SEC Proposes Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants
FOR IMMEDIATE RELEASE
Washington, D.C., June 29, 2011 – The Securities and Exchange Commission today voted to propose rules that would impose certain business conduct standards upon security-based swap dealers and major security-based swap participants when those parties engage in security-based swap transactions.
The SEC’s proposed rules stem from Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which authorizes the Commission to implement a comprehensive framework for regulating the over-the-counter swaps markets.
“The rules we are proposing would level the playing field in the security-based swap market by bringing needed transparency to this market and by seeking to ensure that customers in these transactions are treated fairly,” said SEC Chairman Mary L. Schapiro. “The standards we propose are intended to establish a framework that protects investors and also promotes efficiency, competition, and capital formation.”
The proposed rules would require security-based swap dealers and major security-based swap participants to communicate in a fair and balanced manner and make certain disclosures, including conflicts of interest and material incentives to potential counterparties. Additional requirements would be imposed for dealings with special entities, which include municipalities, pension plans, endowments and similar entities.
Public comments on the SEC’s proposal should be received by Aug. 29, 2011.
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Implementing External Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants
In an effort to encourage accountability and transparency, the Dodd-Frank Act establishes a comprehensive framework for regulating the over-the-counter swaps markets. Among other things, the Act establishes business conduct standards for “security-based swap dealers” and “major security-based swap participants” whenever those entities engage in security-based swap transactions with counterparties, including those that are “special entities.”
Special entities are generally defined to include federal agencies, states and political subdivisions, employee benefit plans as defined under the Employee Retirement Income Security Act of 1974 (ERISA), governmental plans, and endowments.
The proposed rules (15Fh-1 through 15Fh-6 and 15Fk-1) seek to implement the business conduct requirements described in Section 764 of the Dodd-Frank Act. Among other things, the proposed rules would require security-based swap dealers and major security-based swap participants to:
- Verify whether a counterparty is an eligible contract participant and whether it is a special entity.
- Disclose to the counterparty material information about the security-based swap, including material risks, characteristics, incentives and conflicts of interest.
- Provide the counterparty with information concerning the daily mark of the security-based swap.
- Provide the counterparty with information regarding the ability to require clearing of the security-based swap.
- Communicate with counterparties in a fair and balanced manner based on principles of fair dealing and good faith.
- Establish a supervisory and compliance infrastructure.
- Designate a chief compliance officer that is required to fulfill the described duties and provide an annual compliance report.
The proposed rules also would require security-based swap dealers to:
- Determine that any recommendations they make regarding security-based swaps are suitable for their counterparties (this proposal is similar to the FINRA rule regarding suitability, including institutional suitability).
- Establish, maintain and enforce 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 such counterparty.
- Comply with rules designed to prevent “pay-to-play.”
The proposed rules also would define what it means to “act as an advisor” to a special entity, and would require that a security-based swap dealer who acts as an advisor to a special entity:
- Act in the “best interests” of the special entity.
- Make reasonable efforts to obtain information that it needs to determine that the recommendation is in the “best interests” of the special entity.
In addition, the proposed rules would require security-based swap dealers and major security-based swap participants acting as counterparties to special entities to reasonably believe that the counterparty has an independent representative who meets the following requirements:
- Has sufficient knowledge to evaluate the transaction and risks.
- Is not subject to a statutory disqualification.
- Is independent of the security-based swap dealer or major security-based swap participant.
- Undertakes a duty to act in the best interests of the special entity.
- Makes appropriate disclosures of material information concerning the security-based swap.
- Provides written representations to the special entity regarding fair pricing and appropriateness of the security-based swap.
In addition, the independent representative would be subject to pay-to-play regulations, and if the special entity is an ERISA plan, the independent representative would be required to be a fiduciary under ERISA.
The SEC worked closely with the CFTC in preparing this proposal. The CFTC also has proposed rules with respect to the external business conduct standards of swap dealers and major swap participants. See Business Conduct Standards for Swap Dealers and Major Swap Participants with Counterparties, 75 FR 80638 (CFTC Dec. 22, 2010). In preparing this proposal, the SEC and the CFTC held approximately 30 joint meetings with interested parties to solicit a variety of views. Commission staff also has consulted with Department of Labor representatives on this rulemaking.
The proposal seeks public comment and data on a broad range of issues relating to the proposed rules, including the costs and benefits associated with the proposal. Public comments are due Aug. 29, 2011. After careful review of the comments, the Commission will consider whether to adopt the proposed rules or modify them.