foreign
regulators may supervise the party, or the party’s
activities.
1480 See Exchange Act rule 3a71–6(c)(2)(i). This
provision has been changed from the proposal to
reflect the fact that potential applicants will not be
limited to security-based swap dealers. This
provision also has been changed from the proposal
by removing a redundant reference to the foreign
authorities being ‘‘under the system.’’ In addition,
the introductory part of paragraph (c)(2) has been
modified from the proposal to refer to requests
made ‘‘pursuant to paragraph (c)(1)’’ (rather than
‘‘pursuant to paragraph (a)(1)’’ as set forth in the
proposal), consistent with the revised structure of
the rule.

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compliance, each such party must
provide the certification and opinion of
counsel that is described in Exchange
Act rule 15Fb2–4(c), as if the party were
subject to that requirement at the time
of the request.1481 Rule 15Fb2–4(c)
requires that nonresident security-based
swap dealers and major security-based
swap participants must certify, and
provide an associated opinion of
counsel, that the entity can as a matter
of law, and will, provide the
Commission with prompt access to the
entity’s books and records and submit to
onsite inspection and examination by
the Commission.1482 This part of the
final rule is generally consistent with
the proposal, with one change to permit
an entity to apply for substituted
compliance before the entity registers
with the Commission.1483
The final rule also has been revised
from the proposal to implement an
analogous requirement in connection
with substituted compliance
applications by foreign financial
regulatory authorities.1484 In particular,
the final rule provides that foreign
financial regulatory authorities may
make substituted compliance requests
only if each such authority provides
adequate assurances that no law or
policy of any relevant foreign
jurisdiction would impede the ability of
any entity that is directly supervised by
the foreign financial regulatory
1481 See

Exchange Act rule 3a71–6(c)(2)(ii).
Exchange Act rule 15Fb2–4(c). Under
that rule, the certification must state that the entity
‘‘can, as a matter of law, and will’’ provide such
access to the Commission, while the opinion of
counsel only says that the entity ‘‘can, as a matter
of law’’ provide such a certification.
As noted, although commenters to the CrossBorder Proposing Release had questioned such
direct access on deference-related grounds, the
Commission subsequently adopted a final rule
requiring those certifications and opinions of
counsel as prerequisites to registration by
nonresident entities. See notes 1408 and 1409,
supra. In adopting that prerequisite, we noted our
belief that ‘‘significant elements of an effective
regulatory regime are the Commission’s abilities to
access registered SBS Entities’ books and records
and to inspect and examine the operations of
registered SBS Entities.’’ See Registration Adopting
Release, 80 FR at 48981, supra note 989.
1483 The final rule, in contrast to the proposal,
states that the party must provide the certification
and opinion of counsel ‘‘as if the party were subject
to that requirement at the time of the request.’’
Because the requirements of rule 15Fb2–4(c) are
imposed on an entity applying for registration with
the Commission, the addition of that language
should facilitate the ability of an entity to apply for
substituted compliance before the entity is required
to register with the Commission as a security-based
swap dealer or as a major security-based swap
participant.
1484 See Exchange Act rule 3a71–6(c)(3). As noted
above, the final rule has been modified from the
proposal to permit foreign financial regulatory
authorities to submit substituted compliance
applications, necessitating the addition of this
prerequisite to applications by such authorities.

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1482 See

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authority, and that may register with the
Commission as a security-based swap
dealer or major security-based swap
participant, to provide prompt access to
the Commission to such entity’s books
and records or to submit to onsite
inspection or examination by the
Commission.1485
In general, those prerequisites to the
submission of substituted compliance
applications by entities or by foreign
financial authorities should promote
efficiency in the substituted compliance
assessment process. The prerequisites
particularly will help focus such
assessments upon those jurisdictions
that would not effectively prohibit
entities from registering as dealers or
major participants as a result of blocking
statutes or other laws or policies that
otherwise would impede the
Commission’s ability to exercise its
supervisory authority and
responsibilities over registered entities.
In other words, if a jurisdiction has
blocking statutes or other laws or
policies that would preclude the
registration of such dealers and major
participants with the Commission, there
would be no purpose to the Commission
considering a substituted compliance
application in connection with that
jurisdiction.
Exchange Act rule 0–13, which
addresses the submission of substituted
compliance applications, states that the
Commission will not consider
hypothetical requests for substituted
compliance orders.1486 Consistent with
that limitation, when the Commission
reviews substituted compliance
applications, it would take into account
whether particular jurisdictions contain
entities that reasonably may be expected
to register with the Commission as
security-based swap dealers or major
security-based swap participants based
on their level of security-based swap
activity connected with U.S. persons or
the U.S. market.
IV. Explanation of Dates
A. Effective Date
These final rules will be effective 60
days following publication in the
Federal Register.
1485 While applications by foreign financial
regulatory authorities must include such adequate
assurances, the rule does not specifically require
those applications to be accompanied by opinions
of counsel (in contrast to applications submitted by
entities that seek to rely on substituted compliance).
Opinions of counsel, however, provide one possible
way in which such authorities may provide the
necessary adequate assurances.
1486 See Exchange Act rule 0–13(e).

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30081

B. Compliance Date
The Commission believes it
appropriate not to apply these rules
until entities are required to register as
SBS Dealers or Major SBS Participants.
Therefore, with the exception of the
application of customer protection
requirements described in final Rule
3a71–3(c) to transactions described
under final Rule 3a71–3(a)(8)(i)(B), the
Commission is adopting a compliance
date for final Rules 15Fh–1 through
15Fh–6 1487 and Rule 15Fk–1 that is the
same as the compliance date of the SBS
Entity registration rules (‘‘Registration
Compliance Date’’).1488
In the Registration Adopting Release,
the Commission provided that the
Registration Compliance Date will be
the later of: Six months after the date of
publication in the Federal Register of
final rules establishing capital, margin
and segregation requirements for SBS
Entities; 1489 the compliance date of
final rules establishing recordkeeping
and reporting requirements for SBS
Entities; 1490 the compliance date of
final rules establishing business conduct
requirements under Sections 15F(h) and
15F(k) of the Exchange Act; or the
compliance date for final rules
establishing a process for a registered
SBS Entity to make an application to the
Commission to allow an associated
person who is subject to a statutory
disqualification to effect or be involved
in effecting security-based swaps on the
SBS Entity’s behalf.1491
The Commission has previously noted
the potential complexities associated
with identifying transactions of a dealer
that it arranges, negotiates, or executes
by personnel located in the United
States under Rule 3a71–
3(b)(1)(iii)(C),1492 which requires a non1487 See Section II.H.9 (Certain Political
Contributions by SBS Dealers), supra, discussing,
among other things, how Rule 15Fh–6 applies to
contributions made before the SBS Dealer registered
with the Commission as such as well as how the
rule’s ‘‘look back’’ provision will not apply to
contributions made before the compliance date of
the rule by newly covered associates to which the
look back applies.
1488 See Registration Adopting Release, supra
note 989.
1489 The Commission previously has proposed
rules to establish capital, margin and segregation
requirements for SBS Entities. See Capital, Margin,
and Segregation Requirements for Security-Based
Swap Dealers and Major Security-Based Swap
Participants and Capital Requirements for BrokerDealers, Exchange Act Release No. 68071 (Oct. 18,
2012), 77 FR 70213 (Nov. 23, 2012).
1490 The Commission previously has proposed
rules to establish recordkeeping and reporting
requirements for SBS Entities. See Recordkeeping
Release, 79 FR 25193, supra note 242.
1491 See Registration Adopting Release, supra
note 989.
1492 See U.S. Activity Adopting Release, 81 FR
8636–37.

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U.S.-person dealer to include such
transactions in its de minimis threshold
calculations. In the U.S. Activity
Adopting Release, the Commission
specified that the compliance date for
that rule is ‘‘the later of (a) 12 months
following publication in the Federal
Register, or (b) the SBS Entity Counting
Date.’’ 1493 Because the Commission
believes similar potential complexities
exist with respect to such transactions
that are included in ‘‘U.S. business’’ as
defined in final Rule 3a71–3(a)(8)(i)(B),
the Commission is adopting a
compliance date for application of
customer protection requirements
described in final Rule 3a71–3(c) to
transactions described under final Rule
3a71–3(a)(8)(i)(B) that is the later of (a)
12 months following publication in the
Federal Register, or (b) the Registration
Compliance Date.
The Commission believes that these
timing requirements should provide
firms with adequate time to review the
business conduct rules being adopted
today and make appropriate business
decisions before being required to
comply with the requirements of the
rules.

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C. Application to Substituted
Compliance
For the substituted compliance
provisions of Rule 3a71–6, the
Commission similarly is adopting an
effective date of 60 days following
publication in the Federal Register.
There will be no separate compliance
date in connection with that rule, as the
rule does not impose obligations upon
entities separate and apart from the
underlying business conduct
requirements. As discussed above,
security-based swap dealers and major
security-based swap participants will
not be required to comply with the
business conduct requirements until
they are registered, and the registration
requirement for those entities will not
be triggered until a number of regulatory
benchmarks have been met.
In practice, the Commission
recognizes that if the requirements of a
foreign regime are comparable to Title
VII requirements, and the other
prerequisites to substituted compliance
also have been satisfied, then it may be
appropriate to permit a security-based
swap dealer or major security-based
swap participant to rely on substituted
compliance commencing at the time
that entity is registered with the
Commission. Accordingly, the
Commission would consider substituted
compliance requests that are submitted
1493 Id.

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prior to the compliance date for the
entity registration requirements.
V. Paperwork Reduction Act
Certain provisions of the Rules
impose new ‘‘collection of information’’
requirements within the meaning of the
Paperwork Reduction Act of 1995
(‘‘PRA’’).1494 In accordance with 44
U.S.C. 3507 and 5 CFR 1320.11, the
Commission submitted the provisions to
the Office of Management and Budget
(‘‘OMB’’) for review when it issued the
Proposing Release. The titles for these
collections are ‘‘Business Conduct
Standards for Security-Based Swap
Dealers and Major Security-Based Swap
Participants,’’ and ‘‘Designation of Chief
Compliance Officer of Security-Based
Swap Dealers and Major Security-Based
Swap Participants.’’
Compliance with collection of
information requirements is mandatory.
An agency may not conduct or sponsor,
and a person is not required to respond
to, a collection of information unless it
displays a currently valid OMB control
number. OMB assigned control number
3235–0732 to the new collections of
information.
In the Proposing Release, the
Commission requested comment on the
collection of information requirements
contained therein, as well as the
accuracy of the Commission’s related
estimates and statements regarding the
associated costs and burdens of the
proposed rules. As noted above, the
Commission received 43 comment
letters addressing the Proposing Release,
as well as those portions of the CrossBorder Proposing Release that
referenced the proposed rules governing
business conduct standards for securitybased swap dealers. Although none of
the comment letters specifically
addressed the Commission’s estimates
for the proposed collection of
information requirements, the views of
commenters relevant to the
Commission’s analysis of burdens,
costs, and benefits of the proposed rules
are discussed in Section IV.C, below.
The Commission continues to believe
that the methodology used for
calculating the burdens set forth in the
Proposing Release is appropriate.
However, where noted, certain estimates
have been modified, as necessary, to
conform to the adopted rules and to
reflect the most recent data available to
the Commission. Other than these
changes, the Commission’s estimates
remain unchanged from those in the
Proposing Release.
As a part of this release, the
Commission also is adopting Rule 3a67–
1494 44

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10(d) and Rule 3a71–3(c), which among
other things, provide an exception to
certain of the business conduct
standards described in section 15F(h) of
the Act, and the rules and regulations
thereunder, to registered Major SBS
Participants and registered SBS Dealers
in certain transactions conducted
through the foreign branch of their U.S.person counterparty. As part of the
process of availing themselves of this
exception, registered Major SBS
Participants (in the case of Rule 3a67–
10(d)) and registered SBS Dealers (in the
case of Rule 3a71–3(c)) would be
permitted to rely on certain
representations provided to them by
their counterparties regarding whether a
transaction is conducted through a
foreign branch. The requirements
regarding those representations are
contained in Rule 3a71–3(a)(3)(ii). The
Commission previously published a
notice requesting comment on the
collection of information requirements
in Rule 3a71–3 as part of the CrossBorder Proposing Release, and
submitted those proposed collection of
information requirements to OMB for
review in accordance with 44 U.S.C.
3507 and 5 CFR 1320.11. The title of the
collection of information related to the
representation in Rule 3a71–3 is
‘‘Reliance on Counterparty
Representations Regarding Activity
Within the United States.’’ OMB has not
yet assigned a control number to this
collection.
The Commission also is adopting Rule
3a71–6 to provide for substituted
compliance in connection with the
business conduct requirements. As
proposed, the title of the information
collection associated with that rule was
‘‘Rule 3a71–5 Substituted Compliance
for Foreign Security-Based Swap
Dealers.’’ 1495 The OMB assigned control
number 3235–0715 to the new
collection of information. In the CrossBorder Proposing Release, the
Commission solicited comment on the
collection of information requirements
associated with the substituted
compliance rule and on the accuracy of
the Commission’s related statements.
The Commission received no comments
on those proposed information
collection requirements.

1495 Consistent with the renumbering of the rule
and the potential availability of substituted
compliance to Major SBS Participants, the revised
title of the collection of information is ‘‘Rule 3a71–
6 Substituted Compliance for Foreign SecurityBased Swap Entities.’’

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A. Summary of Collections of
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1. Definitions
Rule 15Fh–2(d) defines a ‘‘special
entity’’ as: (1) A Federal agency; (2) a
State, State agency, city, county,
municipality, other political subdivision
of a State, or any instrumentality,
department, or a corporation of or
established by a State or political
subdivision of a State; (3) any employee
benefit plan subject to Title I of ERISA;
(4) any employee benefit plan defined in
Section 3 of ERISA, not otherwise
defined as a special entity, unless such
employee benefit plan elects not to be
a special entity by notifying an SBS
dealer or Major SBS Participant of its
election prior to entering into a securitybased swap; (5) any governmental plan,
as defined in Section 3(32) of ERISA; or
(6) any endowment, including
organizations described in Section
501(c)(3) of the Internal Revenue Code.
The proposed rule included employee
benefit plans ‘‘defined in’’ ERISA within
the special entity definition. The final
rule similarly includes employee benefit
plans ‘‘defined in’’ ERISA that are not
otherwise ‘‘subject to’’ ERISA within the
special entity definition, although it
provides such benefit plans with the
ability to opt out of special entity status.
2. Verification of Status
Rule 15Fh–3(a)(1) requires an SBS
Entity to verify that a counterparty
meets the eligibility standards for ECP
status before entering into a securitybased swap with that counterparty other
than with respect to a transaction
executed on a registered national
securities exchange.
Rule 15Fh–3(a)(2) requires an SBS
Entity to verify whether a counterparty
is a special entity before entering into a
security-based swap transaction with
that counterparty, unless the transaction
is executed on a registered or exempt
SEF or registered national securities
exchange, and the SBS Entity does not
know the identity of the counterparty at
a reasonably sufficient time prior to the
transaction to permit the SBS Entity to
comply with the obligations of the rule.
Rule 15Fh–3(a)(3) requires an SBS
Entity, in verifying the special entity
status of a counterparty pursuant to
Rule 15Fh–3(a)(2), to verify whether a
counterparty is eligible to elect not to be
a special entity as provided for in the
adopted special entity definition in Rule
15Fh–2(d)(4), and if so, to notify such
counterparty of its right to make such an
election. An SBS Entity may satisfy
these verification requirements through
any reasonable means including, among
other things, by obtaining written

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representations from the counterparty as
to specific facts about the
counterparty.1496
3. Disclosures by SBS Entities
Rule 15Fh–3(b) generally requires an
SBS Entity at a reasonably sufficient
time prior to entering into a securitybased swap to disclose to a counterparty
(other than an SBS Entity or Swap
Entity) material information concerning
the security-based swap in a manner
reasonably designed to allow the
counterparty to assess: (1) The material
risks and characteristics of a particular
security-based swap; and (2) any
material incentives or conflicts of
interest that the SBS Entity may have in
connection with the security-based
swap. These disclosure requirements do
not apply unless the identity of the
counterparty is known to the SBS Entity
at a reasonably sufficient time prior to
execution of the transaction to permit
the SBS Entity to comply with the
obligations of the rule. The rule also
requires the SBS Entity to make a
written record of any non-written
disclosures made pursuant to this
provision, and timely provide a written
version of these disclosures to
counterparties no later than the delivery
of the trade acknowledgement of the
particular transaction.
Rule 15Fh–3(c)(1), for cleared
security-based swaps, requires an SBS
Entity to, upon request of the
counterparty, disclose the daily mark to
the counterparty (other than an SBS
Entity or Swap Entity). The daily mark
that the SBS Entity receives from the
appropriate clearing agency. Rule 15Fh–
3(c)(2), for uncleared security-based
swaps, requires an SBS Entity to
disclose the daily mark to the
counterparty, which is the midpoint
between the bid and offer, or the
calculated equivalent thereof, as of the
close of business, unless the parties
agree in writing to a different time, on
each business day during the term of the
security-based swap. Rule 15Fh–3(c)(2)
also requires disclosure of the data
sources and a description of the
methodology and assumptions used to
prepare the daily mark for an uncleared
security-based swap, as well as
disclosure of any material changes to
such data sources, methodology or
assumptions during the term of the
security-based swap. Rule 15Fh–3(c)(1)
and (2) also require an SBS Entity to
provide the daily mark without charge
1496 The Commission separately has proposed
rules regarding recordkeeping and reporting
requirements for SBS Entities that would require an
SBS Entity to keep records of its verification. See
Recordkeeping Release, 79 FR 25193, 25208 and
25217–25218, supra note 242.

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to the counterparty and without
restrictions on the internal use of the
daily mark by the counterparty.
Rule 15Fh–3(d) requires an SBS
Entity to disclose information regarding
clearing rights to its counterparties
(other than an SBS Entity or Swap
Entity), so long as the identity of the
counterparty is known to the SBS Entity
at a reasonably sufficient time prior to
execution of the transaction to permit
the SBS Entity to comply with the
obligations of the rule. Pursuant to the
rule, before entering into a securitybased swap that is subject to the
clearing requirements of Section 3C(a)
of the Exchange Act, the SBS Entity
shall disclose to the counterparty the
names of the clearing agencies that
accept the security-based swap for
clearing, and through which of those
clearing agencies the SBS Entity is
authorized or permitted, directly or
through a designated clearing member,
to clear the security-based swap;
disclose to the counterparty whether
any of the named clearing agencies
satisfy the standard for clearing under
Section 3C(a)(1) of the Exchange Act;
and notify the counterparty that it shall
have the sole right to select which
clearing agency shall be used to clear
the security-based swap. For securitybased swaps, not subject to the clearing
requirements of Section 3C(a) of the
Exchange Act, before entering into a
security-based swap, the SBS Entity
shall determine whether the securitybased swap is accepted for clearing by
one or more clearing agencies; disclose
to the counterparty the names of the
clearing agencies that accept the
security-based swap for clearing, and
whether the SBS Entity is authorized or
permitted, directly or through a
designated clearing member, to clear the
security-based swap through such
clearing agencies; and notify the
counterparty that it may elect to require
clearing of the security-based swap and
shall have the sole right to select the
clearing agency at which the securitybased swap will be cleared, provided it
is a clearing agency at which the SBS
Entity is authorized or permitted,
directly or through a designated clearing
member, to clear the security-based
swap. To the extent that the disclosures
required by Rule 15Fh–3(d) are not
provided in writing prior to the
execution of the transaction, the SBS
Entity is required to make a written
record of the non-written disclosures
and provide the counterparty with a
written version of these disclosure no
later than the delivery of the trade
acknowledgement for the transaction.

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4. Know Your Counterparty and
Recommendations
Rule 15Fh–3(e) requires an SBS
Dealer to establish, maintain and
enforce written policies and procedures
reasonably designed to obtain and retain
a record of the essential facts concerning
each counterparty whose identity is
known to the SBS Dealer that are
necessary for conducting business with
such counterparty. The essential facts
are: (1) Facts required to comply with
applicable laws, regulations and rules;
(2) facts required to implement the SBS
Dealer’s credit and operational risk
management policies in connection
with transactions entered into with such
counterparty; and (3) information
regarding the authority of any person
acting for such counterparty.
Rule 15Fh–3(f)(1) requires an SBS
Dealer recommending a security-based
swap or trading strategy involving a
security-based swap to a counterparty
(other than an SBS Entity or a Swap
Entity) to: (i) Undertake reasonable
diligence to understand the potential
risks and rewards associated with the
recommendation; and (ii) have a
reasonable basis to believe that the
recommendation is suitable for the
counterparty. To establish a reasonable
basis for a recommendation, an SBS
Dealer must have or obtain relevant
information regarding the counterparty,
including the counterparty’s investment
profile, trading objectives, and its ability
to absorb potential losses associated
with the recommended security-based
swap or trading strategy involving a
security-based swap.
Under Rule 15Fh–3(f)(2), an SBS
Dealer may also fulfill its suitability
obligations under Rule 15Fh–3(f)(1)(ii)
with respect to an institutional
counterparty (defined as a counterparty
that is an eligible contract participant as
defined in clauses (A)(i), (ii), (iii), (iv),
(viii), (ix) or (x), or clause (B)(ii) (other
than a person described in clause (A)(v))
of Section 1a(18) of the Commodity
Exchange Act and the rules and
regulations thereunder, or any person
(whether a natural person, corporation,
partnership, trust or otherwise) with
total assets of at least $50 million) if: (i)
The SBS Dealer reasonably determines
that the counterparty (or its agent) is
capable of independently evaluating the
investment risks with regard to the
relevant security-based swap or trading
strategy involving a security-based
swap; (ii) the counterparty (or its agent)
affirmatively represents in writing that
it is exercising its independent
judgment in evaluating the
recommendations of the SBS Dealer
with regard to the relevant security-

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based swap or trading strategy; and (iii)
the SBS Dealer discloses to the
counterparty that it is acting in its
capacity as a counterparty and is not
undertaking to assess the suitability of
the security-based swap or trading
strategy for the counterparty. Under
Rule 15Fh–3(f)(3), an SBS Dealer will be
deemed to have satisfied the
requirements of Rule 15Fh–3(f)(2)(i) if it
receives written representations, as
provided in Rule 15Fh–1(b), that: (i) In
the case of a counterparty that is not a
special entity, the counterparty has
complied in good faith with written
policies and procedures that are
reasonably designed to ensure that the
persons responsible for evaluating the
recommendation and making trading
decisions on behalf of the counterparty
are capable of doing so; and (ii) in the
case of a counterparty that is a special
entity, satisfy the terms of the safe
harbor in Rule 15Fh–5(b).
5. Fair and Balanced Communications
Rule 15Fh–3(g) requires an SBS Entity
to communicate with its counterparties
in a fair and balanced manner based on
principles of fair dealing and good faith.
The rule requires that: (1)
Communications provide a sound basis
for evaluating the facts with regard to a
particular security-based swap or
trading strategy involving a securitybased swap; (2) communications not
imply that past performance will recur
or make any exaggerated or unwarranted
claim, opinion, or forecast; and (3) any
statement referring to potential
opportunities or advantages presented
by a particular security-based swap be
balanced by an equally detailed
statement of the corresponding risks.
6. Supervision
Rule 15Fh–3(h) requires an SBS
Entity to establish and maintain a
system to supervise, and to diligently
supervise, its business and the activities
of its associated persons. Such a system
shall be reasonably designed to prevent
violations of the provisions of
applicable federal securities laws and
the rules and regulations thereunder
relating to its business as an SBS Entity.
At a minimum, the supervisory system
must: (i) Designate at least one person
with authority to carry out supervisory
responsibilities for each type of business
in which the SBS Entity engages for
which registration as an SBS Entity is
required; (ii) use reasonable efforts to
determine all such supervisors are
qualified, either by virtue of experience
or training, to carry out their assigned
responsibilities; and (iii) establish,
maintain and enforce written policies
and procedures addressing the

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supervision of the types of securitybased swap business in which the SBS
Entity is engaged and the activities of it
associated persons that are reasonably
designed to prevent violations of
applicable securities laws and rules and
regulations thereunder.
Such written policies and procedures
must include, at a minimum,
procedures: (a) For the review by a
supervisor of transactions for which
registration as an SBS Entity is required;
(b) for the review by a supervisor of
incoming and outgoing written
(including electronic) correspondence
with counterparties or potential
counterparties and internal written
communications relating to the SBS
Entity’s security-based swap business;
(c) for a periodic review, at least
annually, of the security-based swap
business in which the SBS Entity
engages that is reasonably designed to
assist in detecting and preventing
violations of applicable federal
securities laws and regulations; (d) to
conduct a reasonable investigation
regarding the good character, business
repute, qualifications, and experience of
any person prior to that person’s
association with the SBS Entity; (e) to
consider whether to permit an
associated person to establish or
maintain a securities or commodities
account or a trading relationship in the
name of, or for the benefit of, such
associated person at another financial
institution, and if permitted, to
supervise the trading at such institution;
(f) describing the supervisory system,
including the titles, qualifications and
locations of supervisory persons and the
responsibilities of each supervisory
person with respect to the types of
business in which the SBS Entity is
engaged; (g) prohibiting an associated
person who performs a supervisory
function from supervising his or her
own activities or reporting to, or having
his or her compensation or continued
employment determined by, a person or
persons he or she is supervising;
provided that if the SBS Entity
determines, with respect to any of its
supervisory personnel, that compliance
with this requirement is not possible
because of the firm’s size or a
supervisory person’s position within the
firm, then the SBS Entity must
document the factors used to reach such
determination and how the supervisory
arrangement otherwise complies with
this rule, and include a summary of
such determination in the annual
compliance report prepared by the SBS
Entity’s CCO pursuant to Rule 15Fk–
1(c); (h) reasonably designed to prevent
the supervisory system from being

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compromised due to conflicts of interest
that may be present with respect to the
associated person being supervised,
including the position of such person,
the revenue such person generates for
the SBS Entity, or any compensation
that the associated person conducting
the supervision may derive from the
associated person being supervised; and
(i) reasonably designed, taking into
consideration the nature of the SBS
Entity’s business, to comply with the
duties set forth in Section 15F(j) of the
Exchange Act.
Rule 15Fh–3(h)(3) provides that an
SBS Entity (or associated person of an
SBS Entity) will not be deemed to have
failed to diligently supervise another
person if that person is not subject to his
or her supervision, or if: (i) The SBS
Entity has established and maintained
written policies and procedures (as
required in Rule15Fh–3(h)(2)(iii)), and a
documented system for applying those
policies and procedures that would
reasonably be expected to prevent and
detect, insofar as practicable, any
violation of the federal securities laws
and the rules and regulations
thereunder relating to security-based
swaps; and (ii) the SBS Entity or
associated person has reasonably
discharged the duties and obligations
required by such written policies and
procedures and documented system and
did not have a reasonable basis to
believe that such written policies and
procedures and documented system
were not being followed.
Rule 15Fh–3(h)(4) provides that an
SBS Entity must also promptly amend
its written supervisory procedures as
appropriate when material changes
occur in applicable securities laws,
rules, or regulations thereunder, as well
as when material changes occur in its
business or supervisory system, and
promptly communicate any material
amendments to its supervisory
procedures to all associated persons to
whom such amendments are relevant
based on their activities and
responsibilities.
7. SBS Dealers Acting as Advisors to
Special Entities
Rule 15Fh–4(b)(1) imposes the duty
on an SBS Dealer that acts as an advisor
to a special entity regarding a securitybased swap to make a reasonable
determination that any security-based
swap or trading strategy involving a
security-based swap recommended by
the SBS Dealer is in the best interests of
the special entity. Paragraph (b)(2) also
requires an SBS Dealer acting as an
advisor to a special entity to make
reasonable efforts to obtain such
information as it considers necessary to

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make a reasonable determination that a
security-based swap or related trading
strategy is in the best interests of the
special entity. The information that
must be obtained to make this
reasonable determination includes, but
is not limited to: (i) The authority of the
special entity to enter into a securitybased swap; (ii) the financial status and
future funding needs of the special
entity; (iii) the tax status of the special
entity; (iv) the hedging, investment,
financing or other objectives of the
special entity; (v) the experience of the
special entity with respect to securitybased swaps, generally, and securitybased swaps of the type and complexity
being recommended; (vi) whether the
special entity has the financial
capability to withstand changes in
market conditions during the term of the
security-based swap; and (vii) such
other information as is relevant to the
particular facts and circumstances of the
special entity, market conditions and
the type of security-based swap or
trading strategy being recommended.
However, the requirements of Rule
15Fh–4(b) do not apply to a securitybased swap if: (i) The transaction is
executed on a registered or exempt SEF
or a registered national securities
exchange; and (ii) the SBS Dealer does
not know the identity of the
counterparty at a reasonably sufficient
time prior to execution of the
transaction to permit the SBS Dealer to
comply with the obligations of this rule.
Rule 15Fh–2(a) generally provides
that an SBS Dealer acts as an advisor to
a special entity when it recommends a
security-based swap or security-based
swap trading strategy to that special
entity. Rule 15Fh–2(a)(1) provides a safe
harbor under which an SBS Dealer will
not be deemed to act as an advisor to a
special entity that is subject to Title I of
ERISA if: (i) The special entity
represents in writing that it has a
fiduciary as defined in Section 3 of
ERISA that is responsible for
representing the special entity in
connection with the security-based
swap; (ii) the fiduciary represents in
writing that it acknowledges that the
SBS Dealer is not acting as an advisor;
and (iii) the special entity represents in
writing that (a) it will comply in good
faith with written policies and
procedures reasonably designed to
ensure that any recommendation the
special entity receives from the SBS
Dealer involving a security-based swap
transaction is evaluated by a fiduciary
before it is entered into; or (b) that any
recommendation the special entity
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be evaluated by a fiduciary before the
transaction is entered into.1497
Rule 15Fh–2(a)(2) provides a safe
harbor for transactions between an SBS
Dealer and any special entity. Under
this rule, an SBS Dealer that
recommends a security-based swap or
security-based swap trading strategy to
any special entity (other than a special
entity subject to Title I of ERISA) will
not be deemed to act as an advisor to
that special entity if the special entity
represents in writing that it
acknowledges that the SBS Dealer is not
acting as an advisor, and that it will rely
on advice from a qualified independent
representative, as defined in Rule 15Fh–
5(a). The SBS Dealer must also disclose
to the special entity that it is not
undertaking to act in the best interests
of the special entity, as otherwise
required by Section 15F(h)(4) of the
Exchange Act.1498
8. SBS Entities Acting as Counterparties
to Special Entities
Rule 15Fh–5(a)(1) requires an SBS
Entity that offers to enter into or enters
into a security-based swap with a
special entity (other than a special
entity that is an employee benefit plan
subject to Title I of ERISA), to have a
reasonable basis to believe that the
special entity has a qualified
independent representative that meets
certain specified qualifications. For
purposes of Rule 15Fh–5(a)(1), a
qualified independent representative
must: (i) Have sufficient knowledge to
evaluate the transaction and related
risks; (ii) not be subject to a statutory
disqualification; (iii) undertake a duty to
act in the best interests of the special
entity; (iv) make appropriate and timely
disclosures to the special entity of
material information concerning the
security-based swap; (iv) evaluate,
consistent with any guidelines provided
by the special entity, the fair pricing and
appropriateness of the security-based
swap; (v) in the case of a special entity
defined in Rule 15Fh–2(d)(2) or (5), be
subject to the pay-to-play prohibitions
of the Commission, the CFTC, or a selfregulatory organization that is subject to
the jurisdiction of the Commission or
the CFTC (unless the independent
representative is an employee of the
special entity); and (vii) be independent
of the SBS Entity that is the
counterparty to a proposed securitybased swap.1499
Rule 15Fh–5(a)(1) also provides that a
representative of a special entity will be
‘‘independent’’ of an SBS Entity if the
1497 Rule

15Fh–2(a)(1).
15Fh–2(a)(2).
1499 Rule 15Fh–5(a)(1)(vii).
1498 Rule

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representative does not have a
relationship with the SBS Entity,
whether compensatory or otherwise,
that reasonably could affect the
independent judgment or decisionmaking of the representative.1500 In
addition, a special entity’s
representative will be deemed to be
‘‘independent’’ of an SBS Entity if: (1)
The representative is not and was not an
associated person of the SBS Entity
within one year of representing the
special entity in connection with the
security-based swap; (2) the
representative provides timely
disclosures to the special entity of all
material conflicts of interest that could
reasonably affect the judgment or
decision making of the representative
with respect to its obligations to the
special entity, and complies with
policies and procedures reasonably
designed to manage and mitigate such
material conflicts of interest; and (3) the
SBS Entity did not refer, recommend, or
introduce the representative to the
special entity within one year of the
representative’s representation of the
special entity in connection with the
security-based swap.1501
Rule 15Fh–5(a)(2) provides that an
SBS Entity that offers to enter into or
enters into a security-based swap with
a special entity as defined in Rule
15Fh–2(d)(3) (any employee benefit
plan that subject to Title I of ERISA)
must have a reasonable basis to believe
the special entity has a representative
that is a fiduciary as defined in Section
3 of ERISA.
Rule 15Fh–5(b) provides safe harbors
for SBS Dealers seeking to form a
reasonable basis regarding the
qualifications of the independent
representative. Under Rule 15Fh–
5(b)(1), an SBS Entity shall be deemed
to have a reasonable basis to believe that
a special entity (other than an ERISA
special entity) has a representative that
satisfies the requirements of Rule 15Fh–
5(a)(1) if: (i) The special entity
represents in writing to the SBS Entity
that it has complied in good faith with
written policies and procedures
reasonably designed to ensure that it has
selected a representative that satisfies
the requirements of Rule 15Fh–5(a)(1),
and that such policies and procedures
provide for ongoing monitoring of the
performance of such representative
consistent with Rule 15Fh–5(a)(1); and
(ii) the representative represents in
writing to the special entity and the SBS
Entity that the representative: (a) Has
policies and procedures reasonably
designed to ensure that it satisfies the
1500 Rule
1501 Rule

15Fh–5(a)(1)(vii)(A).
15Fh–5(a)(1)(vii)(B).

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applicable requirements of Rule 15Fh–
5(a)(1); (b) meets the independence
requirements of Rule 15Fh–5(a)(1)(vii);
and (c) is legally obligated to comply
with the requirements of Rule 15Fh–
5(a)(1) by agreement, condition of
employment, law, rule, regulation, or
other enforceable duty.
Under Rule 15Fh–5(b)(2), an SBS
Entity shall be deemed to have a
reasonable basis to believe that an
ERISA special entity has a
representative that satisfies the
requirements of Rule 15Fh–5(a)(2),
provided that the special entity provides
in writing to the SBS Entity the
representative’s name and contact
information, and represents in writing
that the representative is a fiduciary as
defined in Section 3 of ERISA.
Under Rule 15Fh–5(c), before
initiation of a security-based swap, an
SBS Dealer must disclose to the special
entity in writing the capacity in which
the SBS Dealer is acting in connection
with the security-based swap, and, if the
SBS Dealer engages in business with the
counterparty in more than one capacity,
the SBS Dealer must disclose the
material differences between such
capacities and any other financial
transaction or service involving the
counterparty to the special entity.
Under Rule 15Fh–5(d), formerly Rule
15Fh–5(c), the provisions of Rule
15Fh–5 do not apply when two
conditions are satisfied: (1) The
transaction is executed on an registered
or exempt SEF or registered national
securities exchange; and (2) the SBS
Entity is unaware of the counterparty’s
identity, at a reasonably sufficient time
prior to the execution of the transaction
to permit the SBS Entity to comply with
the obligations of the rule.
9. Political Contributions
Rule 15Fh–6(b) prohibits an SBS
Dealer from offering to enter into, or
entering into a security-based swap, or
a trading strategy involving a securitybased swap, with a municipal entity
within two years after any contribution
by the SBS Dealer or its covered
associates to an official of such
municipal entity, subject to certain
exceptions. These prohibitions do not
apply to certain contributions made by
an SBS Dealer’s covered associate if the
SBS Dealer discovered the contribution
within 120 calendar days of the date of
such contribution, the contribution did
not exceed $350, and the covered
associate obtained a return of the
contribution within 60 calendar days of
the date of discovery of the contribution
by the SBS Dealer. However, a SBS
dealer may not rely on that provision
more than three times in any 12-month

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period if it has more than 50 covered
associated, and no more than twice if it
has 50 or fewer covered associates. The
Commission may also, upon
application, exempt a security-based
swap dealer from the prohibitions of the
rule after consideration of several
factors.
The provisions of Rule 15Fh–6 do not
apply when two conditions are satisfied:
(1) The transaction is executed on an
registered or exempt SEF or registered
national securities exchange; and (2) the
SBS Dealer is unaware of the
counterparty’s identity, at a reasonably
sufficient time prior to the execution of
the transaction to permit the SBS Dealer
to comply with the obligations of the
rule.
10. Chief Compliance Officer
Rule 15Fk–1 requires an SBS Entity to
designate an individual to serve as CCO
on its registration form. Under Rule
15Fk–1(b)(1) the CCO must report
directly to the board of directors or
senior officer of the SBS Entity. Under
Rule 15Fk–1(b)(2), the CCO must take
reasonable steps to ensure that the SBS
Entity establishes, maintains, and
reviews written policies and procedures
reasonably designed to achieve
compliance with the Exchange Act and
the rules and regulations thereunder
relating to its business as an SBS Entity
by: (1) Reviewing the SBS Entity’s
compliance with the SBS Entity
requirements described in Section 15F
of the Exchange Act and the rules and
regulations thereunder (where such
review shall involve preparing the SBS
Entity’s annual assessment of its written
policies and procedures reasonably
designed to achieve compliance with
Section 15F of the Exchange Act and the
rules and regulations thereunder); (2)
taking reasonable steps to ensure the
SBS Entity establishes, maintains, and
reviews policies and procedures
reasonably designed to remediate noncompliance issues identified by the CCO
through any means, including any
compliance office review, look-back,
internal or external audit finding, selfreporting to the Commission and other
appropriate authorities, or complaint
that can be validated; and (3) taking
reasonable steps to ensure that the SBS
Entity establishes and follows
procedures reasonably designed for the
handling, management response,
remediation, retesting, and resolution of
non-compliance issues. Under Rule
15Fk–1(b)(3), the CCO must take
reasonable steps to resolve any material
conflicts of interest that may arise, in
consultation with the board or the
senior officer of the SBS Entity. Under
Rule 15Fk–1(b)(4), the CCO must

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
administer each policy and procedure
that is required to be established
pursuant to Section 15F of the Exchange
Act and the rules and regulations
thereunder.
Under Rule 15Fk–1(c), the CCO must
also prepare and sign an annual
compliance report that must be
submitted to the Commission within 30
days following the deadline for filing
the SBS Entity’s annual financial report
with the Commission pursuant to
Section 15F of the Exchange Act and the
rules and regulations thereunder. This
annual compliance report must contain
a description of the written policies and
procedures of the SBS Entity described
in Rule 15Fk–1(b), outlined above,
including the code of ethics and conflict
of interest policies. The compliance
report must also include, at a minimum,
a description of: (1) The SBS Entity’s
assessment of the effectiveness of its
policies and procedures relating to its
business as an SBS Entity; (2) any
material changes to the policies and
procedures since the date of the
preceding compliance report; (3) any
areas for improvement and
recommended potential or prospective
changes or improvements to its
compliance program and resources
devoted to compliance; (4) any material
non-compliance matters identified; and
(5) the financial, managerial,
operational, and staffing resources set
aside for compliance with the Exchange
Act and the rules and regulations
thereunder relating to its business as an
SBS Entity, including any material
deficiencies in such resources. The
report must be submitted to the board of
directors and audit committee (or
equivalent bodies) and the senior officer
of the SBS Entity prior to submission to
the Commission. The report also must
be discussed in one or more meetings
(addressing the obligations of this rule)
that were conducted by the senior
officer with the CCO in the preceding 12
months, and must include a certification
by the CCO or senior officer that, to the
best of his or her knowledge and
reasonable belief and under penalty of
law, the information contained in the
compliance report is accurate and
complete in all material respects.
The final rule allows an SBS Entity to
incorporate by reference sections of a
compliance report that has been
submitted with the current or
immediately preceding reporting period
to the Commission, and allows an SBS
Entity to request from the Commission
an extension of time to submit its
compliance report, provided that the
SBS Entity’s failure to timely submit the
report could not be eliminated by the
SBS Entity without unreasonable effort

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or expense. Extensions of the deadline
will be granted at the discretion of the
Commission. The final rule also requires
an SBS Entity to promptly submit an
amended compliance report if material
errors or omissions in the report are
identified.
Under Rule 15k–1(d), the
compensation and removal of the CCO
shall require the approval of a majority
of the board of directors of the SBS
Entity.
11. Foreign Branch Exception
Rule 3a67–10(d), as adopted, provides
that registered major security-based
swap participants shall not be subject to
business conduct standards described in
section 15F(h) of the Act (15 U.S.C.
78o–10(h)), and the rules and
regulations thereunder, other than rules
and regulations prescribed by the
Commission pursuant to section
15F(h)(1)(B) of the Act, in certain
transactions conducted through the
foreign branch of their U.S.-person
counterparty. Rule 3a71–3(c), as
adopted, provides a similar exception
for registered security-based swap
dealers. The previously adopted
definition of ‘‘transaction conducted
through a foreign branch’’ permits a
person to rely on its U.S. bank
counterparty’s representation that the
transaction ‘‘was arranged, negotiated,
and executed on behalf of the foreign
branch solely by persons located outside
the United States, unless such person
knows or has reason to know that the
representation is not accurate.’’ 1502
12. Substituted Compliance Rule
Rule 3a71–6, as adopted, provides
that the Commission may, conditionally
or unconditionally, by order, make a
determination with respect to a foreign
financial regulatory system that
compliance with specified requirements
under such foreign financial regulatory
system by a registered non-U.S. SBS
Entity, or class thereof, may satisfy
certain business conduct requirements
by complying with the comparable
foreign requirements. The availability of
substituted compliance would be
predicated on a determination by the
Commission that the relevant foreign
requirements are comparable to the
requirements that otherwise would be
applicable, taking into account the
scope and objectives of the relevant
foreign requirements,1503 and the
1502 See

Exchange Act rule 3a71–3(a)(3)(ii).
the specific context of substituted
compliance for the business conduct requirements,
prior to making any comparability determination
the Commission intends to consider whether the
information that is required to be provided to
counterparties pursuant to the requirements of the
1503 In

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30087

effectiveness of supervision and
enforcement under the foreign
regulatory regime.1504 The availability
of substituted compliance further would
be predicated on there being a
supervisory and enforcement MOU or
other arrangement between the
Commission and the relevant foreign
authority addressing supervisory and
enforcement cooperation and other
matters arising under the substituted
compliance determination.1505
Requests for substituted compliance
may come from parties or groups of
parties that may rely on substituted
compliance, or from foreign financial
authorities supervising such parties or
their security-based swap activities.1506
Under the final rule, the Commission
would make any determinations with
regard to the applicable business
conduct requirements, rather than on a
firm-by-firm basis. Once the
Commission has made a substituted
compliance determination, other
similarly situated market participants
would be able to rely on that
determination to the extent applicable
and subject to any corresponding
conditions. Accordingly, the
Commission expects that requests for a
substituted compliance determination
would be made only where an entity
seeks to rely on particular requirements
of a foreign jurisdiction that has not
previously been the subject of a
substituted compliance request. The
Commission believes that this approach
would substantially reduce the burden
associated with requesting substituted
compliance determinations for an entity
that relies on a previously issued
determination, and, therefore,
complying with the Commission’s rules
and regulations more generally.
As provided by Exchange Act Rule 0–
13, which the Commission adopted in
2014, applications for substituted
compliance determinations in
connection with these requirements
must be accompanied by supporting
documentation necessary for the
Commission to make the determination,
including information regarding
applicable requirements established by
the foreign financial regulatory
foreign jurisdiction, the counterparty protections
under the requirements of the foreign jurisdiction,
the mandates for supervisory systems under the
requirements of the foreign jurisdiction, and the
CCO requirements under the foreign jurisdiction are
comparable with the applicable Exchange Act
provisions. See Exchange Act Rule 3a71–6(d).
1504 See Exchange Act Rule 3a71–6(a)(2)(i).
1505 See Exchange Act Rule 3a71–6(a)(2)(ii).
1506 See Exchange Act Rule 3a71–6(c)(1). Such
parties or groups of parties may make requests only
if each such party or its activities is directly
supervised by the foreign financial authority. See
Exchange Act Rule 3a71–6(c)(2).

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authority or authorities, as well as the
methods used by the foreign financial
regulatory authority or authorities to
monitor and enforce compliance with
such rules, and to cite to and discuss
applicable precedent.1507
B. Use of Information
1. Verification of Status
Rule 15Fh–3(a) requires an SBS Entity
to verify that a counterparty meets the
eligibility standards for ECP status
before offering to enter into or entering
into a security-based swap other than
with respect to a transaction executed
on a registered national securities
exchange. The SBS Entity will use this
information to comply with Section 6(l)
of the Exchange Act (15 U.S.C. 78(f)(l)),
which prohibits a person from entering
into a security-based swap with a
counterparty that is not an ECP other
than on a registered national securities
exchange. The rule also requires the
SBS Entity to verify, for non-anonymous
transactions, whether a counterparty is
a special entity before entering into a
security-based swap transaction with
that counterparty, unless the transaction
is executed on a registered or exempt
security-based swap execution facility
or registered national securities
exchange. The SBS Entity will use this
information to assess its need to comply
with the requirements applicable to
dealings with special entities under
Rules 15Fh–4(b) and 15Fh–5. In
addition, the Commission staff may
review this information in connection
with examinations and investigations.

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2. Disclosures by SBS Entities
The disclosures that SBS Entities
must provide to a counterparty (other
than an SBS Entity or a Swap Entity)
will help the counterparty understand
the material risks and characteristics of
a particular security-based swap, as well
as the material incentives or conflicts of
interest that the SBS Entity may have in
connection with the security-based
swap. As a result, these disclosures will
assist the counterparty in assessing the
transaction by providing them with a
1507 See Exchange Act Rule 0–13(e). Rule 0–13
also specifies other prerequisites for the filing of
substituted compliance applications (e.g.,
requirements regarding the use of English, the use
of electronic or paper requests, contact information,
and public notice and comment in connection with
complete applications).
In adopting Rule 0–13, the Commission also
noted that because Rule 0–13 was a procedural rule
that did not provide any substituted compliance
rights, ‘‘collections of information arising from
substituted compliance requests, including
associated control numbers, [would] be addressed
in connection with any applicable substantive
rulemakings that provide for substituted
compliance.’’ See SBS Entity Definitions Adopting
Release, 79 FR at 47366 n.778, supra note 1451.

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better understanding of the expected
performance of the security-based swap
under various market conditions. The
disclosures will also give counterparties
additional transparency and insight into
the pricing and collateral requirements
of security-based swaps.
Rule 15Fh–3(d) requires SBS Entities,
before entering into a security-based
swap with a counterparty (other than an
SBS Entity or Swap Entity), to
determine whether the security-based
swap is subject to the clearing
requirements of Section 3C(a) of the
Exchange Act and to disclose its
determination to counterparties, along
with certain information regarding the
clearing alternatives available to them.
In addition to assisting the SBS Entity
and its CCO in supervising and
assessing internal compliance with the
statute and rules, the Commission staff
may also review this information in
connection with examinations and
investigations.
3. Know Your Counterparty and
Recommendations
These collections of information will
help SBS Dealers comply with
applicable laws, regulations and rules,
as well as assist SBS Dealers in
effectively dealing with counterparties.
For example, these collections of
information may better enable SBS
Dealers to make appropriate
recommendations for counterparties,
and to gather from the counterparty any
information that the SBS Dealer needs
for credit and risk management
purposes. Furthermore, these
collections of information will assist
SBS Dealers in determining whether it
is reasonable to rely on various
representations from a counterparty,
and in evaluating the risks of trading
with that counterparty. The information
will also assist a CCO in determining
whether the SBS Entity has written
policies and procedures reasonably
designed to obtain and retain a record
of the essential facts concerning each
known counterparty, and to make
suitable recommendations to its
counterparties. The Commission staff
may also review this information in
connection with examinations and
investigations.
4. Fair and Balanced Communications
The collection of information
concerning the risks of a security-based
swap will assist an SBS Entity in
communicating with counterparties in a
fair and balanced manner by requiring,
among other things, that
communications provide a sound basis
for evaluating the facts with regard to a
particular security-based swap and, if a

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statement refers to potential
opportunities or advantages presented
by a particular security-based swap, that
statement must be balanced by an
equally detailed statement of
corresponding risks. It will also help the
CCO in ensuring that the SBS Entity is
communicating with counterparties in a
fair and balanced manner based on
principles of fair dealing and good faith
by establishing certain express
requirements with which these
communications must comply. Acting
on the basis of fair and balanced
information, the counterparty will also
be better equipped to make more
informed investment decisions. The
Commission staff may also review this
information in connection with
examinations and investigations.
5. Supervision
The requirement to establish and
maintain a reasonably designed system
to supervise, and to diligently supervise,
the business and the activities of
associated persons will assist an SBS
Entity in preventing violations of the
applicable securities laws, rules and
regulations related to the business of an
SBS Entity. The CCO may use this
information in discharging his or her
duties under Rule 15Fk–1 and in
determining whether remediation efforts
are required. The collection of
information will also be useful to
supervisors in understanding and
carrying out their supervisory
responsibilities. The Commission staff
may also review this information in
connection with examinations and
investigations.
6. SBS Dealers Acting as Advisors to
Special Entities
Certain information collected under
Rule 15Fh–4(b) will help SBS Dealers
that act as advisors to special entities to
make a reasonable determination that
they are acting in the best interests of
those special entities.
Other information collected under
Rule 15Fh–2(a) will help SBS Dealers
establish that they are not acting as
advisors to special entities.
These collections of information will
also assist CCOs in determining whether
an SBS Dealer has complied with
relevant provisions of the Exchange Act,
as well as the rules and regulations
thereunder. The Commission staff may
also review this information in
connection with examinations and
investigations.
7. SBS Entities Acting as Counterparties
to Special Entities
The information collected under Rule
15Fh–5(a) will assist an SBS Entity in

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forming a reasonable basis to believe
that a special entity has a qualified
independent representative that meets
the requirements of the rule.
The written representations required
under Rule 15Fh–5(b) will assist in, and
provide a safe harbor for, an SBS Entity
forming a reasonable basis as to the
qualifications of the independent
representative, including
representations that: (i) The special
entity has complied in good faith with
written policies and procedures
reasonably designed to ensure its
representative satisfies the requirements
of Rule 15Fh–5(a)(1), and that such
policies and procedures provide for
ongoing monitoring of the performance
of such representative consistent with
Rule 15Fh–5(a)(1); and that (ii) the
representative has policies and
procedures designed to ensure that it
satisfies the requirements of Rule 15Fh–
5(a)(1); meets the requirements of Rule
15Fh–5(a)(1)(i), (ii), (iii), (vi) and (vii);
and is legally obligated to comply with
the requirements of Rule 15Fh–5(a)(1)
by agreement, condition of employment,
law, rule, regulation, or other
enforceable duty.
Disclosures under Rule 15Fh–5(c)
regarding the capacity in which an SBS
Dealer is acting in connection with a
security-based swap will provide
additional transparency to special
entities as to any material differences
between the SBS Dealer’s capacities and
any other financial transaction or
service involving the counterparty to the
special entity, such as when an SBS
Dealer is acting as a counterparty or
principal on the other side of a
transaction with potentially adverse
interests.
These collections of information will
also assist a CCO in assessing the SBS
Entity’s compliance with relevant
provisions of the Exchange Act. The
Commission staff may also review this
information in connection with
examinations and investigations.
8. Political Contributions
Rule 15Fh–6 will deter SBS Dealers
from participating, even indirectly, in
pay to play practices. In addition to
assisting the SBS Dealer and its CCO in
supervising and assessing internal
compliance with the pay to play
prohibitions, the Commission staff may
also review this information in
connection with examinations and
investigations.
9. Chief Compliance Officer
The information collected under Rule
15Fk–1 will assist the CCO in
overseeing and administering an SBS
Entity’s compliance with the provisions

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of the Exchange Act and the rules and
regulations thereunder relating to its
business as an SBS Entity. The
Commission staff may also review this
information in connection with
examinations and investigations.
10. Foreign Branch Exception
Under the final rules, a registered
major security-based swap participant
or registered security-based swap dealer
is not subject to the requirements
relating to business conduct standards
described in section 15F(h) of the Act
(15 U.S.C. 78o–10(h)), and the rules and
regulations thereunder, other than the
rules and regulations prescribed by the
Commission pursuant to section
15F(h)(1)(B) of the Act, in certain
transactions conducted through the
foreign branch of their U.S.-person
counterparty. For these purposes, the
foreign branch of a U.S. bank must be
the counterparty to the security-based
swap transaction, and the transaction
must be arranged, negotiated, and
executed on behalf of the foreign branch
solely by persons located outside the
United States.1508
As discussed in the Cross-Border
Proposing Release, the Commission
acknowledges that verifying whether a
security-based swap transaction falls
within the definition of ‘‘transaction
conducted through a foreign branch’’
could require significant due diligence.
The definition’s representation
provision would mitigate the
operational difficulties and costs that
otherwise could arise in connection
with investigating the activities of a
counterparty to ensure compliance with
the corresponding rules.1509
11. Substituted Compliance Rule
The Commission would use the
information collected pursuant to
Exchange Act Rule 3a71–6, as adopted,
to evaluate requests for substituted
compliance with respect to the business
conduct requirements applicable to
security-based swap entities. The
requests for substituted compliance
determinations are required when a
person seeks a substituted compliance
determination.
Consistent with Exchange Act Rule 0–
13(h), the Commission will publish in
the Federal Register a notice that a
complete application has been
submitted, and provide the public the
opportunity to submit to the
Commission any information that
relates to the Commission action
requested in the application.
1508 See

Exchange Act rule 3a71–3(a)(3)(i).
Cross-Border Proposing Release, 78 FR at
31107, supra note 6.
1509 See

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C. Respondents
In the Proposing Release, the
Commission stated its belief that
approximately fifty entities may fit
within the definition of SBS Dealer and
that up to five entities may fit within the
definition of Major SBS Participant.1510
Further, the Commission understands
swap and security-based swap markets
to be integrated, and continues to
estimate that approximately thirty-five
firms that may register as SBS Entities
will also be registered with the CFTC as
Swap Entities.1511 As a result, these
entities will also be subject to the
business conduct standards applicable
to Swap Entities, which the CFTC
adopted in 2012. In addition, the
Commission continues to estimate that
approximately sixteen registered brokerdealers will also register as SBS
Dealers.1512 In the Proposing Release,
the Commission estimated that fewer
than eight firms not otherwise registered
with the CFTC or the Commission
would register as SBS Entities. Based on
an analysis of updated DTCC data, the
Commission now estimates that four
registrants would not otherwise be
registered with the CFTC or the
Commission.1513
In the Proposing Release, the
Commission estimated that there were
approximately 8,500 market
participants, including approximately
1,200 special entities in the securitybased swap markets.1514 Based on an
analysis of more recent DTCC data and
our understanding of security-based
swap markets, we currently believe that
there are approximately 10,900 market
participants in the security-based swap
market, of which 1,141 are special
entities.1515 Of the 10,900 market
participants, we estimate approximately
68% of them (7,412) are also swap
1510 Proposing Release, 76 FR at 42442, supra
note 3. See also Registration Adopting Release, 80
FR at 48990, supra note 965.
1511 Proposing Release, 76 FR at 42442, supra
note 3. See also Registration Adopting Release, 80
FR at 48990, supra note 989.
1512 Proposing Release, 76 FR at 42442, supra
note 3. See also Registration Adopting Release, 80
FR at 48990, supra note 1129.
1513 See Registration Adopting Release, 80 FR at
48990, supra note 1129.
1514 Proposing Release, 76 FR at 42442, supra
note 3.
1515 As discussed in the economic baseline,
estimates of the number and type of market
participants are based on hand classifications of
TIW data for 2006–2014. Our classifications are not
sufficiently granular to distinguish between ERISA
special entities, and special entities defined in, but
not subject to ERISA, and our estimates include
both. Therefore, our estimates reflect both ERISA
special entities, and entities that may choose to opt
out of the special entity status under these final
rules. See Sections VI.B and Section VI.C.4.i, infra.

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market participants.1516 Based upon the
number of registered municipal
advisors, we estimate that there are
approximately 385 third-party
independent representatives for special
entities.1517 In the Proposing Release,
we estimated that approximately 95% of
special entities would use a third-party
independent representative.1518 Based
on additional data from DTCC through
2014, the Commission currently
estimates that approximately 98% of
special entities would use a third-party
independent representative in their
security-based swap transactions.1519
For purposes of calculating reporting
burdens, in the Proposing Release, we
estimated that 60 special entities (the
remaining 5% of special entities), had
employees who could serve as an inhouse independent representative.1520
The Commission currently estimates
that the remaining 2% of special
entities, or 25 special entities, have
employees who currently negotiate on
behalf of and advise the special entity
regarding security-based swap
transactions, and who could likely
fulfill the qualifications and obligations
of the independent representative.1521
Consequently, the Commission
estimates a total of 410 potential
independent representatives.1522 We
received no comments on any of the
1516 This estimation assumes that the proportion
of single name CDS market participants that also
use index CDS is representative of the proportion
of security-based swap market participants that are
swap market participants in 2014. See Section
VI.B.6, infra.
1517 As of January 1, 2016 there were 665
municipal advisors registered with the Commission
(http://www.sec.gov/help/foia-docsmuniadvisorshtm.html), of which 381 indicated
that they expect to provide advice concerning the
use of municipal derivatives or advice or
recommendations concerning the selection of other
municipal advisors or underwriters with respect to
municipal financial products or the issuance of
municipal securities. We expect that many of these
municipal advisors will also act as independent
representatives for other special entities. The
Commission therefore estimates that approximately
385 municipal advisors will act as independent
representatives to special entities with respect to
security-based swaps.
1518 Proposing Release, 76 FR at 42442, supra
note 3.
1519 The estimate is based on available market
data for November 2006–December 2014 provided
by DTCC that indicates approximately 98% of
special entities used registered or unregistered
third-party investment advisers in connection with
security-based swaps transactions.
1520 Proposing Release, 76 FR at 42442, supra
note 3.
1521 The estimate is based on available market
data for November 2006–December 2014 provided
by DTCC.
1522 The estimate is based on the following
calculation: 385 third-party independent
representatives + 25 in-house independent
representatives.

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foregoing estimates or our basis for the
estimates.
In the Cross-Border Proposing
Release, the Commission preliminarily
estimated that 50 entities may include a
representation that a security-based
swap is a ‘‘transaction conducted
through a foreign branch’’ in their
trading relationship documentation.1523
We estimate that, consistent with the
proposal, a total of 50 entities may incur
burdens under this collection of
information, whether solely in
connection with the business conduct
requirements being adopted in this
release or also in connection with the
application of the de minimis
exception.1524
Under the final rule related to
substituted compliance, applications for
substituted compliance may be filed by
foreign financial authorities, or by nonU.S. SBS Entities. Based on the analysis
of recent data, the Commission staff
expects that there may be approximately
22 non-U.S. entities that potentially may
register as SBS Dealers, out of
approximately 50 total entities that may
register as SBS Dealers.1525 Potentially,
all such non-U.S. SBS Dealers, or some
subset thereof, may seek to rely on
substituted compliance in connection
with these business conduct
requirements.1526
In practice, the Commission expects
that the greater portion of any such
substituted compliance requests will be
submitted by foreign financial
authorities, given their expertise in
connection with the relevant
substantive requirements, and in
connection with their supervisory and
enforcement oversight with regard to
security-based swap dealers and their
activities.
D. Total Annual Reporting and
Recordkeeping Burdens
As discussed in Section I.C., above,
aspects of Rules 15Fh–1 to 15Fh–6
conform, to the extent practicable, to the
business conduct standards applicable
to Swap Dealers or Major Swap
Participants promulgated by the
CFTC.1527 Therefore, to the extent an
1523 See Cross-Border Proposing Release, 78 FR at
31108, supra note 6.
1524 See id. See also Cross-Border Adopting
Release, 79 FR at 47366, supra note 193.
1525 See U.S. Activity Adopting Release, 81 FR at
8605, supra note 17.
1526 Consistent with prior estimates, the
Commission staff further believes that there may be
zero to five major security-based swap participants.
See Cross-Border Proposing Release, 78 FR at
31103, supra note 6. It is possible that some subset
of those entities will be non-U.S. major securitybased swap participants that will seek to rely on
substituted compliance in connection with the
business conduct requirements.
1527 See CFTC Adopting Release, supra note 21.

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SBS Entity already complies with the
CFTC’s business conduct standards, the
Commission believes there will be
minimal additional burden in
complying with the requirements under
the Commission’s business conduct
standards, as adopted.1528
Furthermore, a number of these rules
are based on existing FINRA rules.
Accordingly, the Commission expects
that the estimated 16 SBS Entities that
are also registered as broker-dealers are
already complying with a number of
these requirements in the context of
their equities businesses.
1. Verification of Status
As discussed above, the Commission
estimates that approximately 55 SBS
Entities (of which we expect
approximately 35 will be dually
registered with the CFTC as Swap
Entities) will be required to verify
whether a counterparty is an ECP or
special entity, as required by Rule
15Fh–3(a). These verification
requirements are the same under the
business conduct standards adopted by
the CFTC.1529 We understand that
industry has developed protocols and
questionnaires that allow the
counterparty to indicate its status,
whether or not it is a special entity and
whether it elects to be treated as a
special entity.1530 As a result of these
protocols and questionnaires, the
Commission continues to believe that
these dually registered SBS Entities will
not incur any start-up or ongoing
burdens in complying with the rules, as
adopted, because they already adhere to
the relevant protocols to obtain the
information under the CFTC’s business
conduct standards. The remaining 20
SBS Entities will each incur $500 in
start-up burdens to adhere to the
protocols. In addition, each
1528 Notably, the CFTC adopted its final rules in
2012. Current estimates reflect the fact that the
CFTC rules have been in place since that time, and
that registrants will not incur a de novo burden in
complying with the Commission’s rules, which
largely conform to those of the CFTC. In addition,
as noted in the Proposing Release, some banks will
register as SBS Dealers. Banking agencies, such as
the Office of the Comptroller of the Currency, have
issued guidance to national banks that engage in
financial derivatives transactions regarding
business conduct procedures, and, accordingly, the
banks that may register as SBS Entities are also
likely already complying with similar requirements.
See e.g., Risk Management of Financial Derivatives,
Office of Comptroller of the Currency Banking
Circular No. 277 (Oct. 27, 1993).
1529 See CFTC Adopting Release, 75 FR at 80658,
supra note 21. Accordingly, the SBS Entities that
would also be registered as a Swap Dealer or Major
Swap Participant with the CFTC would have
verification procedures for engaging in swaps.
1530 See ISDA August 2012 DF Protocol at http://
www2.isda.org/functional-areas/protocolmanagement/protocol/8 (‘‘ISDA August 2012 DF
Protocol’’).

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counterparty that does not already
adhere to the protocols will incur $500
in start-up burdens to adhere to the
protocols. In addition to the $500 fee to
adhere to the protocol, in order to
adhere to the protocol, an adherence
letter must also be submitted, the form
of which is provided online.
Accordingly, we conservatively estimate
that one hour will be needed to input
the data required to generate the
adherence letter.1531 We do not
anticipate any ongoing burdens with
respect to this rule. We anticipate that
the parties will adhere to the protocol.
We also anticipate that in connection
with each transaction, SBS Entities will
require counterparties to provide a
certificate indicating that there are no
changes to the representations included
in the protocol and that reliance on
those representations would be
reasonable.
As noted above, the Commission
believes that approximately 7,412 of the
10,900 security-based swap market
participants (which include SBS
Entities and counterparties) are also
swap market participants and likely
already adhere to the relevant
protocol.1532 These 7,412 market
participants would not have any startup burdens or ongoing burdens with
respect to verification. The remaining
3,488 market participants would incur
$500 each to adhere to the protocol for
an aggregate total of $1,744,000 and one
hour for the adherence letter for an
aggregate total of 3,488 hours.1533
2. Disclosures by SBS Entities

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Pursuant to Rule 15Fh–3(b), (c), and
(d), SBS Entities would be required to
provide certain disclosures to market
participants. Based on the Commission’s
experience with burden estimates for
1531 In lieu of adhering to the protocol, market
participants may engage in bilateral negotiations
either to obtain representations regarding the status
of the counterparty or the SBS Entity may conduct
due diligence to determine the status of the
counterparty. However, given the relatively low
cost and time burden to adhere to the protocol, we
estimate that market participants will choose to
adhere to the protocol rather than pay counsel to
negotiate representations or conduct the necessary
due diligence in the absence of any indications that
reliance on such representations would not be
reasonable. For the purposes of this estimate, we
have assumed that reliance on the representations
in the protocol would be reasonable.
1532 See supra Section V.C. regarding the estimate
for the number of market participants.
1533 Although we understand that ISDA offers
bulk pricing for multiple entities that are part of the
same corporate group or for fund families, we do
not have the data as to how many of the 3,488
market participants are related entities that would
be able to take advantage of this bulk pricing. As
a result, we have conservatively estimated that each
of the 3,488 market participants would incur the
$500 fee and the hour for the adherence letter.

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similar disclosure requirements,1534 as
well as our discussions with market
participants,1535 we understand that the
SBS Entities that are dually registered
with the CFTC already provide their
counterparties with disclosures similar
to those required under Rules 15Fh–3(b)
and (c). To the extent that the material
characteristics required by Rule 15Fh–
3(b)(1) are included in the
documentation of a security-based
swap, such as the master agreement,
credit support annex, trade confirmation
or other documents, the Commission
does not believe that any additional
burden will be required for the
disclosure of material characteristics.
For other required disclosures relating
to material risks required by Rule 15Fh–
3(b)(1) or disclosures relating to material
incentives or conflicts of interest
required by Rule 15Fh–3(b)(2), the
Commission understands that certain
market participants have developed
standardized disclosures for some of
these requirements.1536 For example,
many SBS Dealers already provide a
statement of potential risks related to
investing in certain security-based
swaps to their counterparties. However,
to the extent that an SBS Entity and
counterparty engage in a highly bespoke
transaction, the standardized disclosure
may not satisfy all of the SBS Entities
disclosure requirements. In those cases,
the SBS Entity will likely use a
combination of standardized disclosures
and de novo disclosures to fulfill its
obligations under Rules 15Fh–3(b)(1)
and (2).
In some cases, such as disclosures
about the daily mark for a cleared
security-based swap, the SBS Entity is
obligated to provide the daily mark
upon request. We understand that in the
current model of clearing security-based
swaps, the security-based swap between
1534 For disclosures similar to the disclosure of
methodologies and assumptions of daily mark, see
Disclosure of Accounting Policies for Derivative
Financial Instruments and Derivative Commodity
Instruments and Disclosure of Quantitative and
Qualitative Information about Market Risk Inherent
in Derivative Financial Instruments, Other
Financial Instruments and Derivative Commodity
Instruments, Securities Act Release No. 7386 (Jan.
31, 1997), 62 FR 6044 (Feb. 10, 1997).
1535 See Proposing Release n. 14, 76 FR at 42398,
supra note 3. See also, supra note 19 regarding a
list of Commission staff meetings with interested
parties.
1536 See e.g., ISDA General Disclosure Statement
for Transactions (August 2015). To the extent that
disclosures of material risks and characteristics
under Rule 15Fh–3(b)(1) or disclosures of material
incentives and conflicts of interest under Rule
15Fh–3(b)(2) are initially provided orally, the
additional burden of providing a written version of
the disclosure at or before delivery of the trade
confirmation pursuant to Rule 15Fh–3(b)(3) will be
considered in connection with the overall reporting
and recordkeeping burdens of the SBS Entity. See
Recordkeeping Release, supra note 242.

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the SBS Entity and counterparty is
terminated upon novation by the
clearing agency. The SBS Entity would
no longer have any obligation to provide
a daily mark to the original counterparty
because a security-based swap no longer
exists between them. Therefore, there
would not be any ongoing burden on the
SBS Entity. Depending on how quickly
the security-based swap is cleared, there
may not be an initial burden on the SBS
Entity either. Unlike the CFTC’s rule,
Rule 15Fh–3(c)(1) does not require a
pre-trade daily mark. So if the securitybased swap is cleared before the end of
the next day and the clearing results in
novation of the original swap, the SBS
Entity would not have any daily mark
obligations for the cleared swap.
For uncleared security-based swaps,
the Commission believes that SBS
Entities may need to slightly modify the
models used for calculating variation
margin to calculate the daily mark. In
addition, the SBS Entity will need to
provide the counterparty with a
description of the methodologies and
assumptions used to calculate the daily
mark.
Nevertheless, existing accounting
standards and other disclosure
requirements under the Exchange Act,
such as FASB Accounting Standards
Codification Topic 820, Fair Value
Measurements and Disclosures, or Item
305 of Regulation S–K, require
disclosures similar to the description of
the methodologies and assumptions of
the daily mark. To the extent that the
model it uses and methodologies and
assumptions are not already prepared,
the SBS Entity may need to prepare the
initial description of the data sources,
methodologies and assumptions. In
addition, the SBS Entity will have an
ongoing burden of updating the
disclosure for any material changes to
the data sources, methodologies and
assumptions.
The Commission continues to believe
that SBS Entities will use internal staff
to revise existing disclosures to comply
with Rules 15Fh–3(b) and (c), and to
assist in preparing language to comply
with Rule 15Fh–3(d) regarding the
clearing options available for a
particular security-based swap. In
addition, the requirements of Rule
15Fh–3(d) are not the same as the CFTC
requirements to disclose clearing
choices, so SBS Entities will need to
develop new disclosures.
The Commission estimates that in
2014 there has been approximately
740,700 security-based swap
transactions between an SBS Dealer and
a counterparty that is not an SBS Dealer.
Of these, the Commission estimates that
approximately 428,000 were new or

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amended trades requiring these
disclosures.1537 In view of the factors
discussed in the Economic Analysis
section and elsewhere in this release,
the Commission recognizes that the time
required to develop an infrastructure to
provide these disclosures will vary
significantly depending on, among other
factors, the complexity and nature of the
SBS Entity’s security-based swap
business, its market risk management
activities, its existing disclosure
practices, whether the security-based
swap is cleared or uncleared and other
applicable regulatory requirements.
Under the rule, as adopted, SBS Entities
could make the required disclosures to
their counterparties through
standardized documentation, such as a
master agreement or other written
agreement, if the parties so agree. The
Commission recognizes that it will
likely be necessary to prepare some
disclosures that are particular to a
transaction to meet all of an SBS
Entity’s disclosure obligations under
Rules 15Fh–3(b), (c) and (d). The
Commission also believes that, because
the reporting burden will generally
require refining or revising an SBS
Entity’s existing disclosure processes,
the disclosures will be prepared
internally.
Given the foregoing, the Commission
continues to conservatively estimate
that on average, SBS Entities will
initially require three persons from
trading and structuring, three persons
from legal, two persons from operations,
and four persons from compliance, for
100 hours each, to comply with the
rules.1538 This team will analyze the
changes necessary to comply with the
new disclosure requirements, including
the redesign of current compliance
systems, if necessary, as well as the
creation of functional requirements and
system specifications for any systems
development work that may be needed
to automate the disclosure process.1539
1537 Available DTCC–TIW data for 2014 indicated
approximately 740,700 transactions between SBS
Entities and non-SBS Entities during that time
period. Of these, approximately 240,000 were new
trades, and 188,000 were amendments. Of the
approximately 240,000 new trades between likely
SBS Dealers and non-dealers, only 1,000 trades or
approximately 0.5% were voluntarily cleared
bilateral trades in 2014.
1538 In the Proposing Release, the Commission
used this estimate and it recognizes the
development of market practice to comply with
very similar CFTC rules. It also recognizes that
given the current model used for clearing securitybased swaps, daily mark disclosures in that context
are unlikely to be required. Furthermore, no
comments were received on these estimates. As a
result, the Commission conservatively continues to
use these estimates.
1539 Some SBS Entities may choose to utilize inhouse counsel to review, revise and prepare these
disclosures.

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This will amount to an aggregate initial
burden of 66,000 hours.1540
Following the initial analysis and
development of specifications, the
Commission continues to estimate that
half of these persons will still be
required to spend 20 hours annually to
re-evaluate and modify the disclosures
and system requirements as necessary,
amounting to an ongoing annual burden
of 6,600 hours.1541 In addition, the
Commission estimates that on average,
the SBS Entities will require one burden
hour per security-based swap to
evaluate whether more particularized
disclosures are necessary for the
transaction and to develop the
additional disclosures for an aggregate
ongoing burden of 428,000 hours.1542
The Commission also continues to
estimate that, to create and maintain an
information technology infrastructure to
the specifications identified by the team
of persons from trading and structuring,
legal, operations and compliance
described above, each SBS Entity will
require, on average, eight full-time
persons for six months of systems
development, programming and testing,
amounting to a total initial burden of
440,000 hours.1543 The Commission
continues to estimate that maintenance
of this system will require two full-time
persons for a total ongoing burden of
220,000 hours annually.1544
3. Know Your Counterparty and
Recommendations
As noted in the Proposing Release, the
estimates in this paragraph reflect the
Commission’s experience with and
burden estimates for similar collections
of information, as well as our
discussions with market
participants.1545 The Commission
continues to believe that most SBS
1540 The estimate is based on the following
calculation: (55 SBS Entities) × (12 persons) × (100
hours).
1541 The estimate is based on the following
calculation: (55 SBS Entities) × (6 persons) × (20
hours).
1542 The estimate is based on the following
calculation: (428,000 security-based swaps that
require these disclosures) × (1 hour). The
Commission realizes that some assessments may
take less time and some may take more. In addition,
to the extent that additional disclosures are
required, drafting the disclosure is likely to take
more than an hour, but we expect the vast majority
of transactions will not require additional
disclosures so that an average of one hour per
transaction is a reasonable estimate.
1543 The estimate is based on the following
calculation: (55 SBS Entities) × (4 persons) × (2000
hours).
1544 The estimate is based on the following
calculation: (55 SBS Entities) × (2 persons) × (2000
hours).
1545 See Proposing Release n. 14, 76 FR at 42398,
supra note 3. See also supra note 19 regarding a list
of Commission staff meetings with interested
parties.

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Dealers already have policies and
procedures in place for knowing their
counterparties, to comply with existing
CFTC and FINRA standards. The
Commission estimates that, on average,
the rules will require each SBS Dealer
to initially spend approximately five
hours to review existing policies and
procedures and to document the
collection of information necessary to
comply with its ‘‘know your
counterparty’’ obligations—for a total
initial burden of 250 hours. The
Commission also continues to estimate
that an SBS Dealer will spend an
average of approximately 30 additional
minutes each year per unique non-SBS
Dealer counterparty to assess whether
the SBS Dealer is in compliance with
the rules’ know your counterparty
requirements—a total ongoing burden of
approximately 11,500 hours
annually,1546 or an average of 230 hours
annually per SBS Dealer.1547
In addition, the Commission estimates
that the counterparties will require
approximately ten hours for each
counterparty or its agent to collect and
provide essential facts to the SBS Dealer
for a total initial burden of 109,000
hours.1548
The Commission expects that, given
the institutional nature of the
participants involved in security-based
swaps, most SBS Dealers will obtain the
representations in Rules 15Fh–3(f)(2)
and (3) to comply with Rule 15Fh–
3(f).1549 For the 1,141 special entities,
we expect SBS Entities will not act as
an advisor pursuant to Rule 15Fh–2(a)
and accordingly, the burden estimates
for the SBS Entities and special entities
are included in the context of the
discussion for that rule, infra. For the
7,412 security-based swap market
participants that are also swap market
participants, including the thirty-five
firms that we expect to be dually
registered as Swap Dealers and SBS
Dealers, most of the requisite
1546 The estimate is based on the following
calculation: (23,000 unique SBS Dealer—non-dealer
counterparty pairs) × 30 minutes / 60 minutes. In
the Proposing Release, the Commission estimated
47,000 unique SBS Dealer—non-dealer
counterparty pairs. Based on updated DTCC–TIW
data, we now estimate 23,000 SBS Dealer—nondealer counterparty pairs.
1547 To the extent that the SBS Dealer is
unfamiliar with the counterparty, the Commission
would expect a greater time burden and as an SBS
Dealer becomes more familiar with the particular
counterparty, the Commission would expect a
lesser time burden. As a result, we use 30 minutes
as an average estimate.
1548 The estimate is based on 10,900 market
participants × 10 hours.
1549 The Commission bases its expectation on its
observation and experience in the context of
transactions by broker-dealers with institutional
clients and the use of FINRA’s institutional
suitability exception in that context.

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representations have been drafted for
the swaps context.1550 We understand
that swap market participants are
currently utilizing standardized
representations that are currently in
Schedule 3 of the ISDA August 2012 DF
Protocol. The $50 million institutional
suitability threshold is consistent with
the institutional suitability exception in
FINRA standards, but may require SBS
Dealers to obtain an additional
representation or conduct due diligence
to determine the counterparty has total
assets of at least $50 million. To the
extent that any modifications are
necessary to adapt those representations
to the security-based swap context, we
conservatively estimate that market
participants will each require two hours
to assess the necessity and make any
necessary modifications for the securitybased swap context for an aggregate
initial burden of 12,542 hours for the
market participants that participate in
both the security-based swaps market
and the swaps market.1551 We do not
anticipate any ongoing burden with
respect to the requisite representations
because the representations in the
swaps context are deemed repeated ‘‘as
of the occurrence of each Swap
Communication Event’’ and we would
anticipate a similar construction in the
security-based swap context. For the
remaining 3,488 market participants, we
expect that they will draft the requisite
representations to comply with the
institutional suitability analysis in Rule
15Fh–3(f)(2). We also anticipate that
these 3,488 market participants are
likely to model their representations on
the representations included in the
ISDA August 2012 DF Protocol because
the SBS Entity is already familiar with
those particular representations.
Accordingly, we estimate that the
remaining 3,488 market participants
will each require five hours to review
and agree to representations similar to
those included in such protocol for an
aggregate initial burden of 17,440
hours.1552 Again, we do not anticipate

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1550 Of

the 7,412 market participants that engage
in both swaps and security-based swaps, a
proportion of them will also be special entities.
This calculation assumes all of the special entities
are engaged in transactions in both markets, leaving
6,271 market participants (7,412 market
participants ¥1,141 special entities) to adapt the
representations in the ISDA August 2012 DF
Protocol to the security-based swap context, as
necessary.
1551 This calculation is based on the assumption
that all of the special entities are engaged in both
the swaps market and the security-based swaps
market and that the special entities will choose to
comply with the safe harbor of Rule 15Fh–5(b).
(7,412 market participants ¥1,141 special entities)
× (2 hours).
1552 This estimate is based on the following
calculation: (3,488 market participants) × (5 hours).

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an ongoing burden for these
representations for the reasons set forth
above.
4. Fair and Balanced Communications
Rule 15Fh–3(g) requires SBS Entities
to communicate with counterparties ‘‘in
a fair and balanced manner, based on
principles of fair dealing and good
faith.’’ The three specific standards of
Rule 15Fh–3(g) require that: (1)
Communications must provide a sound
basis for evaluating the facts with
respect to any security-based swap or
trading strategy involving a securitybased swap; (2) communications may
not imply that past performance will
recur, or make any exaggerated or
unwarranted claim, opinion, or forecast;
and (3) any statement referring to the
potential opportunities or advantages
presented by a security-based swap or
trading strategy involving a securitybased swap shall be balanced by an
equally detailed statement of the
corresponding risks.1553 We expect that
a discussion of material risks of the
transaction will be included in the
documentation for the security-based
swap. The Commission believes that all
55 SBS Entities will be required to
comply with Rule 15Fh–3(g), and that
they will likely send their existing
marketing materials to outside counsel
for review and comment. Accordingly,
the Commission continues to believe
that each SBS Entity will likely incur
$6,000 in legal costs, or $330,000 in the
aggregate initial burden, to draft or
review statements of potential
opportunities and corresponding risks
in the marketing materials for single
name and narrow based index credit
default swaps, total return swaps and
other security-based swaps.1554
The Commission additionally believes
that compliance with Rule 15Fh-3(g)
would require a review of SBS Entities’
1553 To the extent that the 16 registered brokerdealers that are expected to register as SBS Entities
are also FINRA members, they are already subject
to these similar FINRA requirements in the nonsecurity based swap context. Cf. FINRA Rule
2210(d)(1)(D) (‘‘Members must ensure that
statements are clear and not misleading within the
context in which they are made, and that they
provide balanced treatment of risks and potential
benefits. Communications must be consistent with
the risks of fluctuating prices and the uncertainty
of dividends, rates of return and yield inherent to
investments.’’) The Commission believes that this
requirement addresses concerns raised by a
commenter that to be fair and balanced,
communications must inform investors of both the
potential rewards and risks of their investments.
See Levin, supra note 5.
1554 The Commission estimates that the review of
marketing materials for these three categories of
security-based swaps would require 5 hours of
outside counsel time, at an average cost of $400 per
hour. This estimate also assumes that each SBS
Entity engages in all three categories of securitybased swaps.

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other communications to their
counterparties, such as emails and
Bloomberg messages. However, we
believe that such additional
communications would likely be
reviewed internally, by in-house legal
counsel or an SBS Entity’s CCO. We
estimate that the initial internal burden
hours associated with this review would
be approximately six hours, for an
aggregate total of 330 hours.1555
For more bespoke transactions, the
cost for outside counsel to review the
marketing materials will depend on the
complexity, novelty and nature of the
product, but the Commission expects a
higher cost associated with the review
for more novel products. The
Commission accordingly estimates an
initial, aggregate compliance cost for the
marketing materials relating to bespoke
single name and narrow based index
credit default swaps, total return swaps
and other security-based swaps at
$462,000.1556
As stated above in Section II.G.5, Rule
15Fh–3(g) applies to communications
made before the parties enter into a
security-based swap, and continues to
apply over the term of a security-based
swap. The Commission believes that the
ongoing compliance costs associated
with the rule will likely be limited to a
review of SBS Entities’ email
communications sent to counterparties,
which we believe will likely be done by
in-house counsel. We estimate that the
ongoing compliance costs of the rule
will be approximately two burden
hours, for an aggregate total of 330
hours.1557
5. Supervision
As outlined above, Rule 15Fh–3(h)
requires an SBS Entity to establish and
maintain a system to supervise, and to
diligently supervise, its business and
the activities of its associated persons.
Such a system shall be reasonably
designed to prevent violations of the
provisions of applicable federal
1555 The Commission estimates that the review of
additional communications for these three
categories of security-based swaps would require
internal burden hours for each of the 55 SBS
Entities. This estimate also assumes that each SBS
Entity engages in all three categories of securitybased swaps.
1556 The Commission estimates the review of the
marketing materials for each of these categories
would require seven hours of outside counsel time
at a cost of $400 per hour. This estimate also
assumes that each SBS Entity engages in all three
categories of transactions.
1557 The Commission estimates that the review of
additional communications for these three
categories of security-based swaps would require
two internal burden hours for each of the 55 SBS
Entities. This estimate also assumes that each SBS
Entity engages in all three categories of securitybased swaps.

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securities laws and the rules and
regulations thereunder relating to its
business as an SBS Entity. The written
policies and procedures required by
Rule 15Fh–3(h) must include, at a
minimum, procedures for nine specific
areas of supervision.
As for the number of SBS Entities
respondents, the Commission continues
to estimate that approximately 55 SBS
Entities (of which we expect
approximately 35 will be dually
registered with the CFTC as Swap
Entities) will be required to comply
with analogous supervision rules like
those required by Rule 15Fh–3(h).1558
The supervision requirements in Rule
15Fh–3(h) are largely the same under
the business conduct standards and
related rules adopted by the CFTC.1559
The estimates in this paragraph reflect
the foregoing information, as well as the
Commission’s general experience with
and understanding of the burden
estimates in similar contexts, including,
but not limited to, FINRA’s analogous
supervision rules. While each of the
nine written policies and procedures
required, at a minimum, by Rule 15Fh–
3(h) will vary in cost, the Commission
continues to estimate that such policies
and procedures will require, on average,
210 hours per respondent, per policy
and procedure to initially prepare
written policies and procedures in order
to establish a system to diligently
supervise those policies and procedures,
or an average of 1,890 burden hours per
SBS Entity—resulting in an initial
aggregate burden of 103,950 hours.1560
The Commission also continues to
expect that many SBS Entities will
primarily rely on outside counsel for the
collection of information required under
this rule at a rate of $400 per hour, for
an average of 450 hours per respondent,
with a minimum of nine policies and
procedures, resulting in an outside
initial cost burden of $180,000 per
respondent—or an aggregate initial cost
1558 Proposing Release, 76 FR at 42442, supra
note 3. See also Registration Adopting Release, 80
FR at 48990, supra note 1129.
1559 See Commodity Exchange Act Rule 23.602.
See also Commodity Exchange Act Rule 23.402(a)
(policies and procedures to ensure compliance);
Commodity Exchange Act Rule 3.3(d)(1)
(administration of compliance policies and
procedures). Accordingly, the SBS Entities that
would also be registered as a swap dealer or major
swap participant with the CFTC would have
supervision policies and procedures for engaging in
swaps.
1560 See Proposing Release, 76 FR at 42446, supra
note 3. The estimate is based on the following
calculation: (210 hours) × (9 policies and
procedures) × (55 SBS Entities). The estimates
reflected do not include the burden and cost of
actually complying with the underlying substance
of these written policies and procedures as that is
beyond the scope of the PRA analysis.

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of $9,900,000.1561 Once these policies
and procedures are established, the
Commission continues to estimate that,
on average, each SBS Entity will spend
approximately 540 hours
(approximately 60 hours per policy and
procedure) each year to maintain these
policies and procedures, yielding a total
ongoing annual burden of
approximately 29,700 internal burden
hours (55 SBS Entities × 540 hours).1562
The Commission believes that the
maintenance of these policies and
procedures will be conducted
internally.
6. SBS Dealers Acting as Advisors to
Special Entities
As discussed above, Rule 15Fh–4
imposes on SBS Dealers that act as
advisors to special entities a duty to
make a reasonable determination that
any security-based swap or related
trading strategy that the SBS Dealer
recommends is in the ‘‘best interests’’ of
the special entity. Rule 15Fh–2(a) states
that an SBS Dealer ‘‘acts as an advisor’’
to a special entity when it recommends
a security-based swap or related trading
strategy to the special entity. However,
the rule provides a safe harbor whereby
an SBS Entity will not be deemed an
‘‘advisor’’ if an ERISA special entity
counterparty relies on advice from an
ERISA fiduciary, or where any special
entity counterparty relies on advice
from a qualified independent
representative that acts in its best
interests.1563
In the Proposing Release, the
Commission recognized the inherent
tensions that arise where SBS Dealers
recommend a security-based swap or
related transaction to special entity
counterparties.1564 Given the parties’
incentive to transact in security-based
swaps, the Commission believes that the
parties are likely to resolve these
tensions by providing the necessary
representations and disclosures to meet
the requirements of the safe harbor
under Rule 15Fh–2(a)(1)–(2), such that
an SBS Dealer will not be deemed to act
as an advisor to a special entity,
particularly for transactions in which
the SBS Dealer is the counterparty to the
transaction.
1561 Some SBS Entities may choose to utilize inhouse counsel to initially prepare these policy and
procedure, which would mitigate the aggregate
initial cost, but the Commission’s estimate of
$9,900,000 reflects a conservative assumption of
SBS Entities primarily relying on outside counsel
to prepare these materials.
1562 See Proposing Release, 76 FR at 42446, supra
note 3.
1563 Rule 15Fh–2(a)(1)–(2).
1564 See Proposing Release, 76 FR at 42424, supra
note 3.

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Among swap dealers operating under
the CFTC’s parallel safe harbor,1565
parties have generally included
representations in standard swap
documentation that both counterparties
are acting as principals, and that the
counterparty is not relying on any
communication from the swap dealer as
investment advice. We believe that SBS
Dealers and their special entity
counterparties will similarly include the
requisite representations in standard
security-based swap documentation.
These representations will need to be
reviewed and revised to ensure that they
comply with the rules the Commission
adopts today.
As stated in the Proposing Release,
the Commission continues to believe
that the 50 SBS Dealers will primarily
rely on in-house counsel for compliance
with this rule, each of which will need
approximately five internal burden
hours to draft, review and revise the
representations in its standard securitybased swap documentation to comply
with Rule 15Fh–2(a)(1)–(2), for an initial
aggregate burden of 250 hours.1566 The
Commission also believes that, once an
SBS Dealer revises the language of the
representations to meet the
requirements of Rule 15Fh–2(a)(1)–(2),
such language will become part of the
SBS Dealer’s standard security-based
swap documentation and, accordingly,
there will be no further ongoing burden
associated with this rule. For
transactions in which an SBS Dealer is
not a counterparty and chooses to act as
an advisor, the Commission estimates
that an SBS Entity will require
approximately 20 internal burden hours
to collect the requisite information from
each special entity, for an aggregate
initial burden of approximately 1,700
hours.1567
7. SBS Entities Acting as Counterparties
to Special Entities
Where a special entity is a
counterparty to a security-based swap,
Rule 15Fh–5(a)(1) requires an SBS
Entity to have a reasonable basis for
believing that the special entity has a
qualified independent representative
1565 See

CFTC Regulation § 23.440(b)(1)–(2).
Proposing Release, 76 FR at 42446, supra
note 3. This estimate is based on multiplying the
number of SBS Dealers (50) by the number of
estimated internal burden hours (5).
1567 This estimate is based on available market
data for November 2006–September 2014 provided
by DTCC that indicates 85 unique pairs of SBS
Dealers and U.S. special entities without a thirdparty investment adviser. Based on 2014 single
name CDS data in DTCC–TIW, there were 2 unique
trading relationships between likely SBS Dealers
and special entities without a third party
investment adviser, which entered into 272 new
trades and 200 terminations, representing 0.039%
of all transactions in 2014.
1566 See

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that meets specified requirements.
Where the special entity counterparty is
an ERISA plan, under Rule 15Fh–
5(a)(2), the SBS Entity must have a
reasonable basis to believe that the
ERISA plan is represented by an ERISA
fiduciary. The Commission believes that
written representations will likely
provide the basis for establishing an
SBS Entity’s reasonable belief regarding
the qualifications of the independent
representative.
As stated in the Proposing Release,
the Commission continues to believe
that the burden for determining whether
an independent representative is
independent of the SBS Entity will
depend on the size of the independent
representative, the size of the SBS
Entity, and the volume of transactions
with which each is engaged. The
Commission further believes that each
SBS Entity would initially require
written representations regarding the
qualifications of a special entity’s
independent representative, but would
only require updates to the independent
representative’s qualifications in
subsequent dealings with the same
independent representative throughout
the duration of the swap term, provided
the volume and nature of the securitybased swap transaction remain the
same.
Regarding the initial burden estimates
for SBS Entities, the Commission’s
updated estimates reflect that each SBS
Entity will interact with and be required
to form a reasonable basis regarding the
qualifications of approximately 385
independent, third-party representatives
and 25 in-house independent
representatives, for a total of 410
independent representatives. In the
Proposing Release, the Commission
estimated an average internal burden of
15 hours for each SBS Entity per
independent representative. We have
increased this estimate based on
changes to the representations that SBS
Entities will have to obtain and now
estimate that each SBS Entity, on
average, will initially require
approximately 15.5 internal burden
hours from the SBS Entity’s own inhouse counsel per independent
representative to collect the information
necessary to comply with this
requirement. This will result in an
aggregate initial burden of 349,525
internal hours (15.5 hours × 410
independent representatives × 55 SBS
Entities).1568 We do not believe there
1568 While the Commission does not believe that
every SBS Entity is likely to deal with every
independent representative, we do not have data on
the average number of independent representatives
with whom each SBS Entity would deal.
Accordingly, for the purposes of these calculations,

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will be any external burdens associated
with this rule.
With regard to SBS Entities’ ongoing
burden, the Commission believes that
such burden would be minimal, since,
once an SBS Entity forms a reasonable
basis to believe that a given
independent representative meets the
qualifications of Rule 15Fh–5, the SBS
Entity will not likely need to reaffirm
that independent representative’s
qualifications anew, but could instead
rely on past representations regarding
the representative’s qualifications. We
estimate that SBS Entities will incur an
ongoing, aggregate burden of 22,500
hours (1 hour × 55 SBS Entities × 410
independent representatives) per year as
a result of this rule.
In addition to the burdens imposed on
SBS Entities, Rule 15Fh–5(a)(1) will also
impose a burden on special entities’
independent representatives to collect
the necessary information regarding
their relevant qualifications, and
provide that information to the SBS
Entity and/or the special entity. The
Commission continues to believe that
the reporting burden for the
independent representative will consist
of providing written representations to
the SBS Entity and/or the special entity
it represents. The Commission believes
that the burden associated with an
independent representative’s obligation
to assess its independence from the SBS
Entity will likely depend on the size of
the independent representative, the size
of the SBS Entity, the interactions
between the independent representative
and the SBS Entity, the policies and
procedures of the independent
representative and depend less on the
number of transactions in which the
independent representative is engaged.
The policies and procedures of the
independent representative will
facilitate its ability to quickly assess,
disclose, manage and mitigate any
potential material conflicts of interest.
We now believe the number of
transactions in which the independent
representative engages is less likely to
impact this assessment. Accordingly, we
have updated our estimates.
We anticipate that independent
representatives will rely on in-house
counsel to collect and submit the
relevant documentation and information
regarding its qualifications. The
Commission also estimates that each
independent representative, on average,
will initially require approximately 16
internal burden hours from its in-house
counsel per SBS Entity to collect the
information necessary to comply with
we have assumed that each SBS Entity will deal
with each independent representative.

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30095

this requirement.1569 This will result in
an aggregate initial burden of 360,800
internal hours (16 hours × 410
independent representatives × 55 SBS
Entities).
As with SBS Entities’ ongoing burden
associated with this rule, the
Commission believes that the ongoing
burden imposed on independent
representatives would be minimal,
since, once the independent
representative has provided information
regarding its qualifications to the SBS
Entity, the independent representative
will not likely need to collect or provide
that information again, but could
instead rely on a bring down certificate
that reflects past representations
regarding its qualifications. We estimate
that independent representatives will
incur an ongoing, aggregate burden of
22,500 hours (1 hour × 55 SBS Entities
× 410 independent representatives) per
year as a result of this rule.1570 We do
not believe there will be external
burdens associated with this rule.
8. Political Contributions
As noted above, the Commission
believes that there will be
approximately 50 SBS Dealers subject to
these rules, and estimates that all of
them will provide, or will seek to
provide, security-based swap services to
municipal entities. SBS Dealers, in
order to supervise and assess internal
compliance with the pay to play rules,
will need to collect information
regarding the political contributions of
SBS Dealers and their covered
associates. In addition, SBS Dealers’
covered associates will also need to
collect and provide the information
required by these rules to SBS Dealers.
The Commission’s estimates in this
paragraph take into account the burden
of the covered associates and the SBS
Dealers. These estimates also reflect the
1569 While the Commission does not believe that
every independent representative is likely to deal
with every SBS Entity, we do not have data on the
average number of SBS Entities with whom each
independent representative would deal.
Accordingly, for the purposes of these calculations,
we have assumed that each SBS Entity will deal
with each independent representative.
1570 We note that, in the Proposing Release, we
based our burden estimates for evaluating an
independent representative’s qualifications on the
underlying assumption that representations
regarding an independent representative’s
qualifications must be provided prior to every
transaction, and therefore the associated burden
calculations were transaction-specific. See
Proposing Release, 76 FR 42446–7, supra note 3.
However, based on the observed practices of swap
market participants, we now believe that
representations regarding an independent
representative’s qualifications need only be
provided in the context of each relationship with
an SBS Entity. Our revised calculations, which are
now relationship-specific, reflect this shift in our
underlying assumption.

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Commission’s experience with and
burden estimates for similar
requirements, as well as our discussions
with market participants.1571 Based on
the foregoing, the Commission estimates
that it will take, on average,
approximately 185 hours per SBS
Dealer—resulting in a total initial
burden of 9,250 hours 1572 to collect the
information regarding the political
contributions of SBS Dealers and their
covered associates to assist SBS Dealer
in their compliance with the rule. The
Commission believes that many SBS
Dealers will primarily rely on in-house
counsel for the collection of information
required under this rule.
Additionally, we expect some SBS
Dealers to incur one-time costs to
establish or enhance current systems to
assist in their compliance with the rule.
These costs will vary widely among
firms. Similar to the estimates made by
the Commission in connection with the
Advisers Act pay to play rule, we have
also estimated that some small and
medium firms will incur start-up costs,
on average, of $10,000, and larger firms
will incur, on average, $100,000.
Assuming all SBS Dealers will be larger
firms, the initial cost to establish or
enhance current systems to assist in
their compliance with the rule is
estimated at $5,000,000 for all SBS
Dealers.1573 Nevertheless, we note that
some SBS Dealers may not incur any
system costs if they determine a system
is unnecessary due to their limited
number of employees, or their limited
number of municipal entity
counterparties. Furthermore, like other
large firms, SBS Dealers have likely
devoted significant resources to
automating compliance and reporting
with respect to regulations concerning
certain political contributions. This rule
could, therefore, cause them to enhance
the existing systems that had originally
been designed to comply with MSRB
Rules G–37 and G–38 and Advisers Act
Rule 206(4)–5.
The final rules also allow SBS Dealers
to file applications for exemptive relief,
and outline a list of items to be
addressed, including, whether the SBS
Dealer has developed policies and
procedures to monitor political
contributions; the steps taken after
discovery of the contribution; and the
1571 See Advisers Act Pay-to-Play Release, 75 FR
41018, 41061–65, supra note 1100. See also supra
note 19 regarding a list of Commission staff
meetings with interested parties.
1572 The estimate is based on the following
calculation: (185 hours × 50 SBS Dealers).
1573 The initial cost is estimated at: 50 SBS
Dealers × $100,000 = $5,000,000. See Advisers Act
Pay-to-Play Release, 75 FR at 41061, supra note
1100 (estimating that larger firms will incur, on
average, $100,000, in start-up costs).

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apparent intent in making the
contribution based on the facts and
circumstances of each case. The
incidence of exemptive relief related to
MSRB Rule G–37 and the number of
applications the Commission has
received under the Advisers Act Rule
206(4)–5 may be indicative of the
possible applications for exemptive
relief under these final rules. Consistent
with the Commission’s estimates in
connection with Advisers Act Rule
206(4)–5, we also estimate that a firm
that applies for an exemption will hire
outside counsel to prepare an exemptive
request, and estimate that the number of
hours counsel will spend preparing and
submitting an application between 16
hours to 32 hours, at a rate of $400 per
hour. Recognizing that this is an
estimate, we conservatively estimate
that the Commission may receive up to
two applications for exemptive relief
per year with respect to pay to play
rules.1574 at a total ongoing cost of
$25,600 per year, assuming
conservatively 32 hours for outside
counsel to prepare an exemptive
request.1575

continues to estimate that a total of
$60,000 in outside legal costs will be
incurred to, among other things, assist
in the preparation of the annual
compliance report and the SBS Entity’s
annual assessment of its written policies
and procedures, as a result of this
burden per respondent, for a total initial
outside cost burden of $3,300,000.1577
A CCO will also be required to
prepare and submit annual compliance
reports to the Commission and the SBS
Entity’s board of directors. In the
Proposing Release, the Commission
estimated that these reports would
require on average 92 hours per
respondent per year for an ongoing
annual burden of 5,060 hours. As a
result of additional descriptions that
some CCOs will have to include in their
annual compliance reports, we now
estimate that these reports will require
on average 93 hours per respondent per
year for an ongoing annual burden of
5,115.1578 Because the report will be
submitted by an internal CCO, the
Commission does not expect any
external costs associated therewith.

9. Chief Compliance Officer
Under Rule 15Fk–1, an SBS Entity’s
CCO is responsible for, among other
things, taking reasonable steps to ensure
that the SBS Entity establishes and
maintains policies and procedures
reasonably designed to ensure
compliance by the SBS Entity with the
Exchange Act and the rules and
regulations thereunder relating to its
business as an SBS Entity. The
Commission continues to estimate that,
on average, the establishment and
administration of the policies and
procedures required under Rule 15Fk–1
(e.g., preparing an annual compliance
report and the SBS Entity’s annual
assessment of its written policies and
procedures reasonably designed to
achieve compliance with Section 15F
and the rules and regulations
thereunder) will require 630 hours to
create and 180 hours to administer per
year per respondent, for a total burden
of 34,650 initial hours, and 9,900 hours
per year on average, on an ongoing
basis.1576 The Commission also

10. Foreign Branch Exception

1574 FINRA has granted 17 exemptive letters
related to Rule G–37 between 1/05 and 12/15 (11
years) http://www.finra.org/industry/exemptiveletters. In addition, the Commission has received 13
applications under the Adviser’s act (since the
compliance date, approximately 4 years).
1575 Ongoing: (Outside counsel at $400 per hour
× 32 hours per application × 2) = $25,600. See
Advisers Act Pay-to-Play Release, 75 FR at 41065,
supra note 1100 (making similar estimates in
connection with Advisers Act Rule 206(4)–5).
1576 See Proposing Release, 76 FR at 42448, supra
note 3.

1577 See id. This figure is the result of an
estimated $400 per hour cost for outside legal
services times 150 hours for 3 policies and
procedures for 55 respondents. See SDR
Registration Release, supra note 1202.
1578 The estimate is based on the following
calculation: (93 hours) × (55 SBS Dealers).
1579 See Cross-Border Proposing Release, 78 FR at
31108, supra note 6 (explaining that the
Commission estimated that 50 entities may include
a representation that security-based swap is a
‘‘transaction conducted through a foreign branch’’
in their trading relationship documentation).

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The Commission estimates the onetime paperwork burden associated with
developing representations under this
collection of information would be, for
each U.S. bank counterparty that may
make such representations to its
registered Major SBS Participant or
registered SBS Dealer counterparty, no
more than five hours, and up to $2,000
for the services of outside professionals,
for an estimate of approximately 250
hours and $100,000 across all securitybased swap counterparties that may
make such representations.1579 This
estimate assumes little or no reliance on
standardized disclosure language.
However, as the Commission has
previously noted in connection with
this collection of information, in most
cases, the representations associated
with the definition of ‘‘transaction
conducted through a foreign branch’’ are
likely to be made through amendments
to the parties’ existing trading
documentation (e.g., the schedule to a

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master agreement).1580 Because these
representations relate to new regulatory
requirements, the Commission
anticipates that U.S. bank counterparties
may elect to develop and incorporate
these representations in trading
documentation soon after the effective
date of the Commission’s security-based
swap regulations, rather than
incorporating specific language on a
transactional basis. The Commission
believes that parties would be able to
adopt, where appropriate, standardized
language across all of their securitybased swap trading relationships.
The Commission expects that the
majority of the burden associated with
the new disclosure requirements will be
experienced during the first year as
language is developed and trading
documentation is amended. After the
new representations are developed and
incorporated into trading
documentation, the Commission
continues to believe that the on-going
paperwork burden associated with this
requirement will be 10 hours per U.S.
bank counterparty for verifying
representations with existing
counterparties, for a total of
approximately 500 hours across all
applicable U.S. bank counterparties.1581

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11. Substituted Compliance Rule
Rule 3a71–6 under the Exchange Act
would require submission of certain
information to the Commission to the
extent that foreign financial authorities
or security-based swap dealers or major
security-based swap participants elect to
request a substituted compliance
determination with respect to the Title
VII business conduct requirements.
Consistent with Exchange Act Rule 0–
13, such applications must be
accompanied by supporting
documentation necessary for the
Commission to evaluate the request,
1580 See Cross-Border Adopting Release, 79 FR at
47366, supra note 193. See also Cross-Border
Proposing Release, 78 FR at 31108, supra note 6
(noting that entities may include the representation
in their trading relationship documentation). The
Commission believes that because trading
relationship documentation is established between
two counterparties, the question of whether one of
those counterparties is able to represent that it is
entering into a ‘‘transaction conducted through a
foreign branch’’ would not change on a transactionby-transaction basis and, therefore, such
representations would generally be made in the
schedule to a master agreement, rather than in
individual confirmations.
1581 The Commission staff estimates that this
burden would consist of 10 hours of in-house
counsel time for each security-based swap market
participant that may make such representations. See
Cross-Border Adopting Release, 79 FR 47367
(estimating 10 hours per counterparty for
verification), supra note 193; Cross-Border
Proposing Release, 78 FR 31108 (same), supra note
6.

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including information regarding
applicable foreign requirements, and the
methods used by foreign authorities to
monitor and enforce compliance.
The Commission expects that
registered security-based swap dealers
and major security-based swap
participants will seek to rely on
substituted compliance upon
registration, and that it is likely that the
majority of such requests will be made
during the first year following the
effective date of this substituted
compliance rule. Requests would not be
necessary with regard to applicable
rules and regulations of a foreign
jurisdiction that have previously been
the subject of a substituted compliance
determination in connection with the
applicable rules.
In light of the provisions of the final
rule and rule 0–13, permitting
substituted compliance applications to
be made by foreign regulatory
authorities, the Commission expects
that the great majority of substituted
compliance applications will be
submitted by foreign authorities, and
that very few substituted compliance
requests will come from SBS Entities.
For purposes of this assessment, the
Commission estimates that three such
SBS Entities will submit such
applications.1582 The Commission
estimates that the total one-time
paperwork burden incurred by such
entities associated with preparing and
submitting a request for a substituted
compliance determination in
connection with the business conduct
requirements will be approximately 240
hours, plus $240,000 for the services of
outside professionals for all three
requests.1583
1582 This estimate differs from the Cross-Border
Proposing Release estimate, that there would be no
more than 50 requests for substituted compliance
determinations pursuant to proposed Rule 3a71–5.
See Cross-Border Proposing Release, 78 FR at
31110, supra note 6. The revised estimate reflects
our expectation that the large majority of
substituted compliance requests will be made by
foreign regulatory authorities, rather than by market
participants.
1583 Consistent with the per-request estimates in
the Cross-Border Proposing Release, the
Commission estimates that the paperwork burden
associated with making each such substituted
compliance request would be approximately 80
hours of in-house counsel time, plus $80,000 for the
services of outside professionals (based on 200
hours of outside time * 400). See Cross-Border
Proposing Release, 78 FR at 31110, supra note 6.
In practice, those amounts may overestimate the
costs of requests pursuant to Rule 3a71–6 as
adopted, as such requests would solely address
business conduct requirements, rather than the
broader proposed scope of substituted compliance
set forth in that proposal.

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E. Collections of Information are
Mandatory
With the exception of the collection of
information related to the foreign
branch exception, compliance with
collection of information requirements
under these rules is mandatory for all
SBS Dealers and SBS Entities. An
agency may not conduct or sponsor, and
a person is not required to respond to,
a collection of information unless it
displays a currently valid OMB control
number.
Compliance with the collection of
information requirements associated
with rule 3a71–6, regarding the
availability of substituted compliance, is
mandatory for all foreign financial
authorities or non-U.S. SBS Entities that
seek a substituted compliance
determination.
F. Confidentiality
The forms that the Commission has
adopted for use by applicants for
registration as security-based swap
dealers or major security-based swap
participants provide for applicants to
notify the Commission regarding
intended reliance on substituted
compliance.1584 Also, the Commission
generally will make requests for
substituted compliance determination
public, subject to requests for
confidential treatment being submitted
pursuant to any applicable provisions
governing confidentiality under the
Exchange Act.1585
The representations provided in
connection with the foreign branch
exception would be provided
voluntarily by certain U.S. bank
counterparties to their registered SBS
Dealer counterparties; therefore, the
Commission would not typically receive
confidential information as a result of
this collection of information. However,
to the extent that the Commission
receives confidential information
contained in a representation document
through our examination and oversight
program, an investigation, or some other
means, such information would be kept
confidential, subject to the provisions of
applicable law.
G. Retention Period of Recordkeeping
Requirements
SBS Dealers will be required to retain
records and information relating to
1584 See Registration Adopting Release, 80 FR at
49049, supra note 989 (questions 3A, B and C of
Form SBSE–A, addressing potential reliance on
substituted compliance determinations)
1585 See SBS Entity Definitions Adopting Release,
79 FR at 47359, supra note 1451 (discussing
confidentiality provisions under the Exchange Act
in connection with adopting Rule 0–13, governing
applications for substituted compliance).

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these rules for the required retention
periods specified in Exchange Act Rule
17a–4.
VI. Economic Analysis

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A. Introduction and Broad Economic
Considerations
The Commission is sensitive to the
costs and benefits imposed by its rules.
This section presents an analysis of the
particular economic effects—including
costs, benefits and impact on efficiency,
competition, and capital formation—
that may result from our final rules.
Section 3(f) of the Exchange Act
requires the Commission, when
engaging in rulemaking that requires the
Commission to consider or determine
whether an action is necessary or
appropriate in the public interest, to
consider, in addition to the protection of
investors, whether the action will
promote efficiency, competition, and
capital formation. Further, Section
23(a)(2) of the Exchange Act requires the
Commission, when adopting rules
under the Exchange Act, to consider the
impact that any new rule would have on
competition and to not adopt any rule
that would impose a burden on
competition that is not necessary or
appropriate in furtherance of the
purposes of the Exchange Act. In the
Proposing Release, the Commission
solicited comments on all aspects of the
costs and benefits associated with the
proposed rules, including any effect the
proposed business conduct rules may
have on efficiency, competition, and
capital formation.1586 The Commission
has considered these comments and has
modified some of the rules being
adopted as discussed in sections I, II
and III, supra.
The business conduct rules as
adopted implement the requirements
under Sections 15F(h) and 15F(k) of the
Exchange Act as added by Section
764(a) of the Dodd-Frank Act. As
discussed in Section VI.C, infra, the
final rules include both requirements
expressly addressed by Title VII of the
Dodd-Frank Act, as well as
discretionary rules designed to further
the principles which underlie the
statutory requirements. These
discretionary rules include
requirements to make certain additional
disclosures; certain ‘‘know your
counterparty’’ obligations; suitability
obligations for SBS Dealers; prohibitions
against certain ‘‘pay to play’’ activities;
and a requirement of board approval for
decisions related to the compensation or
removal of the CCO.
1586 See

Proposing Release, supra note 3.

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SBS Entities play a central role in
intermediating transactions in complex
and opaque security-based swaps, and
enjoy significant informational
advantages compared to their less
sophisticated counterparties. For
instance, SBS Dealers observe quote
solicitations and order flow. SBS
Dealers may also act as lenders,
placement agents, underwriters,
structurers or securitizers of the
securities underlying security-based
swaps. As a result of operating in such
additional capacities, SBS Dealers may
have superior information about the
quality of security-based swaps and of
securities underlying security-based
swaps. Major SBS Participants may have
lower volumes of dealing activity than
SBS Dealers, but may hold large
concentrated positions in security-based
swaps,1587 and may have specialized
expertise in pricing and trading
security-based swaps. At the same time,
less informed and less sophisticated
counterparties do not observe order
flow, may have less information
concerning the risks and expected
returns of security-based swaps and
reference securities, and may have less
expertise in valuing complex securitybased swaps.
In addition, SBS Dealers are for-profit
entities with business incentives that
may be competing with those of their
counterparties. Due to the nature of
their market making and intermediation
roles, SBS Dealers purchase securitybased swaps from counterparties
seeking to sell them, and sell securitybased swaps to counterparties seeking to
buy them. When SBS Dealers transact as
principal risk holders and do not hedge
their exposures, they benefit from
directional market moves that result in
losses for their counterparties. When
SBS Dealers hedge their exposures and
do not carry balance sheet risk, they
may be indifferent to directional price
moves of the security-based swap, but
profit from charging high fees to their
counterparties, whereas their
counterparties benefit from low fees and
transaction costs. If SBS Dealers
recommend security-based swaps to
counterparties, such recommendations
may be influenced by the above
business incentives. Counterparties of
SBS Dealers may be aware of these
competing incentives, and SBS Dealers
generally benefit from intermediating a
greater volume of trades, potentially
mitigating these effects. However,
informational asymmetries between SBS
Dealers and their counterparties
outlined above may limit the ability of
1587 See Definitions Adopting Release, 77 FR at
30751–30756, supra note 115.

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counterparties to decouple the potential
biases and information components of
SBS Dealer recommendations, and to
evaluate the merits of each securitybased swap.
Broadly, these external business
conduct rules as adopted may decrease
informational asymmetries between SBS
Entities and their less sophisticated
counterparties and strengthen
counterparty protections. This may
enable market participants to make
better informed investment decisions,
and enhance allocative efficiency in
security-based swap markets.
The baseline for our economic
analysis reflects rules adopted as part of
the SBS Entity Definitions Adopting
Release, the Cross-Border Adopting
Release, Regulation SBSR and SDR
Rules,1588 as well as SBS Entity
registration rules. We also recognize that
final U.S. Activity rules have been
adopted, and affect the scope of crossborder transactions that will become
subject to various substantive Title VII
requirements, including those related to
business conduct standards. While these
rules are not yet in effect, to perform a
meaningful analysis of the business
conduct requirements being adopted
and their cross-border application, our
baseline includes the final U.S. Activity
rules.1589
Title VII provides a statutory
framework for the OTC derivatives
market and divides authority to regulate
that market between the CFTC (which
regulates swaps) and the Commission
(which regulates security-based swaps).
We note that many entities expected to
register with the Commission as SBS
Entities are currently intermediating
large volumes of transactions across
swap, security-based swap and
reference security markets. The
Commission has previously estimated
that of the total 55 entities expected to
register with the Commission as SBS
Entities, up to 35 entities are registered
with the CFTC as Swap Entities, and up
to 16 entities are registered with the
Commission as broker-dealers.1590 Since
broker-dealers registered with the
Commission and Swap Entities
registered with the CFTC are required to
join an SRO, the majority of SBS
Entities may already be subject to CFTC
and SRO oversight. Therefore, we
anticipate that many of the entities
1588 17 CFR 232.11, 232.101, 232.305, and
232.407; 17 CFR 240.13n–1 to 240.13n–12 (‘‘SDR
Rules’’). See SDR Registration Release, supra note
1202.
1589 See U.S. Activity Adopting Release, 81 FR at
8598.
1590 See Registration Adopting Release, 80 FR at
49000, supra note 989. Also see U.S. Activity
Proposing Release, 80 FR at 27458, supra note 9.

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expected to register as SBS Entities and
become subject to the Commission’s
final business conduct rules may have
already brought their business into
compliance with CFTC business
conduct requirements and SRO rules,
among others. The Commission has
sought to harmonize, to the extent
practicable, the final business conduct
requirements with existing requirements
applicable to SBS Dealers and brokerdealers. Obligations imposed on SBS
Entities in this rulemaking are modeled
on, and largely similar to, obligations
applicable to Swap Entities and
registered broker-dealers. These
obligations include disclosure, knowyour-customer, suitability, pay-to-play,
supervision, and compliance
responsibilities. The Commission has
also considered the implications of
certain business conduct rules regarding
special entities subject to ERISA. DOL
staff has stated that the final business
conduct standards neither conflict with
DOL regulations nor compel SBS
Entities to engage in fiduciary conduct,
as discussed in Section II.D supra.
As discussed in the economic
baseline, extensive cross-market
participation of dealers and non-dealer
counterparties in swap, security-based
swap and reference security markets
points to a high degree of market
integration. The Commission has sought
to harmonize, to the extent practicable,
final business conduct requirements
with other existing rules, which may
result in efficiencies and lower
incremental economic costs for crossregistered SBS Entities and their
counterparties than might have
otherwise resulted.1591
Nonetheless, the Commission
recognizes—as reflected in the
economic analysis—that the final rules
establish new requirements applicable
to SBS Entities, and that complying
with these requirements will entail costs
to SBS Entities. In considering the
economic consequences of these final
rules we have been mindful of the direct
and indirect costs these rules will
impose on market participants, as well
as the effect of various business conduct
requirements on the ability of
counterparties to transact with SBS
Entities. We have considered the likely
costs and benefits of the final business
conduct requirements for SBS Entities,
1591 A number of commenters recommended the
Commission to harmonize external business
conduct rules with those of the CFTC. See, e.g.,
Barnard, supra note 5; Levin, supra note 5; APPA,
supra note 5; BlackRock, supra note 5; NABL, supra
note 5; Nomura, supra note 5; AFGI (July 2013),
supra note 5; ISDA (July 2013), supra note 5;
Barnard (July 2015), supra note 10; and SIFMA
(August 2015), supra note 5.

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counterparties in security-based swap
markets, investors in reference security
markets, as well as stakeholders in
special entities, such as taxpayers,
pension holders, endowment
beneficiaries, and investors in
municipal securities. We have also
considered how various types of market
participants may respond to the
obligations and safe harbors in these
final rules.
Some of these final rules impose
requirements on SBS Dealers only,
whereas others apply to transactions by
both SBS Dealers and Major SBS
Participants. These final rules have
considered potential differences
between the roles SBS Dealers and
Major SBS Participants in securitybased swap markets. As discussed in the
sections that follow, registered SBS
Dealers are expected to intermediate
large volumes of security-based swaps
and to transact with many hundreds or
thousands of counterparties, whereas
Major SBS Participants will be holding
significant positions in SBS without
intermediating significant volumes of
deals.1592 As discussed in Regulation
SBSR, SBS Dealers manage large
changes in exposure to reference entities
(inventory risk).1593 Large CDS
transactions on a particular reference
entity create large inventory positions
that affect SBS Dealers’ exposure to the
credit risk of reference assets. SBS
Dealers may actively manage inventory
risks that they do not want to bear by
entering into offsetting contracts that
diversify or hedge new risk exposures.
Doing so requires finding market
participants, typically in the interdealer
market, who are willing to act as
counterparties to these offsetting
contracts.1594 Further, as discussed
above, SBS Dealers observe order flow
and may be involved in arranging or
structuring security-based swaps,
enjoying informational advantages
relative to their non-dealer
counterparties. In contrast, participants
required to register as Major SBS
Participants will have accumulated
large positions in security-based swaps
but have dealing activity below the de
1592 See Definitions Adopting Release, 77 FR at
30751–30756, supra note 115.
1593 See Regulation SBSR Adopting Release, 80
FR at 14617, infra note 1602.
1594 See ‘‘Inventory risk management by dealers
in the single-name credit default swap market’’
(October 17, 2014) at 5, available at http://
www.sec.gov/comments/s7-34-10/s73410-184.pdf.
The analysis uses DTCC–TIW data to describe how
SBS Dealers manage inventory risk by hedging.
Also see FN14 citing to Hansch, Oliver, Narayan Y.
Naik, and S. Viswanathan. ‘‘Do inventories matter
in dealership markets? Evidence from the London
Stock Exchange.’’ The Journal of Finance 53, no. 5
(1998): 1623–1656.

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minimis threshold. As a result of their
substantial positions, Major SBS
Participants may be susceptible to
market risks. We have considered these
differences in risks arising from the
security-based swap activity of the two
types of SBS Entities.
We have also taken into account
comments regarding the different
application of various business conduct
requirements to SBS Dealers and Major
SBS Participants,1595 including one
comment that imposition of ‘‘dealerlike’’ obligations on Major SBS
Participants may undermine market
development, and reduce competition
and counterparty choice.1596 The
Commission recognizes that SBS
Dealers serve as the points of
connection in security-based swap
markets, whereas Major SBS
Participants may have greater market
impacts and risks associated with
holding larger security-based swap
positions. As discussed in Section II,
these final rules are intended to provide
counterparty protections and reduce
information asymmetries. The
Commission is imposing counterparty
status verification, disclosure, fair and
balanced communications, supervision,
antifraud, CCO rules and rules related to
counterparties of special entities on
both SBS Dealers and Major SBS
Participants. The final rules limit the
scope of ‘‘know your counterparty’’,
suitability, pay to play and certain
special entity rules to SBS Dealers.
Therefore, counterparties of Major SBS
Participants, as well as counterparties of
SBS Dealers, may benefit from
counterparty protections and
information benefits of these final rules.
At the same time, Major SBS
Participants will not be subject to the
full range of business conduct
obligations where business conduct
requirements are not expressly
addressed by the Dodd-Frank Act or the
statute applies a requirement only to
SBS Dealers. We further discuss these
considerations in the sections that
follow.
We recognize that costs of rules
imposed on Major SBS Participants may
be passed on to counterparties in the
form of transaction costs or a decreased
willingness to intermediate transactions
with non-SBS or Swap Entity
counterparties. As reflected in the
economic baseline, the Commission
estimates that of the 55 SBS Entities that
may register with the Commission,
between zero and five entities may be
Major SBS Participants. The
1595 See, e.g., MFA, supra note 5; Blackrock,
supra note 5; CFA, supra note 5.
1596 See MFA, supra note 5.

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Commission also estimates that nonSBS Entity counterparties may transact
with a median of three and an average
of four SBS Dealers per year. Should
Major SBS Participants become less
willing to transact with non-SBS or
Swap Entity counterparties, SBS Dealers
are likely to step in to intermediate OTC
trades. As articulated in prior sections,
the Commission believes that imposing
certain final business conduct rules on
both SBS Dealers and Major SBS
Participants may reduce information
asymmetries and enhance counterparty
protections in security-based swap
markets.
Final business conduct rules reflect
the informational advantage of SBS
Entities relative to other market
participants. SBS Dealers enjoy
informational advantages over their
non-SBS Entity counterparties. As we
quantify in the economic baseline, interdealer transactions play a significant
role in security-based swap markets,
and security-based swap activity is
highly concentrated among a small
number of dealers. SBS Dealers observe
deal flow, and may act in other
capacities, such as in the capacity of
underwriters or arrangers, in relation to
reference securities underlying securitybased swaps. Major SBS Participants
may also be better informed about the
risks and valuations of security-based
swaps due to their large positions in
security-based swaps. Therefore,
compared to other counterparties, both
SBS Dealers and Major SBS Participants
may be better informed and better able
to assess material risks and
characteristics of security-based swaps.
Final disclosure and suitability rules are
limited to security-based swap activities
between SBS Entities and counterparties
that are not themselves SBS or Swap
Entities. Other external business
conduct rules explicitly address
conduct of SBS Entities when they act
as counterparties or advisors to special
entities, such as employee benefit plans,
municipalities and endowments.
The Commission has considered
counterparty protections, information
asymmetries and risks arising from
arm’s length and inter-affiliate
transactions. Inter-affiliate transactions
may be conducted for the purposes of
internal risk management within a
commonly controlled corporate group
with generally aligned incentives and
few informational asymmetries, and
may involve the same personnel acting
in or on behalf of both parties. Imposing
business conduct requirements on
transactions among various control
affiliates of the same SBS Entity is less
likely to result in counterparty
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improvements in allocative efficiency,
but would result in additional costs and
execution delays for SBS Entities.1597
Similar to the CFTC’s adopted
approach, the final business conduct
rules 240.15Fh–3(a)–(f), 240.15Fh–4(b),
and 240.15F–5 will apply to arm’s
length transactions and exclude
transactions that SBS Entities enter into
with their majority-owned affiliates.
The Commission notes that, where
possible, it has attempted to quantify
the costs, benefits, and effects on
efficiency, competition, and capital
formation expected to result from
adopting these rules. In many cases,
however, the Commission is unable to
quantify the economic effects. Crucially,
many of the relevant economic effects,
such as counterparty protections,
information asymmetry, the ability of
less informed market participants to
overcome information asymmetries, and
the value of Commission enforcement
and oversight, are inherently difficult to
quantify. In other cases, we lack the
information necessary to provide
reasonable estimates. For example, we
lack data on business conduct practices
of U.S. SBS Entities’ foreign branches;
profitability of SBS Dealer and Major
SBS Participant transactions at various
volume levels, by type (SEF execution
versus OTC/bespoke) and by
counterparty (other SBS and Swap
Entities, special entities, all other
counterparties); the magnitude of the
conflicts of interest related to the ‘‘pay
to play’’ practices by SBS Entities with
respect to special entities and the degree
of reliance of dually registered SBS
Entities on covered associates already
subject to similar prohibitions; and how
SBS Entities, new entrants, and
counterparties, including those
currently not transacting in securitybased swap markets, may react to
specific business conduct rules. To the
best of our knowledge, no such data are
publicly available and commenters have
not provided data to allow such
quantification.
B. Baseline
To assess the economic impact of the
final rules described in this release, we
are using as our baseline the securitybased swap market as it exists at the
time of this release, including
applicable rules we have already
adopted but excluding rules that we
1597 As discussed in Section II.A, supra, all
commenters recommended not applying these final
rules to inter-affiliate transactions. See ABA
Securities Association, supra note 5; FIA/ISDA/
SIFMA, supra note 5; SIFMA (August 2015), supra
note 5.

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have proposed but not yet finalized.1598
The analysis includes the statutory
provisions that currently govern the
security-based swap market pursuant to
the Dodd-Frank Act, and rules adopted
in the Definitions Adopting Release, the
Cross-Border Adopting Release,1599 the
SDR Registration Release,1600 the SBS
Entity Registration Adopting
Release,1601 and the Regulation SBSR
Adopting Release,1602 along with U.S.
Activity rules,1603 as these final rules—
even if compliance is not yet required—
are part of the existing regulatory
landscape that market participants
expect to govern their security-based
swap activity.
The business conduct rules include a
variety of standards for conduct by SBS
Entities when they transact with
counterparties. While certain
requirements apply to SBS Entity
transactions with all counterparties,
some requirements will affect only SBS
Entity transactions with non-SBS or
Swap Entities, others distinguish
between SBS Dealers and Major SBS
Participants, and yet others offer relief
for anonymous transactions. The
following sections describe current
security-based swap market activity,
participants, common dealing
structures, counterparties, and patterns
of cross-border and cross-market
participation.
1. Available Data Regarding SecurityBased Swap Activity
Our understanding of the market is
informed in part by available data on
security-based swap transactions,
though we acknowledge that limitations
in the data limit the extent to which we
can quantitatively characterize the
market.1604 Because these data do not
cover the entire market, we have
developed an understanding of market
activity using a sample of transactions
data that includes only certain portions
1598 We also considered, where appropriate, the
impact of rules and technical standards
promulgated by other regulators, such as the CFTC
and the European Securities and Markets Authority,
on practices in the security-based swap market.
1599 See Cross-Border Adopting Release, supra
note 684.
1600 See SDR Registration Release, supra note
1202.
1601 See Registration Adopting Release, supra
note 989.
1602 See ‘‘Regulation SBSR-Reporting and
Dissemination of Security-Based Swap
Information,’’ Exchange Act Release No. 74244
(Feb. 11, 2015), 80 FR 14563 (Mar. 19, 2015)
(‘‘Regulation SBSR Adopting Release’’).
1603 See U.S. Activity Adopting Release 81 FR
8598.
1604 We also rely on qualitative information
regarding market structure and evolving market
practices provided by commenters, both in letters
and in meetings with Commission staff, and
knowledge and expertise of Commission staff.

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of the market. We believe, however, that
the data underlying our analysis here
provide reasonably comprehensive
information regarding single-name CDS
transactions and the composition of
participants in the single-name CDS
market.
Specifically, our analysis of the state
of the current security-based swap
market is based on data obtained from
the DTCC Derivatives Repository
Limited Trade Information Warehouse
(‘‘TIW’’), especially data regarding the
activity of market participants in the
single-name CDS market during the
period from 2008 to 2014. According to
data published by the Bank for
International Settlements (‘‘BIS’’), the
global notional amount outstanding in
single-name CDS was approximately
$9.04 trillion,1605 in multi-name index
CDS was approximately $6.75 trillion,
and in multi-name, non-index CDS was
approximately $611 billion. The total
gross market value outstanding in
single-name CDS was approximately
$366 billion, and in multi-name CDS
instruments was approximately $227
billion.1606 The global notional amount
outstanding in equity forwards and
swaps as of December 2014 was $2.50
trillion, with total gross market value of
$177 billion.1607 As these figures show
(and as we have previously noted),
although the definition of security-based
swaps is not limited to single-name
CDS, single-name CDS contracts make
up a majority of security-based swaps,
and we believe that the single-name
CDS data are sufficiently representative
of the market to inform our analysis of
the state of the current security-based
swap market.1608
1605 The global notional amount outstanding
represents the total face amount used to calculate
payments under outstanding contracts. The gross
market value is the cost of replacing all open
contracts at current market prices.
1606 See semi-annual OTC derivatives statistics at
December 2014, Table 19, available at http://
www.bis.org/statistics/dt1920a.pdf (accessed Jul.
29, 2015).
1607 These totals include both swaps and securitybased swaps, as well as products that are excluded
from the definition of ‘‘swap,’’ such as certain
equity forwards.
1608 While other repositories may collect data on
transactions in total return swaps on equity and
debt, we do not currently have access to such data
for these products (or other products that are
security-based swaps). Consistent with the CrossBorder Proposing Release, we believe that data
related to single-name CDS provide reasonably
comprehensive information for purposes of this
analysis, as such transactions appear to constitute

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We note that the data available to us
from TIW do not encompass those CDS
transactions that both: (i) Do not involve
U.S. counterparties; 1609 and (ii) are
based on non-U.S. reference entities.
Notwithstanding this limitation, the
TIW data should provide sufficient
information to permit us to identify the
types of market participants active in
the security-based swap market and the
general pattern of dealing within that
market.1610
2. Security-Based Swap Market: Market
Participants and Dealing Structures
a. Security-Based Swap Market
Participants
Activity in the security-based swap
market is concentrated among a
relatively small number of entities that
act as dealers in this market. In addition
to these entities, thousands of other
participants appear as counterparties to
roughly 74 percent of the security-based swap
market as measured on the basis of gross notional
outstanding. See Cross-Border Proposing Release,
78 FR 31120 n.1301.
Also consistent with our approach in that release,
with the exception of the analysis regarding the
degree of overlap between participation in the
single-name CDS market and the index CDS market
(cross-market activity), our analysis below does not
include data regarding index CDS as we do not
currently have sufficient information to classify
index CDS as swaps or security-based swaps.
1609 Following publication of the Warehouse
Trust Guidance on CDS data access, TIW surveyed
market participants, asking for the physical address
associated with each of their accounts (i.e., where
the account is organized as a legal entity). This
physical address is designated the registered office
location by TIW. When an account reports a
registered office location, we have assumed that the
registered office location reflects the place of
domicile for the fund or account. When an account
does not report a registered office location, we have
assumed that the settlement country reported by the
investment adviser or parent entity to the fund or
account is the place of domicile. Thus, for purposes
of this analysis, we have classified accounts as
‘‘U.S. counterparties’’ when they have reported a
registered office location in the United States. We
note, however, that this classification is not
necessarily identical in all cases to the definition of
‘‘U.S. person’’ under Exchange Act rule 3a71–
3(a)(4).
1610 The challenges we face in estimating
measures of current market activity stem, in part,
from the absence of comprehensive reporting
requirements for security-based swap market
participants. The Commission has adopted rules
regarding trade reporting, data elements, and public
reporting for security-based swaps that are designed
to, when fully implemented, provide the
Commission with additional measures of market
activity that will allow us to better understand and
monitor activity in the security-based swap market.
See Regulation SBSR Adopting Release, 80 FR at
14699–14700, supra note 1602.

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security-based swap contracts in our
sample, and include, but are not limited
to, investment companies, pension
funds, private (hedge) funds, sovereign
entities, and industrial companies. We
observe that most non-dealer users of
security-based swaps do not engage
directly in the trading of swaps, but
trade through banks, investment
advisers, or other types of firms acting
as dealers or agents. Based on an
analysis of the counterparties to trades
reported to the TIW, there are 1,875
entities that engaged directly in trading
between November 2006 and December
2014.1611
As shown in Table 1, below, close to
three-quarters of these entities (DTCCdefined ‘‘firms’’ shown in TIW, which
we refer to here as ‘‘transacting agents’’)
were identified as investment advisers,
of which approximately 40 percent
(about 30 percent of all transacting
agents) were registered as investment
advisers under the Advisers Act.1612
Although investment advisers comprise
the vast majority of transacting agents,
the transactions they executed account
for only 11.5 percent of all single-name
CDS trading activity reported to the
TIW, measured by number of
transaction-sides (each transaction has
two transaction sides, i.e., two
transaction counterparties). The vast
majority of transactions (83.7 percent)
measured by number of transactionsides were executed by ISDA-recognized
dealers.
1611 These 1,875 entities, which are presented in
more detail in Table 1, below, include all DTCCdefined ‘‘firms’’ shown in TIW as transaction
counterparties that report at least one transaction to
TIW as of December 2014. The staff in the Division
of Economic and Risk Analysis classified these
firms, which are shown as transaction
counterparties, by machine matching names to
known third-party databases and by manual
classification. See, e.g., Cross-Border Proposing
Release, 78 FR 31120, n. 1304, supra note 6. Manual
classification was based in part on searches of the
EDGAR and Bloomberg databases, the SEC’s
Investment Adviser Public Disclosure database, and
a firm’s public Web site or the public Web site of
the account represented by a firm. The staff also
referred to ISDA protocol adherence letters
available on the ISDA Web site.
1612 See 15 U.S.C. 80b1–80b21. Transacting agents
participate directly in the security-based swap
market, without relying on an intermediary, on
behalf of principals. For example, a university
endowment may hold a position in a security-based
swap that is established by an investment adviser
that transacts on the endowment’s behalf. In this
case, the university endowment is a principal that
uses the investment adviser as its transacting agent.

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TABLE 1—THE NUMBER OF TRANSACTING AGENTS BY COUNTERPARTY TYPE AND THE FRACTION OF TOTAL TRADING
ACTIVITY, FROM NOVEMBER 2006 THROUGH DECEMBER 2014, REPRESENTED BY EACH COUNTERPARTY TYPE 1613
Transacting agents

Number

Percent

Transaction
share
(percent)

Investment advisers .....................................................................................................................
—SEC registered ..................................................................................................................
Banks ...........................................................................................................................................
Pension Funds .............................................................................................................................
Insurance Companies ..................................................................................................................
ISDA-Recognized Dealers 1614 ....................................................................................................
Other ............................................................................................................................................

1,425
571
252
27
38
17
116

76.0
30.5
13.4
1.4
2.0
0.9
6.2

11.5
7.7
4.3
0.1
0.2
83.7
0.2

Total ...............................................................................................................................

1,875

99.9

100

Principal holders of CDS risk
exposure are represented by ‘‘accounts’’
in the TIW.1615 The staff’s analysis of
these accounts in TIW shows that the
1,875 transacting agents classified in
Table 1 represent 10,900 principal risk
holders. Table 2, below, classifies these

principal risk holders by their
counterparty type and whether they are
represented by a registered or
unregistered investment adviser.1616 For
instance, banks in Table 1 allocated
transactions across 327 accounts, of
which 23 were represented by

investment advisers. In the remaining
304 instances, banks traded for their
own accounts. Meanwhile, ISDArecognized dealers in Table 1 allocated
transactions across 75 accounts.

TABLE 2—THE NUMBER AND PERCENTAGE OF ACCOUNT HOLDERS—BY TYPE—WHO PARTICIPATE IN THE SECURITYBASED SWAP MARKET THROUGH A REGISTERED INVESTMENT ADVISER, AN UNREGISTERED INVESTMENT ADVISER, OR
DIRECTLY AS A TRANSACTING AGENT, FROM NOVEMBER 2006 THROUGH DECEMBER 2014.1617

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Account holders by type

Number

Represented
by a registered
investment
adviser

Represented
by an
unregistered
investment
adviser

Participant is
transacting
agent 1618

Private Funds ...................................................................................................
DFA Special Entities ........................................................................................
Registered Investment Companies ..................................................................
Banks (non-ISDA-recognized dealers) ............................................................
Insurance Companies ......................................................................................
ISDA-Recognized Dealers ...............................................................................
Foreign Sovereigns ..........................................................................................
Non-Financial Corporations .............................................................................
Finance Companies .........................................................................................
Other/Unclassified ............................................................................................

3,168
1,141
800
327
232
75
72
61
13
5,011

1,569
1,088
768
17
150
0
53
43
6
3,327

50%
95%
96%
5%
65%
0%
74%
70%
46%
66%

1,565 49%
33
3%
30
4%
6
2%
21
9%
0
0%
3
4%
3
5%
0
0%
1,452 29%

34
1%
20
2%
2
0%
304
93%
61
26%
75 100%
16
22%
15
25%
7
54%
232
5%

All ..............................................................................................................

10,900

7,021

64%

3,113

766

29%

7%

Among the accounts, there are 1,141
Dodd-Frank Act-defined special
entities 1619 and 800 investment
companies registered under the

Investment Company Act of 1940.1620
Private funds comprise the largest type
of account holders that we were able to
classify, and although not verified

through a recognized database, most of
the funds we were not able to classify
appear to be private funds.1621

1613 Adjustments to these statistics reflect
updated classifications of counterparties and
transactions classification resulting from further
analysis of the TIW data.
1614 For the purpose of this analysis, the ISDArecognized dealers are those identified by ISDA as
belonging to the G14 or G16 dealer group during the
period: JP Morgan Chase NA (and Bear Stearns),
Morgan Stanley, Bank of America NA (and Merrill
Lynch), Goldman Sachs, Deutsche Bank AG,
Barclays Capital, Citigroup, UBS, Credit Suisse AG,
RBS Group, BNP Paribas, HSBC Bank, Lehman
Brothers, Socie´te´ Ge´ne´rale, Credit Agricole, Wells
Fargo and Nomura. See, e.g., http://www.isda.org/
c_and_a/pdf/ISDA-Operations-Survey-2010.pdf.
1615 ‘‘Accounts’’ as defined in the TIW context are
not equivalent to ‘‘accounts’’ in the definition of
‘‘U.S. person’’ provided by Exchange Act rule 3a71–
3(a)(4)(i)(C). They also do not necessarily represent
separate legal persons. One entity or legal person

may have multiple accounts. For example, a bank
may have one DTCC account for its U.S.
headquarters and one DTCC account for one of its
foreign branches.
1616 Unregistered investment advisers include all
investment advisers not registered under the
Investment Advisers Act and may include
investment advisers registered with a state or a
foreign authority.
1617 Adjustments to these statistics reflect
updated classifications of counterparties and
transactions classification resulting from further
analysis of the TIW data.
1618 This column reflects the number of
participants who are also trading for their own
accounts.
1619 Our manual classification does not
distinguish between special entities subject to
ERISA and special entities defined in, but not
subject to ERISA, and this estimate includes both

groups of entities. Therefore, our analysis includes
entities that may opt out of the special entity status
under these final rules. If many such entities opt
out, this figure may overestimate the number of
market participants subject to business conduct
standards with regards to special entities. See
Section VI.C.4.
1620 See 15 U.S.C. 80a1–80a64. There remain
approximately 5,000 DTCC ‘‘accounts’’ unclassified
by type. Although unclassified, each was manually
reviewed to verify that it was not likely to be a
special entity within the meaning of the DoddFrank Act and instead was likely to be an entity
such as a corporation, an insurance company, or a
bank.
1621 For the purposes of this discussion, ‘‘private
fund’’ encompasses various unregistered pooled
investment vehicles, including hedge funds, private
equity funds, and venture capital funds.

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b. Participant Domiciles
As depicted in Figure 1 above,
domiciles of new accounts participating
in the market have shifted over time. It
is unclear whether these shifts represent
changes in the types of participants
active in this market, changes in
reporting or changes in transaction
volumes in particular underliers. For
example, the increased percentage of
new entrants that are foreign accounts
may reflect an increase in participation
by foreign account holders in the
security-based swap market, and the
increased percentage of the subset of
new entrants that are foreign accounts
managed by U.S. persons also may
reflect more specifically the flexibility
with which market participants can
restructure their market participation in
response to regulatory intervention,
competitive pressures, and other
stimuli.1623 On the other hand, apparent
1622 See Section VI.B.1, supra (explaining how
domiciles for firms were identified for purposes of
this analysis).
1623 See Charles Levinson, ‘‘U.S. banks moved
billions in trades beyond the CFTC’s reach,’’
Reuters (Aug. 21, 2015), available at: http://
www.reuters.com/article/2015/08/21/usa-banksswaps-idUSL3N10S57R20150821.

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changes in the percentage of new
accounts with foreign domiciles may
reflect improvements in reporting by
market participants to TIW, an increase
in the percentage of transactions
between U.S. and non-U.S.
counterparties, and/or increased
transactions in single-name CDS on U.S.
reference entities by foreign persons.1624
c. Market Centers
A market participant’s domicile,
however, does not necessarily
correspond to where it engages in
security-based swap activity. In
particular, financial groups engaged in
security-based swap dealing activity
operate in multiple market centers and
carry out such activity with
counterparties around the world.1625
Several commenters noted that many
market participants that are engaged in
1624 As noted above, the available data do not
include all security-based swap transactions but
only transactions in single name CDS that involve
either (1) at least one account domiciled in the
United States (regardless of the reference entity) or
(2) single-name CDS on a U.S. reference entity
(regardless of the U.S.-person status of the
counterparties).
1625 See U.S. Activity Proposing Release, 80 FR
27449–27452, supra note 9.

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30103

dealing activity prefer to use traders and
manage risk for security-based swaps in
the jurisdiction where the underlier is
traded. Thus, although a significant
amount of the dealing activity in
security-based swaps on U.S. reference
entities involves non-U.S. dealers, we
understand that these dealers tend to
carry out much of the security-based
swap trading and related riskmanagement activities in these securitybased swaps within the United
States.1626 Some dealers have explained
that being able to centralize their
trading, sales, risk management and
other activities related to U.S. reference
entities in U.S. operations (even when
the resulting transaction is booked in a
foreign entity) improves the efficiency
of their dealing business.
Consistent with these operational
concerns and the global nature of the
security-based swap market, the
available data appear to confirm that
participants in this market are in fact
active in market centers around the
globe. Although, as noted above, the
available data do not permit us to
identify the location of personnel in a
1626 See

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transaction, TIW transaction records
indicate that firms that are likely to be
security-based swap dealers operate out
of branch locations in key market
centers around the world, including
New York, London, Tokyo, Hong Kong,
Chicago, Sydney, Toronto, Frankfurt,
Singapore and the Cayman Islands.1627
Given these market characteristics
and practices, participants in the
security-based swap market may bear
the financial risk of a security-based
swap transaction in a location different
from the location where the transaction
is arranged, negotiated, or executed, or
where economic decisions are made by
managers on behalf of beneficial
owners. Market activity may also occur
in a jurisdiction other than where the
market participant or its counterparty
books the transaction. Similarly, a
participant in the security-based swap
market may be exposed to counterparty
risk from a counterparty located in a
jurisdiction that is different from the
market center or centers in which it
participates.
d. Common Business Structures for
Firms Engaged in Security-Based Swap
Dealing Activity
A financial group that engages in a
global security-based swap dealing
business in multiple market centers may
choose to structure its dealing business
in a number of different ways. This
structure, including where it books the
transactions that constitute that
business and how it carries out marketfacing activities that generate those
transactions, reflects a range of business
and regulatory considerations, which
each financial group may weigh
differently.
A financial group may choose to book
all of its security-based swap
transactions, regardless of where the
transaction originated, in a single,
central booking entity. That entity
generally retains the risk associated
with that transaction, but it also may lay
off that risk to another affiliate via a
back-to-back transaction or an
assignment of the security-based
swap.1628 Alternatively, a financial
group may book security-based swaps
arising from its dealing business in
separate affiliates, which may be located
in the jurisdiction where it originates
the risk associated with the securitybased swap, or, alternatively, the
jurisdiction where it manages that risk.
1627 TIW

transaction records contain a proxy for
the domicile of an entity, which may differ from
branch locations, which are separately identified in
the transaction records.
1628 See U.S. Activity Proposing Release, 80 FR
27463, supra note 9; Cross-Border Proposing
Release, 78 FR 30977–78, supra note 6.

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Some financial groups may book
transactions originating in a particular
region to an affiliate established in a
jurisdiction located in that region.1629
Regardless of where a financial group
determines to book its security-based
swaps arising out of its dealing activity,
it is likely to operate offices that
perform sales or trading functions in
one or more market centers in other
jurisdictions. Maintaining sales and
trading desks in global market centers
permits the financial group to deal with
counterparties in that jurisdiction or in
a specific geographic region, or to
ensure that it is able to provide liquidity
to counterparties in other
jurisdictions,1630 for example, when a
counterparty’s home financial markets
are closed. A financial group engaged in
a security-based swap dealing business
also may choose to manage its trading
book in particular reference entities or
securities primarily from a trading desk
that can take advantage of local
expertise in such products or that can
gain access to better liquidity, which
may permit it to more efficiently price
such products or to otherwise compete
more effectively in the security-based
swap market. Some financial groups
prefer to centralize risk management,
pricing, and hedging for specific
products with the personnel responsible
for carrying out the trading of such
products to mitigate operational risk
associated with transactions in those
products.
The financial group affiliate that
books these transactions may carry out
related market-facing activities, whether
in its home jurisdiction or in a foreign
jurisdiction, using either its own
personnel or the personnel of an
affiliated or unaffiliated agent. For
example, the financial group may
determine that another affiliate in the
financial group employs personnel who
possess expertise in relevant products or
who have established sales relationships
with key counterparties in a foreign
jurisdiction, making it more efficient to
use the personnel of the affiliate to
engage in security-based swap dealing
activity on its behalf in that jurisdiction.
In these cases, the affiliate that books
these transactions and its affiliated
1629 There is some indication that this booking
structure is becoming increasingly common in the
market. See, e.g., ‘‘Regional swaps booking
replacing global hubs,’’ Risk.net (Sep. 4, 2015),
available at: http://www.risk.net/risk-magazine/
feature/2423975/regional-swaps-booking-replacingglobal-hubs. Such a development may be reflected
in the increasing percentage of new entrants that
have a foreign domicile, as described above.
1630 These offices may be branches or offices of
the booking entity itself, or branches or offices of
an affiliated agent, such as, in the United States, a
registered broker-dealer.

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agent may operate as an integrated
dealing business, each performing
distinct core functions in carrying out
that business.
Alternatively, the financial group
affiliate that books these transactions
may in some circumstances, determine
to engage the services of an unaffiliated
agent through which it can engage in
dealing activity. For example, a
financial group may determine that
using an interdealer broker may provide
an efficient means of participating in the
interdealer market in its own, or in
another, jurisdiction, particularly if it is
seeking to do so anonymously or to take
a position in products that trade
relatively infrequently.1631 A financial
group may also use unaffiliated agents
that operate at its direction. Such an
arrangement may be particularly
valuable in enabling a financial group to
service clients or access liquidity in
jurisdictions in which it has no securitybased swap operations of its own.
We understand that financial group
affiliates (whether affiliated with U.S.based financial groups or not) that are
established in foreign jurisdictions may
use any of these structures to engage in
dealing activity in the United States,
and that they may seek to engage in
dealing activity in the United States to
transact with both U.S.-person and nonU.S.-person counterparties. In
transactions with non-U.S.-person
counterparties, these foreign affiliates
may affirmatively seek to engage in
dealing activity in the United States
because the sales personnel of the nonU.S.-person dealer (or of its agent) in the
United States have existing
relationships with counterparties in
other locations (such as Canada or Latin
America) or because the trading
personnel of the non-U.S.-person dealer
(or of its agent) in the United States
have the expertise to manage the trading
books for security-based swaps on U.S.
reference securities or entities. We
understand that some of these foreign
affiliates engage in dealing activity in
the United States through their
personnel (or personnel of their
affiliates) in part to ensure that they are
able to provide their own
counterparties, or those of financial
group affiliates in other jurisdictions,
with access to liquidity (often in nonU.S. reference entities) during U.S.
business hours, permitting them to meet
1631 We understand that interdealer brokers may
provide voice or electronic trading services that,
among other things, permit dealers to take positions
or hedge risks in a manner that preserves their
anonymity until the trade is executed. These
interdealer brokers also may play a particularly
important role in facilitating transactions in lessliquid security-based swaps.

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client demand even when the home
markets are closed. In some cases, such
as when seeking to transact with other
dealers through an interdealer broker,
these foreign affiliates may act, in a
dealing capacity, in the United States
through an unaffiliated, third-party
agent.

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e. Current Estimates of Number of SBS
Dealers and Major SBS Participants
As discussed above, security-based
swap activity is concentrated in a
relatively small number of dealers,
which already represent a small
percentage of all market participants
active in the security-based swap
market. Based on analysis of 2014 data,
our earlier estimates of the number of
entities likely to register as securitybased swap dealers remain largely
unchanged.1632 Of the approximately 50
entities that we estimate may potentially
register as security-based swap dealers,
we believe it is reasonable to expect 22
to be non-U.S. persons.1633 Under the
rules as they currently exist, we
identified approximately 170 entities
engaged in single-name CDS activity,
with all counterparties, of $2 billion or
more. Of those entities, 155 would be
expected to incur assessment costs to
determine whether they meet the
‘‘security-based swap dealer’’ definition.
Approximately 57 of these entities are
non-U.S. persons.
Many of these dealers are already
subject to other regulatory frameworks
under U.S. law based on their role as
intermediaries or on the volume of their
positions in other products, such as
swaps. Available data supports our prior
estimates, based on our experience and
understanding of the swap and securitybased swap market that of the 55 firms
that might register as SBS Dealers or
Major SBS Participants, approximately
35 would also be registered with the
1632 See Registration Adopting Release, 80 FR
49000, supra note 989.
1633 These estimates are based on the number of
accounts in TIW data with total notional volume in
excess of de minimis thresholds, increased by a
factor of two, to account for any potential growth
in the security-based swap market, to account for
the fact that we are limited in observing transaction
records for activity between non-U.S. persons to
those that reference U.S. underliers, and to account
for the fact that we do not observe security-based
swap transactions other than in single-name CDS.
See U.S. Activity Proposing Release, 80 FR 27452,
supra note 9. See also Definitions Adopting Release,
77 FR 30725, n.1457, supra note 115.

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CFTC as Swap Dealers or Major Swap
Participants.1634 Based on our analysis
of TIW data and filings with the
Commission, we estimate that 16 market
participants expected to register as SBS
Dealers have already registered with the
Commission as broker-dealers and are
thus subject to Exchange Act and FINRA
requirements applicable to such entities.
Finally, as we discuss below, some
dealers may be subject to similar
requirements in one or more foreign
jurisdictions.
3. Security-Based Swap Market: Levels
of Security-Based Swap Trading
Activity
As already noted, firms that act as
dealers play a central role in the
security-based swap market. Based on
an analysis of 2014 single name CDS
data in TIW, accounts of those firms that
are likely to exceed the SBS Dealer de
minimis thresholds and trigger
registration requirements intermediated
transactions with a gross notional
amount of approximately $8.5 trillion,
over 60 percent of which was
intermediated by top 5 dealer
accounts.1635
These dealers transact with hundreds
or thousands of counterparties.
Approximately 35 percent of accounts
of firms expected to register as SBS
Dealers and observable in TIW have
entered into security-based swaps with
over 1,000 unique counterparty
accounts as of year-end 2014. 1636
Approximately 9 percent of these
accounts transacted with 500–1,000
unique counterparty accounts; another
1634 Based on our analysis of 2014 TIW data and
the list of swap dealers provisionally registered
with the CFTC, and applying the methodology used
in the Definitions Adopting Release, we estimate
that substantially all registered security-based swap
dealers would also be registered as swap dealers
with the CFTC. See U.S. Activity Proposing Release,
80 FR 27458, supra note 9; Registration Adopting
Release, 80 FR 49000, supra note 989. See also
CFTC list of provisionally registered swap dealers,
available at: http://www.cftc.gov/LawRegulation/
DoddFrankAct/registerswapdealer.
1635 Commission staff analysis of TIW transaction
records indicates that approximately 99 percent of
single name CDS price-forming transactions in 2014
involved an ISDA-recognized dealer.
1636 Many dealer entities and financial groups
transact through numerous accounts. Given that
individual accounts may transact with hundreds of
counterparties, we may infer that entities and
financial groups, which may have multiple
accounts, transact with at least as many
counterparties as the largest of their accounts in
terms of number of counterparties.

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35 percent transacted with 100–500
unique accounts, and only 22 percent of
these accounts intermediated swaps
with fewer than 100 unique
counterparties in 2014. The median
dealer account transacted with 453
unique accounts (with an average of
approximately 759 unique accounts).
Non-dealer counterparties transact
almost exclusively with these dealers.
The median non-dealer counterparty
transacted with 3 dealer accounts (with
an average of approximately 4 dealer
accounts) in 2014.
Figure 2 below describes the
percentage of global, notional
transaction volume in North American
corporate single-name CDS reported to
the TIW between January 2008 and
December 2014, separated by whether
transactions are between two ISDArecognized dealers (interdealer
transactions) or whether a transaction
has at least one non-dealer counterparty.
Figure 2 also shows that the portion
of the notional volume of North
American corporate single-name CDS
represented by interdealer transactions
has remained fairly constant and that
interdealer transactions continue to
represent a significant majority of
trading activity even as notional volume
has declined over the past six years,1637
from more than $6 trillion in 2008 to
less than $3 trillion in 2014.1638 The
high level of interdealer trading activity
reflects the central position of a small
number of dealers, each of which
intermediates trades with many
hundreds of counterparties. While we
are unable to quantify the current level
of trading costs for single-name CDS,
those dealers appear to enjoy market
power as a result of their small number
and the large proportion of order flow
they privately observe.
Figure 2: Global, notional trading
volume in North American corporate
single-name CDS by calendar year and
the fraction of volume that is
interdealer.
1637 The start of this decline predates the
enactment of the Dodd-Frank Act and the proposal
of rules thereunder, which is important to note for
the purpose of understanding the economic
baseline for this rulemaking.
1638 This estimate is lower than the gross notional
amount of $8.5 trillion noted above as it includes
only the subset of single-name CDS referencing
North American corporate documentation, as
discussed above.

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Against this backdrop 1639 of
declining North American corporate
single-name CDS activity, about half of
the trading activity in North American
corporate single-name CDS reflected in
the set of data we analyzed was between
counterparties domiciled in the United
States and counterparties domiciled
abroad, as shown in Figure 3 below.
Using the self-reported registered office
location of the TIW accounts as a proxy
for domicile, we estimate that only 12
percent of the global transaction volume
by notional volume between 2008 and
2014 was between two U.S.-domiciled
counterparties, compared to 48 percent
entered into between one U.S.domiciled counterparty and a foreigndomiciled counterparty and 40 percent
entered into between two foreigndomiciled counterparties.1640
1639 Adjustments to these statistics from the
proposal reflect additional analysis of TIW data. Cf.
Registration Adopting Release, 80 FR 49001, supra
note 989 (showing slightly different values for 2012
through 2014). For the purposes of this analysis, we
assume that same-day cleared transactions reflect
inter-dealer activity.
1640 For purposes of this discussion, we have
assumed that the registered office location reflects
the place of domicile for the fund or account, but
we note that this domicile does not necessarily

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If we consider the number of crossborder transactions instead from the
perspective of the domicile of the
corporate group (e.g., by classifying a
foreign bank branch or foreign
subsidiary of a U.S. entity as domiciled
in the United States), the percentages
shift significantly. Under this approach,
the fraction of transactions entered into
between two U.S.-domiciled
counterparties increases to 32 percent,
and to 51 percent for transactions
entered into between a U.S.-domiciled
counterparty and a foreign-domiciled
counterparty.
By contrast, the proportion of activity
between two foreign-domiciled
counterparties drops from 40 percent to
17 percent. This change in respective
shares based on different classifications
suggests that the activity of foreign
subsidiaries of U.S. firms and foreign
branches of U.S. banks accounts for a
higher percentage of security-based
swap activity than U.S. subsidiaries of
foreign firms and U.S. branches of
foreign banks. It also demonstrates that
correspond to the location of an entity’s sales or
trading desk. See U.S. Activity Adopting Release,
81 FR 8607.

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financial groups based in the United
States are involved in an overwhelming
majority (approximately 83 percent) of
all reported transactions in North
American corporate single-name CDS.
Financial groups based in the United
States are also involved in a majority of
interdealer transactions in North
American corporate single-name CDS.
Of transactions on North American
corporate single-name CDS between two
ISDA-recognized dealers and their
branches or affiliates, 65 percent of
transaction notional volume involved at
least one account of an entity with a
U.S. parent.
In addition, we note that a significant
majority of North American corporate
single-name CDS transactions occur in
the interdealer market or between
dealers and non-U.S.-person nondealers, with the remaining (and much
smaller) portion of the market consisting
of transactions between dealers and
U.S.-person non-dealers. Specifically,
79.5 percent of North American
corporate single-name CDS transactions
involved either two ISDA-recognized
dealers or an ISDA-recognized dealer
and a non-U.S.-person non-dealer.
Approximately 20 percent of such

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transactions involved an ISDA-

recognized dealer and a U.S.-person
non-dealer.

4. Global Regulatory Efforts
In 2009, leaders of the G20—whose
membership includes the United States,
18 other countries, and the European
Union (‘‘EU’’)—addressed global
improvements in the OTC derivatives
markets. They expressed their view on
a variety of issues relating to OTC
derivatives contracts. In subsequent
summits, the G20 leaders have returned
to OTC derivatives regulatory reform
and encouraged international
consultation in developing standards for
these markets.1641
Many SBS Dealers likely will be
subject to foreign regulation of their
security-based swap activities that are
similar to regulations that may apply to
them pursuant to Title VII, even if the
relevant foreign jurisdictions do not
classify certain market participants as
‘‘dealers’’ for regulatory purposes. Some
of these regulations may duplicate, and
in some cases conflict with, certain
elements of the Title VII regulatory
framework.
Foreign legislative and regulatory
efforts have focused on five general

areas: Moving OTC derivatives onto
organized trading platforms, requiring
central clearing of OTC derivatives,
requiring post-trade reporting of
transaction data for regulatory purposes
and public dissemination of
anonymized versions of such data,
establishing or enhancing capital
requirements for non-centrally cleared
OTC derivatives transactions, and
establishing or enhancing margin and
other risk mitigation requirements for
non-centrally cleared OTC derivatives
transactions. Foreign jurisdictions have
been actively implementing regulations
in connection with each of these
categories of requirements. Regulatory
transaction reporting requirements are
in force in a number of jurisdictions
including the EU, Hong Kong SAR,
Japan, Australia, Brazil, Canada, China,
India, Indonesia, South Korea, Mexico,
Russia, Saudi Arabia, and Singapore;
other jurisdictions are in the process of
proposing legislation and rules to
implement these requirements.1642 In

1641 See, e.g., G20 Leaders’ Final Declaration,
November 2011, para. 24 available at: https://
g20.org/wp-content/uploads/2014/12/Declaration_
eng_Cannes.pdf.

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1642 Information regarding ongoing regulatory
developments described in this section was
primarily obtained from progress reports on
implementation of OTC derivatives market reforms
published by the Financial Stability Board. These
are available at: http://

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addition, a number of major foreign
jurisdictions have initiated the process
of implementing margin and other risk
mitigation requirements for noncentrally cleared OTC derivatives
transactions.1643 Several jurisdictions
have also taken steps to implement the
Basel III recommendations governing
capital requirements for financial
entities, which include enhanced
capital charges for non-centrally cleared
OTC derivatives transactions.1644
www.financialstabilityboard.org/publications/
progress-reports/?policy_area[]=17.
1643 In November 2015, the Financial Stability
Board reported that 12 member jurisdictions
participating in its tenth progress report on OTC
derivatives market reforms had in force a legislative
framework or other authority to require exchange of
margin for non-centrally cleared transactions and
had published implementing standards or
requirements for consultation or proposal. A further
11 member jurisdictions had a legislative
framework or other authority in force or published
for consultation or proposal. See Financial Stability
Board, OTC Derivatives Market Reforms Tenth
Progress Report on Implementation (November
2015), available at http://
www.financialstabilityboard.org/wp-content/
uploads/OTC-Derivatives-10th-Progress-Report.pdf.
1644 In November 2015, the Financial Stability
Board reported that 18 member jurisdictions
participating in its tenth progress report on OTC
derivatives market reforms had in force standards
or requirements covering more than 90% of

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5. Dually Registered Entities
We expect the magnitude of the above
economic costs, benefits, and effects on
efficiency, competition and capital
formation to depend on the extent to
which SBS Entities are already
complying with similar business
conduct rules. As discussed extensively
in the baseline and in the sections that
follow, most entities expected to register
with the Commission and become
subject to these final business conduct
standards have registered with the CFTC
as Swap Entities or with the
Commission as broker-dealers.
Therefore, they have already become
subject to CFTC’s adopted external
business conduct rules and/or FINRA
rules related to, among others,
suitability, communications with the
public, supervision, and compliance.
The Commission has sought to
harmonize the regulatory regimes in
recognition of swap and security-based
swap market integration and extensive
cross-market participation. As a result,
some SBS Entities may have already
restructured their activities to comply
with many of the substantive business
conduct standards being adopted.
Dually registered SBS Entities that have
already restructured their systems and
activities to comply with parallel CFTC
and FINRA rules may incur lower costs
relative to non-dually registered SBS
Entities. The specific economic costs,
benefits, and effects on efficiency,
competition, and capital formation of
various business conduct rules and
requirements are discussed in further
detail in the sections that follow.
Wherever practicable, we also evaluate
the economic effects of the various rules
being adopted against these parallel
rules, and other reasonable alternatives.

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6. Cross-Market Participation
As noted above, persons registered as
SBS Dealers and Major SBS Participants
are likely also to engage in swap
activity, which is subject to regulation
by the CFTC.1645 This overlap reflects
the relationship between single-name
CDS contracts, which are security-based
transactions that require enhanced capital charges
for non-centrally cleared transactions. A further
three member jurisdictions had a legislative
framework or other authority in force and had
adopted implementing standards or requirements
that were not yet in force. An additional three
member jurisdictions had a legislative framework or
other authority in force or published for
consultation or proposal. See Financial Stability
Board, OTC Derivatives Market Reforms Tenth
Progress Report on Implementation (November
2015), available at http://
www.financialstabilityboard.org/wp-content/
uploads/OTC-Derivatives-10th-Progress-Report.pdf.
1645 See U.S. Activity Adopting Release, 81 FR
8609; Registration Adopting Release, 80 FR 49000,
supra note 989.

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swaps, and index CDS contracts, which
may be swaps or security-based swaps.
A single-name CDS contract covers
default events for a single reference
entity or reference security. Index CDS
contracts and related products make
payouts that are contingent on the
default of index components and allow
participants in these instruments to gain
exposure to the credit risk of the basket
of reference entities that comprise the
index, which is a function of the credit
risk of the index components. A default
event for a reference entity that is an
index component will result in payoffs
on both single-name CDS written on the
reference entity and index CDS written
on indices that contain the reference
entity. Because of this relationship
between the payoffs of single-name CDS
and index CDS products, prices of these
products depend upon one another,1646
creating hedging opportunities across
these markets.
These hedging opportunities mean
that participants that are active in one
market are likely to be active in the
other. Commission staff analysis of
approximately 4,500 TIW accounts that
participated in the market for singlename CDS in 2014 revealed that
approximately 3,000 of those accounts,
or 67 percent, also participated in the
market for index CDS. Of the accounts
that participated in both markets, data
regarding transactions in 2014 suggest
that, conditional on an account
transacting in notional volume of index
CDS in the top third of accounts, the
probability of the same account landing
in the top third of accounts in terms of
single-name CDS notional volume is
approximately 64 percent; by contrast,
the probability of the same account
landing in the bottom third of accounts
in terms of single-name CDS notional
volume is only 10 percent.1647
Similarly, since the payoffs of
security-based swaps are dependent
upon the value of underlying securities,
activity in the security-based swap
market can be correlated with activity in
underlying securities markets. Securitybased swaps may be used in order to
hedge or speculate on price movements
of reference securities or the credit risk
of reference securities. For instance,
prices of both CDS and corporate bonds
1646 ‘‘Correlation’’ typically refers to linear
relationships between variables; ‘‘dependence’’
captures a broader set of relationships that may be
more appropriate for certain swaps and securitybased swaps. See, e.g., Casella, George and Roger L.
Berger, ‘‘Statistical Inference’’ (2002), at 171.
1647 The Commission recently revised its
methodology for estimating cross-market
participation of TIW accounts. This has resulted in
an increase in the reported number of accounts that
participated in both markets relative to previous
Commission releases.

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are sensitive to the credit risk of
underlying reference securities. As a
result, trading across markets may
sometimes result in information and
risk spillovers between these markets,
with informational efficiency, pricing
and liquidity in the security-based swap
market affecting informational
efficiency, pricing, and liquidity in
markets for related assets, such as
equities and corporate bonds.1648
7. Pay to Play Prohibitions
The baseline against which we are
assessing the potential effects of the pay
to play prohibitions in these final
business conduct rules reflects MSRB
Rules G–37 and G–38, SEC Rule 206(4)–
5 under the Advisers Act, as well as
CFTC Regulation 23.451. First, we note
that MSRB rules G–37 and G–38 are
currently effective and are part of the
economic baseline. Second, Rule
206(4)–5 prohibits an adviser and its
covered associates from providing or
agreeing to provide, directly or
indirectly, payment to any third party
for solicitation of advisory business
from any government entity on such
adviser’s behalf unless such third party
is a ‘‘regulated person,’’ defined in Rule
206(4)–5 as (i) an SEC-registered
investment adviser, (ii) a registered
broker or dealer subject to pay-to-play
rules adopted by a registered national
securities association, or (iii) a
registered municipal advisor that is
subject to pay-to-play rules adopted by
the MSRB (‘‘third-party solicitor ban’’).
Although the compliance date for the
third-party solicitor ban was July 31,
2015, the Division of Investment
Management stated that it will not
1648 See the Registration Adopting Release, 80 FR
49003, supra note 989. Empirical evidence on the
direction and significance of the CDS-bond market
spillover is mixed. See also Massa and Zhang (2012)
Massa & L. Zhang, CDS and the Liquidity Provision
in the Bond Market (INSEAD Working Paper No.
2012/114/FIN, 2012), available at http://
papers.ssrn.com/sol3/
papers.cfm?abstract_id=2164675 (considering
whether the presence of CDS improves pricing and
liquidity of investment grade bonds in 2001–2009);
S. Das, M. Kalimipalli & S. Nayak, Did CDS Trading
Improve the Market for Corporate Bonds?, 111 J.
Fin. Econ. 495 (2014) (considering the effects of
CDS trading on the efficiency, pricing error and
liquidity of corporate bond markets); M. Oehmke &
A. Zawadowski, The Anatomy of the CDS Market,
Rev. of Fin. Studies (forthcoming), available at
https://www0.gsb.columbia.edu/faculty/moehmke/
papers/OehmkeZawadowski_CDS.pdf (suggesting a
standardization and liquidity role of CDS markets
and documenting cross-market arbitrage links
between the CDS market and the bond market); and
Boehmer, S. Chava, & H. Tookes, Related Securities
and Equity Market Quality: The Cases of CDS, 50(3)
J. Fin. & Quant. Analysis (2015), pp 509–541
(providing evidence that firms with traded CDS
contracts on their debt experience significantly
lower liquidity and price efficiency in equity
markets when these firms are closer to default and
in times of high market volatility).

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recommend enforcement action to the
Commission with respect to the thirdparty solicitor ban until the later of (1)
the effective date of a FINRA pay-toplay rule or (2) the effective date of an
MSRB pay-to-play rule for registered
municipal advisors.1649 Therefore,
certain parts of Rule 206(4)–5—the
prohibition from receiving
compensation for advising government
entities for two years after certain
contributions are made, and the
prohibition from coordinating and
soliciting contributions to government
officials and parties—enter into our
economic baseline.
Third, Commodity Exchange Act Rule
23.451 prohibits Swap Dealers from
offering to enter or entering into a swap
with governmental special entities
within two years of any contribution to
an official of such entity by the Swap
Dealer or any covered associate. The
CFTC has similarly stated that the rule
is intended to deter fraud and undue
influence that harms the public, and to
promote consistency in the business
conduct standards that apply to
financial market professionals dealing
with municipal entities. However, CFTC
Letter No. 12–33 provided no-action
relief from Regulation 23.451 to Swap
Dealers and their covered associates
with respect to ‘‘governmental plans’’
defined in Section 3 of ERISA, to the
extent that such plans are not otherwise
covered by SEC and/or MSRB rules. The
CFTC has also clarified that the two year
‘‘look-back’’ period does not include
any time period that precedes the date
on which an entity is required to
register as a Swap Dealer.1650
As indicated above, we estimate that
up to 35 of 55 entities seeking to register
as SBS Entities may be registered with
the CFTC as Swap Entities.
Additionally, based on an analysis of
2014 TIW data on accounts likely to
trigger SBS Dealer registration
requirements, we have identified 18
entities belonging to a corporate group
with at least one MSRB registered
broker-dealer or bank-dealer.1651
Finally, as discussed in section V, the
Commission continues to estimate that
the overwhelming majority of
1649 See ‘‘Staff Responses to Questions About the
Pay to Play Rule,’’ Question I.4, updated as of Jun.
25, 2015. Available at: http://www.sec.gov/divsions/
investment/pay-to-play-faq.htm, last accessed 4/6/
2016.
1650 See CFTC 77 FR at 9827. See also: CFTC NoAction Letter No. 12–33 Amended, available at
http://www.cftc.gov/ucm/groups/public/
@lrlettergeneral/documents/letter/12-33.pdf, last
accessed 8/27/2015.
1651 See ‘‘Broker-Dealers and Bank Dealers
Registered with the MSRB’’, available at http://
www.msrb.org/BDRegistrants.aspx, last accessed
2/8/2016.

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independent representatives of special
entities subject to these final rules are
likely already registered as municipal
advisors.1652 As a result of the pay to
play rules currently in effect, some SBS
Entities and third-party independent
advisers of special entities may have
restructured their business practices in
various markets to comply with certain
restrictions imposed by pay to play
rules on investment advisers, municipal
advisors, and SBS Entities discussed
above.
C. Costs and Benefits of Business
Conduct Rules
1. Verification of Status and Know Your
Counterparty Rules
Rule 15Fh–3(a)(1) requires an SBS
Entity to verify that a counterparty
meets the standards for an eligible
contract participant before entering into
a security-based swap with the
counterparty, except for transactions
executed on a registered national
securities exchange. Rule 15Fh–3(a)(2)
requires SBS Entities to verify whether
a known counterparty is a special entity
before entering into a security-based
swap with that counterparty, except for
transactions executed on a registered or
exempt SEF or registered national
securities exchange, where the SBS
Entity does not know the identity of the
counterparty at a reasonably sufficient
time prior to execution of the
transaction to permit compliance with
obligations of the rule. Rule 15Fh–
3(a)(3) requires SBS Entities to verify
whether a counterparty is eligible to
elect not to be a special entity under
Rule 15Fh–2(d)(4) and, if so, notify such
counterparty of its right to make such an
election.1653 Finally, Rule 15Fh–3(e)
requires that SBS Dealers establish,
maintain and enforce written policies
and procedures reasonably designed to
obtain and retain records of the essential
facts concerning each known
counterparty necessary for conducting
business with such counterparties. The
scope of such essential facts includes
facts required to comply with applicable
1652 As of January 1, 2016 there were 665
municipal advisors registered with the Commission
(http://www.sec.gov/help/foia-docsmuniadvisorshtm.html). Of those, 381 indicated
that they expect to provide advice concerning the
use of municipal derivatives or advice or
recommendations concerning the selection of other
municipal advisors or underwriters with respect to
municipal financial products or the issuance of
municipal securities. We expect that many of these
municipal advisors will also act as independent
representatives for other special entities. As
discussed in Section V, the Commission estimates
that approximately 385 municipal advisors will act
as independent representatives to special entities
with respect to security-based swaps.
1653 See Section II.H supra.

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laws, regulations and rules; facts
required to implement the SBS Dealer’s
credit and operational risk management
policies; and information regarding the
authority of persons acting for such
counterparties.1654
We recognize that many SBS Entities,
in the course of business, already may
be conducting due diligence and fact
gathering concerning their securitybased swap counterparties, which may
reduce the economic effects of this rule.
The scope of the ‘‘know your
counterparty’’ rule reflects differences
in the roles of entities likely to register
as SBS Dealers and entities that may
register as Major SBS Participants. The
Commission believes that entities that
will register as SBS Dealers will
intermediate a large volume of securitybased swap transactions as both
principal risk holders and agents
transacting on behalf of principal risk
holders, such as special entities. As
discussed in the economic baseline, we
understand that entities currently
operating as dealers in security-based
swap markets play a central
intermediation role, transacting with
hundreds and thousands of non-dealer
counterparties and accounting for large
activity volumes. At the same time, the
Commission expects that Major SBS
Participants will hold large positions in
security-based swaps, but have low
volumes of security-based swap activity.
Hence, we expect Major SBS
Participants may not play the central
intermediation role fulfilled by SBS
Dealers.
These rules limit the scope of
application of the ‘‘know your
counterparty’’ requirement to SBS
Dealers, and exclude Major SBS
Participants. As a result, entities that
may register as Major SBS Participants
will not bear the costs of compliance
with this rule. At the same time, SBS
Dealers will be required to comply and
bear related compliance costs. We note
that this approach is substantially
similar to the CFTC’s final external
business conduct rules, which limit the
scope of ‘‘know your counterparty’’
requirements to Swap Dealers. This
results in a consistent treatment of
entities that may trigger both Major
Swap Participant and Major SBS
Participant registration requirements,
and will enable Major Swap Participants
to enter into security-based swap
positions without bearing additional
compliance costs to comply with our
‘‘know your counterparty’’ requirement.
1654 The ability of SBS Entities to rely on
representations to comply with these and other
business conduct rules is discussed in detail in the
section VI.C.4 below.

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To the extent that SBS Dealers do not
already collect and retain essential facts
about their counterparties as a part of
their normal course of business, this
requirement will increase the cost to
SBS Dealers of entering into securitybased swaps. Specifically, SBS dealers
will incur costs of complying with the
verification requirements and costs of
establishing, maintaining, and enforcing
policies and procedures reasonably
designed to obtain and retain essential
facts about each known counterparty
that are necessary for conducting
business with such counterparty. We
note that the ability to rely on
counterparty representations to fulfill
the SBS Dealer diligence requirement
partly lowers compliance burdens, as
reflected in our estimates. Further, to
the extent that the majority of SBS
Entities have already cross-registered
with the CFTC as Swap Entities and
have become subject to substantially
similar verification and ‘‘know your
counterparty’’ requirements, and to the
extent the majority of their
counterparties transact across swap and
security-based swap markets and have
already benefited from existing CFTC
rules, the economic effects of these final
rules may be partly mitigated.
Direct costs of compliance with
verification of status requirements
related to adherence to standardized
protocols by SBS Entities that are not
dually registered as Swap Entities are
estimated at, approximately,
$17,600.1655 As discussed in Section V,
these estimates include costs related to
verification of counterparty’s eligibility
to elect not to be a special entity and
notification of counterparties of their
right to make such an election. In
addition, SBS Dealers will also be
required to comply with ‘‘know your
counterparty’’ obligations, which will
require a review of existing policies and
procedures and related documentation,
involving an estimated initial cost of
$95,000 for all SBS Dealers.1656 Further,
direct ongoing costs of ‘‘know your
counterparty’’ obligations are estimated
at approximately $4,370,000 per year for
all SBS Dealers.1657
Increases in SBS Entity costs due to
these obligations may be reflected in the
terms offered to counterparties, and
increases in counterparty costs may
affect their willingness to transact in
security-based swaps. Further,

counterparties of SBS Entities that are
not also participating in swap markets
and relying on the above protocols may
incur costs associated with the
verification of status requirement and
related adherence letters, estimated at
approximately $3,051,840.1658 As
estimated in Section V, counterparties
or their agents will also be required to
collect and provide essential facts to the
SBS Dealer to comply with the ‘‘know
your counterparty’’ obligations for an
initial total cost estimate of
approximately $41,420,000.1659
We note that the eligible contract
participant status verification
requirement does not apply to
transactions executed on a registered
national securities exchange. In
addition, the special entity status
verification requirement does not apply
to transactions where the SBS Entity
does not know the identity of the
counterparty at a reasonably sufficient
time prior to execution of the
transaction to permit compliance. This
limits the scope of the transactions
covered by final rules, therefore
potentially reducing the expected
benefits. However, since anonymous
transactions will not be subject to these
requirements, the rule imposes lower
costs, delays and implementation
challenges with respect to anonymous
trades. This approach to anonymous
transactions executed on registered
exchanges or SEFs may incentivize SBS
Entities to trade through these venues,
to avoid imposition of these obligations
under final business conduct rules. The
compliance costs imposed on SBS
Entities by these and other business
conduct requirements (excluding
anonymous transactions executed on a
registered exchange or SEF) may lead to
a decrease in the volume of OTC
bilateral security-based swap trades, and
an increase in the volume of
transactions executed on exchanges or
SEFs. This may facilitate liquidity, price
discovery and risk mitigation in these
transparent venues, which may attract
greater market participation. The overall
effects will depend on the value of
disclosure and suitability requirements,
customization and bilateral
relationships in OTC transactions,
compared with the standardization,
liquidity and execution quality of
contracts in SEFs and exchanges, among
others.

1655 Initial outside counsel cost: $500 * (20 nonCFTC registered SBS Entities) = $10,000. Initial
adherence letter burden: (In-house attorney at $380
per hour) × 20 hours = $7,600.
1656 Initial cost: (In-house attorney at $380 per
hour) × 250 hours = $95,000.
1657 (In-house attorney at $380 per hour) × 11,500
hours = $4,370,000.

1658 Initial costs of disclosure of essential facts:
$500 × (3,468 counterparties) = $1,734,000. Initial
costs of adherence letters: (In-house attorney at
$380 per hour) × 3,468 counterparties = $1,317,840.
Total initial costs: $1,734,000 + $1,317,840 =
$3,051,840.
1659 Initial cost: (In-house attorney at $380 per
hour) × 109,000 hours = $41,420,000.

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As an alternative to the approach
taken in the final rules, the Commission
has considered imposing specific
requirements as to the form and manner
of documentation. Specific
documentation requirements could
result in greater information gathering
and documentation by SBS Entities
fulfilling their status verification and
‘‘know your counterparty’’ obligations,
which may further strengthen
counterparty protections and reduce
evasion. However, we recognize
commenter concerns regarding costs
and loss of flexibility from imposing
specific documentation requirements,
and the importance of private
contractual negotiation, as well as the
need to impose effective verification
and documentation requirements to
facilitate enforcement.1660 We therefore
declined to adopt this approach.
The Commission is adopting a ‘‘know
your counterparty’’ requirement based
on a policies and procedures approach.
However, the final rules explicitly
delineate certain items that the
Commission believes are essential facts
concerning the counterparty that are
necessary for conducting business with
such counterparty. The CFTC has
adopted a substantially similar
requirement for swap dealers to
implement policies and procedures
reasonably designed to obtain and retain
a record of the essential facts about each
known counterparty that are necessary
for conducting business with such
counterparty. As noted earlier, in light
of extensive cross-market participation
between swap and security-based swap
markets, and expected cross-registration
of SBS Entities already complying with
CFTC’s business conduct rules,
harmonization with the CFTC regime
may facilitate continued integration
between these markets and may
potentially reduce duplicative
compliance costs for some dual
registrants.
2. Disclosures and Communications
The Commission is adopting rules
concerning SBS Entity disclosures of
material risks, characteristics,
incentives, conflicts of interest and
daily mark of security-based swaps to
their counterparties. The final rules also
require SBS Entities to make a written
record of the non-written disclosures
and provide a written version of these
disclosures to counterparties no later
than the delivery of the trade
acknowledgement for a particular
transaction. We note that the scope of
the final disclosure requirements is
1660 See FIA/ISDA/SIFMA, supra note 5; CFA,
supra note 5.

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limited to counterparties that are not
themselves SBS or Swap Entities, the
economic effects of which are discussed
below.
Broadly, these disclosure rules may
mitigate information asymmetries
between more informed SBS Entities
and less informed counterparties, and
may allow them to make more informed
decisions about capital allocation and
counterparty selection. At the same
time, SBS Entities profit from
information rents 1661 and, to the extent
that disclosures will inform their
counterparties, SBS Entities may forgo
profits on security-based swaps with
counterparties as a result of these
requirements. In addition, SBS Entities
will incur direct compliance costs. As
discussed in Section V and consistent
with our analysis in the Proposing
Release, compliance with disclosure
rules will involve an initial cost burden
of which has been estimated at
approximately $25,080,000, with the
ongoing burden estimated at $2,508,000
for all SBS Entities.1662 Similarly, the
Commission estimates that information
technology infrastructure required to
comply with final disclosure rules will
require will cost approximately
$124,520,000 initially, and an
additional $62,260,000 per year for all
SBS Entities.1663 In addition, the
Commission estimates that SBS Entities
will incur costs of evaluating whether
more particularized disclosures are
necessary for each transaction and of
developing the additional disclosures
for an ongoing aggregate estimated cost
of $121,124,000.1664 These and other
costs less amenable to quantification
and discussed below may be passed on
to counterparties.
These rules may enhance
transparency and protect counterparties,
1661 Rents refer to profits that SBS Entities earn
by trading with counterparties who are less
informed. In a market with competitive access to
information, there is no informational premium;
SBS Entities only earn a liquidity premium. The
difference between the competitive liquidity
premium and the actual profits that SBS Entities
earn is the economic rent. See Cross-Border
Adopting Release, 79 FR 47283.
As the Commission articulated in other releases,
transparency stemming from the SDR Rules and
Regulation SBSR should reduce the informational
advantage of SBS dealers and promote competition
among SBS dealers and other market participants.
See SDR Registration Release 80 FR at 14528, supra
note 1202; Regulation SBSR Adopting Release,
supra note 1602.
1662 Initial cost: (In-house attorney at $380 per
hour) × 66,000 hours = $25,080,000. Ongoing cost:
(In-house attorney at $380 per hour) × 6,600 hours
= $2,508,000.
1663 Initial cost: (Compliance manager at $283 per
hour) × 440,000 hours = $124,520,000. Ongoing
cost: (Compliance manager at $283 per hour) ×
220,000 hours = $62,260,000.
1664 Ongoing cost: (Compliance manager at $283
per hour) × 428,000 hours = $121,124,000.

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a. Risks, Characteristics, and Conflicts of
Interest
Rule 15Fh–3(b) requires SBS Entities
to make disclosures concerning a
security based swap’s material risks and
characteristics, and the SBS Entity’s
material incentives or conflicts of
interest before entering into a securitybased swap. In addition to
implementing the statutory
requirements, the rule also requires SBS
Entities to make a written record of the
non-written disclosures and provide a
written version of these disclosures to
counterparties in a timely manner, but
no later than the delivery of the trade
acknowledgement for a particular
transaction.
In evaluating the economic effects of
this rule, we note that security-based
swaps are complex products, and
security-based swap markets are more
opaque than markets for regular equity
or fixed income products. Securitybased swap markets are characterized by
a high degree of informational
asymmetry among various groups of
counterparties. As described in the
economic baseline, dealers intermediate

large volumes of security-based swaps,
observe quote solicitations and order
flow. In addition, SBS Dealers may
serve in a variety of capacities such as
placement agents, underwriters,
structurers, securitizers, and lenders in
relation to security-based swaps and the
securities underlying them. Further, as
outlined above, SBS Dealers generally
have business incentives that may be
competing with those of their
counterparties as a result of taking on
the opposite side of the transactions,
and may have specific conflicts of
interest due to their advisory, market
making, trader and other roles. As
discussed in Section VI.A, Major SBS
Participants may also be better informed
about the risks and valuations of
security-based swaps due to their large
positions in security-based swaps,
compared with their non-SBS Entity
counterparties.
At the same time, counterparties that
are not SBS or Swap Entities do not
observe quote solicitations or order
flow, and are less likely to arrange or
structure security-based swaps and their
underlying securities. Such
counterparties may also be generally
less informed about the nature and risks
of security-based swaps due to their low
volume of activity, as indicated by the
low transaction share of non-dealers in
Table 1 of the economic baseline. Many
non-dealer counterparties transact in
security-based swaps through
investment advisers; however
approximately 7% transact in securitybased swaps directly. If the required
disclosures are informative to non-SBS
Entities, these final rules may help less
informed market participants make
more informed counterparty and capital
allocation choices. The records
requirement may facilitate the
implementation of the disclosure
requirement, enabling counterparties to
reference the non-written disclosures
made prior to entering into the swap
during the life of the security-based
swap.
As we have recognized,1666
informational asymmetry can negatively
affect market participation and decrease
the amount of trading—a problem
commonly known as adverse
selection.1667 When information about
security-based swap risks, liquidity,
pricing and counterparty incentives is
scarce, market participants may be less
willing to enter into transactions and
the overall level of trading may fall. To

1665 See Table 2 of the economic baseline, which
shows the overwhelming majority of most groups of
non-dealer market participants are represented by
investment advisers in security-based swap
transactions. See also, e.g., MFA, supra note 5.

1666 See, e.g., Registration Adopting Release 80 FR
at 49004, supra note 989.
1667 See George A. Akerlof, The Market For
‘‘Lemons’’: Quality Uncertainty and the Market
Mechanism, 84 Q.J. Econ. 488 (1970).

but may also adversely affect the
willingness of SBS Entities to
intermediate OTC security-based swaps
with non-SBS or Swap Entity
counterparties, and the costs of entering
OTC security-based swaps for non-SBS
or Swap Entity counterparties may
increase. This fundamental tradeoff is
discussed in more detail in the sections
below with respect to individual
disclosure requirements, their scope and
implementation. The overall economic
effects of the final disclosure
requirements will depend on the
severity of informational asymmetries
and conflicts of interest in securitybased swap markets, the ability of some
counterparties of SBS Entities to obtain
similar information independently
without the required disclosures and the
costs of doing so,1665 and the
information content of the required
disclosures, and the extent to which
market participants have already
learned from similar disclosures
pertaining to swap transactions.
We note that the SBS Entities will not
be required to comply with pretransaction disclosure requirements if
the identity of the counterparty is not
known to the SBS Entity at a reasonably
sufficient time prior to execution of the
transaction to permit the SBS Entity to
comply with these obligations.

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the extent that adverse selection costs
are currently present in security-based
swap markets, if market participants
become better informed as a result of
these final rules, they may increase their
activity in security-based swaps, which
may facilitate greater informational
efficiency and liquidity in securitybased swap markets. Disclosures may
inform counterparties of SBS Entities
about security-based swap markets, and
counterparties may learn from
repeatedly accessing these markets.
Hence, most of the benefits are expected
to be incurred by existing participants
when the first disclosures are made, and
by new market participants when they
first enter the market. However, to the
extent that disclosures will contain
transaction-specific information
concerning risks, incentives, pricing and
clearing of individual security-based
swaps, the informational benefits
described above may persist.
At the same time, disclosures required
under these proposed rules will involve
costs to SBS Entities and their
counterparties. As discussed in Section
V, SBS Entities will bear direct
compliance burdens related to the
disclosures, which are reflected in our
compliance cost estimates above. In
addition, since SBS Entities are more
informed about security-based swaps,
they are able to extract information rents
in the form of higher markups and fees
charged to non-dealer counterparties. If
SBS Entity disclosures better inform
counterparties concerning
characteristics and risks of securitybased swaps, these rules may reduce the
informational advantage of SBS Entities
relative to their counterparties and
decrease profitability of transactions
with non-SBS Entity counterparties,
which may reduce incentives for dealers
to provide liquidity to these
counterparties.1668
We recognize that the above costs may
be passed on to counterparties through
more adverse price and non-price terms
of security-based swaps. To the extent
that SBS Entities may be unable to
recover these costs, they may become
less likely to intermediate transactions
with non-SBS or Swap Entity
counterparties and decrease
participation in U.S. security-based
1668 For instance, Grossman and Stiglitz (1980)
showed that because information is costly, prices
cannot perfectly reflect the information which is
available, since if it did, those who spent resources
to obtain it would receive no compensation. In
other words, informational efficiency reduces
incentives of economic agents to expend resources
to acquire information, and there is an equilibrium
amount of ‘‘disequilibrium’’. See Sanford J.
Grossman and Joseph E. Stiglitz, On the
Impossibility of Informationally Efficient Markets,
70 American Economic Review 393–408 (1980).

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swap markets. Further, since final
business conduct rules require these
disclosures to be made prior to entering
into the security-based swap, the
disclosure requirements may involve
some delays in execution and may affect
liquidity in security-based swaps, to the
extent that these disclosures are not
already being made in master
agreements or post trade
acknowledgements. We have considered
how the timing, manner and content of
disclosures may affect these competing
considerations. First, we recognize that
the ability to rely on master agreements,
standardized disclosures and ex post
trade acknowledgements of oral
disclosures may significantly reduce
ongoing transaction specific costs and
potential execution delays, as
recognized by a commenter,1669 but may
reduce the specificity and information
content of disclosures. As the
Commission discussed in the Proposing
Release,1670 security-based swaps are
executed under master agreements and
SBS Entities may elect to make required
disclosures in a master agreement or
accompanying standardized document.
However, as stated in the Proposing
Release and discussed in Section II,
supra, standardized disclosures will not
be sufficient in all circumstances and
certain provisions may need to be
tailored to the particular transaction,
most notably pricing and other
transaction-specific commercial terms.
We have considered commenter
concerns that oral disclosures may not
satisfy the goal of pre-trade
transparency, may make enforcement
more difficult, and may allow SBS
Entities to obscure conflicts of interest
and misrepresent risks until after trade
confirmation.1671 However, we are
sensitive to the fact that alternative
requirements to provide extensive
written disclosures of risks,
characteristics, incentives and conflicts
of interest before an SBS Entity enters
into a transaction with a counterparty
may increase transaction costs or
impose execution delays, which may be
particularly significant in periods of
high market volatility. We have received
comments that a requirement to provide
these disclosures ‘‘at a reasonably
sufficient time’’ prior to entering the
security-based swap transaction, in
writing may better inform
unsophisticated counterparties,1672
however it may further raise the risks
1669 See
1670 See

FIA/ISDA/SIFMA, supra note 5.
Proposing Release, 76 FR at 42406, supra

note 3.
1671 See CFA, supra note 5.
1672 See Better Markets (August 2011), supra note
5 and CFA, supra note 5.

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discussed above. These could result in
potentially significant execution delays,
decreases in liquidity and SBS Entity
willingness to intermediate transactions
with non-SBS or Swap Entity
counterparties. We also note that, as
proposed, under the final rules,
standardized disclosure will not be
sufficient in all circumstances: Some
forms of disclosure may be highly
standardized, but certain provisions will
need to be tailored to reflect material
characteristics of individual
transactions, most notably pricing and
other transaction-specific commercial
terms. The CFTC’s approach to manner
and form of disclosures is substantially
similar to the proposed requirements
and to the rule being adopted. In the
Proposing Release, the Commission
interpreted the statutory requirement to
disclose material risks and
characteristics of the security-based
swap itself, and not of the underlying
reference security or index.1673 As an
alternative, the Commission could
include underliers in the scope of
required disclosures. Compared to the
approach being adopted, the alternative
may help better inform less
sophisticated investors and enable them
to make better tailored investment
decisions. However, it may increase
transactional costs and execution
delays, which are particularly costly
during times of high market volatility.
Further, information about many
underliers, such as corporate, municipal
and sovereign bonds, is more likely to
be publicly available.
We have received mixed comments
on the relative balance of these
competing considerations with respect
to underlier disclosures.1674 Under the
CFTC’s approach, disclosures regarding
underlying assets are not generally
required, but to the extent that
payments or cash-flows of the swap are
materially affected by the performance
of an underlying asset for which
publicly available information is not
available, the Swap Entity is required to
provide disclosure about the material
risks and characteristics of the
underlying asset to enable the
counterparty to assess the material risks
of the swap. As described in Section II,
our final rules require disclosure
regarding the referenced security, index,
asset or issuer if it would be considered
material to investors in evaluating the
1673 See Proposing Release, 76 FR at 42407, supra
note 3.
1674 See, e.g., Better Markets (2011) Letter; SIFMA
(2011) Letter; FIA/ISDA/SIFMA supra note 5;
Levin, supra note 5; Markit, supra note 5; Barnard,
supra note 5; CFA, supra note 5. Also see Section
II.G.2 supra.

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security-based swap, including any
related payments.
Finally, we have considered the
alternatives of adopting more
prescriptive requirements of
characteristics to be disclosed, an
explicit risk taxonomy, requirements
concerning volatility and liquidity
metrics, and scenario analysis regarding
political, economic events and
underlying market factors. These
approaches also present a tradeoff
between informing investors and
protecting counterparties, and costs and
willingness of SBS Entities to
intermediate trades with non-SBS or
Swap Entity counterparties, similar to
the effects described above.
For instance, disclosure of a scenario
analysis may inform counterparties, but
may be particularly costly since such
analysis may depend on the specific
terms of the agreement. To the extent
that the provision of scenario analysis
will impose costs on SBS Entities, a
requirement to include scenario analysis
as part of mandated disclosures may
result in bundling research and advice,
with SBS intermediation functions for
all affected transactions. This would
increase costs to SBS Entities, and these
costs are likely to be passed on to
counterparties. Further, one commenter
suggested that the requirement to
produce and disclose scenario analysis
for each transaction may delay
execution and expose counterparties to
market risk in times of market
volatility.1675
As an alternative, the CFTC’s
approach allows counterparties to opt in
to receive the scenario analysis for
swaps that are not available for trading
on a SEF, and requires Swap Dealers to
disclose to counterparties their right to
receive the scenario analysis. The
CFTC’s external business conduct rules
do not prescribe whether and how swap
dealers may be able to charge for such
analysis and we do not have data
regarding whether any counterparties
are taking advantage of the rule
provision. We understand that
counterparties already privately
negotiate terms of over-the-counter
derivatives with SBS Dealers, which
may also serve in advisory and other
capacities. As discussed in the
economic baseline, non-dealer market
participants are typically institutional
investors, the overwhelming majority of
which rely on investment advisers in
their security-based swap activities. It is
unclear that a requirement to disclose
the right to receive a scenario analysis
would affect the demand for such
analyses or inform counterparties.
1675 See

SIFMA (August 2011), supra note 5.

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The Commission has also considered
an alternative of adopting prescriptive
risk taxonomies, and requiring
disclosure of volatility and liquidity
metrics. While these requirements may
reveal additional information to
counterparties, they may be less
informative for customized over-the
counter security-based swaps, may fail
to capture risks of new products, and
would increase costs. To the extent that
these requirements would increase SBS
Entity costs of transacting with non-SBS
or Swap Entity counterparties, these
costs would also adversely affect terms
of security-based swaps for non-SBS or
Swap Entity counterparties. Rule 15Fh–
3(b)(2) also requires SBS Entities to
disclose any material incentives or
conflicts of interest that an SBS Entity
may have in connection with the
security swap, including any
compensation or other incentives from
any source other than the counterparty.
As articulated in Section II, this rule
will not require SBS Entities to report
all profits or expected returns from the
swap or related hedging or trading
activities, but will require reporting of
incentives, such as revenue sharing
arrangements, from any source other
than the counterparty in connection
with the swap. To the extent that
disclosure informs counterparties
regarding SBS Entity conflicts of
interest, counterparties of SBS Entities
may become better able to make
informed decisions about security-based
swaps and the SBS Entities they transact
with. When SBS Entity conflicts of
interest are severe, disclosure of such
conflicts may lead counterparties to
renegotiate the terms of a transaction or
select another counterparty with fewer
conflicts of interest, contributing to
more efficient capital allocation by nondealer counterparties. Importantly, this
requirement does not prohibit material
conflicts of interest. Instead, the rule
focuses on disclosure of material
incentives and conflicts of interest,
which may help counterparties better
evaluate the terms and risks of
transacting with an SBS Entity. The
severity of these conflicts of interest in
security-based swaps, the awareness of
non-SBS or Swap Entity counterparties
about these conflicts, the similarity
between disclosures of conflicts already
made by SBS Entities cross-registered as
Swap Entities under CFTC rules with
disclosures that will be made under
these final rules, and the
informativeness of the newly required
disclosures will influence the
magnitude of the benefits described
above.

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We recognize that final external
business conduct rules for Swap Entities
are already in place and include a
similar set of conflict of interest
disclosure rules. Swap Entities are
already disclosing incentives and
conflicts of interest in swap
transactions, which enters into our
economic baseline and is reflected in
current market activity. Non-SBS or
Swap Entity counterparties that are
transacting with the same dealers in
both swap and security-based swap
markets have benefited from such
disclosures in swap markets, and may
have already become familiar with
standardized disclosures by Swap
Dealer counterparties. To the extent that
disclosures by the same dealers related
to, for instance, index CDS and single
name CDS may be similar, such
counterparties may enjoy fewer benefits
of these final rules. However, we note
that the rules being adopted require
disclosures specific to security-based
swap transactions, and certain
disclosures will need to be tailored to a
particular security-based swap.
In addition to direct costs of
compliance born by SBS Entities, to the
extent that disclosures will provide new
and relevant information about SBS
Entity conflicts of interest, SBS Entities
with significant conflicts of interest may
lose business to SBS Entities that do not
have such conflicts. While this
requirement may impose costs on those
SBS Entities with the most acute
conflicts, such disclosures may benefit
less conflicted SBS Entities, enhance
protections of counterparties, and
improve the ability of market
participants to make informed
counterparty decisions.
We have considered the costs and
benefits of an alternative requiring a
disclosure of the difference in
compensation between selling a
security-based swap versus another
product with similar economic terms, or
expected profit of the SBS Entity from
the transaction, as suggested by some
commenters.1676 We do not believe that
disclosure of SBS Entity profits to
counterparties would protect
counterparties or improve their ability
to make suitable investment decisions,
relative to the approach being adopted,
and are not adopting this alternative.
SBS Entities compete for business on
price, execution quality, underlier and
counterparty risks, among others. We
understand that counterparties need
information about price, non-price
terms and risks of the security-based
swap and conflicts of interest of the SBS
Entity to be able to assess the relative
1676 See

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merits of a particular transaction. The
final business conduct rules being
adopted will require SBS Entities to
disclose to their non SBS Entity
counterparties material characteristics
and risks of the transaction, as well as
any compensation or incentives from
any source other than the counterparty
in connection with the security-based
swap. Rules 15Fh–3(c) and 15Fh–3(d),
the economic effects of which are
discussed below, will also require
disclosure of the daily mark and
clearing rights. We also note that SDR
Rules and Regulation SBSR adopted by
the Commission will introduce posttrade transparency to security-based
markets, and counterparties will have
access to more extensive and more
accurate information upon which to
make trading and valuation
determinations when compliance with
these rules is required.
SBS Entities are for-profit entities,
buying security-based swaps from
counterparties seeking to sell them; and
selling swaps to counterparties seeking
to purchase them. When SBS Entities
carry balance sheet risk, they profit from
directional price moves that result in
losses for their counterparties and so,
they may have an incentive to offload
security-based swaps in their inventory
on less informed non-dealer
counterparties, even where such
security-based swaps are unsuitable.
When SBS Entities hedge their
inventory risk and do not carry balance
sheet exposure, they benefit from
charging higher costs and fees to their
counterparties. SBS Entity business
incentives may, therefore, be generally
competing with the interests or
positions of their counterparties.
However, SBS Entities have reputational
incentives and benefit from
intermediating a greater volume of trade
which, all else given, mitigates this
conflict. Further, it is unclear that
market participants are generally
unaware of these competing incentives.
SBS Entities act as principal risk
holders and transacting agents effecting
security-based swaps on behalf of their
customers. An SBS Entity’s expected
return on a security-based swap
depends on, among others, price terms
of the swap, cost of funds, shorting
constraints, balance sheet exposures,
costs of underlying elements of the
security-based swap, and costs of
structuring the security-based swap. It is
unclear that disclosure of expected
profits of an SBS Entity has any bearing
on a counterparty’s expected cost of the
transaction, quality of execution or
assessment of the risks of a securitybased swap given the counterparty’s
investment objectives, horizons,

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hedging needs, financial condition
etc.1677 As a practical consideration, the
SBS Entity’s expected profit would
depend on potentially proprietary data
and valuation models, and numerous
assumptions about future market
factors. At the same time, such a
requirement would impose direct costs
of producing disclosures and potential
reputational costs on SBS Entities; if the
costs become significant, some SBS
Entities may reduce security-based swap
market activity with non-SBS or Swap
Entity counterparties. We note that the
rules being adopted not only require
disclosure of material characteristics,
risks, conflicts of interest or incentives,
daily mark and clearing rights, but also
include fair and balanced
communications, antifraud, supervision,
compliance, and conduct requirements.
b. Daily Mark
Rule 15Fh–3(c) requires SBS Entities
to disclose the daily mark to
counterparties other than SBS or Swap
Entities upon request. For cleared
security-based swaps, the rules require
an SBS Entity to disclose, upon request
of the counterparty, the daily mark that
the SBS Entity receives from the
appropriate clearing agency. For
uncleared swaps, Rule 15Fh–3(c)
implements the statutory provision and
requires the SBS Entity make this
disclosure on a daily basis for any
uncleared security-based swap by
providing the midpoint between the bid
and offer, or the calculated equivalent
thereof, as of the close of business
unless the parties agree in writing
otherwise. The method for computing
the daily mark is not provided in the
statute. For uncleared swaps, the SBS
Entity would also be able to use market
quotations for comparable securitybased swaps and model implied
valuations. The SBS Entity is also
required to disclose data sources,
methodologies and assumptions used to
prepare the daily mark, and promptly
disclose any material changes to the
above during the term of the securitybased swap.
Similar to the economic effects of
disclosures concerning material risks
and characteristics of security-based
swaps, the overall impact of the daily
mark disclosure depends on the severity
of the informational asymmetries
between SBS Entities and counterparties
regarding market prices of securitybased swaps; the amount of disclosure
unsophisticated counterparties require
1677 For instance, one commenter asserted that the
best protection for a counterparty is reviewing and
selecting the best available pricing. See FIA/ISDA/
SIFMA, supra note 5.

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to become better informed; the
informativeness of the disclosures; and
the direct and indirect costs of
producing such disclosures by SBS
Entities. For cleared security-based
swaps, the requirement to disclose the
daily mark from clearing agencies is an
explicit statutory requirement, and
provides a standardized and comparable
reference point for counterparties.1678
As described above, based on the
current model for clearing securitybased swaps, the security-based swap
between the SBS Entity and
counterparty is terminated upon
novation by the clearing agency. The
SBS Entity would no longer have any
obligation to provide a daily mark to the
original counterparty because a securitybased swap no longer exists between
them. Therefore, there would not be any
ongoing burden on the SBS Entity.
The ability of SBS Entities to rely on
quotes, model imputed prices or prices
of comparable security-based swaps to
calculate the daily mark for uncleared
swaps may produce valuations that are
potentially superior to stale market
prices on illiquid contracts. However,
we continue to recognize that SBS
Entities may influence the daily mark
disclosed to their less sophisticated
counterparties by varying modeling
assumptions, data sources and
methodology which produce the daily
mark, as supported by some
commenters.1679 This tradeoff is
partially mitigated by the requirement to
disclose data sources and a description
of the methodology and assumptions
used to prepare the daily mark, and
promptly disclose any material changes
during the term of the swap.
As we recognized in the Proposing
Release,1680 we anticipate significant
variability in the models and data
sources, methodology and assumptions
used by different SBS Entities, leading
to different daily marks being
established for similar security-based
swaps. As a result, security-based swap
1678 We have received comment that SBS Entities
may have direct or indirect affiliations or
relationships with clearing agencies and market
data providers, which may pose conflicts of
interest. See Levin, supra note 5. Should such
conflicts exist, they may be partly mitigated by
other substantive business conduct requirements
being adopted, such as the antifraud provision,
requirement to engage in fair and balanced
communications, and other statutory obligations.
Further, counterparties will be able to select the
venue in which security-based swaps will be
cleared and will benefit from SBS Entities’
disclosures of incentives and conflicts of interest
under these final rules.
1679 See, e.g., Levin, supra note 5; IDC, supra note
5.
1680 See Proposing Release, 76 FR at 42449, supra
note 3. Also see, e.g., FIA/ISDA/SIFMA, supra note
5.

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
market participants that consider the
daily mark as an indicator in the
reporting of their positions may report
different valuations of similar securitybased swap positions. However, we
continue to believe that since, as
quantified in the economic baseline,
non-dealer counterparties typically
transact with multiple dealers,
counterparties may be able to observe
and analyze differences in securitybased swap valuations across SBS
Entities. We recognize that the daily
mark may not be a reliable reference
point for estimating fair values,
potential net asset values or prices at
which the security-based swap could be
executed as suggested by a
commenter,1681 however, we continue
to believe that it may inform
counterparty understanding of their
financial relationship with SBS
Entities.1682
We are sensitive to cost
considerations, and recognize that costs
borne by SBS Entities as a result of the
final business conduct rules may be
passed on to counterparties in the form
of higher transaction costs. Further, if
these costs are significant, SBS Entities
may reduce their security-based swap
activity or become less willing to
intermediate swaps with certain groups
of counterparties. As a result, liquidity,
price discovery and market access of
certain groups of counterparties may be
adversely affected. As articulated in the
Proposing Release, we understand that
SBS Entities routinely assess end-of-day
values in the course of their business as
an integral component of risk
management. We continue to believe
that SBS Entities may already be
estimating values that may be used to
fulfil the daily mark disclosure
requirement, and, therefore, to the
extent this is the case, direct compliance
costs of this requirement to costs of
producing disclosures may be less than
estimated above.
One commenter indicated that
requiring Major SBS Participants to
comply with the daily mark requirement
for uncleared swaps would result in
‘‘significant, unnecessary increased
costs without any meaningful
benefit.’’ 1683 We recognize that the
broader scope of this requirement will
impose costs on Major SBS Participants,
as reflected in our compliance cost
estimates. To the extent that Major SBS
Participants may be better informed
about the risks and valuations of
security-based swaps and more sensitive
1681 See
1682 See

to market risk due to their significant
positions, disclosures of the daily mark
may help their non SBS Entity
counterparties make more informed
counterparty and valuation
determinations. We note that the rules
being adopted provide all SBS Entities
significant flexibility with respect to
how they may estimate the daily mark
for uncleared swaps. Specifically,
similar to SBS Dealers, Major SBS
Participants will be able to rely on
market quotes for similar swaps, model
based prices or some combination
thereof under Rule 15Fh–3(c). The
Commission continues to believe that
informing counterparties’ understanding
of their financial relationship with SBS
Entities is an important benefit of these
final rules.
As discussed in Section II, supra, SBS
Entities will not necessarily be able to
use the same mark for collateral
purposes and for meeting the disclosure
requirement. We recognize commenter
concern that this approach may impose
additional costs of estimating and
disclosing a daily mark valuation on
SBS Entities with respect to transactions
where both counterparties have agreed
on a basis for margining uncleared
swaps.1684 As discussed above, the
Commission continues to believe that
the daily mark disclosure, as being
adopted for the purposes of this rule,
would provide a useful and meaningful
reference point for counterparties
holding positions in uncleared securitybased swaps.
Currently, entities that are likely to
trigger SBS Entity registration
requirements due to their volume of
dealing activity are not required to
disclose daily marks of security-based
swaps, or data sources, assumptions and
methodologies used to calculate them.
While this requirement is currently
effective in swap markets and some SBS
Entities may be making such securitybased swap specific disclosures
voluntarily, these final rules impose
mandatory disclosure requirements on
all SBS Entities in their security-based
swap transactions with counterparties
that are not themselves SBS Entities or
Swap Entities. The requirement to
disclose data sources, assumptions and
methodology used to calculate the value
of security-based swaps may reduce the
informational advantage SBS Entities
enjoy as a result of developing superior
valuation models or information, as
supported by public comments.1685
However, these costs are partly
mitigated by the ability to rely on

MFA, supra note 5.
Proposing Release, 76 FR at 42449, supra

note 3.
1683 See MFA, supra note 5.

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1684 See

FIA/ISDA/SIFMA, supra note 5.
e.g., MFA, supra note 5; IDC, supra note

1685 See,

5.

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30115

standardized disclosures and a
description of the models, as opposed to
disclosures of the models themselves.
c. Clearing Rights
Finally, Rule 15Fh–3(d) requires SBS
Entities to make disclosures regarding
clearing rights to counterparties that are
not SBS Entities or Swap Entities before
entering into the security-based swap.
For security-based swaps not subject to
mandatory clearing, the SBS Entity
would be required to determine whether
the security-based swap is accepted for
clearing by one or more clearing
agencies, to disclose the names of
clearing agencies that accept the
security-based swap for clearing, and to
notify the counterparty of their right to
elect clearing and the agency used to
clear the transaction. For security-based
swaps subject to mandatory clearing, the
final rules require SBS Entities to
disclose clearing agency names to the
counterparty, and to notify the
counterparty of their right to select the
clearing agency subject to Section
3C(g)(5) of the Act. The rule also
requires SBS Entities to make a written
record of the non-written disclosures
and provide counterparties with a
written version of these disclosures no
later than the delivery of the trade
acknowledgement of the transaction.
The required disclosure of clearing
rights may increase how informed a
counterparty is concerning the
availability of clearing in general, the
ability to require clearing of securitybased swaps, as well as the names of
clearing agencies that may accept a
given security-based swap for clearing.
The reliance on standardized
disclosures may lead to more general
and less transaction specific information
being communicated, reflecting
information that has already been
absorbed by market participants and
potentially reducing these benefits. To
the extent that the rule results in greater
transparency concerning clearing rights,
the volume of cleared security-based
swaps may increase.
We note that clearing is currently
voluntary and available for CDS
only.1686 Disclosure of the clearing
1686 Mandatory clearing is not currently in effect
and we currently do not have sufficient information
to estimate the number and volume of securitybased swap transactions executed across different
trading venues and using these various execution
practices. However, the Commission staff has
performed an analysis of voluntary clearing activity
in single name CDS markets, which generally
informs our analysis. See SEC Division of Economic
and Risk Analysis, Single-Name Corporate Credit
Default Swaps: Background Data Analysis on
Voluntary Clearing Activity, 15 (Apr. 2015),
available at http://www.sec.gov/dera/staff-papers/
white-papers/voluntary-clearing-activity.pdf.

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agencies that accept a security-based
swap for clearing may inform
counterparties of the right to clear and
of various clearing agencies that are able
to clear a given security-based swap,
particularly clearing agencies that have
just started accepting a given securitybased swap or group of security-based
swaps for clearing. This may enhance
potential competition among clearing
agencies in the future, which may lower
clearing costs or improve quality of
clearing services. The above effect may
be more significant if more clearing
agencies register to clear security-based
swaps and clearing becomes available
for security-based swaps other than
CDS, which are currently being cleared
voluntarily.
Currently, SBS Entities are not yet
required to register and are not subject
to substantive Title VII requirements,
including business conduct rules.
Therefore, SBS Entities currently are not
required to produce disclosures
concerning clearing rights and a list of
clearing agencies accepting a securitybased swap for clearing. Entities that are
currently registered with the CFTC as
Swap Entities are required to make
clearing rights disclosures for swap
transactions. Under these final rules, all
SBS Entities will bear costs of
producing the clearing rights
disclosures pertaining to security-based
swap transactions, and communicating
them to their counterparties other than
SBS Entities and Swap Entities, as
estimated in Sections V and VI.C above.
However, we recognize that these costs
may be lower for dually registered SBS
Entities that may have already adjusted
their systems and practices to comply
with parallel CFTC rules. We also
recognize that if, as a result of the
disclosure, some counterparties begin
choosing to clear as well as choosing the
agency used to clear the transaction,
SBS Entities may lose potentially
beneficial flexibility related to clearing,
which may affect the price of securitybased swaps. In addition, if clearing
rights disclosures lead to a greater
volume of transactions cleared through
registered clearing agencies, increases in
clearing costs borne by SBS Entities may
be passed on to counterparties.
3. Suitability
SBS Dealers intermediate large
volumes of security-based swaps,
buying products from counterparties
seeking to sell them; and selling swaps
to counterparties seeking to purchase
them. When SBS Dealer exposure is not
hedged by offsetting transactions with
other dealers, SBS Dealers act as
principal risk holders, benefiting from
directional price moves that result in

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losses for their counterparties, and vice
versa. SBS Dealers carrying inventory
may have an incentive to recommend
security-based swaps from their
inventory that may be unsuitable to
their counterparties, but help to manage
dealer inventory risk. When SBS Dealers
hedge the underlying risk of a
transaction, dealer profits stem from
commissions and fees charged to their
counterparties in relation to the
security-based swap. As a result, SBS
Dealer incentives may be generally
inconsistent with, or may be contrary to
the economic interests of their
counterparties.
As discussed in earlier sections, SBS
Dealers are more informed than their
non-dealer counterparties as they can
directly observe pre-trade requests for
quotes and order flow. Where SBS
Dealers have previously acted in other
capacities, such as in the capacity of an
underwriter, arranger or structurer of a
security-based swap, they may have
superior information about the quality
and risk of a specific security-based
swap and its underlying assets. As a
result, SBS Dealers may have superior
information about the inherent value
and risk of security-based swaps,
including information concerning
whether a given security-based swap is
unsuitable for a particular non-dealer
counterparty given the counterparty’s
horizon and ability to absorb losses,
among other things.
When SBS Dealers advise their
counterparties regarding security-based
swaps, the above conflicts of interest
may result in recommendations of
security-based swaps that may be
unsuitable for a given counterparty. For
instance, more complex security-based
swaps are more opaque and difficult to
price for less informed counterparties;
they may also be unsuitable for a greater
number of non-dealer
counterparties.1687 At the same time,
such transactions may be profitable for
the dealer. To the extent that SBS
Dealers may be recommending
unsuitable security-based swaps, and to
the extent counterparties may be relying
on such advice and are unable to
observe and decouple bias from the
information component of the
recommendation, counterparties may be
entering into security-based transactions
inconsistent with their investment
objectives and risk tolerance. The
central role and high market share of a
small number of SBS Dealers described
in the economic baseline may reduce
1687 The

Commission recognizes that complex
over-the-counter security-based swaps may benefit
some market participants due to the ability to tailor
economic terms to counterparties’ hedging needs or
market views.

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the effectiveness of reputational
considerations in mitigating these
effects.
Under Rule 15Fh–3(f)(1), SBS Dealers
recommending security-based swaps or
trading strategies involving a securitybased swap to counterparties other than
an SBS Entity or a Swap Entity are
required to (i) undertake reasonable
diligence to understand potential risks
and rewards associated with the
recommendation; and, (ii) have a
reasonable basis to believe that the
recommended swap or strategy is
suitable for the counterparty, taking into
account, among other things, the
counterparty’s investment profile,
trading objectives and ability to absorb
potential losses. Rule 15Fh–3(f)(2)
includes an alternative for institutional
counterparties (defined as a
counterparty that is an eligible contract
participant as defined in clauses (A)(i),
(ii), (iii), (iv), (viii), (ix) or (x), or clause
(B)(ii) of Section 1a(18) of the
Commodity Exchange Act and the rules
and regulations thereunder, or any
person (whether a natural person,
corporation, partnership, trust or
otherwise) with total assets of at least
$50 million) that allows an SBS Dealer
to satisfy its customer-specific
suitability obligations in Rule 15Fh–
3(f)(1)(ii) if (i) the SBS Dealer reasonably
determines that the counterparty or
agent with delegated authority is
capable of independently evaluating
investment risks with respect to a given
security-based swap or strategy; (ii) the
counterparty or agent represents in
writing that they are exercising
independent judgment in evaluating the
dealer’s recommendations; and (iii) the
SBS Dealer discloses that it is acting as
a counterparty and not assessing
suitability. Under Rule 15Fh–3(f)(3), an
SBS Dealer will be deemed to have
satisfied the requirements of the first
prong of the institutional suitability
alternative in Rule 15Fh–3(f)(2)(i) if it
receives written representations that: (i)
In the case of a counterparty that is not
a special entity, the counterparty has
complied in good faith with written
policies and procedures that are
reasonably designed to ensure that the
persons responsible for evaluating the
recommendation and making trading
decisions on behalf of the counterparty
are capable of doing so; and (ii) in the
case of a counterparty that is a special
entity, satisfy the terms of the safe
harbor in Rule 15Fh–5(b).
a. Costs and Benefits
Rule 15Fh–3(f)(1) may benefit
counterparties by requiring that SBS
Dealers undertake reasonable diligence
to understand the potential risk and

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rewards associated with recommended
security-based swaps or trading
strategies involving security-based
swaps and that these recommendations
are suitable for the counterparty given
the counterparty’s investment profile,
trading objectives, and ability to absorb
potential losses. As a result,
counterparties of SBS Dealers may
become more likely to allocate capital to
suitable security-based swaps,
potentially enhancing counterparty
protections and allocative efficiency.1688
These benefits are expected to accrue
only to the extent that some SBS Dealers
otherwise may be making unsuitable
recommendations, and to the extent that
non-SBS or Swap Entity counterparties
rely on such SBS Dealer
recommendations in their capital
allocation decisions. If incentive
conflicts or governance failures within
counterparties, or other factors
unrelated to SBS Dealer
recommendations, for instance, reaching
for yield in low interest rate
environments, contribute to potentially
unsuitable security-based swap choices,
the benefits of these rules may be
muted. The suitability standard does not
require dealers to disclose whether
another suitable security-based swap or
underlier has superior material
characteristics. Therefore, some of the
above counterparty protection and
allocative efficiency benefits of the
suitability standard may be less.
Further, this benefit is likely to be
highest for those counterparties of SBS
Dealers which do not already rely on
professional asset managers or
independent advisers in security-based
swap transactions.
The suitability requirement will
impose costs on SBS Dealers. First, the
rule requires SBS Dealers to undertake
reasonable diligence to understand the
potential risks and rewards of the
security-based swaps or trading strategy
involving a security-based swap they
recommend. Second, the rule will
involve direct costs required to make an
assessment of suitability of a securitybased swap or asset class for each
counterparty.1689 As estimated in
Section V, we expect that SBS Dealers
may seek to obtain representations at an
estimated cost of up to $11,393,160.1690
Further, the Commission recognizes that
suitability assessments under these final
1688 See, e.g., CFA, supra note 5; Levin, supra
note 5.
1689 See, e.g., FIA/ISDA/SIFMA, supra note 5.
1690 Initial cost: (In-house attorney at $380 per
hour) × (6,271 × 2 hours for participants active in
both swaps and SBS markets + 3,488 × 5 hours for
participants active in SBS markets only) = 380 ×
29,982 = $11,393,160.

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rules may give rise to potential liability
and litigation costs of SBS Dealers.
In considering the economic effects of
this final rule, we note that the
suitability requirement does not apply
to recommendations made to SBS
Dealers, Major SBS Participants, Swap
Dealers, or Major Swap Participants.
Therefore, the rule may result in higher
costs to SBS Dealers in transacting with
non-SBS or Swap Entity counterparties.
Additionally, costs of suitability
assessments may be higher for
counterparties with which an SBS
Dealer has had no prior transactions.
The rule may adversely affect
counterparties of SBS Dealers that are
not themselves SBS Dealers, Major SBS
Participants, Swap Dealers, or Major
Swap Participants. In addition, SBS
Dealer cost increases due to suitability
assessments discussed above may be
passed on to counterparties, and, if a
significant percentage of the costs
cannot be recovered, the willingness of
SBS Dealers to make recommendations
to non-dealer counterparties may
decrease. Further, SBS Dealers may
have superior information about the
quality of security-based swaps they
intermediate, but have significantly less
information about their counterparty.
This informational asymmetry may
result in SBS Dealers not recommending
security-based swaps that may be
potentially suitable to the counterparty.
Moreover, to the extent that customer
suitability evaluations take time and
require additional due diligence, the
rule may result in execution delays,
particularly during times of high market
volatility when the value of risk
mitigation may be higher. We note,
however, that suitability requirements
apply only with respect to swaps being
recommended by SBS Dealers, and
counterparties may continue to have
access to security-based swaps
intermediated without bundled SBS
Dealer advice, as well as swaps
executed on SEFs or registered
exchanges.
The above benefits and costs of the
suitability rule are likely to be limited
by the scope of these final rules and the
institutional suitability alternative. The
suitability requirement is limited to
transactions between SBS Dealers and
counterparties that are not themselves
SBS or Swap Entities. We believe that
SBS Entities are likely to be able to
independently evaluate material risks,
pricing, and overall suitability of a
security-based swap given, among
others, their investment objectives and
risk tolerance. As shown in Figure 3, the
majority of trades and trade notional
involved trades among dealers, which
substantially reduces the scope of

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30117

application of the suitability
requirement. Further, as discussed
below, the scope of application of the
suitability rule may be reduced if SBS
Dealers are able to take advantage of the
institutional suitability alternative for
customer-specific suitability with
respect to a significant fraction of
transactions.
As noted in the proposing release,1691
many SBS Dealers may already have an
obligation to make suitable
recommendations in other contexts.
FINRA imposes a suitability
requirement on recommendations by
broker-dealers and we have elsewhere
estimated that up to 16 entities
registering with the Commission as SBS
Entities may be already operating as
registered broker-dealers subject to
Commission and FINRA oversight.1692
As discussed in Section II, Swap Dealers
registered with the CFTC are also
subject to reasonable basis and
customer-specific suitability
requirements with respect to swap
transactions under Rule 23.434, and we
have elsewhere estimated that up to 35
SBS Entities may be cross-registered
with the CFTC as Swap Entities. Some
of these cross-registered entities may
have adjusted their compliance
infrastructure and recommendation
practices. These considerations may
mitigate both the costs and the benefits
of these final rules.
b. Institutional Suitability Alternative
Rule 15Fh–3(f)(2) includes an
institutional suitability alternative for
customer-specific suitability
assessments. SBS Dealers will be
deemed to have fulfilled their customerspecific suitability obligations if they
reasonably determine that the
counterparty or its agent is capable of
independently evaluating the
investment risks; the counterparty or
agent affirmatively represents in writing
that they are evaluating the investment
independently; and the SBS Dealer
discloses that it is not undertaking to
assess suitability for the counterparty.
The institutional suitability alternative
for customer-specific suitability
requirements will not be available with
respect to counterparties that are not
institutional counterparties (defined as a
counterparty that is an eligible contract
participant as defined in clauses (A)(i),
(ii), (iii), (iv), (viii), (ix) or (x), or clause
(B)(ii) of Section 1a(18) of the
Commodity Exchange Act and the rules
and regulations thereunder, or any
1691 See Proposing Release, 76 FR at 42450, supra
note 3.
1692 See Registration Adopting Release, 80 FR at
49000, supra note 989.

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person (whether a natural person,
corporation, partnership, trust or
otherwise) with total assets of at least
$50 million. Recommendations of any
potentially unsuitable products could
involve losses and lead to inefficient
capital allocation by non-dealer
counterparties when such
counterparties lack the ability to
independently assess suitability of
security-based swap transactions they
enter into. Sophisticated institutions or
entities that rely on independent
advisors in their decision making may
be better able to independently assess
the merits and suitability of a given
security-based swap. Therefore, more
sophisticated counterparties and
counterparties that rely on independent
advisers to assess disclosures and
analyze the relative merits of individual
swaps are less likely to benefit from the
suitability rule. The institutional
suitability alternative reflects these
considerations.
As a result of the institutional
suitability alternative, SBS Dealers will
not be required to undertake customerspecific suitability evaluations for
counterparties that the rule presumes
are capable of independently evaluating
investment risks with regard to the
relevant security-based swap or trading
strategy involving a security-based
swap. As shown in Table 2 of the
economic baseline, between November
2006 and December 2014, 99% of
private funds, 100% of registered
investment companies, 72% of
insurance companies, 75% of nonfinancial firms and 98% of special
entities were represented by investment
advisers. Hence, non-dealer
counterparties generally have thirdparty representation and may be able to
evaluate security-based swaps
independently of SBS Dealers. Many
SBS Dealers may be able to rely on the
institutional suitability alternative to
fulfill their customer-specific suitability
obligations. Therefore, a large fraction of
transactions may qualify for the
institutional suitability alternative, and
the economic effects of the suitability
requirement above may accrue to a
small share of security-based swap
market activity.
In addition, the institutional
suitability alternative for customerspecific suitability will not be available
for SBS Dealers making
recommendations to counterparties that
are not institutional counterparties. The
$50 million asset threshold in the
institutional counterparty definition
narrows the scope of the alternative and
increases the potential counterparty
protection and allocative efficiency
benefits of the final suitability rule. Our

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data do not allow us to estimate how
many counterparties that would not
meet the institutional counterparty
definition are currently transacting in
security-based swap markets and relying
on recommendations by SBS Dealers,
asset size thresholds for counterparties
at which the intended information and
counterparty protection benefits of these
final rules become significant, or the
extent to which asset size and
counterparty sophistication may be
correlated in security-based swap
markets. We also recognize that the $50
million asset size threshold may
increase costs and diverges from the
suitability safe harbor adopted by the
CFTC as part of business conduct
standards for Swap Entities. As a result,
all SBS Dealers that are dually
registered with the CFTC as Swap
Dealers will face a bifurcated suitability
standard in swaps and security-based
swaps, such as index CDS and single
name CDS, with respect to
counterparties that do not meet the
institutional counterparty definition. In
response to these final rules, dually
registered SBS Dealers may choose not
to rely on the institutional suitability
alternative when making
recommendations to counterparties that
do not meet the institutional
counterparty definition in both swap
and security-based swap markets.
Direct burdens and costs of suitability
assessments have been estimated above.
The Commission also recognizes that
this aspect of the institutional suitability
alternative may increase system
complexity, liability and other costs less
amenable to quantification that SBS
Dealers will incur as a result of advising
and transacting with small
counterparties in security-based swaps.
These costs may be passed on to
counterparties of SBS Dealers, which
may experience an increase in
transaction costs, decreased access to
SBS Dealer advice, or decreased
willingness of SBS Dealers to
intermediate over-the-counter securitybased swaps.
However, affected counterparties may
continue to retain access to anonymous
SEF or exchange executed securitybased swaps, which are not subject to
the suitability requirements of these
final rules. Further, while the asset
threshold in the institutional suitability
alternative diverges from the CFTC’s
approach to suitability for Swap
Dealers, it aligns with FINRA’s asset
threshold for the institutional account
definition. SBS Dealers cross-registered
as broker-dealers are currently unable to
rely on institutional suitability when
recommending less complex products,
such as vanilla equity or fixed income

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instruments, to the same group of
counterparties, and may be less affected
by the institutional counterparty asset
threshold for the suitability alternative.
We note that SBS Dealers will be able
to avail themselves of the institutional
suitability alternative when making
recommendations to certain financial
institutions, insurance companies,
registered investment companies,
commodity pools with at least $5
million in assets, broker-dealers, futures
commission merchants, floor brokers,
investment advisers and commodity
trading advisors with less than $50
million in assets. As discussed above,
the Commission believes that the $50
million asset threshold may enhance
counterparty protection and allocative
efficiency benefits of the final suitability
rule relative to the alternative of not
including an asset threshold as part of
institutional suitability.
We note that the institutional
suitability alternative is not applicable
to the suitability requirement to
undertake reasonable diligence to
understand the potential risks and
rewards associated with the
recommended security-based swap or
trading strategy involving a securitybased swap. However, when SBS
Dealers rely on the alternative, they will
not be required to make customerspecific suitability assessments with
respect to individual counterparties’
investment profile, trading objectives
and ability to absorb losses.
As clarified in Section II, the
Commission believes that parties should
be able to make the disclosures and
representations required by Rules 15Fh–
3(f)(2) and (3) on a transaction-bytransaction basis, on an asset-class-byasset-class basis, or in terms of all
potential transactions between the
parties. As a result, SBS Dealers will not
be required to assess customer-specific
suitability of whole asset classes or all
security-based swaps, if the
counterparty makes appropriate
representations and other institutional
suitability requirements are met.
To the extent that security-based
swaps are heterogeneous in their risk
and expected return characteristics, and
since the degree of counterparty
sophistication and familiarity with
various types of security-based swaps
may vary over time, such an approach
to institutional suitability may lower the
benefits of the rule. However, the ability
to take advantage of the institutional
suitability alternative for groups of
security-based swaps, asset classes or
counterparties as a whole mitigates the
burdens imposed on SBS Dealers,1693
1693 See,

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particularly when such dealers
intermediate multiple homogeneous
transactions with the same counterparty
over a limited time period. For instance,
as we have noted in the economic
baseline, based on an analysis of DTCC–
TIW data, an average unique dealernondealer pair entered into
approximately 32 transactions in 2014.
The ability of dealers to rely on the
institutional suitability alternative for
some or all of the trades with a given
counterparty would be less costly, and
may also limit execution delays
facilitating market access to securitybased swaps.
In addition to the above
considerations concerning institutional
suitability, we note that the final
suitability requirements will not apply
if an SBS Dealer does not recommend a
security-based swap or trading strategy
involving a security-based swap to
counterparties. As estimated above, the
suitability requirement imposes costs on
SBS Dealers, and may decrease their
willingness to recommend securitybased swaps to non-SBS or Swap Entity
counterparties. However, as discussed
throughout the release, we believe that
the overwhelming majority of market
participants already have access to third
party advice concerning security-based
swaps.
Finally, suitability obligations will
also apply to transactions with special
entities, and the institutional suitability
alternative described above will be
available for special entity
counterparties that meet the
institutional counterparty definition
(i.e., have total assets of at least $50
million).
4. Special Entities
The business conduct rules being
adopted include a number of
requirements for SBS Entities specific to
their dealings with special entities
governing, among other things: (a) The
scope of entities that will be subject to
the substantive special entity standards;
(b) the duty to verify and inform entities
when they are eligible to elect not to be
considered a special entity for the
purposes of these rules; (c) the
definition of qualified independent
representative for such purposes; (d) the
conduct of SBS Entities when they act
as counterparties to special entities; (e)
the conduct of SBS Dealers when they
act as advisors to special entities.
a. Scope and Verification
First, as part of verification of status
requirement under Rule 15Fh–3(a)(2),
SBS Entities will be required to verify
whether a counterparty is a special
entity before entering into a security-

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based swap, unless the transaction is
executed on a registered or exempt SEF
or registered national securities
exchange, and the SBS Entity does not
know the identity of the counterparty at
a reasonably sufficient time prior to
execution of the transaction to permit
the SBS Entity to comply with the rule.
Under Rule 15Fh–3(a)(3), an SBS Entity
shall also verify whether a counterparty
is eligible to elect not to be a special
entity, and, if so, notify such
counterparty of its right to make such an
election. Rule 15Fh–2(e) defines the
scope of special entities to include,
among other things, federal and state
agencies, States, cities, counties,
municipalities, and other political
subdivisions of a State,
instrumentalities, departments or
corporations of or established by a State
or political subdivision of a State,
employee benefit plans subject to Title
I of ERISA, governmental plans as
defined in Section 3(32) of ERISA, and
endowments. Rule 15Fh–2(e) also
provides that employee benefit plans
defined in Section 3 of ERISA, that are
not otherwise defined as special
entities, may elect not to be treated as
special entities by notifying an SBS
Entity prior to entering into a securitybased swap.
These final rules define the set of
special entities that will be able to avail
themselves of the protections in these
final rules. The inclusion of entities
defined in, but not subject to, ERISA
into the special entity category, subject
to an opt out provision, increases the set
of market participants afforded the
counterparty protections under the final
business conduct standards, relative to
the exclusive application of these rules
to entities subject to ERISA.1694 At the
same time, as discussed below,
compliance with these final rules
concerning special entities will entail
direct and indirect costs for SBS
Entities. Increased costs to SBS Entities
may be passed on to special entity
counterparties in the form of more
adverse terms of available securitybased swaps or a decreased willingness
of SBS Entities to intermediate such
swaps with special entities, which may
reduce special entities’ access to such
security-based swaps.1695 The ability of
1694 See Church Alliance (August 2011), supra
note 5 and Church Alliance (October 2011), supra
note 5, suggesting that church plans may benefit
from enhanced conduct by SBS Entities in their
advisory or intermediation roles, and requesting
clarification of status of church plans for purposes
of regulations under Dodd Frank.
1695 As we discuss in Section VI.C.4.f, special
entity rules will not apply to security-based swaps
executed on registered or exempt SEFs or registered
national security exchanges, where SBS Entities do
not know the identity of the counterparty at a

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special entities defined in, but not
subject to, ERISA to opt out of the
special entity status may give such
entities greater flexibility in structuring
their relationships with SBS Entities,
and allow them to trade off the benefits
of counterparty protections in these
final rules against potentially greater
costs and lower liquidity in SBS Entity
intermediated OTC security-based
swaps.
We note that the opt out approach for
special entities defined in, but not
subject to, ERISA differs from parallel
CFTC business conduct rules, which
allow such entities to opt into the
special entity status instead. As
discussed in the economic baseline, the
Commission expects extensive crossregistration of SBS Entities as Swap
Entities, and understands most market
participants transact in both swap and
security-based swap markets. To the
extent that SBS Entities have significant
bargaining power in transactions with
special entities, special entities that
have selected not to opt into the special
entity status in swap markets are likely
to opt out of similar protections under
these final rules. Therefore, it is unclear
whether the ability of special entities
defined in, but not subject to ERISA to
opt out of special entity protections
would lead to a greater number of
special entities benefiting from
counterparty protections in these final
rules, relative to the opt in approach.
We also recognize that under the final
rules, if a special entity chooses to opt
out of the special entity status, it would
be required to provide a written notice
to the SBS Entity and would bear
related costs. The overall economic
effects of this rule will, therefore,
depend on the number of entities
defined in, but not subject to, ERISA
that will choose to opt out of the special
entity status, the costs of producing
notices, and magnitude of the
transaction cost increases in OTC
security-based swaps resulting from
compliance with these final special
entity rules.
Estimates of special entity market
participants in our economic baseline
are based on manual account
classifications, and our data is not
sufficiently granular to estimate the
number of special entities defined in but
not subject to ERISA currently active in
security-based swap markets that may
be scoped in by these rules. Special
reasonably sufficient time prior to execution of the
transaction to permit the SBS Entity to comply with
these final obligations. Therefore, special entities
and entities defined in, but not subject to ERISA,
regardless of their opt out decision, will continue
to have access to anonymous SEF or exchange
executed security-based swaps.

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entities represent approximately 8% of
market participants in swap
markets.1696 Out of 3,635 special
entities subscribed to the ISDA August
2012 DF Protocol, 1,453 market
participants (approximately 40%)
elected to be a special entity under the
protocol. This may indicate that a
substantial number of market
participants in swap markets may have
opted into the special entity treatment.
However, we note that using hand
classifications of accounts in TIW data
on 2006–2014, we estimate that special
entities represent approximately 10.5%
of single name CDS market participants
by count (see Table 2 above). This
estimate is comparable to the 8% of all
special entities adhering to the ISDA
August 2012 DF Protocol, and our hand
classifications of accounts do not
distinguish between special entities
subject to ERISA, and those defined in
but not subject to ERISA. Therefore, our
analysis of special entity transaction
activity throughout the release likely
includes both special entities subject to
ERISA, and entities defined in but not
subject to ERISA that may opt out of the
special entity protections of these final
rules.
Special entity requirements and
related costs will not apply to securitybased swaps transacted on registered
national securities exchanges and
registered or exempt SEFs, if the SBS
Entity does not know the identity of the
counterparty at a reasonably sufficient
time prior to execution of the
transaction to permit the SBS Entity to
comply with the obligations of the rules.
We recognize that some security-based
swaps executed on a SEF or exchange
may be bilaterally negotiated, which
may point to potential counterparty and
information benefits of applying the
business conduct rules to SEF and
exchange traded security-based swaps.
However, bilateral negotiations are
likely to require an SBS Entity to know
the identity of the counterparty at a
reasonably sufficient time prior to
execution to permit compliance. We
also recognize that conflicts of interest
may affect SBS Dealer recommendations
of security-based swaps regardless of the
venue in which these transactions are
executed. It is not clear whether an SBS
Dealer would be able to make a
recommendation to a counterparty
whose identity is not known at a
1696 This estimate is based upon data provided by
ISDA as of December 31, 2015 on the number and
type of market participants adhering to the ISDA
August 2012 DF Protocol. See Memorandum from
Lindsay Kidwell to File (Feb. 18, 2016) available on
the Commission’s Web site at http://www.sec.gov/
comments/s7-25-11/s72511.shtml under ‘‘Meetings
with SEC Officials.’’ See also Section VI.B.

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reasonably sufficient time prior to
execution. Finally, as we discuss
throughout the release, while business
conduct rules, including rules
concerning special entities, may result
in significant benefits, they will impose
direct and indirect costs on SBS
Entities. In the context of SEF
transactions, the application of these
rules may increase transaction costs,
add complexity and delays, or require
negotiation with counterparties. To the
extent that security-based swaps
executed through SEFs may represent
exclusively arms-length transactions,
the terms of which are not negotiated,
the imposition of the final business
conduct rules on such trades could
increase costs without corresponding
benefits anticipated by these final rules.
For instance, if clearing reduces credit
risk of counterparties, SBS Entities may
compete on transaction costs and
quality of execution, as opposed to
credit risks of the transaction, as
suggested by commenters.1697 These
final rules recognize these competing
considerations and provide explicit
relief for transactions executed on a
registered or exempt SEF or registered
national exchange, if the SBS Entity
does not know the identity of the
special entity counterparty at a
reasonably sufficient time prior to
execution of the transaction to permit
compliance with the obligations of the
rule. Finally, the Commission continues
to recognize that the benefits of these
final special entity rules are expected to
primarily accrue to entities that are less
informed about security-based swap
markets. While special entities will not
be able to opt out of the protections of
these final rules as discussed in section
VI.C.8, SBS Entities will be able to rely
on an independent representative safe
harbor, the economic effects of which
are considered in detail in the sections
that follow.
As discussed in Section II, the special
entity definition does not include
collective investment vehicles, and the
final rules do not require SBS Dealers to
determine whether any of the investors
in the collective investment vehicle
counterparty qualify as special entities.
Such an approach limits the scope of
application of these final rules, reducing
potential counterparty protection and
allocative efficiency benefits, but also
potential costs and risks of loss of access
by special entities and entities defined
in, but not subject to ERISA, to securitybased swaps.
1697 See SIFMA (August 2011), supra note 5 and
BlackRock, supra note 5.

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b. SBS Entities as Counterparties to
Special Entities
Under final Rule 15Fh–5(a) an SBS
Entity that offers to enter or enters into
a security-based swap with a special
entity must have a reasonable basis to
believe that the special entity has a
qualified independent representative.
Under Rule 15Fh–5(c), before initiating
a swap, an SBS Dealer will also be
required to disclose in writing the
capacity in which the dealer is acting in
connection with the security-based
swap. Additionally, if the SBS Dealer or
its associated persons engage or have
engaged in business with the special
entity in more than one capacity, the
dealer would be required to disclose the
material differences between such
capacities and any other financial
transactions or service involving the
special entity. As discussed in section
II.H.7 supra, the SBS Dealer may use
generalized disclosures regarding the
capacities in which the SBS Dealer and
its associated persons have acted or may
act with respect to the special entity,
along with a statement distinguishing
those capacities from the capacity in
which the SBS Dealer is acting with
respect to the present security-based
swap. The requirements in Rule 15Fh–
5 do not apply to a security-based swap
if the transaction is being executed on
a registered or exempt SEF or registered
national securities exchange, and the
SBS Entity does not know the identity
of the counterparty at a reasonably
sufficient time prior to execution of the
transaction to permit compliance with
these obligations.
Qualified independent representatives
must have sufficient knowledge to
evaluate the transaction and risks; may
not be subject to statutory
disqualification; undertake a duty to act
in the best interests of the special entity;
appropriately and timely disclose
material information concerning the
security-based swap to the special
entity; evaluate, consistent with any
guidelines provided by the special
entity, the fairness of pricing and
appropriateness of the security-based
swap; and for certain types of special
entities the representative must be
subject to rules for the Commission, the
CFTC, or a SRO prohibiting it from
engaging in specified activities if certain
political contributions have been made,
unless the representative is an employee
of the special entity. Independence
requires that a representative does not
have a relationship with the SBS Entity,
whether compensatory or otherwise,
that reasonably could affect the
independent judgment or decisionmaking of the representative. A

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representative will be deemed to be
independent of an SBS Entity if, within
one year of representing the special
entity in connection with the securitybased swap, the representative was not
an associated person of an SBS Entity;
provides timely disclosures to the
special entity of all material conflicts of
interest that could reasonably affect the
judgment or decision making of the
representative with respect to its
obligations to the special entity;
complies with policies and procedures
reasonably designed to manage and
mitigate such material conflicts of
interest; and the SBS Entity did not
refer, recommend, or introduce it to the
special entity within one year of the
representative’s representation of the
special entity in connection with the
security-based swap. As proposed by
some commenters, ERISA plans will be
able to comply with these requirements
by relying on an ERISA fiduciary.1698
Further, as we discuss in more detail
below, the independence requirement
refers to the representative’s
independence of the SBS Entity and not
of the special entity and so, qualified
investment representatives that are
employees or associates of the special
entity may qualify as independent
representatives for the purposes of these
rules.
In contrast with the final rule, the
proposed rule defined independence
based on a two-prong test of (1)
associated person status within the
preceding year; and (2) ten percent or
greater revenue reliance on a given SBS
Entity. We are sensitive to commenter
concerns that this definition may
impose undue restrictions and cost
burdens on SBS Entities, and may be
difficult to implement.1699 Further, the
CFTC’s independence formulation
applicable to Swap Entities does not
include a ten percent revenue prong in
the independent test with special
entities. In light of active cross-market
participation and expected SBS Entity
cross-registration, adopting a
substantively different independence
requirement from that required by Swap
Entities may impose costs of compliance
with two different independent
representation standards. At the same
time, it is unclear that such an approach
would be more beneficial to
counterparty protections, Commission
oversight or enforcement in security1698 See ABC, supra note 5 and SIFMA (August
2011), supra note 5.
1699 See, e.g., SIFMA (August 2011), supra note 5;
APPA; BlackRock, supra note 5; SIFMA (August
2011), supra note 5; ABA Committees, supra note
5; FIA/ISDA/SIFMA, supra note 5; Blackrock, supra
note 5.

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based swaps relative to the approach
being adopted.
Under this rule, special entities
transacting with more informed and
sophisticated SBS Entities will have the
benefit of representation by a qualified
independent representative that has a
duty to act in the best interests of the
entity. To the extent that some special
entities are less informed about securitybased swaps and less able to unwind
biases that may exist in potentially
conflicted recommendations than other
counterparties, this requirement may
appropriately facilitate stronger
protections and superior capital
allocation decisions by special entities.
Better informed special entities, such as
large well-informed pension funds that
regularly transact in security-based
swaps, are likely to enjoy fewer benefits
of this requirement. However, they may
also be more likely to use investment
advisers in their current security-based
swap transactions, in which case they
would need to make that representation
to an SBS Dealer under Rule 15Fh–5(b).
In addition, similar to our earlier
discussion of suitability rules, to the
extent that special entities may be
entering security-based swap
transactions with inferior risk-return
characteristics as a result of internal
incentive conflicts or macro factors,
such as reaching for yield in a low
interest rate environment, the benefits of
these protections may be muted.
Further, special entities that transact
with the SBS Dealer in a variety of roles,
such as investment adviser or
underwriter, will benefit from greater
transparency about the capacity in
which the dealer is entering the
security-based swap. For instance, if an
SBS Dealer currently engages in
business with a special entity in the
capacity of an investment adviser, the
SBS Dealer would be required to
disclose that it is not acting in such
capacity if it is seeking to enter into a
security-based swap with the special
entity. This may help counterparties
better understand the nature of the
incentives of an SBS Dealer in relation
to a given security-based swap
transaction.
This rule will involve direct and
indirect costs. SBS Entity counterparties
will incur costs of obtaining a
reasonable basis to believe that the
special entity has a qualified
independent representative. Based on
our estimates in Section V, all SBS
Entities acting as counterparties to
special entities will incur an aggregate
initial cost of, approximately,

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$132,819,500.1700 Ongoing costs of
compliance with rules for
counterparties of special entities will
involve updating representations and
verifications for transactions with thirdparty non-employee independent
representatives, estimated at
$8,569,000.1701 In-house independent
representatives will bear costs of making
representations to SBS Entities, which
will involve an aggregate initial
compliance burden of, approximately,
$137,104,000 with an ongoing cost of
$8,569,000.1702
In addition, some special entities may
be entering security-based swaps with
SBS Entities that are not in their best
interest, and advice from qualified
independent representatives may help
inform special entities and enable them
to make better investment decisions.
Therefore, this rule may improve
allocative efficiency of security-based
swap investments. However, as noted
earlier, SBS Entities are for-profit
entities, and, to the extent that SBS
Entities are currently intermediating
security-based swaps that are not in the
best interests of some of their special
entity counterparties, the rule may
lower an SBS Entity’s profitability of
intermediating security-based swaps
with special entities. SBS Entities may
attempt to recoup these costs in the
form of less attractive security-based
swap terms, or become less willing to
transact with special entities. As an
additional consideration, entities with
activity levels below de minimis
triggering SBS Dealer registration, but
with positions large enough to require
Major SBS Participant registration will
bear these costs of intermediating
transactions with special entities. If the
costs of intermediated security-based
swaps with special entities are
substantial, some Major SBS
Participants may reduce or stop
transacting with special entity
counterparties.
These costs may be lower if SBS
Entities’ special entity counterparties
provide representations that allow SBS
Entities to take advantage of the safe
harbor in Rule 15Fh–5(b). Our data do
not allow us to estimate the number of
1700 Aggregate initial cost: (In-house attorney at
$380 per hour) × 349,525 hours = $132,819,500.
1701 Ongoing aggregate cost: (In-house attorney at
$380 per hour) × 22,500 hours = $8,569,000.
1702 Initial cost: (In-house attorney at $380 per
hour) × 360,800 hours = $137,104,000. We believe
that in-house investment advisers may be
compensated similarly to in-house attorneys. To the
extent that the rate of compensation for
independent representatives may be lower, these
figures may overestimate the aggregate initial
burden related to these final rules.
Ongoing: (In-house attorney at $380 per hour) ×
22,500 hours = $8,569,000.

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special entities currently relying on
qualified independent representatives
since we cannot observe whether they
have conflicts of interest with SBS
Entities that would preclude them from
meeting independence requirements of
these final rules. However, we note that,
as reflected in the economic baseline,
special entities represent approximately
10.5% of account holders in DTCC TIW
between 2006 and 2014. Only
approximately 2% of special entities did
not rely on investment advisers in their
single name CDS trades, with 85 unique
pairs of SBS Dealers and U.S. special
entities transacting in single name CDS.
In 2014, there were 2 unique trading
relationships between likely SBS
Dealers and special entities without a
third party investment adviser,
representing approximately 0.039% of
all transactions in 2014. Therefore, the
overwhelming majority of special
entities may already be relying on
investment advisers in their securitybased swap transactions. However, we
do not observe whether advisors in TIW
data meet the independence and
qualification requirements being
adopted in these final rules. If a
significant fraction of third party
representatives does not meet the
qualified independent representative
requirements in these final rules, special
entity counterparties of SBS Entities
may choose to replace third party
representatives with those that do have
requisite qualifications and
independence, enabling continued
transaction activity with SBS Entities, or
may lose access to SBS Entity
intermediated OTC security-based
swaps.
As estimated above, all special entity
counterparties of SBS Entities will face
costs of making representations to SBS
Entities concerning their reliance on
independent advisors acting in their
best interests. To the extent SBS Entities
transact with special entities that are not
already relying on representatives, or
are relying on representatives that
would not meet the qualification and
independence criteria in these final
rules, such special entities would incur
costs of obtaining a new representative
and making necessary representations, if
they wish to facilitate the SBS Entities’
reliance on the safe harbor. This may
increase demand for the services of
qualified independent representatives,
and independent representatives may
require higher compensation to reflect
such higher demand. Such costs will
depend on the number of third-party
representatives of special entities that
do not currently meet the independence
and qualification requirements of these

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final rules; the resulting increase in the
demand for new representation; and the
supply of investment advisers not
currently representing special entities in
security-based swaps that would be
considered qualified and independent
under these final rules. We lack data to
quantify these effects and commenters
did not provide information that would
enable such quantification. We are,
therefore, unable to estimate these costs.
Under the final rules, SBS Entities
may become counterparties of special
entities only if they have a reasonable
basis to believe that the special entity
has a qualified independent
representative. We note that Rule 15Fh–
1(b) allows SBS Entities to rely on
written representations of a
counterparty to satisfy its due diligence
requirements. As a result, SBS Entities
that can rely on representations will not
be required to conduct independent
assessments of the qualifications or
independence of special entity
representatives, as proposed by some
commenters.1703 These issues are
discussed in further detail in Section
VI.C.4.iv below.
c. SBS Dealers as Advisors to Special
Entities
Rule 15Fh–2(a) introduces in a default
presumption that an SBS Dealer acts as
an advisor to a special entity when it
recommends a security-based swap or a
trading strategy that involves the use of
a security-based swap to the special
entity. The rule provides a safe harbor,
where an SBS Dealer will not be acting
as advisor when a special entity
represents that it acknowledges that the
SBS Dealer is not acting as an advisor,
that the special entity will rely on
advice from a qualified independent
representative, and the SBS Dealer
discloses to the special entity that it is
not undertaking to act in the best
interest of the special entity. The rule
also provides a safe harbor for SBS
Dealers transacting with ERISA special
entities, where the SBS Dealer will not
be acting as an advisor if the special
entity represents that it has an ERISA
fiduciary; the fiduciary represents in
writing that it acknowledges that the
SBS Dealer is not acting as an advisor;
and the special entity represents either
that it will comply in good faith with
written policies and procedures
designed to ensure that any
recommendation received from the SBS
Dealer involving a security-based swap
transaction is evaluated by a fiduciary,
or that any recommendation received
from the SBS Dealer involving a
1703 See,

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security-based swap transaction will be
evaluated by a fiduciary.
Rule 15Fh–4(b) establishes
requirements for an SBS Dealer acting as
an advisor to special entities. Rule
15Fh–4(b)(1) provides that an SBS
Dealer acting as an advisor to a special
entity shall have a duty to make a
reasonable determination that any
security-based swap or trading strategy
involving a security-based swap
recommended by the SBS Dealer is in
the best interests of the special entity.
Rule 15Fh–4(b)(2) requires an SBS
Dealer acting as an advisor to a special
entity to make reasonable efforts to
obtain such information that the SBS
Dealer considers necessary to make such
a determination.
The final rules except transactions
executed on registered or exempt SEFs
or registered national securities
exchanges if an SBS Dealer does not
know the identity of the counterparty at
a reasonably sufficient time prior to
execution to permit compliance with
these final obligations.
As discussed in detail in earlier
sections, SBS Dealers enjoy
informational advantages relative to
their nondealer counterparties, and are
for profit entities with business interests
that may conflict with those of their
counterparties in principal and/or
agency transactions. Hence, SBS Dealers
may have conflicts of interest related to
the security-based swaps and the
securities underlying them.1704 Such
conflicts of interest may influence SBS
Dealer recommendations to their
counterparties. The final business
conduct rules may lessen the reliance of
special entities on SBS Dealer
recommendations, but, they may also
limit special entities’ access to securitybased swap related investment advice
and OTC security-based swaps.
Special entity counterparties may be
aware of these fundamental incentives
of SBS Dealers and of the complexity
and opacity of security-based swaps,
and may be able to recognize and parse
out the potential bias in dealer
recommendations. As discussed above,
special entities represent a small
fraction of market participants and
almost exclusively rely on investment
advisers. We also note that, to the extent
special entities are currently allocating
capital inefficiently in security-based
swaps, they may be doing so for reasons
unrelated to SBS Dealer
recommendations, such as reaching for
yield in a low interest rate environment,
1704 See Sections VI.A and VI.C.2 for a more
detailed discussion of informational asymmetries
and conflicts of interest related to security-based
swap dealing activity.

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
or as a result of fund manager incentive
conflicts. If special entity participation
in security-based swap markets is
driven by these other factors and is not
a result of reliance on SBS Dealer
recommendations, the benefits of these
rules may be reduced.
As we have noted in prior sections,
based on TIW data for 2006 through
2014, approximately 98% of special
entities transacting in single name CDS
trades in TIW rely on advisors. We lack
data to estimate how many of these
advisors may be considered qualified
independent representatives for the
purposes of the safe harbor. However,
we recognize that the economic effects
of this rule may be significantly reduced
if many SBS Dealers avail themselves of
the safe harbor in their transactions with
and recommendations to special
entities.
We note that under the final rules,
when an SBS Dealer makes a
recommendation to a special entity, and
obtains the representations and makes
the disclosures required by the safe
harbor, the SBS Dealer will not be
required to comply with the best
interest standard in Rule 15Fh–4(b).
However, if, in such cases the special
entity counterparty has less than $50
million in assets (and therefore, does
not meet the institutional counterparty
definition), the SBS Dealer will still be
required to comply with its customerspecific suitability obligations in Rule
15Fh–3(f)(1)(ii). This provision imposes
customer-specific suitability obligations
on SBS Dealers who cannot take
advantage of the institutional suitability
alternative in Rule 15Fh–3(f)(2). This
may enhance potential counterparty
protection and allocative efficiency
benefits of the final special entity rules
relative to the alternative of not
imposing customer-specific suitability
obligations with respect to special
entities under the safe harbor with less
than $50 million in assets. Our data do
not allow us to estimate how many
special entities would fall under the $50
million asset size threshold; asset size
thresholds for special entities at which
the intended information and
counterparty protection benefits of these
final rules become significant; or the
extent to which asset size and special
entity sophistication may be correlated
in security-based swap markets.
We also recognize that this approach
diverges from the institutional
suitability alternative adopted by the
CFTC as part of business conduct
standards for Swap Entities. As a result,
all SBS Dealers that are dually
registered with the CFTC as Swap
Dealers will face two different standards
of care in swaps and security-based

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swaps when making recommendations
to special entities with less than $50
million in assets. As a result, dually
registered SBS Dealers may choose not
to rely on the institutional suitability
alternative when making
recommendations to special entities
with less than $50 million in both swap
and security-based swap markets. This
aspect of the alternative may increase
costs that SBS Dealers will incur as a
result of advising and transacting with
small special entities in security-based
swaps. SBS Dealers may reduce their
provision of advice to small special
entities or pass on such costs to
counterparties in the form of higher
transaction costs or a decreased
willingness to intermediate over-thecounter security-based swaps. Further,
as discussed above, the Commission
believes that suitability obligations for
special entities with less than $50
million in assets may increase the
potential counterparty protection and
allocative efficiency benefits of the final
special entity rules. Therefore, the
primary economic effects of these rules
depend on the degree to which special
entities rely on conflicted SBS Dealer
recommendations in their securitybased swap decisions, the value of
biased security-based swap
recommendations by SBS Dealers, the
relative cost of outside investment
advice concerning security-based swaps,
and the fraction of SBS Dealers that will
be able to take advantage of the
qualified independent representative
safe harbor.
Therefore, the primary economic
effects of these rules depend on the
degree to which special entities rely on
conflicted SBS Dealer recommendations
in their security-based swap decisions,
the value of biased security-based swap
recommendations by SBS Dealers, the
relative cost of outside investment
advice concerning security-based swaps,
and the fraction of SBS Dealers that will
be able to take advantage of the
qualified independent representative
safe harbor.
SBS Dealers will be unable to
recommend security-based swaps that
are not in special entities’ best interests,
and will therefore forego potential
incremental profits from such
transactions. SBS Dealer ‘‘best interest’’
determinations concerning
recommended security-based swaps
may potentially give rise to dealer
liability or litigation risk if there are
differences of opinion concerning the
relative merits of different securitybased swaps and counterparties incur
losses. SBS Dealer registration is not
currently required, disclosure of
litigation reserves by SBS Dealers is not

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30123

mandatory, and the economic
magnitude of such costs will depend on
how special entities, their
representatives and SBS Dealers will
respond to these final rules. Therefore,
we are unable to estimate these costs.
However, we recognize that some SBS
Dealers may incur such costs. In
addition, the aggregate initial costs of
revising representations and collecting
requisite information from special
entities related to the requirements for
SBS Dealers serving as advisors to
special entities are estimated at
$741,000.1705
SBS Dealers that are most affected by
these costs may respond to the final
rules by ceasing to provide securitybased swap recommendations to special
entities, limiting special entities’ access
to such investment advice, or by
decreasing their willingness to
intermediate OTC security-based swaps
with special entities. However, we note
that SBS Dealers that lose the most
profit as a result of the requirement to
provide advice in their counterparties’
best interests may have been issuing
more conflicted recommendations that
were not in the special entities’ best
interests. Therefore, special entities may
lose access to such conflicted advice,
but the remaining advice by SBS Dealers
should be consistent with special
entities’ best interest.
d. Independent Representation:
Alternatives
We have considered alternatives that
result in tightening of the independence
requirements for representatives, for
instance, through the imposition of a
longer look back period in the
associated person prong of the
independence definition. More stringent
independence requirements may
mitigate potential conflicts of interest
and biases in security-based swap
recommendations registered
representatives make to special entities.
However, as tabulated in Table 2, the
majority of market participants rely on
investment advisers for their securitybased swap transactions, and more
stringent definitions will limit the
number of representatives qualified to
advise special entities in security-based
swaps. A decrease in the supply of
independent representatives may
increase the cost of retaining
independent representation and limit
access by smaller, less sophisticated
counterparties that benefit from
independent advice and representation
1705 Initial cost: (In-house attorney at $380 per
hour) × ((250 hours to draft, review and revise the
representations in standard SBS documentation) +
(1,700 hours to collect information from each
special entity) = $741,000.

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in opaque and complex security-based
swap transactions. Further, more
stringent independence requirements
may decrease the level of specialized
expertise of representatives. We have
received mixed comments on the
relative merits of various definitions of
independence, commenters did not
quantify the economic costs or benefits
of the alternatives 1706 and no such data
is available at present time. As indicated
earlier, the independence definition
being adopted is consistent with the
CFTC’s approach in swap markets.
Finally, we have considered
eliminating the independent
representative safe harbor from the
special entity requirements, as
suggested by some commenters.1707 To
the extent that unsophisticated
counterparties rely on independent
outside advisors or professional
portfolio managers acting in their best
interest, the economic effects of
potential biases in SBS Dealer
recommendations may be mitigated.
Sophisticated entities and entities
relying on independent advice from
qualified fiduciaries are less likely to
benefit from SBS Dealer best interest
recommendations, particularly in light
of the disclosures being adopted as part
of these final rules. At the same time,
the costs of SBS Entity advice under the
best interest standard would be passed
on to special entities, increasing costs of
security-based swaps and potentially
limiting market access for special
entities. Further, SBS Entities may have
superior information about securitybased swaps, but face information
asymmetries concerning the nature of
financial and business risks of their
counterparties. Special entities may be
better able to assess the relative merits
of a given security-based swap
transaction when relying on
independent qualified representatives,
as opposed to engaging SBS Entities to
make such recommendations under a
best interest standard.
Similarly, prohibiting SBS Dealers
from selling derivatives when the
special entity would be better served by
more traditional debt instruments, as
suggested by one commenter,1708 will
impede market access by special entities
to a potentially valuable vehicle for risk
mitigation. For some special entities,
particularly for sophisticated entities,
entities relying on independent advice
1706 See, e.g., Better Markets (August 2011), supra
note 5; NAIPFA, supra note 5; CFA, supra note 5;
FIA/ISDA/SIFMA, supra note 5; APPA; BlackRock,
supra note 5; SIFMA (August 2011), supra note 5;
and Blackrock, supra note 5.
1707 Better Markets (August 2011), supra note 5;
CFA, supra note 5; and AFSCME, supra note 5.
1708 See CFA, supra note 5.

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from qualified advisors, and entities
with risk management needs best
addressed by OTC security-based swaps,
such costs are likely to be significant.
Further, this alternative would preclude
special entities from accessing one of
the vehicles for trading on negative
information about risks of the
underlying securities. Excluding
informed and sophisticated special
entities from security-based swaps
markets may decrease price efficiency
and liquidity, and fragment swap,
security-based swap and underlying
reference security markets. However, if
such special entities are prohibited from
accessing OTC security-based swaps,
these entities would be able to access
standardized security-based swaps
traded on registered national exchanges
or SEFs. This may increase the volume
of security-based swap trades transacted
on these platforms.
e. Reliance on Representations
Rule 15Fh–1(b) allows SBS Entities to
rely on the written representations of a
counterparty to satisfy its due diligence
requirements, unless they have
information that would cause a
reasonable person to question the
accuracy of the representation. While
these final rules impose new costs on
SBS Entities, Rule 15Fh–1(b) will enable
SBS Entities to rely on representations
in lieu of independent due diligence,
under certain circumstances. Since SBS
Entities may be able to rely on
representations to fulfil the
requirements in these final rules, we
expect they will do so when the costs
of reliance on representations are lower
than those of independent due
diligence, to the extent that special
entities are willing and able to provide
representations that meet the
requirements of the rule. This may,
therefore, provide potentially beneficial
flexibility to SBS Entities in managing
their compliance obligations under
these final rules.
Relying on special entities’
representations concerning the
qualifications, and independence of
investment representatives should be
less costly for SBS Entities than
conducting independent substantive
evaluations of qualifications and
independence of their counterparties’
representatives. To the extent that the
best interest standard introduces costs
for SBS Entities, and to the extent that
the qualified independent
representative safe harbor may mitigate
these costs as discussed in prior
sections, Rule 15Fh–1(b) may enable
SBS Entities to make recommendations
and serve as counterparties to special
entities at lower costs under reliance on

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counterparty representations than under
independent due diligence. However, if
an SBS Entity has information that
would lead a reasonable person to
question the accuracy of the
representation, SBS Entities will be
required to perform independent due
diligence.
We have considered an ‘‘actual
knowledge’’ standard as an alternative
to the reliance on representation
standard. Under an ‘‘actual knowledge’’
standard, an SBS Entity can rely on a
representation unless it knows that the
representation is inaccurate. The
alternative could allow SBS Entities to
rely on questionable representations
insofar as they do not have actual
knowledge that the representation is
inaccurate, even if they have
information that would cause
reasonable persons to question their
accuracy. As a result, this alternative
would reduce the benefits of the
verification of status, know your
counterparty, suitability and special
entity requirements and result in weaker
protections for counterparties to SBS
Entities. However, SBS Entities would
be able to rely on counterparty
representations with respect to a
potentially greater set of transactions
and counterparties. To the extent that
reliance on representations may lower
SBS Entity costs from these final
business conduct rules, this actual
knowledge standard alternative for
reliance on representations has the
potential to further reduce costs.
We have received mixed comments
on the relative merits of these standards,
with some commenters supporting the
actual knowledge standard,1709 others
supporting the reasonable person
reliance standard,1710 and others
opposing both standards as too low.1711
None of the commenters quantified the
potential economic costs or benefits of
the proposed standards, and we lack
information or data to quantify the
above economic effects. For instance,
we lack information about the number
of transactions between special entities
and SBS Entities conducted in reliance
on representations, the accuracy of
which reasonable persons would
question but where SBS Entities lack
actual knowledge of falsehood, and the
costs of independently evaluating a
representative’s qualifications and
independence which will depend on an
individual SBS Entity’s choice to
1709 See, e.g., SIFMA (August 2011), supra note 5;
FIA/ISDA/SIFMA, supra note 5; CCMR, supra note
5; APPA, supra note 5; BlackRock, supra note 5);
ABC (2011); ABA Committees, supra note 5.
1710 See, e.g., Better Markets (2011).
1711 See CFA, supra note 5 and AFSCME, supra
note 5.

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perform due diligence in house and the
efficiency of related internal business
processes, or to retain a third party due
diligence provider and the related
choice of service provider. In addition,
we have received comment that, where
SBS Dealers are required to conduct
independent due diligence, they may
face potential litigation risk if they
approve a representative who is
subsequently determined to be lacking
expertise, as well as potential litigation
from representatives whom they have
chosen to disqualify, which may
discourage SBS Dealers from
intermediating OTC security-based
swaps with certain groups of
counterparties.1712 Commenters have
not provided any information to enable
us to quantify these costs and we have
no data to enable such quantification.
We note that under CFTC rules, Swap
Entities are subject to the reasonable
person reliance standard being adopted
in these final rules. We also note that
swap and security-based swap markets
are interconnected, market participants
transact across these markets, and many
SBS Entities are expected to be duallyregistered as Swap Entities. If the same
dealers face differential compliance
costs of transacting over the counter
with the same special entities in, for
instance, single name and index CDS,
dealing activity may flow to the market
with lower compliance costs,
potentially fragmenting price discovery
and liquidity. Further, the standard
being adopted is likely more timely and
cost effective than an approach
permitting no reliance on
representations.
We have also considered alternative
approaches involving a higher standard
for reliance on representations or
requiring SBS Entities to conduct an
independent analysis of conflicts and
qualifications of each independent
representative of a special entity, with
which they may be negotiating swaps.
This approach may enhance SBS
Entities’ due diligence with respect to
representatives of special entity
counterparties, but may decrease the
willingness or ability of SBS Entities to
provide special entities with access to
security-based swaps.1713 As an
additional consideration, we understand
that most market participants in swap
markets and Swap Entities have adopted
a multilateral protocol as a means of
complying with the CFTC external
business conduct rules. While we
understand that the representations
contained in the protocol only expressly
address swap transactions, we have
1712 See

ABC, supra note 5.
e.g., NAIPFA, supra note 5.

1713 See,

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received comment that factual matters
addressed by those representations
typically do not vary between swap and
security-based swap transactions. To the
extent that cross-market participation of
dealers and non-dealer counterparties is
a significant feature of security-based
swap markets, requiring duallyregistered SBS Entities to obtain
separate representations or conduct
independent due diligence specifically
addressing security-based swaps may
impose additional costs, which may be
passed on to counterparties and limit
their access to OTC security-based
swaps.1714 In addition, as discussed
above, we have received comment that
requiring SBS Dealers to conduct
independent due diligence may lead to
potential litigation risk from approving
representatives subsequently
determined to be lacking expertise or
representatives that are disapproved.
According to the comment letter, this
may discourage SBS Dealers from
intermediating OTC security-based
swaps with certain groups of
counterparties.1715 The commenter did
not provide any estimate of such
potential costs and the Commission has
no data to enable such quantification.
However, we recognize that these costs
may be significant, and it is unclear that
the independent due diligence
alternative is superior to the reliance on
representation approach being adopted.
f. Magnitude of the Economic Effects
When considering the likely
magnitude of the economic effects of
special entity rules discussed above, we
note that, based on data for November
2006 through December 2014,
approximately 98% of special entities
relied on investment advisors for their
single name CDS trades in DTCC–TIW,
and only approximately 2% of special
entities acted as a transacting agents.1716
We lack data or other information to
estimate how many investment advisers
currently representing special entities in
security-based swap markets will be
considered qualified and independent
for the purposes of compliance with
these final rules, or how many SBS
Entities would be able to rely on the
independent representative safe harbor
in their transactions with special
entities. Commenters did not provide
data that would enable such
quantification. In addition, we lack data
on the associations of investment
1714 See

SIFMA (November 2015), supra note 5.
ABC, supra note 5.
1716 Approximately 95% of special entities relied
on SEC registered investment advisers, and another
3% of special entities used unregistered investment
advisers. See Table 2 of the economic baseline,
Section VI.B supra.
1715 See

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30125

advisers with SBS Entities in the past
year, the extent of their advisory roles
in relationships with special entities,
the existence of conflicts of interest, and
other information. Therefore, we cannot
quantify how many special entities may
be able to rely on representations.
However, in light of special entities’
heavy reliance on investment advisers
in security-based swap transactions, it is
unclear whether a substantial portion of
special entities rely on SBS Entity
recommendations in their securitybased swap transactions.
We also recognize similarities
between the CFTC’s business conduct
standards, FINRA rules, and the rules
being adopted, as well as extensive
cross-market participation—all of which
may reduce both the economic costs (if
dually registered entities have already
restructured their compliance
infrastructure to comply with similar
rules) and the benefits of these rules (if,
for instance, special entities have
learned about potential biases in
recommendations from new market
practices of the same dealers in other
financial markets). We note that our
final business conduct standards
include transaction level requirements.
Therefore, as we discuss and estimate
above, some benefits and costs related to
individual security-based transactions
are still likely to accrue to special
entities, their qualified independent
representatives, and SBS Entities; even
those already subject to similar rules in
other markets. Further, some SBS
Entities and potential new entrants may
not be cross-registered with the CFTC or
with FINRA, and may, therefore, not
already be subject to similar rules in
other markets.
Finally, the rules relating to
transactions with special entities will
not apply to security-based swaps
executed on registered or exempt SEFs
or registered national security
exchanges, where SBS Entities do not
know the identity of the counterparty at
a reasonably sufficient time prior to
execution of the transaction to permit
the SBS Entity to comply with the
obligations of the rules. Therefore,
special entities would not receive the
benefits of additional counterparty
protections of these rules when
transacting anonymously through SEFs
or registered national securities
exchanges. However, as noted earlier
these final rules may increase the costs
of SBS Entities and reduce their
information rents, which may lead SBS
Entities to seek to recover lost profits
through more adverse terms of OTC
swaps sold to special entities, or
reduced willingness to transact with
special entities. Since anonymous SEF

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or exchange traded security-based
swaps will not be subject to these final
requirements, the risk that special
entities will lose access to securitybased swaps may be reduced.
5. Fraud, Fair and Balanced
Communications, Supervision

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a. Antifraud
The final business conduct rules
include a set of antifraud provisions
covering SBS Entity transactions with
all counterparties, and with special
entities. With respect to special entities,
rules 15Fh–4(a)(1) and 15Fh–4(a)(2)
prohibit SBS Entities from employing
any device, scheme, or artifice to
defraud special entities, and from
engaging in any transaction, practice or
course of business that operates as a
fraud or deceit. Rule 15Fh–4(a)(3)
imposes a general ban on SBS Entities
engaging in any act, practice, or course
of business that is fraudulent, deceptive
or manipulative.
To the extent fraudulent, deceptive or
manipulative conduct may affect the
choice of the SBS Entity’s counterparty
and the decision to enter into a given
swap, antifraud protections may lead to
an increased flow of transactions to SBS
Entities not engaging in fraudulent
practices. To the extent that the risk of
fraud may affect the willingness of
market participants to transact in
security-based swap markets, antifraud
protections may increase the
willingness of non-SBS or Swap Entity
counterparties to participate in securitybased swap markets. We recognize that,
as indicated by a commenter, general
antifraud and anti-manipulation
provisions of existing federal securities
laws and Commission rules offer similar
protections.1717 Therefore, the
magnitude of these economic benefits
relative to the economic baseline is
expected to be de minimis. Further, in
light of SBS Entities’ ongoing statutory
antifraud obligations, we anticipate that
entities likely to trigger SBS Entity
registration requirements have already
developed policies and procedures
necessary for compliance with these
final rules. Therefore, the magnitude of
the economic costs to SBS Entities from
these final rules is expected to be de
minimis as well.
The Commission is not establishing a
policies and procedures safe harbor for
non-scienter violations, or provisions
regarding the protection for
counterparty confidential information.
As an alternative to these final rules, the
Commission could adopt such a safe
harbor. For instance, the Commission
1717 See

Barnard, supra note 5.

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could adopt a rule where an SBS Entity
would be able to establish an affirmative
defense by demonstrating that it did not
act intentionally or recklessly, and
complied in good faith with written
policies and procedures reasonably
designed to meet this particular
requirement. The adoption of such a
safe harbor may reduce compliance and
litigation costs related to nonscienter
fraudulent, deceptive or abusive
practices or conduct that may occur
despite SBS Entities having developed
and implemented all relevant policies
and procedures, acting in good faith.
However, a safe harbor against fraud
may weaken counterparty protections in
a market for complex and opaque
securities.
b. Fair and Balanced Communications
Under rule 15Fh–3(g), SBS Entities
are required to communicate with
counterparties in a fair and balanced
manner based on principles of fair
dealing and good faith. As discussed in
Sections I and II, this rule is harmonized
with FINRA’s communications with the
public rule. To the extent that up to 16
likely SBS Entities may be crossregistered as broker-dealers, some SBS
Entities are already complying with
these requirements with respect to
securities transactions. Specifically, all
communications must provide a sound
basis for evaluating a given securitybased swap or trading strategy,
communications may not imply that
past performance will recur, or make
exaggerated and unwarranted claims.
Rule 15Fh–3(g) clarifies the kinds of
communications that would be
consistent with fair dealing or good faith
communications. In conjunction with
the antifraud rules and enhanced
disclosure requirements, the fair and
balanced communications rule aims to
provide transparency to market
participants transacting with SBS
Entities. To the extent to which
counterparties of SBS Entities may have
asymmetric information or are less
sophisticated, this requirement may
help protect counterparties and improve
their ability to select the most
appropriate security-based swap and
counterparty.
We recognize that the requirement
may impose costs on SBS Entities. As
indicated in Section V, the related
initial aggregate costs are estimated at
$917,400 for the industry, with ongoing
costs of approximately $125,400.1718
1718 Initial internal cost: (In-house attorney $380
per hour) × 330 = $125,400. Initial external legal
counsel costs: $330,000 + $462,000 = 792,000.
Ongoing costs: (In-house attorney $380 per hour) ×
330 = $125,400.

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c. Supervision
Rule 15Fh–3(h) requires SBS Entities
to establish and maintain a supervision
system and diligently supervise their
business and the activities of their
associated persons. At a minimum the
supervisory system must (1) designate at
least one person with supervisory
authority for each type of a business in
which the SBS Entity engages that
requires registration as an SBS Entity;
(2) use reasonable efforts to determine
that all supervisors are qualified; and (3)
establish, maintain and enforce written
policies and procedures addressing the
supervision of the types of securitybased swap business an SBS Entity is
engaged in and the activities of its
associated persons, that are reasonably
designed to prevent violations of
applicable securities laws, and rules and
regulations thereunder. The rule lists
specific types of policies and
procedures that must be included.
In addition, SBS Entities and their
associated persons will not be deemed
to have failed to diligently supervise if
(1) the SBS Entity has certain written
policies and procedures and a
documented system for applying them
that would reasonably be expected to
prevent and detect, insofar as
practicable, any violation of the federal
securities laws and the rules and
regulations thereunder relating to
security-based swaps; and (2) the SBS
Entity or its associated person has
reasonably discharged the duties and
obligations required by such written
policies and procedures and system,
and did not have a reasonable basis to
believe they were not being followed.
Lastly, SBS Entities have an
obligation to promptly amend written
supervisory policies and procedures
when there are material changes to
applicable securities laws, rules and
regulations, or when there are material
changes to the SBS Entity’s business or
supervisory system. SBS Entities are
also required to promptly communicate
any material amendments to their
supervisory procedures to all associated
persons to whom such amendments are
relevant based on their activities and
responsibilities.
The Commission recognizes that these
final supervision rules may impose
certain burdens and costs on SBS
Entities. Specifically, SBS Entities will
be required to establish and maintain a
supervision system consistent with the
minimum requirements articulated in
Rule 15Fh–3(h); to diligently supervise
their business and the activities of their
associated persons; and to amend their
written supervisory policies and
procedures when material changes

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occur to applicable laws, rules or
regulations or to their business or
supervisory systems, and promptly
communicate such amendments to all
associated persons to whom such
amendments are relevant.1719 Based on
estimates in Section V, compliance with
the supervision rules may involve an
aggregate initial cost of $39,317,850 and
an ongoing cost of $8,405,100 for all
SBS Entities.1720 In addition, these final
rules impose new supervision
requirements on SBS Entities, which
may increase the probability and related
costs of responding to legal actions.
However, to the extent that these
supervision rules may enhance
compliance with federal securities laws
and Commission rules and regulations
thereunder, the probability and costs of
responding to regulatory inquiries and
private actions may actually decrease.
We have considered the alternative of
excluding Major SBS Participants from
the scope of the supervision rules and
have received mixed comment on the
issue, as discussed in Section II. One
commenter indicated that the rule may
impose burdensome and costly
supervisory procedures on Major SBS
Participants that are not appropriate
given their non-dealer role in the
marketplace, and the potential costs of
compliance ‘‘would be without any
meaningful offsetting benefit for other
market participants or the financial
markets as a whole.’’ 1721 The
commenter did not provide any data to
quantify potential costs or benefits for
Major SBS Participants. We recognize
that these rules impose requirements
and costs on Major SBS Participants
they are not currently required to bear,
as reflected in our estimates. We also
note that the Commission elsewhere
estimated that only between zero and
five entities may seek to register with
the Commission as Major SBS
Participants. The Commission continues
to believe that due to their large
positions in security-based swaps,
activities of Major SBS Participants may
pose significant risks, such as market
and counterparty risks, in securitybased swap markets, as discussed in
Section II above, the Commission
believes the application of the rules is
thus appropriate.
1719 See Section V for an estimate of burdens and
costs related to the diligent supervision rules.
1720 Initial internal cost: (Compliance manager
$283 per hour) × 103,950 = $29,417,850. Initial
external legal counsel costs: $9,900,000. Ongoing
costs: (Compliance manager $283 per hour) ×
29,700 = $8,405,100.
1721 See MFA, supra note 5.

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6. CCO Rules
Rule 15Fk–1 requires an SBS Entity to
designate a CCO, and imposes certain
duties and responsibilities on that CCO,
including the preparation of an annual
compliance report. In addition, under
Rule 15Fk–1(d), the compensation and
removal of the CCO require the approval
of a majority of the board of directors of
the SBS Entity. We note that the
adopted SBS Entity registration forms
already require SBS Entities to designate
an individual to serve as a CCO, which
enters into an economic baseline against
which we are assessing the effects of
these final rules. Therefore, the primary
economic effects of these final CCO
rules stem from the annual compliance
report requirement, other duties of the
CCO, and CCO compensation and
removal requirements.
a. Annual Compliance Report, Conflicts
of Interest, Policies and Procedures
Rule 15Fk–1(c) requires each SBS
Entity’s CCO to prepare and sign an
annual compliance report containing a
description of the SBS Entity’s written
policies and procedures described in
paragraph (b) of the rule, including the
code of ethics and conflict of interest
policies. The report must also contain a
description of: the SBS Entity’s
assessment of the effectiveness of its
policies and procedures relating to its
business as an SBS Entity; any material
changes to the SBS Entity’s policies and
procedures; any areas for improvement,
and recommended potential or
prospective changes or improvements to
the SBS Entity’s compliance program
and resources devoted to compliance;
any material non-compliance matters;
and the financial, managerial,
operational, and staffing resources set
aside for compliance with the Exchange
Act and the rules and regulations
thereunder relating to its business as an
SBS Entity, including any material
deficiencies in such resources. Further,
SBS Entities must promptly submit an
amended compliance report if material
errors or omissions in the report are
identified. The submission of the annual
compliance report as required by the
final rules may help the Commission
assess the compliance activities of SBS
Entities.
In addition, Rule 15Fk–1(b)(2)
requires the CCO to take reasonable
steps to ensure that the SBS Entity
establishes, maintains and reviews
policies and procedures reasonably
designed to achieve compliance with
the Act and the rules and regulations
thereunder relating to its business as an
SBS Entity by: Reviewing the
compliance of the SBS Entity; and

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30127

taking reasonable steps to ensure that
the SBS Entity establishes policies and
procedures for the remediation and
handling of non-compliance issues.
Rule 15Fk–1(b)(3) requires the CCO, in
consultation with the board of directors
or senior officer, to take reasonable steps
to resolve any material conflicts of
interest that may arise; and Rule 15Fk–
1(b)(4) requires the CCO to administer
each policy and procedure required to
be established under Section 15F of the
Exchange Act and the rules and
regulations thereunder.
Our final rules impose a set of duties
and responsibilities on CCOs of SBS
Entities. As described in the economic
baseline and discussed in earlier
sections, the Commission believes that a
number of entities that will seek to
register as SBS Entities may be dually
registered, and may already be required
to comply with some of these rules in
swap or reference security markets.
However, we note that SBS Entity
registration is currently not required,
and entities intermediating securitybased swaps, including dually
registered entities, are not required to
comply with business conduct or CCO
rules relating to their business as an SBS
Entity. Therefore, these rules impose a
new set of requirements on a population
of SBS Entity registrants as they pertain
to security-based swap business. To the
extent that CCO oversight may facilitate
compliance, the above rules may
enhance compliance of SBS Entities
with federal securities laws and other
Commission rules.1722
Based on our analysis in Section V,
the establishment and administration of
the policies and procedures required
under Rule 15Fk–1 will involve a total
initial cost of approximately
$13,105,950, and an ongoing cost of
approximately $2,801,700 per year for
all SBS Entities.1723 Ongoing costs of
preparation of an annual compliance
report by the CCO is estimated at
approximately $2,480,775 for all SBS
Entities.1724
In addition, these rules impose new
requirements concerning CCO duties.
These final rules also require the annual
compliance report to include a
1722 The Commission has elsewhere stated that
strong internal compliance programs lower the
likelihood of non-compliance with securities rules
and regulations. See SDR Registration Release, 80
FR at 14543, supra note 1202.
1723 Initial cost of policies and procedures:
(Compliance manager at $283 per hour) × 34,650
hours = $9,805,950. Initial cost of outside counsel:
$3,300,000. Total initial cost: $9,805,950 +
$3,300,000 = $13,105,950. Ongoing cost:
(Compliance manager at $283 per hour) × 9,900
hours = $2,801,700.
1724 Ongoing cost of compliance reporting: (CCO
at $485 per hour) × 5,115 hours = $2,480,775.

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certification by the CCO or senior
officer, and may increase CCO or senior
officer liability when the CCO or senior
officer executes the required
certification. If SBS Entity CCOs or
senior officers are risk averse, they may
require additional liability insurance,
higher compensation or lower incentive
pay as a fraction of overall
compensation. To the extent that
liability may be a significant
consideration for some SBS Entities,
this may lower the labor supply of
senior officers or CCOs in security-based
swap markets.
b. CCO Removal and Compensation
CCOs play a central role in
monitoring compliance with federal
securities laws and regulations. These
final rules elevate approval of decisions
regarding the compensation or removal
of the CCO to the board. As indicated
in the proposing release, the
Commission believes that the approach
being adopted may reduce inherent
conflicts of interest that arise when CCO
compensation and removal decisions
are made by individuals whose
compliance with applicable law and
regulations the CCO is responsible for
monitoring.1725 The rule, therefore, may
mitigate CCO conflicts of interest within
SBS Entities, and may strengthen SBS
Entity compliance with federal
securities laws and Commission rules,
including these final business conduct
rules.
SBS Entities are expected to be
primarily large institutions and may be
part of organizational structures that
include hundreds of entities, with
varying levels of business complexity.
Many SBS Entities may also be active in
swap markets, while others may also
perform broker-dealer functions or have
banking operations; yet others may
focus their primary business on
security-based swaps. As a result,
different governance and oversight
structures may be suitable for different
SBS Entities depending on their internal
operations, business complexity, and
the role security-based swap
transactions play in their overall
operations, among others. Therefore, the
rule limits the ability to delegate CCO
compensation and removal decisions to
a senior officer, which may be optimal
for some SBS Entities.
CCO compensation and removal
decisions require an understanding of
security-based swap markets and the
SBS Entities’ business opportunities in
such markets, compliance risks related
to various SBS Entity activities and
1725 See

Proposing Release, 76 FR at 42451, supra

note 3.

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transactions, the labor market for CCOs
of SBS Entities, and an ability to infer
the quality of skills and effort exerted by
the CCO from performance. To the
extent SBS Entity boards lack specific
expertise necessary to approve
compensation and removal decisions,
such boards may currently delegate
these functions to other officers, such as
head of compliance, chief risk officer, or
other persons. As a result of the final
rules, such delegation will not be
permitted, and boards of some SBS
Entities may be required to gather
additional information or gain expertise
necessary to approve compensation and
removal decisions.
SBS Entities that currently delegate
these functions to other officers may
need to refocus board resources on the
area of compliance. As a result, SBS
Entity boards may need to replace
existing directors, hire new directors, or
retain the services of independent
executive search and compensation
consultants that are familiar with
security-based swaps. This may detract
from the time and resources SBS Entity
boards are able to invest in overseeing
activities in other markets, which may
represent a larger fraction of the
business and shareholder profits for
some SBS Entities. To the extent that
SBS Entity boards face time and
resource constraints, they may also
become less effective at monitoring and
advising SBS Entities in areas outside of
compliance. Further, the requirement
that SBS Entity boards approve CCO
compensation and removal decisions,
may increase the liability of SBS
Entity’s directors, which may increase
the costs of director liability insurance
and director compensation.
Nevertheless, as discussed above, the
Commission continues to believe that
these final rules may reduce certain
conflicts of interest related to CCO
compensation and removal decisions,
which may strengthen SBS Entity
compliance with federal securities laws
and Commission rules.
The final rules do not address the
appointment of the CCO. However, the
rules require the CCO to report directly
to the board or senior officer, and
require decisions regarding the
compensation and removal of the CCO
to be approved by the board. As a result,
some SBS Entities may separate
reporting to and appointment by the
senior officer, from compensation and
removal decisions by the board. The
Commission recognizes that
appointment, compensation and
removal decisions may be inextricably
intertwined, requiring an informed
assessment of the CCO’s talent, abilities,
expertise and performance when

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compared against external candidates,
as well as an understanding of the CCO
labor market. Further, a senior officer
may have conflicts of interest in CCO
appointment decisions similar to those
present in CCO compensation or
removal decisions. A potential
separation of the CCO reporting line and
appointment decisions from
compensation and removal decisions
may decrease the quality of these
decisions. However, the ability of some
SBS Entity boards to continue to rely on
senior officers for the CCO to report to
and for appointment decisions may
mitigate some of the resource drain on
boards of SBS Entities discussed above.
We have considered an alternative
approach under which only
independent members of the board can
approve decisions regarding the
compensation, appointment and
removal of CCOs, as proposed by some
commenters,1726 as well as requiring
certain minimum CCO qualifications
and governance practices. Independent
directors may have fewer conflicts of
interest and may be less likely to be
influenced by CCOs, strengthening their
oversight role, which may enhance SBS
Entity compliance with security laws,
and rules and regulations thereunder. At
the same time, outside directors face an
informational asymmetry with respect
to the SBS Entity’s risks and investment
opportunities, and may lack an intimate
understanding of the SBS Entity’s
business. We understand that SBS
Entities may trade off the value of
specific expertise in security-based
swaps on the one hand, with the value
of independence in the face of potential
conflicts of interest on the other hand,
in the context of each SBS Entity’s
operations. Requiring specific CCO
qualifications and other governance
practices of all SBS Entities may
enhance compliance for some SBS
Entities, but may also involve
potentially costly restructuring of
internal governance structures and
operations while offering few benefits
for other SBS Entities as recognized by
one commenter.1727
Additionally, appropriate CCO
qualifications may depend on the CCO’s
functional roles and expertise, and
business activities that the SBS Entity
engage in, particularly for SBS Entities
that operate within larger consolidated
financial institutions with the same
CCO. One-size-fits-all qualification
requirements or competency exams
would restrict the level and type of
expertise of CCOs that SBS Entities are
1726 See, e.g., Barnard, supra note 5 and Better
Markets (August 2011), supra note 5.
1727 See FIA/ISDA/SIFMA, supra note 5.

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able to retain, and would require some
SBS Entities to remove the current CCOs
and search for new CCOs meeting the
imposed qualification requirements.
Crucially, it is not clear how many SBS
Entities currently hire and retain
underqualified CCOs. The Commission
is not requiring any particular level or
type of competency or business
experience for a CCO as part of these
final rules. However, as discussed in
Section II, the Commission believes that
an SBS Entity’s CCO generally should
be competent and knowledgeable
regarding the federal securities laws,
empowered with full responsibility and
authority to develop appropriate
policies and procedures for the SBS
Entity, as necessary, and responsible for
monitoring compliance with the SBS
Entity’s policies and procedures
adopted pursuant to rules under the
Exchange Act. Similarly, mandatory
quarterly or annual meetings with the
board or certain committees of SBS
Entities, proposed by one
commenter,1728 may not mitigate
potential conflicts of interest involving
CCOs, or facilitate compliance where
such conflicts or deficiencies stem from
board or committee collective action
problems, weak monitoring or
misaligned incentives, instead of a lack
of communication or information.
As discussed in Section II,
commenters disagreed on the relative
merits of the approach being adopted
and the alternatives above.1729 The
above economic effects are not readily
amenable to quantification. Commenters
did not provide data or other
information that would facilitate
quantification of these effects; no such
data is publicly available. The overall
effects of these competing
considerations regarding the CCO rules
being adopted depend on internal
governance structures of SBS Entities,
their organizational complexity, severity
of the conflicts of interest between SBS
Entity CCOs and other officers, reliance
of existing SBS Entity boards on
external executive search and
compensation consultants, importance
of security-based swap performance and
compliance for SBS Entity profitability
and counterparty protections, optimal
delegation of oversight, and the ways in
which SBS Entities may restructure
their business in response to these and
other pending substantive Title VII
rules.
1728 See

Better Markets (October 2013), supra note

5.
1729 See, e.g., FIA/ISDA/SIFMA, supra note 5,
Better Markets, supra note 5; CFA, supra note 5.
Also see Section II.I supra.

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7. Pay To Play
Rules 15Fh–5(a)(1)(vi) and 15Fh–6
impose a two-year time out period after
certain political contributions by
security-swap dealers and certain
independent representatives. Rule
15Fh–6(b) generally prohibits SBS
Dealers from offering to enter into, or
entering into, a security-based swap or
trading strategy involving a securitybased swap with a municipal entity
within two years following any
contribution to an official of such
municipal entity made by the SBS
Dealer or any of its covered associates.
The rule also prohibits SBS Dealers and
any covered associates from providing
or agreeing to provide payment to any
person to solicit a municipal entity to
offer to enter into, or to enter into,
security-based swaps, unless such
person is a regulated person. The rule
prohibits SBS Dealers and any covered
associates from coordinating or
soliciting any person or political action
committee to make contributions to
officials of a municipal entity, or to a
political party of a state or locality, with
which the SBS Dealer is offering to enter
into, or has entered into, a securitybased swap or a trading strategy
involving a security-based swap.
Under Rule 15Fh–6(a)(2) covered
associates will include general partners,
managing members, executive officers
or other persons of similar status or
function; employees who solicit
municipal entities to enter securitybased swaps with an SBS dealer, and all
persons directly or indirectly
supervising such employees; and
political action committees controlled
by such persons or SBS Dealers.
These final rules also limit political
contributions by independent
representatives in security-based swaps.
Under Rule 15Fh–5(a) SBS Entities who
offer to enter into or enter into a
security-based swap with a special
entity must have a reasonable basis to
believe that the special entity has a
qualified independent representative.
Rule 15Fh–5(a)(1)(vi) provides that in
the case of a special entity, a qualified
independent representative is a person
that is subject to rules of the
Commission, the CFTC or an SRO
prohibiting it from engaging in specified
activities if certain political
contributions have been made, except
where the independent representative is
an employee of the special entity.
As discussed in more detail below,
our economic analysis of these final
rules reflects the fact that a large
majority of entities expected to seek
registration as SBS Entities are expected
to be dually registered and required to

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comply with similar pay to play rules in
other markets.
These final rules are intended to
address pay to play relationships that
may interfere with the process by which
municipal entities allocate capital to
security-based swaps to enhance returns
or manage risk on behalf of their
stakeholders.1730 To the extent that
these final rules reduce the incidence of
pay to play practices, municipal entities
may become less subject to conflicts of
interest related to political contributions
by SBS Dealers. To the extent that
conflicts of interest related to political
contributions may currently be affecting
capital allocation by municipal entities,
resulting in inefficiencies from
conflicted counterparty or product
selection, these rules may benefit
municipal entities and their
stakeholders. Consistent with the
expected benefits articulated in the
proposing release, these rules may deter
undue influence from SBS dealers and
advisors. Therefore, these rules may
enhance counterparty protections of
municipal entities and increase
allocative efficiency. In addition, these
rules may also encourage SBS Dealers to
compete on the merits of the
transaction. Similarly, under Rule
15Fh–5 qualified independent
representatives of special entities in
security-based swaps will be employees
and representatives subject to pay to
play rules of the Commission, the CFTC
or an SRO, such as registered municipal
advisors or registered investment
advisers. To the extent that some special
entities may currently rely on advisors
that are not employees or registered
investment or municipal advisors,
special entities may become less
affected by potential conflicts of interest
of representatives, and independent
representatives may be encouraged to
compete on their qualifications, service
quality, and cost. These benefits may
flow through to stakeholders of
municipal entities, such as participants
in public pension plans and taxpayers.
To the extent that SBS Dealers are
currently recovering the costs from pay
to play practices in the form of higher
prices of security-based swaps, these
final rules may decrease transaction
costs. We have no data or other
information on the prevalence of
political contributions of SBS Dealers,
the number and contributions of their
covered associates, and transaction costs
and non-price terms of security-based
swaps offered for sale to special entities.
Such data is not publicly available and
commenters have not provided data to
1730 See Proposing Release, 76 FR at 42450, supra
note 3.

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enable such quantification. However, a
study by Butler, Fauver and Mortal
(2009) found that negotiated bid deals
had underwriter gross spreads of 12–14
basis points (about one-seventh of the
mean gross spread) higher during the
pay-to-play era.1731 The study
concluded that, when underwriting
firms were routinely able to make
political campaign contributions to win
underwriting business, gross spreads
were significantly higher, but only for
those deals that were negotiated that
enable conflicted underwriter selection.
This may indicate that, absent pay to
play rules, offerings subject to conflicts
of interest related to political
contributions may not always be
negotiated at market rates. Pay to play
rules may decrease certain costs to
municipal entities and their
stakeholders, but may increase costs to
dealers from greater quality based
competition.
Several caveats apply. While the pay
to play regime considered in the study
above examines the effects of the
contribution limits in the 1994 pay to
play reforms, and the contribution
thresholds in these final rules are
comparable in magnitude, we cannot
quantify the levels at which certain
political contributions by SBS Dealers
and their covered associates may give
rise to conflicts of interest. However, we
note that de minimis thresholds in the
final rules have been harmonized with
existing rules to which Swap Entities
and investment advisers are subject. We
also note that the effect on spreads
quantified above has been estimated
around the adoption of the MSRB pay
to play rule. These final rules follow pay
to play rules adopted by the MSRB, the
CFTC and the Commission. In light of
extensive cross-market participation and
expected dual registration of some
entities, the economic effects of these
final rules may be smaller than those
discussed above, if some SBS Dealers
and other market participants have
already restructured their business
practices in security-based swap
markets as a result of existing pay to
play rules in other markets.
Finally, the two-year time out may
disincentivize direct political
1731 See Alexander W. Butler, Larry Fauver, and
Sandra Mortal, Corruption, Political Connections,
and Municipal Finance, 22 The Review of Financial
Studies 28–73 (2009).
In a theoretical model by Cotton (2012),
contributions may increase access but not
necessarily improve outcomes for some agents,
while contribution limits decrease rent extraction
and may encourage more evidence disclosure. See
C. Cotton, Pay-to-play Politics: Informational
Lobbying and Contribution Limits When Money
Buys Access, 96 Journal of Public Economics 369–
386 (2012).

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contributions to certain officials by SBS
Dealers and their covered associates. To
the extent that SBS Dealers and covered
associates may increase contributions to
other entities, such as 501(c)
organizations 1732 or independent
expenditure committees, which are not
subject to these final rules, and to the
extent these other expenditures may
facilitate ongoing pay to play practices,
the above benefits may be reduced.
As a result of the pay to play rule,
SBS Dealers will incur costs, including
costs of establishing and implementing
policies and procedures to monitor the
political contributions made by the SBS
Dealer and its covered associates. As
indicated in Section V, pay to play rules
will require collection of information
regarding political contributions of SBS
Dealers and their covered associates,
which may cost up to $3,515,000 for all
dealers.1733 Additionally, as discussed
in Section V above, SBS Dealers may
incur one-time initial costs to establish
or enhance current systems to assist in
their compliance with the rule,
estimated at up to $5,000,000 for all SBS
Dealers.1734 Compliance costs imposed
by the rule are expected to vary
significantly among SBS Dealers,
depending on, among other things, the
number of covered associates and the
supervisory structure of the SBS Dealer;
the degree to which compliance
procedures are automated (such as
policies and procedures requiring preclearance); and the extent to which the
SBS Dealer may already have policies
and procedures guiding political
contributions under ethics or
compliance programs. Smaller SBS
Dealers, for example, would likely have
a small number of covered associates,
and thus expend fewer resources to
comply with the proposed rule.
However, to the extent that the cost of
developing policies and procedures may
have a high fixed cost component,
smaller SBS dealers may incur costs that
represent a higher percentage of net
income. Lastly, these costs will be
greater for SBS Dealers with multiple
layers of supervision and a higher
1732 See, e.g., McCutcheon v. Federal Election
Commission, 134 S.Ct. 1434, 1460 (2014).
1733 Initial cost: (In-house attorney at $380 per
hour) × 9,250 hours = $3,515,000. This figure may
overestimate the initial cost burden on some SBS
Dealers if some of the functions are performed by
in-house compliance managers instead of in-house
attorneys.
1734 In the Advisers Act pay to play rule, the
Commission estimated that firms with over 15
covered associates incur, on average, $100,000
startup costs. Assuming all SBS Dealers will have
over 15 covered associates, the initial cost is
estimated at: 50 SBS Dealers × $100,000 =
$5,000,000. See Advisers Act Pay-to-Play Release,
supra note 1100 (adopting Advisers Act Rule
206(4)–5)).

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number of covered associates with
shorter tenures.
Under the final rules, the two-year
time out on SBS dealing with municipal
entities is triggered when any of the
covered associates has contributed in
excess of the de minimis thresholds.
While developing and implementing
policies and procedures related to
political contributions and training
covered associates may mitigate this
risk, some SBS Dealers may still trigger
the time out despite these measures due
to contributions by one of their covered
associates.
Such SBS Dealers will incur costs
from the loss of business with
municipal entities. We note that the
final rules contain a safe harbor for
contributions by natural persons that
predate the date of becoming a covered
associate by more than 6 months, if such
associates do not solicit municipal
entities on behalf of the SBS Dealer.
Further, if the SBS Dealer discovers the
triggering contribution under $350
within 4 months and secures a return of
funds within 60 days, the prohibition
will not apply. In response to
commenter concerns,1735 and consistent
with Advisers Act Rule 206(4)–5, the
final rules provide up to two such
exemptions per year for dealers with 50
or fewer covered associates, and up to
three such exemptions for dealers with
over 50 covered associates. We do not
have data or other information
concerning the number of general
partners, managing members, executive
officers or other persons of similar
status and function in SBS Entities; the
number of employees that solicit
municipal entities to enter securitybased swaps with SBS Dealers; SBS
Dealer supervisory structures for such
employees; or political action
committees controlled by such persons
or SBS Dealers. However, the
Commission has previously estimated
that as many as 423 natural persons may
associate with each SBS Dealer.1736
Therefore, we believe that many SBS
Entities are likely to be able to take
advantage of up to 3 annual exemptions
against inadvertent violations described
above.
The final rules also allow SBS Dealers
to file applications for exemptive relief,
and outline a list of items to be
addressed, including, whether the SBS
Dealer has developed policies and
procedures to monitor political
contributions; the steps taken after
discovery of the contribution; and the
apparent intent in making the
1735 FIA/ISDA/SIFMA,

supra note 5.
Rule of Practice 194 Proposing Release,
80 FR at 51710.
1736 See

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contribution based on the facts and
circumstances of each case. These safe
harbors, combined with the ability to
apply for exemptive relief, may partly
mitigate the direct and indirect costs of
SBS Dealers triggering the timeout and
being precluded from dealing with
municipal entities.
As discussed in Section V, the
incidence of exemptive relief related to
MSRB Rule G–37 and the number of
applications the Commission has
received under the Adviser’s act pay to
play rules may be indicative of possible
applications for exemptive relief under
these final rules. Recognizing that this is
an estimate, we conservatively estimate
that the Commission may receive up to
two applications for exemptive relief
per year with respect to pay to play
rules,1737 at a total ongoing cost of
$25,600 per year.1738
Costs of compliance with the final pay
to play rules may be recovered by SBS
Dealers in the form of higher costs of
security-based swaps offered to
municipal entities. If the costs are
significant and cannot be fully
recovered from counterparties some SBS
Dealers may limit their security-based
swap transactions with municipal
entities and reduce their access to OTC
security-based swaps. However, the payto-play rules do not apply to securitybased swaps executed on national
registered exchanges or SEFs, where the
security-based swap dealer does not
know the identity of the counterparty to
the transaction at a reasonably sufficient
time prior to execution to permit the
security-based swap dealer to comply.
Therefore, municipal entities will retain
access to more liquid and standardized
security-based swaps executed on SEFs
or registered national exchanges, and
will continue to be able to rely on
security-based swaps as a tool for risk
mitigation.
Once SBS Dealers have to comply
with the rule, to the extent that SBS
Dealers currently engaging in pay to
play practices enjoy a competitive
advantage over SBS Dealers that are not,
1737 FINRA has granted 17 exemptive letters
related to Rule G–37 between 1/2005 and 12/2015
(11 years) http://www.finra.org/industry/exemptiveletters. As of 1/2016 there were 665 SEC registered
muni advisers http://www.sec.gov/help/foia-docsmuniadvisorshtm.html. Using these figures, we
obtain an estimate of (17 applications/11 years) ×
(50 SBS Dealers/665) = 0.117 applications per year.
In addition, the Commission has received 13
applications under the Adviser’s act (since the
compliance date, approximately 4 years). As of
2/2016 there were 11,959 registered investment
advisers filing form ADV https://www.sec.gov/foia/
docs/invafoia.htm. Using these figures, (13
applications/4 years) × (50 SBS Dealers/11,959) =
0.014 applications per year.
1738 Ongoing cost: (Outside counsel at $400 per
hour × 32 hours per application × 2) = $25,600.

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they may lose some of their business
with municipal entities and related
profits. However, other SBS Dealers that
do not currently engage in pay to play
practices may win business, and SBS
Dealers may begin to seek competitive
advantages through lower transaction
costs, more customized security-based
swaps, or superior execution,
benefitting municipal entity
counterparties.
If some SBS Dealers currently
intermediating a significant volume of
transactions with municipal entities
trigger the two-year time out, it could
limit the number of SBS Dealers able to
offer to enter into or enter into securitybased swaps with municipal entities.
However, the lost market share is likely
to be picked up by other SBS Dealers.
The presence and direction of any
economic effects would depend on the
number of SBS Dealers that trigger the
time outs; the market power of the
prohibited SBS Dealers; the market
power of SBS Dealers that may be able
to step in; and the importance of
bilateral relationships. Further,
municipal entities will continue to have
unconstrained access to security-based
swaps transacted through SEFs or
registered national security exchanges.
The Commission recognizes that these
rules impose restrictions on persons that
can represent special entities in
security-based swap transactions of
special entities with SBS Entities. As
discussed in Section II.H.6.f, under Rule
15Fh–5(a)(1)(vi), qualified independent
representatives of special entities must
be subject to pay to play rules of the
Commission, the CFTC or an SRO,
except where the independent
representative is an employee of the
special entity. If special entities
currently rely on advisors not subject to
pay to play rules, or do not rely on
independent advisors in their
transactions with SBS Entities in
security-based swaps, they will incur
costs related to retaining qualified
independent representatives. These
costs will depend on the type of advisor
search the special entity would choose
to perform, the special entity’s ability to
delegate such functions to current
employees, and labor market conditions
for qualified independent
representatives. Table 2 of the economic
baseline shows that the overwhelming
majority of special entities transact
through SEC registered investment
advisers already subject to similar pay
to play rules under the Adviser’s Act.
Special entities that do not transact
through SEC registered investment
advisers likely rely on municipal
advisors subject to MSRB rules or
employees in their transactions with

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SBS Entities. While we have no data or
other information to enable us to
identify what fraction of advisors
representing special entities would meet
the qualified independent
representative requirements of these
final rules, the above considerations
indicate that costs of pay to play rules
for independent representatives of
special entities may be mitigated.
However, the Commission recognizes
that, to the extent that some
representatives currently intermediating
special entity transactions with SBS
Entities would be prohibited from
advising special entities under these
final rules, some representatives may
incur costs related to loss of business,
and competition among qualified
independent representatives of special
entities may decrease. At the same time,
representatives prohibited from such
activities under these final rules may
seek to register as SEC registered
investment advisers, MSRB registered
municipal advisors or special entity
employees, becoming subject to pay to
play rules referenced in Rule 15Fh–
5(a)(1)(vi) and continuing to represent
special entities in compliance with
these final rules. Therefore, the overall
effect of pay to play rules on
competition among qualified
independent representatives of special
entities is unclear.
As a result of the two-year time out
and other pay to play requirements, SBS
Dealers transacting with municipal
entities, as well as covered associates of
SBS Dealers, may be less likely to make
certain political contributions and
payments to political parties at or above
de minimis thresholds. This may result
in a decrease in funding by SBS Dealers
and their covered associates for such
campaigns through direct contributions
and political action committees.
However, to the extent that the two-year
time out may disincentivize direct
contributions, SBS Dealers and covered
associates may turn to other avenues of
political speech, such as contributing
unlimited amounts to 501(c)
organizations or independent
expenditure committees, which are not
required to disclose donors and are not
prohibited under these final rules.1739
Therefore, the overall effect of these
final rules on the aggregate volume of
political contributions by SBS Dealers
and their covered associates to
campaigns is unclear.
As clarified in Section II, the
Commission is adopting an approach,
under which these prohibitions will not
be triggered for an SBS Dealer or any of
1739 See, e.g., McCutcheon v. Federal Election
Commission, 134 S.Ct. 1434, 1460 (2014).

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its covered associates by contributions
made before the SBS Dealer registered
with the Commission as such. We also
note that these prohibitions will not
apply to contributions made before the
compliance date of the rule by newly
covered associates to which the look
back applies. At the same time, if
individuals who later become covered
associates make a triggering
contribution on or after the compliance
date of this rule, the contribution would
trigger the two-year time out if it were
made less than, as applicable, six
months or two years before the
individual became a newly covered
associate.
We have also considered the
alternative, under which dealers would
enjoy a safe harbor where the municipal
entity is represented by a qualified
independent representative, as proposed
by one commenter.1740 Such an
alternative would lower the scope of
entities and transactions affected by the
pay to play prohibitions. As discussed
in earlier sections and discussed in the
economic baseline, approximately 98%
of special entities rely on investment
advisers in their CDS transactions.
While we do not have data or
information allowing us to conclude
whether these investment advisers
would be considered independent
qualified representatives under our final
rules, this alternative has the potential
to substantially reduce the scope of
application of the pay to play rules.
While this may reduce direct and
indirect costs of pay to play rules for
SBS Dealers, this may also reduce their
benefits, if qualified independent
advisor representation does not fully
resolve conflicts of interest related to
prohibited political contributions by
SBS Dealers and covered associates.
Finally, we have considered the
alternative of increasing or decreasing
the number of exemptions for
inadvertent violations. The ability of
SBS Dealers to cure reduces the risk that
some SBS Dealers may trigger a twoyear timeout as a result of inadvertent
violations due to prohibited
contributions by covered associates,
related losses, and potential adverse
effects on competition and market
liquidity. At the same time, increasing
the number of automatic exceptions
available to SBS Dealers decreases their
incentives to monitor their and their
covered associates’ political
contributions, and may facilitate
ongoing pay to play practices. We also
note that, under the rules being adopted,
in addition to such automatic
exceptions, SBS Dealers would be able
1740 See

SIFMA (August 2011), supra note 5.

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to apply with the Commission for
exemptive relief.
We do not have data or any other
information concerning the sizes,
donors and recipients of political
contributions of entities that may trigger
SBS Dealer registration and covered
associates. No such information is
publicly available, and commenters did
not provide data enabling such
quantification. Therefore, we cannot
quantify the magnitude of the above
effects.
8. Scope
a. Inter-Affiliate Transactions
The final business conduct rules are
designed to facilitate counterparty
protections, reduce information
asymmetries, and enable Commission
oversight. However, as discussed in
Sections V and VI above, these final
rules impose direct and indirect
compliance costs, and may erode SBS
Entities’ profitability of dealing in
security-based swaps, which may
reduce the incentive for dealers to
intermediate SBS transactions and
provide liquidity to end users. We
recognize, however, that some market
participants, such as complex and
diversified corporations or institutions,
may in the regular course of business
enter into inter-affiliate security-based
swaps to manage risk inside a corporate
group or to transfer risk to a treasury
department or central affiliate.
When the economic interests of those
affiliates are aligned adequately, as
would be found in the case of majorityownership, such security-based swaps
serve to allocate or transfer risks within
an affiliated group, rather than to move
those risks out of the group to an
unaffiliated third party. Therefore, the
application of these final business
conduct rules to security-based swaps
that SBS Entities enter into with
majority-owned affiliates is unlikely to
yield enhanced counterparty protections
as discussed above. At the same time,
SBS Entities would incur costs related
to compliance with these final rules for
such transactions. Therefore, the
exclusion of such transactions may
avoid costs that are less likely to be
offset by the economic benefits
considered above. Further, the CFTC
excludes such swaps from substantive
business conduct requirements for Swap
Entities. Imposing these rules with
respect to such security-based swaps
would increase the relative costs of
transacting in security-based swap
markets, including single-name CDS,
and swap markets, including index
CDS. Such an approach may fragment
an otherwise integrated market and

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could lead to a flight of liquidity to
swap markets, with follow on effects on
market liquidity and price discovery. As
indicated earlier, Rule 15Fh–1(a)
specifies that security-based swaps that
SBS Entities enter into with the
majority-owned affiliates will be
excluded from Rules 15Fh–3(a) through
15Fh–3(f), 240.15Fh–4(b) and
240.15Fh–5. We note that CCO and
supervision rules will continue to apply
to dealers engaging in such swaps.
b. Opt Out
These final rules are intended to
strengthen counterparty protections,
reduce informational asymmetries
between SBS Entities and their
counterparties, and enhance
Commission oversight over securitybased swap markets. We recognize the
inherent heterogeneity in the level of
general sophistication and informedness
specific to security-based swaps of
various counterparties of SBS Entities,
as suggested by some commenters.1741
The final rules do not allow
counterparties of SBS Entities to opt out
from some or all of the substantive
business conduct requirements, such as
disclosures of material characteristics,
risks, conflicts of interest, incentives
and clearing rights; suitability
assessments or pay to play rules. As a
result, more sophisticated and better
informed counterparties of SBS Entities
may enjoy few benefits, but may incur
costs from these final rules.
The final rules reflect these competing
considerations through a reliance on
representations approach, and in safe
harbors and alternatives, such as the
institutional suitability alternative for
customer-specific suitability and the
independent advisor safe harbor for SBS
Entities advising special entities.
Further, some of the requirements, such
as pre-trade disclosures of material
incentives, risks and characteristics,
will not apply to counterparties that are
themselves SBS or Swap Entities. Yet
other rules impose requirements on SBS
Dealers, but not on Major SBS
Participants, recognizing the central role
of dealers as intermediaries in securitybased swap markets. Finally, as
discussed throughout the release, many
of these final business conduct
requirements are harmonized with
CFTC and FINRA conduct rules, which
do not allow counterparties to opt out
of these or similar protections.
We also note that if counterparties are
able to opt-out of some or all of the
substantive requirements, SBS Entities
may have an incentive to require opt-out
of these final rules prior to transacting
1741 See,

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with their counterparties, or cease
business with such counterparties. This
effect is more likely to be present for
SBS Entity—counterparty relationships,
in which counterparties have the least
bargaining power, such as less
sophisticated counterparties that do not
regularly access security-based swap
markets, do not have established
relationships with multiple dealers, and
engage in low volumes of security-based
swap activity. This may result in
smaller, less sophisticated and less
informed counterparties, which are ex
ante most likely to benefit from the
disclosures and protections in these
final rules, opting out of business
conduct rules or risking the loss of
access to OTC security-based swaps if
opt out was permitted. However, we
recognize that the ability of
counterparties to opt out of these final
rules would give such entities greater
flexibility in structuring their
relationships with SBS Entities relative
to the approach being adopted, and
allow them to trade off the benefits of
counterparty protections and
information benefits of these final rules
against potentially greater costs and
lower liquidity in SBS Entity
intermediated OTC security-based
swaps under these final business
conduct standards.
Finally, these economic
considerations are attenuated by the fact
that many of the final rules are not
applicable to if the SBS Entity does not
know the identity of the counterparty at
a reasonably sufficient time prior to the
execution of the transaction to permit
the SBS Entity to comply with the
obligations of the rule and, in certain
instances, the transaction is executed on
a registered national exchange or a
registered or exempt SEF.
9. Cross-Border Application
As the Commission has indicated in
other releases,1742 security-based swap
markets are global, and market data
presented in the economic baseline
demonstrates extensive cross-border
participation in security-based swap
markets. For instance, Figure 1 shows
that, based on DTCC–TIW data for 2014,
approximately half of all new accounts
participating in the market are accounts
with a domicile outside the U.S. Viewed
from the perspective of the domiciles of
the counterparties booking credit
default swap (‘‘CDS’’) transactions,
approximately 48 percent of price
forming North American corporate
single-name CDS transactions from
1742 See, e.g., Cross-Border Adopting Release, 79
FR at 47280, supra note 684; U.S. Activity
Proposing Release, 80 FR at 27454.

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January 2008 to December 2014 were
cross-border transactions between a
U.S.-domiciled counterparty and a
foreign-domiciled counterparty, and an
additional 40 percent of such CDS
transactions were between two foreigndomiciled counterparties (see Figure 3).
Thus, only 12 percent of the global
transaction volume by notional volume
between 2008 and 2014 was between
two U.S.-domiciled counterparties,
using registered office location of the
TIW accounts to identify domiciles.
Together, these data indicate that crossborder transactions are a common
feature of dealing activity in the
security-based swap market.
Further, SBS Dealers and other
counterparties are highly
interconnected, with most dealers
transacting with hundreds of
counterparties, and most non-dealers
transacting with several dealers.1743 The
global scale of the security-based swap
market allows counterparties to access
liquidity across jurisdictional
boundaries, providing market
participants with opportunities to share
these risks with counterparties around
the world. Because dealers facilitate the
great majority of security-based swap
transactions, with bilateral relationships
that extend to potentially thousands of
counterparties, deficiencies in SBS
Dealer disclosures, recommendations of
unsuitable security-based swaps, and
informational asymmetries may affect a
large number of counterparties and have
potentially significant cross-border
implications.
a. Scope of Application to SBS Entities
As discussed in Section III, business
conduct requirements fall into two
categories: Entity-level business conduct
requirements, such as CCO rules and
supervision, and transaction-level
requirements, such as disclosure and
suitability. The final rules create certain
exceptions from application of the
transaction-level business conduct
requirements to registered SBS Dealers
and Major SBS Participants in certain
transactions. With respect to SBS
Dealers, these transaction-level
requirements will apply to any
transaction that constitutes an SBS
Dealer’s U.S. business but not to any
transaction that constitutes its foreign
business. For U.S. SBS Dealers, U.S.
business includes all of their
1743 Based on an analysis of 2014 DTCC–TIW
transaction data, accounts likely to register with the
Commission as SBS Dealers have on average 759
unique counterparties (a median of 453 unique
counterparties). All other accounts (i.e., those more
likely to belong to non-dealers) averaged four
unique counterparties (a median of three
counterparties).

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transactions, except for certain
transactions conducted through a
foreign branch. For foreign SBS Dealers,
U.S. business includes all of their
transactions with U.S. persons (except
for certain transactions conducted
through a foreign branch of a U.S.person counterparty) and transactions
captured by the U.S. Activity Test (i.e.,
transactions with another non-U.S.
person that the foreign SBS Dealer
arranges, negotiates, or executes using
personnel located in a U.S. branch or
office).
The final rule creates a slightly
different exception for Major SBS
Participants. U.S. Major SBS
Participants must comply with the
business conduct requirements in all
their transactions, except for certain
transactions conducted through a
foreign branch, and foreign Major SBS
Participants must comply with the
requirements in their transactions with
U.S. persons, except for certain
transactions conducted through a
foreign branch. Under the final rule, the
exception for foreign Major SBS
Participants does not incorporate a U.S.
Activity Test.
In considering the economic effects of
this cross-border approach, we
recognize that the economic baseline
reflects markets as they exist today, in
which compliance with business
conduct standards for security-based
swaps is not required. Therefore, these
final business conduct rules will apply
with respect to security-based swap
transactions intermediated by SBS
Entities where they currently do not.
Under Exchange Act Section 15F, these
requirements apply to registered SBS
Entities by virtue of their registration
with the Commission and, in the
absence of any exceptions to the
requirements, would apply to all
business of a registered SBS Entity.
However, final Exchange Act rules
3a71–3(c) and 3a67–10(d) create certain
exceptions, as described above, that
limit the application of these
requirements to a subset of the
transactions of a registered SBS Entity.
For example, a foreign SBS Dealer
transacting with a foreign counterparty
will not be subject to Title VII
transaction-level business conduct
requirements if the foreign SBS Dealer
does not rely on personnel located in
the United States to arrange, negotiate or
execute the swap, including with
respect to transactions in which the
foreign SBS Dealer’s counterparty may
have relied on personnel located in the
United States.
However, we recognize that the
inclusion of the U.S. Activity Test in the
definition of ‘‘U.S. business’’ for foreign

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dealers may increase the set of
transactions that will be required to
comply with these final business
conduct rules, relative to the alternative
under which foreign dealers transacting
with foreign counterparties are not
subject to these final rules. We also
recognize that capturing transactions of
foreign SBS Entities with U.S. persons
may increase the set of transactions
subject to the final business conduct
rules as compared to the alternative of
not capturing such transactions.
The final cross-border approach to the
scope of the final business conduct
requirements may produce several
benefits. First, classifying certain rules,
such as diligent supervision and CCO
rules, as entity-level requirements that
apply to the entire security-based swap
business of the registered SBS Entity
may facilitate Commission oversight of
registered SBS Entities and enhance
compliance with federal securities laws
and Commission rules. For example, as
discussed in Section III and in the
Cross-Border Proposing Release,
supervision and CCO rules are aimed at
mitigating conflicts of interest and
enhancing compliance with securities
laws, rules and regulations thereunder
by the entire registered SBS Entity. The
Commission continues to recognize that
relevant conflicts of interest and noncompliance may arise as a result of
transactions comprising an SBS Entity’s
foreign business. Further, we note that
CCO duties include establishing,
maintaining, and reviewing policies and
procedures reasonably designed to
ensure compliance with applicable
Exchange Act requirements that apply
to the SBS Entity as a whole. As
discussed in Section III, the
Commission is applying diligent
supervision and CCO duties rules at the
entity level.
Second, by imposing transaction-level
requirements on transactions of SBS
Entities with U.S.-person
counterparties, subject to a tailored
foreign branch exception, these final
rules result in disclosure, suitability,
fair and balanced communications and
special entity requirements, among
others, applying to transactions that are
particularly likely to raise the types of
counterparty protection and other
concerns addressed by Title VII
business conduct requirements, whether
carried out by U.S. or foreign SBS
Entities. Specifically, this approach to
security-based swap transactions
between registered SBS Entities and
U.S. persons may potentially enhance
the expected counterparty protection,
reduce information asymmetry, and
facilitate Commission oversight benefits

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of these final rules to the U.S. securitybased swap market.
Third, requiring registered foreign
SBS Dealers (but not Major SBS
Participants) to comply with business
conduct requirements with respect to
any transaction with another non-U.S.person counterparty that the foreign
SBS Dealer arranges, negotiates, or
executes using personnel located in the
United States will facilitate more
uniform regulatory treatment of the
security-based swap activity of
registered SBS Dealers operating in the
United States, mitigating potential
competitive distortions.1744 Although
applying other business conduct
frameworks (such as broker-dealer
regulation) to this activity may achieve
similar regulatory goals, the availability
of exceptions, exclusions and safe
harbors may mean that alternative
frameworks may not apply to certain
business structures used by registered
SBS Dealers to carry out their business
in the United States.1745 Moreover,
these alternative frameworks may apply
only to the U.S. intermediary of the
foreign SBS Dealer and not to the SBS
Dealer itself. These final rules will avoid
these differences in application, along
with the potential competitive
disparities they may create, by
subjecting all registered SBS Dealers
engaged in transactions captured by the
U.S. Activity test to the same business
conduct framework, including, among
others, disclosure, suitability, and fair
and balanced communication rules.
Applying business conduct rules to all
security-based swap trades arranged,
negotiated or executed by personnel
located in the U.S. also may reduce
disparities between U.S. and foreign
SBS Dealers competing for business
with the same foreign counterparties.
We recognize that foreign SBS Dealers
transacting with foreign counterparties
1744 We recognize that, depending on the business
structure that a registered U.S. or foreign SBS
Dealer employs, an intermediary (such as an agent
that is a registered broker-dealer) may already be
subject to certain business conduct requirements
with respect to the SBS Dealer’s counterparty in the
transaction. However, we continue to believe that
it may be important that registered SBS Dealers
themselves are subject to these final business
conduct requirements with respect to securitybased swap transactions that are part of their U.S.
business. Because SBS Dealers and their agents may
allocate between themselves specific
responsibilities in connection with these business
conduct requirements, to the extent that these
requirements overlap with requirements applicable
directly to the agent (for example, in its capacity as
a broker), and the SBS Dealer allocates
responsibility for complying with relevant
requirements to its agent, we expect any increase
in costs arising from the proposed rules may be
mitigated.
1745 For example, Exchange Act section 3(a)(4)(B)
excepts banks from the definition of ‘‘broker’’ with
respect to certain activity.

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may be subject to foreign regulations in
addition to these final rules, giving rise
to potentially duplicative compliance
costs, pointed out by commenters.1746
However, as discussed in Section III
above, the Commission believes that
requiring registered foreign SBS Dealers
to comply with the transaction-level
business conduct requirements with
respect to these transactions may
enhance transparency, strengthen
counterparty protections, and integrity
of the U.S. security-based swap market.
Moreover, the Commission is
adopting a framework that would
potentially permit foreign SBS Dealers
to satisfy their requirements with
respect to certain of the business
conduct requirements by complying
with comparable requirements of a
foreign jurisdiction. Therefore, foreign
SBS Dealers engaged in U.S. Activity
may be able to comply with these final
rules by complying with foreign
jurisdictions’ rules and regulations, to
the extent that the Commission makes
substituted compliance determinations
and the other prerequisites to
substituted compliance have been
satisfied. This may mitigate the
potential for conflicting requirements
and duplication in compliance costs.
We recognize that there will be limits to
the availability of substituted
compliance, including the possibility
that substituted compliance may be
permitted with regard to some
requirements and not others, or that, in
certain circumstances, substituted
compliance may not be permitted with
respect to any requirements with regard
to a particular jurisdiction depending on
our assessment of the comparability of
the relevant foreign requirements and
the availability of supervisory and
enforcement arrangements among the
Commission and relevant foreign
financial regulatory authorities.
However, the Commission does not
believe it would be appropriate to
permit foreign security-based swap
dealers to satisfy these final business
conduct requirements by complying
with foreign requirements when the
prerequisites to substituted compliance
have not been satisfied.1747
As we noted earlier, these rules limit
the scope of application of these final
business conduct requirements by
excluding certain transactions of
registered foreign and U.S. SBS Entities
from the requirements. However, as we
have also noted, relative to the baseline,
1746 See, e.g., IIB (July 2015), supra note 10; ISDA
(July 2015), supra note 10; SIFMA–AMG (July
2015), supra note 10; SIFMA/FSR (July 2015), supra
note 10, commenting on the U.S. Activity Proposing
Release.
1747 See Section III, supra.

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final Exchange Act rules 3a71–3(c) and
3a67–10(d), together with the
substantive rules being adopted in this
release, should result in an increase in
costs and benefits from the baseline.
Specifically, the final approach to crossborder application of the final business
conduct rules may increase assessment
and programmatic costs of registered
SBS Dealers, but may also increase
related counterparty protections, reduce
informational asymmetries and enhance
Commission oversight.
With respect to assessment costs,
registered SBS Entities likely will
establish systems to identify
transactions that are subject to the
business conduct requirements. Foreign
SBS Entities will need to establish
systems to identify transactions with
U.S. persons (including whether the
transaction is conducted through a
foreign branch of that person), and
foreign SBS Dealers will need to
establish systems to identify
transactions falling within the U.S.
Activity Test. Similarly, U.S. SBS
Entities will incur additional
assessment costs related to identifying
their own transactions conducted
through a foreign branch, including
such transactions with U.S.-person
counterparties that constitute
transactions conducted through a
foreign branch of those U.S.-person
counterparties. Most of the assessment
costs with respect to analysis and
systems to track transactions have been
evaluated in connection with other
Commission rules; therefore, our
economic baseline includes all
registered SBS Entities have those
systems in place. For instance, in the
Cross-Border Adopting Release, the
Commission estimated foreign SBS
Entity assessment costs with respect to
systems tracking transactions with U.S.
persons for purposes of counting
transactions toward the major securitybased swap participant position
thresholds and the security-based swap
dealer de minimis thresholds.1748
1748 See Cross-Border Adopting Release, 79 FR
47332–34 (evaluating foreign SBS Dealer
assessment costs with respect to systems tracking
transactions with U.S. persons); id. at 47353–54
(evaluating foreign Major SBS Participant
assessment costs with respect to systems tracking
transactions with U.S. persons). In that release, the
foreign branch exception applied only to U.S. banks
that were themselves registered SBS Dealers, and
our evaluation of analysis costs borne by such
persons were based on a system that would evaluate
whether a counterparty was a U.S. person, whether
that counterparty was transacting through a foreign
branch, and whether that counterparty was a
registered SBS Dealer, among other things. See, e.g.,
Cross-Border Adopting Release, 79 FR 47353.
Because the analysis to determine whether the
transaction-level business conduct requirements
apply in a transaction by a foreign SBS Entity with

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Similarly, in the U.S. Activity Adopting
Release, the Commission evaluated the
assessment costs to SBS Dealers related
to including transactions falling within
the U.S. Activity Test in a non-U.S.
person’s dealer de minimis
requirements.1749 Once registered, these
SBS Entities will be able to use these
systems in connection with identifying
whether a transaction is subject to the
transaction-level business conduct
requirements.
However, in addition to these
previously evaluated costs, U.S. SBS
Entities conducting business through a
foreign branch will need to classify their
counterparties and transactions to
determine whether business conduct
transaction-level requirements apply.
We believe that the costs to a U.S. SBS
Entity of creating systems to identify
transactions it conducts through a
foreign branch with U.S.-person
counterparties and to determine
whether any such transactions are
conducted through the foreign branch of
its U.S.-person counterparties may be
similar to costs associated with the
systems that foreign persons are likely
to establish to perform the dealer de
minimis or major participant threshold
calculations. In both cases such systems
would have to flag a person’s securitybased swaps against the specific criteria
embedded in the final rules. Based on
the methodology set out in the CrossBorder Adopting Release for estimating
costs of systems designed to identify
similar criteria,1750 we estimate these
assessment costs may include one-time
programming costs of $14,904 and
ongoing annual costs of $16,612 per SBS
Entity.1751 Based on a review of DTCC–
a U.S. person involve only a determination whether
the counterparty is a U.S. person and whether it is
transacting through a foreign branch, we believe
that the system whose costs were estimated in these
prior releases should be sufficient for the analysis
required by foreign SBS Entities under these rules.
1749 See U.S. Activity Adopting Release, 81 FR
8627 (evaluating assessment costs to SBS Dealers
with respect to systems for tracking transactions
arising from U.S. activity).
1750 See Cross-Border Adopting Release, 79 FR
47332, note 681. See also Definitions Adopting
Release, 77 FR 30734–35, note 107.
1751 In the Definitions Adopting Release, we
estimated that the one-time programming costs of
$13,692 per entity and annual ongoing assessment
costs of $15,268. See Definitions Adopting Release,
77 FR 30734–35, and accompanying text (providing
an explanation of the methodology used to estimate
these costs). The hourly cost figures in the
Definitions Adopting Release for the positions of
Compliance Attorney, Compliance Manager,
Programmer Analyst, and Senior Internal Auditor
were based on data from SIFMA’s Management &
Professional Earnings in the Securities Industry
2010.
For purposes of the cost estimates in this release,
we have updated these figures with more recent
data as follows: The figure for a Compliance
Attorney is $334/hour, the figure for a Compliance

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30135

TIW data relating to single-name CDS
activity in 2014, we estimate that up to
5 U.S. SBS Dealers conducted dealing
activity through foreign branches, and
we conservatively estimate that there
may be as many as 5 U.S. Major SBS
Participants. Assuming that all ten of
these U.S. SBS Entities elected to
establish a system to identify
transactions conducted through a
foreign branch or conducted through the
foreign branch of their U.S.
counterparties, the total assessment
costs associated with our final business
conduct rules would be approximately
$149,040 in one-time annual
programming costs and $166,120 in
ongoing annual costs.1752
As recognized in Section III above,
SBS Entities would be permitted to rely
on certain representations provided to
them by their U.S. bank counterparties
regarding whether a transaction is
conducted through a foreign branch.
Initial costs to the U.S. bank
counterparties of developing related
representations are estimated at
$195,000.1753 Aggregate ongoing costs to
the U.S. bank counterparties of
representations are estimated at
approximately $190,000 per year.1754
Manager is $283/hour, the figure for a Programmer
Analyst is $220/hour, and the figure for a Senior
Internal Auditor is $209/hour, each from SIFMA’s
Management & Professional Earnings in the
Securities Industry 2013, modified by SEC staff to
account for an 1800-hour work-year and multiplied
by 5.35 to account for bonuses, firm size, employee
benefits, and overhead. We also have updated the
Definitions Adopting Release’s $464/hour figure for
a Chief Financial Officer, which was based on 2011
data, with a revised figure of $500/hour, for a Chief
Financial Officer with five years of experience in
New York, that is from http://www.payscale.com,
modified by Commission staff to account for an
1800-hour work-year and multiplied by 5.35 to
account for bonuses, firm size, employee benefits,
and overhead. See http://www.payscale.com (last
visited Apr. 16, 2014).
Incorporating these new cost figures, the updated
one-time programming costs based upon our
assumptions regarding the number of hours
required in the Definitions Adopting Release would
be $14,904 per entity, i.e., (Compliance Attorney at
$334 per hour for 2 hours) + (Compliance Manager
at $283 per hour for 8 hours) + (Programmer
Analyst at $220 per hour for 40 hours) + (Senior
Internal Auditor at $209 per hour for 8 hours) +
(Chief Financial Officer at $500 per hour for 3
hours) = $14,904, and the annual ongoing costs
would be $16,612 per entity, i.e., ((Senior Internal
Auditor at $209 per hour for 16 hours) +
Compliance Attorney at $334 per hour for 4 hours)
+ (Compliance Manager at $283 per hour for 4
hours) + (Chief Financial Officer at $500 per hour
for 4 hours) + (Programmer Analyst at $220 per
hour for 40 hours) = $16,612).
1752 One-time annual programming cost: $14,904
× 10 U.S. SBS Entities = $149,040. Ongoing annual
cost: $16,612 × 10 U.S. SBS Entities = $166,120.
1753 Initial cost: Outside counsel $100,000 +
((Attorney at $380 per hour) × 250 hours = $95,000)
= $195,000).
1754 Ongoing cost: (In-house attorney at $380 per
hour) × 500 hours = $190,000.

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This scope of transactions subject to
business conduct requirements may also
affect the programmatic costs incurred
by participants in security-based swap
markets. For entities already required to
register as SBS Entities under current
rules, this rule may increase the set of
transactions and counterparties to
which they must apply business
conduct requirements, relative to the
baseline under which no business
conduct requirements apply. We
continue to recognize that requiring
compliance of foreign SBS Dealers
transacting with foreign counterparties
where transactions were arranged,
negotiated or executed by personnel
located in the United States may
discourage reliance by foreign SBS
Entities on personnel located in the
United States. Some foreign SBS Dealers
transacting with foreign counterparties
may choose to relocate their personnel
outside of the United States, or replace
personnel located in the United States
with personnel not located in the
United States to avoid compliance with
these final rules. To the extent that these
final rules may increase the costs of
foreign SBS Entities, or influence
competition between U.S. and foreign
SBS Dealers, the terms of security-based
swaps intermediated by foreign SBS
Dealers may deteriorate and foreign SBS
Dealers may become less willing to
intermediate security-based swap
transactions. The approach taken in this
rule may mitigate some of the
commenter concerns with the initial
proposal by focusing only on the
location of the foreign dealer’s or its
agent’s market-facing personnel, and not
the location of its counterparties’
activity.1755 Further, these final rules
allow for the possibility of substituted
compliance for foreign SBS Dealers,
including in connection with their
security-based swap activity with
foreign counterparties. Therefore, as
discussed above, these costs may be
incurred primarily by foreign SBS
Entities subject to less stringent
business conduct rules in their foreign
jurisdictions, where the ex-ante benefits
of these final rules may be greater.1756
The Commission has received
comment that this approach to the
application of business conduct
requirements may impose costs of
additional disclosures and
representations on asset managers
servicing foreign clients.1757 As we
1755 See

U.S. Activity Adopting Release, 81 FR

8634.
1756 See, e.g., SIFMA–AMG (July 2015) supra note
10 and ISDA (July 2015), supra note 10, on the U.S.
Activity Proposing Release.
1757 See SIFMA–AMG (July 2015), supra note 10,
at 4.

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noted in Section III, these final rules do
not apply directly to asset managers,
and asset managers will incur no
liability under these rules. However, we
recognize that SBS Entities may have
certain expectations of asset managers
in connection with the transactions
involving funds. Depending on how
SBS Entities and asset managers choose
to allocate these responsibilities, asset
managers may incur some fraction of the
costs estimated above. The commenter
also argued that the final rules may
result in asset managers separating
block trades for U.S. and non-U.S.
persons, for whom business conduct
eligibility has not been verified, and
obtaining assurances that the dealer’s
personnel arranging, negotiating or
executing block trades for non-U.S.
persons is not based in the U.S. We
recognize that, to the extent this affects
the ability of asset managers to find
counterparties to block trades with nonU.S. persons or the costs of doing so,
liquidity may become fragmented and
execution price of certain block trades
may be adversely affected. We note that
some asset managers may be complying
with similar requirements, such as those
under the Exchange Act and FINRA
rules applicable to U.S. broker-dealers
related to transactions in cash securities
that these broker-dealers intermediate
on behalf of foreign brokers.
We have considered the alternative of
applying business conduct rules to all
security-based swap transactions of all
registered SBS Entities. This approach
would increase the scope of transactions
subject to these substantive rules,
increasing programmatic costs of
compliance by registered SBS Entities—
costs that are likely to be passed on to
counterparties. Under the rules being
adopted, the U.S. business of foreign
SBS Dealers excludes transactions
conducted through a foreign branch.
Further, the final rule provides for an
exception from the transaction-level
business conduct requirements when a
foreign Major SBS Participant (or a U.S.
Major SBS Participant in a transaction
conducted through its foreign branch)
enters into a transaction with a foreign
branch of a U.S. person.
To the extent that potential losses on
security-based swap transactions may
flow from foreign branches of U.S.
persons to the U.S. business of U.S.
persons, excluding transactions of
foreign SBS Dealers with foreign
branches of U.S. persons from the
definition of U.S. business may increase
risks to U.S. persons and impact the
integrity of U.S. markets. However,
compliance with business conduct
requirements with respect to securitybased swap transactions between

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foreign SBS Entities and foreign
branches of U.S. persons would further
increase costs of foreign SBS Entities.
Such costs may be passed along to
foreign branches of U.S. persons in the
form of higher transaction costs or
reduced access to security-based swap
transactions with foreign SBS
Entities.1758 We lack data regarding the
reliance of U.S. persons on foreign
branches for their security-based swap
activity with foreign SBS Dealers,
current business conduct practices of
foreign SBS Dealers in their
relationships with foreign branches of
U.S. persons, and the value of bilateral
relationships for this group of market
participants. Therefore, we are unable to
quantify these effects. However, the
approach being adopted recognizes
these competing risk and access
considerations.
The Commission has also considered
the alternative of applying these final
business conduct rules to all
transactions that a U.S. SBS Entity
enters into, including any transaction
conducted through its foreign branch.
Importantly, the definition of
‘‘transactions conducted through a
foreign branch’’ requires the transaction
to be arranged, negotiated or executed in
the foreign branch.1759 The activities of
foreign branches of U.S. SBS Dealers
relying on foreign personnel transacting
with foreign counterparties may not
pose the same compliance and
counterparty risks in U.S. markets as
those addressed by these final business
conduct requirements. As a result, this
alternative may produce fewer intended
benefits associated with these final
rules, but would increase costs of U.S.
SBS Dealers transacting with foreign
counterparties.
The Commission has also considered
the alternative of excepting all
transactions of a foreign SBS Dealer
with non-U.S. persons, including
transactions that involve U.S. activity.
We recognize that the alternative would
decrease the set of transactions subject
to the final business conduct rules,
reducing both assessment and
programmatic costs to foreign SBS
Dealers, and expected programmatic
benefits of these final rules discussed
above. Data on North American
corporate single name CDS market in
Figure 3 of the economic baseline
suggest that activity among non-U.S.
domiciled accounts represents as much
as 17% (if we use the domicile of a
corporate group) to 40% (if we use
registered office location) of global
1758 See Cross-Border Adopting Release, 79 FR at
47343, supra note 684.
1759 See Exchange Act Rule 3a71–3(a)(3).

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
notional volume, and potentially a
larger percentage if firms restructure
their business in response to such an
exception. We do not currently have
data on which of those trades are
arranged, negotiated or executed by U.S.
personnel of foreign SBS Dealers.
However, we note that the U.S. Activity
Test in these final rules will subject
some foreign SBS Dealer transactions
with foreign counterparties to these
business conduct rules. Therefore, this
alternative would reduce the scope of
activity subject to the transaction-level
requirements of these final rules, and
their resulting costs and benefits,
relative to the approach being adopted.
In addition, this alternative could put
U.S. SBS Entities at a competitive
disadvantage due to higher direct and
indirect costs related to these final
business conduct rules when dealing
with foreign counterparties. This
approach may also incentivize U.S. SBS
Dealers to restructure to be considered
a non-U.S. person, while continuing to
rely on personnel located in the United
States to negotiate, arrange or execute
security-based swap transactions with
their foreign counterparties. As
recognized above, we understand
security-based swap markets to be
global, and we expect registered SBS
Dealers transact across multiple
jurisdictions. This alternative may
involve potentially significant frictions
to cross-border transaction activity and
may lead to fractioned liquidity and
participation in otherwise globally
integrated markets. The approach being
adopted may reduce incentives to
engage in such restructuring by
requiring that foreign SBS Dealers
comply with transactional business
conduct requirements even when
transacting with another non-U.S.
person where such security-based swap
transactions are arranged, negotiated or
executed by personnel located in the
United States.
Finally, we have considered an
alternative approach that would limit
the scope of application of these final
business conduct rules to transactions
between registered SBS Entities and
U.S. person counterparties. This
alternative would exclude transactions
between U.S. as well as non-U.S. SBS
Dealers and their foreign counterparties,
which may significantly decrease the
scope of application and potential
economic effects of these final rules.
First, excluding transactions between
U.S. SBS Dealers and their foreign
counterparties from the scope of these
requirements may reduce direct and
indirect compliance costs of U.S. SBS
Dealers, potentially reducing transaction
costs or improving liquidity; however, it

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may reduce potential information
benefits of these final rules. Second,
similar to the discussion above,
excluding transactions between foreign
SBS Dealers and their foreign
counterparties may mitigate incentives
for inefficient relocation by financial
groups that use a non-U.S. dealer to
carry out their dealing activity in the
United States.
However, to the extent compliance
with these business conduct
requirements is costly and these costs
are passed along to counterparties in, for
instance, more adverse pricing and
lower liquidity of available OTC
security-based swaps, this alternative
may give rise to competitive disparities
between U.S. and non-U.S.
counterparties of registered SBS Dealers.
U.S. counterparties that are members of
financial groups may respond by
restructuring their security-based swap
activity so that it is carried out by a nonU.S. person, in which case none of its
transactions with SBS Dealers would be
required to comply with transaction
level business conduct requirements
and incur related costs. To the extent
that counterparties restructure their
security-based swap activity in response
to the incentives created by the
competitive disparities and market
fragmentation, a significant portion of
that activity may occur outside the
scope of these final business conduct
requirements. U.S. persons that
currently transact with SBS Dealers may
have an incentive to migrate that
business to affiliated non-U.S. persons
to stay competitive with their non-U.S.
competitors. The fraction of U.S.
counterparties able to perform such
restructuring and related costs are
unclear. In contrast, the approach being
adopted recognizes the importance of
SBS Entity conduct for counterparty
protections, may decrease incentives for
such evasion, and enhance Commission
oversight of registered SBS Entities.
b. Substituted Compliance
As discussed in Section III, the final
rules contemplate a substituted
compliance regime for substantive
business conduct requirements.
Substituted compliance may permit the
counterparty protection, information
and Commission oversight benefits of
these final business conduct rules to be
achieved while avoiding potential
duplication of compliance costs that
foreign SBS Entities may otherwise
incur. As indicated in the Cross-Border
release,1760 to the extent that our
business conduct rules conflict with
1760 See Cross-Border Adopting Release, 79 FR at
47359, supra note 684.

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30137

regulations in foreign jurisdictions that
also govern the activity of foreign SBS
Entities that are subject to Title VII
business conduct requirements, these
final rules could act as a barrier to entry
for foreign SBS Entities into the U.S.
security-based swap market. Allowing
market participants to comply with
these final business conduct rules via
substituted compliance could facilitate
participation of non-resident SBS
Entities in U.S. security-based swap
markets. If foreign regulatory regimes
are comparable to these final rules
requirements,1761 and to the extent that
such foreign regimes have adequate
compliance and enforcement
capabilities, allowing substituted
compliance for nonresident SBS Entities
may help promote market efficiency and
enhance competition in U.S. markets,
potentially benefiting non-dealer
counterparties.
At the same time, the process of
making substituted compliance requests
may cause nonresident SBS Entities to
incur additional costs of applying for a
substituted compliance determination.
In Section V the Commission has
estimated that three security-based swap
dealers will submit substituted
compliance applications, noting that the
majority of substituted compliance
requests may be made by foreign
authorities. Based on our analysis of
domiciles of likely SBS Entity
registrants and our understanding of the
market, we believe that there may be
between four and nine substituted
compliance applications with respect to
these final rules. The total cost
associated with SBS Entities preparing
and submitting requests for substituted
compliance determinations in
connection with the business conduct
requirements are estimated at,
approximately, $406,770 1762 for up to
1761 See

ISDA (August 2013), supra note 7.
internal cost of substituted compliance
applications for SBS Entity applicants: (In-house
attorney at $380 per hour) × (80 hours) × 3 =
$91,200. External: (External counsel at 400$ per
hour) × 200 × 3 = $240,000.
Consistent with the Registration Adopting
release, certification and opinion of counsel is
estimated at: (a) (In-house attorney at $380 per
hour) × 0.5 hours × 3 = $570. (b) External: (External
counsel at 400$ per hour) × 62.5 × 3 = $75,000. See
Registration Adopting Release, 80 FR at 48994
Total cost for SBS Entities: $240,000 + $75,000
+ $91,200 + $570 = $406,770
As noted in Section V, those amounts may
overestimate the costs of requests pursuant to Rule
3a71–6 as adopted, as such requests would solely
address business conduct requirements, rather than
the broader proposed scope of substituted
compliance set forth in that proposal. In addition,
some SBS Entities may receive a positive
substituted compliance determination and use the
same certification and opinion of counsel when
1762 Initial

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three requests. We also estimate that up
to six foreign jurisdictions may make
substituted compliance requests in
connection with these final business
conduct standards at an estimated cost
of up to $524,790.1763
We note that substituted compliance
requests will be made on a voluntary
basis, and nonresident SBS Entities
would only make such requests when
the anticipated costs of relying on
substituted compliance are lower than
the costs of complying directly with
these final rules. Further, after a
substituted compliance determination is
made, SBS Entities would choose
substituted compliance only if their
expected private benefits from
participating in U.S. security-based
swap markets exceed expected private
costs, including any conditions the
Commission may attach to the
substituted compliance determination.
We also recognize that these costs and
the overall economic effects of allowing
substituted compliance for these final
business conduct rules will depend on,
among others, whether (and to what
extent) substituted compliance requests
will be granted for jurisdictions in
which some of the most active
nonresident SBS Entities are currently
residing; the costs of potential
relocation, business restructuring, or
direct compliance by nonresident SBS
Entities in jurisdictions for which
substituted compliance is not granted;
the relevant information required to
demonstrate consistency between the
foreign regulatory requirements and the
Commission’s business conduct rules;
the relevant information required to
demonstrate the adequacy of the foreign
regime’s compliance and enforcement
mechanisms; and the fraction of SBS
Entities in a given jurisdiction that may
rely on substituted compliance if
available.
We note that substituted compliance
determinations will be made on a
jurisdiction-wide basis. As a result, after
filing for registration, the costs of which were
assessed in the Registration Adopting Release.
1763 We believe that foreign jurisdictions are less
likely to rely on outside counsel in preparing
substituted compliance determinations and
adequate assurances concerning Rule 15Fb2–4(c). In
lieu of outside counsel we believe they will rely on
internal government attorneys, estimated using SEC
hourly cost for management and professional staff
of $255.
Initial cost of substituted compliance applications
for up to 6 foreign jurisdiction: (Government
management and professional staff at $255) × (80 +
200) × 6 = $428,400.
Initial cost of certifications and assurances
concerning Rule 15Fb2–4(c): (Government
management and professional staff at $255) × (0.5
+ 62.5) × 6 = $96,390.
Total cost for foreign jurisdictions: $428,400 +
$96,390 = $524,790.

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the first applicant from a given
jurisdiction receives an affirmative
substituted compliance determination,
all SBS Entities from the same
jurisdiction will be able to comply with
these final rules by complying with
requirements of that foreign jurisdiction
without bearing the related substituted
compliance application costs. Such an
approach eliminates duplication in
application costs for SBS Entities from
the same jurisdictions. However, foreign
SBS Entities that are the first to make a
substituted compliance application from
a given jurisdiction will also bear
greater costs, which disadvantages first
movers. SBS Entities that intermediate
greater volume or hold larger positions
of security-based swaps in the United
States, and SBS Entities that face greater
costs of direct compliance with these
final rules compared to costs of
compliance with rules of a foreign
jurisdiction may be the first SBS Entities
to make substituted compliance
applications and bear application costs.
SBS Entities in foreign jurisdictions
with blocking laws, privacy laws,
secrecy laws and other legal barriers
inconsistent with the Commission’s
authority over registered entities will be
unable to take advantage of substituted
compliance. As part of these final rules,
the Commission is adopting a
requirement that, in order to make a
request for substituted compliance, each
party must provide the certification and
opinion of counsel that the entity can as
a matter of law, and will, provide the
Commission with prompt access to the
entity’s books and records and submit to
onsite inspection and examination by
the Commission. Similarly, foreign
financial regulatory authorities may
make substituted compliance requests
only if they can provide adequate
assurances that no law or policy of any
relevant foreign jurisdiction would
impede the ability of any entity that is
directly supervised by the authority and
that may register as an SBS Entity to
provide prompt access to the
Commission to books and records or to
submit to onsite inspection or
examination. As a result of these
requirements, the scope of SBS Entities
and jurisdictions able to take advantage
of substituted compliance may be
reduced. However, as we have stated
elsewhere,1764 the Commission believes
that significant elements of an effective
regulatory regime are the Commission’s
abilities to access registered SBS
Entities’ books and records and to
1764 See Registration Adopting Release, 80 FR at
48981.

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inspect and examine the operations of
registered SBS Entities.
We note that U.S. SBS Entities will
not be able to rely on substituted
compliance with respect to any
transactions, including transactions
with foreign counterparties.
Alternatively, the Commission could
allow substituted compliance for U.S.
SBS Entities. Under the alternative, U.S.
SBS Entities would be able to comply
with these substantive transaction-level
requirements by complying with
business conduct requirements of a
comparable regulatory regime when
dealing with counterparties domiciled
in foreign countries. We recognize that
U.S. SBS Entities may be competing for
foreign counterparty business with
foreign SBS Entities, and substituted
compliance may reduce costs of
complying with these final business
conduct requirements. Under the
alternative, the ability of U.S. SBS
Entities to rely on substituted
compliance may increase the
profitability of U.S. SBS Entities
transactions with foreign counterparties
or may increase business for U.S. SBS
Entities seeking to intermediate
security-based swaps with foreign
market participants. However, such an
approach may adversely impact
counterparty protection, informational
asymmetry and Commission oversight
benefits of these substantive
requirements enjoyed by all
counterparties of U.S. SBS Entities as a
result of potential differences among
global regulatory regimes. Since any
potential costs of compliance with these
substantive requirements may be passed
on to counterparties, such an alternative
may result in differential access and
security-based swap terms of U.S. and
foreign counterparties of U.S. SBS
Entities.
Under the approach being adopted,
foreign SBS Entities will be able to
comply with these final business
conduct requirements by complying
with comparable foreign requirements.
We have considered an alternative
approach, under which the availability
of substituted compliance is predicated
on a finding of a direct conflict between
Title VII and foreign regulatory
requirements. Under this alternative,
foreign SBS Entities that are currently
complying with comparable (though not
identical) requirements, would be
required to bring their activities into
compliance with these final rules,
absent a direct conflict between Title VII
requirements and their foreign
regulatory regime. If the scope of
comparable regulatory regimes is
broader than the scope of regimes that
are in direct conflict with the

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requirements of Title VII, this
alternative may enable SBS Entities
from fewer jurisdictions to take
advantage of substituted compliance. As
a result, the economic benefits of
substituted compliance discussed above
may be reduced.
Fewer foreign SBS Entities being
eligible for substituted compliance may
also reduce direct application costs to
the industry. However, the burden of
establishing a direct conflict may be
greater than the burden related to
establishing comparability, which may
increase direct substituted compliance
costs per application.
Crucially, if fewer SBS Entities are
able to take advantage of substituted
compliance under this alternative, a
greater number of foreign SBS Entities
would be required to incur costs of
restructuring their systems and
processes to comply with these final
rules. Alternatively, foreign SBS Entities
may choose relocate to another
jurisdiction, or decrease their
participation in U.S. security-based
swap markets below thresholds
triggering SBS Entity registration
requirements and compliance with
these final rules. To the extent that these
costs may be passed on to
counterparties of foreign SBS Entities or
affect liquidity provision by foreign SBS
Entities, transaction costs may increase
and liquidity may be reduced. Further
these costs may create a barrier to entry
for foreign SBS Entities into U.S.
security-based swap markets, and
facilitate market segmentation.
Under this alternative, counterparties
of foreign SBS Entities unable to rely on
substituted compliance may benefit to a
greater extent from the transparency and
counterparty protections of these final
rules. Further, U.S. SBS Entities and
foreign SBS Entities from jurisdictions
that are able to rely on substituted
compliance may step in to intermediate
trades with counterparties impacted by
foreign SBS Entities unable to rely on
substituted compliance. The
Commission’s future substituted
compliance determinations with respect
to individual foreign regimes will affect
the scope of affected foreign SBS
Entities. Therefore, we are unable to
estimate and compare the number,
market share and scope of
counterparties of foreign SBS Entities
that may be able to rely on substituted
compliance under the approach being
adopted, and under the alternative.
However, we note that, using DTCC–
TIW data as of year-end 2014, all foreign
SBS Dealers likely to trigger registration
requirements were responsible for 35%
of the notional volume of all likely SBS
Entities. In addition, as we have noted

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earlier in the economic analysis, in 2014
non-dealer counterparties transacted
with a median of three and an average
of four SBS Dealers.
We have also considered an
alternative approach under which
foreign SBS Entities would be able to
rely on substituted compliance only in
their transactions with non-U.S.
counterparties. This alternative would
effectively limit the scope of substituted
compliance to non-U.S. SBS Entities
that are transacting with non-U.S.
counterparties, but are subject to these
final rules as a result of their reliance on
U.S. personnel discussed above. Such
an approach could ensure that U.S.
counterparties of all SBS Entities benefit
from the same transparency and
counterparty protection benefits of these
final rules, regardless of the degree of
comparability of foreign regimes.
However, some foreign SBS Entities
already complying with comparable
regimes would incur additional costs of
restructuring to comply with these final
rules without being able to rely on
substituted compliance in their
transactions with U.S. counterparties. If
such costs are significant, non-U.S. SBS
Entities may become less willing to
intermediate transactions with U.S.
counterparties and transaction costs
borne by U.S. counterparties may
increase. While other U.S. SBS Entities
are likely to step in and provide the
necessary liquidity, this approach may
adversely impact competition and
facilitate market segmentation.
D. Effects on Efficiency, Competition
and Capital Formation
In adopting these final rules, we are
required to consider their effects on
efficiency, competition and capital
formation. As we discuss below, these
final rules may enhance transparency,
and improve informational and
allocative efficiency in security-based
swap markets. Greater transparency and
allocative efficiency may incentivize
quality based competition among
market participants in general, and SBS
Dealers in particular. In the discussion
below, we address the potential effects
of final disclosure, suitability and
special entity rules on informational
and allocative efficiency, and their
effects on capital formation in securitybased swap and reference security
markets. We also consider how
harmonization with the CFTC external
business conduct rules facilitates
ongoing market integration between
swap and security-based swap markets,
and lowers informational inefficiencies.
Finally, we discuss the competitive
burdens of compliance costs, their
effects on the willingness of SBS Dealers

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to intermediate transactions with certain
groups of counterparties, as well as
competitive effects of the cross-border
approach being adopted.
The business conduct standards for
SBS Entities, including requirements to
disclose material risks, characteristics,
incentives and conflicts of interest
related to security-based swaps, as well
as the fair and balanced
communications rule, may reduce
information asymmetries between SBS
Entities and their less sophisticated
counterparties. To the extent that
adverse selection costs described in
Section VI.C.2 are present in securitybased swap markets, market participants
may become more informed and may
increase their activity in security-based
swaps, which may improve market
quality. To the extent that securitybased swap market participants
consider disclosures under these final
rules informative in selecting securitybased swaps and SBS Entity
counterparties, these final rules may
help market participants make more
informed counterparty choices. The
increased disclosure of information
regarding material risks and
characteristics, incentives and conflicts
of interest may lead to improved
informational efficiency and qualitybased competition among SBS Entities
to the extent that market participants
rely on this information in selecting
security-based swaps and
counterparties.
However, as more informed
counterparties, SBS Entities are able to
extract information rents from nondealer counterparties. To the extent that
the business conduct rules help inform
counterparties, these rules may reduce
the informational advantage of SBS
Entities, and may decrease profitability
of their transactions with non-dealer
counterparties. As a result of disclosures
of material risks, daily mark, conflicts of
interest and other information regarding
security-based swaps, some private
information of SBS Dealers about the
quality of security-based swaps and
underlying reference securities may
become public. As a result, securitybased swap prices and dealer profit
margins may decrease. These rules may
reduce the incentives of SBS Dealers to
gather private information that is
impounded into prices, and SBS Dealer
willingness to intermediate securitybased swap transactions with nondealer counterparties.
Enhanced disclosures and
counterparty protections of these
Business Conduct Standards may
improve access to information, and may
attract non-dealer market participants
into security-based swap markets. These

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rules may, therefore, protect end users
and other non-dealers that are effecting
security-based swaps to manage risk or
trade on negative information, which
may improve their ability to make
appropriate and informed portfolio
decisions. However, if these rules result
in less informed market participants
playing an increasingly larger role in
security-based swap markets,
informational efficiency in securitybased swap markets may decrease. This
consideration is attenuated by the fact
that uninformed participants bring
valuable liquidity enabling informed
traders, such as SBS Dealers, to execute
informed trades with less price impact.
The overall effects of these final rules on
price discovery and informational
efficiency in security-based swap
markets are, therefore, difficult to
assess.
The final suitability and special entity
rules would require SBS Dealers to
evaluate the suitability of trades for nondealer counterparties and special
entities when making recommendations
to such counterparties, unless the SBS
Dealer can rely on the institutional
suitability alternative to fulfill its
customer-specific suitability obligations.
SBS Dealers may have superior
information about security-based swaps,
but may face an informational
asymmetry when analyzing the hedging
needs, risk tolerance and horizons of
their counterparties. This requirement
may preclude SBS Dealers from
recommending some security-based
swaps that may be truly suitable for a
given counterparty, while
recommending other security-based
swaps that may be less suitable. The
presence and magnitude of this
economic effect depends on the tradeoff
between the severity of information
asymmetry concerning the nature of the
swap and asymmetry concerning the
counterparty, and potential losses and
risks of investing in unsuitable securitybased swaps relative to foregone profits
from not investing in suitable securitybased swaps.
Suitability requirements and resulting
costs could further increase the costs to
SBS Dealers of recommending securitybased swaps to non-dealer
counterparties, particularly
counterparties with which the SBS
Dealer has had no prior transactions,
and counterparties that do not meet
institutional suitability requirements.
We also recognize that these rules may
limit the ability of SBS Dealers to
recommend some security-based swaps
to certain counterparties, which may
decrease the potential range of
counterparties and products that some
SBS Dealers may intermediate. If these

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effects result in SBS Dealers refraining
from advising or transacting with some
counterparties, and these counterparties
are otherwise unable to receive advice
or enter into security-based swaps, the
suitability requirement may come at a
net cost to these counterparties and
would place them at a disadvantage
relative to larger, more sophisticated
competitors. To the extent that these
counterparties do not participate in the
security-based swap market as a result
of these costs, adverse effects on market
participation and liquidity may follow.
However, as we noted previously,
market data available to us reveal that
relatively few counterparties enter into
security-based swap agreements with an
SBS Dealer without third-party
representation, particularly among
special entities. As a result of this thirdparty representation and the SBS
Dealer’s ability to fulfill its customerspecific suitability obligations by,
among other things, making the
determination that a counterparty’s
agent is capable of independently
evaluating investment risk, as well as
the exception of anonymous SEF
executed security-based swaps, we do
not believe that market access is likely
to be restricted.
The final pay to play rules may
reduce pay to play practices among SBS
Dealers. To the extent that political
contributions may currently be
influencing counterparty and securitybased swap selection, these rules may
mitigate these influences and enhance
allocative efficiency of municipal
entities and facilitate greater qualitybased competition of SBS Dealers.
However, if some SBS Dealers become
subject to a two-year time out due to
inadvertent violations of the de minimis
thresholds by themselves or their
covered associates, and are unable to
secure exemptive relief, fewer SBS
Dealers may be able to transact with
municipal entities in security-based
swaps, which may increase the pricing
power and decrease quality of execution
of swaps offered to municipal entities
by the remaining SBS Dealers. We note
that SBS Dealers will have to keep
updated records of political
contributions of their covered
associates, ensure their accuracy,
promptly discover triggering
contributions and seek their return. The
costs of implementing such policies and
procedures related to political
contributions of covered associates will
be greater for larger SBS Dealers with
multiple layers of supervision and a
higher number of covered associates
with shorter tenures. While other
business conduct rules tend to impose

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fixed burdens, which represent a higher
fraction of net income for smaller SBS
Dealers, this particular requirement may
be significantly more costly for larger
SBS Dealers.
Further, under these final rules,
representatives of special entities
transacting with SBS Entities are likely
to be employees or independent
representatives subject to Commission,
CFTC or SRO pay to play rules. To the
extent that some special entity
representatives currently intermediating
transactions with SBS Entities are not
registered investment advisers,
municipal advisors, other fiduciaries or
employees, they may be unable to
represent special entities in securitybased swap transactions with SBS
Entities unless they register as such.
This may decrease competition among
qualified investment representatives of
special entities, or incentivize
unregistered representatives to register,
for instance, as investment advisers
with the Commission or as municipal
advisors with the MSRB.
The direct and indirect costs of
compliance with these final business
conduct rules may be recovered by SBS
Entities in the form of higher transaction
costs or more adverse non-price terms of
security-based swaps offered to
counterparties. To the extent that these
costs cannot be recovered, incentives for
some entities to operate as registered
U.S. SBS Entities may be reduced,1765
which may adversely affect competition
in security-based swap markets. In
addition, some counterparties may lose
access to the market for OTC swaps.
However, we note that, as discussed
above, anonymous SEF transactions are
exempt from some of the substantive
requirements of these final rules, which
may allow such counterparties to retain
access to security-based swaps. Further,
to the extent that these rules impose
costs and restrictions on non-SEF trades
that are not born by SBS Entities related
to SEF trades, the volume of
transactions executed on SEFs may
increase. We recognize that, as a result,
these final rules may increase the
programmatic costs and benefits of
pending SEF and clearing rules, with
their follow on effects on efficiency,
competition and capital formation,
which will be evaluated in pending SEF
and clearing rules. We recognize
similarities between CFTC external
business conduct standards for Swap
Entities, FINRA rules for broker dealers
and the rules being adopted. Due to
extensive cross-market participation,
many of the entities expected to register
1765 See

U.S. Activity Adopting Release, 81 FR at

8629.

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as SBS Entities will have already
registered with the CFTC as Swap
Entities or with the Commission as
broker dealers, yet others may already
be subject to similar MSRB rules. To the
extent that these final rules involve
initial compliance costs, dually
registered SBS entities may experience
significantly lower initial compliance
costs. At the same time, new entrants
and SBS Entities that are not dually
registered may face higher costs.
Competitive effects of these final
business conduct rules primarily stem
from differences in burdens incurred by
dual registrants on the one hand, and
non-dually registered SBS Entities and
new entrants on the other.
In addition to the competitive effects
of compliance burdens above, the crossborder approach adopted in these final
rules may impact competition between
U.S. and non-U.S. SBS Entities and their
U.S. and non-U.S. personnel. A
substituted compliance regime for
business conduct requirements and
their application to non-U.S. persons’
dealing transactions that are arranged,
negotiated, or executed using personnel
located in the United States may
mitigate competitive frictions between
U.S. and non-U.S. SBS Dealers that
transact with foreign counterparties, and
may promote market efficiency. The
final cross-border approach to business
conduct requirements will result in a
uniform application of these
requirements to U.S. and non-U.S. SBS
Dealers and their agents. If only U.S.
SBS Dealers and their agents were
subject to disclosure, suitability and
other requirements in these final rules
when transacting with foreign
counterparties, the costs of such
disclosures would primarily be incurred
by U.S. SBS Dealers, their agents, and
their counterparties. In contrast, nonU.S. SBS Dealers and their agents,
including personnel located in the
United States, would potentially have a
competitive advantage over U.S. SBS
Dealers in serving non-U.S. person
counterparties using personnel located
in a U.S. branch or office, were their
activities not subject to the same
requirements.1766 Therefore, the crossborder application of these final
business conduct rules may enhance
competition among these SBS Dealers.
Access to SEC-regulated securitybased swap markets increases hedging
opportunities for financial market
intermediaries; such hedging
opportunities reduce risks and allow
1766 See, e.g., Arnoud W.A. Boot, Silva Dezelan,
and Todd T. Milbourn, ‘‘Regulatory Distortions in
a Competitive Financial Services Industry,’’ Journal
of Financial Services Research, Vol. 17, No. 1
(2000).

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intermediaries to facilitate a greater
volume of financing activities, including
issuance of equity and debt securities,
and therefore contribute to capital
formation. As we have stated in other
releases,1767 this may be particularly
true in underlying securities markets,
where potential pricing and liquidity
effects in security-based swap markets
may feedback and impact the market for
reference entity securities. Securitybased swap markets may enable better
risk mitigation by investors in
underlying reference securities, such as
CDS hedging of the credit risk of
corporate bond investments. The
possible contraction in security-based
swap market participation by SBS
Entities due to costs of compliance with
these final rules may adversely impact
underlying reference security markets,
including pricing and liquidity in
corporate bond and equity markets. This
may have a negative effect on the ability
of firms to raise debt and equity capital
to finance real investment. However, the
spillover from potential deterioration in
security-based swap markets into
underlying reference security markets
may also be positive. Sophisticated
institutional investors transact across
CDS and bond markets to trade on
information pertaining to the credit risk
of underlying reference debt. A
potential negative shock to securitybased swap market liquidity and dealing
by SBS Entities with non-SBS Entity
counterparties as a result of required
compliance with these final rules may,
in fact, drive sophisticated institutions
to search for liquidity pools and lower
price impact of informed trades to
reference security markets. If
institutions begin to trade more actively
in underlying reference security
markets, such as corporate bond markets
as a result, there may be positive effects
on liquidity and informational
efficiency of corporate bond and equity
markets.1768 This may enable firms to
raise more debt and equity at potentially
lower costs to finance real investment.
VII. Regulatory Flexibility Act
Certification
The Regulatory Flexibility Act
(‘‘RFA’’) 1769 requires Federal agencies,
in promulgating rules, to consider the
impact of those rules on small entities.
The Commission certified in the
Proposing Release, pursuant to Section
605(b) of the RFA,1770 that proposed
Rules 15Fh–1 through 15Fh–6 and Rule
1767 See Registration Adopting Release, 80 FR
49008, supra note 989.
1768 See Section VI.B.5.
1769 5 U.S.C. 601 et seq.
1770 5 U.S.C. 605(b).

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15Fk–1 would not, if adopted, have a
significant economic impact on a
substantial number of ‘‘small
entities.’’ 1771 The Commission received
no comments on this certification.
For purposes of Commission
rulemaking in connection with the RFA,
a small entity includes: (i) When used
with reference to an ‘‘issuer’’ or a
‘‘person,’’ other than an investment
company, an ‘‘issuer’’ or ‘‘person’’ that,
on the last day of its most recent fiscal
year, had total assets of $5 million or
less; 1772 or (ii) a broker-dealer with total
capital (net worth plus subordinated
liabilities) of less than $500,000 on the
date in the prior fiscal year as of which
its audited financial statements were
prepared pursuant to Rule 17a–5(d)
under the Exchange Act,1773 or, if not
required to file such statements, a
broker-dealer with total capital (net
worth plus subordinated liabilities) of
less than $500,000 on the last day of the
preceding fiscal year (or in the time that
it has been in business, if shorter); and
is not affiliated with any person (other
than a natural person) that is not a small
business or small organization.1774 With
respect to investment companies in
connection with the RFA, the term
‘‘small business’’ or ‘‘small
organization’’ means an investment
company that, together with other
investment companies in the same
group of related investment companies,
has net assets of $50 million or less as
of the end of its most recent fiscal year.
Under the standards adopted by the
Small Business Administration, small
entities in the finance and insurance
industry include the following: (i) For
entities in credit intermediation and
related activities,1775 entities with $550
million or less in assets or, (ii) for nondepository credit intermediation and
certain other activities,1776 $38.5
1771 Although Section 601(b) of the RFA defines
the term ‘‘small entity,’’ the statute permits agencies
to formulate their own definitions. The Commission
has adopted definitions for the term small entity for
the purposes of Commission rulemaking in
accordance with the RFA. Those definitions, as
relevant to this proposed rulemaking, are set forth
in Rule 0–10, 17 CFR 240.0–10. See Statement of
Management on Internal Control, Exchange Act
Release No. 18451 (Jan. 28, 1982), 47 FR 5215 (Feb.
4, 1982).
1772 See 17 CFR 240.0–10(a).
1773 See 17 CFR 240.17a–5(d).
1774 See 17 CFR 240.0–10(c).
1775 Including commercial banks, savings
institutions, credit unions, firms involved in other
depository credit intermediation, credit card
issuing, sales financing, consumer lending, real
estate credit, and international trade financing. 13
CFR 121.201 at Subsector 522.
1776 Including firms involved in secondary market
financing, all other non-depository credit
intermediation, mortgage and nonmortgage loan
brokers, financial transactions processing, reserve,

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million or less in annual receipts; (iii)
for entities in financial investments and
related activities,1777 entities with $38.5
million or less in annual receipts; (iv)
for insurance carriers and entities in
related activities,1778 entities with $38.5
million or less in annual receipts, or
1,500 employees for direct property and
casualty insurance carriers; and (v) for
funds, trusts, and other financial
vehicles,1779 entities with $32.5 million
or less in annual receipts.1780
With respect to SBS Entities, based on
feedback from market participants and
our information about the securitybased swap markets, the Commission
continues to believe that (1) the types of
entities that would engage in more than
a de minimis amount of dealing activity
involving security-based swaps—which
generally would be large financial
institutions—would not be ‘‘small
entities’’ for purposes of the RFA; and
(2) the types of entities that may have
security-based swap positions above the
level required to be ‘‘major securitybased swap participants’’ would not be
‘‘small entities’’ for purposes of the
RFA.1781
For the foregoing reasons, the
Commission certifies that the SBS Entity
registration rules and forms, as adopted
would not have a significant economic
impact on a substantial number of small
entities for purposes of the RFA.
and clearing house activities, and other activities
related to credit intermediation. 13 CFR 121.201 at
Subsector 522.
1777 Including firms involved in investment
banking and securities dealing, securities brokerage,
commodity contracts dealing, commodity contracts
brokerage, securities and commodity exchanges,
miscellaneous intermediation, portfolio
management, providing investment advice, trust,
fiduciary and custody activities, and miscellaneous
financial investment activities. 13 CFR 121.201 at
Subsector 523.
1778 Including direct life insurance carriers, direct
health and medical insurance carriers, direct
property and casualty insurance carriers, direct title
insurance carriers, other direct insurance (except
life, health and medical) carriers, reinsurance
carriers, insurance agencies and brokerages, claims
adjusting, third party administration of insurance
and pension funds, and all other insurance related
activities. 13 CFR 121.201 at Subsector 524.
1779 Including pension funds, health and welfare
funds, other insurance funds, open-end investment
funds, trusts, estates, and agency accounts, real
estate investment trusts and other financial
vehicles. 13 CFR 121.201 at Subsector 525.
1780 See 13 CFR 121.201.
1781 See Recordkeeping Release, 79 FR 25194,
25296–97 & n.1441, supra note 242; Further
Definition of ‘‘Swap Dealer,’’ ‘‘Security-Based Swap
Dealer,’’ ‘‘Major Swap Participant,’’ ‘‘Major
Security-Based Swap Participant’’ and ‘‘Eligible
Contract Participant,’’ Exchange Act Release No.
66868 (Apr. 27, 2012), 77 FR 30596, 30743 (May 23,
2012) (joint Commission/CFTC final rules);
Registration Adopting Release, 80 FR 48964, 49012–
49013, supra note 989.

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Statutory Basis and Text of Final Rules
Pursuant to the Exchange Act and,
particularly, Sections 2, 3(b), 3C, 9, 10,
11A, 15, 15F, 17(a) and (b), 23(a) and
30(c) thereof (15 U.S.C. 78b, 78c(b),
78i(i), 78i(j), 78j, 78k–1, 78o, 78o–10,
78q(a) and (b), 78w(a) and 78dd(c)), the
Commission is adopting Rule 3a71–6,
Rules 15Fh–1 through 15Fh–6, and Rule
15Fk–1, and is amending Rules 3a67–10
and 3a71–3, to address the business
conduct obligations of security-based
swap dealers and major security-based
swap participants, including the crossborder application of those obligations
and the availability of substituted
compliance in connection with those
obligations.

§ 240.3a67–10 Foreign major securitybased swap participants.

(a) * * *
(5) U.S. major security-based swap
participant means a major securitybased swap participant, as defined in
section 3(a)(67) of the Act (15 U.S.C.
78c(a)(67)), and the rules and
regulations thereunder, that is a U.S.
person.
(6) Foreign major security-based swap
participant means a major securitybased swap participant, as defined in
section 3(a)(67) of the Act (15 U.S.C.
78c(a)(67)), and the rules and
regulations thereunder, that is not a U.S.
person.
*
*
*
*
*
(d) Application of customer protection
requirements. (1) A registered foreign
List of Subjects in 17 CFR Part 240
major security-based swap participant
Brokers, Reporting and recordkeeping shall not be subject to the requirements
requirements, Securities.
relating to business conduct standards
described in section 15F(h) of the Act
Text of the Final Rules
(15 U.S.C. 78o–10(h)), and the rules and
For the reasons set forth in the
regulations thereunder, other than rules
preamble, the Securities and Exchange
and regulations prescribed by the
Commission is amending Title 17,
Commission pursuant to section
Chapter II of the Code of Federal
15F(h)(1)(B) of the Act (15 U.S.C. 78o–
Regulations, as follows:
10(h)(1)(B)), with respect to a securitybased swap transaction with a
PART 240—GENERAL RULES AND
counterparty that is not a U.S. person or
REGULATIONS, SECURITIES
with a counterparty that is a U.S. person
EXCHANGE ACT OF 1934
in a transaction conducted through a
foreign branch of the U.S. person.
■ 1. The authority citation for part 240
(2) A registered U.S. major securitycontinues to read, and sectional
based swap participant shall not be
authorities for sections 240.3a71–6,
subject to the requirements relating to
240.15Fh–1 through 240.15Fh–6, and
business conduct standards described in
240.15Fk–1 are added in numerical
section 15F(h) of the Act (15 U.S.C.
order to read as follows:
78o–10(h)), and the rules and
Authority: 15 U.S.C. 77c, 77d, 77g, 77j,
regulations thereunder, other than rules
77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn,
and regulations prescribed by the
77sss, 77ttt, 78c, 78c–3, 78c–5, 78d, 78e, 78f,
Commission pursuant to section
78g, 78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m,
15F(h)(1)(B) of the Act (15 U.S.C. 78o–
78n, 78n–1, 78o, 78o–4, 78o–10, 78p, 78q,
10(h)(1)(B)), with respect to a security78q–1, 78s, 78u–5, 78w, 78x, 78dd, 78ll,
78mm, 80a–20, 80a–23, 80a–29, 80a–37, 80b– based swap transaction that constitutes
3, 80b–4, 80b–11, 7201 et seq., and 8302; 7
a transaction conducted through a
U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18
foreign branch of the registered U.S.
U.S.C. 1350; and Pub. L. 111–203, 939A, 124
major security-based swap participant
Stat. 1376, (2010), unless otherwise noted.
with a non-U.S. person or with a U.S.*
*
*
*
*
person counterparty that constitutes a
transaction conducted through a foreign
Section 240.3a67–10, 240.3a71–3,
240.3a71–4, 240.3a71–5, and 240.3a71–6 are
branch of that U.S.-person counterparty.
also issued under Pub. L. 111–203, secs. 712, ■ 3. § 240.3a71–3 is amended by:
761(b), 124 Stat. 1754 (2010), and 15 U.S.C.
■ a. Adding paragraphs (a)(6) through
78dd(c).
(9); and
■ b. Adding paragraph (c).
*
*
*
*
*
The additions read as follows:
Sections 240.15Fh–1 through 240.15Fh–6
and 240.15Fk–1 are also issued under sec.
943, Pub. L. 111–203, 124 Stat. 1376.

*

*
*
*
*
■ 2. § 240.3a67–10 is amended by:
■ a. Adding paragraphs (a)(5) and (6);
and
■ b. Adding paragraph (d).
The additions read as follows:

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§ 240.3a71–3 Cross-border security-based
swap dealing activity.

(a) * * *
(6) U.S. security-based swap dealer
means a security-based swap dealer, as
defined in section 3(a)(71) of the Act (15
U.S.C. 78c(a)(71)), and the rules and
regulations thereunder, that is a U.S.
person.

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
(7) Foreign security-based swap dealer
means a security-based swap dealer, as
defined in section 3(a)(71) of the Act (15
U.S.C. 78c(a)(71)), and the rules and
regulations thereunder, that is not a U.S.
person.
(8) U.S. business means:
(i) With respect to a foreign securitybased swap dealer:
(A) Any security-based swap
transaction entered into, or offered to be
entered into, by or on behalf of such
foreign security-based swap dealer, with
a U.S. person (other than a transaction
conducted through a foreign branch of
that person); or
(B) Any security-based swap
transaction arranged, negotiated, or
executed by personnel of the foreign
security-based swap dealer located in a
U.S. branch or office, or by personnel of
an agent of the foreign security-based
swap dealer located in a U.S. branch or
office; and
(ii) With respect to a U.S. securitybased swap dealer, any transaction
entered into or offered to be entered into
by or on behalf of such U.S. securitybased swap dealer, other than a
transaction conducted through a foreign
branch with a non-U.S. person or with
a U.S.-person counterparty that
constitutes a transaction conducted
through a foreign branch of the
counterparty.
(9) Foreign business means securitybased swap transactions entered into, or
offered to be entered into, by or on
behalf of a security-based swap dealer,
other than the U.S. business of such
person.
*
*
*
*
*
(c) Application of customer protection
requirements. A registered securitybased swap dealer, with respect to its
foreign business, shall not be subject to
the requirements relating to business
conduct standards described in section
15F(h) of the Act (15 U.S.C. 78o–10(h)),
and the rules and regulations
thereunder, other than the rules and
regulations prescribed by the
Commission pursuant to section
15F(h)(1)(B) of the Act (15 U.S.C. 78o–
10(h)(1)(B)).
■ 4. Add § 240.3a71–6 to read as
follows:

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§ 240.3a71–6 Substituted compliance for
security-based swap dealers and major
security-based swap participants.

(a) Determinations—(1) In general.
Subject to paragraph (a)(2) of this
section, the Commission may,
conditionally or unconditionally, by
order, make a determination with
respect to a foreign financial regulatory
system that compliance with specified
requirements under such foreign

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financial regulatory system by a
registered security-based swap dealer
and/or by a registered major securitybased swap participant (each a
‘‘security-based swap entity’’), or class
thereof, may satisfy the corresponding
requirements identified in paragraph (d)
of this section that would otherwise
apply to such security-based swap
entity (or class thereof).
(2) Standard. The Commission shall
not make a substituted compliance
determination under paragraph (a)(1) of
this section unless the Commission:
(i) Determines that the requirements
of such foreign financial regulatory
system applicable to such securitybased swap entity (or class thereof) or to
the activities of such security-based
swap entity (or class thereof) are
comparable to otherwise applicable
requirements, after taking into account
such factors as the Commission
determines are appropriate, such as the
scope and objectives of the relevant
foreign regulatory requirements (taking
into account the applicable criteria set
forth in paragraph (d) of this section), as
well as the effectiveness of the
supervisory compliance program
administered, and the enforcement
authority exercised, by a foreign
financial regulatory authority or
authorities in such system to support its
oversight of such security-based swap
entity (or class thereof) or of the
activities of such security-based swap
entity (or class thereof); and
(ii) Has entered into a supervisory and
enforcement memorandum of
understanding and/or other arrangement
with the relevant foreign financial
regulatory authority or authorities under
such foreign financial regulatory system
addressing supervisory and enforcement
cooperation and other matters arising
under the substituted compliance
determination.
(3) Withdrawal or modification. The
Commission may, on its own initiative,
by order, modify or withdraw a
substituted compliance determination
under paragraph (a)(1) of this section,
after appropriate notice and opportunity
for comment.
(b) Reliance by security-based swap
entities. A registered security-based
swap entity may satisfy the
requirements described in paragraph (d)
of this section by complying with
corresponding law, rules and
regulations under a foreign financial
regulatory system, provided:
(1) The Commission has made a
substituted compliance determination
pursuant to paragraph (a)(1) of this
section regarding such foreign financial
regulatory system providing that
compliance with specified requirements

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30143

under such foreign financial regulatory
system by such registered security-based
swap entity (or class thereof) may satisfy
the corresponding requirements
described in paragraph (d) of this
section; and
(2) Such registered security-based
swap entity satisfies any conditions set
forth in a substituted compliance
determination made by the Commission
pursuant to paragraph (a)(1) of this
section.
(c) Requests for determinations. (1) A
party or group of parties that potentially
would comply with specified
requirements pursuant to paragraph
(a)(1), or any foreign financial regulatory
authority or authorities supervising
such a party or its security-based swap
activities, may file an application,
pursuant to the procedures set forth in
§ 240.0–13, requesting that the
Commission make a substituted
compliance determination pursuant to
paragraph (a)(1) of this section, with
respect to one or more requirements
described in paragraph (d) of this
section.
(2) Such a party or group of parties
may make a request under paragraph
(c)(1) of this section only if:
(i) Each such party, or the party’s
activities, is directly supervised by the
foreign financial regulatory authority or
authorities with respect to the foreign
regulatory requirements relating to the
applicable requirements described in
paragraph (d) of this section; and
(ii) Each such party provides the
certification and opinion of counsel as
described in § 240.15Fb2–4(c), as if the
party were subject to that requirement at
the time of the request.
(3) Such foreign financial authority or
authorities may make a request under
paragraph (c)(1) of this section only if
each such authority provides adequate
assurances that no law or policy of any
relevant foreign jurisdiction would
impede the ability of any entity that is
directly supervised by the foreign
financial regulatory authority and that
may register with the Commission as a
security-based swap dealer or major
security-based swap participant to
provide prompt access to the
Commission to such entity’s books and
records or to submit to onsite inspection
or examination by the Commission.
(d) Eligible requirements. The
Commission may make a substituted
compliance determination under
paragraph (a)(1) of this section to permit
security-based swap entities that are not
U.S. persons (as defined in § 240.3a71–
3(a)(4)), but not security-based swap
entities that are U.S. persons, to satisfy
the following requirements by

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations

complying with comparable foreign
requirements:
(1) Business conduct and supervision.
The business conduct and supervision
requirements of sections 15F(h) and (j)
of the Act (15 U.S.C. 78o–10(h) and (j))
and §§ 240.15Fh–3 through 15Fh–6,
other than the antifraud provisions of
section 15F(h)(4)(A) of the Act and
§ 240.15Fh–4(a), and other than the
provisions of sections 15F(j)(3) and
15F(j)(4)(B) of the Act; provided,
however, that prior to making such a
substituted compliance determination
the Commission intends to consider
whether the information that is required
to be provided to counterparties
pursuant to the requirements of the
foreign financial regulatory system, the
counterparty protections under the
requirements of the foreign financial
regulatory system, the mandates for
supervisory systems under the
requirements of the foreign financial
regulatory system, and the duties
imposed by the foreign financial
regulatory system, are comparable to
those associated with the applicable
provisions arising under the Act and its
rules and regulations.
(2) Chief compliance officer. The chief
compliance officer requirements of
section 15F(k) of the Act (15 U.S.C. 78o–
10(k)) and § 240.15Fk–1; provided,
however, that prior to making such a
substituted compliance determination
the Commission intends to consider
whether the requirements of the foreign
financial regulatory system regarding
chief compliance officer obligations are
comparable to those required pursuant
to the applicable provisions arising
under the Act and its rules and
regulations.
■ 5. Add §§ 240.15Fh–1 through
240.15Fh–6, and § 240.15Fk–1 to read as
follows:

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§ 240.15Fh–1 Scope and reliance on
representations.

(a) Scope. Sections 240.15Fh–1
through 240.15Fh–6, and 240.15Fk–1
are not intended to limit, or restrict, the
applicability of other provisions of the
federal securities laws, including but
not limited to section 17(a) of the
Securities Act of 1933 and sections 9
and 10(b) of the Act, and rules and
regulations thereunder, or other
applicable laws and rules and
regulations. Sections 240.15Fh–1
through 240.15Fh–6, and 240.15Fk–1
apply, as relevant, in connection with
entering into security-based swaps and
continue to apply, as appropriate, over
the term of executed security-based
swaps. Sections 240.15Fh–3(a) through
240.15Fh–3(f), 240.15Fh–4(b) and
240.15Fh–5 are not applicable to

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security-based swaps that security-based
swap dealers or major security-based
swap participants enter into with their
majority-owned affiliates. For these
purposes the counterparties to a
security-based swap are majority-owned
affiliates if one counterparty directly or
indirectly owns a majority interest in
the other, or if a third party directly or
indirectly owns a majority interest in
both counterparties to the securitybased swap, where ‘‘majority interest’’ is
the right to vote or direct the vote of a
majority of a class of voting securities of
an entity, the power to sell or direct the
sale of a majority of a class of voting
securities of an entity, or the right to
receive upon dissolution or the
contribution of a majority of the capital
of a partnership.
(b) Reliance on representations. A
security-based swap dealer or major
security-based swap participant may
rely on written representations from the
counterparty or its representative to
satisfy its due diligence requirements
under § 240.15Fh, unless it has
information that would cause a
reasonable person to question the
accuracy of the representation.
§ 240.15Fh–2

Definitions.

As used in §§ 240.15Fh–1 through
240.15Fh–6:
(a) Act as an advisor to a special
entity. A security-based swap dealer
acts as an advisor to a special entity
when it recommends a security-based
swap or a trading strategy that involves
the use of a security-based swap to the
special entity, unless:
(1) With respect to a special entity as
defined in § 240.15Fh–2(d)(3):
(i) The special entity represents in
writing that it has a fiduciary as defined
in section 3 of the Employee Retirement
Income Security Act of 1974 (29 U.S.C.
1002) that is responsible for
representing the special entity in
connection with the security-based
swap;
(ii) The fiduciary represents in writing
that it acknowledges that the securitybased swap dealer is not acting as an
advisor; and
(iii) The special entity represents in
writing:
(A) That it will comply in good faith
with written policies and procedures
reasonably designed to ensure that any
recommendation the special entity
receives from the security-based swap
dealer involving a security-based swap
transaction is evaluated by a fiduciary
before the transaction is entered into; or
(B) That any recommendation the
special entity receives from the securitybased swap dealer involving a securitybased swap transaction will be

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evaluated by a fiduciary before the
transaction is entered into.
(2) With respect to any special entity:
(i) The special entity represents in
writing that:
(A) It acknowledges that the securitybased swap dealer is not acting as an
advisor; and
(B) The special entity will rely on
advice from a qualified independent
representative as defined in § 240.15Fh–
5(a); and
(ii) The security-based swap dealer
discloses to the special entity that it is
not undertaking to act in the best
interest of the special entity, as
otherwise required by section 15F(h)(4)
of the Act.
(b) Eligible contract participant means
any person as defined in section 3(a)(65)
of the Act and the rules and regulations
thereunder and in section 1a of the
Commodity Exchange Act (7 U.S.C. 1a)
and the rules and regulations
thereunder.
(c) Security-based swap dealer or
major security-based swap participant
includes, where relevant, an associated
person of the security-based swap dealer
or major security-based swap
participant.
(d) Special entity means:
(1) A Federal agency;
(2) A State, State agency, city, county,
municipality, other political subdivision
of a State, or any instrumentality,
department, or a corporation of or
established by a State or political
subdivision of a State;
(3) Any employee benefit plan,
subject to Title I of the Employee
Retirement Income Security Act of 1974
(29 U.S.C. 1002);
(4) Any employee benefit plan
defined in section 3 of the Employee
Retirement Income Security Act of 1974
(29 U.S.C. 1002) and not otherwise
defined as a special entity, unless such
employee benefit plan elects not to be
a special entity by notifying a securitybased swap dealer or major securitybased swap participant of its election
prior to entering into a security-based
swap with the particular security-based
swap dealer or major security-based
swap participant;
(5) Any governmental plan, as defined
in section 3(32) of the Employee
Retirement Income Security Act of 1974
(29 U.S.C. 1002(32)); or
(6) Any endowment, including an
endowment that is an organization
described in section 501(c)(3) of the
Internal Revenue Code of 1986.
(e) A person is subject to a statutory
disqualification for purposes of
§ 240.15Fh–5 if that person would be
subject to a statutory disqualification, as

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
described in section 3(a)(39)(A)–(F) of
the Act.

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§ 240.15Fh–3 Business conduct
requirements.

(a) Counterparty status—(1) Eligible
contract participant. A security-based
swap dealer or a major security-based
swap participant shall verify that a
counterparty meets the eligibility
standards for an eligible contract
participant before entering into a
security-based swap with that
counterparty, provided that the
requirements of this paragraph (a)(1)
shall not apply to a transaction executed
on a registered national securities
exchange.
(2) Special entity. A security-based
swap dealer or a major security-based
swap participant shall verify whether a
counterparty is a special entity before
entering into a security-based swap with
that counterparty, unless the transaction
is executed on a registered or exempt
security-based swap execution facility
or registered national securities
exchange, and the security-based swap
dealer or major security-based swap
participant does not know the identity
of the counterparty at a reasonably
sufficient time prior to execution of the
transaction to permit the security-based
swap dealer or major security-based
swap participant to comply with the
obligations of paragraph (a) of this
section.
(3) Special entity election. In verifying
the special entity status of a
counterparty pursuant to § 240.15Fh–
3(a)(2), a security-based swap dealer or
major security-based swap participant
shall verify whether a counterparty is
eligible to elect not to be a special entity
under § 240.15Fh–2(d)(4) and, if so,
notify such counterparty of its right to
make such an election.
(b) Disclosure. At a reasonably
sufficient time prior to entering into a
security-based swap, a security-based
swap dealer or major security-based
swap participant shall disclose to a
counterparty, other than a securitybased swap dealer, major security-based
swap participant, swap dealer or major
swap participant, material information
concerning the security-based swap in a
manner reasonably designed to allow
the counterparty to assess the material
risks and characteristics and material
incentives or conflicts of interest, as
described below, so long as the identity
of the counterparty is known to the
security-based swap dealer or major
security-based swap participant at a
reasonably sufficient time prior to
execution of the transaction to permit
the security-based swap dealer or major
security-based swap participant to

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comply with the obligations of
paragraph (b) of this section.
(1) Material risks and characteristics
means the material risks and
characteristics of the particular securitybased swap, which may include:
(i) Market, credit, liquidity, foreign
currency, legal, operational, and any
other applicable risks; and
(ii) The material economic terms of
the security-based swap, the terms
relating to the operation of the securitybased swap, and the rights and
obligations of the parties during the
term of the security-based swap.
(2) Material incentives or conflicts of
interest means any material incentives
or conflicts of interest that the securitybased swap dealer or major securitybased swap participant may have in
connection with the security-based
swap, including any compensation or
other incentives from any source other
than the counterparty in connection
with the security-based swap to be
entered into with the counterparty.
(3) Record. The security-based swap
dealer or major security-based swap
participant shall make a written record
of the non-written disclosures made
pursuant to this paragraph (b), and
provide a written version of these
disclosures to its counterparties in a
timely manner, but in any case no later
than the delivery of the trade
acknowledgement of the particular
transaction pursuant to § 240.15Fi–1.
(c) Daily mark. A security-based swap
dealer or major security-based swap
participant shall disclose the daily mark
to the counterparty, other than a
security-based swap dealer, major
security-based swap participant, swap
dealer or major swap participant, which
shall be:
(1) For a cleared security-based swap,
upon request of the counterparty, the
daily mark that the security-based swap
dealer or major security-based swap
participant receives from the
appropriate clearing agency;
(2) For an uncleared security-based
swap, the midpoint between the bid and
offer, or the calculated equivalent
thereof, as of the close of business,
unless the parties agree in writing
otherwise to a different time, on each
business day during the term of the
security-based swap. The daily mark
may be based on market quotations for
comparable security-based swaps,
mathematical models or a combination
thereof. The security-based swap dealer
or major security-based swap
participant shall also disclose its data
sources and a description of the
methodology and assumptions used to
prepare the daily mark, and promptly
disclose any material changes to such

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data sources, methodology and
assumptions during the term of the
security-based swap; and
(3) The security-based swap dealer or
major security-based swap participant
shall provide the daily mark without
charge to the counterparty and without
restrictions on the internal use of the
daily mark by the counterparty.
(d) Disclosure regarding clearing
rights. A security-based swap dealer or
major security-based swap participant
shall disclose the following information
to a counterparty, other than a securitybased swap dealer, major security-based
swap participant, swap dealer or major
swap participant, so long as the identity
of the counterparty is known to the
security-based swap dealer or major
security-based swap participant at a
reasonably sufficient time prior to
execution of the transaction to permit
the security-based swap dealer or major
security-based swap participant to
comply with the obligations of
paragraph (d) of this section:
(1) For security-based swaps subject to
clearing requirement. Before entering
into a security-based swap subject to the
clearing requirement under section
3C(a) of the Act, a security-based swap
dealer or major security-based swap
participant shall:
(i) Disclose to the counterparty the
names of the clearing agencies that
accept the security-based swap for
clearing, and through which of those
clearing agencies the security-based
swap dealer or major security-based
swap participant is authorized or
permitted, directly or through a
designated clearing member, to clear the
security-based swap; and
(ii) Notify the counterparty that it
shall have the sole right to select which
of the clearing agencies described in
paragraph (d)(1)(i) of this section shall
be used to clear the security-based swap
subject to section 3C(g)(5) of the Act.
(2) For security-based swaps not
subject to clearing requirement. Before
entering into a security-based swap not
subject to the clearing requirement
under section 3C(a) of the Act, a
security-based swap dealer or major
security-based swap participant shall:
(i) Determine whether the securitybased swap is accepted for clearing by
one or more clearing agencies;
(ii) Disclose to the counterparty the
names of the clearing agencies that
accept the security-based swap for
clearing, and whether the security-based
swap dealer or major security-based
swap participant is authorized or
permitted, directly or through a
designated clearing member, to clear the
security-based swap through such
clearing agencies; and

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(iii) Notify the counterparty that it
may elect to require clearing of the
security-based swap and shall have the
sole right to select the clearing agency
at which the security-based swap will
be cleared, provided it is a clearing
agency at which the security-based
swap dealer or major security-based
swap participant is authorized or
permitted, directly or through a
designated clearing member, to clear the
security-based swap.
(3) Record. The security-based swap
dealer or major security-based swap
participant shall make a written record
of the non-written disclosures made
pursuant to this paragraph (d), and
provide a written version of these
disclosures to its counterparties in a
timely manner, but in any case no later
than the delivery of the trade
acknowledgement of the particular
transaction pursuant to § 240.15Fi–1.
(e) Know your counterparty. Each
security-based swap dealer shall
establish, maintain and enforce written
policies and procedures reasonably
designed to obtain and retain a record
of the essential facts concerning each
counterparty whose identity is known to
the security-based swap dealer that are
necessary for conducting business with
such counterparty. For purposes of
paragraph (e) of this section, the
essential facts concerning a
counterparty are:
(1) Facts required to comply with
applicable laws, regulations and rules;
(2) Facts required to implement the
security-based swap dealer’s credit and
operational risk management policies in
connection with transactions entered
into with such counterparty; and
(3) Information regarding the
authority of any person acting for such
counterparty.
(f) Recommendations of securitybased swaps or trading strategies. (1) A
security-based swap dealer that
recommends a security-based swap or
trading strategy involving a securitybased swap to a counterparty, other than
a security-based swap dealer, major
security-based swap participant, swap
dealer, or major swap participant, must:
(i) Undertake reasonable diligence to
understand the potential risks and
rewards associated with the
recommended security-based swap or
trading strategy involving a securitybased swap; and
(ii) Have a reasonable basis to believe
that a recommended security-based
swap or trading strategy involving a
security-based swap is suitable for the
counterparty. To establish a reasonable
basis for a recommendation, a securitybased swap dealer must have or obtain
relevant information regarding the

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counterparty, including the
counterparty’s investment profile,
trading objectives, and its ability to
absorb potential losses associated with
the recommended security-based swap
or trading strategy involving a securitybased swap.
(2) A security-based swap dealer may
also fulfill its obligations under
paragraph (f)(1)(ii) of this section with
respect to an institutional counterparty,
if:
(i) The security-based swap dealer
reasonably determines that the
counterparty, or an agent to which the
counterparty has delegated decisionmaking authority, is capable of
independently evaluating investment
risks with regard to the relevant
security-based swap or trading strategy
involving a security-based swap;
(ii) The counterparty or its agent
affirmatively represents in writing that
it is exercising independent judgment in
evaluating the recommendations of the
security-based swap dealer with regard
to the relevant security-based swap or
trading strategy involving a securitybased swap; and
(iii) The security-based swap dealer
discloses that it is acting in its capacity
as a counterparty, and is not
undertaking to assess the suitability of
the security-based swap or trading
strategy for the counterparty.
(3) A security-based swap dealer will
be deemed to have satisfied its
obligations under paragraph (f)(2)(i) of
this section if it receives written
representations, as provided in
§ 240.15Fh–1(b), that:
(i) In the case of a counterparty that
is not a special entity, the counterparty
has complied in good faith with written
policies and procedures that are
reasonably designed to ensure that the
persons responsible for evaluating the
recommendation and making trading
decisions on behalf of the counterparty
are capable of doing so; or
(ii) In the case of a counterparty that
is a special entity, satisfy the terms of
the safe harbor in § 240.15Fh–5(b).
(4) For purposes of paragraph (f)(2) of
this section, an institutional
counterparty is a counterparty that is an
eligible contract participant as defined
in clauses (A)(i), (ii), (iii), (iv), (viii), (ix)
or (x), or clause (B)(ii) (other than a
person described in clause (A)(v)) of
section 1a(18) of the Commodity
Exchange Act (7 U.S.C. 1(a)(18)) and the
rules and regulations thereunder, or any
person (whether a natural person,
corporation, partnership, trust or
otherwise) with total assets of at least
$50 million.
(g) Fair and balanced
communications. A security-based swap

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dealer or major security-based swap
participant shall communicate with
counterparties in a fair and balanced
manner based on principles of fair
dealing and good faith. In particular:
(1) Communications must provide a
sound basis for evaluating the facts with
regard to any particular security-based
swap or trading strategy involving a
security-based swap;
(2) Communications may not imply
that past performance will recur or
make any exaggerated or unwarranted
claim, opinion or forecast; and
(3) Any statement referring to the
potential opportunities or advantages
presented by a security-based swap
shall be balanced by an equally detailed
statement of the corresponding risks.
(h) Supervision—(1) In general. A
security-based swap dealer or major
security-based swap participant shall
establish and maintain a system to
supervise, and shall diligently
supervise, its business and the activities
of its associated persons. Such a system
shall be reasonably designed to prevent
violations of the provisions of
applicable federal securities laws and
the rules and regulations thereunder
relating to its business as a securitybased swap dealer or major securitybased swap participant, respectively.
(2) Minimum requirements. The
system required by paragraph (h)(1) of
this section shall, at a minimum,
provide for:
(i) The designation of at least one
person with authority to carry out the
supervisory responsibilities of the
security-based swap dealer or major
security-based swap participant for each
type of business in which it engages for
which registration as a security-based
swap dealer or major security-based
swap participant is required;
(ii) The use of reasonable efforts to
determine that all supervisors are
qualified, either by virtue of experience
or training, to carry out their assigned
responsibilities; and
(iii) Establishment, maintenance and
enforcement of written policies and
procedures addressing the supervision
of the types of security-based swap
business in which the security-based
swap dealer or major security-based
swap participant is engaged and the
activities of its associated persons that
are reasonably designed to prevent
violations of applicable federal
securities laws and the rules and
regulations thereunder, and that
include, at a minimum:
(A) Procedures for the review by a
supervisor of transactions for which
registration as a security-based swap
dealer or major security-based swap
participant is required;

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations
(B) Procedures for the review by a
supervisor of incoming and outgoing
written (including electronic)
correspondence with counterparties or
potential counterparties and internal
written communications relating to the
security-based swap dealer’s or major
security-based swap participant’s
business involving security-based
swaps;
(C) Procedures for a periodic review,
at least annually, of the security-based
swap business in which the securitybased swap dealer or major securitybased swap participant engages that is
reasonably designed to assist in
detecting and preventing violations of
applicable federal securities laws and
the rules and regulations thereunder;
(D) Procedures to conduct a
reasonable investigation regarding the
good character, business repute,
qualifications, and experience of any
person prior to that person’s association
with the security-based swap dealer or
major security-based swap participant;
(E) Procedures to consider whether to
permit an associated person to establish
or maintain a securities or commodities
account or a trading relationship in the
name of, or for the benefit of such
associated person, at another securitybased swap dealer, broker, dealer,
investment adviser, or other financial
institution; and if permitted, procedures
to supervise the trading at the other
security-based swap dealer, broker,
dealer, investment adviser, or financial
institution;
(F) A description of the supervisory
system, including the titles,
qualifications and locations of
supervisory persons and the
responsibilities of each supervisory
person with respect to the types of
business in which the security-based
swap dealer or major security-based
swap participant is engaged;
(G) Procedures prohibiting an
associated person who performs a
supervisory function from supervising
his or her own activities or reporting to,
or having his or her compensation or
continued employment determined by,
a person or persons he or she is
supervising; provided, however, that if
the security-based swap dealer or major
security-based swap participant
determines, with respect to any of its
supervisory personnel, that compliance
with this requirement is not possible
because of the firm’s size or a
supervisory person’s position within the
firm, the security-based swap dealer or
major security-based swap participant
must document the factors used to reach
such determination and how the
supervisory arrangement with respect to
such supervisory personnel otherwise

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complies with paragraph (h)(1) of this
section, and include a summary of such
determination in the annual compliance
report prepared by the security-based
swap dealer’s or major security-based
swap participant’s chief compliance
officer pursuant to § 240.15Fk–1(c);
(H) Procedures reasonably designed to
prevent the supervisory system required
by paragraph (h)(1) of this section from
being compromised due to the conflicts
of interest that may be present with
respect to the associated person being
supervised, including the position of
such person, the revenue such person
generates for the security-based swap
dealer or major security-based swap
participant, or any compensation that
the associated person conducting the
supervision may derive from the
associated person being supervised; and
(I) Procedures reasonably designed,
taking into consideration the nature of
such security-based swap dealer’s or
major security-based swap participant’s
business, to comply with the duties set
forth in section 15F(j) of the Act.
(3) Failure to supervise. A securitybased swap dealer or major securitybased swap participant or an associated
person of a security-based swap dealer
or major security-based swap
participant shall not be deemed to have
failed to diligently supervise any other
person, if such other person is not
subject to his or her supervision, or if:
(i) The security-based swap dealer or
major security-based swap participant
has established and maintained written
policies and procedures as required in
§ 240.15Fh–3(h)(2)(iii), and a
documented system for applying those
policies and procedures, that would
reasonably be expected to prevent and
detect, insofar as practicable, any
violation of the federal securities laws
and the rules and regulations
thereunder relating to security-based
swaps; and
(ii) The security-based swap dealer or
major security-based swap participant,
or associated person of the securitybased swap dealer or major securitybased swap participant, has reasonably
discharged the duties and obligations
required by such written policies and
procedures and documented system and
did not have a reasonable basis to
believe that such written policies and
procedures and documented system
were not being followed.
(4) Maintenance of written
supervisory procedures. A securitybased swap dealer or major securitybased swap participant shall:
(i) Promptly amend its written
supervisory procedures as appropriate
when material changes occur in
applicable securities laws or rules or

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30147

regulations thereunder, and when
material changes occur in its business or
supervisory system; and
(ii) Promptly communicate any
material amendments to its supervisory
procedures to all associated persons to
whom such amendments are relevant
based on their activities and
responsibilities.
§ 240.15Fh–4 Antifraud provisions for
security-based swap dealers and major
security-based swap participants; special
requirements for security-based swap
dealers acting as advisors to special
entities.

(a) Antifraud provisions. It shall be
unlawful for a security-based swap
dealer or major security-based swap
participant:
(1) To employ any device, scheme, or
artifice to defraud any special entity or
prospective customer who is a special
entity;
(2) To engage in any transaction,
practice, or course of business that
operates as a fraud or deceit on any
special entity or prospective customer
who is a special entity; or
(3) To engage in any act, practice, or
course of business that is fraudulent,
deceptive, or manipulative.
(b) Special requirements for securitybased swap dealers acting as advisors to
special entities. A security-based swap
dealer that acts as an advisor to a special
entity regarding a security-based swap
shall comply with the following
requirements:
(1) Duty. The security-based swap
dealer shall have a duty to make a
reasonable determination that any
security-based swap or trading strategy
involving a security-based swap
recommended by the security-based
swap dealer is in the best interests of the
special entity.
(2) Reasonable efforts. The securitybased swap dealer shall make
reasonable efforts to obtain such
information that the security-based
swap dealer considers necessary to
make a reasonable determination that a
security-based swap or trading strategy
involving a security-based swap is in
the best interests of the special entity.
This information shall include, but not
be limited to:
(i) The authority of the special entity
to enter into a security-based swap;
(ii) The financial status of the special
entity, as well as future funding needs;
(iii) The tax status of the special
entity;
(iv) The hedging, investment,
financing or other objectives of the
special entity;
(v) The experience of the special
entity with respect to entering into

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security-based swaps, generally, and
security-based swaps of the type and
complexity being recommended;
(vi) Whether the special entity has the
financial capability to withstand
changes in market conditions during the
term of the security-based swap; and
(vii) Such other information as is
relevant to the particular facts and
circumstances of the special entity,
market conditions and the type of
security-based swap or trading strategy
involving a security-based swap being
recommended.
(3) Exception. The requirements of
this paragraph (b) shall not apply with
respect to a security-based swap if:
(i) The transaction is executed on a
registered or exempt security-based
swap execution facility or registered
national securities exchange; and
(ii) The security-based swap dealer
does not know the identity of the
counterparty at a reasonably sufficient
time prior to execution of the
transaction to permit the security-based
swap dealer to comply with the
obligations of paragraph (b) of this
section.

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§ 240.15Fh–5 Special requirements for
security-based swap dealers and major
security-based swap participants acting as
counterparties to special entities.

(a)(1) A security-based swap dealer or
major security-based swap participant
that offers to enter into or enters into a
security-based swap with a special
entity, other than a special entity
defined in § 240.15Fh–2(d)(3), must
have a reasonable basis to believe that
the special entity has a qualified
independent representative. For these
purposes, a qualified independent
representative is a representative that:
(i) Has sufficient knowledge to
evaluate the transaction and risks;
(ii) Is not subject to a statutory
disqualification;
(iii) Undertakes a duty to act in the
best interests of the special entity;
(iv) Makes appropriate and timely
disclosures to the special entity of
material information concerning the
security-based swap;
(v) Evaluates, consistent with any
guidelines provided by the special
entity, the fair pricing and the
appropriateness of the security-based
swap;
(vi) In the case of a special entity
defined in §§ 240.15Fh–2(d)(2) or (5), is
a person that is subject to rules of the
Commission, the Commodity Futures
Trading Commission or a self-regulatory
organization subject to the jurisdiction
of the Commission or the Commodity
Futures Trading Commission
prohibiting it from engaging in specified

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activities if certain political
contributions have been made, provided
that this paragraph (a)(1)(vi) shall not
apply if the independent representative
is an employee of the special entity; and
(vii) Is independent of the securitybased swap dealer or major securitybased swap participant.
(A) A representative of a special entity
is independent of a security-based swap
dealer or major security-based swap
participant if the representative does not
have a relationship with the securitybased swap dealer or major securitybased swap participant, whether
compensatory or otherwise, that
reasonably could affect the independent
judgment or decision-making of the
representative.
(B) A representative of a special entity
will be deemed to be independent of a
security-based swap dealer or major
security-based swap participant if:
(1) The representative is not and,
within one year of representing the
special entity in connection with the
security-based swap, was not an
associated person of the security-based
swap dealer or major security-based
swap participant;
(2) The representative provides timely
disclosures to the special entity of all
material conflicts of interest that could
reasonably affect the judgment or
decision making of the representative
with respect to its obligations to the
special entity and complies with
policies and procedures reasonably
designed to manage and mitigate such
material conflicts of interest; and
(3) The security-based swap dealer or
major security-based swap participant
did not refer, recommend, or introduce
the representative to the special entity
within one year of the representative’s
representation of the special entity in
connection with the security-based
swap.
(2) A security-based swap dealer or
major security-based swap participant
that offers to enter into or enters into a
security-based swap with a special
entity as defined in § 240.15Fh–2(d)(3)
must have a reasonable basis to believe
that the special entity has a
representative that is a fiduciary as
defined in section 3 of the Employee
Retirement Income Security Act of 1974
(29 U.S.C. 1002).
(b) Safe harbor. (1) A security-based
swap dealer or major security-based
swap participant shall be deemed to
have a reasonable basis to believe that
the special entity, other than a special
entity defined in § 240.15Fh–2(d)(3), has
a representative that satisfies the
applicable requirements of paragraph
(a)(1) of this section, provided that:

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(i) The special entity represents in
writing to the security-based swap
dealer or major security-based swap
participant that it has complied in good
faith with written policies and
procedures reasonably designed to
ensure that it has selected a
representative that satisfies the
applicable requirements of paragraph
(a)(1) of this section, and that such
policies and procedures provide for
ongoing monitoring of the performance
of such representative consistent with
the requirements of paragraph (a)(1) of
this section; and
(ii) The representative represents in
writing to the special entity and
security-based swap dealer or major
security-based swap participant that the
representative:
(A) Has policies and procedures
reasonably designed to ensure that it
satisfies the applicable requirements of
paragraph (a)(1) of this section;
(B) Meets the independence test in
paragraph (a)(1)(vii) of this section; has
the knowledge required under
paragraph (a)(1)(i) of this section; is not
subject to a statutory disqualification
under paragraph (a)(1)(ii) of this section;
undertakes a duty to act in the best
interests of the special entity as required
under paragraph (a)(1)(iii) of this
section; and is subject to the
requirements regarding political
contributions, as applicable, under
paragraph (a)(1)(vi) of this section; and
(C) Is legally obligated to comply with
the applicable requirements of
paragraph (a)(1) of this section by
agreement, condition of employment,
law, rule, regulation, or other
enforceable duty.
(2) A security-based swap dealer or
major security-based swap participant
shall be deemed to have a reasonable
basis to believe that a special entity
defined in § 240.15Fh–2(d)(3) of this
section has a representative that satisfies
the applicable requirements in
paragraph (a)(2) of this section,
provided that the special entity provides
in writing to the security-based swap
dealer or major security-based swap
participant the representative’s name
and contact information, and represents
in writing that the representative is a
fiduciary as defined in section 3 of the
Employee Retirement Income Security
Act of 1974 (29 U.S.C. 1002).
(c) Before initiation of a securitybased swap with a special entity, a
security-based swap dealer shall
disclose to the special entity in writing
the capacity in which the security-based
swap dealer is acting in connection with
the security-based swap and, if the
security-based swap dealer engages in
business with the counterparty in more

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than one capacity, the security-based
swap dealer shall disclose the material
differences between such capacities and
any other financial transaction or
service involving the counterparty.
(d) The requirements of this section
shall not apply with respect to a
security-based swap if:
(1) The transaction is executed on a
registered or exempt security-based
swap execution facility or registered
national securities exchange; and
(2) The security-based swap dealer or
major security-based swap participant
does not know the identity of the
counterparty at a reasonably sufficient
time prior to execution of the
transaction to permit the security-based
swap dealer or major security-based
swap participant to comply with the
obligations of paragraphs (a) through (c)
of this section.

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§ 240.15Fh–6 Political contributions by
certain security-based swap dealers.

(a) Definitions. For the purposes of
this section:
(1) The term contribution means any
gift, subscription, loan, advance, or
deposit of money or anything of value
made:
(i) For the purpose of influencing any
election for federal, state or local office;
(ii) For payment of debt incurred in
connection with any such election; or
(iii) For transition or inaugural
expenses incurred by the successful
candidate for state or local office.
(2) The term covered associate means:
(i) Any general partner, managing
member or executive officer, or other
person with a similar status or function;
(ii) Any employee who solicits a
municipal entity to enter into a securitybased swap with the security-based
swap dealer and any person who
supervises, directly or indirectly, such
employee; and
(iii) A political action committee
controlled by the security-based swap
dealer or by a person described in
paragraphs (a)(2)(i) and (ii) of this
section.
(3) The term executive officer of a
security-based swap dealer means:
(i) The president;
(ii) Any vice president in charge of a
principal business unit, division or
function (such as sales, administration
or finance);
(iii) Any other officer of the securitybased swap dealer who performs a
policy-making function; or
(iv) Any other person who performs
similar policy-making functions for the
security-based swap dealer.
(4) The term municipal entity is
defined in section 15B(e)(8) of the Act.
(5) The term official of a municipal
entity means any person (including any

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election committee for such person)
who was, at the time of the contribution,
an incumbent, candidate or successful
candidate for elective office of a
municipal entity, if the office:
(i) Is directly or indirectly responsible
for, or can influence the outcome of, the
selection of a security-based swap
dealer by a municipal entity; or
(ii) Has authority to appoint any
person who is directly or indirectly
responsible for, or can influence the
outcome of, the selection of a securitybased swap dealer by a municipal
entity.
(6) The term payment means any gift,
subscription, loan, advance, or deposit
of money or anything of value.
(7) The term regulated person means:
(i) A person that is subject to rules of
the Commission, the Commodity
Futures Trading Commission or a selfregulatory organization subject to the
jurisdiction of the Commission or the
Commodity Futures Trading
Commission prohibiting it from
engaging in specified activities if certain
political contributions have been made,
or its officers or employees;
(ii) A general partner, managing
member or executive officer of such
person, or other individual with a
similar status or function; or
(iii) An employee of such person who
solicits a municipal entity for the
security-based swap dealer and any
person who supervises, directly or
indirectly, such employee.
(8) The term solicit means a direct or
indirect communication by any person
with a municipal entity for the purpose
of obtaining or retaining an engagement
related to a security-based swap.
(b) Prohibitions and exceptions. (1) It
shall be unlawful for a security-based
swap dealer to offer to enter into, or
enter into, a security-based swap, or a
trading strategy involving a securitybased swap, with a municipal entity
within two years after any contribution
to an official of such municipal entity
was made by the security-based swap
dealer, or by any covered associate of
the security-based swap dealer.
(2) The prohibition in paragraph (b)(1)
of this section does not apply:
(i) If the only contributions made by
the security-based swap dealer to an
official of such municipal entity were
made by a covered associate, if a natural
person:
(A) To officials for whom the covered
associate was entitled to vote at the time
of the contributions, if the contributions
in the aggregate do not exceed $350 to
any one official per election; or
(B) To officials for whom the covered
associate was not entitled to vote at the
time of the contributions, if the

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30149

contributions in the aggregate do not
exceed $150 to any one official, per
election;
(ii) To a security-based swap dealer as
a result of a contribution made by a
natural person more than six months
prior to becoming a covered associate of
the security-based swap dealer,
however, this exclusion shall not apply
if the natural person, after becoming a
covered associate, solicits the municipal
entity on behalf of the security-based
swap dealer to offer to enter into, or to
enter into, security-based swap, or a
trading strategy involving a securitybased swap; or
(iii) With respect to a security-based
swap that is executed on a registered
national securities exchange or
registered or exempt security-based
swap execution facility where the
security-based swap dealer does not
know the identity of the counterparty to
the transaction at a reasonably sufficient
time prior to execution of the
transaction to permit the security-based
swap dealer to comply with the
obligations of paragraph (b)(1) of this
section.
(3) No security-based swap dealer or
any covered associate of the securitybased swap dealer shall:
(i) Provide or agree to provide,
directly or indirectly, payment to any
person to solicit a municipal entity to
offer to enter into, or to enter into, a
security-based swap or any trading
strategy involving a security-based swap
with that security-based swap dealer
unless such person is a regulated
person; or
(ii) Coordinate, or solicit any person
or political action committee to make,
any:
(A) Contribution to an official of a
municipal entity with which the
security-based swap dealer is offering to
enter into, or has entered into, a
security-based swap or a trading strategy
involving a security-based swap; or
(B) Payment to a political party of a
state or locality with which the securitybased swap dealer is offering to enter
into, or has entered into, a securitybased swap or a trading strategy
involving a security-based swap.
(c) Circumvention of rule. No securitybased swap dealer shall, directly or
indirectly, through or by any other
person or means, do any act that would
result in a violation of paragraph (a) or
(b) of this section.
(d) Requests for exemption. The
Commission, upon application, may
conditionally or unconditionally
exempt a security-based swap dealer
from the prohibition under paragraph
(b)(1) of this section. In determining
whether to grant an exemption, the

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Federal Register / Vol. 81, No. 93 / Friday, May 13, 2016 / Rules and Regulations

Commission will consider, among other
factors:
(1) Whether the exemption is
necessary or appropriate in the public
interest and consistent with the
protection of investors and the purposes
of the Act;
(2) Whether the security-based swap
dealer:
(i) Before the contribution resulting in
the prohibition was made, adopted and
implemented policies and procedures
reasonably designed to prevent
violations of this section;
(ii) Prior to or at the time the
contribution which resulted in such
prohibition was made, had no actual
knowledge of the contribution; and
(iii) After learning of the contribution:
(A) Has taken all available steps to
cause the contributor involved in
making the contribution which resulted
in such prohibition to obtain a return of
the contribution; and
(B) Has taken such other remedial or
preventive measures as may be
appropriate under the circumstances;
(3) Whether, at the time of the
contribution, the contributor was a
covered associate or otherwise an
employee of the security-based swap
dealer, or was seeking such
employment;
(4) The timing and amount of the
contribution which resulted in the
prohibition;
(5) The nature of the election (e.g.,
federal, state or local); and
(6) The contributor’s apparent intent
or motive in making the contribution
that resulted in the prohibition, as
evidenced by the facts and
circumstances surrounding the
contribution.
(e) Prohibitions inapplicable. (1) The
prohibitions under paragraph (b) of this
section shall not apply to a contribution
made by a covered associate of the
security-based swap dealer if:
(i) The security-based swap dealer
discovered the contribution within 120
calendar days of the date of such
contribution;
(ii) The contribution did not exceed
$350; and
(iii) The covered associate obtained a
return of the contribution within 60
calendar days of the date of discovery of
the contribution by the security-based
swap dealer.
(2) A security-based swap dealer that
has more than 50 covered associates
may not rely on paragraph (e)(1) of this
section more than three times in any 12month period, while a security-based
swap dealer that has 50 or fewer
covered associates may not rely on
paragraph (e)(1) of this section more
than twice in any 12-month period.

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(3) A security-based swap dealer may
not rely on paragraph (e)(1) of this
section more than once for any covered
associate, regardless of the time between
contributions.
§ 240.15Fk–1 Designation of chief
compliance officer for security-based swap
dealers and major security-based swap
participants.

(a) In general. A security-based swap
dealer and major security-based swap
participant shall designate an individual
to serve as a chief compliance officer on
its registration form.
(b) Duties. The chief compliance
officer shall:
(1) Report directly to the board of
directors or to the senior officer of the
security-based swap dealer or major
security-based swap participant; and
(2) Take reasonable steps to ensure
that the registrant establishes, maintains
and reviews written policies and
procedures reasonably designed to
achieve compliance with the Act and
the rules and regulations thereunder
relating to its business as a securitybased swap dealer or major securitybased swap participant by:
(i) Reviewing the compliance of the
security-based swap dealer or major
security-based swap participant with
respect to the security-based swap
dealer and major security-based swap
participant requirements described in
section 15F of the Act, and the rules and
regulations thereunder, where the
review shall involve preparing the
registrant’s annual assessment of its
written policies and procedures
reasonably designed to achieve
compliance with section 15F of the Act,
and the rules and regulations
thereunder, by the security-based swap
dealer or major security-based swap
participant;
(ii) Taking reasonable steps to ensure
that the registrant establishes, maintains
and reviews policies and procedures
reasonably designed to remediate noncompliance issues identified by the
chief compliance officer through any
means, including any:
(A) Compliance office review;
(B) Look-back;
(C) Internal or external audit finding;
(D) Self-reporting to the Commission
and other appropriate authorities; or
(E) Complaint that can be validated;
and
(iii) Taking reasonable steps to ensure
that the registrant establishes and
follows procedures reasonably designed
for the handling, management response,
remediation, retesting, and resolution of
non-compliance issues;
(3) In consultation with the board of
directors or the senior officer of the

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security-based swap dealer or major
security-based swap participant, take
reasonable steps to resolve any material
conflicts of interest that may arise; and
(4) Administer each policy and
procedure that is required to be
established pursuant to section 15F of
the Act and the rules and regulations
thereunder.
(c) Annual reports—(1) In general.
The chief compliance officer shall
annually prepare and sign a compliance
report that contains a description of the
written policies and procedures of the
security-based swap dealer or major
security-based swap participant
described in paragraph (b) of this
section (including the code of ethics and
conflict of interest policies).
(2) Requirements. (i) Each compliance
report shall also contain, at a minimum,
a description of:
(A) The security-based swap dealer or
major security-based swap participant’s
assessment of the effectiveness of its
policies and procedures relating to its
business as a security-based swap dealer
or major security-based participant;
(B) Any material changes to the
registrant’s policies and procedures
since the date of the preceding
compliance report;
(C) Any areas for improvement, and
recommended potential or prospective
changes or improvements to its
compliance program and resources
devoted to compliance;
(D) Any material non-compliance
matters identified; and
(E) The financial, managerial,
operational, and staffing resources set
aside for compliance with the Act and
the rules and regulations thereunder
relating to its business as a securitybased swap dealer or major securitybased swap participant, including any
material deficiencies in such resources.
(ii) A compliance report under
paragraph (c)(1) of this section also
shall:
(A) Be submitted to the Commission
within 30 days following the deadline
for filing the security-based swap
dealer’s or major security-based swap
participant’s annual financial report
with the Commission pursuant to
section 15F of the Act and rules and
regulations thereunder;
(B) Be submitted to the board of
directors and audit committee (or
equivalent bodies) and the senior officer
of the security-based swap dealer or
major security-based swap participant
prior to submission to the Commission;
(C) Be discussed in one or more
meetings conducted by the senior officer
with the chief compliance officer(s) in
the preceding 12 months, the subject of

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which addresses the obligations in this
section; and
(D) Include a certification by the chief
compliance officer or senior officer that,
to the best of his or her knowledge and
reasonable belief and under penalty of
law, the information contained in the
compliance report is accurate and
complete in all material respects.
(iii) Extensions of time. A securitybased swap dealer or major securitybased swap participant may request
from the Commission an extension of
time to submit its compliance report,
provided the registrant’s failure to
timely submit the report could not be
eliminated by the registrant without
unreasonable effort or expense.
Extensions of the deadline will be
granted at the discretion of the
Commission.
(iv) Incorporation by reference. A
security-based swap dealer or major
security-based swap participant may
incorporate by reference sections of a
compliance report that have been
submitted within the current or
immediately preceding reporting period
to the Commission.
(v) Amendments. A security-based
swap dealer or major security-based
swap participant shall promptly submit

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an amended compliance report if
material errors or omissions in the
report are identified. An amendment
must contain the certification required
under paragraph (c)(2)(ii)(D) of this
section.
(d) Compensation and removal. The
compensation and removal of the chief
compliance officer shall require the
approval of a majority of the board of
directors of the security-based swap
dealer or major security-based swap
participant.
(e) Definitions. For purposes of this
section, references to:
(1) The board or board of directors
shall include a body performing a
function similar to the board of
directors.
(2) The senior officer shall include the
chief executive officer or other
equivalent officer.
(3) Complaint that can be validated
shall include any written complaint by
a counterparty involving the securitybased swap dealer or major securitybased swap participant or associated
person of a security-based swap dealer
or major security-based swap
participant that can be supported upon
reasonable investigation.
(4) A material non-compliance matter
means any non-compliance matter about

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30151

which the board of directors of the
security-based swap dealer or major
security-based swap participant would
reasonably need to know to oversee the
compliance of the security-based swap
dealer or major security-based swap
participant, and that involves, without
limitation:
(i) A violation of the federal securities
laws relating to its business as a
security-based swap dealer or major
security-based swap participant by the
firm or its officers, directors, employees
or agents;
(ii) A violation of the policies and
procedures relating to its business as a
security-based swap dealer or major
security-based swap participant by the
firm or its officers, directors, employees
or agents; or
(iii) A weakness in the design or
implementation of the policies and
procedures relating to its business as a
security-based swap dealer or major
security-based swap participant.
By the Commission.
Dated: April 14, 2016.
Brent J. Fields,
Secretary.
[FR Doc. 2016–10918 Filed 5–12–16; 8:45 am]
BILLING CODE 8011–01–P

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