[Federal Register Volume 77, Number 64 (Tuesday, April 3, 2012)]
[Rules and Regulations]
[Pages 20128-20215]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-5317]



[[Page 20127]]

Vol. 77

Tuesday,

No. 64

April 3, 2012

Part II





Commodity Futures Trading Commission





-----------------------------------------------------------------------





17 CFR Parts 1, 3, and 23





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; Final Rule

Federal Register / Vol. 77 , No. 64 / Tuesday, April 3, 2012 / Rules 
and Regulations

[[Page 20128]]


-----------------------------------------------------------------------

COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 3, and 23

RIN 3038-AC96


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

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

-----------------------------------------------------------------------

SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC) 
is adopting regulations to implement certain provisions of Title VII of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act). These regulations set forth reporting and recordkeeping 
requirements and daily trading records requirements for swap dealers 
(SDs) and major swap participants (MSPs). These regulations also set 
forth certain duties imposed upon SDs and MSPs registered with the 
Commission with regard to: Risk management procedures; monitoring of 
trading to prevent violations of applicable position limits; diligent 
supervision; business continuity and disaster recovery; disclosure and 
the ability of regulators to obtain general information; and antitrust 
considerations. In addition, these regulations establish conflicts-of-
interest requirements for SDs, MSPs, futures commission merchants 
(FCMs), and introducing brokers (IBs) with regard to firewalls between 
research and trading and between clearing and trading. Finally, these 
regulations also require each FCM, SD, and MSP to designate a chief 
compliance officer, prescribe qualifications and duties of the chief 
compliance officer, and require that the chief compliance officer 
prepare, certify, and furnish to the Commission an annual report 
containing an assessment of the registrant's compliance activities.

DATES: The rules are effective June 4, 2012. Specific compliance dates 
are discussed in the supplementary information.

FOR FURTHER INFORMATION CONTACT: Frank N. Fisanich, Chief Counsel, 202-
418-5949, <a href="/cdn-cgi/l/email-protection#7016161903111e19131830131604135e171f06"><span class="__cf_email__" data-cfemail="97f1f1fee4f6f9fef4ffd7f4f1e3f4b9f0f8e1">[email protected]</span></a>, Division of Swap Dealer and Intermediary 
Oversight, Ward P. Griffin, Counsel, 202-418-5425, <a href="/cdn-cgi/l/email-protection#bacdddc8d3dcdcd3d4fad9dcced994ddd5cc"><span class="__cf_email__" data-cfemail="582f3f2a313e3e3136183b3e2c3b763f372e">[email protected]</span></a>, 
Office of the General Counsel, and Hannah Ropp, Economist, 202-418-
5228, <a href="/cdn-cgi/l/email-protection#38504a574848785b5e4c5b165f574e"><span class="__cf_email__" data-cfemail="b5ddc7dac5c5f5d6d3c1d69bd2dac3">[email protected]</span></a>, Office of the Chief Economist, Commodity Futures 
Trading Commission, Three Lafayette Centre, 1155 21st Street NW., 
Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background
II. Comments on the Notices of Proposed Rulemaking
    A. Regulatory Structure
    B. Reporting, Recordkeeping, and Daily Trading Records 
Requirements for SDs and MSPs
    C. General Records Requirement--Sec.  23.201
    D. Daily Trading Records--Sec.  23.202
    E. Records; Retention and Inspection--Sec.  23.203
    F. Duties of Swap Dealers and Major Swap Participants
    G. Risk Management Program for SDs and MSPs--Sec.  23.600
    H. Monitoring of Position Limits--Sec.  23.601
    I. Diligent Supervision--Sec.  23.602
    J. Business Continuity and Disaster Recovery--Sec.  23.603
    K. General Information: Availability for Disclosure and 
Inspection--Sec.  23.606
    L. Antitrust Considerations--Sec.  23.607
    M. Conflicts of Interest Policies and Procedures by SDs, MSPs, 
FCMs, and IBs--Sec.  23.605, Sec.  1.71
    N. Designation of a Chief Compliance Officer; Required 
Compliance Policies; and Annual Report of an FCM, SD, or MSP
III. Effective Dates and Compliance Dates
    A. Comments Regarding Compliance Dates
    B. Compliance Dates
IV. Cost Benefit Considerations
    A. Introduction
    B. General Considerations
    C. Comments Regarding the Scope of the Proposed Rules
    D. Recordkeeping, Reporting, and Daily Trading Records 
Requirements for SDs and MSPs
    E. Duties and Risk Management Requirements of SDs and MSPs
    F. Conflicts-of-Interest Policies and Procedures for SDs, MSPs, 
FCMs, and IBs
    G. Designation of a Chief Compliance Officer, Required 
Compliance Policies, and Annual Report of an FCM, SD, or MSP
    H. Conclusion
V. Related Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act

I. Background

    The Commission is hereby adopting Sec.  23.200 through Sec.  23.205 
\1\ setting forth reporting and recordkeeping requirements and daily 
trading records requirements for SDs and MSPs, as required under 
sections 4s(f) and 4s(g) of the Commodity Exchange Act (CEA); Sec.  
23.600 through Sec.  23.607 setting forth certain duties imposed upon 
SDs and MSPs with regard to: (1) Risk management procedures; (2) 
monitoring of trading to prevent violations of applicable position 
limits; (3) diligent supervision; (4) business continuity and disaster 
recovery; (5) conflicts of interest policies and procedures; (6) 
disclosure and the ability of regulators to obtain general information; 
and (7) antitrust considerations, as required under section 4s(j) of 
the CEA; Sec.  3.3 requiring FCMs, SDs, and MSPs to designate a chief 
compliance officer, prescribing qualifications and duties of the chief 
compliance officer, and requiring the chief compliance officer to 
prepare, certify, and furnish to the Commission an annual report 
containing an assessment of the registrant's compliance activities, as 
required under sections 4d(d) and 4s(k) of the CEA; and Sec.  1.71 
setting forth certain duties imposed on FCMs and IBs with regard to 
implementing conflicts of interest policies and procedures, as required 
under section 4d(c) of the CEA; as well as amendments to Sec.  3.1 to 
add chief compliance officers to the definition of ``principal'' and to 
add a new definition of ``board of directors.''
---------------------------------------------------------------------------

    \1\ Commission regulations referred to herein are found at 17 
CFR Ch. 1.
---------------------------------------------------------------------------

II. Comments on the Notices of Proposed Rulemaking

    The final rules adopted herein were proposed in five separate 
notices of proposed rulemaking.\2\ Each proposed rulemaking was subject 
to an initial 60-day public comment period and a re-opened comment 
period of 30 days.\3\ The Commission received a total of approximately 
114 comment letters directed specifically at the proposed rules.\4\ The 
Commission considered

[[Page 20129]]

each of these comments in formulating the final regulations.\5\
---------------------------------------------------------------------------

    \2\ See 75 FR 76666 (Dec. 9, 2010) (Reporting, Recordkeeping, 
and Daily Trading Records Requirements for Swap Dealers and Major 
Swap Participants (Recordkeeping NPRM)); 75 FR 71397 (Nov. 23, 2010) 
(Regulations Establishing and Governing the Duties of Swap Dealers 
and Major Swap Participants (Duties NPRM)); 75 FR 70152 (Nov. 17, 
2010) (Implementation of Conflicts of Interest Policies and 
Procedures by Futures Commission Merchants and Introducing Brokers 
(FCM/IB Conflicts NPRM)); 75 FR 71391 (Nov. 23, 2010) 
(Implementation of Conflicts of Interest Policies and Procedures by 
Swap Dealers and Major Swap Participants (SD/MSP Conflicts NPRM)); 
and 75 FR 70881 (Nov. 19, 2010) (Designation of a Chief Compliance 
Officer; Required Compliance Policies; and Annual Report of a 
Futures Commission Merchant, Swap Dealer, or Major Swap Participant 
(CCO NPRM)).
    \3\ See 76 FR 25274 (May 4, 2011) (extending or re-opening 
comment periods for multiple Dodd-Frank proposed rulemakings).
    \4\ Comment files for each proposed rulemaking can be found on 
the Commission Web site, www.cftc.gov.
    \5\ The Commission also reviewed the proposed rule of the 
Securities and Exchange Commission concerning business conduct 
standards for security-based swap dealers and major security-based 
swap participants. See 76 FR 42396 (July 18, 2011).
---------------------------------------------------------------------------

    The Chairman and Commissioners, as well as Commission staff, 
participated in numerous meetings with representatives of potential SDs 
and MSPs, existing FCMs, trade associations, public interest groups, 
traders, and other interested parties. In addition, the Commission has 
consulted with other U.S. financial regulators including: (i) The 
Securities and Exchange Commission (SEC); (ii) the Board of Governors 
of the Federal Reserve System; (iii) the Office of the Comptroller of 
the Currency; and (iv) the Federal Deposit Insurance Corporation. Staff 
from each of these agencies has had the opportunity to provide oral 
and/or written comments to this adopting release, and the final 
regulations incorporate elements of the comments provided. The 
Commission intends to work with the Federal Deposit Insurance 
Corporation (FDIC) to establish appropriate information-sharing 
arrangements to ensure that the FDIC has the information it needs to 
exercise authority under Title II of the Dodd-Frank Act or the Federal 
Deposit Insurance Act with regard to any SD or MSP registered with the 
Commission.
    The Commission is mindful of the benefits of harmonizing its 
regulatory framework with that of its counterparts in foreign 
countries. The Commission has therefore monitored global advisory, 
legislative, and regulatory proposals, and has consulted with foreign 
regulators in developing the final regulations.

A. Regulatory Structure

    The proposed regulations did not differentiate between SDs and MSPs 
that may be a division of a larger entity or institution, but not a 
separate legal entity. The proposed regulations also did not 
differentiate between SDs and MSPs, but, rather, applied identical 
rules to both types of entities. The proposals, however, solicited 
comments on whether certain provisions of the proposed regulations 
should be modified or adjusted to reflect the differences among SDs or 
MSPs. In addition, the proposed regulations tracked the scope of the 
statutory text, and did not, by their terms, apply only to the swap 
activities of SDs and MSPs.
    In its comment letter, Cargill, Incorporated (Cargill) argued that 
the proposed rules should recognize Congressional intent to permit a 
business with a swap dealing division to be subject to SD regulation 
only for the activities of that division. Cargill recommended that the 
Commission make clear that the Commission's regulations only apply to 
the swap dealing business of an SD that is a division of a larger 
company, and not to the other business activities of the company.
    MetLife, Inc. (MetLife), the Managed Funds Association (MFA), 
BlackRock, and the Asset Management Group of the Securities Industry 
and Financial Markets Association (AMG) each argued that the Dodd-Frank 
Act does not require that the Commission to apply the same rules to 
MSPs as those applied to SDs and that MSPs should not be subject to the 
same regulations as SDs because MSPs do not engage in market-making 
activities.
    The Securities Industry and Financial Markets Association (SIFMA) 
and the Federal Home Loan Banks (FHLBs) each recommended that the 
Commission's regulations should allow registrants that are regulated by 
a prudential regulator to comply with the Commission's regulations on a 
substituted compliance basis by complying with comparable regulations 
of their prudential regulator.
    In response to Cargill's comment, the Commission is including a new 
definition of ``swaps activities'' in the final regulations, as 
follows: ``Swaps activities means a registrant's activities related to 
swaps and any product used to hedge such swaps, including, but not 
limited to, futures, options, other swaps or security-based swaps, debt 
or equity securities, foreign currency, physical commodities, and other 
derivatives.''
    The Commission is using this term in the final regulations to (i) 
limit the scope of the risk management requirements in Sec.  23.600 to 
only the swap activities of SDs and MSPs; (ii) define the extent of the 
recordkeeping requirement in Sec.  23.201; and (iii) limit the scope of 
the duties and responsibilities of the chief compliance officer of an 
SD or MSP in Sec.  3.3 to the swaps activities of SDs and MSPs.\6\
---------------------------------------------------------------------------

    \6\ In addition, the Commission anticipates that under its 
further definition of ``swap dealer,'' an SD that has applied for 
and received a limited purpose designation from the Commission will 
be subject to these regulations only for the categories or 
activities for which the limited purpose designation is granted.
---------------------------------------------------------------------------

    The Commission is not modifying the regulations to differentiate 
between SDs and MSPs. The Commission observes that no provision of 
sections 4s(f), (g), (j), and (k) of the CEA, as added by the Dodd-
Frank Act, differentiates between the duties and requirements of SDs 
and those of MSPs. The Commission thus has determined that the intent 
of sections 4s(f), (g), (j), and (k) is to apply the same requirements 
to MSPs and SDs, and the Commission is taking the same approach in the 
final regulations. The Commission believes that to the extent the final 
regulations are not applicable to an MSP's activities, the MSP is not 
burdened by being subject to the regulations.
    The Commission has considered but rejected a substituted compliance 
regime with respect to the final rule for registrants subject to 
regulation by a prudential regulator. The Commission notes that section 
4s(e) of the CEA grants prudential regulators exclusive authority to 
prescribe capital and margin requirements for SDs and MSPs that are 
banks, but does not extend such authority to any other part of section 
4s. Because SDs and MSPs will be registrants of the Commission, the 
Commission has determined that its interest in ensuring that all 
registrants are subject to consistent regulation outweighs any burden 
that may be placed on registrants that are subject to regulation by a 
prudential regulator. However, the Commission observes that many of its 
final regulations are modeled on prudential regulations and 
supervision. Thus the two regimes would be broadly consistent.

B. Reporting, Recordkeeping, and Daily Trading Records Requirements for 
SDs and MSPs

    As added by section 731 of the Dodd-Frank Act, sections 4s(f) and 
4s(g) of the CEA established reporting and recordkeeping requirements 
and daily trading records requirements for SDs and MSPs.
    Section 4s(f)(1) requires SDs and MSPs to ``make such reports as 
are required by the Commission by rule or regulation regarding the 
transactions and positions and financial condition of the registered 
swap dealer or major swap participant.'' In the Recordkeeping NPRM, the 
Commission proposed regulations, pursuant to sections 4s(f)(1)(B)(i) 
and (ii) of the CEA, prescribing the books and records requirements of 
``all activities related to the business of swap dealers or major swap 
participants,'' regardless of whether or not the entity has a 
prudential regulator.
    In addition, the Commission proposed regulations in the 
Recordkeeping NPRM pursuant to section 4s(g)(1) of the CEA, requiring 
that SDs and MSPs ``maintain daily trading records of the swaps of the 
registered swap dealer and major swap participant and all related 
records (including related cash and forward transactions) and recorded

[[Page 20130]]

communications, including electronic mail, instant messages, and 
recordings of telephone calls.'' The Commission notes that section 
4s(g)(3) requires that daily trading records for each swap transaction 
be identifiable by counterparty, and section 4s(g)(4) specifies that 
SDs and MSPs maintain a ``complete audit trail for conducting 
comprehensive and accurate trade reconstructions.'' The Commission 
received 14 comment letters in response to the Recordkeeping NPRM and 
considered each in formulating the final rules.

C. General Records Requirement--Sec.  23.201

    Proposed Sec.  23.201 set forth the records that SDs and MSPs must 
maintain. The records required under the proposed rule included full 
and complete swap transaction information, including all documents on 
which swap information is originally recorded.
1. Additional Types of Records To Be Retained
    In the Recordkeeping NPRM, the Commission requested comments 
regarding whether additional types of records other than those 
specified in the proposed rules should be required to be kept by SDs 
and MSPs. The Commission also requested comment regarding whether 
drafts of documents should be kept.
    The Working Group of Commercial Energy Firms (The Working Group) 
commented that the current proposal is sufficient and any additional 
record retention requirements would be of little value to the 
Commission. Chris Barnard, however, recommended that drafts of 
documents should also be kept, arguing that the decision process 
leading up to a final document can be very informative. In order to 
regulate the use of high-frequency and algorithmic trading strategies, 
Better Markets, Inc. (Better Markets) recommended that the Commission 
require SDs and MSPs that employ high-frequency and algorithmic trading 
strategies to maintain records of each strategy employed including a 
description of the strategy and its objectives and the algorithms 
employed, and to maintain a record of every order, cancellation, and 
trade that occurs in the implementation of each strategy, indexed to 
the electronic record of the strategy description and properly time 
stamped.
    Having considered these comments and the comments discussed below 
regarding specific recordkeeping requirements, the Commission has 
determined that the record retention requirements as proposed are 
sufficient and has not included any additional requirements in the 
final rules. With respect to Better Markets' comment, the Commission 
notes that pursuant to Sec.  23.600(d)(9), as adopted in this release 
and discussed further below, SDs and MSPs are required to ensure that 
use of trading programs is subject to policies and procedures governing 
their use, supervision, maintenance, testing, and inspection, and that 
such policies and procedures are subject to a recordkeeping requirement 
pursuant to Sec.  23.600(g).
2. Reliance on Records of Swap Data Repositories
    The proposed regulations did not address whether an SD or MSP may 
rely on reporting a swap to a swap data repository (SDR) as a means of 
meeting their recordkeeping requirements. Proposed Sec.  23.203(b)(2) 
required records of any swap to be kept for the life of the swap and 
for a period of five years following the termination, maturity, 
expiration, transfer, assignment, or novation date of the swap.
    The International Swaps and Derivatives Association (ISDA) and 
SIFMA (together, ISDA & SIFMA) requested that the Commission clarify 
the extent to which SDs and MSPs may rely upon SDRs to retain records 
beyond the time periods that registrants currently retain such records. 
ISDA & SIFMA did not elaborate on the current retention periods for 
swaps records, nor did they explain how this approach would work in the 
absence of established SDRs for all types of swaps.
    At this time, the Commission has determined not to permit SDs and 
MSPs to rely solely on SDRs to meet their recordkeeping obligations 
under the rules. The Commission believes that reliance on SDRs may be a 
cost-efficient alternative in the future, but such reliance would be 
premature at the present time. Additionally, the Commission believes 
that SDs and MSPs must maintain complete records of their swaps for the 
purposes of risk management. The data that is required to be reported 
to an SDR may not be sufficient for these purposes.
3. Transaction Records Maintained in a Form and Manner Identifiable and 
Searchable by Transaction and Counterparty--Sec. Sec.  23.201(a)(1), 
23.202(a), and 23.202(b)
    Proposed Sec.  23.201(a)(1) required SDs and MSPs to keep 
transaction records in a form identifiable and searchable by 
transaction and by counterparty. Proposed Sec. Sec.  23.202(a) and 
23.202(b) also required SDs and MSPs to keep daily trading records for 
each swap and any related cash or forward transaction as a separate 
electronic file identifiable and searchable by transaction and 
counterparty.
    ISDA & SIFMA recommended that the decision whether to maintain each 
transaction record as a separate electronic file be left to the 
reporting counterparties. ISDA & SIFMA argued that SDs and MSPs 
routinely store data across a number of systems, and that aggregating 
transaction data from all systems into a single electronic file would 
require enormous investment across market participants and would 
require a substantial implementation period.
    The Working Group argued that tying records of unfilled or 
cancelled orders, correspondence (e.g., voice records, email, and 
instant messages), journals, memoranda, and other records required by 
proposed Sec.  23.201(a)(1) to each individual transaction in a manner 
that is identifiable and searchable by transaction would create an 
enormous technical burden, likely requiring the review, sorting, and 
assignment of such data to each transaction manually by individual 
employees. The Working Group recommended therefore that the Commission 
allow SDs and MSPs to maintain records of the required information in 
the form and manner currently employed by such firms, not in a single 
comprehensive file, if such records would be readily accessible and 
could be provided to the Commission within a reasonable amount of time 
following a request.
    The Commission agrees with the comments, in part, and is modifying 
the proposed rules to remove the provision in Sec.  23.202(a) and Sec.  
23.202(b) that requires each transaction record to be maintained as a 
separate electronic file. The Commission believes that this 
modification will make the requirement less burdensome for SDs and MSPs 
because it will allow such registrants to maintain searchable databases 
of the required records without the added cost and time needed to 
compile records into individual electronic files. The Commission notes 
that the rule, as modified, does not require the raw data in such 
databases to be tagged with transaction and counterparty identifiers so 
long as the SD or MSP can readily access and identify records 
pertaining to a transaction or counterparty by running a search on the 
raw data. In response to The Working Group's comments, the Commission 
confirms that swap records can be maintained under current market 
practice so long as the records are readily accessible, are 
identifiable and searchable by transaction and counterparty, and 
otherwise meet the

[[Page 20131]]

requirements of Sec.  1.31, as required under Sec.  23.203.
    However, the Commission observes that section 4s(g)(3) of the CEA 
requires registrants to ``maintain daily trading records for each 
counterparty in a manner and form that is identifiable with each swap 
transaction.'' In accordance with this statutory provision, the rules 
clarify that such trading records should be searchable by transaction 
and by counterparty. Maintaining records in this manner may prove 
costly for some SDs and MSPs, but this approach is required by statute 
and necessary for accurate audit trail construction, which is paramount 
for successful enforcement of trade practice cases.
4. Business Records--Sec.  23.201(b)
    As proposed, Sec.  23.201(b) required SDs and MSPs to keep full, 
complete, and systematic business records, including records related to 
corporate governance, financial records, complaints, and marketing and 
sales materials.
    The Working Group acknowledged that market participants presently 
retain records that would qualify as business records under the 
proposal, although not in a single comprehensive file. The Working 
Group recommended that the Commission permit these records to be 
retained as they currently are in the normal course of business, as 
long as such records can be readily accessed and provided to the 
Commission upon request. For example, many entities retain financial 
records within their accounting departments, while marketing and sales 
materials would be retained separately within another division. The 
Working Group also recommended that the Commission clarify that when a 
subsidiary is determined to be an SD or MSP, but its parent company is 
not, business records should only be required to be retained for the 
subsidiary.
    In response to The Working Group's comments, the Commission 
confirms that the rule does not require SDs and MSPs to keep the 
required business records in a single comprehensive file. So long as 
SDs and MSPs are keeping full, complete, and systematic business 
records that are available for inspection or disclosure, the 
requirements of Sec.  23.201(b) would be met. The Commission also notes 
that the rule applies only to registered SDs and MSPs, and, therefore, 
the rules would not apply to the parent company of a registrant unless 
the parent company is also an SD or MSP.
5. Records of Complaints Received--Sec.  23.201(b)
    Proposed Sec.  23.201(b) required SDs and MSPs to retain a record 
of complaints received, certain identifying information about the 
complainant, and a record of the disposition of the complaint.
    MFA commented that the requirement to retain a record of complaints 
is inappropriate for MSPs because, except in the event such entities 
are registered as commodity trading advisors or commodity pool 
operators: (a) Entities that may be classified as MSPs would not be 
members of NFA or similar organizations; and (b) the filing of such 
complaints against entities that may be classified as MSPs is neither 
customary nor consistent with such entities' activities in the market.
    Having considered MFA's comment, the Commission is adopting the 
rule as proposed. MSPs are, by definition, market participants that 
have a substantial position in swaps, that have outstanding swaps that 
create substantial counterparty exposure that could have serious 
adverse effects on the financial stability of the U.S. financial 
markets, or that are highly leveraged. Consequently, the Commission 
believes it is possible that a record of complaints, or a pattern of 
complaints, made against an MSP could be of regulatory value to the 
Commission. The Commission also notes that pursuant to the Commission's 
MSP registration rule, each MSP registered with the Commission is also 
required to be a member of at least one registered self-regulatory 
organization (SRO).\7\
---------------------------------------------------------------------------

    \7\ See 17 CFR 170.16 Registration of Swap Dealers and Major 
Swap Participants, 77 FR 2613 (Jan. 19, 2012) (stating ``Each person 
registered as a swap dealer or a major swap participant must become 
and remain a member of at least one futures association that is 
registered under section 17 of the Act and that provides for the 
membership therein of such swap dealer or major swap participant, as 
the case may be, unless no such futures association is so 
registered.''), available at www.cftc.gov.
---------------------------------------------------------------------------

6. Records of Marketing and Sales Materials--Sec.  23.201(b)(4)
    Proposed Sec.  23.201(b)(4) required SDs and MSPs to retain copies 
of all marketing and sales presentations, advertisements, literature, 
and communications, and a record of the SD's or MSP's compliance with 
applicable Federal requirements, Commission regulations, and the rules 
of any SRO related to marketing and sales materials.
    MFA commented that because MSPs are not market makers, they do not 
produce such materials for public dissemination. Therefore, MFA felt 
that the concerns about SD marketing and sales materials that 
necessitate the SDs' recordkeeping requirement are inapplicable to 
MSPs.
    The Commission has decided not to remove MSPs from the relevant 
provisions of the rule because MSPs would need to comply with the 
recordkeeping requirement only to the extent that they produce such 
materials. To the extent that an MSP does not produce marketing or 
sales materials, the requirements of the rule would be inapplicable.
7. Records of Date and Time of Reports To Swap Data Repositories and 
Data Reported in Real-Time--Sec.  23.201(c) and Sec.  23.201(d)
    Proposed Sec.  23.201(c) required SDs and MSPs to retain a record 
of the date and time the SD or MSP reported data or information to SDRs 
under proposed Part 45. Proposed Sec.  23.201(d) required SDs and MSPs 
to retain a record of the date and time the SD or MSP reported 
information for purposes of real-time public reporting under proposed 
Part 43.
    With regard to such records, The Working Group requested that the 
Commission clarify that the record of the date and time of reports to 
SDRs and for real-time public reporting be to the minute, and not to 
the second.
    The proposed rule did not specify the form of the depiction of time 
in records of reports made under parts 43 or 45, other than to say that 
the record must include the ``date and time.'' The Commission confirms 
that SDs and MSPs may record time for the purpose of Sec.  23.201 in 
their discretion, so long as they comply with any independent 
requirements under Parts 43 and 45.
8. Records of a ``Rationale'' for Certain Swap Determinations--Sec.  
23.201(d)(2) & (3)
    Proposed Sec.  23.201(d)(2) and (3) required SDs and MSPs to retain 
a record of the rationale for reporting a less specific data field than 
is required under the proposed real-time public reporting requirements 
in part 43, and a record of the rationale for determining that a swap 
is a large notional swap as required under proposed part 43.
    The Working Group requested clarification as to what the Commission 
is seeking with respect to a ``rationale'' for these scenarios. The 
Working Group questions what purpose this information would serve, or 
what benefit the Commission hopes to derive for purposes of carrying 
out its duties under the CEA.

[[Page 20132]]

    The Commission has determined that any substantive recordkeeping 
requirements necessary for compliance with Part 43 will be taken up in 
that part and thus has deleted the proposed ``rationale'' requirements 
from Sec.  23.201.

D. Daily Trading Records--Sec.  23.202

    Section 4s(g)(1) of the CEA requires that SDs and MSPs maintain 
daily trading records of their swaps and ``all related records 
(including related cash and forward transactions).'' Section 4s(g)(1) 
also requires that SDs and MSPs maintain recorded communications, 
including electronic mail, instant messages, and recordings of 
telephone calls. Section 4s(g)(2) provides that the daily trading 
records shall include such information as the Commission shall require 
by rule or regulation. Proposed Sec.  23.202 prescribed daily trading 
record requirements, which would include trade information related to 
pre-execution, execution, and post-execution data.
1. Records of Pre-Execution Trade Information--Sec.  23.202(a)(1)
    Proposed Sec.  23.202(a)(1) required SDs and MSPs to make and keep 
records of pre-execution trade information, including records of all 
oral and written communications concerning quotes, solicitations, bids, 
offers, instructions, trading, and prices that lead to the execution of 
a swap, however communicated.
    The Air Transport Association of America, Inc. (ATA) commented that 
the current telephone recording systems in use by SDs and MSPs may not 
meet all of the proposed rule's requirements, and that implementing 
telephone recording systems that are compliant with the requirements 
would impose a significant additional cost. The ATA's members 
recognized that there may be benefits from the recording requirement, 
but they are uncertain that those benefits outweigh the costs of 
purchasing new, or upgrading existing, telephone phone recording and 
retrieval systems. The ATA is concerned that the cost of complying with 
all of the various rules proposed by the Commission will erect 
unnecessarily high barriers to entry for SDs, foreclosing all but the 
largest firms from acting as SDs.
    MFA commented that it would be inappropriate to impose on MSPs the 
additional burden of maintaining a record of all oral communications 
made or received because the SDs with which MSPs enter into swaps would 
record such information. For the same reasons, MFA commented that the 
Commission should not require MSPs to create records of the date and 
time of quotations received or the date and time of execution of each 
swap and each related cash or forward transaction.
    The Working Group argued that even if technology exists to record 
the required data in a format searchable by transaction and 
counterparty, it would not be possible to identify pre-execution data 
specified by the Commission as being applicable to a specific trade 
because traders and other commercial employees typically engage in 
ongoing dialogue with counterparties over an extended period of time 
and do not initiate communications specific to a single trade. The 
Working Group commented that it would be extremely difficult and time 
consuming to review manually each communication by a specific trader to 
determine which conversations or documents ultimately led to the 
execution of a particular swap and then assign that communication to a 
unified file.
    ISDA & SIFMA asserted that where pre-execution records are 
maintained today they are captured prior to the execution of a swap and 
as such they are not linked to a trade. ISDA & SIFMA argued that while 
it may be possible potentially to search by counterparty with some 
investment in additional technology, it would not be possible to search 
by transaction because the infrastructure to link to a transaction is 
not in place today and the procedural and technical feasibility to do 
so has not been contemplated nor evaluated. ISDA & SIFMA strongly 
recommended that the Commission limit the rule to a description of data 
required as part of a trading record without dictating how such data 
should be stored and, in particular, that the Commission exclude oral 
communications from the electronic searchability requirement.
    Having considered these comments, the Commission is modifying the 
proposed rule to remove the requirement that each transaction record be 
maintained as a separate electronic file, which should be less 
burdensome for SDs and MSPs because it will allow these registrants to 
maintain searchable databases of the required records without the added 
cost and time needed to compile the required records into individual 
electronic files. The Commission notes that section 4s(g)(3) of the CEA 
requires registrants to ``maintain daily trading records for each 
counterparty in a manner and form that is identifiable with each swap 
transaction.'' The rule as adopted clarifies that such counterparty 
records must be searchable by transaction and by counterparty. 
Maintaining records in this form may prove costly for some registrants, 
but such form is mandated by the CEA.
    However, in light of commenters' concerns, the Commission is 
adopting Sec.  23.206, which delegates to the Director of the Division 
of Swap Dealer and Intermediary Oversight the authority to establish an 
alternative compliance schedule for requirements of Sec.  23.202 that 
are found to be technologically and economically impracticable for an 
SD or MSP affected by Sec.  23.202. The purpose of Sec.  23.206 is to 
facilitate the ability of the Commission to provide a technologically 
practicable compliance schedule for affected SDs or MSPs that seek to 
comply in good faith with the requirements of Sec.  23.202.
    In order to obtain relief under Sec.  23.206, an affected SD or MSP 
must submit a request for relief to the Director of the Division of 
Swap Dealer and Intermediary Oversight. SDs and MSPs submitting 
requests for relief must specify the basis in fact supporting their 
claims that compliance with Sec.  23.202 would be technologically or 
economically impracticable. Such a request may include a recitation of 
the specific costs and technical obstacles particular to the entity 
seeking relief and the efforts the entity intends to make in order to 
ensure compliance according to an alternative compliance schedule. 
Relief granted under Sec.  23.206 shall not cause a registrant to be 
out of compliance or deemed in violation of any registration 
requirements.
    Such requests for an alternative compliance schedule shall be acted 
upon by the Director of the Division of Swap Dealer and Intermediary 
Oversight or designees thereto within 30 days from the time such a 
request is received. If not acted upon within the 30 day period, such 
request will be deemed approved.
    The Commission notes that some commenters to a proposed Commission 
rulemaking to amend Sec.  1.35,\8\ which would require voice recording 
for futures and swap trading by FCMs and other registrants, raised 
questions about statements made in the preamble of the Recordkeeping 
NPRM. In that preamble, the Commission stated that proposed Sec.  
23.202 ``would not establish an affirmative new requirement to create 
recordings of all telephone conversations if the complete audit trail 
requirement can be met through other means, such as electronic 
messaging or trading.'' \9\ For avoidance of doubt, the Commission 
notes that the rule requires

[[Page 20133]]

a record of ``all oral and written communications provided or received 
concerning quotes, solicitations, bids, offers, instructions, trading, 
and prices, that lead to the execution of a swap.'' Thus, to the extent 
this pre-execution trade information does not include information 
communicated by telephone, the Commission confirms that an SD or MSP is 
under no obligation to create recordings of its telephone 
conversations. If, however, any of this pre-execution trade information 
is communicated by telephone, the SD or MSP must record such 
communications.
---------------------------------------------------------------------------

    \8\ See Comments to Adaptation of Commission Regulations to 
Accommodate Swaps, 76 FR 33066, 33088-89 (June 7, 2011), available 
on the Commission's Web site: www.cftc.gov.
    \9\ See Recordkeeping NPRM, 75 FR at 76668.
---------------------------------------------------------------------------

    With respect to MFA's comments, section 4s(g)(4) of the CEA applies 
to both SDs and MSPs. Consequently, the audit trail requirements of the 
proposed rules apply equally to both SDs and MSPs because it is 
necessary that all Commission registrants have complete and accurate 
daily trading records. Moreover, the Commission notes that MFA did not 
provide any factual support for its assertion that every swap entered 
by an MSP would have an SD as the counterparty.
2. Records of Source and Time of Quotations--Sec.  23.202(a)(1)(ii)
    Proposed Sec.  23.202(a)(1)(ii) required SDs and MSPs to make and 
keep a record of the date and time, using Coordinated Universal Time 
(UTC), by timestamp or other timing device, for each quotation provided 
to, or received from, a counterparty prior to execution of a swap.
    The Working Group argued that the Commission should not require a 
timestamp for every quote given or received, as the timestamp is 
unnecessary, overly burdensome, and would not assist in trade 
reconstruction. Further, The Working Group argued that most entities do 
not currently capture or store this information, that it would be 
difficult to do so, particularly given that quotations may be developed 
by multiple sources, and retention of the time of quotations will add 
additional compliance costs on market participants. The Working Group 
also requested clarification as to the meaning of ``reliable timing 
data for the initiation'' of a transaction.
    MFA commented that the Commission should not require MSPs to create 
records of the date and time of quotations received or the date and 
time of execution of each swap and each related cash or forward 
transaction. MFA argued that since SDs should keep such records in 
connection with their market-making activities, to require an MSP 
customer to maintain the same records would be duplicative and a 
significant and unnecessary burden on MSPs.
    Having considered these comments, the Commission is adopting the 
rule as proposed. As noted above, the Commission observes that section 
4s(g)(4) of the CEA requires both SDs and MSPs to maintain a complete 
audit trail for conducting comprehensive and accurate trade 
reconstructions. The Commission therefore believes that the audit trail 
requirements of the rule should apply to both SDs and MSPs because it 
is necessary that all Commission registrants have complete and accurate 
daily trading records. As explained above, no support has been offered 
for MFA's assertion that an SD will be the counterparty to every swap 
executed with an MSP. Additionally, a comprehensive and accurate trade 
reconstruction necessarily entails a reconstruction of the sequence of 
events leading up to a trade and that this sequence cannot be 
reconstructed accurately without reliable timing information. It is 
noteworthy that commenters were unable to provide any alternative to 
the timestamp requirement. Therefore, the Commission is retaining the 
timestamp requirement in the final rule.
    With respect to The Working Group's concern regarding the 
``reliable timing data'' requirement, the Commission confirms that the 
form of ``reliable timing data'' could be a timestamp, but the exact 
form is left to the discretion of the registrant.
3. Timestamp for Quotations Using Universal Coordinated Time (UTC)--
Sec.  23.202(a)(1)(ii)
    The proposed regulation required SDs and MSPs to record the time of 
each quotation provided to or received from a counterparty prior to 
execution using Universal Coordinated Time.
    ISDA & SIFMA commented that the value derived by moving the 
industry to UTC appears minimal when compared to the costs involved. 
ISDA & SIFMA provided the Commission with no quantitative data 
regarding these purported additional costs.
    Having considered ISDA & SIFMA's comment, the Commission is 
adopting the rule as proposed. The use of UTC in the rule reflects a 
consistent approach taken by the Commission in this rule and the 
Commission's final rules for real-time public reporting \10\ and the 
swap data reporting rule.\11\ By requiring the use of UTC in Sec.  
23.202, the Commission is ensuring that the requirements of Part 23, 
Part 43, and Part 45 remain consistent to the extent possible.
---------------------------------------------------------------------------

    \10\ See Real-Time Public Reporting of Swap Transaction Data, 77 
FR 1182, 1251 (Jan. 9, 2012).
    \11\ See Swap Data Recordkeeping and Reporting Requirements, 77 
FR 2136, 2212 (Jan. 13, 2012).
---------------------------------------------------------------------------

4. Records of Time of Execution--Sec.  23.202(a)(2)(iv)
    Proposed Sec.  23.202(a)(2)(iv) required SDs and MSPs to record the 
date and time of execution of each swap to the nearest minute.
    The Working Group argued that the proposed rule conflicts with both 
the proposed real-time reporting rule and proposed swap data 
recordkeeping and reporting rule, which required that the time of 
execution be displayed to the second, rather than minute. The Working 
Group requested that the Commission be consistent in all of the its 
recordkeeping and reporting rules, and further requested that the 
Commission adopt a minute requirement, rather than displaying to the 
second.
    The Commission is adopting the rule as proposed. The Commission 
notes that the ``nearest minute'' standard is the standard for futures 
orders under existing Sec.  1.35. The Commission also notes that the 
final swap data recordkeeping and reporting rule does not require the 
time of execution be displayed to the second.\12\ While the proposed 
real-time reporting rule would require a registrant to record the time 
of execution to the second in some instances, the Commission believes 
recordkeeping to the nearest minute is sufficient for purposes of 
maintaining daily trading records and is consistent with Sec.  1.35.
---------------------------------------------------------------------------

    \12\ See Swap Data Recordkeeping and Reporting Requirements, 77 
FR 2136, 2212, 2215 (Jan. 13, 2012).
---------------------------------------------------------------------------

5. Records of Reconciliation Processes--Sec.  23.202(a)(3)(iii)
    Proposed Sec.  23.202(a)(3)(iii) required SDs and MSPs to keep 
records of portfolio reconciliation results, categorized by transaction 
and counterparty.
    ISDA & SIFMA commented that maintaining records of reconciliation 
processes by transaction and counterparty may be particularly 
problematic because this data is not required to be captured in other 
markets, such as securities or bond markets, and significant additional 
infrastructure development would thus be required before this data 
could be captured and stored. ISDA & SIFMA recommended an ongoing 
dialogue between the Commission and the industry to understand the 
requirements for systems needed to meet the

[[Page 20134]]

requirements of the proposed rule, in particular the degree to which 
retained data will need to be identifiable and searchable.
    The records of portfolio reconciliation results required under the 
rule are the minimum needed to monitor an SD's or MSP's compliance with 
the Commission's proposed Sec.  23.502 on portfolio reconciliation.\13\ 
Thus, the Commission is adopting the rule as proposed.
---------------------------------------------------------------------------

    \13\ See Confirmation, Portfolio Reconciliation, and Portfolio 
Compression Requirements for Swap Dealers and Major Swap 
Participants, 75 FR 81519, 81531 (Dec. 28, 2010).
---------------------------------------------------------------------------

6. Daily Trading Records for Cash and Forward Transactions Related to a 
Swap--Sec.  23.202(b)
    Proposed Sec.  23.202(b) required SDs and MSPs to keep daily 
trading records, similar to those SDs and MSPs are required to keep for 
swaps, for related cash and forward transactions, defined under 
proposed Sec.  23.200 as ``a purchase or sale for immediate or deferred 
physical shipment or delivery of an asset related to a swap where the 
swap and the related cash or forward transaction are used to hedge, 
mitigate the risk of, or offset one another.''
    The Working Group urged the Commission to recognize that, although 
participants in physical energy commodity markets use swaps and futures 
to hedge underlying physical positions, they do not, as a general 
matter, execute such transactions specifically for the purpose of 
hedging a specified underlying physical position. Rather, according to 
The Working Group, the predominant practice in physical energy markets 
is to hedge underlying physical positions on a portfolio or aggregate 
basis. Given the wide use of portfolio hedging in energy markets, The 
Working Group believes it would be difficult for energy market 
participants to link physical positions with arguably ``related'' swap 
transactions. The Working Group believes that compliance with proposed 
Sec.  23.202(b) would impose a large number of very expensive and 
burdensome requirements on millions of physical transactions that are 
undertaken by commercial energy firms that are also parties to swap 
transactions.
    ISDA & SIFMA commented that hedging and risk mitigation activities 
referred to in the proposed daily trading records rule are typically 
not executed with respect to specific trades; rather they are executed 
against the overall positions of business units such as trading desks 
and that it would not be possible to link cash and forward transactions 
to a specific swap. ISDA & SIFMA also commented that the reference to 
``hedge'' also requires clarity to know the extent to which it comports 
with existing definitions in the CEA.
    Having considered these comments, the Commission is adopting the 
rule as proposed. The Commission notes that section 4s(g)(1) of the CEA 
requires registrants to ``maintain daily trading records of their swaps 
* * * and related records (including related cash and forward 
transactions) * * *.'' Rule Sec.  23.200 defines ``related cash and 
forward transactions'' as ``a purchase or sale for immediate or 
deferred physical shipment or delivery of an asset related to a swap 
where the swap and the related cash and forward transaction are used to 
hedge, mitigate the risk of, or offset one another.'' The Commission 
observes that the definition requires that a ``related cash and forward 
transaction'' be related to at least one swap, but does not prohibit 
such transaction from being related to more than one swap, or a swap 
from being related to more than one related cash or forward 
transaction. Therefore, the Commission believes the commenters' 
concerns that compliance with the rule is not possible in the context 
of portfolio hedging is misplaced. In addition, in response to the 
comments received, the Commission confirms that this definition is used 
solely for purposes of SD and MSP recordkeeping and is not intended to 
define hedging transactions for any other purpose or any other 
Commission regulation.

E. Records; Retention and Inspection--Sec.  23.203

1. Swap and Related Cash or Forward Record Retention Period--Sec.  
23.203(b)(2)
    Proposed Sec.  23.203(b)(2) required SDs and MSPs to retain records 
of any swap or related cash or forward transaction until the 
termination or maturity of the transaction and for a period of five 
years after such date.
    MFA commented that the vast majority of its members do not 
currently keep records of transactions for five years following the 
termination, expiration, or maturity of the transactions and compliance 
with this rule would be burdensome and costly. MFA recommended that the 
Commission not impose this record retention requirement on MSPs.
    The Working Group argued that the long-term electronic storage of 
significant amounts of pre-execution communications will prove costly 
over the proposed five-year period. The Working Group recommended that 
the Commission re-evaluate whether all records subject to the proposed 
rule's retention requirements require a five year retention period.
    ISDA & SIFMA recommended that further analysis and consultation be 
performed on the costs and benefits of holding records of all oral and 
written communications that lead to execution of a swap for the life of 
a swap plus five years. ISDA & SIFMA commented that they would be 
supportive of a voice recording obligation aligned to the rules of the 
UK Financial Services Authority, which are to retain recordings for a 
minimum period of six months.
    By contrast, Chris Barnard recommended that records should be 
required to be kept indefinitely rather than the general five years 
under the proposal.
    Having considered these comments, the Commission notes that 
proposed revisions to Commission regulation Sec.  1.31 require 
retention of swap transaction records for a period of five years 
following the termination, expiration, or maturity of a swap,\14\ and 
that Sec.  23.203 is consistent with retention requirements under the 
final swap data reporting rule.\15\ However, in response to commenters' 
concerns regarding retention of pre-execution trade information, the 
Commission is revising the rule to require that voice recordings need 
be kept for only one year. The Commission believes that the one-year 
retention period for voice recordings will enable the Commission to 
execute its enforcement responsibilities under the CEA adequately while 
minimizing the costs imposed on SDs and MSPs.
---------------------------------------------------------------------------

    \14\ See Adaptation of Commission Regulations to Accommodate 
Swaps, 76 FR 33066, 33088 (June 7, 2011).
    \15\ See 17 CFR 45.2, Swap Data Recordkeeping and Reporting 
Requirements, 77 FR 2136, 2198 (Jan. 13, 2012).
---------------------------------------------------------------------------

2. ``Readily Accessible''--Sec.  23.203(b)(1) and (b)(2)
    The proposed regulation required SDs and MSPs to have both general 
records and swaps and related cash or forward transaction records 
readily accessible for the first two years of the applicable retention 
period.
    The Working Group recommended that the Commission clarify whether 
the requirement that retained records be ``readily accessible'' means 
readily accessible by the registrant or by the Commission.
    In response, the Commission observes that the term ``readily 
accessible'' has been the operative standard in Sec.  1.31 of the 
Commission's regulations for several years. Specifically, Sec.  1.31 
requires that

[[Page 20135]]

``[a]ll books and records required to be kept by the Act or by these 
regulations shall be kept for a period of five years from the date 
thereof and shall be readily accessible during the first 2 years of the 
5-year period.'' In response to The Working Group's request for 
clarification, the Commission expects a registrant to be able to access 
such records promptly, and such records ``shall be open to inspection 
by any representative of the Commission or the United States Department 
of Justice.'' \16\
---------------------------------------------------------------------------

    \16\ Regulation 1.31 further provides that ``[a]ll such books 
and records shall be open to inspection by any representative of the 
Commission or the United States Department of Justice.''
---------------------------------------------------------------------------

3. Records To Be Retained in Accordance With Commission Regulation 
1.31--Sec.  23.203(b)
    Proposed Sec.  23.203(b) required SDs and MSPs to maintain records 
in accordance with existing Sec.  1.31.
    The Working Group commented that Sec.  1.31 appears to apply to 
written documents, including electronic images of such documents, and 
does not seem suitable for electronic records such as those in a 
trading system, that do not originate from a written document. To be 
made workable for purposes of complying with the Commission's proposed 
requirements, The Working Group recommended that Sec.  1.31 be revised 
to reflect current technologies and industry practices relating to 
digitized data storage.
    The Commission has considered The Working Group's comment, but is 
adopting the rule as proposed. The Commission believes that The Working 
Group's concerns about Sec.  1.31 have been addressed by a subsequent 
rule proposal to amend Sec.  1.31 to reflect current technologies and 
industry practices related to digitized data storage.\17\ If these 
amendments are finalized, the Commission believes that Sec.  1.31 will 
be compatible with electronic records in a trading system and other 
records that do not originate from a written document.
---------------------------------------------------------------------------

    \17\ See Adaptation of Commission Regulations to Accommodate 
Swaps, 76 FR 33066, 33088 (June 7, 2011).
---------------------------------------------------------------------------

F. Duties of SDs and MSPs

    As part of an overall business conduct regime for SDs and MSPs, 
section 4s(j) of the CEA, as added by section 731 of the Dodd-Frank 
Act, sets forth certain duties for SDs and MSPs, including the duty to: 
(1) Monitor trading to prevent violations of applicable position 
limits; (2) establish risk management procedures adequate for managing 
the day-to-day business of the SD or MSP; (3) disclose to the 
Commission and to applicable prudential regulators \18\ general 
information relating to swaps trading, practices, and financial 
integrity; (4) establish and enforce internal systems and procedures to 
obtain information needed to perform all of the duties prescribed by 
Commission regulations; (5) implement conflict-of-interest systems and 
procedures; and (6) refrain from taking any action that would result in 
an unreasonable restraint of trade or impose a material anticompetitive 
burden on trading or clearing. In its Duties NPRM, the Commission 
proposed six regulations to implement section 4s(j), specifically 
addressing risk management, monitoring of positions limits, diligent 
supervision, business continuity and disaster recovery, the 
availability of general information, and antitrust considerations. The 
Commission's proposed conflicts of interest policies and procedures 
were the subject of the separate SD/MSP Conflicts NPRM and are 
discussed below. The Commission received 20 comment letters in response 
to the Duties NPRM and considered each in formulating the final rules.
---------------------------------------------------------------------------

    \18\ This term is defined for the purposes of this rulemaking 
and has the same meaning as section 1(a)(39) of the CEA, which 
includes 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 Association, and the Federal 
Housing Finance Agency.
---------------------------------------------------------------------------

G. Risk Management Program for SDs and MSPs--Sec.  23.600

    The Commission proposed Sec.  23.600, which required SDs and MSPs 
to establish and maintain a risk management program reasonably designed 
to monitor and manage the risks associated with their business as an SD 
or MSP. Proposed Sec.  23.600 specifically required the risk management 
program established by SDs and MSPs to consist of written policies and 
procedures; to have its risk management policies and procedures 
approved by the governing body of the SD or MSP; and to establish a 
risk management unit independent from the business trading unit to 
administer the risk management program.
1. Definitions--Sec.  23.600(a)
    The Commission proposed definitions of ``affiliate,'' ``business 
trading unit,'' ``clearing unit,'' ``governing body,'' ``prudential 
regulator,'' and ``senior management.'' \19\ The definitions set forth 
in Sec.  23.600(a) will apply only to provisions contained in Sec.  
23.600. The Commission is adopting the definitions largely as proposed, 
with the exceptions discussed below.
---------------------------------------------------------------------------

    \19\ No comments were received on the proposed Sec.  23.600(a) 
definitions of ``affiliate,'' ``clearing unit,'' or ``prudential 
regulator.'' With the exception of one change to the definition of 
``prudential regulator'', the Commission has decided to adopt those 
definitions as proposed.
---------------------------------------------------------------------------

a. Business Trading Unit--Sec.  23.600(a)(2)
    SIFMA recommended that (i) the Commission modify the definition of 
``business trading unit'' to delete the phrase ``or is involved in'' 
and replace it with ``directly engaged in'' to avoid inclusion of risk 
management, legal, credit, and operations personnel, all of whom could 
be deemed to be ``involved in'' business trading unit activities; and 
(ii) the Commission clarify that independent financial control 
functions that perform price verification for internal purposes (as 
opposed to providing prices to clients) are excluded from the business 
trading unit.
    The Commission did not intend to include risk management, legal, 
credit, and operations personnel in the definition and has revised the 
definition to exclude such personnel. However, the Commission does not 
believe that only those personnel ``directly engaged in'' pricing, 
trading, sales, marketing, advertising, solicitation, structuring, or 
brokerage activities sufficiently captures those personnel intended to 
be included by the definition for purposes of the rule. Thus, the 
Commission is modifying the proposed definition to exclude risk 
management, legal, credit, and operations personnel, but also to 
include specifically personnel exercising direct supervisory authority 
over the performance of business trading unit functions. Per SIFMA's 
recommendation, the Commission also has modified the definition to 
exclude price verification for risk management purposes from the list 
of business trading unit functions. The Commission believes that the 
definition as revised will be less burdensome for registrants, but 
retains the original intent of the definition.
b. Governing Body and Senior Management--Sec.  23.600(a)(3) and (4)
    Cargill recommended that the Commission expand the definitions of 
governing body and senior management to include the governing body or 
senior management of the division of a larger company. Cargill, SIFMA, 
and MetLife also recommended that the Commission permit a management 
committee or board committee to serve the function of a governing body. 
SIFMA further requested that the Commission confirm that governing body 
and senior management approvals required under the proposed rules may 
occur at the holding company level.

[[Page 20136]]

    SIFMA recommended that the Commission not limit the definition of 
``senior management'' to direct reports of the chief executive officer, 
but include any other officer having supervisory or management 
responsibility (including at the consolidated group level) for any 
organizational unit, department or division. BG Americas & Global LNG 
(BGA) argued that the requirement that the risk management unit report 
directly to a senior officer that reports directly to the CEO is too 
rigid and does not reflect the reality of most energy trading 
companies.
    In response to commenters, the Commission is modifying the proposed 
definition of ``governing body'' to allow an SD or MSP to designate as 
its governing body ``(1) a board of directors; (2) a body performing a 
function similar to a board of directors; (3) any committee of a board 
or body; or (4) the chief executive officer of a registrant, or any 
such board, body, committee or officer of a division of a registrant, 
provided that the registrant's swaps activities for which registration 
with the Commission is required are wholly contained in a separately 
identifiable division.'' The Commission believes that under this 
definition the governing body of an SD or MSP could include a board 
committee or the governing body or senior management of a division, 
provided that the swaps activities of an SD or MSP are wholly contained 
in a separately identifiable division.
    Likewise, in response to commenters, the Commission is modifying 
the proposed definition of ``senior management'' to provide increased 
flexibility in registrant governance structures. The Commission is 
revising the proposed definition to require only that senior management 
consist of officers of the SD or MSP that have been ``specifically 
granted the authority and responsibility by the registrant's governing 
body to fulfill the requirements of senior management.''
    The Commission believes that the increased flexibility permitted by 
the revised definitions of ``governing body'' and ``senior management'' 
will be less burdensome for SDs and MSPs, but retains the Commission's 
intent to have accountability at the highest level of management.
2. Scope of Risk Management Program--Sec.  23.600(b)
    The proposed regulations required SDs and MSPs to establish, 
document, maintain, and enforce a system of risk management policies 
and procedures designed to monitor and manage the risks associated with 
the business of the SD or MSP and the Risk Management Program to take 
into account risks posed by affiliates and take an integrated approach 
to risk management at the consolidated entity level.
    The Working Group, MetLife, and the Office of the Comptroller of 
the Currency argued that Sec.  23.600 should be limited to the risks 
associated with swaps activities, and not other business lines in which 
the SD or MSP may engage. The Working Group also recommended that the 
rule be revised to require the risk management program to take into 
account only swaps-related risks posed by affiliates and take an 
integrated approach to risk management at the consolidated entity level 
to the extent the SD or MSP deems necessary to enable effective risk 
and compliance oversight.
    Based on these comments, the Commission has determined that the 
risk management rules will be limited in scope to apply only to the 
swaps activities of SDs and MSPs and is modifying proposed Sec.  
23.600(b)(1) as recommended by The Working Group.
    On the other hand, the Commission has rejected The Working Group's 
recommendation that SDs and MSPs consider only swaps-related risks 
posed by affiliates. The Commission believes that an SD or MSP should 
be aware of all risks posed by affiliates, and the rule should require 
the SD's or MSP's Risk Management Program to be integrated into overall 
risk management considerations at the consolidated entity level. 
However, the Commission is modifying proposed Sec.  23.600(c)(1)(ii) to 
reflect the fact that Risk Management Programs within an SD or MSP may 
not have the authority to direct other divisions of a larger company.
    Further, the Commission recognizes that some SDs and MSPs will be 
part of a larger holding company structure that may include affiliates 
that are engaged in a wide array of business activities. The Commission 
understands with respect to these entities, that in some instances, the 
top level company in the holding company structure is in the best 
position to evaluate the risks that an affiliate of an SD or MSP may 
pose to the enterprise, as it has the benefit of an organization-wide 
view and because an affiliate's business may be wholly unrelated to 
swaps activities. Therefore, to the extent an SD or MSP is part of a 
holding company with an integrated risk management program, the SD or 
MSP may address affiliate risks and comply with Sec.  23.600(c)(1)(ii) 
through its participation in a consolidated entity risk management 
program.
3. Flexibility To Design Risk Management Program--Sec.  23.600(b)
    The proposed regulation required a registrant's risk management 
program to include certain enumerated elements: identification of risks 
and risk tolerance limits; periodic risk exposure reports; a new 
product policy; policies and procedures to monitor and manage market 
risk, credit risk, liquidity risk, foreign currency risk, legal risk, 
operational risk, and settlement risk; use of central counterparties; 
compliance with margin and capital requirements; and monitoring of 
compliance with risk management program.
    The Working Group and the Edison Electric Institute (EEI) commented 
that proposed Sec.  23.600 requires a level of detail in the Risk 
Management Program not provided for in the Dodd-Frank Act, and 
recommended that the final rules be flexible enough to allow firms to 
adapt their existing compliance and risk management measures, and not 
cause firms to add entirely new compliance or risk management 
infrastructure.
    Having considered these comments, the Commission is adopting the 
rule substantially as proposed. The Commission believes that the 
requirements of the rules represent prudent risk management practices, 
but do not prescribe rigid organizational structures. The Commission 
also believes the ``policies and procedures'' approach provides an 
adequate amount of flexibility that will allow registrants to rely upon 
any existing compliance or risk management capabilities to meet the 
requirements of the proposed rules. The Commission further believes 
that nothing would prevent firms from relying upon existing compliance 
and risk management programs to a significant degree.
4. Risk Management Policies and Procedures--Sec.  23.600(b)(2)
    Proposed Sec.  23.600(b)(2) required that a registrant's risk 
management program be described in written policies and procedures, 
that such policies and procedures be approved in writing by the 
registrant's governing body, and that such policies and procedures be 
provided to the Commission upon registration and following any material 
change.
    SIFMA recommended that the Commission clarify that written risk 
management policies and procedures need not be documented in a single, 
consolidated set, so long as such policies and procedures address all 
of the elements of the risk management program required by the proposed 
rules. Cargill commented that registrants

[[Page 20137]]

should not be required to furnish risk management policies and 
procedures to the Commission, as such policies and reports can be 
obtained by the Commission by special call or reviewed during 
examinations. By way of contrast, Chris Barnard recommended that the 
Commission expand the reporting requirement to include public 
disclosure to allow for market participants to assess a registrant's 
approach to risk management and increase confidence in the swap 
markets.
    In response to SIFMA's and Cargill's comments, the Commission is 
modifying the proposed rule to provide that an SD's or MSP's written 
policies and procedures must be provided upon application for 
registration to the Commission, or to a futures association registered 
under section 17 of the CEA, if directed by the Commission, but 
thereafter only upon request of the Commission. Additionally, the 
Commission confirms that, so long as the required policies and 
procedures are maintained in a reasonably useable and accessible 
fashion, the rule is not intended to mandate the form or manner of 
documentation or retention.
    With respect to Mr. Barnard's recommendation, the Commission is not 
adopting a public disclosure requirement because registrants' risk 
management policies and procedures may contain sensitive or proprietary 
information.
5. Risk Management Unit--Sec.  23.600(b)(5)
    Proposed Sec.  23.600(b)(5) required SDs and MSPs to establish a 
risk management unit that reports directly to senior management, that 
is independent from the business trading unit, and that has sufficient 
authority and resources to carry out the risk management program 
required by the proposed regulations.
    SIFMA recommended that the Commission clarify that different risk 
management processes may be managed by independent control functions, 
organized by relevant discipline or specialization, and that such 
functions, so long as they comply with the independence and other 
requirements applicable to the risk management unit, need not be part 
of a single risk management unit. To facilitate a functional working 
relationship, The Working Group recommended that the Commission clarify 
that separation of the risk management unit and business trading unit 
requires only separate and independent oversight of business unit and 
risk management unit personnel, but not actual physical separation of 
such personnel.
    BGA recommends that the Commission allow the risk and trading units 
to report to a shared senior officer, as long as the senior officer 
does not participate in directing, organizing, or executing trades. 
According to BGA, this would be consistent with the Federal Energy 
Regulatory Commission's requirement for achieving independence between 
franchised public utilities and their market-regulated power sales 
affiliates, and would achieve the appropriate level of independence 
without requiring companies to overhaul their existing management 
structures.
    Better Markets commented that simply requiring Risk Management Unit 
independence is inadequate and recommends that the Commission ensure 
independence with rules similar to those proposed to ensure 
independence of research analysts in proposed Sec.  23.605, while 
Cargill requested that the Commission provide greater flexibility in 
how SDs arrange monitoring and compliance of their risk management 
program, rather than rigidly requiring complete independence from the 
business trading unit.
    Having considered these comments, the Commission is adopting the 
rule as proposed. While Sec.  23.600(b)(5) does not require a 
registrant's risk management unit to be a formal division in the 
registrant's organizational structure, the Commission expects that an 
SD or MSP will be able to identify all personnel responsible for 
required risk management activities as its ``risk management unit'' 
even if such personnel fulfill other functions in addition to their 
risk management activities. In addition, Sec.  23.600(b)(5) permits SDs 
and MSPs to establish dual reporting lines for risk management 
personnel performing functions in addition to their risk management 
duties, but the rule would not permit a member of the risk management 
unit to report to any officer in the business trading unit for any non-
risk management activity. The Commission believes that such dual 
reporting invites conflicts of interest and would violate the rule's 
risk management unit independence requirement.
    As requested by The Working Group, the Commission confirms that 
independence of the risk management unit from the business trading unit 
does not require physical separation.
    The Commission notes that per the revised definition of ``senior 
management'' discussed above, the risk management unit will not be 
required to report to an officer that reports directly to the CEO, but 
to ensure the independence of the risk management unit, the rule would 
not permit the risk management unit and business trading unit to report 
to a shared senior officer. The Commission also believes, however, that 
reporting line independence is sufficient to ensure accountability for 
the independence of the risk management unit, and, therefore, is not 
requiring firewalls of the type required in Sec.  23.605 to ensure 
research analysts are free from conflicts of interest, as proposed by 
the Better Markets comment.
6. Risk Measurement Frequency--Sec.  23.600(c)(4)
    Proposed Sec.  23.600(c)(4) required registrants to measure their 
market, credit, liquidity, and foreign currency risk daily.
    MetLife commented that the daily risk measuring required by the 
proposed rule may be excessive for some MSPs, may require substantial 
information technology and human capital investments, and recommended 
that the frequency of risk measuring should be determined by an MSP's 
risk management unit and governing body, rather than be mandated by the 
Commission.
    The Commission is adopting the rule as proposed. MSPs are, by 
definition, market participants that have a substantial position in 
swaps, and have outstanding swaps that create substantial counterparty 
exposure that could have serious adverse effects on the financial 
stability of the U.S. financial markets, or are highly leveraged. 
Therefore, the Commission believes that it is entirely appropriate to 
require such market participants to measure their market, credit, 
liquidity, and foreign currency risk at least daily.
7. Approval of Exceptions to Risk Tolerance Limits--Sec.  
23.600(c)(1)(i)
    Proposed Sec.  23.600(c)(1)(i) required that risk tolerance limits 
be approved by an SD's or MSP's senior management and governing body 
and that exceptions to such limits be approved, at a minimum, by a 
supervisor in the risk management unit.
    SIFMA recommended that, subject to aggregate risk limits 
established for the relevant trading supervisor's authority, trading 
supervisors, rather than risk management personnel, should have the 
authority to approve risk tolerance limit exceptions. SIFMA argued that 
the required quarterly risk exposure reports provided to a registrant's 
senior management and governing body are an adequate check on decision-
making by trading supervisors.

[[Page 20138]]

    In response to SIFMA's comments, the Commission is revising 
proposed Sec.  23.600(c)(1)(i) to remove the provision that requires 
risk management personnel to approve exceptions to risk tolerance 
limits. Instead, the Commission has determined that exceptions, along 
with the risk tolerance limits, must be subject to written policies and 
procedures. With this change, SDs and MSPs are free to grant discretion 
to trading supervisors to approve risk tolerance limit exceptions 
within the overall risk tolerance limits approved by the registrant's 
senior management and governing body.
8. New Product Policy--Sec.  23.600(c)(3)
    Proposed Sec.  23.600(c)(3) required SDs and MSPs to include a new 
product policy in their risk management programs. The proposed 
regulations required that such policies include an assessment of the 
risks of any new product prior to engaging in transactions and 
specifically required an assessment of potential counterparties; the 
product's economic function; pricing methodologies; legal and 
regulatory issues; market, credit, liquidity, foreign currency, 
operational, and settlement risks; product risk characteristics; and 
whether the product would alter the overall risk profile of the 
registrant.
    The Working Group recommended that the regulations require only 
that (i) before an SD or MSP offers a new product, it must conduct due 
diligence that is commensurate with the risks associated with such 
product, and (ii) the decision to offer the product be approved by 
appropriate risk management and business unit personnel. In addition, 
the Working Group suggested that the Commission provide that the 
determination as to whether a product is ``new'' should be left to the 
SD or MSP.
    SIFMA recommended that (i) the Commission clarify that a registrant 
may structure its new product approval framework so as to focus on only 
those risk elements that are deemed to be relevant to the product at 
issue, rather than rigidly following the enumerated list in Sec.  
23.600(c)(3); (ii) the Commission allow registrants to provide 
contingent or limited preliminary approval of new products at a risk 
level that would not be material to the registrant, in order to provide 
registrants with the opportunity to obtain experience with the product 
and to facilitate development of appropriate risk management processes 
for such product; and (iii) the Commission harmonize its new product 
policy rules with existing regulatory guidance in this area from 
banking regulators, the SEC, and SROs.
    In response to the commenters' suggestions, the Commission confirms 
that the list of risks in Sec.  23.600(c)(3)(ii) only need be 
considered if relevant to the new product, and the Commission is 
modifying the first sentence of the proposed rule to include the phrase 
``all relevant risks associated with the new product.''
    In response to SIFMA's recommendation, the Commission also is 
revising the proposed rule to permit SDs and MSPs to grant limited 
preliminary approval of new products (i) at a risk level that would not 
be material to the registrant, and (ii) solely for the purpose of 
facilitating development of appropriate operational and risk management 
processes for such product.
    The Commission is not making any other changes to the rule as 
proposed. The new product policy was adapted from existing banking and 
SEC guidance in this area, and the Commission believes the rule as 
proposed provides adequate guidance with respect to the factors to be 
considered in determining whether a product is ``new'' and whether the 
product presents new risks that should be addressed prior to engaging 
in any transaction involving the new product.
9. Reporting of Risk Exposure Reports to the Commission--Sec.  
23.600(c)(2)(ii)
    Proposed Sec.  23.600(c)(2)(ii) required SDs and MSPs to provide 
their senior management and governing body with quarterly Risk Exposure 
Reports detailing the registrant's risk exposure and any 
recommendations for changes to the risk management program, and copies 
of these reports were required to be furnished to the Commission within 
five business days of providing them to senior management.
    The Working Group recommended that the Commission provide a 
standard form of report for any report to be required under the 
proposed rules, and to clarify what the governing body or senior 
management is expected to do with information delivered under the 
rules. The Working Group and Cargill also recommended that Risk 
Exposure Reports should be required to be submitted to the Commission 
only upon request so as not to drain Commission resources.
    The Commission is not modifying the proposed rule to require SDs' 
and MSPs' periodic Risk Exposure Reports to be submitted to the 
Commission only upon request. As discussed below, the rule will require 
SDs and MSPs to provide these reports to their senior management and 
governing body no less than quarterly, thus the Commission believes 
that also furnishing the reports to the Commission quarterly will not 
be an additional burden.
    In response to The Working Group, the Commission has determined not 
to provide a standard, prescriptive form for the report; rather the 
form of the report is left to the discretion of the registrant.
    In response to The Working Group's request for clarification about 
what management is supposed to do with Risk Exposure Reports, the 
Commission believes these reports will serve important informational 
purposes related to the key risks associated with the registrants' 
swaps activities and help to ensure accountability at the highest 
levels for those swap activities of registrants.
10. Reporting to Senior Management and/or Governing Body--Sec.  
23.600(c)(2)(ii)
    Proposed Sec.  23.600(c)(2)(ii) required SDs and MSPs to provide 
their senior management and governing body with Risk Exposure Reports 
detailing the registrant's risk exposure, and any recommendations for 
changes to the risk management program, quarterly and upon any material 
change in the risk exposure of the registrant.
    The Working Group and Cargill each commented that Risk Exposure 
Reports should be provided to senior management and governing body 
annually. The Working Group argued that quarterly reporting would be 
too costly and burdensome, would take resources away from risk 
monitoring, and the frequency may force firms to disclose risk 
exposures before remedial steps can be taken.
    The Commission is adopting the rule as proposed. The Commission 
does not believe that provision of Risk Exposure Reports to senior 
management and the governing body of a registrant four times a year is 
overly burdensome, but rather will provide management with the 
information necessary to monitor and make adjustments to risk levels in 
a timely manner.
11. Frequency of Review, Testing, and Audit--Sec.  23.600(e)
    Proposed Sec.  23.600(e) required SDs and MSPs to review and test 
their risk management programs quarterly using internal or external 
auditors independent of the business trading unit.
    The Working Group, Cargill, and MetLife each recommended that both 
the frequency and the scope of audits of the risk management program be 
left to the discretion of the registrant, so long

[[Page 20139]]

as such audits are effective and are conducted at least annually. The 
Working Group and Cargill argued that this regime would provide the 
desired results without the unnecessary cost and administrative burden 
imposed by the proposed rules. The Working Group also recommended that 
the Commission define or clarify what ``testing'' of the Risk 
Management Program requires.
    Having considered these comments, the Commission is modifying 
proposed Sec.  23.600(e) to require only annual testing and audit of an 
SD's or MSP's Risk Management Program. The Commission has determined 
not to specify testing procedures at this time, but to leave the design 
and implementation of testing procedures to the reasonable judgment of 
each registrant.
12. Risk Categories--Sec.  23.600(c)(4)
    As proposed, Sec.  23.600(c)(4) required SD and MSP risk management 
programs to include, at a minimum, certain enumerated elements, 
including policies and procedures to monitor and manage market risk, 
credit risk, liquidity risk, foreign currency risk, legal risk, and 
operational risk.
    SIFMA recommended that the Commission clarify that so long as the 
enumerated risks in Sec.  23.600(c)(4) are systematically monitored and 
managed, the Commission does not intend to require that each enumerated 
risk be subject to distinct risk management processes.
    While the rule requires that each enumerated risk must be the 
subject of distinct risk management policies and procedures, Commission 
does not intend to mandate specific risk management processes. The 
specific methods of monitoring and managing all risks associated with 
the swaps activities of an SD or MSP are left to the discretion of the 
registrant.
13. Market Risk--Sec.  23.600(c)(4)(i)
    Proposed Sec.  23.600(c)(4)(i) required SDs and MSPs to measure 
their market risk daily, including exposure due to unique product 
characteristics, volatility of prices, basis and correlation risks, 
leverage, sensitivity of option positions, and position concentration. 
The proposed rule would require that if valuation data is derived from 
pricing models, that such models be validated by qualified, independent 
persons.
    The Working Group recommended that metrics for options, 
particularly the sensitivity for options, be required to be measured on 
a frequency less than daily, as metrics can require complex 
calculations, some of which must be done outside the trading or risk 
management system. The Working Group also recommended that the 
Commission clarify that models may be verified by independent, but 
internal, qualified persons.
    In response to The Working Group's comments, the Commission 
clarifies that, to the extent that an input for measurement of market 
risk has a reasonable degree of accuracy over a period longer than one 
day, it would be permissible for a registrant's risk management 
policies to reflect the conclusion that such an input would not need to 
be calculated daily for purposes of the daily measurement of a 
registrant's market risk. The Commission also is modifying the proposed 
rule to clarify that pricing models may be verified by qualified, 
independent internal persons.
14. General Ledger Reconciliation--Sec.  23.600(c)(4)(i)(C)
    The proposed regulations required SDs and MSPs to reconcile profits 
and losses resulting from valuations with the general ledger at least 
once each business day.
    The Working Group commented that, to the extent that transaction 
valuations are tracked daily, they ordinarily would be tracked in the 
firm's trading or risk management system, not the general ledger 
system. The Working Group recommended that consolidation to the general 
ledger only be required monthly.
    Having considered these comments, the Commission has determined 
that the rule need not require daily reconciliation to the general 
ledger in order to address the need to manage the risk of a failure to 
account properly for profits and losses. The Commission therefore is 
revising the proposed rule to require only that SDs and MSPs have 
policies and procedures to ensure ``periodic reconciliation of profits 
and losses resulting from valuations with the general ledger.''
15. Establishment of Credit Limits Prior to Trading--Sec.  23.600(d)(2)
    Proposed Sec.  23.600(d)(2) required that SDs and MSPs have 
policies and procedures requiring traders to transact only with 
counterparties for whom credit limits have been established.
    The Working Group recommended that the Commission allow discretion 
to make exceptions to the requirement that trades only be executed with 
counterparties for which credit limits have been established for 
certain limited risk transactions. Arguing that some transactions carry 
no counterparty credit risk and that some SDs and MSPs may hedge their 
counterparty credit risk, SIFMA recommended that, instead of requiring 
establishment of credit limits prior to trading, the Commission require 
only that a credit risk evaluation be made prior to trading.
    The Commission is adopting the rule as proposed. The Commission 
observes that the rule does not define ``credit limit'' and thus 
provides sufficient discretion to SDs and MSPs to implement policies 
addressing limited counterparty credit risk transactions.
16. Credit Risk Measurement--Sec.  23.600(c)(4)(ii)(A)
    Proposed Sec.  23.600(c)(4)(ii)(A) required SDs and MSPs to have 
credit risk policies and procedures providing for daily measurement of 
overall credit exposure to ensure compliance with counterparty credit 
limits.
    Better Markets argued that the Commission's proposal for rules 
relating to credit risk are inadequate insofar as they do not provide 
guidance on how credit risk is to be measured. Better Markets 
recommended that the Commission's rules relating to management of 
credit risk require measurement of credit risk using the same 
techniques employed by derivatives clearing organizations (DCOs) 
registered with the Commission. Better Markets also specifically 
recommended that the Commission require credit risk policies of SDs and 
MSPs to address (i) the risk posed by collateral triggers (like credit 
rating downgrades) that may require immediate funding under stressful 
circumstances, and (ii) the credit risk of futures commission merchants 
(FCMs) acting for the SD or MSP as its clearing member.
    Having considered Better Market's comments, the Commission is 
adopting the rule as proposed. The Commission believes it need not 
specify a credit risk measurement methodology because the adequacy of a 
registrant's individual credit risk measurement methodology will be 
assessed upon a review of a registrant's policies and procedures during 
registration or upon examination. The Commission also believes that 
credit risk to FCMs would be covered by the required monitoring and 
risk management of clearing members by DCOs and the Commission.
17. Liquidity Risk--Sec.  23.600(c)(4)(iii)(B)
    The proposed rules required SDs and MSPs to test their procedures 
for liquidating all non-cash collateral in a timely manner and without 
significant effect on price.
    SIFMA argued that firms assess the types of collateral that they 
are willing to accept based on the risk, volatility,

[[Page 20140]]

liquidity, and other characteristics of the collateral and additionally 
establish conservative haircuts for the valuation of collateral, not 
through testing by actual or simulated disposition of collateral. SIFMA 
therefore recommended that the Commission not require testing of 
liquidation procedures by simulated disposition, but only require 
policies and procedures for identifying acceptable collateral and 
establishing appropriate haircuts, taking into account reasonably 
anticipatable adverse price movements.
    The proposed rule was not intended to impose a requirement that 
registrants test collateral liquidation procedures by means of actual 
or simulated disposition. However, to clarify this matter, the 
Commission is revising the proposed rule to require policies and 
procedures that ``assess'' rather than ``test'' procedures to liquidate 
all non-cash collateral in a timely manner without significant effect 
on price.
18. Foreign Currency Risk--Sec.  23.600(c)(4)(iv)
    Proposed Sec.  23.600(c)(4) required SDs and MSPs to measure the 
amount of capital exposed to fluctuations in the value of foreign 
currency daily.
    The Working Group recommended that the Commission permit the 
frequency of measurement of capital exposed to fluctuations in the 
value of foreign currency to be left to the discretion of the firm, 
rather than mandating daily measurement.
    The Commission believes that the foreign exchange markets are fluid 
and quick moving, and, therefore, the requirement for daily measurement 
is not excessive. Accordingly, the Commission is adopting the rule as 
proposed with respect to foreign currency risk.
19. Legal Risk--Sec.  23.600(c)(4)(v)
    Proposed Sec.  23.600(c)(4)(v) required SDs' and MSPs' risk 
management policies and procedures to address determinations that 
transactions and netting arrangements entered into by the registrant 
have a sound legal basis and documentation tracking to ensure 
completeness of transaction documentation.
    SIFMA recommended that the Commission require only policies and 
procedures to identify and evaluate the legal risks arising in 
connection with the registrant's business.
    The Commission is making no changes to the rule as proposed. The 
Commission believes that the two enumerated requirements with respect 
to legal risk are of special importance with respect to trade 
processing and risk measurement, but are by no means exhaustive of the 
legal risks arising in connection with a registrant's business, all of 
which must be identified by the registrant's risk management policies 
and procedures.
20. Operational Risk--Sec.  23.600(c)(4)(vi)
    Proposed Sec.  23.600(c)(4)(vi) required SDs and MSPs to establish 
policies and procedures for managing operational risks, including 
procedures accounting for reconciliation of all operating and 
information systems.
    The Working Group and SIFMA recommended that the Commission clarify 
what is meant by ``reconciliation of operating and information 
systems,'' as information contained in systems may be reconciled, but 
systems themselves may not be.
    Chris Barnard recommended that the proposed rule be expanded and be 
more specific about the types of operational risk to be monitored and 
controlled, arguing that operational risk failures effectively allow 
other types of risk, such as credit risk and market risk to be 
excessive. Mr. Barnard also recommended that the proposed rule be 
expanded to require management for the increased risks inherent in 
using programs or models from external providers or vendors to avoid 
using ``black boxes'' without controls and review.
    The Commission agrees with commenters that data within operating 
and information systems should be reconciled, rather than the systems 
themselves. Consequently, the Commission is modifying the proposed rule 
to refer to reconciliation of data within operating and information 
systems. As modified, the Commission believes that the rule is 
sufficiently specific to enable SDs and MSPs to establish policies and 
procedures for adequately managing operational risks, and as such, the 
Commission is making no changes to the rule based on Mr. Barnard's 
comments. Nonetheless, the Commission notes that Mr. Barnard's concern 
about black boxes is addressed, in part, by the requirement to have 
policies and procedures governing the use and supervision of trading 
programs under proposed Sec.  23.600(d)(9), as discussed further below.
21. Use of Central Counterparties--Sec.  23.600(c)(5)
    Proposed Sec.  23.600(c)(5) required SDs and MSPs to establish 
policies and procedures related to central clearing of swaps, including 
policies that require the use of clearing when a swap is subject to a 
mandatory clearing determination issued by the Commission, policies 
setting forth conditions for the voluntary use of central clearing as a 
means of mitigating counterparty credit risk, and policies requiring 
diligent investigation into the adequacy of financial resources and 
risk management procedures of any central counterparty through which 
the registrant clears.
    The Working Group argued that the adequacy of resources and risk 
management at CCPs registered with the Commission should be monitored 
by the Commission, not individual firms. EEI requested that the 
Commission clarify that proposed Sec.  23.600(c)(5) is not seeking to 
require SDs to use central clearing to mitigate risk if clearing is not 
required under a valid exemption.
    The Commission is adopting the rule regarding use of central 
counterparties as proposed. The Commission's registration of a central 
counterparty as a DCO is based on a determination that the applicant 
meets core principles under the Commodity Exchange Act and Commission 
regulations. It does not, however, serve as a substitute for the due 
diligence of registrants who must evaluate the use of a central 
counterparty in light of their own circumstances. In addition, SDs and 
MSPs may elect to clear swaps that are not required to be cleared on a 
voluntary basis through central counterparties that are not registered 
with the Commission. In those instances, an SD or MSP engaging in some 
manner of due diligence prior to submitting a swap for clearing would 
be part of a prudent risk management program. In response to EEI's 
comment, the Commission observes that the rule would require only that 
registrants evaluate the use of central clearing as a means of 
mitigating counterparty credit risk and as part of their overall risk 
management strategy. Moreover, the rule expressly notes the exception 
from mandatory clearing that is provided for under section 2(h)(7) of 
the CEA.
22. Business Trading Unit--Sec.  23.600(d)
    As proposed, Sec.  23.600(d) required SDs and MSPs to establish 
policies and procedures that require all trading policies to be 
approved by the governing body of the registrant.
    The Working Group recommended that the governing body of an SD or 
MSP be permitted to delegate approval of trading policies to those with 
expertise.
    The revisions to the definition of governing body discussed above, 
which allows for a governing body to consist of a committee or the CEO, 
sufficiently address the Working Group's concerns.

[[Page 20141]]

The Commission thus has made no changes to the rule.
23. Transaction Entry by Traders--Sec.  23.600(d)(5)
    Proposed Sec.  23.600(d)(5) required SDs and MSPs to establish 
policies and procedures that require each trader to follow established 
policies and procedures for executing and confirming all transactions. 
Further, in a discussion about the independence of the risk management 
unit in the preamble to the proposal, the Commission stated that 
``personnel responsible for recording transactions in the books of the 
swap dealer or major swap participant cannot be the same as those 
responsible for executing transactions.''
    The Working Group requested clarification about requirements for 
transaction entry based on the statements made in the preamble to the 
proposal. The Working Group argued that if the reference to recording 
transactions in the books of a firm is intended to refer to entries 
into the general ledger system, then the Working Group agreed that this 
process should be subject to the usual segregation of duties 
requirements that protect the general ledger system, but that there is 
no reasonable basis to prohibit individuals who execute transactions 
from entering the information regarding such transactions into a firm's 
trading or risk management system.
    BGA commented that typical practice is for traders to enter the 
trade into the deal monitoring system, and then the risk control group 
performs a daily review of all new and amended trading activity. BGA 
explained that the mid-office risk control review is followed by a 
second review of the trade activity performed by the back-office 
confirmations group, which generates confirmations and performs 
portfolio reconciliations to match key trade attributes with 
counterparties. BGA requested clarification that the reference to 
``recording transactions in the books'' in the proposal preamble is not 
intended to restrict the initial recording of the trade into the deal 
capture system by the trader, but refers to the daily review and 
confirmation and portfolio reconciliation processes performed by the 
mid and back offices.
    SIFMA requested that the Commission confirm that compliance with 
the rule would not preclude trading personnel from entering the trades 
they execute into a registrant's trade capture system, provided that 
the registrant has appropriate policies and procedures reasonably 
designed to identify the entry of fictitious trades or the failure to 
accurately enter actual trades.
    In response to these comments, the Commission confirms that the 
rule is not intended to restrict the initial recording of trades into a 
trade capture system by the trader. Rather, the rule requires traders 
to follow established policies and procedures governing trade execution 
and confirmation.
24. Monitoring of Trading--Sec.  23.600(d)(4) & (d)(9)
    As proposed, Sec.  23.600(d)(4) required SDs and MSPs to establish 
policies and procedures designed to monitor each trader throughout the 
trading day to prevent the trader from exceeding any limit to which the 
trader is subject, or from otherwise incurring undue risk. The proposed 
regulations also require registrants to ensure that trade discrepancies 
are brought to the immediate attention of senior management and are 
documented.
    The Working Group, with respect to internal limits, recommended 
that daily monitoring should be at the product desk level, not the 
trader level, as market practice is to set internal limits at the desk 
level. Also, the Working Group and SIFMA requested that the Commission 
clarify that ``monitor each trader throughout the trading day'' does 
not mean continuous monitoring, and recommended that the Commission 
remove the requirement that firms monitor traders to prevent traders 
from ``incurring undue risk'' because the meaning of the phrase is 
ambiguous. The Working Group also recommended that the Commission 
define ``trade discrepancies'' and add a materiality standard to the 
escalation requirement.
    MetLife commented that intraday monitoring of traders may be 
excessive for some MSPs, especially MSPs that use swaps only for 
hedging purposes. MetLife recommended that the Commission allow the 
type of monitoring and its frequency to be determined by an MSP's risk 
management unit and governing body.
    Having considered these comments, the Commission is revising the 
proposed rule to require monitoring be performed to prevent the 
incurrence of ``unauthorized risk'' rather than ``undue risk.'' The 
Commission believes this formulation better reflects the intent of the 
rule, which is to ensure that SDs and MSPs have instituted safeguards 
against the risk of losses to the firm due to rogue trading.
    In response to The Working Group's comment requesting a definition 
of ``trade discrepancies,'' the Commission notes that the term ``trade 
discrepancies'' is intended to refer to any discrepancies between the 
SD or MSP and its counterparties and to any discrepancies in records or 
systems of the SD or MSP. Also in response to The Working Group's 
recommendation that the proposed rule be modified to add a materiality 
standard for reporting of trade discrepancies to management, the 
Commission is modifying the rule to require that only trade 
discrepancies that are not immaterial, clerical errors be brought to 
the immediate attention of management of the business trading unit. The 
rule continues to require that all trade discrepancies be documented.
    The Commission has made no other changes to the rule based on the 
comments received. The Commission believes that prudent risk management 
requires intraday monitoring of traders to detect prohibited activity 
that may be otherwise undetectable. The Commission notes that the rule 
requires monitoring of traders to prevent traders from ``exceeding any 
limit to which the trader is subject'' but does not specify the types 
of limits to be monitored. Thus, the Commission observes that the 
setting of limits requiring intraday monitoring is left to the 
discretion of each SD and MSP.
    In addition, the Commission is finalizing the requirement that SDs 
and MSPs have policies and procedures governing the use and supervision 
of trading programs under proposed Sec.  23.600(d)(9), but deleting the 
term ``algorithmic'' from the rule text. This rule is an important 
measure for ensuring that SDs and MSPs monitor their trading 
activities. In addition to the risk management requirements under this 
rule, the Commission notes that the use of trading programs would be 
subject to, among other things, any applicable prohibitions on 
disruptive trading practices under the CEA and Commission regulations. 
The Commission also anticipates addressing the related issues of 
testing and supervision of electronic trading systems and mitigation of 
the risks posed by high frequency trading.
25. Brokers--Sec.  23.600(d)(8)
    Proposed Sec.  23.600(d)(8) required SDs and MSPs to establish 
policies and procedures to ensure that the risk management unit reviews 
broker's statements, reconciles brokers' charges to estimates, reviews 
and monitors broker's commissions, and initiates payment to brokers.
    The Working Group, SIFMA, and MetLife each recommended that the 
risk management unit not be tasked with reviewing brokers' statements, 
monitoring commissions or initiating broker payments, as these 
functions are

[[Page 20142]]

currently handled by operations or other control units.
    The Commission agrees with commenters that review of brokers' 
statements, monitoring commissions or initiating broker payments need 
not be performed by risk management personnel. The Commission is 
revising the proposed rule to replace this requirement with a 
requirement that risk management policies and procedures include 
periodic audit of broker's statements and payments by persons 
independent of the business trading unit. This change provides the 
relief requested by commenters while maintaining the requirement that 
risks connected to the use of brokers are adequately monitored and 
managed.

H. Monitoring of Position Limits--Sec.  23.601

    To implement section 4s(j)(1) of the CEA, the Commission proposed 
Sec.  23.601 in the Duties NPRM, which required SDs and MSPs to 
establish policies and procedures to monitor, detect, and prevent 
violations of applicable position limits established by the Commission, 
a designated contract market (DCM), or a swap execution facility (SEF), 
and to monitor for and prevent improper reliance upon any exemptions or 
exclusions from such position limits. Proposed Sec.  23.601 also 
required SDs and MSPs to: (i) Convert all swap positions into 
equivalent futures positions using the methodology set forth in 
Commission regulations; (ii) provide training to all relevant personnel 
on applicable position limits on an annual basis and promptly upon any 
change to applicable position limits; (iii) test its procedure for 
monitoring and preventing position limit violations for adequacy and 
effectiveness each month; (iv) audit its position limit procedures 
annually; (v) implement an early warning system designed to alert 
senior management when position limits are in danger of being breached; 
and (vi) report any detected violation of applicable position limits to 
the registrant's governing body and to the Commission. Only four market 
participants and trade groups provided comments on the Commission's 
proposal.
1. Monitoring for Violations of Position Limits--Sec.  23.601(a)
    The Working Group argued that it is not possible to determine 
whether transactions that individual traders enter into violate 
position limits without placing the transactions in the context of an 
entire portfolio and any relevant hedge exemptions. The Working Group 
requested clarification that the requirement for intraday monitoring of 
traders under proposed Sec.  23.600(d)(4) does not require monitoring 
of individual traders for violations of position limits, and that 
monitoring for violations of position limits is only required in the 
context of aggregate swaps and futures portfolios.
    The Commission believes that The Working Group's request for 
clarification is outside the scope of these rules. The level at which 
monitoring for violations of position limits will be required is 
subject to the final position limit rules,\20\ and the Commission 
directs SDs and MSPs to review new Sec.  151.7 of the final position 
limit rules for guidance when establishing the Position Limit 
Procedures required by this rule.
---------------------------------------------------------------------------

    \20\ See 17 CFR 151.7, Position Limits for Futures and Swaps, 76 
FR 71626, 71692 (Nov. 18, 2011) (adopting 17 CFR 151.7 pertaining to 
the aggregation of positions).
---------------------------------------------------------------------------

    BGA expressed concern about the requirement that an SD or MSP 
``prevent violations'' of position limits established by the 
Commission. BGA argued that despite having a robust compliance program, 
it is impossible for an SD or MSP to ``prevent violations'' because a 
company cannot before-the-fact prevent a trader from entering a deal 
that causes a position limit violation. Thus, BGA recommended that the 
Commission clarify that as long as an SD or MSP provides training on 
the position limits and establishes and enforces policies for 
monitoring, detecting, and curing violations, they will have met the 
obligation to ``prevent violations.''
    The Commission agrees with BGA that SDs and MSPs should be held to 
a standard of reasonableness in regard to efforts to prevent violations 
of position limits. The Commission therefore is revising the proposed 
rule to state that ``[e]ach swap dealer and major swap participant 
shall establish and enforce written policies and procedures that are 
reasonably designed to monitor for and prevent violations of applicable 
position limits * * *'' (modification to rule text in italics).
2. Training on Applicable Position Limits--Sec.  23.601(c)
    SIFMA recommended that the Commission revise Sec.  23.601(c) to 
provide that a change in position limit levels will not trigger 
``training,'' but only require effective notification. The Commission 
agrees with SIFMA's view and is revising the proposed rule accordingly.
3. Diligent Monitoring and Diligent Supervision To Ensure Compliance--
Sec.  23.601(d)
    SIFMA recommended that the Commission clarify that monitoring for 
compliance with position limits need not be performed by risk 
management personnel, but may be performed by independent compliance, 
operations, or supervisory personnel.
    The rule does not require that position limit monitoring be 
performed by risk management personnel, nor was such a requirement 
intended. The Commission confirms that monitoring procedures may be 
conducted at the discretion of the SD or MSP.
4. Reporting Violations to the Governing Body and the Commission--Sec.  
23.601(e)
    The Working Group and MetLife doubted the utility of alerting the 
governing body of nonmaterial violations of position limits as required 
under proposed Sec.  23.601(e), and recommended that the Commission 
require alerting the governing body only when a violation is material 
and allow registrants to define escalation procedures based on 
materiality in their Position Limit Procedures.
    The Commission does not believe that reporting of position limit 
violations to the governing body of the registrant should be subject to 
a materiality standard and is adopting the rule as proposed. The 
Commission intends the reporting rule to ensure accountability for 
compliance with position limits at the highest levels of management and 
believes applying a materiality standard to such reporting would 
undermine the intention of the rule and introduce unnecessary 
complication for registrants trying to determine how much of a breach 
would amount to a material breach. However, the Commission observes 
that a registrant's governing body could take into account the 
magnitude of the breach and other facts and circumstances in 
remediating its monitoring program. For instance, a governing body 
would respond differently to small, inadvertent breaches that are 
promptly corrected than larger, repeated violations.
    With respect to reporting of position limit violations to the 
Commission, The Working Group argued that the reporting of on-exchange 
violations of position limits to the Commission is already done by DCMs 
and will likely be the responsibility of SEFs as well, so SDs and MSPs 
should not be required to report on-exchange violations to avoid 
inundating the Commission with redundant information. The Working Group 
conceded, however, that if

[[Page 20143]]

position limit rules require the aggregation of exchange-traded swaps 
and over-the-counter swaps, then SDs and MSPs should be required to 
report position limit violations that occur because of over-the-counter 
swaps, but recommended that such reporting requirement be subject to a 
materiality standard.
    The Commission agrees that on-exchange position limit violations 
need not be reported to the Commission by registrants, as they will be 
reported by DCMs or SEFs and has modified the final rule accordingly.
5. Testing and Audit of Position Limit Procedures--Sec.  23.601(f) and 
(h)
    With respect to monthly testing of Position Limit Procedures 
required under proposed Sec.  23.601(f) and annual audit required under 
proposed Sec.  23.601(h), SIFMA recommended that testing and audit of 
Position Limit Procedures be required only annually and not be required 
to be done all at the same time, The Working Group recommended that 
testing only be required on a semi-annual basis (or on a more frequent 
basis as the firm might determine to be effective), and MetLife 
requested that the Commission permit the frequency of testing to be 
determined by an MSP based on the extent of its swap activities. 
MetLife also recommended that there be a clear exemption from testing 
requirements for MSPs that do not trade in swaps for which position 
limits have been established. SIFMA requested that the Commission 
clarify that testing should consist of testing for accurate capture of 
all relevant desk positions by position reporting systems and that 
Sec.  23.601(h) be revised to allow for ``agreed upon procedures'' for 
external auditors.
    Having considered these comments, the Commission has determined 
that monthly testing of Position Limit Procedures by registrants may be 
unduly burdensome, but believes that only annual or semi-annual testing 
would be inadequate as such could allow violations to remain undetected 
for long periods. The Commission therefore is modifying the proposed 
rule to require quarterly testing, and, in response to the comment of 
MetLife, only if the registrant trades in swaps for which position 
limits have been established. The annual audit requirement is being 
adopted as proposed. In response to the request of SIFMA, the 
Commission confirms that testing of Position Limit Procedures is 
expected to entail testing of the accuracy of capture of all relevant 
desk positions by position reporting systems.
6. Quarterly Reporting of Compliance With Position Limits--Sec.  
23.601(g)
    With respect to quarterly reporting of compliance with position 
limits to the chief compliance officer, senior management, and 
governing body under proposed Sec.  23.601(g), The Working Group 
recommended that the proposed rule should be revised to require only 
annual reports to the entity's senior management and governing body.
    As stated above, the Commission intends the reporting rule to 
ensure accountability for compliance with applicable position limits at 
the highest levels of management. The Commission believes that the 
burden of quarterly reporting is outweighed by the benefit of timely 
notification to decision makers within the SD and MSP of the entity's 
record of compliance with applicable position limits, thus providing a 
timely opportunity to adjust or revise Position Limit Procedures to 
prevent future violations, if necessary.

I. Diligent Supervision--Sec.  23.602

    Proposed Sec.  23.602 was intended to implement section 4s(h)(1)(B) 
of the CEA, which requires each SD and MSP to conform with Commission 
regulations related to diligent supervision of the business of the SD 
and MSP. The proposed regulations required SDs and MSPs to establish a 
system to supervise all activities relating to its business performed 
by its partners, members, officers, employees, and agents, that such 
system be reasonably designed to achieve compliance with the CEA and 
Commission regulations, that such system designate a person with 
authority to carry out the supervisory responsibilities of the SD or 
MSP, and that all such supervisors meet qualification standards that 
the Commission finds necessary or appropriate.
    The Working Group recommended that the Commission not require 
designation of a single individual with responsibility for supervision, 
but should allow for designation of a reporting line and that 
designated supervisors should be permitted to delegate supervisory 
authority. The Working Group also recommended that SDs and MSPs be 
given discretion to determine supervisor qualifications, rather than 
meet ``qualification standards as the Commission finds necessary or 
appropriate.''
    MFA recommended that the Commission clarify that the rules do not 
impose any new (a) fiduciary obligations or duties (i.e., duties beyond 
those to which participants in the futures and derivatives markets 
would otherwise be subject to by agreement or by operation of common 
law), or (b) supervisory duties on market participants. MFA argued that 
proposed Sec.  23.602 (Diligent Supervision) is similar to the NFA's 
supervision rule for FCMs (Compliance Rule 2-9), and MFA is concerned 
that Sec.  23.602 may impose fiduciary and supervisory obligations on 
registrants similar to those that the NFA imposes on FCMs with respect 
to third parties.
    In response to The Working Group's first comment, the Commission is 
revising the proposed rule to require ``at least one person'' rather 
than ``a person'' be designated with authority to carry out supervisory 
responsibilities, which should permit SDs and MSPs more flexibility in 
designing and implementing the required supervisory system. With 
respect to the remaining comments of The Working Group, the Commission 
believes that full accountability for compliance with the CEA and 
Commission regulations is best served by requiring designation of 
individuals with supervisory responsibility and that reporting line 
responsibility is not adequate.
    With respect to MFA's comments, the Commission observes that the 
rule relates generally to the supervision necessary to achieve 
compliance with the CEA and Commission regulations by the registrant. 
Many of the specific activities to be supervised are subject to the CEA 
and other Commission rules that are outside the scope of this 
rulemaking. The Commission does not intend that Sec.  23.602 impose a 
fiduciary duty on SDs or MSPs beyond that which would otherwise exist.
    Other than the foregoing, the Commission has adopted the rule as 
proposed.

J. Business Continuity and Disaster Recovery--Sec.  23.603

    Proposed Sec.  23.603 required SDs and MSPs to establish a business 
continuity and disaster recovery plan that includes procedures for and 
the maintenance of back-up facilities, systems, infrastructure, 
personnel, and other resources to achieve the timely recovery of data 
and documentation and to resume operations generally within the next 
business day. The proposed regulations also required SDs and MSPs to 
have their business continuity and disaster recovery plan tested 
annually by qualified, independent internal audit personnel or a 
qualified third party audit service.
    Tellefsen and Company, L.L.C. (Tellefsen) commented that most, if 
not all, of potential SDs have the technology and network 
infrastructure in place to

[[Page 20144]]

achieve a next day recovery time objective. However, Tellefsen 
recommended that the Commission carefully evaluate the business 
continuity management capabilities of MSPs before establishing a hard 
date by which these metrics must be in place, as the Commission may 
have greatly underestimated the time and scope of work for firms to 
develop, implement and test their business continuity management 
capabilities (Tellefsen estimates 68-200 person days). The Working 
Group also argued that the Commission should not require next business 
day recovery for non-systemically important SDs or MSPs, but should 
only require recovery ``reasonably promptly.''
    The Working Group argued that the Commission should not require 
staffing of back-up facilities to avoid the burden of requiring two 
persons for the same job. The Working Group also recommended that the 
Commission should not require annual testing of the business continuity 
and disaster recovery plan by independent auditors because independent 
audits would be too costly.
    SIFMA recommended that the Commission clarify that an SD's or MSP's 
business continuity and disaster recovery plan may be part of a 
consolidated plan established for the various entities in a holding 
company group if they share common personnel, premises, resources, 
systems, and infrastructure. SIFMA also recommended that the Commission 
permit SDs and MSPs subject to the business continuity and disaster 
recovery requirements of a prudential regulator, or other regulator 
determined to be comparable by the Commission, to comply with Sec.  
23.603 on a substituted compliance basis.
    The Commission believes that Tellefsen's concerns regarding the 
ability of MSPs to comply with the required recovery period will be 
addressed through the phased implementation of the rule, discussed 
below.
    In response to The Working Group's comment regarding staffing of 
back-up facilities, the Commission is modifying the proposed rule to 
clarify that, so long as prompt recovery is reasonably ensured, SDs and 
MSPs may provide for alternative staffing of back-up facilities as 
required under the circumstances. The Commission also agrees with the 
Working Group that annual testing may be performed by qualified 
internal personnel and is modifying the proposed rule accordingly. 
However, the Commission believes that independent audits are required 
to ensure that business continuity and disaster recovery plans remain 
in compliance with the rule, but that annual audits would be 
unnecessary and unduly burdensome and costly. Therefore, the Commission 
is revising the proposed rule to require independent audits only every 
three years.
    The Commission believes that all SDs and MSPs may be critically 
important to the proper functioning of the swaps market. SDs are 
critical participants in the swap market and MSPs may, by definition, 
have exposures that could have serious adverse effects on the financial 
stability of the United States. Therefore, the Commission continues to 
believe that a one business day recovery period is the necessary 
objective for SDs' and MSPs' business continuity and disaster recovery 
plans. Accordingly, the Commission is not modifying the final rule in 
this respect.
    In response to SIFMA's comments, the Commission confirms that so 
long as a consolidated business continuity and disaster recovery plan 
established for the various entities in a holding company group that 
includes an SD or MSP, or any such plan that is required by a 
prudential regulator of the SD or MSP, meets the requirements of the 
rule, such SD or MSP would be in compliance with the Commission's rule. 
The Commission believes that this result is contemplated by the rule as 
proposed and so is not modifying the rule in this respect.

K. General Information: Availability for Disclosure and Inspection--
Sec.  23.606

    Proposed Sec.  23.606 required SDs and MSPs to make available for 
disclosure and inspection by the Commission and the SD's or MSP's 
prudential regulator, all information required by, or related to, the 
CEA and Commission regulations.
    The Working Group recommended that the Commission clarify what is 
meant by ``available for disclosure'' if such is different from 
``available for inspection.'' The Working Group also argued that SDs 
and MSPs should not be required to revise information systems to store 
information specifically required by each Commission rule, because 
storage would require extensive investigation that is unnecessary to 
ensure compliance with the rule.
    Having considered The Working Group's comments, the Commission is 
adopting the rule as proposed. The Commission does not believe the rule 
specifies or requires any particular storage medium or methodology, but 
rather only requires SDs and MSPs to have information systems capable 
of producing the required information promptly. The Commission also has 
determined not to define further ``available for disclosure'' or 
``available for inspection'' because it believes these terms as 
employed in the rule have their plain meanings.

L. Antitrust Considerations--Sec.  23.607

    Proposed Sec.  23.607 prohibited SDs and MSPs from adopting any 
process or taking any action that results in any unreasonable restraint 
of trade or imposes any material anticompetitive burden on trading or 
clearing, unless necessary or appropriate to achieve the purposes of 
the CEA. The proposed rule also required SDs and MSPs to adopt policies 
and procedures to prevent such actions.
    SIFMA agreed with the Commission's proposed policies and procedures 
approach. SIFMA argued however that Sec.  23.607(a) goes further, by 
imposing a blanket prohibition on a registrant adopting any process or 
taking any action that results in any unreasonable restraint of trade, 
or imposes any material anticompetitive burden on trading or clearing 
(unless necessary or appropriate to achieve the purposes of the CEA). 
SIFMA expressed concern that, given the counterparty rescission and 
private right of action provisions of the CEA, this prohibition could 
introduce additional private liability that is unnecessary in light of 
the enforcement authority of the Commission and antitrust authorities 
and existing private rights of action under the antitrust laws. SIFMA 
therefore recommended that the Commission delete Sec.  23.607(a) and 
instead rely upon the policies and procedures requirement included in 
Sec.  23.607(b).
    Having considered SIFMA's comments, the Commission is adopting the 
rule as proposed. The blanket prohibition in Sec.  23.607(a) is taken 
directly from the statutory provision and appropriately implements the 
prohibition in section 4s(j)(6) of the CEA.

M. Conflicts of Interest Policies and Procedures by SDs, MSPs, FCMs, 
and IBs--Sec.  23.605, Sec.  1.71

    As discussed above, section 4s(j) of the CEA, as added by section 
731 of the Dodd-Frank Act, sets forth certain duties for SDs and MSPs, 
including the duty to implement conflict-of-interest systems and 
procedures. Specifically, section 4s(j)(5) mandates that SDs and MSPs 
implement conflict-of-interest systems and procedures that ``establish 
structural and institutional safeguards to ensure that the activities 
of any person

[[Page 20145]]

within the firm relating to research or analysis of the price or market 
for any commodity or swap or acting in a role of providing clearing 
activities or making determinations as to accepting clearing customers 
are separated by appropriate informational partitions within the firm 
from the review, pressure, or oversight of persons whose involvement in 
pricing, trading, or clearing activities might potentially bias their 
judgment or supervision and contravene the core principles of open 
access and the business conduct standards described in this Act.'' 
Section 4s(j)(5) further requires that such systems and procedures 
``address such other issues as the Commission determines to be 
appropriate.'' Proposed Sec.  23.605, as set forth in the SD/MSP 
Conflicts NPRM, addressed the statutory mandate of section 4s(j)(5).
    In relevant part, section 732 of the Dodd-Frank Act amended section 
4d of the CEA by creating a new subsection (c), which mandates that the 
Commission ``require that futures commission merchants and introducing 
brokers implement conflict-of-interest systems and procedures.'' New 
section 4d(c) mandates that such systems and procedures ``establish 
structural and institutional safeguards to ensure that the activities 
of any person within the firm relating to research or analysis of the 
price or market for any commodity are separated by appropriate 
informational partitions within the firm from the review, pressure, or 
oversight of persons whose involvement in trading or clearing 
activities might potentially bias the judgment or supervision of the 
persons.'' New section 4d(c) further requires that such systems and 
procedures ``address such other issues as the Commission determines to 
be appropriate.'' Proposed Sec.  1.71, as set forth in the FCM/IB 
Conflicts NPRM, addressed the statutory mandate of section 4d(c).
    As proposed, Sec. Sec.  23.605 and 1.71 were identical in all 
material respects. The Commission received 29 comment letters to the 
SD/MSP Conflicts NPRM and 26 comment letters to the FCM/IB Conflicts 
NPRM. Many commenters provided comments addressing identical provisions 
or issues in both proposed rules. The discussion below thus addresses 
comments to both proposed rules unless otherwise indicated.
1. Compliance Oversight by Self-Regulatory Organizations (SROs)
    Although proposed Sec. Sec.  23.605 and 1.71 prescribed the 
implementation of conflict-of-interest policies and procedures by SDs, 
MSPs, FCMs, and IBs, the proposal did not address compliance oversight 
by SROs. Nonetheless, the Commission received comments on whether the 
conflict-of-interest policies and procedures mandated under sections 
4s(j)(5) and 4d(c) of the CEA should be prescribed by the Commission or 
by an SRO.
    The Futures Industry Association (FIA), ISDA, and SIFMA, in a joint 
comment, argued that an SRO should oversee and enforce the conflict-of-
interest requirements on SDs, MSPs, FCMs, and IBs. FIA, ISDA, and SIFMA 
stated that SROs would be in a better position than the Commission to 
address the likely need for future amendments to the rule. The comment 
suggested that the Commission establish a framework governing the 
implementation of conflict-of-interest policies and procedures, and 
instruct the appropriate SRO to write detailed compliance requirements 
within that framework, including the execution of audit and compliance 
functions, and the issuance of specific guidance that would be subject 
to the Commission's review and approval. In a separate comment, JP 
Morgan expressed a general agreement with the points raised in the FIA/
ISDA/SIFMA letter.
    Michael Greenberger and UNITE HERE commented that the monitoring 
and enforcement of the implementation of conflict-of-interest policies 
and procedures for SDs and MSPs should be carried out by the 
Commission, as opposed to SROs.
    Having considered the comments, the Commission is adopting the rule 
as proposed on this issue. Unlike section 15D of the Securities 
Exchange Act of 1934, which mandated that conflict-of-interest rules be 
adopted either by the SEC, or by a registered securities association or 
national securities exchange, sections 4s(j)(5) and 4d(c) of the CEA as 
added by sections 731 and 732 of the Dodd-Frank Act, respectively, 
direct the CFTC to promulgate such rules. The Commission will continue 
to collaborate with SROs on conflict-of-interest policies and 
procedures, particularly with respect to their effectiveness.
2. Exemptive Relief
    The Commission's proposal in the FCM/IB NPRM did not expressly 
address issues surrounding the Commission's exemptive authority. 
Nonetheless, the Committee on Futures and Derivatives Regulation of the 
New York City Bar Association argued that, due to the unprecedented 
scope and breadth of the Commission's rulemakings, the Commission will 
encounter situations it had not previously considered, rules that do 
not operate in the manner intended, or unintended consequences when the 
rules are applied in a specific context. In such situations, exemptive 
relief would be appropriate and the Commission should prepare for such 
situations by providing Commission staff with the authority to grant 
exemptive relief in each rule. Having considered the comment, the 
Commission does not believe it appropriate to address exemptive relief 
in this rule. Rather, any person may submit a request for an exemptive, 
no-action or interpretive letter, in accordance with the procedures set 
forth in Commission Regulation 140.99.\21\ Further, should any person, 
in the future, believe that an amendment to a Commission regulation is 
warranted, such person may petition the Commission for an amendment in 
accordance with the procedures set forth in Commission Regulation 
13.2.\22\
---------------------------------------------------------------------------

    \21\ 17 CFR 140.99.
    \22\ 17 CFR 13.2.
---------------------------------------------------------------------------

3. Consistent Conflicts-of-Interest Treatment Between FCMs/IBs and SDs/
MSPs
    Pierpont Securities Holdings LLC expressed agreement with the 
Commission's proposal to apply Sec.  23.605 and Sec.  1.71 in a manner 
that is consistent with one another. The consistency is particularly 
important in situations where a FCM is an affiliate of, or dually 
registered as, an SD or MSP. The Commission acknowledges the comment 
and notes its belief that such consistent treatment is reasonable and 
reflects the statutory directives and policy goals underlying sections 
4d(c) and 4s(j)(5) of the CEA, as amended by sections 732 and 731 of 
the Dodd-Frank Act, respectively.
4. Definitions--Sec.  23.605(a), Sec.  1.71(a)
a. Business Trading Unit--Sec.  23.605(a)(2), Sec.  1.71(a)(2)
    The proposed rules defined the term ``business trading unit'' as 
``any department, division, group, or personnel of a [SD, MSP, FCM, or 
IB] or any of its affiliates, whether or not identified as such, that 
performs or is involved in any pricing, trading, sales, marketing, 
advertising, solicitation, structuring, or brokerage activities on 
behalf of a [SD, MSP, FCM, or IB].''
    The Commission received a comment from the FHLBs, and a joint 
comment from FIA, ISDA, and SIFMA, arguing that the Commission should 
clarify that Sec.  23.605(a)(2) and Sec.  1.71(a)(2) apply to 
traditional ``front office'' functions and not to those functions that 
support the

[[Page 20146]]

front office, such as legal, compliance, operations, credit, and human 
resources functions. FIA/ISDA/SIFMA noted that in order to fulfill 
legal, compliance, and risk management functions, firms are integrated 
such that the exclusion of such control and/or support functions should 
be excluded from the definitions of business trading unit and clearing 
unit. In a separate comment, JP Morgan expressed a general agreement 
with the points raised in the FIA/ISDA/SIFMA letter.
    In the preambles of the SD/MSP and FCM/IB NPRMs, the Commission 
noted that the proposed rules are not intended to hinder the execution 
of sound risk management programs by SDs, MSPs, FCMs, IBs, or by any 
affiliate of an SD, MSP, FCM, or IB. The Commission's proposals largely 
addressed the issue raised by the commenters in the proposed 
definitions of ``non-research personnel'' at Sec.  23.605(a)(5) and 
Sec.  1.71(a)(5), which carved out legal and compliance personnel from 
those definitions. In addition, the final rule modified the definition 
of non-research personnel to those employees who are not directly 
responsible for, or otherwise not directly involved in, research or 
analysis intended for inclusion in a research report. The Commission 
believes its prior statements and these changes should clarify the 
scope of the definitions.
    Nonetheless, upon reviewing the comments, the Commission has 
determined it appropriate to modify the definitions. The rule language, 
as originally proposed, is amended in the final rules to: (1) Clarify 
that the term includes those persons who directly perform or exercise 
supervisory authority over the performance of the tasks listed in the 
rule, and not those who merely are ``involved in'' such activities, 
such as the legal, compliance, human resources, risk management, 
operations, and other support functions; and (2) exclude price 
verification for risk management purposes from the types of pricing 
activities covered by the definitions. The Commission believes that 
these changes will address the issues raised by the commenters while 
ensuring that the rule text properly reflects the intent of the 
Commission.
b. Clearing Unit--Sec.  23.605(a)(3), Sec.  1.71(a)(3)
    The proposed rules defined the term ``clearing unit'' as ``any 
department, division, group, or personnel of a [SD, MSP, FCM, or IB] or 
any of its affiliates, whether or not identified as such, that performs 
or is involved in any proprietary or customer clearing activities on 
behalf of a [SD, MSP, FCM, or IB].''
    Similar to the concerns raised in comments on the proposed 
definition of ``business trading unit,'' FIA, ISDA, and SIFMA, in a 
joint comment, argued that the Commission should clarify that Sec.  
23.605 and Sec.  1.71 applies to traditional ``front office'' functions 
and not to functions that support the front office, such as legal, 
compliance, operations, credit, and human resources functions. In a 
separate comment, JP Morgan expressed a general agreement with the 
points raised in the FIA/ISDA/SIFMA letter.
    As stated above with respect to the comments received on the 
proposed definition of ``business trading unit,'' the Commission noted 
in the preambles to the SD/MSP and FCM/IB Conflicts NPRMs that the 
proposed rules are not intended to hinder the execution of sound risk 
management programs by SDs, MSPs, FCMs, IBs, or by any affiliate of an 
SD, MSP, FCM, or IB. The NPRMs largely addressed the issue raised by 
the commenters in the proposed definitions of ``non-research 
personnel'' at Sec.  23.605(a)(5) and Sec.  1.71(a)(5), which carved 
out legal and compliance personnel from that definition. The Commission 
reiterates its prior statements on this issue, which should make clear 
the scope of the definitions.
    Nonetheless, upon reviewing the comments, the Commission has 
determined it appropriate to modify the definitions. The rule language, 
as originally proposed, is amended in the final rules to clarify that 
the term includes those persons or groups who perform or exercise 
supervisory authority over the performance of the tasks listed in the 
rules, and not those who merely are ``involved in'' such activities. 
The Commission believes that these changes will address the issues 
raised by the commenters while ensuring that the rule text properly 
reflects the intent of the Commission.
c. Non-Research Personnel--Sec.  23.605(a)(5)
    The proposed rule defined the term ``non-research personnel'' as 
``any employee of the business trading unit or clearing unit, or any 
other employee of the [SD] or [MSP] who is not directly responsible 
for, or otherwise involved with, research concerning a derivative, 
other than legal or compliance personnel.''
    EEI argued that the Commission should limit the definition of non-
research personnel to include only those persons involved with trading, 
pricing, or clearing activities, and not to other areas.
    Upon reviewing the comment, the Commission is adopting the language 
as originally proposed. The Commission believes that changing the 
language in the manner suggested by the commenter would increase the 
risk that SDs or MSPs might attempt to evade the restrictions set forth 
in the rule.
d. Public Appearance--Sec.  23.605(a)(6), Sec.  1.71(a)(6)
    The proposed rules defined the term ``public appearance'' as ``any 
participation in a conference call, seminar, forum (including an 
interactive electronic forum) or other public speaking activity before 
15 or more persons, or interview or appearance before one or more 
representatives of the media, radio, television or print media, or the 
writing of a print media article, in which a research analyst makes a 
recommendation or offers an opinion concerning a derivatives 
transaction.\23\ This term does not include a password-protected 
webcast, conference call, or similar event with 15 or more existing 
customers, provided that all of the event participants previously 
received the most current research report or other documentation that 
contains the required applicable disclosures, and that the research 
analyst appearing at the event corrects and updates during the public 
appearance any disclosures in the research report that are inaccurate, 
misleading, or no longer applicable.''
---------------------------------------------------------------------------

    \23\ The Commission notes that SD and MSP communications with 
counterparties and potential counterparties also are addressed in 
the Commission's external business conduct standards rules. See 
Subpart H of Part 23 of the Commission's Regulations, Business 
Conduct Standards for Swap Dealers and Major Swap Participants with 
Counterparties, 77 FR 9734 (Feb. 17, 2012).
---------------------------------------------------------------------------

    FIA, ISDA, and SIFMA, in a joint comment, argued that the 
definition of public appearance (speaking before 15 or more 
``persons'') should articulate that the term ``person'' includes both a 
customer that is a natural person and one that is an entity. For 
example, if a single institutional customer sends 16 employees to a 
forum held by an SD, MSP, FCM, or IB, each of those employees should 
not be counted as a ``person;'' rather, employees from a single 
institutional customer should be deemed to be one ``person'' at that 
forum, for purposes of the rule. In a separate comment, JP Morgan 
expressed a general agreement with the points raised in the FIA/ISDA/
SIFMA letter.
    Upon reflection, the Commission agrees with the commenters, and is 
altering the rules to incorporate the

[[Page 20147]]

recommendation offered by the commenter. Specifically, the Commission 
is modifying the rule to clarify that the term ``persons'' in this 
context refers to either natural persons or entities. Thus, for 
example, if a single entity sends multiple natural persons as 
representatives to a public speaking activity that may be subject to 
the rule, such natural persons would be counted as a single ``person'' 
for purposes of determining whether the public speaking activity meets 
the definition of ``public appearance.''
e. Research Department--Sec.  23.605(a)(8), Sec.  1.71(a)(8)
    The proposed rules defined the term ``research department'' as 
``any department or division that is principally responsible for 
preparing the substance of a research report relating to any derivative 
on behalf of a [SD, MSP, FCM, or IB], including a department or 
division contained in an affiliate of a [SD, MSP, FCM, or IB].''
    FIA, ISDA, and SIFMA, in a joint comment, argued that the scope of 
``research department,'' and the restrictions imposed by the proposed 
rules concerning research departments, should not apply to the global 
affiliates of an SD, MSP, FCM, or IB. FIA/ISDA/SIFMA posited that the 
imposition of such restrictions on global affiliates would create 
significant logistical hurdles and expenses for multinational firms, 
especially in situations where an affiliate has no significant 
interaction with the SD, MSP, FCM, or IB. Further, FIA/ISDA/SIFMA 
suggested that local regulations governing non-US affiliates may not 
permit such non-US affiliates to comply with the rules. As an 
alternative, FIA/ISDA/SIFMA suggested that the Commission limit the 
rules to requiring disclosure ``on third party research reports,'' and 
focus the Commission's enforcement resources on SDs, MSPs, FCMs, and 
IBs that attempt to evade the rule by moving research analysts to 
affiliates. In a separate comment, JP Morgan expressed a general 
agreement with the points raised in the FIA/ISDA/SIFMA letter.
    Upon reviewing the comments, the Commission has determined it 
appropriate to adopt the rules as originally proposed. The Commission 
believes that the alternatives suggested by FIA/ISDA/SIFMA would 
increase the risk of evasion by multinational registrants. Such risk of 
evasion outweighs any benefit to be derived from the proffered 
alternative. However, to clarify any ambiguity that may exist in the 
rules adopted herein, the Commission confirms that a holding company 
need not examine the research functions of all of its affiliates under 
these rules; rather, a holding company needs only to look at those 
research groups doing research on behalf of an SD, MSP, FCM, or IB. In 
light of its stated intent, the Commission believes that the cost-
effectiveness of the rules will be promoted.
f. Research Report--Sec.  23.605(a)(9), Sec.  1.71(a)(9)
    The proposed rules defined the term ``research report'' as: ``[A]ny 
written communication (including electronic) that includes an analysis 
of the price or market for any derivative, and that provides 
information reasonably sufficient upon which to base a decision to 
enter into a derivatives transaction.'' However, the proposals 
expressly excluded four categories of communications from coverage by 
the definitions.
    FIA, ISDA, and SIFMA, in a joint comment, argued that the 
exclusions from the definition of ``research report'' should be 
expanded to include general market discussions and other communications 
that are not ``research reports'' in other regulatory contexts. The 
definitions should be limited to those research reports analyzing a 
specific derivative or futures transaction. Exclusions set forth in 
other regulatory contexts--specifically NASD Rule 2711(a)(9)(A) and SEC 
Regulation AC--should be included in the Commission's definitions of 
``research report.'' FIA/ISDA/SIFMA further argued that communications 
produced by a business trading unit labeled as a ``trading/sales desk 
product'' and as ``non-research'' should be excluded from the 
definitions of research report. In a separate comment, JP Morgan 
expressed a general agreement with the points raised in the FIA/ISDA/
SIFMA letter.
    EEI argued that the Commission should exclude from the definition 
any communication between an SD or MSP, and its regulator, concerning 
hedging activity. The commenter posited that firms with small trading 
operations should be permitted to publish occasional research reports 
to justify trading decisions, without being subject to the rules set 
forth in the SD/MSP Conflicts NPRM.
    The National Futures Association (NFA) argued that the definition 
in proposed Sec.  1.71(a)(9) was too broad and suggested that the 
definition be limited to reports containing material information at a 
level of detail that amounts to ``a call to action to the customer,'' 
or that could have a price impact on the market for a particular 
product. NFA also argued that the definition should include an 
exception for general market commentary, similar to NASD Rule 2711. 
Newedge USA LLC (Newedge) also argued that the definition in proposed 
Sec.  1.71(a)(9) was too broad, because any discussion of a derivative 
that references the underlying physical commodity or financial 
instrument could be deemed to provide ``information reasonably 
sufficient upon which to base a decision to enter into a derivatives 
transaction.'' Newedge contended that the definition of research report 
should be restricted to ``any written communication * * * including an 
analysis of the price/market for any specific derivative contract, and 
that provides information reasonably sufficient upon which to base a 
decision to enter into a transaction involving such specific derivative 
contract.''
    ADM Investor Services Inc. commented on the differences between 
daily research reports and weekly and monthly research reports, arguing 
that proposed Sec.  1.71(a)(9) unnecessarily threatened existing 
industry practices, particularly with respect to opening and closing 
comments or intraday market comments by IBs, which do not consist of 
detailed research but could be covered by the proposed definition of 
``research report.''
    Having considered the comments, the Commission has determined it 
appropriate to modify the exclusions to the definitions of ``research 
report,'' as that term was proposed in the SD/MSP and FCM/IB Conflicts 
NPRMs. Specifically, the Commission agrees with FIA/ISDA/SIFMA's 
recommendation that ``commentaries on economic, political, or market 
conditions'' and ``statistical summaries of multiple companies' 
financial data, including listings of current ratings'' should be 
excluded from the definitions of research report. With regard to the 
exclusion for commentaries on economic or market conditions, the 
Commission believes that there are distinguishing characteristics 
between research reports setting forth factual statements about the 
market for specific derivatives and commentaries that provide opinion 
on general economic, political, or market conditions. Accordingly, the 
Commission has modified the rules to incorporate those two exclusions 
into the definitions of ``research report.''
    However, the Commission does not believe that other types of 
communications should be excluded from the definitions, because they 
could represent the core focus of a research department doing research 
on behalf of an SD, MSP, FCM, or IB, e.g., asset

[[Page 20148]]

classes, economic variables commonly referenced in derivatives, and on-
the-run swap rates. Adopting the NASD 2711 exclusion for analysis 
concerning economic variables (e.g. rates, inflation) that are commonly 
referenced in derivatives, would create an exception that would swallow 
the rule. For example, research conducted on trends in the interest 
rate, gold, or oil markets are inextricably linked to the swap markets 
that reference those underlying assets or rate.
    The Commission believes that the changes adopted herein will 
increase consistency with NASD Rule 2711, which was promulgated 
pursuant to section 15D of the Securities Exchange Act. The Commission 
believes that the rules, in final form, provide SDs, MSPs, FCMs, and 
IBs with sufficient flexibility concerning solicitation materials 
generated by the trading unit, given the exclusion from coverage of 
``[a]ny communication generated by an employee of the business trading 
unit that is conveyed as a solicitation for entering into a derivatives 
transaction, and is conspicuously identified as such.'' \24\
---------------------------------------------------------------------------

    \24\ The Commission notes that SD and MSP communications with 
counterparties and potential counterparties are addressed in the 
Commission's external business conduct standards rules. See Subpart 
H of Part 23 of the Commission's Regulations, Business Conduct 
Standards for Swap Dealers and Major Swap Participants with 
Counterparties, 77 FR 9734 (Feb. 17, 2012).
---------------------------------------------------------------------------

5. Policies and Procedures--Sec.  23.605(b)
    As proposed, Sec.  23.605(b) required each SD and MSP to ``adopt 
and implement written policies and procedures reasonably designed to 
ensure that the [SD] or [MSP] and its employees comply with the 
provisions of this rule.'' Chris Barnard commented that the prevention 
of SDs and MSPs from engaging in activities with actual, perceived, or 
potential conflicts of interest will improve transparency and 
confidence in the markets, and will reduce risk. The Commission 
acknowledges the comment and is adopting Sec.  23.605(b) without 
revision.
6. Research Analysts and Research Reports--Sec.  23.605(c), Sec.  
1.71(c)
a. Separation of Research Analysts From Business Trading Unit and 
Clearing Unit--Sec.  23.605(c)(1)
    Proposed Sec. Sec.  23.605 and 1.71 prescribed certain restrictions 
on the relationship between the research department and all non-
research personnel. Such restrictions included limitations on 
influencing the content of research reports, the supervision of 
research analysts, and the review or approval of research reports.
    With regard to this proposed rule, MFA suggested that the 
Commission provide additional clarity on the proposed rule by further 
describing the bright lines of separation between the research 
department and non-research personnel. For example, the commenter 
queried whether an SD may house its research department and trading 
department in the same building or on the same floor, and whether 
different key cards for entry into each department are required by the 
rule. Additionally, BlackRock commented that the Commission ``should 
explicitly exempt entities whose research personnel produce reports for 
internal use only.''
    After reviewing the comments, the Commission believes that the 
comments raised by the commenters may best be addressed through 
clarification of the underlying intent of the rule. Accordingly, the 
Commission has determined it appropriate to adopt the rule as it was 
originally proposed. First, with respect to MFA's comments, the rule 
does not expressly require physical separation of the research 
department and all non-research personnel; however, such separation 
will be considered by the Commission to be a good practice by 
registrants in order to minimize the risk of violating the rule. 
Second, with respect to BlackRock's comments, the Commission believes 
that the issue of internal research reports is adequately addressed by 
proposed Sec.  23.605(a)(9)(iv), which excluded from the definition of 
``research report'' any ``internal communications that are not given to 
current or prospective customers.'' \25\
---------------------------------------------------------------------------

    \25\ This language is being adopted by the Commission as 
proposed; however, the provision has been renumbered as Sec.  
23.605(a)(9)(vi).
---------------------------------------------------------------------------

b. Conflicts of Interest Adequately Addressed by Existing Commission 
and NFA Rules
    Proposed Sec.  1.71 did not discuss the issue of whether existing 
Commission and NFA rules adequately address the directives set forth in 
section 4d(c) of the CEA as amended by section 732 of the Dodd-Frank 
Act. Nonetheless, the Commission received comments that raised the 
issue.
    NFA commented that certain of its existing rules address issues 
raised in the Commission's rule proposal, and that the specific 
requirements related to research reports that may not be directly 
applicable to derivatives could have unintended consequences. K&L Gates 
LLP (on behalf of Peregrine Financial Group Inc.), ADM Investor 
Services Inc., John Stewart & Associates Inc., and Stewart-Peterson 
Group Inc. each argued that the issues addressed by the proposed rule 
are already addressed through existing rules.
    Swaps and Derivatives Market Association commented that the 
proposed rules should be adopted as they were originally proposed.
    After considering the comments, the Commission has determined it 
appropriate to adopt the rule, as it was originally proposed, on this 
issue. Although certain Commission and NFA rules tangentially address 
the issues set forth in the proposed rule, section 732 of the Dodd-
Frank Act directed the Commission to take certain actions beyond the 
requirements previously promulgated in the rules of the Commission and 
NFA. Further, given the similarities between section 4d(c) of the CEA 
as amended by section 732 of the Dodd-Frank Act, and section 15D of the 
Securities Exchange Act of 1934, the Commission believes that it is 
important to provide a measure of specificity with respect to the 
conflict-of-interest policies and procedures mandated under section 
4d(c) and Sec.  1.71. Such specificity will promote consistency in the 
marketplace. Further, by maintaining consistency--to the extent 
warranted--with NASD Rule 2711, the Commission believes that the 
proposed rule will minimize disruption to the marketplace, given that 
such standards are well-established in the financial industry.
c. Treatment of Small IBs
    As proposed, Sec.  1.71 did not establish a separate standard for 
small IBs. However, in the preamble of the proposed rule, the 
Commission expressly invited comment on how these rules should apply to 
FCMs and IBs, considering the varying size and scope of the operations 
of such firms. The preamble noted, as an example of how the rule could 
be adjusted to account for firms of different sizes, that NASD Rule 
2711(k) provides an exception from certain requirements for `small 
firms,' defined to include those firms that over the past three years 
have participated in ten or fewer investment banking services 
transactions and generated $5 million or less in gross investment 
banking services revenues from those transactions. The Commission 
solicited comment on whether a similar approach should be adopted for 
small FCMs and IBs. Moreover, the exceptions to the definition of 
research report were designed to address issues typically found in 
smaller firms where individuals in the trading unit perform

[[Page 20149]]

their own research to advise their clients or potential clients.
    Several commenters suggested that small IBs should be excepted from 
the proposed rule. NFA argued that the proposed rule effectively could 
prohibit the business model of a number of firms that provide an 
important service to the industry, particularly with respect to 
agriculture. The commenter suggested that, in adopting an exception for 
small IBs, the Commission could consider the following factors: A 
firm's gross annual revenue, number of associated persons, number of 
annual futures transactions, and nature of the customer base. National 
Introducing Brokers Association, ADM Investor Services Inc., John 
Stewart & Associates Inc., and Stewart-Peterson Group Inc. each argued 
that implementing the proposed rules would be prohibitively costly, 
burdensome, and unnecessary for small IBs, particularly for IBs dealing 
with agricultural commodities, and would force small IBs out of 
business. Chris Barnard noted that small IBs lack the capacity to carry 
the proportionately heavier regulatory burden set forth in the proposed 
rule, and as such, some regulatory mitigation would be beneficial, 
based on number of staff or revenues. Multiple commenters also 
commented on the limited market price impact of research reports 
created or distributed by small IBs, as well as the potential that the 
normal duties of associated persons may be deemed to be research 
activities for purposes of the rule.
    The Commission recognizes and agrees with certain concerns raised 
by the commenters. Thus, upon review of the comments, the Commission is 
adopting a separate regulatory standard for small IBs, reflecting the 
alternative set forth in the preamble of the proposed rule. Section 
4d(c) of the CEA mandates the establishment of ``appropriate 
informational partitions'' within FCMs and IBs, and all such firms are 
bound by that statutory requirement. However, the Commission recognizes 
that the size of an IB plays a significant role in determining the 
appropriateness of such partitions. Accordingly, the rule, in its final 
form, establishes a separate standard for any IB that has generated, 
over the preceding 3 years, $5 million or less in aggregate gross 
revenues from its activities as an IB. This standard is similar to 
language in NASD Rule 2711 that was raised expressly as a possible 
alternative in the preamble of the proposed rule.
    For any IB meeting those financial requirements, Sec.  1.71(c) of 
the rule would not apply. Further, Sec.  1.71(b) has been changed to 
set forth a separate policies and procedures requirement for small IBs. 
The recommended language of new Sec.  1.71(b)(2) largely mirrors the 
statutory requirement of section 4d(c). However, the Commission 
believes that small IBs should be subject to Sec.  1.71(e) (policies 
and procedures mandating disclosure of material incentives and 
conflicts of interest) and Sec.  1.71(f) (recordkeeping and 
reporting).\26\ The Commission believes that these changes to the rule, 
as originally proposed, will address the concerns raised by the 
commenters and limit the cost burden imposed on small IBs.
---------------------------------------------------------------------------

    \26\ The provisions of Sec.  1.71(d) are applicable only to 
FCMs.
---------------------------------------------------------------------------

    Finally, the Commission notes that commentaries on market 
conditions have been excluded from the definition of ``research 
report,'' as discussed above.
d. Insider Trading and Futures Markets
    Proposed Sec.  1.71 did not address insider trading in the futures 
markets, or how that issue impacts the implementation of section 732 of 
the Dodd-Frank Act. Nonetheless, the Commission received comments on 
the issue. Specifically, K&L Gates LLP (on behalf of Peregrine 
Financial Group Inc.), John Stewart & Associates Inc., ADM Investor 
Services Inc., and Stewart-Peterson Group Inc. each argued that the 
proposed rules inappropriately relied upon established rules in the 
securities industry, claiming that no ban on insider trading exists in 
the futures industry. Further, ADM Investor Services Inc. and Stewart-
Peterson Group Inc. each contended that only the publication of a U.S. 
Department of Agriculture market report could have a dramatic effect on 
the futures market.
    Having considered the comments, the Commission has determined not 
to modify the rule on this issue. Section 732 of the Dodd-Frank Act 
directed the Commission to take actions concerning conflict-of-interest 
policies and procedures, and in that provision, Congress included 
language previously included in section 15D of the Securities Exchange 
Act of 1934. Section 15D directed that regulatory language be 
promulgated to implement that statute, and those regulatory standards 
are now well-established in the financial industry. Given the 
similarities in statutory language, coupled with the well-established 
principles set forth in NASD Rule 2711, the Commission believes that it 
is important to provide a measure of specificity with respect to the 
conflict-of-interest policies and procedures mandated under section 
4d(c) and the proposed rule. Such specificity will promote consistency 
and certainty in the marketplace. Further, by maintaining consistency--
to the extent warranted--the Commission believes that the final rule 
will minimize disruption to the marketplace.
e. Exception for FCMs If Engaged in Only a de minimis Amount of 
Proprietary Trading
    Proposed Sec.  1.71 did not set forth a de minimis exception for 
FCMs. Nonetheless, the Commission received a comment from Newedge, 
which argued that FCMs engaging in minimal proprietary trading should 
not be subject to the provisions relating to research analysts. The 
commenter stated that the proposed rule would impose unnecessary 
burdens, and that a firm that engages in only limited proprietary 
trading does not present a risk of conflicts of interest.
    Having considered the comment, the Commission does not believe it 
appropriate to modify the proposed rule on this issue. The imposition 
of a de minimus exception to the conflicts rule is inconsistent with 
the statutory directive that Congress set forth in section 732 of the 
Dodd-Frank Act, which does not distinguish between proprietary trading 
and trading for the accounts of customers. Moreover, the limited nature 
of a firm's proprietary trading does not serve to negate the issues 
intended to be addressed through the statutory mandate.
f. Lack of Examples of Research-Related Conflicts of Interest in the 
Futures Industry
    Proposed Sec.  1.71 did not cite specific examples of conflicts of 
interest in the futures industry, nor did it discuss the prevalence of 
conflicts in the industry. Nonetheless, the Commission received 
comments relating to those issues. K&L Gates LLP (on behalf of 
Peregrine Financial Group Inc.) commented that the Commission failed to 
cite any evidence of conflicts of interest arising from the publication 
of research reports. NFA commented that it had issued guidance 
prohibiting a FCM or IB from trading in a security futures product in 
anticipation of the issuance of a related research report, but that the 
commenter was unaware of any instances of conflicts of interest in 
research reports of security futures products. Further, Senator Carl 
Levin commented that the Commission should encourage compliance by 
developing examples of potential or actual conflicts of interest that 
should be disclosed to investors.
    After considering the comments, the Commission has decided not to 
modify

[[Page 20150]]

the proposed rule on this issue. Section 732 of the Dodd-Frank Act 
directed the Commission to take certain actions concerning conflict-of-
interest policies and procedures. Specifically, as noted in the 
preamble of proposed Sec.  1.71, section 732 ``requires, in relevant 
part, that FCMs and IBs implement conflicts of interest systems and 
procedures that `establish structural and institutional safeguards to 
ensure that the activities of any person within the firm relating to 
research or analysis of the price or market for any commodity are 
separated by appropriate informational partitions within the firm from 
the review, pressure, or oversight of persons whose involvement in 
trading or clearing activities might potentially bias the judgment or 
supervision of the persons.''' This statutory language draws heavily 
from section 15D of the Securities Exchange Act, which was established 
through the Sarbanes-Oxley Act of 2002. The Commission believes that 
the provisions of the proposed rule relating to conflicts of interest 
represent a prudent implementation of the statutory directive.
    As noted above, the regulatory requirements promulgated pursuant to 
section 15D--which are similar to the requirements contained in the 
rule--are now well-established in the financial industry. Given the 
similarities in statutory language, coupled with the well-established 
principles set forth in NASD Rule 2711, the Commission believes that 
the proposed rule will promote consistency and certainty, while 
minimizing disruption, in the marketplace. With respect to Senator 
Levin's recommendation that the Commission should develop examples of 
potential or actual conflicts of interest, the Commission notes the 
many examples cited in Senator Levin's comment letter,\27\ but declines 
to provide additional examples so as not to pre-judge the scope of 
possible future enforcement actions.
---------------------------------------------------------------------------

    \27\ See, e.g., SEC Fact Sheet on Global Analyst Research 
Settlements, SEC (Apr. 28, 2003), available at http://www.sec.gov/news/speech/factsheet.htm; Hans G. Heidle and Xi Li, Is There 
Evidence of Front-Running Before Analyst Recommendations? An 
Analysis of the Quoting Behavior of Nasdaq Market Makers, Nov. 10, 
2003, available at http://www.afajof.org; Joint Report by NASD and 
the NYSE On the Operation and Effectiveness of the Research Analyst 
Conflict of Interest Rules (Dec. 2005), available at http://www.finra.org/Industry/Issues/ResearchAnalystRules/.
---------------------------------------------------------------------------

g. Restriction on Non-Research Personnel From ``Influencing the 
Content'' of Research Reports--Sec.  23.605(c)(1)(i), Sec.  
1.71(c)(1)(i)
    The proposed rule provided that ``[n]onresearch personnel shall not 
influence the content of a research report of the [SD, MSP, FCM, or 
IB].''
    NFA commented that non-research personnel should be allowed to 
influence the content of a research report under certain circumstances 
and, further, that paragraph (i) should be eliminated from proposed 
Sec.  1.71(c)(1). FIA, ISDA, and SIFMA, in a joint comment, argued that 
the proposed prohibition on ``influencing the content'' should be 
eliminated because it would impair ordinary communications between 
research and non-research personnel. As an alternative, FIA/ISDA/SIFMA 
suggested that non-research personnel should be prohibited only from 
``directing the views and opinions expressed in research reports.'' In 
a separate comment, JP Morgan expressed a general agreement with the 
points raised in the FIA/ISDA/SIFMA letter.
    Better Markets commented that the Commission should clarify and 
further restrict the communications covered by the provisions. 
Specifically, Better Markets argued that Sec.  23.605 and Sec.  1.71 
should be expanded not only to prohibit non-research personnel from 
influencing the content of a research report or any decision to publish 
a research report, but also any decision not to publish a report or to 
refrain from including relevant information.
    Upon consideration of the comments, the Commission agrees with the 
suggestions raised by both FIA/ISDA/SIFMA and Better Markets and is 
incorporating the suggestions into the final rules. Specifically, the 
Commission is modifying both proposed rules to remove the phrase 
``shall not influence the content of a research report'' and replacing 
it with the phrase ``shall not direct a research analyst's decision to 
publish a research report of the [SD, MSP, FCM, or IB], and non-
research personnel shall not direct the views and opinions expressed in 
a research report'' The Commission believes that the changes 
accommodate the concerns raised by the commenters while still 
reflecting the intent of the proposed rules.
h. Restriction on Research Analyst Supervision by Business Trading Unit 
or Clearing Unit--Sec.  23.605(c)(1)(ii), Sec.  1.71(c)(1)(ii)
    The proposed rules provided that ``[n]o research analyst may be 
subject to the supervision or control of any employee of the [SD's, 
MSP's, FCM's, or IB's] business trading unit or clearing unit, and no 
personnel engaged in pricing, trading or clearing activities may have 
any influence or control over the evaluation or compensation of a 
research analyst.''
    FIA, ISDA, and SIFMA, in a joint comment, suggested that the 
Commission limit the scope of the rules, whereby employees of business 
trading and clearing units would be prohibited only from acting as 
direct supervisors of research analysts. In a separate comment, JP 
Morgan expressed a general agreement with the points raised in the FIA/
ISDA/SIFMA letter.
    Upon reviewing the comment, the Commission has decided not to 
change the language of the proposed rules in the manner suggested by 
the commenter. Any influence on research analysts by non-research 
senior management responsible for pricing, trading, or clearing 
activities would undermine the conflict-of-interest requirements 
mandated by new sections 4d(c) and 4s(j)(5) of the CEA and set forth in 
the rules. However, the Commission has determined it appropriate to 
clarify the language of the rules, as they had been originally 
proposed, by using the defined terms ``business trading unit'' and 
``clearing unit'' to designate those personnel who may not have 
influence or control over the evaluation or compensation of a research 
analyst.
i. Trading Ahead of Research Report Publication
    Proposed Sec.  1.71 did not expressly impose restrictions against 
trading ahead of the publication of a research report. Senator Carl 
Levin commented that the Commission should add provisions akin to FINRA 
Rule 5280 (Trading Ahead of Research Reports) in order to improve the 
quality of research reports and the integrity of the marketplace. The 
Commission observes that it did not propose a trading ahead prohibition 
in its original proposals. However, the Commission believes that the 
restrictions on communications already included in the rules will 
minimize the opportunities for such activities to take place.\28\ 
Moreover, the Commission will continue to monitor

[[Page 20151]]

this issue and may incorporate such a restriction in a future 
rulemaking.
---------------------------------------------------------------------------

    \28\ The Commission also notes that depending on the facts and 
circumstances, improperly trading ahead or front running 
counterparty orders may constitute fraudulent, deceptive or 
manipulative conduct under sections 4b and 6(c)(1) of the CEA, and 
Sec.  180.1 of Commission regulations, among other fraudulent, 
deceptive, and manipulative practices protections under the CEA and 
Commission regulations.
---------------------------------------------------------------------------

j. Requirement That Legal/Compliance Personnel Supervise Communication 
Between Research and Non-Research Personnel--Sec.  23.605(c)(1)(iv)
    The proposed rule permitted non-research personnel to review a 
research report before its publication ``as necessary only to verify 
the factual accuracy of information in the research report, to provide 
for non-substantive editing, to format the layout or style of the 
research report, or to identify any potential conflicts of interest.'' 
However, such review (1) may only be conducted through authorized legal 
or compliance personnel, and (2) must be properly documented.
    EEI commented that the Commission should exempt communications that 
are factual in nature from oversight by legal and compliance personnel, 
positing that coverage of such communications would hinder 
unnecessarily the development of research reports and unnecessarily 
burden legal/compliance personnel.
    After considering the comment, the Commission has decided to 
promulgate the rule as it was originally proposed. The Commission 
believes that involvement by legal or compliance personnel in such 
communications will reduce significantly the risk that non-research 
personnel will act in an unlawful manner, inadvertently or otherwise.
k. Restrictions on Research Analyst Communications--Sec.  23.605(c)(2), 
Sec.  1.71(c)(2)
    The proposed rules provided that ``[a]ny written or oral 
communication by a research analyst to a current or prospective 
counterparty, or to any employee of the [SD, MSP, FCM, or IB], relating 
to any derivative must not omit any material fact or qualification that 
would cause the communication to be misleading to a reasonable 
person.''
    FIA, ISDA, and SIFMA, in a joint comment, argued that the proposed 
rule would burden an affected firm's operations--especially firms with 
foreign offices--and suggested that internal communications within a 
firm should be exempt from the material facts or qualifications 
required to be communicated to prospective and current customers. FIA/
ISDA/SIFMA further noted that neither NASD Rule 2210 nor similar SRO 
rules contain equivalent restrictions, and that firms should be 
permitted to consider the nature of the audience when assessing whether 
a particular communication is misleading. FIA/ISDA/SIFMA also argued 
that the phrase ``or to any employee'' should be struck from proposed 
Sec. Sec.  23.605(c)(2) and 1.71(c)(2). In a separate comment, JP 
Morgan expressed general agreement with the points raised in the FIA/
ISDA/SIFMA letter.
    Upon review of the comments, the Commission has determined it 
appropriate to change the rules to eliminate restrictions on 
communications to employees of an SD, MSP, FCM, or IB. The Commission 
believes that by deleting the phrase ``or to any employee of the [SD, 
MSP, FCM, or IB],'' the cost concerns implicated by requiring 
registrants to monitor internal communications will be addressed 
without producing a materially adverse impact on the effectiveness of 
the rules. To the extent that commenters stated that firms should be 
permitted to consider the nature of the audience when assessing whether 
a particular communication is misleading, the Commission notes that 
such matters will be governed by the Commission's existing anti-fraud 
standards.
l. Restriction on Influence of Business Trading Unit and Clearing Unit 
on Research Analyst Compensation--Sec.  23.605(c)(3), Sec.  1.71(c)(3)
    Proposed Sec. Sec.  23.605(c)(3) and 1.71(c)(3) provided that an 
SD, MSP, FCM, or IB ``may not consider as a factor in reviewing or 
approving a research analyst's compensation his or her contributions to 
the [SD's, MSP's, FCM's, or IB's] trading or clearing business'' and 
that ``[n]o employee of the business trading unit or clearing unit of 
the [SD, MSP, FCM, or IB] may influence the review or approval of a 
research analyst's compensation.''
    FIA, ISDA, and SIFMA, in a joint comment, contended that research 
management should be able to solicit input from business trading and 
clearing unit personnel, particularly as non-research personnel may be 
in a better position to receive feedback from clients concerning the 
performance of research personnel. FIA/ISDA/SIFMA suggested that the 
Commission exempt from Sec. Sec.  23.605(c)(1)(ii) and 1.71(c)(1)(ii) 
any personnel who occupy non-trading or non-clearing positions, and who 
are not employed in the business trading or clearing units. FIA/ISDA/
SIFMA, as well as Newedge, further argued that research management 
decisions concerning the performance evaluation of research analysts 
should be subject to firm-wide compensation guidelines, as long as they 
are non-discriminatory and non-prejudicial. In a separate comment, JP 
Morgan expressed a general agreement with the points raised in the FIA/
ISDA/SIFMA letter. Newedge complained of a lack of clarity as to which 
personnel of a firm engaged exclusively or substantially in clearing 
activities, and not proprietary trading, would be available to 
supervise and evaluate research analysts. Newedge also argues that 
senior officers and employees of departments other than business 
trading and clearing units should be allowed to have input on 
compensation decisions.
    Michael Greenberger argued that research management should be 
prohibited from soliciting any input of business trading and clearing 
units concerning a research analyst's compensation or performance 
evaluation, even if the influence is indirect or if research management 
maintains the ability to make all final decisions on such 
determinations. Better Markets commented that the provision should be 
broadened. For example, Better Markets argued that a research analyst's 
contribution to the trading business of an affiliate should be 
prohibited from being considered when determining compensation. The 
commenter further noted that, in addition to prohibiting a research 
analyst's contributions to the trading business from being considered 
in respect of an analyst's compensation, ``consideration of adverse 
effects on such trading business'' must be also prohibited from being 
considered.
    After considering the comments, the Commission has determined it 
appropriate to change the language as set forth in the original 
proposal. As revised, the rules permit personnel of a business trading 
unit or clearing unit to forward communications by a client or customer 
to research department management, to the extent that such 
communications relate to feedback, ratings, and other indicators of a 
research analyst's performance provided by the client or customer. The 
Commission believes that the change will address certain concerns 
raised by FIA/ISDA/SIFMA and Newedge while not detracting from the 
policy goals underlying the provision. Beyond that change, the 
Commission has decided not to modify further the language that was 
originally proposed. Maintaining a firewall around research analyst 
compensation decisions is crucial to implementing effective conflict-
of-interest policies and procedures. Nonetheless, to address an issue 
raised by FIA/ISDA/SIFMA, the Commission wishes to clarify the intent 
of the rule. Specifically, the rule is not intended to prohibit 
management decisions concerning the performance evaluation of research 
analysts from being subject

[[Page 20152]]

to firm-wide compensation guidelines, as long as they are non-
discriminatory and non-prejudicial.
m. Relevance of a Promise of Favorable Research to Futures Market--
Sec.  1.71(c)(4)
    As proposed, Sec.  1.71(c)(4) prohibits an FCM or IB from 
``directly or indirectly offer[ing] favorable research, or 
threaten[ing] to change research, to an existing or prospective 
customer as consideration or inducement for the receipt of business or 
compensation.'' K&L Gates LLP (on behalf of Peregrine Financial Group 
Inc.) commented that the provision may be relevant in the context of 
research on a particular company, but it has no relevance in terms of a 
report on soybeans or the Euro.
    After reviewing the comment, the Commission has decided not to 
modify the proposed rule on this issue. The Commission believes that 
the provision appropriately addresses the statutory directive and is an 
important component of firewall protection. Moreover, inclusion of this 
provision will maintain consistency with the conflict-of-interest 
provisions proposed for SDs and MSPs.
n. Disclosure of Conflicts by Research Analysts in Research Reports and 
Public Appearances--Sec.  23.605(c)(5), Sec.  1.71(c)(5)
    Proposed Sec. Sec.  23.605(c)(5)(i) and 1.71(c)(5)(i) required that 
an SD, MSP, FCM, or IB ``disclose in research reports and a research 
analyst must disclose in public appearances: (1) Whether the research 
analyst maintains, from time to time, a financial interest in any 
derivative of a type that the research analyst follows, and the general 
nature of the financial interest; and (2) any other actual, material 
conflicts of interest of the research analyst or [SD, MSP, FCM, or IB] 
of which the research analyst has knowledge at the time of publication 
of the research report or at the time of the public appearance.''
    FIA, ISDA, and SIFMA, in a joint comment, argued that Sec. Sec.  
23.605(c)(5)(i) and 1.71(c)(5)(i) should be limited to disclosing 
whether a research analyst maintains a relevant financial interest ``at 
the time of publication of the report/time of public appearance,'' 
rather than the phrase ``from time to time.'' FIA/ISDA/SIFMA also 
contended that the phrase ``any other actual, material conflict of 
interest of the research analyst'' is vague and would be burdensome to 
implement, requiring coordination among various business units and the 
creation of special databases in order to comply with the rule. In a 
separate comment, JP Morgan expressed a general agreement with the 
points raised in the FIA/ISDA/SIFMA letter. NFA also commented on the 
difficulty for FCMs to remain current on an analyst's financial 
interests, and that the Commission should clarify that the term ``of a 
type that the research analyst follows'' (Sec.  1.71(c)(5)(i)) refers 
to interest rate swaps, credit swaps, equity swaps, and other commodity 
swaps, consistent with the characterization of swaps set forth in the 
Commission's proposed product definitions.
    Senator Carl Levin commented that the Commission should use this 
rule not only to ensure the integrity of research reports, but also to 
impose a broader duty on FCMs and IBs to more completely disclose any 
adverse interest. The commenter suggested that the rule should prohibit 
firms from betting on the failure of instruments they designed and sold 
to customers.
    EEI suggested that the Commission modify the proposed rule to 
provide a de minimis exception from the research analyst financial 
interest disclosure requirements, and that a research analyst should be 
required only to identify relevant financial interests.
    Upon review of the comments, the Commission is modifying the 
language of Sec. Sec.  23.605(c)(5) and 1.71(c)(5) to remove the phrase 
``from time to time.'' The Commission believes that this change will 
address the issue raised by FIA/ISDA/SIFMA. However, the Commission has 
determined that a de minimus exception would be inappropriate given the 
difficulty of deciding when a financial interest is de minimis in this 
context. Further, the Commission believes that the cost concerns of 
FIA/ISDA/SIFMA are misplaced. The rules require disclosure of ``any 
other actual, material conflicts of interest of the research analyst or 
[SD or MSP] of which the research analyst has knowledge at the time of 
publication of the research report or at the time of the public 
appearance'' (emphasis added).\29\ Thus, the disclosure requirement is 
limited to conflicts of which the research analyst has knowledge, and 
the SD, MSP, FCM, or IB need not construct the databases suggested by 
FIA/ISDA/SIFMA in order to comply with the rule.
---------------------------------------------------------------------------

    \29\ The Commission notes that in an action brought for failure 
to disclose a material conflict of interest of an SD or MSP in a 
research report or public appearance, the onus will be on the SD or 
MSP to show that they had policies and procedures reasonably 
designed to ensure that the research analyst had no knowledge of the 
material conflict of interest of the SD or MSP.
---------------------------------------------------------------------------

o. Disclosure of Conflicts in Third-Party Research Reports--Sec.  
23.605(c)(5)(iv), Sec.  1.71(c)(5)(iv)
    As proposed, Sec. Sec.  23.605(c)(5)(iv) and 1.71(c)(5)(iv) 
required that if an SD, MSP, FCM, or IB distributes or makes available 
third-party research reports, each report must be accompanied by 
certain disclosures or an internet link to the appropriate disclosures, 
subject to certain conditions and qualifications.
    EEI argued that the required disclosures are unnecessary because 
third-parties are, by definition, independent of an SD or MSP. FIA, 
ISDA, and SIFMA, in a joint comment, stated that it was unclear what 
disclosures must be made in connection with the distribution of 
independent third-party research reports, given that, by definition, 
the SD, MSP, FCM, or IB has no role in the content or creation of an 
``independent third-party research report.'' In a separate comment, JP 
Morgan expressed a general agreement with the points raised in the FIA/
ISDA/SIFMA letter.
    Upon review of the comments, the Commission is adopting the rule as 
proposed. Third-party research reports provided by a registrant may be 
interpreted by recipients as carrying the endorsement of the registrant 
and may present conflicts-of-interest issues in the same way as 
research reports originating with the registrant's own research 
analysts. The Commission believes that the disclosures will afford 
recipients with a clear understanding of conflicts posed by a 
particular report.
p. Application of Proposed Research Conflicts Rules to Research Reports 
Covering Derivatives and Securities
    The proposed rules and accompanying preambles did not address how 
the proposed requirements would apply to research reports that contain 
information that is subject to the rule and information that is 
securities-related.
    FIA, ISDA, and SIFMA, in a joint comment, questioned how Sec.  
23.605 and Sec.  1.71 would apply to a research report that addresses 
multiple products (i.e., both derivatives and securities), or to a 
report discussing a product that may be a derivative, security, or 
both. FIA/ISDA/SIFMA suggested that only the derivatives section of a 
report discussing securities and derivatives should be subject to the 
proposed regulations. In a separate comment, JP Morgan expressed a 
general agreement with the points raised in the FIA/ISDA/SIFMA letter.
    Upon review of the comments, the Commission has decided not to 
change

[[Page 20153]]

the language that was originally proposed. To the extent that 
securities underlie the derivatives discussed in the report, or to the 
extent that securities are otherwise intertwined with the discussion of 
derivatives, the Commission believes that any such discussion of 
securities should be subject to the Commission's rules. SDs, MSPs, 
FCMs, and IBs will be registered with the Commission, and the swaps and 
futures in which they transact will be within the Commission's 
jurisdiction. Because the value of each swap and future intrinsically 
may be based on the value of one or more underlying instruments, 
research reports by SDs, MSPs, FCMs, or IBs that analyze such 
underlying instruments should be addressed by the conflict-of-interest 
policies and procedures mandated under sections 4d(c) and 4s(j)(5) of 
the CEA.
q. Application of Proposed Research Conflicts Rules to Research 
Analysts Covering Derivatives and Securities
    The proposed rules and accompanying preambles did not address how 
the proposed requirements would apply to research analysts that work 
with derivatives subject to the Commission's rules and securities 
subject to rules promulgated by the SEC or FINRA.
    FIA, ISDA, and SIFMA, in a joint comment, queried how the rule 
would apply to research analysts registered with both futures and 
securities regulators. FIA/ISDA/SIFMA suggested that the Commission 
confirm that individuals subject to both Sec.  23.605 or Sec.  1.71 and 
securities regulations must only comply with Sec.  23.605 or Sec.  1.71 
when acting in the capacity as a ``research analyst,'' as defined by 
Sec.  23.605 or Sec.  1.71. FIA/ISDA/SIFMA also raised concerns with 
respect to inconsistencies between Sec. Sec.  23.605 and 1.71 and other 
rules promulgated in the securities or futures context. In a separate 
comment, JP Morgan expressed a general agreement with the points raised 
in the FIA/ISDA/SIFMA letter.
    Having considered the comments, the Commission confirms that 
individuals subject to both Sec.  23.605 or Sec.  1.71 and securities 
regulations must only comply with Sec.  23.605 or Sec.  1.71 when 
acting in the capacity of a ``research analyst,'' as defined by Sec.  
23.605 or Sec.  1.71. SDs, MSPs, FCMs, and IBs will be registered with 
the Commission, and the swaps and futures in which they transact will 
be within the Commission's jurisdiction. Because the value of each swap 
and future intrinsically may be based on the value of one or more 
underlying instruments, research reports by SDs, MSPs, FCMs, and IBs 
analyzing such underlying instruments should be addressed by the 
conflict-of-interest policies and procedures mandated by new sections 
4d(c) and 4s(j)(5) of the CEA.
7. Clearing Activities--Sec.  23.605(d), Sec.  1.71(d)
a. Separation of Clearing Unit From Business Trading Unit--Sec.  
23.605(d)(1) and (2); Separation of Business Trading Unit and Clearing 
Unit--Sec.  1.71(d)(1) and (2)
    As proposed, Sec.  23.605(d)(1) provided that ``[n]o [SD] or [MSP] 
shall directly or indirectly interfere with or attempt to influence the 
decision of any affiliated clearing member of a [DCO] with regard to 
the provision of clearing services and activities,'' while proposed 
Sec.  1.71(d)(1) congruently provided that ``[n]o [FCM] shall permit 
any affiliated [SD] or [MSP] to directly or indirectly interfere with, 
or attempt to influence, the decision of the clearing unit personnel of 
the [FCM] with regard to the provision of clearing services and 
activities. * * *''
    Likewise, proposed Sec.  23.605(d)(2) provided that ``[e]ach [SD 
and MSP] shall create and maintain an appropriate informational 
partition, as specified in section 4s(j)(5)(A) of the Act, between 
business trading units of the [SD or MSP] and clearing member personnel 
of any affiliated clearing member of a [DCO],'' while proposed Sec.  
1.71(d)(2) congruently provided that ``[e]ach [FCM] shall create and 
maintain an appropriate informational partition between business 
trading units of an affiliated [SD] or [MSP] and clearing unit 
personnel of the [FCM].''
    MFA commented that it supports the prohibition of SDs and MSPs from 
directly or indirectly interfering with, or attempting to influence, 
the decision of any affiliated clearing member of a DCO with regard to 
clearing services and activities, as well as the informational 
partitions between business trading personnel and personnel of an 
affiliated clearing member. Pierpont Securities Holdings LLC also 
supported the Commission's proposals, contending that the informational 
partitions between a business trading unit and a clearing unit within a 
large financial institution must be established and maintained as to 
all personnel, not just supervisory personnel, and the penalties for 
violating those restrictions must be meaningful.
    Swaps and Derivatives Market Association filed two comments on 
these rules, both of which were supportive of the proposals. In the 
first comment, the commenter argued that the proposed separation of 
trading and clearing units in Sec.  23.605(d) should be expanded so as 
to require ``distant physical separation'' of the two. The commenter 
also expressed support for requiring the use of objective criteria in 
determining whether to accept clearing customers. In the second letter, 
the commenter contended that the restrictions set forth in Sec.  
23.605(d), as proposed, correctly address key areas where conflicts 
arise, and that the independence of clearing members is essential to 
accomplish several policy goals of the Dodd-Frank Act. In the second 
comment, the commenter stated its belief that the firewalls mandated by 
the proposed rules ``are critical to reducing potential conflicts 
between the trading unit of an FCM, IB, SD, or MSP and their clearing 
unit.''
    Michael Greenberger also expressed support for Sec.  23.605(d), as 
proposed, noting that attempts to tie clearing decisions to trade 
execution decisions would raise potential conflicts of interest, which 
could serve to block access to clearing and prevent competition among 
execution venues. The commenter also noted that mandatory public 
disclosure of client acceptance criteria by SDs and MSPs is consistent 
with legislative intent. Likewise, Pierpont Securities Holdings LLC 
also expressed support for the Commission's proposal, in particular the 
requirements that no direct or indirect interference or influence be 
permitted by the business trading unit on the clearing unit as to (i) 
whether clearing services will be provided and (ii) how clearing fees 
will be set.
    The Principal Traders Group supported a rule preventing 
interference by the business trading unit of an SD or MSP, with respect 
to the decision of an affiliated FCM to accept a client for clearing 
services, but preferred that the rule be presented in the form 
recommended by FIA/ISDA/SIFMA below.
    In contrast, FIA, ISDA, and SIFMA, in a joint comment, commented 
that the proposed rules would alter the business operations of 
integrated financial services firms to the detriment of clients and in 
a manner disproportionate to achieving the regulatory goals the 
Commission has identified, including the promotion of effective risk 
management. The commenters also argued that the Commission's proposed 
application of the conflicts rules to FCM clearing activities is not 
contemplated by section 732 of the Dodd-Frank Act. FIA/ISDA/SIFMA 
argued that the proposed rules would impair an SD's/MSP's ability to 
follow risk management best practices. FIA/ISDA/SIFMA

[[Page 20154]]

recommended that the Commission not adopt the proposed rules, but 
instead adopt a rule that prohibits an affiliated SD or MSP from 
obtaining information from an affiliated FCM's clearing personnel 
concerning transactions conducted by FCM clients with either their own 
clients or with independent SDs or MSPs. FIA/ISDA/SIFMA also expressed 
support for a rule that would require each FCM's clearing unit to have 
independent management that makes its own final decisions regarding 
clients to which it will offer clearing services as well as the terms 
for those services. FIA/ISDA/SIFMA also suggested that the Commission 
clarify that the rule does not mandate that firms publicize client 
sales and on-boarding decisions.
    UBS Securities LLC echoed certain points made in the FIA/ISDA/SIFMA 
comment, particularly with respect to the ability of a financial 
services firm to operate its swap clearing business as a partnership 
with its trading business in order to serve clients, while JP Morgan 
agreed with the FIA/ISDA/SIFMA comment discussed above. JP Morgan also 
posited that while ``it would be appropriate for the CFTC to issue 
rules prohibiting any activity intended to restrict open access to 
clearing, * * * we believe a SD/MSP should be permitted to work and 
share information with its clearing member affiliate to promote and 
facilitate a client's access to clearing services or to define the 
parameters pursuant to which clearing services will be offered.''
    The FHLBs argued that the proposed rule goes beyond the standards 
set forth in the Dodd-Frank Act and that the proposed rule ``overly 
restricts the ability of [SDs and MSPs] to run their trading and 
clearing operations and effectively service the needs of their end-user 
counterparties.'' The proposed rule also could inhibit SDs and MSPs 
``from taking prudent, well-informed and timely actions in situations 
with respect to the closing out of transactions, in a default scenario 
or otherwise.''
    NFA commented that Sec.  1.71(d) is too broad and may negatively 
impact a firm's ability to share information about customers to make 
credit and risk determinations. UBS Securities LLC echoed certain of 
the points made in the FIA/ISDA/SIFMA comment, particularly with 
respect to the ability of a financial services firm to operate its swap 
clearing business as a partnership with its trading business in order 
to serve clients. Newedge commented that the proposed rule would limit 
firms' ability to coordinate, credit, risk, and other policies, and 
suggested that rather than prohibiting an affiliated SD or MSP from 
interfering with a FCM's decision to provide clearing services, Sec.  
1.71(d) should prohibit a FCM from permitting business trading unit 
personnel of an affiliated SD or MSP from interfering with the FCM's 
decision to provide clearing services.
    Commenters have expressed divergent views on this issue, with some 
commenters strongly favoring the Commission's proposed rules (and, to a 
certain extent, requesting that the rule be expanded), while others 
have advocated that the provision not be adopted. Upon consideration of 
all the comments, the Commission has determined it appropriate to 
promulgate the rules largely as they were originally proposed. The 
separation of the FCM clearing unit from the interference or influence 
of an affiliated SD or MSP is crucial to promoting open access to 
clearing. Open access to clearing will be essential for the expansion 
of client clearing needed for market participants to comply with the 
mandatory clearing of swaps as determined by the Commission under 
section 723 of the Dodd-Frank Act. The Commission believes that the 
promulgation of the language as proposed would be ``appropriate,'' as 
that term is used in section 4d(c) as amended by section 732 of the 
Dodd-Frank Act. Moreover, the Commission does not believe the rule will 
hamper risk management. The Commission notes that it has proposed 
straight-through processing rules,\30\ counterparty clearing 
documentation rules,\31\ and clearing member risk management rules \32\ 
that would, if adopted, minimize the counterparty risk to an SD or MSP 
with respect to transactions required or intended to be cleared.
---------------------------------------------------------------------------

    \30\ See Requirements for Processing, Clearing, and Transfer of 
Customer Positions, 76 FR 13101, 13109 (Mar. 10, 2011).
    \31\ See Customer Clearing Documentation and Timing of 
Acceptance for Clearing, 76 FR 45730, 45737 (Aug. 1, 2011).
    \32\ See Clearing Member Risk Management, 76 FR 45724, 45729 
(Aug. 1, 2011).
---------------------------------------------------------------------------

    In response to commenters' concerns about an FCM's ability to 
manage a default scenario without the benefit of the trading expertise 
in the business trading unit, the Commission is modifying proposed 
Sec.  1.71(d)(2)(i) to permit the business trading unit of an 
affiliated SD or MSP to participate in the activities of an FCM during 
an event of default. Specifically, the business trading unit personnel 
would be permitted to participate in the activities of the FCM, as 
necessary, during any default management undertaken by a derivatives 
clearing organization that results from an event of default and for the 
purposes of transferring, liquidating, or hedging any proprietary or 
customer positions as a result of an event of default.
    In addition, the Commission is including the term ``clearing 
unit,'' as defined in Sec.  23.605(a), in the relevant provisions of 
Sec.  23.605(d). This change will serve to clarify the scope of the 
informational partition between the SD or MSP and the personnel or 
division of a clearing member responsible for the provision of clearing 
services.
    To clarify an issue raised by FIA/ISDA/SIFMA, the Commission notes 
that SDs and MSPs are not required to publicize their client sales and 
on-boarding decisions; rather, the criteria used in making those 
decisions should be publicly available and objective. In other words, 
``all such decisions regarding the acceptance of customers for clearing 
should be made in accordance with publicly disclosed, objective, 
written criteria,'' as stated in the preamble of the proposed rule.
b. Division of Clearing Unit Into Self-Clearing Unit and Customer 
Clearing Unit
    The proposed rules did not distinguish between a self-clearing unit 
(clearing for an SD's or MSP's own trades) and a customer clearing unit 
(clearing for customers and competitors). However, Swaps and 
Derivatives Market Association commented that the proposed rules should 
differentiate between the two units. Having considered that comment, 
the Commission has decided not to modify the language in the manner 
suggested by the commenter. The Commission believes that subdividing 
the clearing unit into two separate sub-units would create an 
unnecessary complication that could erode the firewall mandated by the 
statute.
c. Prohibition on Business Unit Personnel of an SD or MSP From 
Supervising Personnel of an Affiliated DCO-Clearing Member--Sec.  
23.605(d)(2); Restrictions on SD and MSP Business Trading Unit 
Supervision of Clearing Unit of Affiliated FCM--Sec.  1.71(d)(2)(ii)
    As proposed, Sec.  23.605(d)(2) provided that, at a minimum, the 
Sec.  23.605(d)(2) informational partitions ``shall require that no 
employee of a business trading unit of a [SD] or [MSP] shall supervise, 
control, or influence any employee of a clearing member of a 
derivatives clearing organization,'' while proposed, Sec.  
1.71(d)(2)(ii) congruently provided that ``[n]o employee of a business 
trading unit of an affiliated [SD] or [MSP] shall supervise, control, 
or

[[Page 20155]]

influence any employee of a clearing unit of the [FCM].''
    FIA, ISDA, and SIFMA, in a joint comment, posited that because 
employees of a business trading unit and a clearing unit may be 
supervised by the same manager, Sec. Sec.  23.605(d)(2) and 
1.71(d)(2)(ii) should be amended to prohibit an employee of an SD or 
MSP from acting as a direct supervisor of any non-management personnel 
of an affiliated FCM's clearing unit. The commenter also suggested that 
salespeople be permitted to associate with an SD or MSP and with an 
affiliated FCM, and be permitted to act for clients at both entities. 
Further, the commenter argued that a carve-out should be added to 
Sec. Sec.  23.605(d) and 1.71(d) enabling an SD parent to exercise risk 
management over its affiliated FCM (e.g., approving credit and risk 
parameters for common and distinct customers) in a manner that is non-
discriminatory, non-prejudicial, and for the sole purpose of complying 
with group risk and credit policies and parameters. In a separate 
comment, JP Morgan expressed a general agreement with the points raised 
in the FIA/ISDA/SIFMA letter.
    After reviewing the comment, the Commission has decided to adopt 
the rule with certain modifications. Any influence on clearing unit 
personnel by upper-level supervisors involved in business trading unit 
activities would undermine the conflict-of-interest requirements 
mandated by new sections 4d(c) and 4s(j)(5) of the CEA, as amended by 
sections 731 and 732 of the Dodd-Frank Act, respectively, and set forth 
in the rule. Moreover, the Commission does not believe that the rule 
language should be changed to permit sales personnel to act for both 
the trading unit and the clearing unit. The risks associated with this 
approach, in terms of potential undue influence and interference with 
clearing decisions has been well-supported by commenters, as discussed 
above.
    With regard to proposed Sec.  1.71(d), the Commission is making 
certain changes to clarify the intent of the rule. In particular, Sec.  
1.71(d)(1)(vi) is modified to prohibit an affiliated SD or MSP from 
interfering with or influencing decisions related to setting a 
particular customer's fees for clearing services based upon criteria 
that are not generally available and applicable to other customers of 
the FCM. Additionally, as proposed Sec.  1.71(d)(2)(i) required that 
the informational partitions between the business trading unit of the 
affiliated SD or MSP and the clearing unit personnel of the FCM include 
a prohibition on any business trading unit personnel participating in 
any way with the provision of clearing services. As modified, the rule 
clarifies that business trading unit personnel may not condition or tie 
the provision of trading services to the provision of clearing services 
or otherwise participate in clearing services by improperly 
incentivizing or encouraging the use of the affiliated FCM.\33\ In 
addition, as discussed above, business trading unit personnel would be 
permitted to participate in the activities of the FCM in the event of a 
default.
---------------------------------------------------------------------------

    \33\ The Commission generally would not view as ``improper'' 
making available discounted clearing services in connection with 
trading activities, provided that the business trading unit 
personnel comply with applicable prohibitions and restrictions on 
their interactions with the clearing unit. The Commission emphasizes 
in this regard that in Sec.  1.71(d)(2), the term ``improperly'' 
modifies both the term ``incentivizing'' and the term 
``encouraging'' and that the term ``otherwise'' is intended to 
clarify that other ``improper'' activities, similar to conditioning 
or tying, could be subject to Sec.  1.71(d)(2). Such ``improper'' 
activities are limited to those that wrongfully interfere with, or 
attempt to influence, a decision of the affiliated FCM's clearing 
unit personnel specified in Sec.  1.71(d)(1).
---------------------------------------------------------------------------

8. Undue Influence on Customers--Sec.  1.71(e)
    As proposed, Sec.  1.71(e) mandated that FCMs and IBs ``adopt and 
implement written policies and procedures that mandate the disclosure 
to its customers of any material incentives and any material conflicts 
of interest regarding the decision of a customer as to the trade 
execution and/or clearing of the derivatives transaction.''
    K&L Gates LLP (on behalf of Peregrine Financial Group Inc.) 
commented that existing Commission regulations already impose risk 
disclosure requirements on FCMs and IBs, and that the proposed rule 
inappropriately imports a concept from the securities industry into the 
futures industry.
    Better Markets submitted two comment letters in support of the 
proposal. In the first comment, the commenter suggested that the rule 
should extend to the affiliates of an FCM or IB, and that the 
disclosure should include the nature and amounts of the relevant 
interests. In the second comment, the commenter suggested that the rule 
be expanded so that any incentives received by FCMs or SDs in exchange 
for use of various market infrastructures must be fully disclosed. 
Swaps and Derivatives Market Association submitted a comment supporting 
Sec.  1.71(e), as proposed.
    Having considered the comments, the Commission has determined it 
appropriate to adopt the rule as it was originally proposed. The 
Commission believes that in order to ensure that counterparties are 
adequately informed of any material incentives or conflicts prior to 
the execution of a transaction, it is essential that FCMs and IBs be 
required to adopt and implement written policies and procedures that 
require the advance disclosure of such conflicts. In addition to 
addressing issues of customer protection, the policies and procedures 
will promote consistency with proposed Sec.  23.605(e). Further, to the 
extent that Better Markets commented that the rule should be expanded 
to include disclosures of certain incentives received by FCMs and IBs, 
the Commission believes that the recommendation is beyond the scope of 
this rule.
9. Undue Influence on Customers--Sec.  23.605(e)
    As proposed, Sec.  23.605(e) mandated that SDs and MSPs ``adopt and 
implement written policies and procedures that mandate the disclosure 
to its counterparties of any material incentives and any material 
conflicts of interest regarding the decision of a counterparty: (1) 
Whether to execute a derivative on a swap execution facility or 
designated contract market; or (2) Whether to clear a derivative 
through a derivatives clearing organization.''
    FIA, ISDA, and SIFMA, in a joint comment, noted that the proposed 
rule overlaps with disclosures proposed by the Commission in a separate 
notice of proposed rulemaking.\34\ The commenter argued that the 
provision should be narrowed and, alternatively, that the Commission 
could require SDs and MSPs to provide customers with an annual 
disclosure document describing potential conflicts that may exist among 
the firm, its affiliates, clients, and employees. In a separate 
comment, JP Morgan expressed a general agreement with the points raised 
in the FIA/ISDA/SIFMA letter.
---------------------------------------------------------------------------

    \34\ See Business Conduct Standards for SDs and MSPs with 
Counterparties, 75 FR 80638, 80659 (Dec. 22, 2010).
---------------------------------------------------------------------------

    Better Markets submitted two comment letters addressing the 
provision at issue. In the first comment, the commenter suggested that 
the Commission extend the disclosure requirements in several respects. 
In the second comment, the commenter reiterated its belief that 
incentives of SDs and MSPs received in exchange for use of various 
market infrastructures should be fully disclosed. Michael Greenberger, 
UNITE HERE, and Swaps and Derivatives Market Association each submitted 
comments supporting Sec.  23.605(e), as proposed.

[[Page 20156]]

    After considering the comments, the Commission has determined it 
appropriate to adopt the rule as it was originally proposed. The 
Commission believes that in order to ensure that counterparties are 
adequately informed of any material incentives or conflicts prior to 
the execution of a transaction, it is essential that SDs and MSPs be 
required to adopt and implement written policies and procedures that 
require the advance disclosure of such conflicts. In addition to 
addressing issues of customer protection, the policies and procedures 
will promote the efficient use of trading facilities and DCOs for swap 
transactions, by ensuring that counterparties are adequately informed 
of any material incentives or conflicts of an SD or MSP that could 
impact the execution and clearing decisions of the counterparty.

N. Designation of a Chief Compliance Officer; Required Compliance 
Policies; and Annual Report of an FCM, SD, or MSP

    Section 4d(d) of the CEA, as added by section 732 of the Dodd-Frank 
Act, requires that each FCM designate an individual to serve as its 
chief compliance officer (CCO). Likewise, section 4s(k) of the CEA as 
added by section 731 of the Dodd-Frank Act requires that each SD and 
MSP designate an individual to serve as its CCO. The CCO NPRM proposed 
Sec.  3.3(a) to codify these requirements for FCMs, SDs, and MSPs, and 
prescribed certain qualifications for the position.
    Section 4s(k)(2) of the CEA sets forth certain duties to be 
performed by a CCO of an SD and MSP, and section 4d(d) of the CEA 
requires the Commission to promulgate rules concerning the duties of a 
CCO of an FCM. The CCO NPRM proposed Sec.  3.3(d) to codify the duties 
set forth in section 4s(k)(2) and applied them uniformly to FCMs, SDs, 
and MSPs.
    Section 4s(k)(3) of the CEA requires that the CCO of an SD or MSP 
annually prepare and sign a report containing a description of the 
registrant's compliance with the CEA and regulations promulgated under 
the CEA, and a description of each policy and procedure of the CCO, 
including the code of ethics and conflicts of interest policies. 
Proposed Sec.  3.3([e]) \35\ codified this requirement and applied 
these requirements to CCOs of FCMs as well.
---------------------------------------------------------------------------

    \35\ The proposed regulations misnumbered the subsections of 
Sec.  3.3 such that two subsections were designated as ``(d).'' To 
avoid confusion, this release re-designates such sections correctly 
in brackets.
---------------------------------------------------------------------------

    The Commission received 25 comment letters and Commission staff 
participated in one meeting in response to the CCO NPRM and considered 
each in formulating the final rules.
1. Identical Rules Applicable to SDs, MSPs, and FCMs
    The Commission proposed uniform rules applicable to SDs, MSPs, and 
FCMs.
    Rosenthal Collins Group, LLC (Rosenthal) and Newedge commented that 
Congress did not intend for CCOs of FCMs to be subject to the same 
requirements as CCOs for SDs and MSPs, and it is ``overkill'' for CCOs 
of ``pure'' FCMs to be subject to the same requirements as CCOs of SDs 
and MSPs. However, Rosenthal conceded that an FCM that is also an SD or 
MSP should comply with the more stringent requirements.
    NFA questioned why there was no explanation of the decision to 
extend identical requirements to CCOs of FCMs. NFA argued that it is 
more important to harmonize with FINRA Rule 3010 and FINRA Interpretive 
Material 3010-1, Rule 3012, and Rule 3130 because 55% of FCMs are also 
broker-dealers (BDs) registered with the SEC.
    The FHLBs commented that they are already subject to Federal 
Housing Finance Agency (FHFA) regulation, such as internal control 
systems under 12 CFR 917.6, and requested that the Commission defer to 
this regime because duplicative regulations will not increase 
transparency and may cause some limited SDs to leave the business.
    Better Markets supported extension of the same duties to FCMs 
because of their critical role in the market that will expand 
dramatically with the increased use of clearing. The National Society 
of Compliance Professionals (NSCP) also supported application of 
identical CCO requirements to all registrants, provided the NSCP's 
suggested modifications to the rule were made. The Council of 
Institutional Investors (CII) commented that extending the same duties 
to CCOs of FCMs would be comprehensive and consistent, and may help 
mitigate regulatory uncertainties.
    FIA and SIFMA agreed with NSCP that the CCO requirements for SDs, 
MSPs, and FCMs can be harmonized in an identical regime, provided the 
suggested changes to the rule are made to bring the rule into harmony 
with the traditional financial services compliance model. FIA and SIFMA 
also noted that the more traditional compliance model would be 
consistent with the approach the Commission took with regard to retail 
foreign exchange dealers (RFEDs).\36\
---------------------------------------------------------------------------

    \36\ RFEDs are required to designate a CCO and prepare an annual 
compliance certification under current Commission regulations. See 
17 CFR 5.18(j).
---------------------------------------------------------------------------

    With regard to comments that CCOs of FCMs should be subject to 
different or lesser standards than SDs or MSPs, the Commission notes 
that FCMs are subject to fiduciary duty standards,\37\ and agrees with 
Better Markets that the role of FCMs likely will grow in importance as 
client clearing of swaps increases. The Commission also agrees with CII 
that the Commission has an interest in consistent regulation of its 
registrants. As discussed below, after considering the comments of 
NSCP, FIA, SIFMA, and others, the Commission is making a number of 
changes to the final rule to harmonize the rule to the extent possible 
with the traditional financial services compliance model. Therefore, 
the Commission is not promulgating different rules for FCMs. The 
Commission further notes that whereas the Dodd-Frank Act required that 
FCMs designate CCOs, the Act did not establish a similar requirement 
that BDs must designate CCOs under the securities laws. Accordingly, 
the distinction between treatment of FCMs and BDs has a statutory 
basis.
---------------------------------------------------------------------------

    \37\ See Joint Report of the SEC and the CFTC on Harmonization 
of Regulation at 68 (Oct. 16, 2009), available at www.cftc.gov/PressRoom/PressReleases/pr5735-09 (discussing relevant case law 
establishing a fiduciary duty standard for FCMs).
---------------------------------------------------------------------------

    In response to comments regarding consistency with RFED and FINRA 
rules, the Commission believes that the changes to the rule discussed 
below will broadly harmonize the rule with the standard currently 
applicable to CCOs of RFEDs and the standards applicable to the CCOs of 
BDs.
    The Commission recognizes that there may be some overlap with FHFA 
rules for the FHLBs. However, the Commission believes that the two 
approaches are broadly compatible. For example, the FHFA requires 
senior management to establish and implement an effective system to 
track internal control weaknesses and the actions taken to correct 
them, and to monitor and report to the bank's board on the 
effectiveness of the internal control system, whereas the Commission's 
rule requires the CCO to establish, in consultation with the board or 
the senior officer, procedures for the handling, management response, 
remediation, retesting, and closing of noncompliance issues, and to 
have a meeting with the board or senior officer at least once a year. 
These provisions are compatible if the CCO works in

[[Page 20157]]

consultation with the senior officer (as permitted under Sec.  3.3 as 
adopted) to establish a monitoring system. The board would receive the 
benefit of two views on effectiveness of compliance policies--one from 
managers who implement the policies, and one from a monitor of the 
managers, who is the CCO.
2. Harmonization With CCO Rule of the Financial Industry Regulatory 
Authority (FINRA)
    Although the Commission reviewed and considered the existing FINRA 
rules for BDs' CCOs, the duties and requirements of a CCO under section 
4s(k) of the CEA are far more specific than the general policies, 
procedures, and testing requirements of the FINRA rule. Thus, the 
proposed rule necessarily differed in both form and substance from the 
FINRA rule, which was not mandated by statute.
    FIA and SIFMA argued that the proposal should be harmonized with 
existing precedent for compliance models in the financial services 
industry (such as those applicable to BDs), and that NFA, of which SDs 
and MSPs will be required to be members, should have primary 
responsibility for setting compliance standards.
    Newedge argued that jointly registered BD-FCMs should be able to 
apply the requirements of FINRA Rule 3130, which Newedge considers to 
be better designed, and only comply with the Commission's rules if no 
comparable provision exists in Rule 3130. Newedge also argued that NFA 
has extensive experience dealing with FCM CCOs and is best positioned 
to determine their proper role.
    Rosenthal commented that the substantial experience of FINRA and 
NFA in dealing with conduct and compliance should be relied upon, with 
FINRA Rule 3130 as a guide.
    Market participants \38\ in a May 17, 2011 meeting (May Meeting) 
with Commission staff stated that the Commission's rules differed from 
FINRA's rules in three main ways: resolution vs. mitigation of 
conflicts, the term ``ensure compliance'' in the Commission's rules, 
and whether the CEO or the CCO certifies the annual report. The 
participants also stated that, without revisions to the proposed rule, 
they would be required to prepare two annual reports: one for FINRA and 
one for the Commission.
---------------------------------------------------------------------------

    \38\ Representatives from the SEC and Commission staff met with 
industry participants including representatives of FIA, SIFMA, UBS 
Financial Services, Inc., MF Global, Morgan Stanley, JPMorgan Chase 
& Co., Pershing, Alliance Bernstein, and Newedge USA on May 17, 
2011. See http://comments.cftc.gov/PublicComments/.
---------------------------------------------------------------------------

    Having considered these comments, the Commission has determined it 
is unable to conform the rule fully to match the FINRA standard for 
CCOs of BDs and still meet the statutory requirements of section 4s(k). 
However, the Commission believes the purpose of the rule is 
supplemental to--not contradictory with--the relevant provisions of 
FINRA Rules 3010, 3012, and 3130.
    As explained by commenters, the CCO customarily has acted as an 
advisor, and has not had the ability to enforce compliance policies by 
directing staff or making hiring and firing decisions. By way of 
contrast, new section 4s(k) of the CEA requires that the CCO resolve 
conflicts of interest, be responsible for administering certain 
policies and procedures, and ensure compliance with the CEA. While the 
Commission has attempted to be responsive to the traditional role of 
compliance officers in the financial services industry, the Commission 
does not believe that FINRA's rules provide a model that would 
encompass all of the statutory provisions in section 4s(k). The 
Commission believes, however, that the changes to the rule discussed 
below will broadly harmonize the final rule with FINRA standards and 
allow a CCO of a dual registrant to fulfill the duties required by both 
rules without undue duplication or contradiction.
    Notably, as explained above, the Dodd-Frank Act required that FCMs 
designate CCOs, whereas the Act did not establish a similar requirement 
that BDs must designate CCOs under the securities laws. Accordingly, 
the distinction between treatment of FCMs and BDs has a statutory 
basis.
3. Regulatory Structure
    In the CCO NPRM, the Commission requested comment on whether the 
structure of the proposed rules allows for sufficient flexibility.
    EEI urged the Commission to follow the Federal Energy Regulatory 
Commission's approach by setting forth principles or attributes of an 
effective compliance program while leaving the details to the 
registrant.
    Rosenthal argued that the rule should allow for flexibility because 
the role of a CCO varies, and should not be a ``one size fits all,'' 
while NSCP commented that the proposed rules ``strike an appropriate 
balance'' between aspirational standards and forcing all entities to 
conform to one standard. Cargill commented that if the scope of the 
rules is limited to a registrant's swap dealing division, the 
provisions in the proposed rule are ``in general reasonable and provide 
flexibility so that each swap dealer can apply the general requirements 
to its own business structure.''
    Commodity Markets Council (CMC) requested that the Commission 
clarify whether registration as an SD due to activities in one 
commodity would require compliance obligations for all activities of an 
integrated firm, require compliance obligations on the activities of an 
involved affiliate, or require compliance obligations for just those 
activities in the underlying commodity.
    NFA and the FHLBs commented that the rules should explicitly permit 
the CCO to share any other executive role, such as CEO, to provide 
flexibility for smaller firms. NFA also argued that the rules should 
recognize that compliance expertise may reside with more than one 
individual, and thus the Commission should consider allowing an entity 
to designate multiple CCOs, so that each CCO's primary area of 
responsibility is defined, and each CCO should be required to perform 
duties and responsibilities with respect to their defined area. NFA 
also recommended that CCOs explicitly be permitted to consult with 
other employees, outside consultants, lawyers, and accountants.
    Newedge, Hess Corporation (Hess), and The Working Group argued that 
affiliated FCM/SD/MSPs that are separate legal entities should be 
permitted to share the same CCO to increase compliance efficiency. The 
Working Group also argued that the CCO of affiliated registrants should 
be allowed to report to a board of an affiliated entity that controls 
both entities. Better Markets, on the other hand, commented that a 
senior CCO should have overall responsibility of each affiliated and 
controlled entity, even if individual entities within the group have 
CCOs. Better Markets also recommended that the rule require the CCO 
office to be located remotely from the trading floor.
    In response to EEI's recommendation that the Commission set forth 
general principles akin to those required by FERC, the Commission 
observes that the statutory regime established by Congress would not 
permit such an approach.
    The Commission agrees with commenters that CCOs should be permitted 
to ``wear multiple hats.'' In other words, the Commission confirms that 
a CCO may share additional executive responsibilities and/or be an 
existing officer within the entity. This is particularly appropriate in 
smaller firms, which may lack sufficient scale to employ a stand-alone 
CCO. However, employing a stand-alone CCO may be

[[Page 20158]]

appropriate in a larger firm, depending on the scale of its operations 
and degree of the CCO's responsibilities. Additionally, the Commission 
confirms that nothing in the rules would prohibit multiple legal 
entities from designating the same individual as CCO, but the rule as 
adopted will require the CCO to report to each entity's board or senior 
officer, rather than to the board or senior officer of a consolidated 
corporate parent.
    The Commission has determined not to permit designation of multiple 
CCOs with delineated areas of responsibility because this arrangement 
would not comply with sections 4d(d) and 4s(k) of the CEA, which 
require FCMs, SDs, and MSPs to ``designate an individual to serve as 
chief compliance officer.'' In response to NFA's concern about CCOs 
being able to rely on the expertise of others, the annual report 
certification language in the rule as adopted containing the qualifier 
``to the best of his or her knowledge and reasonable belief'' would 
permit the CCO to rely on other experts for statements made in the 
annual report.
    As previously noted, the Commission is clarifying in the final 
rules that the CCO's duties extend only to the activities of the 
registrant that are regulated by the Commission, namely, swaps 
activities of SDs and MSPs and the derivatives activities included in 
the definition of FCM under section 1(a)(28) of the CEA.
4. Public Availability of the Annual Report
    The Working Group commented that it is likely that the annual 
report will not be considered confidential information protected from 
Freedom of Information Act requests, and could expose registrants to 
legal and reputational risk if made public. The Working Group also 
argued that the report may force firms to make disclosures prior to 
having remedial actions agreed with the Commission and put into effect, 
and could grant valuable insight to competitors. The Working Group 
recommended that the Commission take steps to ensure that the 
information remains confidential and should make explicit that there is 
no private right of action for misstatements and inaccurate content in 
the report. EEI also expressed concern about disclosure of confidential 
or proprietary information if the report would be made public. FIA and 
SIFMA recommended that the Commission make the report nonpublic by 
including it in the list of exempted items in Commission regulation 
Sec.  145.5.
    In response to these comments, the Commission notes that a 
registrant may request confidential treatment under Sec.  145.9 for 
information submitted to the Commission under these regulations. 
Accordingly, an FCM, SD, or MSP must petition for confidential 
treatment of its annual report under Sec.  145.9 if it wants the 
Commission to determine that a particular annual report should be 
subject to confidentiality.
5. Definitions--Sec.  3.1
    Proposed amendments to Part 3 of the Commissions regulations in the 
CCO NPRM added chief compliance officers to the definition of 
``principal'' in Sec.  3.1(a)(1), and added definitions of ``compliance 
policies'' and ``board of directors'' at Sec.  3.1(g) and (h), 
respectively.
a. Definition of ``Principal''--Sec.  3.1(a)(1)
    The proposed regulations modified the definition of ``principal'' 
in Part 3 to include a CCO as an example of a person ``having the 
power, directly or indirectly, through agreement or otherwise, to 
exercise a controlling influence over the entity's activities that are 
subject to regulation by the Commission.''
    Rosenthal argued that declaring the CCO to be a principal adds no 
incentive for qualified individuals to become a CCO because he or she 
could be liable outside his/her area of competence or control. 
Rosenthal also argued that it should be the firm's responsibility to 
comply, with ultimate responsibility for compliance placed with the 
firm's senior management. EEI argued that the proposal is overly 
prescriptive, that requiring the CCO to be a principal would require 
significant changes to current practice, and that the reporting 
structure should be left to each individual firm. On the other hand, 
Cargill commented that the requirement to be listed as a principal 
applies statutory disqualification standards that are clear and 
objective.
    NFA recommended that the proposed change to the definition of 
``principal'' be modified to mention the CCO earlier in the definition 
rather than listing the position as an example of a person with 
supervisory authority over business personnel (i.e., a position with 
power to exercise a controlling influence). NFA stated that the rule 
should clarify that the CCO is not a line supervisor, nor does the CCO 
have supervisory authority over personnel.
    FIA and SIFMA argued that, although the FINRA CCO rules require the 
CCO to register as a ``general securities principal,'' FINRA has 
explicitly stated that this ``does not create the presumption that a 
chief compliance officer has supervisory responsibilities or is 
otherwise a control person.'' FIA and SIFMA recommended that the 
Commission make a similar qualifying statement when promulgating the 
final rules.
    Considering these comments, the Commission is modifying the 
proposed rule to list the position of CCO within the definition of 
principal separately for each type of entity as recommended by NFA, 
rather than as an example of someone in a position to exercise a 
controlling influence. The Commission believes that this modification 
addresses the issue sufficiently, without the need to incorporate the 
qualifying statement recommended by FIA and SIFMA. However, this change 
should not be interpreted to undermine the CCO's ability to fulfill the 
CCO's duties as provided for under the CEA and by Commission 
regulation.
b. Definition of Compliance Policies--Sec.  3.1(g)
    The proposed regulations defined ``compliance policies'' broadly to 
include all policies required to be adopted or established by the 
registrant pursuant to the CEA and regulations, including a code of 
ethics.
    The Working Group requested that the Commission clarify that the 
proposed rules do not require that a firm must adopt a code of ethics, 
but only that in its annual report the firm provide a description of a 
code of ethics to the extent that it has one.
    The National Whistleblowers Center (NWC) recommended that the 
Commission establish a rule that provides contact with internal 
compliance departments with the same whistleblower protection as 
contacts with the Commission. NWC also recommended that the Commission 
require registrants to adopt a code of ethics and conduct that contain 
rigorous whistleblower protections. Finally, NWC recommended that the 
Commission require an effective compliance program with the following 
components: Consistent enforcement of the company's code of conduct; 
professional management of the help line; vigorous enforcement of non-
retaliation policies; effective compliance and ethics risk-assessment; 
integration of clear, measurable compliance and ethics goals into the 
registrant's annual plan; direct access and reporting by the CCO to a 
compliance-savvy board; strong compliance and ethics infrastructure; 
compliance audits to uncover law-breaking; CEO action to promote 
compliance; and shared learning within the registrant.

[[Page 20159]]

    In order to achieve maximum consistency across the CCO provisions 
for SDs, MSPs, FCMs, DCOs, SDRs, and SEFs, the Commission has deleted 
the definition of ``compliance policies'' from the rule. The Commission 
believes this definition is unnecessary given the overall changes to 
the scope of the review required by the annual report, discussed below. 
The changes to the scope of the review of the annual report track the 
language of the statute in that the annual report will require a 
description of the written policies and procedures, including a code of 
ethics and conflicts of interest policies. The annual report separately 
will require a description of material compliance with the CEA and 
Commission regulations.
    In response to The Working Group's comment, the Commission notes 
that the statute requires that the CCO prepare and sign an annual 
report that contains a description of each policy and procedure, 
including the code of ethics and conflicts of interest policies. 
Whether a firm decides to adopt a separate code of ethics in 
furtherance of this requirement is left to its discretion.
    In response to NWC's comments, the Commission takes note of NWC's 
points related to whistleblowers as sound practices. However, these 
additional requirements, such as requiring specific whistleblower 
provisions in codes of ethics or conduct are outside the scope of this 
rulemaking.
6. Designation of Chief Compliance Officer--Sec.  3.3(a)
    Proposed Sec.  3.3(a) required each SD, MSP, and FCM to designate 
an individual as a CCO and provide the CCO with the full responsibility 
and authority to develop and enforce, in consultation with the board or 
senior officer, appropriate policies and procedures to fulfill the 
duties set forth in the CEA and regulations.
    EEI argued that a CCO should work in concert with business and 
control functions to assure appropriate policies are in place, but that 
the proposed rules go beyond what is required by the CEA by 
inappropriately imposing upon the CCO full responsibility to develop 
and enforce all policies. Newedge also commented that CCOs generally do 
not have full responsibility to develop and enforce compliance 
policies, and cites a Security Industry Association White Paper that 
states: ``* * * there is a huge difference between the role of the 
Compliance Department and its personnel, and the overall broad firm 
responsibility `to comply' with applicable rules and regulations. The 
Compliance Department plays an integral support function for firm 
compliance programs, but only senior management and business line 
supervisors ultimately are responsible for ensuring firm compliance 
with laws and regulations.''
    Rosenthal commented that the Commission's rules should be revised 
in a manner that reflects the view that the CCO is only an advisor to 
management and should not be viewed as an enforcer of policies within 
the FCM, as that would represent a ten-year step backward in 
governance.
    In an attempt to balance the traditional role of compliance 
officers in the financial service industry with the statutory 
requirements and policy objectives of promoting a strong culture of 
compliance, the Commission is revising proposed Sec.  3.3(a) to (i) 
remove the requirement that a CCO be provided with ``full'' 
responsibility and authority; (ii) remove the requirement that a CCO 
``enforce'' policies and procedures; (iii) limit the responsibilities 
of the CCO to the ``swaps activities'' of SDs and MSPs, and the FCMs' 
derivatives activities included in the definition of FCM under section 
1(a)(28) of the CEA; and (iv) clarify that a CCO need only develop 
policies and procedures to fulfill the duties set forth in, and ensure 
compliance with, the CEA and Commission regulations. The Commission is 
making the changes to Sec.  3.3(a) to alleviate commenters' concerns 
about the use of the term ``enforce'' and about the scope of the CCO's 
duty to develop policies and procedures.
7. Reporting Line--Sec.  3.3(a)(1) & (2)
    Proposed Sec.  3.3(a)(1) required that the CCO report to the board 
of directors or the senior officer of a registrant, that the board or 
senior officer approve the compensation of the CCO, and that the board 
or senior officer meet with the CCO at least once a year to discuss the 
effectiveness of compliance policies and their administration by the 
CCO. Proposed Sec.  3.3(a)(2) also prohibited the board or senior 
officer of a registrant from delegating its authority over the CCO, 
including the authority to remove the CCO.
    The CCO NPRM requested comment on the degree of flexibility in the 
reporting structure, including whether it would be more appropriate for 
a CCO to report to the board or the senior officer; whether the board 
or the senior officer is a stronger advocate on compliance matters; 
whether the proposed reporting structure should address issues related 
to affiliates; and whether the rule should include a provision 
requiring a majority of the board to remove the CCO. The proposal also 
requested comment regarding whether it is necessary to adopt rules for 
the CCO regarding conflicts of interest between compliance interests, 
commercial interests, and ownership interests of a registrant.
    Cargill recommended that the definition of board of directors be 
expanded to include a governing body of a division, such as a 
management committee, if the SD registration applies to activities 
within a division of a larger company, rather than the company as a 
whole. Cargill also recommended that the Commission add a definition of 
``senior officer'' and that it include a senior officer of a division, 
because a division might be more familiar with the swaps activities of 
an SD. Cargill and The Working Group each argued that a requirement 
that a CCO can be removed only by a majority of the members of a 
governing body would be inflexible, and should not be added to the 
rules.
    The Working Group argued that the CCO should be allowed to report 
to a board of an affiliated entity that controls both the affiliate and 
the registrant. The Working Group also argued that the CCO should be 
permitted to operate under the direction of other corporate officers, 
even middle level officers, so that the CCO is not an independent 
inspector general that operates outside the traditional reporting 
structure within a corporate entity. EEI also argued that the proposal 
is overly prescriptive and recommends that the reporting structure be 
left to each individual firm. Similarly, FIA and SIFMA commented that 
although the board is the ultimate supervisory authority, the CCO 
should not be required to directly report to it. Instead, firms should 
be free to determine the reporting structure as long as independence 
and authority as a control function is maintained. FIA and SIFMA 
recommended, for example, that the CCO be allowed to report to the 
chief legal officer or the chief risk officer.
    On the other hand, Rosenthal commented that the CCO should report 
to the board or, if the registrant is not a corporation, to the senior 
officer. Rosenthal also commented that the CCO should be prohibited 
from receiving any transaction or customer-based compensation to 
insulate the CCO from potential conflicts. NSCP also agreed that CCOs 
should report to senior management and have compensation set by 
managers that are not influenced by the profitability of particular 
business units. NSCP noted that new Organizational Sentencing 
Guidelines consider whether individuals with operational responsibility 
for compliance and ethics have direct

[[Page 20160]]

reporting obligations to the governing authority or an appropriate 
subgroup thereof (like an audit committee of a board), which the 
proposed rules would require. NSCP recommended that a provision be 
added to the proposed rules to make it illegal for a registrant to 
coerce a CCO improperly, similar to the one for CCOs of investment 
companies and independent public accountants.
    Better Markets and Chris Barnard recommended that decisions to 
designate or terminate a CCO, as well as compensation decisions, be 
prescribed as the sole responsibility of independent members of the 
board of directors, or audit committee, acting by majority vote, and 
not the responsibility of the executive officer. Better Markets also 
recommended that both the board and the senior officer be required to 
meet with the CCO to discuss the effectiveness of compliance policies, 
and that such meetings be held at least quarterly. Better Markets 
further recommended that the CCO's duties be performed in consultation 
with both the board and the senior officer.
    National Whistleblowers Center (NWC) recommended that the term 
``senior officer'' be defined as the CEO or chairman of the board, and 
should not be the general counsel or a subordinate employee to the CEO. 
NWC believes that the rule should permit the CCO to report to the full 
board at any time with no interference from a board committee or a CEO. 
NWC also argued that the rule should prohibit termination of the CCO 
unless the CCO is presented the opportunity to address the board.
    MetLife requested that the definition of board of directors include 
``(or committee of such board or governing body)'' to permit it to 
continue its current practice of delegating particular responsibilities 
to expert committees of the whole board (i.e., audit, finance, 
investments, risk, and compensation). NFA also sought additional 
flexibility in the reporting structure for CCOs, provided that the 
firm's business unit is not permitted to impose undue pressure on a CCO 
regarding compliance.
    Newedge recommended that the CCO be required to meet at least 
quarterly with the board or senior officer to discuss the effectiveness 
of compliance policies.
    The Working Group believes it is not necessary to address conflicts 
of interest between compliance interests and commercial interests in 
the rule because the independent audit requirements imposed by the 
Sarbanes Oxley Act already address such conflicts.
    Having considered these comments, the Commission will not permit 
CCOs to report to committees of a board of directors. Section 4s(k) of 
the CEA requires the CCO to ``report directly'' to the board or the 
senior officer of the SD or MSP. In other contexts (for example the 
risk management duties rules for SDs and MSPs discussed above), 
reporting to committees of the board is permitted. However, in this 
context, the Commission believes that the statutory requirement that 
the CCO report directly to the board or senior officer does not afford 
such discretion. The Commission is guided by the policy objectives of 
section 4s(k) in reaching the same conclusion with regard to FCMs, and 
observes that no currently registered FCM requested that the CCO report 
to a committee of the board. Indeed, Rosenthal, and FCM, agreed with 
the requirement that CCOs for FCMs report to a board of directors if 
the entity has one, or the senior officer, if the entity does not have 
a board.
    In response to Cargill's comments, the Commission notes that under 
the CEA and under the rules as adopted, a registrant may elect to have 
the CCO report to the senior officer of the registrant. Because, 
``senior officer'' is not defined, if a division of a larger company is 
a registered SD, then the CCO of such registrant could report to the 
senior officer of that division.
    In order to preserve CCO independence, the Commission is not 
changing the requirement that only the board or the senior officer can 
hire, set compensation for, and remove the CCO. However, in order to 
promote consistency among the CCO rules for registrants and registered 
entities, the Commission is modifying proposed Sec.  3.3(a)(1) and (2) 
to (i) require only that the CCO and board or senior officer meet once 
a year and at the election of the CCO, but not mandate the content of 
such meeting; and (ii) to clarify that only the board or senior officer 
may remove the CCO.
    The Commission believes that additional requirements, such as 
providing the CCO an opportunity to address the board prior to removal, 
requiring more frequent meetings between the CCO and the board or 
senior officer, restricting the composition of CCO compensation, or 
mandating independent director approval, would be overly prescriptive 
and unnecessary to achieve the purposes of the rule. Similarly, the 
Commission believes that a provision prohibiting improper coercion is 
unnecessary because the rule adequately ensures CCO independence 
through a direct reporting line to the board or senior officer and by 
requiring compensation decisions to be made by the board or a senior 
officer.
8. Qualifications--Sec.  3.3(b)
    As proposed, Sec.  3.3(b) required the CCO to have the background 
and skills appropriate for fulfilling the responsibilities of the 
position, and prohibited an individual who is statutorily disqualified 
under sections 8a(2) or 8a(3) of the CEA from serving.\39\ The proposal 
requested comments regarding whether additional limitations should be 
placed on CCOs, such as a prohibition on designating a registrant's 
counsel as CCO.
---------------------------------------------------------------------------

    \39\ These CEA sections contain an extensive list of matters 
that constitute grounds pursuant to which the Commission may refuse 
to register a person, including, without limitation, felony 
convictions, commodities or securities law violations, and bars or 
other adverse actions taken by financial regulators.
---------------------------------------------------------------------------

    NFA argued that the statement that no individual disqualified from 
registration under section 8a(2)-(3) of the CEA may serve as a CCO is 
redundant because an SD, MSP, or FCM's registration could be denied or 
revoked under section 8a(2)-(3) of the CEA if any principal of the 
registrant is subject to a statutory disqualification. NFA argues that 
inclusion of this qualification in the proposed rule could appear to 
convey a different standard for CCOs than for other principals.
    Cargill commented that the requirement for a CCO to have ``the 
background and skills appropriate'' is a commendable aspirational goal 
but is too vague a standard for Federal law, and is best reserved as a 
business decision. Cargill agreed that the requirement to be listed as 
a principal applies statutory disqualification standards that are clear 
and objective.
    Newedge recommended that CCOs be required to pass a specific 
compliance examination and obtain a specific compliance license, as is 
the case in the securities world. On the other hand, NSCP does not 
believe that CCOs should have to pass a qualification exam or otherwise 
have a certain number of years in the industry, given the diversity of 
the registrant community. The Working Group also commented that wide 
latitude for qualifications of a CCO is necessary.
    EEI argues that the general counsel and other attorneys should be 
allowed to be the CCO because they are subject to ethics considerations 
and a prohibition on conflicts in their representation. NFA also 
recommended that the CCO be permitted to be an attorney who represents 
the registrant or its board as long as the conflict can be

[[Page 20161]]

managed and duties discharged. Rosenthal and Hess felt that persons 
with legal training may be well-suited as CCOs, and that the rule 
requirement to demonstrate compliance proficiency is reasonable. To the 
contrary, Better Markets argued that a CCO should not be permitted to 
be an attorney that represents the SD, MSP, or FCM, or its board 
because the potential conflict would disqualify such an attorney.
    Having considered these comments, the Commission is adopting the 
rule substantially as proposed, with only a technical change to clarify 
the references to sections 8a(2) and 8a(3) of the CEA. The Commission 
believes it is important for the ``Qualifications'' section of the rule 
to put registrants on notice of the possible disqualification of CCO 
candidates pursuant to the CEA. The benefit of such notice outweighs 
the concern of creating an appearance of a different standard for CCOs 
than for other principals. The Commission is retaining the ``background 
and skills'' qualification in the final rule because the standard 
effectively will prohibit appointment of unqualified persons as CCO. 
However, the Commission does not believe that it is necessary to 
require a proficiency exam for CCOs at this time.
    The Commission also agrees with Better Markets that there may be a 
potential conflict if a member of the legal department or the general 
counsel of a registrant also served as the registrant's CCO. The 
Commission notes that the final rules for SDRs prohibited members of 
the legal department or the entity's general counsel from serving as 
CCO.\40\ On the other hand, the final rules for derivative clearing 
organizations did not include the same prohibition.\41\ Given the 
diversity of FCMs and probable diversity of SDs and MSPs and cost 
considerations, the Commission is taking a flexible approach in these 
final rules and is not prohibiting a member of the legal department or 
general counsel from serving as CCO for an SD, MSP, or FCM. However, 
should a CCO be a member of the registrant's legal department, the 
Commission expects the CCO and registrant to articulate clearly the 
segregation of that individual's CCO and non-CCO responsibilities. All 
reports required under sections 4d(d) and 4s(k) of the CEA, as well as 
the rules promulgated pursuant thereto, are meant to be made available 
to the Commission, and as such, they should not be subject to the 
attorney-client privilege, the work-product doctrine, or other similar 
protections.
---------------------------------------------------------------------------

    \40\ See Swap Data Repositories: Registration Standards, Duties 
and Core Principles, 76 FR 54538, 54584 (Sept. 1, 2011).
    \41\ See 17 CFR 39.10; Derivatives Clearing Organization General 
Provisions and Core Principals, 76 FR 69334, 69434 (Nov. 8, 2011).
---------------------------------------------------------------------------

9. Duty To Establish Compliance Policies--Sec.  3.3(d)(1)
    Proposed Sec.  3.3(d)(1) required the CCO to establish the 
registrant's compliance policies in consultation with the board of 
directors or senior officer.
    Hess and Newedge each argued that the proposal concentrates too 
much of the compliance function on a single individual to the exclusion 
of other members of senior management and day-to-day business line 
supervisors. Hess argued that overemphasis on the independent role of 
the CCO and concentrating responsibility is less effective than 
integration. Instead, Hess recommended that the CCO should remain the 
monitor of the compliance monitors, which they could not be if they are 
responsible for compliance.
    The Commission believes that section 4s(k) of the CEA requires that 
the CCO administer the compliance policies, but that it does not 
require the CCO to establish all of a registrant's compliance policies. 
To alleviate some of the commenters' concerns regarding concentration 
of the compliance function, the Commission is revising the proposed 
rule to track more closely the statutory language of section 4s(k).
10. Duty To Resolve Conflicts of Interest--Sec.  3.3(d)(2)
    Following section 4s(k)(2)(C) of the CEA, proposed Sec.  3.3(d)(2) 
required the CCO, in consultation with the board or senior officer, to 
resolve any conflicts of interest that may arise.
    NFA commented that resolution of conflicts of interest should rest 
with the board or the senior officer, in consultation with the CCO. FIA 
and SIFMA also commented that the CCO should not be deemed to be a 
business line supervisor and the rule should not fundamentally change 
the role of the CCO, which has customarily been an independent advisor 
to the business line supervisors that are ultimately responsible for 
compliance. FIA and SIFMA argued that when Congress used the term 
``resolve any conflicts of interest that may arise,'' Congress did not 
mean resolve in the executive or managerial sense, requiring a CCO to 
examine the facts and determine the course of action. Instead, FIA and 
SIFMA recommended that the rule be revised to provide a definition of 
``resolving conflicts of interest'' that reads: ``designing a system of 
conflict identification, assessment and resolution, advising on 
conflict avoidance or mitigation alternatives, and escalating 
inadequate management responses to conflicts to senior management. * * 
*'' Newedge commented that the CEO and business line supervisors are in 
a better position than the CCO to resolve conflicts. Newedge believes 
that any transfer of regulatory responsibility currently held by 
executive officers to the CCO could have the unintended effect of 
reducing the amount of time and level of concern such officers will 
spend on compliance matters.
    Participants in the May Meeting with Commission staff stated that 
the phrase ``resolve any conflicts of interest'' would traditionally be 
interpreted as eliminating a conflict of interest, but that elimination 
is not always preferable. The participants commented that further 
interpretation is needed to permit conflicts of interest to be 
addressed, mitigated, or conditioned as well. Participants argued that 
the role of a compliance officer is to advise the business line of 
acceptable and unacceptable alternatives, and if the business line 
chooses an unacceptable alternative, then the compliance officer must 
escalate the problem until an acceptable alternative is selected. 
However, participants strongly believed that the compliance officer 
should not be the actual decision maker in the resolution.
    Having considered these comments, the Commission is not removing 
the requirement that the CCO ``resolve'' conflicts of interest from the 
rule because the requirement is provided for in section 4s(k)(2)(C) of 
the CEA. However, the Commission confirms, as suggested by commenters, 
that the term ``resolve'' encompasses both elimination of the conflict 
of interest as well as mitigation of the conflict of interest, and that 
the CCO's role in ``resolving'' conflicts of interest may involve 
actions other than making the final decision. The Commission notes that 
the SEC has taken a similar approach in the preamble of its equivalent 
CCO proposal.\42\
---------------------------------------------------------------------------

    \42\ See Business Conduct Standards for Security-Based Swap 
Dealers and Major Swap Participants, 76 FR 42396, 42436 (July 18, 
2011) (stating ``we would anticipate 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 decisions relating to the ultimate final 
resolution of such conflicts'').

---------------------------------------------------------------------------

[[Page 20162]]

11. Duty To Review and Ensure Compliance--Sec.  3.3(d)(3)
    Following the statutory text of section 4s(k)(2)(E) of the CEA, 
proposed Sec.  3.3(d)(3) required the CCO to review and ``ensure 
compliance'' by the registrant with the registrant's compliance 
policies and all applicable laws and regulations.
    FIA and SIFMA argued that the term ``ensure compliance'' needs to 
be clarified, because the common usage of the word (i.e., to guarantee) 
goes well beyond any existing compliance model and creates a standard 
that is impossible to satisfy. FIA and SIFMA further argued that the 
requirement to remediate non-compliance issues, and the discussion of 
management's response to remediation, acknowledges that instances of 
noncompliance are not wholly preventable by any person, and that it is 
management's responsibility for implementing compliance policies. 
Instead, FIA and SIFMA recommended that the phrase should mean taking 
reasonable steps to adopt, review, test, and modify compliance 
policies, and pointed to the Commission's RFED rule, which requires 
each RFED to designate a CCO that must certify that the RFED has in 
place policies and procedures ``reasonably designed to achieve 
compliance with the Act, rules, regulations and orders thereunder.'' 
FIA and SIFMA also recommended that the Commission add a provision in 
the definition of compliance policies and procedures to include 
``procedures for escalating inadequate management responses to apparent 
material violations of compliance policies and procedures to the 
appropriate level of senior management * * * depending on the facts and 
circumstances of the issues being addressed.''
    The Working Group argued that the requirement to ``ensure 
compliance'' should not be adopted literally from the statute, because 
it is an impossible task. The Working Group recommended that the rules 
be revised to avoid suggestions that an incident of noncompliance by a 
firm might constitute or evidence a failure by a CCO to meet its 
statutory or regulatory responsibilities.
    NSCP argued that ``ensure compliance'' imposes a level of 
responsibility on a CCO that cannot be discharged and is inconsistent 
with the customary role of a compliance officer. Instead, NSCP 
recommended that the CCO ``administer the system of compliance that is 
designed to ensure compliance with compliance policies and applicable 
law.'' NSCP concedes that although the statutory language may be viewed 
as constraining, it offers section 501 of the Gramm-Leach-Bliley Act as 
an example of constraining language modified by regulation. NSCP stated 
that section 501 of that act required financial institutions to adopt 
safeguards to ``ensure the security and confidentiality of personal 
information,'' but that banking regulators modified the standard to 
require adoption of safeguards ``designed to ensure the security and 
confidentiality of personal information.'' NSCP further argued that the 
business units within registrants either obey the law or violate it, 
and a CCO is limited to providing guidance, monitoring for compliance, 
and reporting on the business activities.
    NFA commented that it should not be the duty of the CCO to ensure 
compliance by the FCM, SD, or MSP because it is an impracticable 
standard and imposes a duty to supervise a firm's business activities. 
NFA argued that the rules improperly redefine a CCO's duties, and 
registrants will have difficulty retaining CCOs who are willing to 
perform these duties. NFA believes that FINRA's Rule 3130 sets forth 
the appropriate role of a CCO.
    Participants in the May Meeting with Commission staff stated that 
the CCO's responsibility to escalate (repeatedly if necessary) a 
problem that has not been resolved could serve as a possible meaning of 
the term ``ensure compliance'' when applied to the CCO position.
    EEI believes that a basic tenet of modern compliance is that 
compliance departments advise, monitor, assist, and escalate to a 
governing body if necessary. EEI argued that the act of complying must 
be borne and executed by the business, and imposing responsibility on 
the CCO could abrogate responsibility of senior management and other 
employees.
    Newedge believes that the CCO should be required only to review 
whether a registrant has established policies designed to achieve 
compliance and that the responsibility to enforce compliance should lie 
with the business line. Newedge believes the enormity of the 
obligations assigned to the CCO would result in inadequate means of 
ensuring compliance, defeating the plain purpose of the statute.
    In response to the comments received regarding the role of the CCO 
in ensuring compliance, the Commission is modifying the proposed rule 
to provide that the CCO must take ``reasonable steps to ensure 
compliance.'' The Commission believes that this approach is responsive 
to commenters' concerns, is consistent with the final rules for SDRs 
\43\ and DCOs,\44\ and is broadly consistent with the SEC's proposal 
for the duties of a CCO of a security-based swap dealer or a major 
security-based swap participant.\45\
---------------------------------------------------------------------------

    \43\ See Swap Data Repositories: Registration Standards, Duties 
and Core Principles, 76 FR at 54584 (stating that the duties of an 
SDR's CCO include ``[t]aking reasonable steps to ensure compliance 
with the [CEA] and Commission regulations'').
    \44\ See Derivatives Clearing Organization General Provisions 
and Core Principals, 76 FR at 69434 (stating that the duties of a 
DCO's CCO include ``[t]aking reasonable steps to ensure compliance 
with the [CEA] and Commission regulations'').
    \45\ See Business Conduct Standards for Security-Based Swap 
Dealers and Major Security-Based Swap Participants, 76 FR 42396, 
42458-59 (July 18, 2011) (requiring the CCO of a security-based swap 
dealer or major security-based swap participant to ``[e]stablish, 
maintain and review policies and procedures reasonably designed to 
ensure compliance with the Act and the rules and regulations 
thereunder'').
---------------------------------------------------------------------------

    In response to comments advocating a purely advisory role for the 
CCO, the Commission observes that the role of the CCO required under 
the CEA, as amended by the Dodd-Frank Act, goes beyond what has been 
represented by commenters as the customary and traditional role of a 
compliance officer. While the Commission does not believe, as some 
commenters have suggested, that the CCO's duties under the CEA or Sec.  
3.3 requires that the CCO be granted ultimate supervisory authority by 
a registrant, it is the Commission's expectation that the CCO will, at 
a minimum, be afforded supervisory authority over all staff acting at 
the direction of the CCO. Recent events have demonstrated the 
importance of the active compliance monitoring duties required of the 
CCO under the Dodd-Frank Act, as implemented through these regulations.
12. Duty To Prepare, Sign, and Certify Compliance Annual Report--Sec.  
3.3(d)(6)
    Proposed Sec.  3.3(d)(6) required the CCO of an SD, MSP, or FCM to 
prepare, sign, and certify, under penalty of law, the annual report 
specified in section 4s(k)(3) of the CEA.
    Rosenthal commented that FINRA's approach to certification is 
preferable, i.e., that the CEO certifies that the firm has processes to 
establish, maintain, review, test, and modify written compliance 
policies and written supervisory procedures reasonably designed to 
achieve compliance with securities laws, regulations, and FINRA rules, 
based on a report by the CCO. FIA, SIFMA, and Newedge each argued that 
section 4s(k)(3) of the CEA requires the CCO to sign the annual report, 
but does not require the CCO to certify the report. FIA, SIFMA, MFA, 
Newedge,

[[Page 20163]]

and NFA all recommended that the rule be revised to require the CEO to 
certify the report. Participants in the May Meeting with Commission 
staff stated that requiring the CEO, rather than the CCO, to make a 
certification as to whether policies are in place that are reasonably 
designed to ensure compliance appropriately shares responsibility 
between compliance and business management. FIA and SIFMA recommended 
that if the Commission requires the CCO to certify the annual report, 
then with respect to any Commission registrant that is also a BD, the 
Commission also should require the CEO to make the certification
    Rosenthal argued that requiring the CCO to certify under penalty of 
law will make the CCO liable for firm infractions and will give 
disgruntled customers a roadmap for frivolous lawsuits. Newedge also 
believes that the requirement to certify under penalty of law is not 
fair or practicable because whoever certifies will have to rely on many 
individuals to compile the report. On the other hand, Hess commented 
that the certification language strikes an appropriate balance such 
that strict liability is not imposed for inadvertent errors. NSCP 
commented that the certification that the report is accurate and 
complete should have a materiality qualifier added to it. Participants 
in the May Meeting with Commission staff requested clarification as to 
how the certification of the accuracy and completeness of the 
information in the annual report might be kept separate from matters of 
opinion expressed in the annual report. The participants urged the 
Commission to adopt a standard for the annual report certification that 
is reasonably attainable.
    FIA and SIFMA requested that the Commission clarify that criminal 
liability for the certification will not apply (absent a knowing and 
willful materially false and misleading statement) because there is no 
indication that Congress ever thought CCOs should be subject to 
criminal liability. Similarly, NSCP requested that the Commission 
clarify whether ``under penalty of law'' means liability under 18 
U.S.C. 1001 for a false statement to a Federal officer. FIA and SIFMA 
also felt that imposing criminal liability for annual report 
certifications would make it hard to fill the position of CCO.
    EEI argued that although section 4s(k)(3) of the CEA requires the 
CCO to certify the report, any additional content requirements for the 
annual report beyond what section 4s(k)(3) requires will make the 
certification more difficult.
    In response to these comments, with respect to certification by the 
CCO, the Commission is modifying the proposed rule to permit either the 
CCO or the CEO to make the required certification. Section 4s(k)(3)(A) 
of the CEA requires the CCO to sign the annual report and section 
4s(k)(3)(B)(ii) requires that the annual report contain a certification 
that, under penalty of law, the compliance report is accurate and 
complete. Given the statutory provisions and under these circumstances, 
the Commission believes it is appropriate to afford SDs, MSPs, and FCMs 
the discretion to choose whether the CCO or CEO will make the 
certification.
    The Commission disagrees with commenters that a mere certification 
that policies are in place that are reasonably designed to achieve 
compliance would satisfy the requirements of section 4s(k)(3) of the 
CEA. The Commission believes that the statute also requires a CCO to 
assess how compliance policies are implemented.
    The Commission is of the view that limiting the certification with 
the qualifier ``to the best of his or her knowledge and reasonable 
belief'' addresses commenters' concerns of overbroad liability because 
the rule would not impose liability for compliance matters that are 
beyond the certifying officer's knowledge and reasonable belief at the 
time of certification. If the certifying officer has complied in good 
faith with policies and procedures reasonably designed to confirm the 
accuracy and completeness of the information in the annual report, both 
the registrant and certifying officer would have a basis for defending 
accusations of false, incomplete, or misleading statements or 
representations made in the annual report.
    With respect to requests for clarification of the liability that 
may attach to the certification ``under penalty of law,'' the 
Commission notes that administrative, civil, and/or criminal liability 
could be imposed on the registrant or the certifying officer or both, 
either directly or vicariously. As explained in the NPRM, possible 
violations could include a claim of failure to supervise or false 
statements to the Commission, and the Commission could seek an 
injunction against future violations, civil monetary penalties, and/or 
any other appropriate relief. Additionally, criminal penalties may be 
sought by criminal authorities for willful violations of the CEA or 
Commission regulations, in appropriate cases.
    The Commission is declining to add a materiality qualifier to the 
certification, as suggested by commenters. This approach is consistent 
with the statutory text, with the approach taken in final rules for 
SDRs \46\ and DCOs,\47\ and with proposed CCO rules for SEFs.\48\
---------------------------------------------------------------------------

    \46\ See Swap Data Repositories: Registration Standards, Duties 
and Core Principles, 76 FR at 54584.
    \47\ See Derivatives Clearing Organization General Provisions 
and Core Principals, 76 FR at 69435.
    \48\ See Core Principles and Other Requirements for Swap 
Execution Facilities, 76 FR 1214, 1252 (Jan. 7, 2011).
---------------------------------------------------------------------------

13. Description and Review of Compliance in Annual Report--Sec.  
3.3([e])(1) and (2)
    The proposed regulation required the annual report to contain a 
description of the compliance by the registrant with respect to the CEA 
and regulations; a description of each of the registrant's compliance 
policies; and a review of each applicable requirement under the CEA and 
regulations, and, with respect to each, identification of the policies 
that ensure compliance, an assessment as to the effectiveness of the 
policies, discussion of areas of improvement, and recommendations of 
potential or prospective changes or improvements to its compliance 
program and resources devoted to compliance.
    NSCP, The Working Group, EEI, and Hess each argued that the level 
of detail contemplated by the rule would impose unnecessary burdens on 
the CCO with little offsetting benefits. NSCP argued that a better 
approach would be to follow the SEC requirements for annual reviews of 
compliance by registered investment advisers. NSCP stated that such 
reviews must reflect review of the adequacy of policies established and 
the effectiveness of their implementation (SEC Rule 206(4)-7(b)). NSCP 
believes the proposed rule is overbroad and discourages reporting of 
compliance issues to the CCO because if every issue, no matter how 
trivial, must be reported and recorded, there may be a chilling effect 
on open communication. NSCP believes that the key issue should be 
whether material issues were escalated and remedied. Newedge argued 
that thousands of Federal, SRO, and internal rules apply, so the report 
should contain a summation of compliance, with details only for areas 
of material noncompliance.
    FIA and SIFMA argued that a one-size-fits-all approach to the 
annual report requirements is not appropriate because some registrants 
are not public reporting companies, some have customers while others 
only conduct

[[Page 20164]]

proprietary trading, some deal with retail customers while others only 
deal with sophisticated counterparties, and some are small and local, 
while others are large, integrated institutions with thousands of 
employees worldwide.
    FIA and SIFMA recommended that the Commission specify the material 
issues that should be discussed, so that there is no second guessing 
with respect to the adequacy of the report, and that the Commission 
clarify that compliance policies only include those relating to the CEA 
and Commission regulations. FIA, SIFMA, and NFA also argued that the 
report should identify the policies that are reasonably designed to 
result in compliance, not that ensure compliance. Hess recommended that 
the annual report contain only a summary of the registrant's compliance 
policies and procedures. CMC commented that the scope of activities 
included in the annual report should be limited to those directly 
triggering the requirement of a CCO. EEI argued that inclusion of 
descriptions of violations in the report to the Commission should not 
be decided by the CCO, but should be decided on a case-by-case basis by 
the registrant's governing body. NFA requested that a materiality 
qualifier be added to the requirement that registrants include a 
description of non-compliance.
    Better Markets recommended that the board approve the annual report 
in its entirety or specify where and why it disagrees with any 
provision, and then CCOs should provide the report to the Commission 
either as approved or with statements of disagreement.
    The Working Group recommended that the Commission develop a 
standard form of report and guidance as to how such report needs to be 
completed.
    In response to the comments received, the Commission is modifying 
the proposed requirements for the annual report in Sec.  3.3([e]) to 
(i) require the annual report to contain a description of the 
registrant's policies and procedures, rather than a description of the 
compliance of the registrant; (ii) require the annual report to 
identify the registrant's policies and procedures that ``are reasonably 
designed'' to ensure compliance, rather than those that ensure 
compliance; (iii) require a description of material non-compliance 
issues. The Commission agrees with commenters that certain information 
need be reported only if it is materially significant and that the 
requirement to ``ensure compliance'' can be interpreted to mean 
``safeguard'' rather than ``guarantee.''
14. Certification of Compliance With Sections 619 and 716 of the Dodd-
Frank Act in Annual Report--Sec.  3.3([e])(3)
    The proposed regulation required registrants to include in the 
annual report a certification of compliance with sections 619 and 716 
of the Dodd-Frank Act (the Volcker Rule and Derivatives Push-Out), and 
any rules adopted pursuant to these sections.
    NFA recommended that the certification of compliance with sections 
619 and 716 of Dodd-Frank be deleted, arguing that the Commission 
should wait for the implementing rulemakings for such sections before 
determining certification requirements.
    FIA and SIFMA commented that the requirement to certify compliance 
with the Volcker Rule and Derivatives Push-Out provisions should be 
included as part of the rulemaking that will address the scope and 
requirements of those provisions, but not be prematurely included in 
the CCO rule.
    In consideration of these comments, the Commission has determined 
not to finalize this provision.
15. Description of Compliance Resources in Annual Report--Sec.  
3.3([e])(6)
    Proposed Sec.  3.3([e])(6) required the annual report to contain a 
description of the registrant's financial, managerial, operational, and 
staffing resources set aside for compliance with the CEA and 
regulations, including any deficiencies in such resources.
    FIA and SIFMA argued that the CCO is not in a position to describe 
the financial, material, operational, and staffing resources set aside 
for compliance. FIA and SIFMA recommended that the CCO only be required 
to describe the resources of the compliance department and any 
recommendations that the CCO has made to senior management with regard 
to financial, managerial, operational, or staffing resources.
    The Working Group argued that a description of deficiencies in 
resources dedicated to compliance would require a CCO to identify 
potential shortcomings and report them in a document likely to be 
available to the public, which could materially hinder the CCO's 
ability to function as an integral member of the management team.
    Having considered these comments, the Commission is adopting the 
rule as proposed, but with the addition of a materiality standard with 
respect to the description of any deficiency. The Commission does not 
believe that the required description of resources available for 
compliance would hinder the CCO's ability to fulfill his or her duties 
in coordination with others in the firm. The rule requires a 
description of compliance resources, but does not prescribe the form or 
manner of this description, which the Commission views as within the 
reasonable discretion of the registrant.
16. Delineation of Roles of the Board and Senior Officer in Addressing 
Conflicts of Interest in Annual Report--Sec.  3.3([e])(7)
    The proposed regulations required the annual report to include a 
delineation of the roles and responsibilities of a registrant's board 
of directors or senior officer, relevant board committees, and staff in 
addressing any conflicts of interest, including any necessary 
coordination with, or notification of, other entities, including 
regulators.
    FIA and SIFMA argued that the Sarbanes-Oxley Act already requires 
public companies to report the roles and responsibilities of its board, 
senior officers, and committees in resolving conflicts of interest, so 
the Commission should allow such reporting to satisfy this content 
requirement for the annual report. NFA also recommended that the 
reporting of any necessary coordination with, or notification of other 
entities, including regulators, should be deleted.
    In response to FIA, SIFMA, and NFA's comments, the Commission is 
deleting Sec.  3.3([e])(7) from the final rule. This provision is not 
essential to the Commission's evaluation of registrants' compliance 
programs, and if it is relevant to a material compliance matter, it 
will be provided to the Commission pursuant to Sec.  3.3([e])(6). The 
Commission also notes that removing this provision will make the CCO 
requirements for FCMs, SDs, and MSPs more consistent with the CCO 
requirements for SDRs and DCOs, and those proposed for SEFs.
17. Recordkeeping--Sec.  3.3([g])
    Proposed Sec.  3.3([g]) required FCMs, SDs, and MSPs to maintain 
records of its compliance policies, materials provided to the board in 
connection with its review of the annual compliance report, and work 
papers that form the basis of the annual compliance report.
    The Working Group argued that retaining all materials relating to 
the preparation of the report will cause the CCO to retain all 
materials for fear of an audit that second-guesses the CCO's 
materiality judgments, or the CCO will limit his or her inquiries to 
avoid making a determination of materiality. The Working Group 
recommended that

[[Page 20165]]

materials to be retained should be only those germane to the content of 
the compliance report.
    Better Markets recommended adding a requirement that discussions 
between a CCO and traders or executives with oversight of traders 
involving compliance and trading practices and strategies be recorded 
by the CCO and retained in the CCO's records. Better Markets believes 
this requirement is necessary because the duties of the CCO could come 
into conflict with the interests of traders and managers.
    The Commission is adopting the rule as proposed. In response to The 
Working Group's comment, the Commission believes the rule sufficiently 
qualifies the materials that must be retained by stating that the 
records must be ``relevant'' to the annual report. With regard to 
Better Markets' recommendation that CCOs record discussions with 
traders and executives regarding compliance and trading practices, the 
Commission believes that this material will be covered by the rules to 
the extent that the annual report requires the CCO to assess the 
effectiveness of the registrant's policies and procedures and describe 
any material non-compliance issues and the corresponding action taken. 
Consequently, any conflicts that arise between the CCO and the trading 
unit of an SD, MSP, or FCM in which the CCO believes that the 
requirements of the CEA and Commission regulations, including risk 
management obligations, are not being met, must be included in the 
annual report. Additionally, under Sec.  3.3(g)(1)(iii), all records of 
that conflict as described in the annual report must be maintained. The 
Commission further notes that in such instances, it would be good 
practice for the CCO to make and maintain records of all discussions 
with traders and management.

III. Effective Dates and Compliance Dates

    In the Duties NPRM, Recordkeeping NPRM, and CCO NPRM, the 
Commission requested comment on the length of time necessary for 
registrants to come into compliance with the proposed rules.

A. Comments Regarding Compliance Dates

    The Working Group recommended that the Commission not require 
compliance with proposed Sec. Sec.  23.600 through 23.607 for at least 
two years, not require compliance with proposed Sec. Sec.  23.200 
through 23.205 for six to twelve months to provide adequate time to 
develop the necessary information technology systems and business 
practices, and not require compliance with the CCO designation 
requirement of proposed Sec.  3.3 for one year after registration. With 
respect to Sec.  23.601, The Working Group also commented that if 
complex requirements are included in position limit rules, such as the 
requirement to convert customized bilateral transactions into futures-
equivalents, substantially more time will be required for firms to 
design and implement procedures to monitor compliance with position 
limits. With respect to proposed Sec.  3.3, The Working Group commented 
that entities should be able first to hire a CCO and then be permitted 
a reasonable period of time in which to write, test, and implement 
policies and procedures. With respect to all of the proposed rules, The 
Working Group recommended that the Commission provide an extended 
transition period for firms that have not been prudentially regulated 
by a financial regulator and might require substantial corporate 
restructuring.
    FIA, ISDA, SIFMA, and the Financial Services Forum argued that if 
existing systems are not easily adaptable to Sec. Sec.  23.200 through 
23.205, the Commission must provide sufficient time for registrants to 
make the necessary changes in an orderly manner, but no specific time 
period was provided. FIA, ISDA, SIFMA, and the Financial Services Forum 
also recommended that compliance with proposed Sec.  3.3 should not be 
required until after the regulatory requirements under section 4s of 
the CEA for which the CCO is responsible are finalized and become 
effective.
    Cargill recommended that the Commission provide SDs with at least 
one year to come into compliance with proposed Sec. Sec.  23.600 
through 23.607 following the effective date of the rules. Cargill also 
stated that one year was a reasonable period to comply with proposed 
Sec.  3.3.
    MetLife recommended that the Commission allow one year from 
registration as an MSP to comply with the proposed Sec. Sec.  23.600 
through 23.607, because such compliance will require hiring required 
human capital resources, build out of necessary information technology, 
development of policies and procedures and internal vetting of a 
mandated risk management program. MetLife also stated that it would it 
would require one year after registration to recruit a CCO and develop 
a compliance program in compliance with proposed Sec.  3.3.
    NSCP stated that 18 months was necessary for registrants that do 
not currently have a CCO to comply with proposed Sec.  3.3.
    The Bank of Tokyo-Mitsubishi UFJ, Ltd., Mizuho Corporate Bank, 
Ltd., and Sumitomo Mitsui Banking Corporation recommended that the 
effective date of the rules be deferred until December 31, 2012.
    The Commission received no comments related to the length of time 
necessary for registrants to come into compliance with the rules 
proposed in the SD/MSP Conflicts NPRM and FCM/IB Conflicts NPRM.

B. Compliance Dates

    Having considered the comments received, the Commission is adopting 
the effective and compliance dates as set forth below.
1. Reporting, Recordkeeping and Daily Trading Records of SDs and MSPs--
Sec. Sec.  23.200-23.205
    The effective date of Sec. Sec.  23.200 through 23.205 will be the 
date that is 60 days after publication of the final rules in the 
Federal Register.
    SDs and MSPs that are currently regulated by a U.S. prudential 
regulator or are registrants of the SEC must comply with Sec. Sec.  
23.200, 23.201, 23.202, 23.203, 23.204, and 23.205 by the date that is 
the later of 90 days after publication of these final rules in the 
Federal Register or the date on which SDs and MSPs are required to 
apply for registration pursuant to Sec.  3.10. SDs and MSPs that are 
not currently regulated by a U.S. prudential regulator and are not 
registrants of the SEC must comply with Sec. Sec.  23.200, 23.201, 
23.202, 23.203, 23.204, and 23.205 by the date that is the later of 180 
days after publication of these final rules in the Federal Register or 
the date on which SDs and MSPs are required to apply for registration 
pursuant to Sec.  3.10.
2. Duties of SDs and MSPs--Sec. Sec.  23.600 Through 23.607
    The effective date of Sec. Sec.  23.600 through 23.607 will be the 
date that is 60 days after publication of the final rules in the 
Federal Register.
    With respect to Sec.  23.600 (Risk Management Program), SDs and 
MSPs that are currently regulated by a U.S. prudential regulator or are 
registrants of the SEC must comply with Sec.  23.600 by the date that 
is the later of 90 days after publication of this final rule in the 
Federal Register or the date on which SDs and MSPs are required to 
apply for registration pursuant to Sec.  3.10. SDs and MSPs that are 
not currently regulated by a U.S. prudential regulator and are not 
registrants of the SEC must comply with Sec.  23.600 by the date that 
is the later of 180 days after publication of this final rule in the 
Federal Register or the date

[[Page 20166]]

on which SDs and MSPs are required to apply for registration pursuant 
to Sec.  3.10.
    With respect to Sec.  23.603 (Business Continuity and Disaster 
Recovery), SDs and MSPs that are currently regulated by a U.S. 
prudential regulator or are registrants of the SEC must comply with 
Sec.  23.603 by the date that is the later of 180 days after 
publication of this final rule in the Federal Register or the date on 
which SDs and MSPs are required to apply for registration pursuant to 
Sec.  3.10. SDs and MSPs that are not currently regulated by a U.S. 
prudential regulator and are not registrants of the SEC must comply 
with Sec.  23.603 by the date that is the later of 270 days after 
publication of this final rule in the Federal Register or the date on 
which SDs and MSPs are required to apply for registration pursuant to 
Sec.  3.10.
    With respect to Sec.  23.601 (Monitoring of Position Limits), Sec.  
23.602 (Diligent Supervision), Sec.  23.605 (Conflicts of Interest 
Policies and Procedures), Sec.  23.606 (General Information: 
Availability for Disclosure and Inspection), and Sec.  23.607 
(Antitrust Considerations), SDs and MSPs must comply with Sec. Sec.  
23.601, 23.602, 23.605, 23.606, and 23.607 by the later of the 
effective date of these rules or the date on which SDs and MSPs are 
required to apply for registration pursuant to Sec.  3.10.
3. Conflicts of Interest Policies and Procedures by FCMs and IBs--Sec.  
1.71
    The effective date of Sec.  1.71 will be the date that is 60 days 
after publication of the final rule in the Federal Register.
    FCMs and IBs that are registered with the Commission as of the 
effective date of this rule must comply with Sec.  1.71 by such 
effective date except that such FCMs need not comply with Sec.  1.71(d) 
until the later of the effective date or the date on which SDs and MSPs 
are required to apply for registration pursuant to Sec.  3.10. FCMs and 
IBs that are not registered with the Commission as of the effective 
date of this rule must comply with Sec.  1.71 upon registration with 
the Commission, except that such FCMs need not comply with Sec.  
1.71(d) until the later of their registration or the date on which SDs 
and MSPs are required to apply for registration pursuant to Sec.  3.10.
4. Chief Compliance Officer of FCMs, SDs, and MSPs--Sec.  3.3
    The effective date of Sec.  3.3 and the amendments to Sec.  3.1 
will be the date that is 60 days after publication of the final rule in 
the Federal Register.
    With respect to Sec.  3.3 (Chief Compliance Officer), SDs and MSPs 
that are currently regulated by a U.S. prudential regulator or are 
registrants of the SEC, must comply with Sec.  3.3 by the date that is 
the later of 180 days after publication of this final rule in the 
Federal Register or the date on which SDs and MSPs are required to 
apply for registration pursuant to Sec.  3.10. SDs and MSPs that are 
not currently regulated by a U.S. prudential regulator and are not 
registrants of the SEC must comply with Sec.  3.3 by the date that is 
the later of 360 days after publication of this final rule in the 
Federal Register or the date on which SDs and MSPs are required to 
apply for registration pursuant to Sec.  3.10. FCMs that are (1) 
registered with the Commission as of the effective date of the rule, 
and (2) currently regulated by a U.S. prudential regulator or are 
registrants of the SEC, must comply with Sec.  3.3 by the date that is 
180 days after publication of this final rule in the Federal Register. 
FCMs that are (1) registered with the Commission as of the effective 
date of the rule, and (2) not currently regulated by a U.S. prudential 
regulator and are not registrants of the SEC must comply with Sec.  3.3 
by the date that is 360 days after publication of this final rule in 
the Federal Register. FCMs that are not registered with the Commission 
as of the effective date of this rule must comply with Sec.  3.3 upon 
registration with the Commission.

IV. Cost Benefit Considerations

A. Introduction

    The swaps markets, which have grown exponentially in recent years, 
are now an integral part of the nation's financial system. As the 
financial crisis of 2008 demonstrated, inadequate understanding, 
oversight, and management of swaps can contribute to systemic risk.\49\ 
The internal business conduct standards that the Commission is 
promulgating for SDs and MSPs in this rulemaking are an important 
element of the ``improve[d] financial architecture'' that Congress 
intended in enacting the Dodd-Frank Act.\50\ For, as entities that, 
respectively, engage in swap dealing activities \51\ and ``whose 
outstanding swaps create substantive counterparty exposure that could 
have serious adverse effects on the financial stability of the United 
States banking system or financial markets,'' \52\ the standards that 
SDs and MSPs follow (or fail to follow) in transacting their swaps may 
have repercussions for financial system stability more broadly. 
Effective systemic risk management for swaps begins with effective 
internal risk management protocols of individual SDs and MSPs.
---------------------------------------------------------------------------

    \49\ As the U.S. Senate Committee on Banking, Housing, and Urban 
Affairs explained in reporting what became the Dodd-Frank Act, while 
a ``downturn in the national housing market'' was the 2008 financial 
crisis' ``first trigger:''
    * * * the use of unregulated derivatives products based on 
[faulty mortgage loans was among the elements that] only served to 
spread and magnify the risk. The system operated on the wholesale 
misunderstanding of, or complete disregard for the risks inherent in 
the underlying assets and the complex instruments they were backing 
* * *' Technology, plus globalization, plus finance has created 
something quite new, often called ``financial technology.'' Its 
emergence is a bit like the discovery of fire--productive and 
transforming when used with care, but enormously destructive when 
mishandled' * * * Gaps in the regulatory structure allowed these 
risks and products to flourish outside the view of those responsible 
for overseeing the financial system.
    S. Rep. No. 111-176, at 43 (2010) (quoting former Comptroller of 
the Currency, Eugene Ludwig; citations omitted).
    \50\ Id. at 228. Stated another way, they are an aspect of that 
legislation's ``comprehensive regulation and rules'' to achieve a 
``strengthened infrastructure for the financial system * * * 
intended to make the system more resilient and resistant to the 
adverse effects of financial instability.'' Id. at 228-29.
    \51\ CEA section 1(a)(49)(A).
    \52\ CEA section 1(a)(33)(A)(ii).
---------------------------------------------------------------------------

    Title VII of the Dodd-Frank Act mandates the Commission to 
establish risk management requirements for SDs and MSPs. Specifically, 
Section 731 adds new section 4s of the CEA that, among other things:
    <bullet> Establishes reporting, recordkeeping, and daily trading 
records requirements for SDs and MSPs.\53\
---------------------------------------------------------------------------

    \53\ CEA section 4s(f)&(g).
---------------------------------------------------------------------------

    <bullet> Defines and imposes duties on SDs and MSPs with regard to: 
(1) Risk management procedures,\54\ (2) monitoring of trading to 
prevent violations of applicable position limits,\55\ (3) diligent 
supervision,\56\ (4) disclosure and the ability of regulators to obtain 
general information,\57\ and (5) antitrust considerations.\58\
---------------------------------------------------------------------------

    \54\ CEA section 4s(j)(2).
    \55\ CEA section 4s(j)(1).
    \56\ CEA section 4s(h)(1).
    \57\ CEA section 4s(j)(3).
    \58\ CEA section 4s(j)(6).
---------------------------------------------------------------------------

    <bullet> Establishes conflicts-of-interest requirements for SDs and 
MSPs to establish information partitions between research and trading 
and between trading and clearing.\59\
---------------------------------------------------------------------------

    \59\ CEA section 4s(j)(5).
---------------------------------------------------------------------------

    <bullet> Requires each SD and MSP to designate a chief compliance 
officer, set out qualifications and duties of the chief compliance 
officer, and require that the chief compliance officer prepare, sign, 
and furnish to the Commission an annual report containing an assessment 
of the registrant's compliance activities.\60\
---------------------------------------------------------------------------

    \60\ CEA section 4s(k).
---------------------------------------------------------------------------

    Additionally, Dodd-Frank Act section 732 amends section 4d of the 
CEA to add conflict of interest requirements for

[[Page 20167]]

FCMs and IBs,\61\ and a chief compliance officer requirement for 
FCMs.\62\ This rulemaking implements these provisions of sections 4s 
and 4d of the CEA.
---------------------------------------------------------------------------

    \61\ CEA section 4d(c).
    \62\ CEA section 4d(d).
---------------------------------------------------------------------------

    Section 15(a) \63\ of the CEA requires the Commission to consider 
the costs and benefits of its actions before promulgating a regulation 
under the CEA or issuing an order. Section 15(a) further specifies that 
the costs and benefits shall be evaluated in light of the following 
five broad areas of market and public concern: (1) Protection of market 
participants and the public; (2) efficiency, competitiveness and 
financial integrity of futures markets; (3) price discovery; (4) sound 
risk management practices; and (5) other public interest 
considerations. To the extent that these new regulations reflect the 
statutory requirements of the Dodd-Frank Act, they will not create 
costs and benefits beyond those resulting from Congress's statutory 
mandates in the Dodd-Frank Act.\64\ However, to the extent that the new 
regulations reflect the Commission's own determinations regarding 
implementation of the Dodd-Frank Act's provisions, such Commission 
determinations may result in other costs and benefits. It is these 
other costs and benefits resulting from the Commission's own 
determinations pursuant to and in accordance with the Dodd-Frank Act 
that the Commission considers with respect to the section 15(a) 
factors.
---------------------------------------------------------------------------

    \63\ 7 U.S.C. 19(a).
    \64\ Certain commenters, such as The Working Group and the 
FHLBs, posit that there is no benefit to be derived from internal 
business conduct standards as mandated by Congress and that the 
mandated provisions do not generate sufficient benefits relative to 
costs or contribute to the purposes (e.g., mitigating systemic risk 
and enhancing transparency) of the Dodd-Frank Act. As such, these 
commenters' concerns fall outside the Commission's regulatory 
discretion to implement sections 4s and 4d of the CEA and fail to 
raise issues subject to consider under section 15(a).
---------------------------------------------------------------------------

    The Commission is obligated to estimate the burden of and provide 
supporting statements for any collections of information it seeks to 
establish under considerations contained in the PRA, 44 U.S.C. 3501 et 
seq., and to seek approval of those requirements from the OMB. To the 
extent costs of the rulemaking are associated with collections of 
information, the estimated burden and support for such collections of 
information, as well as the consideration of comments thereto, are 
discussed in the PRA section of this rulemaking and the information 
collection requests filed with OMB as required by that statute. The 
Commission has also considered these costs, which it incorporates 
herein by reference, in its CEA section 15(a) analysis.
    In each of the NPRMs encompassed within this final rulemaking, the 
Commission asked for public comment on the costs and benefits of the 
proposed regulations, and specifically invited commenters to submit 
``any data or other information * * * quantifying or qualifying'' the 
costs and benefits of the proposal.\65\ The Commission also separately 
requested comments on the overall costs and benefits of the proposed 
rules implementing the Dodd-Frank Act.\66\ The Commission received 
approximately 51 comments addressing the cost and benefit 
considerations of the proposed rules, but few commenters presented to 
the Commission quantitative data pertinent to any of the proposed 
rulemakings, and no commenter stated whether such data is ascertainable 
with a degree of certainty that could inform Commission deliberations. 
After conducting a review of applicable academic literature, the 
Commission is not aware of any research reports or studies that are 
directly relevant to its considerations of costs and benefits of these 
final rules.
---------------------------------------------------------------------------

    \65\ See SD/MSP Conflicts NPRM, 75 FR at 71395; FCM/IB Conflicts 
NPRM, 75 FR at 70157; Duties NPRM, 75 FR at 71404; Recordkeeping 
NPRM, 75 FR at 76673; and CCO NPRM, 75 FR at 70886.
    \66\ Id.
---------------------------------------------------------------------------

    The Commission considered the comments on the costs and benefits of 
the proposed rules and, in particular, reasonable alternatives 
suggested by commenters. As detailed in the discussions of each 
rulemaking above, the Commission is adopting alternatives or 
modifications to the proposed rules where, in the Commission's 
judgment, the alternative or modification accomplishes the same 
regulatory objective in a less burdensome manner. Indeed, the 
Commission has sought to reduce the burden on market participants to 
the extent doing so satisfies the statute's requirements and does not 
undermine important benefits that the Commission believes the statute 
was intended to promote. In addition to benefits, the costs of the 
regulations and the steps the Commission has taken to mitigate them are 
discussed below.
    Notwithstanding the paucity of available quantitative information, 
the Commission has endeavored to estimate quantifiable costs and 
benefits of the final rules when possible. Where estimation or 
quantification is not feasible, the Commission provides a qualitative 
assessment of the relevant costs and benefits. In the following 
discussion, the Commission: (i) Addresses comments regarding the 
effects of these final rules in terms of their material costs and 
benefits; (ii) considers the material cost and benefit implications of 
these final rules in comparison to baseline costs imposed by the 
statutory requirements and discusses cost mitigation undertaken in 
modifying the rules as proposed; and (iii) considers the material costs 
and benefits of the final rules in light of the five broad areas of 
market and public concern pursuant to section 15(a) of the CEA. After 
discussing some general considerations applicable to all rulemaking 
areas covered by this release and comments regarding rule scope, the 
cost-benefit considerations are divided among the following rulemaking 
areas: recordkeeping; duties and risk management; conflicts-of-interest 
policies and procedures; and designation of a CCO.

B. General Considerations

    This rulemaking generated an extensive record, which is discussed 
at length throughout this notice as it relates to the substantive 
provisions in the final rules. A number of commenters stated that they 
would incur significant, though largely unquantified, costs because of 
the proposed rules. Others identified benefits attributable to the 
proposed rules or more stringent requirements. The Commission carefully 
considered these comments and the alternatives proposed in them.\67\
---------------------------------------------------------------------------

    \67\ These comments also have been addressed in other sections 
of this release. This section's consideration of costs and benefits 
reviews and assesses them to the more narrow extent that they raise 
relative cost/benefit issues. A complete policy analysis of, and 
response to, these comments can be found in section II of this 
release.
---------------------------------------------------------------------------

    In response to the Commission's invitation for comments on the 
overall costs and benefits of the proposed rules,\68\ Better Markets 
stated that the Commission's cost-benefit analyses in the notices of 
proposed rulemaking may have understated the benefits of the proposed 
rules.\69\ Better Markets argued

[[Page 20168]]

that adequate assessment of the costs and benefits of any single 
proposed rule or element of such a rule would be difficult or 
impossible without considering the integrated regulatory system of the 
Dodd-Frank Act as a whole. According to Better Markets:
---------------------------------------------------------------------------

    \68\ See SD/MSP Conflicts NPRM, 75 FR at 71395; FCM/IB Conflicts 
NPRM, 75 FR at 70157; Duties NPRM, 75 FR at 71404; Recordkeeping 
NPRM, 75 FR at 76673; and CCO NPRM, 75 FR at 70886.
    \69\ See Letter from Better Markets dated June 3, 2011(comment 
file for 75 FR 71397 (Regulations Establishing and Governing the 
Duties of Swap Dealers and Major Swap Participants)). On the other 
hand, certain commenters, such as The Working Group and the FHLBs, 
posit that there is no benefit to be derived from internal business 
conduct standards as mandated by Congress and that the mandated 
provisions do not generate sufficient benefits relative to costs or 
contribute to the purposes (e.g., mitigating systemic risk and 
enhancing transparency) of the Dodd-Frank Act.

    It is undeniable that the Proposed Rules are intended and 
designed to work as a system. Costing-out individual components of 
the Proposed Rules inevitably double counts costs which are 
applicable to multiple individual rules. It also prevents the 
consideration of the full range of benefits that arise from the 
system as a whole that provides for greater stability, reduces 
systemic risk and protects taxpayers and the public treasury from 
---------------------------------------------------------------------------
future bailouts.

Better Markets also stated that an accurate cost benefit assessment 
must include the avoided risk of a new financial crisis and opined that 
one measure of this is the still accumulating cost of the 2008 
financial crisis.\70\ The Commission agrees with Better Markets that 
the proposed rules should operate in a coordinated manner to improve 
and protect financial markets; notwithstanding this, the Commission 
must (and has) conducted a cost-benefit analysis with respect to this 
specific rulemaking.
---------------------------------------------------------------------------

    \70\ The comment letter cited Andrew G. Haldane, Executive 
Director for Financial Stability of the Bank of England, who 
estimated the worldwide cost of the crisis in terms of lost output 
at between $60 trillion and $200 trillion, depending primarily on 
the long term persistence of the effects.
---------------------------------------------------------------------------

    Recognizing that there will be costs incurred to comply with the 
regulations, the Commission believes there are significant benefits to 
be gained from these requirements, including but not limited to, 
increased risk management and enhanced transparency. While the 
Commission notes that the costs and benefits stemming from these 
regulations, in large part, are attributable to the baseline statutory 
mandate, each subsection herein further details the costs and benefits 
of the numerous discrete provisions of the rules in order to inform 
market participants more fully of the costs and benefits anticipated by 
the Commission.
    As a general matter across these rules, the Commission sought to 
ease the burden for market participants through tailored phasing in of 
compliance requirements. In each of the Duties NPRM, Recordkeeping 
NPRM, and CCO NPRM, the Commission requested comment on the length of 
time necessary for registrants to come into compliance with the 
proposed rules. These comments are enumerated in section III.A., and 
the Commission considered those comments in adopting compliance dates 
for each rule as set forth in section III.B. above. The approach 
recommended by commenters and accepted by the Commission recognizes and 
generally differentiates between registrants that have been previously 
regulated by the SEC or a prudential regulator and those that have not 
been previously regulated. The Commission has elected to provide 
additional time for compliance, where appropriate, for those that have 
not been previously regulated. In many instances, the Commission is 
providing more time for all market participants beyond the statutorily 
prescribed minimum of 60 days.

C. Comments Regarding the Scope of the Proposed Rules

    Several commenters questioned the scope of the proposed rules and 
implicitly, if not expressly, whether the breadth as proposed was 
appropriate in light of the costs that would result to certain 
registrants. Comments illustrative of the concerns are discussed below.
    The FHLBs articulated several reasons \71\ for exempting them from 
the proposed internal business conduct standard rules. First, they 
maintain that subjecting FHLBs to internal business conduct standards 
could cause them to cease offering swaps transactions to their risk-
hedging members, depriving their members of a competitive swap 
transaction counterparty and potentially increasing members' hedging 
costs. Second, they maintain that many of the requirements duplicate 
those imposed by their prudential regulator, the Federal Housing 
Finance Agency (FHFA), thus there is no incremental benefit 
attributable to the additional costs of complying with the proposed 
rules.\72\
---------------------------------------------------------------------------

    \71\ In addition to the two reasons discussed, the FHLBs also 
expressed that, unlike external business conduct standards, the 
internal business conduct standards as mandated by Congress in the 
Dodd-Frank Act do not generate benefits to justify their costs. As 
noted above, this concern falls beyond the Commission's 
implementation discretion.
    \72\ SIFMA made a similar argument with respect to all SDs and 
MSPs that are subject to regulation by a prudential regulator.
---------------------------------------------------------------------------

    The Commission finds the FHLB's position unpersuasive. First, the 
concern that FHLBs would cease transacting swaps is undermined by the 
FHLB's position that the proposed rules in large part duplicate the 
requirements of its prudential regulator; if internal business conduct 
standards would likely curb the FHLBs' swaps activity, presumably that 
would have occurred already. Second, the Commission construes the 
FHLB's position to be inconsistent with the statutory intent of 
sections 4s(f), (g), (j), and (k)--i.e., consistent Commission 
oversight of SDs and MSPs, regardless of whether they are also subject 
to regulation by a prudential regulator. For, in the one area that 
Congress intended the Commission to defer to prudential regulation with 
respect to SDs and MSPs--capital and margin requirements--it provided 
so expressly.\73\ There is no such express language requiring 
prudential regulation deference in sections 4s(f), (g), (j), and (k). 
This gives rise to a negative inference that, with respect to them, 
Congress intended the Commission to establish uniform requirements for 
SDs and MSPs, notwithstanding any overlapping prudential regulation. In 
addition, to the extent that, as the FHLBs assert, FHFA rules are 
substantively similar with the proposed rules, compliance with the 
proposed rules should not present substantial additional compliance 
costs.
---------------------------------------------------------------------------

    \73\ See CEA section 4s(e).
---------------------------------------------------------------------------

    The Working Group suggested that the proposed rules would impose 
substantial costs with no corresponding increase in risk management and 
compliance effectiveness. The Commission disagrees. It believes that 
its final internal business conduct standards will enhance risk 
management by requiring, among other things: (1) SDs and MSPs to have a 
complete understanding of the various risks that the entity faces; and 
(2) entities to monitor their traders for compliance with trading 
policies established by the SD or MSP. These final rules also require 
that SDs and MSPs have sound recordkeeping policies in place, which 
will ensure that swap transactions are fully memorialized. Sound risk 
management and internal controls on an individual firm level is the 
basis of systemic risk mitigation.
    Other commenters (MetLife, MFA, BlackRock, and AMG) argued that the 
Dodd-Frank Act does not require the Commission to apply the same rules 
to MSPs as those applied to SDs, and that MSPs should not be subject to 
the same regulations as SDs because MSPs do not engage in market-making 
activities. These commenters contend that the costs of compliance would 
be too high for MSPs. The Commission believes that the statutory 
baseline under sections 4s(f), (g), (j), and (k) of the CEA is 
identical treatment of SDs and MSPs. The statutory provisions of 
sections 4s(f), (g), (j), and (k) of the CEA do not distinguish between 
the requirements applied to SDs and those applied to MSPs. 
Additionally, in response to claims that the costs will be too high for 
MSPs, the Commission notes that if an

[[Page 20169]]

MSP does not engage in certain activities, the regulations pertaining 
to those activities are not applicable. Therefore, in these cases, the 
Commission believes MSPs would be relieved of any burden such 
regulations present.
    Finally, Cargill recommended that the Commission make clear that 
the Commission's regulations only apply to the swap dealing business of 
an SD that is a division of a larger company, and not to the other, 
non-swaps-related business activities of the company.\74\ The 
Commission has accepted the alternative proposed by Cargill by 
including a new definition of ``swaps activities'' in the final 
regulations and by limiting the scope of several requirements to fit 
this definition. Adopting this alternative approach should allow 
entities to understand their duties and requirements under the final 
regulations more clearly and reduce costs by limiting the scope of the 
rules' applicability.
---------------------------------------------------------------------------

    \74\ Presumably, Cargill believes that limiting application of 
Commission regulations to a specific division, rather than the 
entirety of a larger company, will result in cost savings, although 
it does not directly advance this argument.
---------------------------------------------------------------------------

D. Recordkeeping, Reporting, and Daily Trading Records Requirements for 
Swap Dealers and Major Swap Participants

    As added by section 731 of the Dodd-Frank Act, sections 4s(f) and 
4s(g) of the CEA establish reporting and recordkeeping requirements and 
daily trading records requirements for SDs and MSPs. Section 4s(f)(1) 
requires SDs and MSPs to ``make such reports as are required by the 
Commission by rule or regulation regarding the transactions and 
positions and financial condition of the registered swap dealer or 
major swap participant.'' In the Recordkeeping NPRM, the Commission 
proposed regulations, pursuant to sections 4s(f)(1)(B)(i) and (ii) of 
the CEA, prescribing the books and records requirements for ``all 
activities related to the business of swap dealers or major swap 
participants,'' regardless of whether or not the entity has a 
prudential regulator, as required by statute. In addition, the 
Commission proposed regulations in the Recordkeeping NPRM pursuant to 
section 4s(g)(1) of the CEA, requiring that SDs and MSPs ``maintain 
daily trading records of the swaps of the registered swap dealer and 
major swap participant and all related records (including related cash 
and forward transactions) and recorded communications, including 
electronic mail, instant messages, and recordings of telephone calls.'' 
The Commission notes that section 4s(g)(3) requires that daily trading 
records for each swap transaction be identifiable by counterparty, and 
section 4s(g)(4) specifies that SDs and MSPs maintain a ``complete 
audit trail for conducting comprehensive and accurate trade 
reconstructions.''
    The Commission received 14 comment letters on the Recordkeeping 
NPRM. The Commission considered each in formulating the final rules, 
including any alternatives proposed and cost or benefit concerns 
expressed. Of the 14 comments received, five addressed issues relevant 
to the costs and benefits of the proposed rules, but no letters 
provided any quantitative data to support their claims. The comment 
letters focused on 9 areas of the rule that are most relevant to the 
Commission's consideration of costs and benefits. Each of these areas 
is discussed below. A more detailed discussion can be found in section 
II.B-E. above.
1. Additional Types of Records
    In the Recordkeeping NPRM, the Commission requested comments 
regarding whether additional types of records other than those 
specified in the proposed rules under Sec.  23.201 should be required 
to be kept by SDs and MSPs. The Commission also requested comment 
regarding whether drafts of documents should be kept. Having considered 
the comments received,\75\ the Commission is not requiring any 
additional types of records in the final rule. Although the Commission 
agrees that drafts may provide information regarding the development of 
transactions, the Commission does not believe that the marginal 
incremental value of such information is sufficient to require draft 
retention. The Commission also notes that pertinent pre-execution trade 
information that may appear in drafts is already subject to retention 
under the daily trading records rule.
---------------------------------------------------------------------------

    \75\ The Working Group commented that the current proposal is 
sufficient. Chris Barnard, however, recommended that drafts of 
documents should also be kept, arguing that the decision process 
leading up to a final document can be very informative.
---------------------------------------------------------------------------

2. Reliance on SDRs for Recordkeeping Requirements
    The proposed regulations did not address whether an SD or MSP could 
fulfill the recordkeeping requirements by reporting a swap to a swap 
data repository (SDR), but ISDA & SIFMA requested that the Commission 
consider the extent to which SDs and MSPs may rely upon SDRs to retain 
records beyond the time periods that registrants currently retain such 
records. ISDA & SIFMA did not elaborate on the current retention 
periods for swaps records, nor did they explain how this approach would 
work in the absence of established SDRs for all types of swaps. The 
Commission considered this alternative to its recordkeeping rules, but 
determined that it is premature at this time to permit SDs and MSPs to 
rely solely on SDRs to meet their recordkeeping obligations under the 
rules. Additionally, the Commission believes that SDs and MSPs must 
maintain complete records of their swaps for the purposes of risk 
management. The data that is required to be reported to an SDR may not 
be sufficient for these purposes. At present, SDRs are new entities 
under the Dodd-Frank Act with no track record of operation; and, for 
particular swaps asset classes, SDRs have yet to be established. As 
SDRs evolve, the proposed alternative may prove appropriate, but the 
Commission believes that putative cost-savings benefits attributable to 
SDR record retention in lieu of individual firm record retention are 
too speculative presently to justify modification of the proposed 
rules.
3. Records in a Single Electronic File, Searchable by Transaction and 
Counterparty
    Proposed Sec.  23.201(a)(1) required SDs and MSPs to keep 
transaction records in a form identifiable and searchable by 
transaction and by counterparty. Proposed Sec. Sec.  23.202(a) and 
23.202(b) also required SDs and MSPs to keep daily trading records for 
each swap and any related cash or forward transaction as a separate 
electronic file identifiable and searchable by transaction and 
counterparty. Commenters had several concerns with the costs of 
complying with this requirement.\76\ In particular, commenters objected 
to the burden of maintaining the records required for each transaction 
in a separate electronic file and with maintaining the records in a 
manner searchable by transaction and counterparty. No commenter 
quantified the exact cost of these requirements, but the Commission 
recognizes that SDs and MSPs would incur costs to comply with both 
requirements. The Commission retained the requirement that trading 
records be searchable by transaction and

[[Page 20170]]

counterparty because it interprets this to be the statutory minimum 
imposed by section 4s(g)(3) of the CEA, i.e., that registrants 
``maintain daily trading records for each counterparty in a manner and 
form that is identifiable with each swap transaction.'' However, the 
Commission is modifying the proposed rules to remove the provision in 
Sec.  23.202(a) and Sec.  23.202(b) that requires each transaction 
record to be maintained as a separate electronic file. The Commission 
believes that this modification trims the rule's requirements to the 
baseline required by statute, reducing the burden to the maximum extent 
possible.
---------------------------------------------------------------------------

    \76\ ISDA & SIFMA argued that SDs and MSPs routinely store data 
across a number of systems, and that aggregating transaction data 
from all systems into a single electronic file would require a large 
investment across market participants and would require a 
substantial implementation period. The Working Group also argued 
that tying relevant records to each individual transaction in a 
manner that is identifiable and searchable by transaction would 
create a heavy technical burden.
---------------------------------------------------------------------------

4. Form of Maintaining Business Records
    As proposed, Sec.  23.201(b) required SDs and MSPs to keep full, 
complete, and systematic business records, including records related to 
corporate governance, financial records, complaints, and marketing and 
sales materials. The Working Group recommended that, to minimize 
burden, the Commission permit these records to be retained as they 
currently are in the normal course of business. Responding to this 
concern, the Commission confirms that the rule does not require SDs and 
MSPs to keep the required business records in a single comprehensive 
file so long as such records can be readily accessed and provided to 
the Commission upon request. This confirmation as requested by The 
Working Group will minimize the burden on SDs and MSPs with regard to 
establishing new recordkeeping policies.
5. Records of Complaints Received by MSPs
    Proposed Sec.  23.201(b) required SDs and MSPs to retain a record 
of complaints received, certain identifying information about the 
complainant, and a record of the disposition of the complaint. Without 
quantifying any cost, MFA commented that, because MSPs do not have 
customers nor make markets in swaps, it is unwarranted to subject them 
to the burden of retaining a complaint record. The Commission finds 
MFA's position unpersuasive and is adopting the rule as proposed. The 
Commission has no basis to find that the burden of maintaining a 
complaint record will impose significant cost on MSPs. Moreover, the 
Commission believes that the relevant consideration is not whether MSPs 
have customers or whether they make markets, but the fact that they 
have substantial swaps positions and the potential significance of 
their swaps activities that defines them as MSPs. Given this, the 
Commission believes a record of complaints, particularly if it 
establishes a pattern, could be of important regulatory value.
6. Recording of Pre-Execution Trade Information, Including Voice 
Recordings
    Proposed Sec.  23.202(a)(1) required SDs and MSPs to make and keep 
records of pre-execution trade information, including records of all 
oral and written communications concerning quotes, solicitations, bids, 
offers, instructions, trading, and prices that lead to the execution of 
a swap, however communicated. As explained above, the Commission has 
eliminated the requirement that pre-execution trade information be 
maintained in a separate electronic file for each transaction. 
Otherwise the Commission is adopting the rule as proposed despite 
commenters concerns as to the cost of the required recording \77\ 
because it believes the information specified in the rule is the 
minimum necessary to maintain an audit trail as statutorily required by 
section 4s(g)(4) of the CEA.
---------------------------------------------------------------------------

    \77\ ATA commented that the current telephone recording systems 
in use by SDs and MSPs may not meet all of the proposed rule's 
requirements, and that implementing telephone recording systems that 
are compliant with the requirements would impose a significant 
additional cost. Notably, ATA did not propose any alternative ways 
that the Commission might achieve the statutory requirement of the 
CEA in a less burdensome manner.
---------------------------------------------------------------------------

7. Timestamp for Quotations Using Universal Coordinated Time (UTC)
    Proposed Sec.  23.202 required SDs and MSPs to use Universal 
Coordinated Time to record the time of each quotation provided to, or 
received from, a counterparty prior to execution; the time of swap and 
related cash and forward transaction execution; and the time of swap 
confirmation. The rule's use of UTC reflects an approach consistent 
with the Commission's final rules for real-time public reporting,\78\ 
and the swap data reporting rule.\79\ By requiring the use of UTC in 
Sec.  23.202, the Commission is ensuring that the requirements of Part 
23, Part 43, and Part 45 remain consistent to the extent possible. The 
Commission sees important benefits deriving from required UTC 
consistency in reporting and recordkeeping: avoiding the need to 
convert timestamps created in many different time zones is essential 
for timely and efficient automated processing of large amounts of 
market and pricing data by the Commission and others. Based on its 
belief that rapid automated processing is critical to the success of 
its regulatory mission, the Commission disagrees with the comments of 
ISDA & SIFMA in their joint letter that the value of this benefit is 
``minimal'' relative to the cost of moving to UTC, which cost they did 
not quantify. Moreover, the Commission believes that UTC works in 
complimentary tandem with Part 43 and Part 45 measures that promote 
straight-through-processing.\80\
---------------------------------------------------------------------------

    \78\ See Real-Time Public Reporting of Swap Transaction Data, 77 
FR 1182, 1251 (Jan. 9, 2012).
    \79\ See Swap Data Recordkeeping and Reporting Requirements, 77 
FR 2136, 2212 (Jan. 13, 2012).
    \80\ Straight-through processing was considered a ``critical 
risk mitigate'' in a 2005 report released by an industry group 
chaired by the then-chairman of Goldman Sachs and composed of 
representatives from Citigroup, JP Morgan Chase, and Morgan Stanley, 
among other prominent financial institutions. See Counterparty Risk 
Management Policy Group II, Toward Greater Financial Stability: A 
Private Sector Perspective, July 27, 2005, p. 84. Publicly available 
at http://fcic-static.law.stanford.edu/cdn_media/fcic-docs/2005-07-25%20Counterparty%20Risk%20Management%20Policy%20Group-%20Toward%20Greater%20Financial%20Stability.pdf.
---------------------------------------------------------------------------

8. Daily Trading Records for Cash and Forward Transactions Related to a 
Swap
    Proposed Sec.  23.202(b) required SDs and MSPs to keep daily 
trading records, similar to those SDs and MSPs are required to keep for 
swaps, for related cash and forward transactions.\81\ The Commission is 
adopting the rule as proposed because section 4s(g)(1) of the CEA 
requires registrants to ``maintain daily trading records of their swaps 
* * * and related records (including related cash and forward 
transactions) . * * *'' No commenter objected to the proposed 
definition of ``related cash and forward transactions,'' although 
commenters argued that hedging and risk mitigation activities referred 
to in the proposed daily trading records rule typically are not 
executed with respect to specific trades and that it would not be 
possible to link cash and forward transactions to a specific swap.\82\ 
The Working Group also argued that compliance with proposed Sec.  
23.202(b) would impose expensive and burdensome requirements on 
millions of physical transactions that are undertaken by commercial 
energy firms that are also parties to swap transactions. No commenter 
proposed, and the Commission has not identified, an alternative to 
achieve the statutory requirement in a less burdensome manner, however. 
Thus, the

[[Page 20171]]

Commission is adopting the rule as proposed.
---------------------------------------------------------------------------

    \81\ See definition under proposed Sec.  23.200, ``a purchase or 
sale for immediate or deferred physical shipment or delivery of an 
asset related to a swap where the swap and the related cash or 
forward transaction are used to hedge, mitigate the risk of, or 
offset one another.''
    \82\ ISDA & SIFMA and The Working Group made this point.
---------------------------------------------------------------------------

9. Record Retention Period
    Proposed Sec.  23.203(b)(2) required SDs and MSPs to retain records 
of any swap or related cash or forward transaction until the 
termination or maturity of the transaction and for a period of five 
years after such date. The Commission notes that proposed revisions to 
Commission regulation Sec.  1.31 require retention of swap transaction 
records for a period of five years following the termination, 
expiration, or maturity of a swap,\83\ and that Sec.  23.203 is 
consistent with retention requirements under the final swap data 
reporting rule.\84\ However, to mitigate costs in response to 
commenters' concerns \85\ regarding retention of pre-execution trade 
information, the Commission is revising the rule to reduce the voice 
recording retention period to one year. The Commission considered a 
six-month retention period for voice recordings, as recommended by ISDA 
& SIFMA, but determined that for swaps, particularly long tenor swaps, 
a longer period is necessary in order to give trade discrepancies an 
opportunity to surface. In addition, the Commission believes that a 
one-year retention period is necessary to make the audit trail most 
useful for the Commission's enforcement purposes. The Commission 
believes the benefit of available voice recordings to clear up latent 
trade discrepancies and aide in enforcement actions justifies the 
incremental cost of an additional six-month retention period.
---------------------------------------------------------------------------

    \83\ See Adaptation of Commission Regulations to Accommodate 
Swaps, 76 FR 33066, 33088 (June 7, 2011).
    \84\ See Swap Data Recordkeeping and Reporting Requirements, 77 
FR 2136, 2212 (Jan. 13, 2012).
    \85\ See MFA (stating that the vast majority of its members do 
not keep records of transactions for five years and compliance with 
rule as proposed would be burdensome and costly); The Working Group 
(long-term electronic storage of significant amounts of pre-
execution communication will prove costly over five-year period); 
ISDA (supporting a voice recording obligation aligned to the six-
month minimum required by the UK Financial Services Authority); 
SIFMA (same). Chris Barnard, conversely, recommended that records 
should be required to be kept indefinitely rather than the general 
five years under the proposal. Mr. Barnard argued that documents can 
be scanned after five years, so there is no practical reason for 
limiting the retention period and the information would be useful 
for future analytical purposes.
---------------------------------------------------------------------------

Costs
    Sections 4s(f) and (g) of the CEA require SDs and MSPs to adopt and 
implement certain reporting and recordkeeping requirements. The costs 
and benefits that necessarily result from these basic statutory 
requirements are considered to be the ``baseline'' against which the 
costs and benefits of the Commission's final rules are compared or 
measured. The ``baseline'' level of costs includes the costs that 
result from the following activities required by the statute:
    <bullet> Keeping books and records of all activities related to the 
business of the SD or MSP in such form and manner and for such period 
as may be prescribed by the Commission;
    <bullet> Maintaining daily trading records of swaps and related 
cash or forward transactions and recorded communications, including 
electronic mail, instant messages, and recordings of telephone calls, 
and including such information as the Commission shall require;
    <bullet> Maintaining daily trading records for each counterparty in 
a manner and form that is identifiable with each swap;
    <bullet> Maintaining a complete audit trail for conducting 
comprehensive and accurate trade reconstructions.
    Compliance with the statutory baseline alone would result in costs 
for SDs and MSPs. For example, the requirement to maintain recorded 
communications would include the cost of a telephonic recording system. 
Similarly, compliance with the statutory provisions would require data 
storage and retrieval systems.
    Congress mandated that the Commission adopt rules to implement each 
of the statutory provisions. With regard to its implementation 
decisions, the Commission has determined the following to be costs to 
SDs and MSPs to comply with the final regulations regarding 
recordkeeping obligations under Part 23:
    <bullet> Compiling transaction, position, and business records;
    <bullet> Compiling records of data reported to an SDR;
    <bullet> Compiling records of real-time reporting data;
    <bullet> Compiling daily trading records for swaps of pre-trade 
information, including all oral and written communications concerning 
quotes, solicitations, bids, offers, instructions, trading, and prices 
that lead to the execution of a swap, however communicated; execution 
trade information, including the name of the counterparty, the terms of 
each swap, the date and time of execution; and post-execution trade 
information;
    <bullet> Compiling daily trading records for related cash and 
forward transactions of pre-trade information, including all oral and 
written communications concerning quotes, solicitations, bids, offers, 
instructions, trading, and prices that lead to the execution of a 
related cash or forward transaction, however communicated; execution 
trade information, including the name of the counterparty, the terms of 
each swap, the date and time of execution; and post-execution trade 
information;
    <bullet> Data storage, in physical and/or digital format, in most 
cases for the term of a swap plus five years;
    <bullet> Telephonic recording system (to record voice calls related 
to transactions); and
    <bullet> Software and/or hardware updates to existing systems to 
capture and maintain the required records and to convert to Coordinated 
Universal Time.
    With regard to the reporting requirements, the Commission has 
determined that compliance with the requirements relating to reporting 
swap data to an SDR and the real-time public reporting of swap 
transaction data will constitute compliance with such reporting 
requirements in section 4s(f). The reporting rules set forth in this 
release consist of cross-references to the reporting requirements in 
the rules relating to the reporting of swaps to an SDR and the real-
time public reporting of swap transaction data. Accordingly, the 
Commission has considered the costs and benefits of reporting swap data 
to an SDR and real-time public reporting in those final rulemakings; 
therefore, those costs and benefits are not addressed in this 
rulemaking.\86\
---------------------------------------------------------------------------

    \86\ See Swap Data Recordkeeping and Reporting Requirements, 77 
FR 2136 (Jan. 13, 2012); and Real-Time Public Reporting of Swap 
Transaction Data, 77 FR 1182 (Jan. 9, 2012).
---------------------------------------------------------------------------

    As discussed, in adhering to its mandate from Congress, where 
possible the Commission also has attempted to alleviate the burdens on 
affected entities. In this regard, the Commission sought to minimize 
recordkeeping costs by eliminating the requirement that daily trading 
records of swaps and related cash and forward transactions be 
maintained as a separate electronic file.
    Based on the available data, the Commission has been unable to 
reliably quantify the cost of compliance with the recordkeeping 
rules.\87\ Although the rules were adapted from existing recordkeeping 
regulations from a variety of sources including the Commission's 
regulations and those of the SEC, such regulations have evolved over 
time and reliable quantitative data is generally not available 
regarding the costs of compliance with such requirements. A 1998 
adopting release for the SEC's rules for OTC derivatives dealers

[[Page 20172]]

(including recordkeeping rules) cited commenters estimates in a range 
from $75,000 to $500,000 per year. Although dated, these SEC estimates 
provide a measure from which to very roughly attempt to gauge 
compliance costs.\88\ Moreover, because financial entities that will 
likely be required to register as SDs are currently subject to 
prudential regulation or other form of regulatory oversight, the 
Commission believes they will already have some form of recordkeeping 
policies and procedures in place.
---------------------------------------------------------------------------

    \87\ To better inform this assessment, the Commission has 
conducted a review of applicable academic literature, but found no 
research reports or studies that are directly relevant to its 
considerations of costs and benefits of these final rules.
    \88\ See OTC Derivatives Dealers, 63 FR 59362, 59391 (Nov. 3, 
1998).
---------------------------------------------------------------------------

    In contrast, the Commission anticipates that entities that are not 
subject to prudential regulation may incur greater costs to develop the 
infrastructure to comply with these recordkeeping requirements. In this 
respect, one commenter presented a report prepared by National Economic 
Research Associates, Inc. (NERA) stating that (1) compliance by certain 
entities with the proposed requirement that SDs and MSPs retain instant 
messages and tie them to transaction identifiers would entail average 
initial retention costs of $464,000 and average incremental ongoing 
annual costs of $228,000; (2) that the retention of phone calls would 
entail an average initial investment of $649,000 with additional annual 
costs of $382,000; and (3) that the requirement to time stamp 
transactions and use unique identifiers for transactions would entail 
average initial setup costs of $2,800,000 and average annual costs of 
$302,000.\89\ The Commission notes that the required use of unique 
identifiers is the subject of another rulemaking not adopted in this 
release.
---------------------------------------------------------------------------

    \89\ NERA, Cost-Benefit Analysis of the CFTC's Proposed Swap 
Dealer Definition Prepared for the Working Group of Commercial 
Energy Firms, December 20, 2011. In this late-filed comment 
supplement, NERA concludes that cost-benefit considerations compel 
excluding entities ``engaged in production, physical distribution or 
marketing of natural gas, power, or oil that also engage in active 
trading of energy derivatives''--termed ``nonfinancial energy 
companies'' in the report--from regulation as SDs, including these 
recordkeeping and reporting rules.
---------------------------------------------------------------------------

    Certain of the costs associated with these recordkeeping rules 
result from collections of information subject to the Paperwork 
Reduction Act. Costs attributable to collections of information subject 
to the PRA are discussed further in section V.B.1. below. The 
Commission has also considered these costs, which it incorporates by 
reference herein, in its section 15(a) analysis.
Benefits
    The Commission believes these recordkeeping requirements will 
contribute to important, though unquantifiable, benefits intended by 
the Dodd-Frank Act. More specifically, complete, rigorous transactional 
recordkeeping promotes both external and internal risk management by 
providing an audit trail of past transactions. A strong audit trail, in 
turn generates a number of benefits, including the following:
    <bullet> It facilitates a firm's ability to recognize and manage 
its risk, thereby enhancing the risk management of the market as a 
whole.
    <bullet> It acts as a disincentive to engage in unduly risky or 
injurious conduct in that the conduct will be traceable.
    <bullet> In the event such conduct does occur, it provides a 
mechanism for policing such conduct, both internally as part of a 
firm's compliance efforts and externally by regulators.
    <bullet> It provides a basis for efficiently resolving 
transactional disputes.
    <bullet> And, it supports SDR reporting in that it provides a 
backstop to confirm the accuracy of reported information.
Section 15(a) Determination
1. Protection of Market Participants and the Public
    The Commission believes that, by generating the benefits identified 
above, these rules provide important protections to swap market 
participants and the public. The recordkeeping requirements: (1) 
Promote the ability of SDs and MSPs to manage their risks through 
accurate and timely recordkeeping; (2) create disincentives for 
conduct, such as rogue trading, that could be injurious to the firm (as 
well as the market generally) by requiring a comprehensive audit trail; 
(3) support internal compliance efforts by requiring that complaints 
and other pertinent documents be retained; and (4) facilitate 
resolution of trade disputes. Public protection also is enhanced in 
that effective comprehensive, internal risk management improves risk 
management for the market as a whole. Moreover, the rules serve as an 
important link in the risk reduction chain envisioned by Congress in 
enacting the Dodd-Frank Act. Working in concert with other Dodd-Frank 
Act requirements, these rules further the goal of avoiding market 
disruptions and the resulting financial losses to market participants 
and the general public.
    The Commission believes that any incremental costs of the final 
rules over those necessitated by the statutory baseline of sections 
4s(f) and (g) of the CEA do not hinder the goal of effective protection 
of market participants and the public. Because some basic level of 
recordkeeping is fundamental to any financial undertaking, the 
Commission assumes that all likely SDs and MSPs currently keep records 
of some sort for their own internal control purposes. Therefore, the 
incremental costs of complying with the specific requirements of the 
Commission's final rules are unlikely to lead SDs or MSPs to withdraw 
from the market or cause SDs and MSPs to make investments in updating 
recordkeeping systems that would otherwise be directed to activities 
that increase protection of market participants or the public.
2. Efficiency, Competitiveness, and Financial Integrity of Markets \90\
---------------------------------------------------------------------------

    \90\ Although by its terms CEA section 15(a)(2)(B) applies to 
futures markets only, the Commission finds this factor useful in 
analyzing regulations pertaining to swaps markets as well.
---------------------------------------------------------------------------

    Accurate recordkeeping is foundational to sound risk management and 
the financial integrity of SDs and MSPs, which impacts the financial 
integrity of markets. As illustrated by the collapse of firms during 
the 2008 financial crisis, poor recordkeeping can substantially impair 
resolution of customer claims.\91\ Additionally, the recordkeeping 
rules will enhance the financial integrity of the markets by ensuring 
that swap transactions, especially those that are bilaterally executed 
and require the exchange of margin, are documented and recorded in a 
prompt and accurate manner. Market efficiency and competitiveness is 
benefited by accurate and timely recordkeeping and the creation of a 
complete audit trail to the extent that those requirements facilitate 
Commission's enforcement actions against market manipulation and other 
market abuses.
---------------------------------------------------------------------------

    \91\ See In re Lehman Brothers Holdings Inc., 08-13555, and 
Giddens v. Barclays Capital Inc., 09-01732, U.S. Bankruptcy Court, 
Southern District of New York; see also Lehman Derivatives Records a 
``Mess,'' Barclays Executive Says, available at http://www.bloomberg.com/news/2010-08-30/lehman-derivatives-records-a-mess-barclays-executive-says.html (reporting on testimony provided in 
previously cited Lehman bankruptcy proceeding).
---------------------------------------------------------------------------

    On the other hand, compliance with the rules is likely to require 
investment in recordkeeping, storage, and other back office systems; 
investment costs that otherwise could be used to enhance the efficiency 
and competitiveness of front office trading operations. For example, 
the telephonic recording systems that are required for recording oral 
communications may introduce new costs for SDs and MSPs that those

[[Page 20173]]

entities would prefer to avoid in favor of enhancing trading 
operations.
3. Price Discovery
    The Commission has identified no likely material impact on price 
discovery from the costs and benefits of these recordkeeping rules.
4. Sound Risk Management
    The Commission believes that proper recordkeeping--though likely to 
require initial investment in recordkeeping and other back office 
systems--is essential to risk management because it facilitates an 
entity's awareness of its transactions, positions, trading activity, 
internal operations, and any complaints made against it, among other 
things. Such awareness supports sound internal risk management policies 
and procedures by ensuring that decision-makers within SDs and MSPs are 
fully informed about the entity's activities and can take steps to 
mitigate and address significant risks faced by the firm. When 
individual market participants engage in sound risk management 
practices, the entire market benefits. Accordingly, the Commission 
believes that these final rules, notwithstanding potential costs 
identified above, will promote the public interest in sound risk 
management.
5. Other Public Interest Considerations
    The Commission has not identified any other public interest 
considerations that could be impacted by these recordkeeping and 
reporting obligations for SDs and MSPs.

E. Duties and Risk Management Requirements of Swap Dealers and Major 
Swap Participants

    As part of an overall business conduct regime for SDs and MSPs, 
section 4s(j) of the CEA, as added by section 731 of the Dodd-Frank 
Act, sets forth certain duties for SDs and MSPs. In its Duties NPRM, 
the Commission proposed six regulations to implement section 4s(j), 
specifically addressing risk management, monitoring of positions 
limits, diligent supervision, business continuity and disaster 
recovery, the availability of general information, and antitrust 
considerations. The Commission's proposed conflicts-of-interest 
policies and procedures were the subject of the separate SD/MSP 
Conflicts NPRM.
    As described in detail in the preamble, the Commission in preparing 
these final rules sought and incorporated comment from the public. The 
Commission received 20 comment letters on the Duties NPRM, and 
considered each in formulating the final rules. Of the 20, eight 
comments addressed issues relevant to the costs and benefits of the 
proposed rules, but only two provided any quantitative data to support 
their claims. The comments focused on seven areas of the rules that are 
most relevant to the Commission's consideration of costs and benefits. 
Each of these areas is discussed below. A more detailed discussion of 
the Commission's policy decisions can be found in sections II.F-L. 
above.
1. Scope of Risk Management Program
    The proposed regulations required SDs and MSPs to establish, 
document, maintain, and enforce a system of risk management policies 
and procedures designed to monitor and manage the risks associated with 
the business of the SD or MSP. The Working Group, MetLife, and the 
Office of the Comptroller of the Currency, argued in favor of limiting 
Sec.  23.600 to the risks associated with swaps activities, and not 
other business lines in which an entity may engage.\92\ The Commission 
agrees with the commenters that its regulatory purpose is the 
management of the risk associated with SDs' and MSPs' swaps activities, 
not risks from their non-swaps activities, and is modifying the rule as 
they proposed. That is, the Commission is including a new definition of 
``swaps activities'' in the final regulations and thus limiting the 
scope of several requirements. Clearly delimiting the activities of 
registrants subject to the rule in this way reduces the compliance 
burden of Sec.  23.600.
---------------------------------------------------------------------------

    \92\ Although not expressly stated by these commenters, the 
Commission presumes that burden concerns motivate their limitation 
requests, at least in part.
---------------------------------------------------------------------------

    The Commission, however, declines to adopt The Working Group's 
recommendation that the rule be limited further with respect to 
affiliates and consolidated entity risk management.\93\ The Commission 
believes that considering the risks posed by affiliates is part of 
``robust and professional'' risk management as required by section 
4s(j), and provides a benefit to the registrant, its counterparties, 
and the swap market in the form of increased security and stability of 
the registrant. In the Commission's view, it is not unreasonably 
burdensome to require management of risk posed by affiliates--whether 
in the form of inter-affiliate transactions or otherwise--given their 
potential to be of the same kind and magnitude as risks posed by other 
swap counterparties. Likewise, the benefit of increased security and 
stability results from integrating the registrant's risk management 
program with risk management at the consolidated entity level, if 
applicable, where a top level company may be in the best position to 
evaluate risk due to its organization-wide view. Again, in light of 
this benefit, the Commission does not believe integration of an SD's or 
MSP's Risk Management Program into overall risk management at the 
consolidated entity level would be unduly burdensome.
---------------------------------------------------------------------------

    \93\ More specifically, The Working Group recommended that the 
rule be revised to require the risk management program to take into 
account only swaps-related risks posed by affiliates and take an 
integrated approach to risk management at the consolidated entity 
level only to the extent the SD or MSP deems necessary to enable 
effective risk and compliance oversight. Presumably, The Working 
Group recommended these alternatives out of an unexpressed concern 
for increased costs necessitated by monitoring and managing other 
risks posed by affiliates or being required to take an integrated 
approach to risk management; it did not quantify these however.
---------------------------------------------------------------------------

2. Risks Covered by the Risk Management Program
    The proposed regulation required a registrant's risk management 
program to include certain enumerated elements: Identification of risks 
and risk tolerance limits; periodic risk exposure reports; a new 
product policy; policies and procedures to monitor and manage market 
risk, credit risk, liquidity risk, foreign currency risk, legal risk, 
and operational risk; use of central counterparties; compliance with 
margin and capital requirements; monitoring of compliance with risk 
management program; and approval of trading policies and monitoring of 
traders.
    In response to comments received, the Commission is modifying the 
rule in several respects as discussed specifically below. The 
Commission believes that each of these changes will reduce the 
compliance burden on SDs and MSPs. More generally, the Commission 
believes the rules allow registrants to manage their costs by relying 
upon existing compliance or risk management capabilities to a large 
extent.\94\ In this respect, the rules generally only require 
``policies and procedures'' to monitor and manage the enumerated risks, 
but do not prescribe the content of such policies and procedures or 
require any specific control systems.
---------------------------------------------------------------------------

    \94\ Comments of The Working Group, SIFMA, EEI, and MetLife, 
each of whom suggested that proposed Sec.  23.600 be flexible enough 
to allow firms to adapt their existing compliance and risk 
management measures, and not cause firms to add entirely new 
compliance or risk management infrastructure.
---------------------------------------------------------------------------

    Risk Tolerance Limits: With respect to risk tolerance limit 
exceptions, the

[[Page 20174]]

Commission agrees with commenters \95\ that requiring approval by risk 
management personnel would be more costly without materially enhancing 
benefits than allowing SDs and MSPs the flexibility to structure their 
approval process in accordance with written policies and procedures. 
Accordingly, the Commission has modified the rule to reflect this 
approach.
---------------------------------------------------------------------------

    \95\ With respect to exceptions to risk tolerance limits, SIFMA 
recommended that trading supervisors, rather than risk management 
personnel, should have the authority to approve risk tolerance limit 
exceptions because the quarterly risk exposure reports provided to a 
registrant's senior management and governing body are an adequate 
check on decision-making by trading supervisors. Presumably, SIFMA 
believes trading supervisor approval presents less costs than risk 
management unit approval.
---------------------------------------------------------------------------

    New Product Policy Requirement: Concerning the new product policy 
requirement, the Commission notes that the rule was adapted from 
existing regulatory guidance in this area,\96\ and thus believes some 
SDs and MSPs already have such a policy in place; for them, the 
requirement would not impose any new burden. The Commission rejects the 
more limited alternative approach recommended by the Working Group--
i.e., that before offering a new product an SD or MSP need only conduct 
due diligence that is commensurate with the risks associated with a new 
product, and receive approval from appropriate risk management and 
business unit personnel within the firm. While The Working Group's 
recommended approach may be less costly for some unspecified number of 
registrants that to date have not implemented a new product policy in 
line with the proposed rule and existing regulatory guidance, the 
Commission believes that the benefits to SDs, MSPs, and financial 
markets of greater scrutiny for new products, which may entail degrees 
of risk that are not initially evident, are sufficient to adopt the 
rule substantially as proposed. However, the Commission believes that 
SIFMA's recommended alternative--allowing approval of new products on a 
contingent or preliminary limited-time basis at a non-material risk 
level for the registrant to gain product experience and develop 
appropriate risk management processes for the product--better addresses 
the unforeseen risk potential. Accordingly, the Commission considers 
SIFMA's proposed alternative preferable on cost/benefit grounds to the 
rule as proposed and has modified the rule in line with it.
---------------------------------------------------------------------------

    \96\ See OCC's Comptroller's Handbook, Risk Management of 
Financial Derivatives at 7 (Jan. 1997); Federal Reserve Board's 
Trading and Capital-Markets Activities Manual.
---------------------------------------------------------------------------

    Reconciliation of Profits and Losses to the General Ledger: The 
Commission has responded to commenters that objected to the burden of 
daily reconciliation by modifying the rule to require periodic, rather 
than daily, reconciliation. The Commission believes this modification, 
increases the flexibility available to registrants to design cost-
effective procedures best suited to their own circumstances.
    Assessing Liquidity of Non-Cash Collateral: With respect to 
assessing liquidity of non-cash collateral, the Commission agrees with 
commenters that testing by simulated disposition presented an 
unnecessary cost to SDs and MSPs \97\ and has adjusted the final rule 
to provide flexibility for registrants to design procedures to fit 
their own circumstances.
---------------------------------------------------------------------------

    \97\ SIFMA recommended that the Commission not require testing 
of liquidation procedures by simulated disposition, but only require 
policies and procedures for identifying acceptable collateral and 
establishing appropriate haircuts, taking into account reasonably 
anticipatable adverse price movements, arguing that simulated 
disposition could be costly during periods of market stress.
---------------------------------------------------------------------------

    Foreign Currency Risk: With respect to foreign currency risk, 
rather than mandating daily measurement, The Working Group recommended 
relaxing the rule to allow firms discretion with respect to how 
frequently capital exposed to fluctuations in the value of foreign 
currency needs to be measured. The Commission is rejecting The Working 
Group's recommendation because daily measurement is necessary for 
effective prudent risk management because the foreign currency markets 
are fluid, quick moving, and potentially volatile. Given the wide 
availability of foreign currency pricing information at a low cost, the 
Commission does not believe that the cost of daily measurement is 
unduly burdensome in light of the benefit of consistent management of 
foreign currency risk.
    Monitoring of Trading Requirements: Concerning the monitoring of 
trading requirements, the Commission agrees with commenters that the 
proposed rule's requirement that traders be monitored to prevent the 
incurrence of ``undue risk'' is vague and thus potentially burdensome 
to implement. To add clarity, the Commission is revising the rule to 
require monitoring of trading to prevent the incurrence of 
``unauthorized risk.'' \98\
---------------------------------------------------------------------------

    \98\ The Working Group and SIFMA requested that the Commission 
remove the requirement that firms monitor traders to prevent traders 
from ``incurring undue risk'' because the meaning of the phrase is 
ambiguous and presumably more costly to monitor under such standard.
---------------------------------------------------------------------------

    The Commission also agrees with The Working Group's recommendation 
that the proposed rule be modified to add a materiality standard for 
reporting of trade discrepancies to management. Accordingly, the 
Commission is modifying the rule to require that only trade 
discrepancies that are not immaterial, clerical errors be brought to 
the immediate attention of management of the business trading unit.
    Use of Brokers: The Commission agrees with commenters recommending 
against tasking the risk management unit with reviewing brokers' 
statements, monitoring commissions or initiating broker payments; 
allowing these functions to be handled by operations or other control 
units, and presumably lowering the cost of compliance. The Commission 
has narrowed the rule to require risk management units to periodically 
audit brokers' statements and payments only. The Commission believes 
that this modification retains the benefits of the rule (independent 
oversight of the use of brokers), while lowering the cost of compliance 
by not requiring modifications to current operations.
3. Risk Exposure Reports
    Proposed Sec.  23.600(c)(2)(ii) required SDs and MSPs to provide 
their senior management and governing body with quarterly Risk Exposure 
Reports detailing the registrant's risk exposure and any 
recommendations for changes to the risk management program. Copies of 
these reports were required to be furnished to the Commission within 
five business days of providing them to senior management. The Working 
Group and Cargill suggested as an alternative that SDs' and MSPs' 
periodic Risk Exposure Reports be required only annually and submitted 
to the Commission only upon request. They argued that quarterly reports 
will be costly, distract risk management personnel from their primary 
responsibilities, and tax Commission resources to review reports that 
frequently. The Commission is declining to modify the rule as suggested 
because, as recent events have shown, it is important that financial 
firm management have frequent information about the risk exposures 
faced. This affords prompt corrective action important to maintain 
financial stability. The potential costs of instability in the 
financial markets have been exhibited in a number of recent failures of 
major financial institutions, such as Long Term Capital Management, 
Bear Stearns, Lehman Brothers, and others. The Commission believes that 
any incremental additional burden of providing Risk Exposure Reports on 
a quarterly rather than annual basis is not

[[Page 20175]]

significant and is warranted by the benefit of Commission oversight and 
early risk detection capability.
4. Frequency of Risk Management Program Testing
    Proposed Sec.  23.600(e) required SDs and MSPs to review and test 
their risk management programs quarterly using internal or external 
auditors independent of the business trading unit. As explained in more 
detail below, commenters objected to the costs of quarterly risk 
management program testing required by the rule. The Commission is 
modifying proposed Sec.  23.600(e) to require only annual testing and 
audit of an SD's or MSP's risk management program, having been 
persuaded by the comments of The Working Group, Cargill, and MetLife, 
each of which recommended that both the frequency and the scope of 
audits of the risk management program be left to the discretion of the 
registrant so long as such audits are effective and are conducted at 
least annually. The Working Group and Cargill argued that this regime 
would provide the desired results without the unnecessary cost and 
administrative burden imposed by the proposed rules. The Commission 
agrees that the regulatory purpose of periodic testing will be met by 
annual testing. In order to further lessen the burden on SDs and MSPs, 
the Commission has determined not to specify testing procedures at this 
time, but to leave the design and implementation of testing procedures 
to the reasonable judgment of each registrant based on their own 
circumstances.
5. Monitoring of Position Limits
    Proposed Sec.  23.601 required SDs and MSPs to establish policies 
and procedures to monitor, detect, and prevent violations of applicable 
position limits established by the Commission, a designated contract 
market (DCM), or a swap execution facility (SEF), and to monitor for 
and prevent improper reliance upon any exemptions or exclusions from 
such position limits.
    One commenter presented a report prepared by NERA stating that 
compliance with proposed Sec.  23.601 for certain entities would entail 
average incremental start-up costs of $245,000 and average incremental 
ongoing annual costs of $228,000.\99\ The Commission observes that the 
incremental average costs provided by NERA do not differentiate between 
the costs of compliance with proposed Sec.  23.601 and the costs of 
compliance with section 4s(j)(1) of the CEA, which requires each SD and 
MSP to ``monitor its trading in swaps to prevent violations of 
applicable position limits.'' Accordingly, the Commission believes that 
the cost estimates presented by NERA exceed the incremental costs 
attributable to Commission rulemaking. The NERA report, however, 
provides insufficient information to allow the Commission to assess the 
magnitude of the excess.
---------------------------------------------------------------------------

    \99\ NERA Economic Consulting, Cost-Benefit Analysis of the 
CFTC's Proposed Swap Dealer Definition Prepared for the Working 
Group of Commercial Energy Firms, December 20, 2011. In this late-
filed comment supplement, NERA argues that cost-benefit 
considerations compel excluding entities ``engaged in production, 
physical distribution or marketing of natural gas, power, or oil 
that also engage in active trading of energy derivatives''--termed 
``nonfinancial energy companies'' in the report--from regulation as 
swap dealers, including Sec.  23.601.
---------------------------------------------------------------------------

    As discussed in more detail below, the Commission has also 
quantified certain costs of a monitoring regime based on the assumption 
that a firm could choose to implement a particular monitoring regime 
from a wide range of compliance systems, based on the specific, 
individual needs of the firm. Several other commenters requested that 
the rule be modified to lessen the cost burden on registrants.\100\ The 
Commission is reducing the burden on SDs and MSPs by modifying the rule 
as follows: (1) Require policies and procedures reasonably designed to 
monitor for and prevent violations of applicable position limits; (2) 
require only notification to relevant personnel of changes to 
applicable position limits (rather than training); (3) except on-
exchange violations of position limits from the Commission reporting 
requirement; (4) require testing of position limit procedures only if 
the registrant has transactions in instruments for which position 
limits have been established; and (5) require testing of position limit 
procedures quarterly (rather than monthly).
---------------------------------------------------------------------------

    \100\ SIFMA recommended that testing of Position Limit 
Procedures be required only annually and not be required to be done 
all at the same time, The Working Group recommended that testing 
only be required on a semi-annual basis, and MetLife requested that 
the Commission permit the frequency of testing to be determined by 
an MSP based on the extent of its swap activities. MetLife also 
recommended that there be a clear exemption from testing 
requirements for MSPs that do not trade in swaps for which position 
limits have been established. BGA recommended that the Commission 
clarify that as long as an SD or MSP provides training on the 
position limits and establishes and enforces policies for 
monitoring, detecting, and curing violations, they will have met the 
obligation to ``prevent violations.'' SIFMA recommended that the 
Commission revise Sec.  23.601(c) to provide that a change in 
position limit levels will not trigger ``training,'' but only 
require effective notification. The Working Group and MetLife 
recommended that the Commission require alerting the governing body 
only when a violation is material. The Working Group argued that the 
reporting of on-exchange violations of position limits to the 
Commission is already done by DCMs and will likely be the 
responsibility of SEFs as well, so SDs and MSPs should not be 
required to report on-exchange violations.
---------------------------------------------------------------------------

    With respect to quarterly reporting of compliance with position 
limits to the chief compliance officer, senior management, and 
governing body under proposed Sec.  23.601(g), The Working Group 
recommended that the proposed rule should be revised to require only 
annual reports to the entity's senior management and governing body, 
but did not quantify the cost burden of quarterly reporting. The 
Commission recognizes that generating such reports will entail costs in 
the form of preparing and transmitting the reports as required by the 
rule, but is unable to quantify the cost because the reports will vary 
greatly depending on the trading volume of individual SDs and MSPs in 
products for which position limits have been established. As discussed 
above with respect to Risk Exposure Reports, the Commission believes 
that the benefit of such reporting will be timely notification to 
decision makers within the SD and MSP of the entity's record of 
compliance with applicable position limits, thus providing a timely 
opportunity to adjust or revise Position Limit Procedures to prevent 
future violations, if necessary, and avoiding the costs to the public 
of excessive speculation.
6. Diligent Supervision
    Proposed Sec.  23.602 required SDs and MSPs to: (1) Establish a 
system to supervise all activities relating to its business performed 
by its partners, members, officers, employees, and agents; (2) have 
that system be reasonably designed to achieve compliance with the CEA 
and Commission regulations; (3) have that system designate a person 
with authority to carry out the supervisory responsibilities of the SD 
or MSP; and (4) have all such supervisors meet qualification standards 
that the Commission finds necessary or appropriate.
    The benefits of diligent supervision result from increased 
compliance with the regulatory standards of the CEA and the rules of 
the Commission. The standards that SDs and MSPs follow (or fail to 
follow) in transacting their swaps may have repercussions for financial 
system stability more broadly. Effective systemic risk management for 
swaps depends upon effective internal risk management protocols of 
individual SDs and MSPs and effective internal risk management in turn 
depends not

[[Page 20176]]

just on appropriate policies and procedures, but on diligent 
supervision by the registrant to ensure that such policies and 
procedures are actually followed.
    No commenters provided quantitative data on the cost of complying 
with the diligent supervision rule, but several commenters requested 
changes to the rule to lessen the compliance costs of SDs and MSPs.
    The Working Group recommended that the Commission not require 
designation of a single individual with responsibility for supervision. 
The Commission considered whether permitting SDs and MSPs to designate 
more than a single individual for supervisory responsibilities would 
lessen the benefits of the rule and determined that it would not. 
Accordingly, the Commission is modifying the rule to require SDs and 
MSPs to designate ``at least one person'' (rather than ``a person'') 
with authority to carry out supervisory responsibilities.
    The Working Group also recommended that SDs and MSPs be given 
discretion to determine supervisor qualifications, presumably because 
such a standard would entail fewer compliance costs then the standard 
proposed (i.e., ``training, experience, competence, and such other 
qualification standards as the Commission finds necessary or 
appropriate''). The Commission considered whether the benefits of the 
rule could be maintained with this change, and determined they could 
not. Accordingly, the Commission is declining to modify the rule on 
this point because it believes that full accountability for compliance 
with the CEA and Commission regulations is best served by requiring 
designation of individuals with objective qualifications.
7. Business Continuity and Disaster Recovery
    Proposed Sec.  23.603 required SDs and MSPs to establish a business 
continuity and disaster recovery plan that includes procedures for and 
the maintenance of back-up facilities, systems, infrastructure, 
personnel, and other resources to achieve the timely recovery of data 
and documentation and to resume operations generally within the next 
business day. The proposed regulations also required SDs and MSPs to 
have their business continuity and disaster recovery plan tested 
annually by qualified, independent internal audit personnel or a 
qualified third party audit service. The Commission believes that all 
SDs and MSPs may be critically important to the proper functioning of 
the swaps market. SDs are critical participants in the swaps market and 
MSPs may have counterparty exposures that could have serious adverse 
effects on the financial stability of the United States. Therefore, the 
Commission believes the benefit of the rule is that it ensures, to the 
extent practicable, that system failures or natural disaster will not 
stop the proper functioning of the swaps market for more the one 
business day.
    With respect to costs, the Commission again believes that it is not 
possible to reasonably quantify the industry-wide costs of a business 
continuity and disaster recovery program for SDs and MSPs because such 
costs necessarily flow from the size of the SD or MSP and the scope of 
activities in which it engages. One commenter stated that most SDs have 
the technology and network infrastructure in place to achieve a next 
day recovery time objective, reducing the incremental costs of 
compliance for these registrants. But the commenter also believes that 
some MSPs may have to develop and implement a plan from scratch. The 
commenter estimates that it would take up to 200 personnel days for 
MSPs to comply with this requirement. Thus, at eight hours a day and 
$100 per hour,\101\ the upper end of personnel costs related to 
implementation for an MSP would be $160,000. In response, the 
Commission is lengthening the time for compliance to one year from the 
publication date of the final rule in the Federal Register for 
registrants that have not been previously regulated by a U.S. 
prudential regulator and are not SEC registrants. No other commenter 
provided cost estimates of compliance with the rule. Nevertheless, 
several commenters requested changes to the rule to reduce the cost of 
compliance.\102\
---------------------------------------------------------------------------

    \101\ See section V.B. below for a discussion of the 
Commission's use of this hourly wage rate.
    \102\ The Working Group argued that the Commission should not 
require next business day recovery for non-systemically important 
SDs or MSPs, but should only require recovery ``reasonably 
promptly.'' The Working Group also argued that the Commission should 
not require staffing of back-up facilities to avoid the burden of 
requiring two persons for the same job, and recommended that the 
Commission should not require annual testing of the business 
continuity and disaster recovery plan by independent auditors 
because independent audits would be too costly.
---------------------------------------------------------------------------

    To further reduce the compliance burden, the Commission is 
additionally modifying the rule as follows: (1) Requiring procedures 
for alternative staffing (rather than back-up personnel); (2) requiring 
annual testing (rather than auditing); and (3) requiring auditing only 
once every three years. The Commission believes that these changes will 
lower compliance costs without reducing benefits.
    Finally, SIFMA recommended that the Commission clarify that an SD's 
or MSP's business continuity and disaster recovery plan may be part of 
a consolidated plan established for the various entities in a holding 
company group. The Commission confirmed this could be the case.
Costs
    Section 4s(j) of the CEA imposes certain duties and risk management 
requirements on SDs and MSPs. The costs and benefits that necessarily 
result from these basic statutory requirements are considered to be the 
``baseline'' against which the costs and benefits of the Commission's 
final rules are compared or measured. The ``baseline'' level of costs 
includes the costs that result from the following activities required 
by the statute:
    <bullet> Monitoring of trading in swaps to prevent violations of 
applicable position limits;
    <bullet> Establishing robust and professional risk management 
systems;
    <bullet> Disclosing to the Commission and applicable prudential 
regulators general information related to swaps and establishing 
internal systems and procedures to provide such information;
    <bullet> Foregoing any process or action that results in any 
unreasonable restraint of trade, or impose any material anticompetitive 
burden on trading and clearing.
    Compliance with the statutory baseline alone would result in costs 
for SDs and MSPs. For example, the requirement to monitor trading in 
swaps to prevent violations of applicable position limits would include 
the cost of designing and implementing monitoring procedures. 
Similarly, compliance with the statutory provisions would require 
establishment of robust and professional risk management policies and 
procedures.
    Congress mandated that the Commission adopt rules to implement each 
of the statutory provisions. With regard to its implementation 
decisions, the Commission has determined the following to be costs to 
SDs and MSPs to comply with the final regulations regarding duties and 
risk management:
    <bullet> Compiling and reporting certain risk assessment reports;
    <bullet> Establishing, implementing, testing, and reviewing risk 
management policies and procedures;
    <bullet> Auditing of policies and procedures;
    <bullet> Ensuring the monitoring of traders and of applicable 
position limits;

[[Page 20177]]

    <bullet> Implementing diligent supervision policies and procedures; 
and
    <bullet> Implementing, testing, and reviewing business continuity 
and disaster recovery policies and procedures.
    In adhering to its mandate from Congress, where possible the 
Commission has attempted to alleviate the burdens on affected entities. 
The Commission has modified the definition of ``governing body'' to 
provide additional flexibility and potentially eliminate the need for 
some registrants to change their current internal governance 
structures, thereby reducing compliance costs. The Commission has 
clarified that the requirements for a risk management program are 
confined to ``swaps activities'' of registrants, rather than the ``day-
to-day business'' of the registrant, thereby avoiding the potential 
burden associated with an SD's or MSP's need to extend the program to 
any non-swaps business lines. In addition, risk management policies and 
procedures are required to be provided to the Commission only upon 
request, rather than upon any material change, reducing the reporting 
burden on registrants.
    Risk management unit personnel are permitted to fulfill other 
duties. This should provide cost-lowering flexibility and potentially 
eliminate the need for some registrants to change current practices 
dramatically. The Commission also will permit limited preliminary 
approval for new products for testing purposes, reducing the necessary 
time and burden of new product analysis. Pricing models may be 
validated by internal personnel, eliminating the burden of hiring an 
external auditor to validate potentially valuable proprietary 
information. The requirement to reconcile profits and losses to the 
general ledger on a daily basis has been removed. Entities may perform 
an assessment of collateral liquidation procedures, instead of 
performing a potentially time-intensive and expensive test.
    The proposed quarterly testing of risk management programs and 
position limit procedures has been reduced to annual testing to reduce 
costs. The proposed monthly testing of position limit procedures has 
been reduced to quarterly testing. To reduce the burden on senior 
management, only material trade discrepancies are required to be 
brought to senior management. The proposed employee training on 
position limits change has been modified to a notice requirement. 
Position limit violations that occur ``on-exchange'' are no longer 
required to be reported to the Commission by registrants, as the 
exchange will notify the Commission. Finally, business continuity and 
disaster recovery plans are required to be audited triennially (not 
annually, as proposed).
    With respect to quantifying the cost of compliance with the final 
rules, one commenter stated that the cost of implementing a 
comprehensive risk management program will be substantial. The 
commenter analogizes the cost to the cost of implementing a compliance 
program and cites FERC administrative proceedings that required 
implementation of compliance programs at a cost of $1,000,000 to 
$2,000,000. The same commenter also estimates that a required audit of 
the risk management program would cost $24,000 per audit ($96,000 
annually). Another commenter stated that implementation of a business 
continuity and disaster recovery program could take up to 200 personnel 
days. At eight hours a day and $100 per hour,\103\ implementation 
personnel costs alone could thus cost a registrant $160,000. The 
Commission believes these estimates may be on the high end of the range 
of potential costs, given that some likely SDs are subject to 
prudential regulation or other form of regulatory oversight currently 
and will already have some form of risk management and business 
continuity program in place.\104\ By contrast, costs are expected to be 
higher for those entities not currently regulated or not currently 
implementing risk management policies and procedures. In this respect, 
one commenter presented a report prepared by NERA estimating that 
compliance with the proposed rules for some entities in this category 
would entail annual incremental costs of $224,000.\105\
---------------------------------------------------------------------------

    \103\ See section V.B. below for a discussion of the 
Commission's use of this wage rate.
    \104\ The Commission notes that in 2006 the UK FSA conducted a 
cost benefit analysis when promulgating requirements related to 
ensuring effective risk controls, including requirements for 
implementing effective policies and procedures to identify, manage, 
monitor, and report current and possible risks. The UK FSA was 
adopting rules that replaced existing guidance and concluded from 
survey results that the incremental aggregate cost of compliance for 
approximately 2000-2500 firms was [pound]10.5 to 14 million in one-
off costs ($16.4 to 21.9 million at the current exchange rate, or 
$8,200 to $10,950 per firm) and [pound]7 to 9.2 million in ongoing 
costs ($10.9 to 14.4 million at the current exchange rate, or $5,450 
to $7,200 per firm). See FSA Consultation Paper 06/9, Organisational 
Systems and Controls: Common Platform for Firms, Annex 2 (May 2006).
    \105\ NERA, Cost-Benefit Analysis of the CFTC's Proposed Swap 
Dealer Definition Prepared for the Working Group of Commercial 
Energy Firms, December 20, 2011. In the late-filed comment 
supplement, NERA estimates these costs for entities ``engaged in 
production, physical distribution or marketing of natural gas, 
power, or oil that also engage in active trading of energy 
derivatives''--termed ``nonfinancial energy companies'' in the 
report. The figure cited includes costs to maintain a risk 
management program, quarterly audits of the program, and annual 
audits of swap trading relationship documentation, the last of which 
is required under a separate rulemaking proposal not being adopted 
in this release.
---------------------------------------------------------------------------

    The Commission also has estimated potential costs to implement a 
tracking and monitoring system for position limits; the Commission 
anticipates that a firm could choose to implement a monitoring regime 
from a wide range of potential compliance systems, based on the 
specific, individual needs of the firm.\106\ For example, a firm may 
elect to use an automatic software system, which may include high 
initial costs but lower long-term operational and labor costs. 
Conversely, a firm may decide to use a less capital-intensive system 
that requires more human labor to monitor positions. Thus, taking this 
range into account, the Commission anticipates, on average, labor costs 
per entity ranging from 40 to 1,000 annual labor hours, $5,000 to 
$100,000 in total annualized capital/start-up costs, and $1,000 to 
$20,000 in annual operating and maintenance costs.\107\ The Commission 
contrasts this estimate with that provided by one commenter stating 
that compliance with proposed Sec.  23.601 by non-financial energy 
companies would entail average incremental start-up costs of $245,000 
and average incremental ongoing annual costs of $228,000.\108\
---------------------------------------------------------------------------

    \106\ See Position Limits for Futures and Swaps, 76 FR 71626, 
71667 (Nov. 18, 2011).
    \107\ These costs would likely be lower for firms with positions 
far below the speculative limit, as those firms may not need 
comprehensive, real-time analysis of their swaps positions for 
position limit compliance to observe whether they are at or near the 
limit. Costs may be higher for firms with very large or very complex 
positions, as those firms may need comprehensive, real-time analysis 
for compliance purposes. Due to the variation in both number of 
positions held and degree of sophistication in existing risk 
management systems, it is not feasible for the Commission to provide 
a greater degree of specificity as to the particularized costs for 
SDs and MSPs.
    \108\ NERA, Cost-Benefit Analysis of the CFTC's Proposed Swap 
Dealer Definition Prepared for the Working Group of Commercial 
Energy Firms, December 20, 2011. See also text accompanying note 103 
for a discussion of these figures.
---------------------------------------------------------------------------

    Other than as indicated with respect to monitoring for position 
limits, the limited cost data provided by commenters discussed above, 
and costs resulting from collections of information subject to the 
Paperwork Reduction Act (incorporated by reference herein), the 
Commission has little or no reliable quantitative data from which to 
reasonably estimate the costs of compliance with the duties and risk-
management rules.\109\ The

[[Page 20178]]

Commission's review of applicable academic literature yielded no 
research reports or studies directly relevant to its considerations of 
costs of the final rules. Moreover, because it largely refrained from 
establishing prescriptive requirements under Sec.  23.600--requiring 
certain policies and procedures while leaving their design and 
formulation to the discretion of each individual registrant--the 
Commission believes that many of the costs associated with the rules 
will be highly specific to each entity, and thus difficult to quantify 
for an individual firm or on an aggregated basis. Certain of the costs 
associated with these rules addressing duties and risk management 
requirements of SDs and MSPs result from collections of information 
subject to the Paperwork Reduction Act. Costs attributable to 
collections of information subject to the PRA are discussed further in 
section V.B.2. below. The Commission has also considered these costs, 
which it incorporates by reference herein, in its section 15(a) 
analysis.
---------------------------------------------------------------------------

    \109\ Although the rules were adapted from existing risk 
management guidance from a variety of sources including the Federal 
Reserve and the OCC, such guidance has been built up incrementally 
over a period of time and the overall costs of compliance with such 
guidance has not been quantified.
---------------------------------------------------------------------------

Benefits
    The Commission believes that the central, driving role of SDs and 
MSPs in swaps markets--markets that can be systemically critical as 
recent events have shown--requires that SDs and MSPs give due regard 
to, and properly manage, the risks they incur as part of their day-to-
day businesses. The impact of an SD or MSP default may be greater than 
the impact to the entity alone, and of potentially profound 
significance to the financial system broadly. Given this, the 
Commission believes these regulations prescribing internal risk 
management requirements better assure the protection of market 
participants and the public.
    In promulgating the regulations governing the duties of SDs and 
MSPs, the Commission has created a framework that requires proper 
internal oversight but also ensures that these participants retain the 
flexibility to comply in the manner best suited for their individual 
needs. While the Commission recognizes that the costs incurred by 
participants to comply with these regulations may be significant, the 
Commission also believes that the strength of critical market 
participants like SDs and MSPs is a vital component in the strength of 
the financial system as a whole. By requiring entities to monitor the 
risks arising from their operations actively and rigorously, the 
Commission believes that an entity's default risk will decrease 
substantially. Should an emergency situation--such as a natural 
disaster--occur, the largest derivatives market participants will have 
systems in place to resume full operation within one business day, 
mitigating the effects of a major crisis for the financial system as a 
whole. The Commission also recognizes that, given the systemic 
importance of these entities, ensuring proper risk management within 
SDs and MSPs helps to protect the public against major market 
disruptions and financial losses.
    In addition, the registrants will benefit from the required 
oversight of their internal operations. The required monitoring is 
designed to protect an entity from ``rogue'' or unauthorized trading. 
Further, the required monitoring of applicable position limits protects 
the entity from an unforeseen violation that could lead to, among other 
things, an enforcement action from an exchange or the Commission. 
Moreover, the regulations require identification and monitoring of 
several different kinds of risk, allowing entities to realize and 
correct potential issues before problems (and associated costs) 
escalate. Finally, the stability of any entity rests on its ability to 
manage the risks inherent in its business; by requiring stringent 
internal oversight, the Commission believes these regulations will aid 
in the growth and competitiveness of SDs and MSPs by ensuring the 
stability that flows from the most basic forms of risk management.
Section 15(a) Determination
1. Protection of Market Participants and the Public
    The Commission believes that requiring prudent risk management 
policies and procedures lessens the risk of market disruptions and 
financial losses that could greatly impact not only a particular SD or 
MSP, but also other market participants and the public at large. The 
Commission also believes that requiring entities to assess and monitor 
their level of risk, as well as the adequacy of their own risk 
management policies and procedures, helps to: (i) Protect the entity 
from undue impacts from unanticipated market events, (ii) ensure swift 
recovery after a disaster or other emergency, and (iii) promotes the 
stability of the entity. The business practices of SDs and MSPs are of 
critical importance to the integrity and stability of the derivatives 
markets; this makes proper oversight and risk mitigation essential to 
the well-being of the financial system.
    The Commission does not believe that the costs associated with 
these rules will have a detrimental effect on the protection of market 
participants or the public. It is possible that the costs associated 
with these rules will require that SDs and MSPs modify their business 
decisions in order to allocate more resources to risk management, 
monitoring traders, business continuity, and diligent supervision of 
personnel.
2. Efficiency, Competitiveness, and Financial Integrity of Markets 
\110\
---------------------------------------------------------------------------

    \110\ Although by its terms section 15(a)(2)(B) of the CEA 
applies to futures markets only, the Commission finds this factor 
useful in analyzing regulations pertaining to swaps markets as well. 
The Commission has identified no impact to futures markets.
---------------------------------------------------------------------------

    The Commission believes that effective internal risk management and 
oversight helps protect the financial integrity of individual SDs and 
MSPs. Their financial integrity, in turn, promotes the financial 
integrity of derivatives markets by helping to foster confidence in the 
stability of the financial system. Further, the regulations are 
designed to ensure that SDs and MSPs can sustain their market 
operations and meet their financial obligations to market participants, 
further protecting the financial integrity of derivatives markets. 
Additionally, the Commission believes that these regulations, as 
carefully tailored to minimize costs beyond those required by the 
statute, will enhance the efficiency and competitiveness of markets to 
the extent that SDs and MSPs have sound risk management programs and 
proper monitoring of traders. Monitoring traders to ensure that they do 
not engage in manipulative or other disruptive market behaviors is 
crucial to the efficiency of markets.
3. Price Discovery
    The Commission has identified no likely material impact on price 
discovery from the costs and benefits of these duties and risk 
management rules.
4. Sound Risk Management
    The regulations go to the heart of sound risk management for key 
market participants and for the swaps market generally. The rules 
require SDs and MSPs to establish policies and procedures for: (i) 
Monitoring and managing traders and all risks associated with their 
swaps activities, including market, credit, liquidity, foreign 
currency, legal, and operational risk; (ii) business continuity 
planning, and (iii) diligent supervision. Such policies and procedures 
will ensure that the largest derivatives market

[[Page 20179]]

participants understand the risks associated with their swaps 
activities, take steps to mitigate those risks when appropriate, and 
are prepared for managing crisis situations. In essence, these rules 
create risk management benefits by working to prevent SDs and MSPs from 
having to default on their financial obligations, potentially 
threatening overall financial stability in the process.
    The costs associated with these rules will likely require that SDs 
and MSPs allocate more resources to risk management, monitoring 
traders, business continuity, and diligent supervision of personnel. 
The Commission does not foresee that the allocation of these additional 
resources will have a detrimental effect on sound risk management.
5. Other Public Interest Considerations
    The Commission has not identified any other public interest 
considerations that could be impacted by these duties and risk 
management requirements for SDs and MSPs.

F. Conflicts-of-Interest Policies and Procedures for SDs, MSPs, FCMs, 
and IBs

    Section 4s(j) of the CEA, as added by section 731 of the Dodd-Frank 
Act, sets forth certain duties for SDs and MSPs, including the duty to 
implement conflict-of-interest systems and procedures. Specifically, 
section 4s(j)(5) mandates that SDs and MSPs implement conflict-of-
interest systems and procedures that establish safeguards to ensure 
that research activities and the provision of clearing services are 
separated by appropriate informational partitions from the review, 
pressure, or oversight of persons whose involvement in pricing, 
trading, or clearing activities might potentially bias their judgment 
or supervision. Section 4s(j)(5) further requires that such systems and 
procedures ``address such other issues as the Commission determines to 
be appropriate.'' The proposed regulations, as set forth in the SD/MSP 
Conflicts NPRM, addressed the statutory mandate of section 4s(j)(5).
    Similarly, section 732 of the Dodd-Frank Act amended section 4d of 
the CEA by creating a new subsection (c), which mandates that the 
Commission ``require that futures commission merchants and introducing 
brokers implement conflict-of-interest systems and procedures.'' New 
section 4d(c) mandates that such systems and procedures establish 
firewalls between research and trading or clearing. New section 4d(c) 
further requires that such systems and procedures ``address such other 
issues as the Commission determines to be appropriate.'' The proposed 
regulations, as set forth in the FCM/IB Conflicts NPRM, addressed the 
statutory mandate of section 4d(c).
    As described in detail in the preamble, the Commission, in 
preparing these final rules, sought and incorporated comment from the 
public. In the SD/MSP Conflicts NPRM and the FCM/IB Conflicts NPRM, the 
Commission requested comment on the Commission's consideration of costs 
and benefits and invited commenters to provide data quantifying the 
costs and benefits of the proposed regulations.\111\ The Commission 
received 29 comment letters to the SD/MSP Conflicts NPRM and 26 comment 
letters to the FCM/IB Conflicts NPRM. Many commenters provided comments 
addressing identical provisions or issues in both proposed rules. The 
Commission considered each in formulating the final rules, including 
any alternatives and cost concerns. Of the comment letters received, 21 
letters addressed issues relevant to the costs and benefits of the 
proposed rules, but no letters provided any quantitative data to 
support their claims.
---------------------------------------------------------------------------

    \111\ See SD/MSP Conflicts NPRM, 75 FR at 71395 and FCM/IB 
Conflicts NPRM, 75 FR at 70157.
---------------------------------------------------------------------------

    With regard to the conflicts provisions, the comment letters 
focused on 16 areas of the rule that are most relevant to the 
Commission's consideration of costs and benefits. Each of these areas 
is discussed below. A more detailed discussion can be found in section 
II.M. above.
1. Compliance Oversight by SROs
    The Commission declines the recommendation of commenters \112\ to 
delegate conflicts of interest oversight to an SRO because sections 
4d(c) and 4s(j)(5) of the CEA direct the Commission exclusively to 
promulgate such rules. In this regard, the CEA differs from section 15D 
of the Securities Exchange Act of 1934, which mandates that conflict-
of-interest rules be adopted either by the SEC or by an SRO. Therefore, 
the cost savings that the commenters asserted would result from the 
delegation of oversight and rulemaking authority to an SRO are in fact 
not an option that the Commission may consider under the statutory 
framework provided by the Congress.
---------------------------------------------------------------------------

    \112\ FIA, ISDA, SIFMA, and JP Morgan suggested that the 
Commission instruct an appropriate SRO to write detailed compliance 
requirements within a framework set forth by the Commission because 
SROs would be in a better position than the Commission to address 
the likely need for future amendments to the rule. The Commission 
presumes that the commenters believe that this alternative 
arrangement would streamline compliance requirements resulting in 
cost savings. The Commission notes, however, that the comments of 
Michael Greenberger and UNITE HERE supported monitoring and 
enforcement of the implementation of conflict-of-interest policies 
and procedures by the Commission, as opposed to SROs.
---------------------------------------------------------------------------

2. Non-Research Personnel
    EEI argued that the Commission should limit the definition of non-
research personnel \113\ to only those persons involved with trading, 
pricing, or clearing activities because implementing the restrictions 
on communications between research analysts and all non-research 
personnel as the proposed rule more broadly defined the term will be 
burdensome. Sections 4d(c) and 4s(j)(5) of the CEA require 
informational partitions between research analysts and persons involved 
in pricing, trading, or clearing activities. The Commission recognizes 
that extending the requirement for informational partitions above the 
statutory minimum to all non-research personnel may cause registrants 
to experience some incremental cost increase, though EEI did not 
provide any quantification. Notwithstanding this, however, the 
Commission is adopting the definition as proposed because it believes 
doing so closes a significant window that could be exploited to evade 
the statutory purpose--i.e., to ensure that research reports published 
by registrants are free from bias. The Commission believes that 
informational partitions only between research analysts and persons 
involved in pricing, trading, or clearing activities are unlikely to 
ensure that research reports are free from bias because other personnel 
may have similar motives for influencing the content of research 
reports, or may be subject to the influence of pricing, trading, or 
clearing personnel and thus present an avenue of indirect influence on 
research personnel. The Commission observes that the definition and use 
of the term ``non-research personnel'' was adapted from NASD rule 2711, 
which also prohibits all non-research personnel from reviewing or 
approving a securities research report prior to publication.\114\ Thus, 
despite some potential

[[Page 20180]]

incremental cost to registrants, the Commission believes that ensuring 
unbiased registrant research reports accords with statutory intent and 
justifies the increased burden.
---------------------------------------------------------------------------

    \113\ The proposed rule defined the term ``non-research 
personnel'' as ``any employee of the business trading unit or 
clearing unit, or any other employee of the [SD] or [MSP] who is not 
directly responsible for, or otherwise involved with, research 
concerning a derivative, other than legal or compliance personnel.''
    \114\ See NASD rule 2711(b)(2) (stating ``no employee of the 
investment banking department or any other employee of the member 
who is not directly responsible for investment research (`non-
research personnel'), other than legal or compliance personnel, may 
review or approve a research report of the member before its 
publication'').
---------------------------------------------------------------------------

3. Public appearances by research personnel
    The proposed rules defined the term ``public appearance'' as ``any 
participation in a conference call, seminar, forum (including an 
interactive electronic forum) or other public speaking activity before 
15 or more persons * * *.'' FIA, ISDA, and SIFMA argued that the 
definition of public appearance should articulate that the term 
``person'' includes both a customer that is a natural person and one 
that is an entity. The Commission presumes these commenters to be 
concerned that requiring public-appearance disclosures when the 15-
person threshold is crossed due to attendance by multiple 
representatives of one entity increases the disclosure burden with no 
attendant increase in benefit. The Commission agrees and is modifying 
the rule accordingly.
4. Research department
    FIA, ISDA, and SIFMA, in a joint comment, objected that the 
imposition of the rule's restrictions to research departments \115\ of 
global affiliates would create logistical difficulties and expense for 
multinational firms; this impact was not quantified by the commenters. 
FIA, ISDA, and SIFMA suggested that the Commission limit the rules to 
requiring disclosure ``on third party research reports.'' The 
Commission believes that the rule helps ensure that the research 
reports produced by or on behalf of an SD, MSP, FCM, or IB, on which 
consumers may rely in making investment or risk management decisions, 
are not biased in favor of the financial interest of the SD, MSP, FCM, 
or IB--a benefit. This, in turn, promotes consumer confidence in such 
reports--another benefit. Therefore, because it believes that the 
alternative suggested by FIA, ISDA, and SIFMA would be unacceptably 
porous and invite evasion by registrants that move their research 
function to an affiliate, the Commission is adopting the rule as 
proposed. The Commission believes that ensuring that the intended 
benefits of the rule are not depleted through evasion justifies any 
incremental cost of extending the rule to affiliates of registrants. In 
addition, the Commission believes that the increased costs are not as 
significant as posited by the commenters. A registrant need not examine 
the research functions of all of its affiliates under these rules; 
rather, the rules only require that a registrant apply the 
informational partitions of the rules to those research groups doing 
research on behalf of an SD, MSP, FCM, or IB.
---------------------------------------------------------------------------

    \115\ The proposed rules defined the term ``research 
department'' as ``any department or division that is principally 
responsible for preparing the substance of a research report 
relating to any derivative * * * including a department or division 
contained in an affiliate * * *.''
---------------------------------------------------------------------------

5. Research Report
    As proposed, the definition of the term ``research report'' 
expressly excluded four categories of communications from coverage. 
After considering the comments received, the Commission is expanding 
the list of exclusions as recommended to include ``commentaries on 
economic, political or market conditions'' and ``statistical summaries 
of multiple companies' financial data, including listings of current 
ratings.'' As modified, the Commission believes the rule strikes a 
reasonable balance between the need to identify research reports on 
which an investor or risk manager may rely in making a decision to 
enter into a swap or other derivative that may also be subject to 
potential bias in favor of the financial interest of an SD, MSP, FCM, 
or IB, and those research reports on which an investor or risk manager 
may rely, but that are not likely to be subject to such bias. The 
benefits of the rule as modified are that the rules foster less biased 
research reports without burdening registrants with unnecessary 
restrictions on those research reports that, by their nature, are not 
likely to be subject to bias. To maintain these benefits, the 
Commission declines to broaden the definitional exclusion as suggested 
by commenters \116\ to communications the Commission believes could 
represent the core focus of a research department--e.g., asset classes, 
economic variables commonly referenced in derivatives, and on-the-run 
swap rates--and thus be susceptible to bias.
---------------------------------------------------------------------------

    \116\ FIA, ISDA, and SIFMA argued for the expansion of the 
exclusions that the Commission has accepted. FIA/ISDA/SIFMA further 
argued that communications produced by a business trading unit 
labeled as a ``trading/sales desk product'' and as ``non-research'' 
should be excluded from the definitions of research report. In a 
separate comment, JP Morgan expressed a general agreement with the 
points raised in the FIA/ISDA/SIFMA letter. EEI argued that the 
Commission should exclude from the definition any communication 
between an SD or MSP, and its regulator, concerning hedging activity 
because firms with small trading operations should be permitted to 
publish occasional research reports to justify trading decisions, 
without being subject the proposed rules. NFA also argued that the 
definition in proposed Sec.  1.71(a)(9) was too broad and suggested 
that the definition be limited in a number of ways similar to NASD 
Rule 2711. Newedge also argued that the definition was too broad and 
suggested a more narrow definition of research report.
---------------------------------------------------------------------------

6. Conflicts of Interest Adequately Addressed by Existing Commission 
and NFA Rules; FCM de minimis Exception
    NFA commented that existing NFA rules address issues raised in 
proposed Sec.  1.71, and that the rule could have unintended 
consequences. K&L Gates LLP (on behalf of Peregrine Financial Group 
Inc.), ADM Investor Services Inc., John Stewart & Associates Inc., and 
Stewart-Peterson Group Inc. each agreed with NFA that existing rules of 
NFA and the Commission are sufficient, and thus the additional 
compliance costs imposed by the rules are not justified.
    The Commission believes that sections 4d(c) and 4s(j)(5) of the CEA 
require registrants to institute safeguards beyond what has been 
previously required in the rules of the Commission and NFA, and, 
accordingly, is adopting the rule substantially as proposed. For 
example, the statutory provisions require ``structural and 
institutional safeguards'' to ensure that research and trading 
functions are ``separated by appropriate informational partitions,'' a 
requirement not imposed by existing NFA or Commission rules. Thus, to 
the extent institution of these additional safeguards incur added 
costs, these are attributable to the statutory requirements imposed by 
Congress. Moreover, by providing specificity under the rules with 
respect to the conflict-of-interest requirement and by maintaining 
consistency with NASD Rule 2711, the Commission believes that the rule 
will minimize disruption to the market and minimize the additional 
compliance costs required by the CEA because the rules rely on well-
established standards.
7. FCM de minimis Exception
    Newedge commented that FCMs engaging in minimal proprietary trading 
should not be subject to the burdens of the rule relating to research 
analysts because such a firm does not present a risk of conflicts of 
interest. Again, the Commission notes that sections 4d(c) and 4s(j)(5) 
of the CEA require registrants to institute ``structural and 
institutional safeguards'' to ensure that research and trading 
functions are ``separated by appropriate informational partitions,'' 
and that neither of these sections makes an allowance for a de minimis 
amount of trading or research. Thus, the Commission cannot adopt the 
alternative approach suggested by Newedge because the imposition of a 
de minimis exception to the conflicts rule

[[Page 20181]]

is inconsistent with the statutory directive that Congress set forth. 
Moreover, the Commission does not believe that the limited nature of a 
firm's proprietary trading negates the issues intended to be addressed 
through the statutory mandate because a firm engaged in trading solely 
on behalf of customers can increase its commissions by encouraging an 
increase in trading activity through research reports.
8. Small IB Exception
    In the FCM/IB Conflicts NPRM, the Commission invited comment on how 
the proposed rules should apply to FCMs and IBs, considering the 
varying size and scope of the operations of such firms. A number of 
commenters requested relief for small IBs on grounds that the burden to 
them would be high and could discourage them from providing research to 
the detriment of customers seeking to hedge commercial risk.\117\ Given 
the mandate of section 4d(c) of the CEA to establish ``appropriate 
informational partitions'' within all FCMs and IBs, the Commission is 
not able to exempt small firms from the statutory requirements.
---------------------------------------------------------------------------

    \117\ NFA, National Introducing Brokers Association, ADM 
Investor Services Inc., John Stewart & Associates Inc., and Stewart-
Peterson Group Inc. each argued that implementing the proposed rules 
would be prohibitively costly, burdensome, and unnecessary for small 
IBs, particularly for IBs dealing with agricultural commodities 
where the IB may have only a few employees engaged in both research 
and trading for customers, and would force an unspecified number of 
small IBs out of business. Chris Barnard noted that small IBs lack 
the capacity to carry the proportionately heavier regulatory burden 
set forth in the proposed rule, and as such, some regulatory 
mitigation would be beneficial based on number of staff or revenues. 
Multiple commenters also commented on the limited market price 
impact of research reports created or distributed by small IBs.
---------------------------------------------------------------------------

    The Commission, however, recognizes that an IB's size is a 
significant factor in determining the ``appropriateness'' of the 
informational partitions required by section 4d(c). Thus, in light of 
the burden to small IBs and the attendant loss of research benefits for 
consumers that could result, the Commission has modified Sec.  1.71(b) 
to set forth a separate policies and procedures requirement for small 
IBs designed to provide them greater flexibility in determining the 
appropriate informational partitions required under their own 
circumstances.\118\
---------------------------------------------------------------------------

    \118\ The threshold to qualify for this small IB alternative is 
$5 million or less in aggregate gross revenues generated over the 
preceding 3 years from activities as an IB. This approach is similar 
to that taken in NASD Rule 2711 and was raised as a possible 
alternative in the preamble of the proposed rule.
---------------------------------------------------------------------------

9. Restriction on Non-Research Personnel From ``Influencing the 
Content'' of Research Reports
    The proposed rules provided that non-research personnel shall not 
influence the content of a research report. In response to commenters' 
concerns that the proposed standard was unnecessarily broad and would 
tend to chill all communications, including those beneficial to 
research integrity, between research and non-research personnel, the 
Commission is modifying the rules in line with suggested alternatives 
to provide instead that non-research personnel shall not direct the 
views and opinions expressed in a research report.\119\ The Commission 
believes that accepting this change will reduce the compliance burden 
of registrants because it directs compliance efforts toward ensuring 
that the views and opinions expressed in research reports are those of 
the research analyst, rather than attempting to prohibit all 
influence.\120\
---------------------------------------------------------------------------

    \119\ FIA, ISDA, SIFMA, and JP Morgan argued that the proposed 
prohibition on ``influencing the content'' should be eliminated 
because it would impair ordinary communications between research and 
non-research personnel. As an alternative, FIA/ISDA/SIFMA suggested 
that non-research personnel should be prohibited only from 
``directing the views and opinions expressed in research reports.'' 
Better Markets argued that the rules should be expanded to include 
any decision not to publish a report or to refrain from including 
relevant information.
    \120\ The Commission further modified the rules in response to 
commenters to provide that non-research personnel shall not direct a 
research analyst's decision to publish a research report. The 
Commission believes this is a burden-neutral modification to provide 
clarification, however.
---------------------------------------------------------------------------

10. Restriction on Research Analyst Supervision by Business Trading 
Unit or Clearing Unit
    The proposed rules prohibited (1) supervision or control of a 
research analyst by any employee of the registrant's business trading 
unit or clearing unit, and (2) influence or control over the evaluation 
or compensation of a research analyst by personnel engaged in pricing, 
trading, or clearing activities. The intent of the rules is to foster 
research free of bias that may result from research analysts' 
expectation of increased compensation for producing research reports 
favorable to the financial interests of personnel in the business 
trading unit or clearing unit--a benefit.
    FIA, ISDA, and SIFMA recommended--presumably on the basis that 
requiring a separate reporting line adds to the compliance burden--that 
the restriction only apply to direct supervision of research analysts, 
and not to others further up the management chain. No commenter 
provided quantitative information with respect to the costs of such 
burden. The Commission believes that it has resolved the concerns of 
commenters through (1) changes to the definitions of ``business trading 
unit'' and ``clearing unit'' discussed in section II.M above, and (2) 
using those definitions to designate personnel who may not have 
influence or control over the evaluation or compensation of a research 
analyst. As modified, the definitions reach only those performing 
certain functions in the unit and those supervising the performance of 
those functions. The Commission believes the threat to research analyst 
independence that would result from permitting supervision by any 
member of the business trading unit or clearing unit, as defined in the 
final rules, justifies adopting the rule as proposed.
11. Requirement That Legal/Compliance Personnel Supervise Communication 
Between Research and Non-Research Personnel
    The proposed rules permitted non-research personnel to review a 
research report before its publication for limited purposes, such as 
verifying factual accuracy. Such review: (1) May only be conducted 
through authorized legal or compliance personnel, and (2) must be 
properly documented. In this respect, the rules maintain consistency 
with NASD Rule 2711 and the Commission believes that such consistency 
will minimize compliance costs because the rules rely on well-
established standards. In addition, the Commission notes that the 
benefit of this provision is that it maintains the independence of the 
views and opinions expressed in research reports while improving the 
accuracy of such reports. The rules accomplish these benefits by 
balancing the need for some review of research reports by non-research 
personnel, while ensuring the review is limited in scope by requiring 
the presence of legal or compliance personnel.
    EEI recommended that the Commission exempt communications that are 
factual in nature from oversight by legal and compliance personnel, 
arguing that such oversight unnecessarily burdens legal/compliance 
personnel. EEI did not further qualify or quantify the costs implicated 
by the proposed exemption. Upon consideration of the alternative's 
cost/benefit ramifications, the Commission determined to adopt the rule 
as proposed. The Commission finds the suggested alternative 
unacceptable for several reasons. First, the Commission does not 
believe that registrants will be able to distinguish easily

[[Page 20182]]

communications that are ``factual in nature'' from those that are not, 
likely resulting in more uncertainty and needed review by legal and 
compliance personnel, not less. In addition, the Commission believes 
that allowing for communications that are merely ``factual in nature'' 
opens an avenue for evasion that could undermine the rules' intended 
benefits.
12. Restrictions on Research Analyst Communications
    The proposed rules provided that a research analysts' written or 
oral communication relating to any derivative must not omit any 
material fact or qualification that would cause the communication to be 
misleading to a reasonable person. The requirement, as proposed, 
applied to external communications to a current or prospective 
counterparty as well as internal communications to any employee of the 
registrant. The Commission intends the rules to promote research report 
integrity--i.e., help ensure that reports are both unbiased in favor of 
a registrant's financial interests and factually accurate in material 
respects. The Commission anticipates that the cost attendant to achieve 
the accuracy component of this intended benefit is any increased time a 
registrant spends ensuring that research analysts' reports are free of 
material misleading inaccuracies.
    FIA, ISDA, SIFMA, and JP Morgan commented that the proposed rule 
would materially burden an affected firm's operations because it 
applies to internal communications as well as external communications. 
Upon consideration of the potentially significant cost of including 
internal communications relative to the limited gain in intended 
benefits, the Commission is modifying the rules to exclude 
communications with employees of the registrant from the requirement.
13. Restriction on Influence of Business Trading Unit and Clearing Unit 
on Research Analyst Compensation
    Proposed Sec. Sec.  23.605(c)(3) and 1.71(c)(3) precludes (1) a 
registrant from considering a research analyst's contribution to the 
trading or clearing business as a factor in his or her compensation 
review or approval, and (2) a review or approval role for business 
trading or clearing unit personnel with respect to a research analyst's 
compensation. As articulated above, the Commission believes that the 
benefit of unbiased research flows directly from a research analyst's 
independence, which is compromised if the analyst's compensation is 
subject to business trading or clearing unit influence.
    The Commission recognizes that the rule, to some incremental 
extent, may add to compliance costs, although no commenter specifically 
articulated or quantified this impact. After considering the comments 
received,\121\ the Commission has determined to revise the proposed 
rule to relieve the compliance burden by permitting communications to 
research department management relating to client or customer feedback, 
ratings, and other indicators of a research analyst's performance. The 
Commission does not believe that this relaxation will negatively impact 
research independence. The Commission declines to further modify the 
rule, however, based on its belief that maintaining a firewall around 
research analyst compensation decisions is crucial to implementing 
effective conflict-of-interest policies and procedures and ensuring the 
benefits of unbiased research reports. The Commission also confirms 
that the rule does not prohibit compensation decisions from being 
subject to non-discriminatory and non-prejudicial firm-wide 
compensation guidelines.
---------------------------------------------------------------------------

    \121\ FIA, ISDA, SIFMA, and JP Morgan contended that research 
management should be able to solicit input from business trading and 
clearing unit personnel concerning the performance of research 
personnel. FIA/ISDA/SIFMA, as well as Newedge, further argued that 
research management decisions should be subject to firm-wide 
compensation guidelines. By contrast, Michael Greenberger argued 
that research management should be prohibited from soliciting any 
input of business trading and clearing units concerning a research 
analyst's compensation or performance evaluation, even if the 
influence is indirect or if research management maintains the 
ability to make all final decisions on such determinations. Better 
Markets commented that the provision should be broadened.
---------------------------------------------------------------------------

14. Disclosure of Conflicts by Research Analysts in Research Reports 
and Public Appearances; Disclosure of Conflicts in Third-Party Research 
Reports
    Proposed Sec. Sec.  23.605(c)(5)(i) and 1.71(c)(5)(i) required 
certain disclosures in registrants' research reports and at research 
analysts' public appearances. Specifically, it required disclosure of 
whether the analyst that prepared the report or makes the appearance 
maintains, from time to time, a financial interest in the types of 
derivatives that the analyst follows, the general nature of such 
interest, and any other material conflicts of interest of which the 
research analyst has knowledge. Additionally, as proposed, Sec. Sec.  
23.605(c)(5)(iv) and 1.71(c)(5)(iv) required that, if a registrant 
distributes or makes available third-party research reports, each 
report be accompanied by certain disclosures pertinent to conflicts of 
interest. The required disclosures benefit consumers of research 
reports produced by SDs, MSPs, FCMs, and IBs because they alert the 
consumers of such reports to interests that may influence the content 
of such reports, allowing the consumer to make an independent judgment 
as to their value.
    Several commenters recommended changes that could lessen the 
incremental (though unquantified) compliance costs of the rule by 
curtailing the required disclosures.\122\ The Commission has considered 
these comments and has determined that the benefits of the rule will be 
maintained without subjecting registrants to the burden of determining 
and disclosing financial interests that are maintained ``from time to 
time.'' Thus, the Commission is modifying the language of Sec. Sec.  
23.605(c)(5) and 1.71(c)(5) to remove the phrase ``from time to time,'' 
such that a research analyst need only disclose whether she maintains a 
relevant financial interest at the time of publication of the report or 
the time of a public appearance. However, the Commission is not 
adopting a de minimis exception, due to the difficulty of deciding when 
a financial interest is de minimis in this context. A de minimis 
exception would require a registrant to determine the threshold point 
at which a financial interest poses a threat of conflicts of interest--
a nebulous standard; such determination is likely to increase the costs 
of compliance of the rule over the cost that would be incurred to 
simply disclose all financial interests.
---------------------------------------------------------------------------

    \122\ FIA, ISDA, and SIFMA argued that Sec. Sec.  
23.605(c)(5)(i) and 1.71(c)(5)(i) should be limited to disclosing 
whether a research analyst maintains a relevant financial interest 
at the time of publication of the report/time of public appearance, 
rather than ``from time to time'' as provided in the rule. EEI 
suggested that the Commission modify the proposed rule to provide a 
de minimis exception to the disclosure requirements, such that a 
research analyst should be required only to identify relevant 
financial interests.
---------------------------------------------------------------------------

    Commenters also raised concerns regarding the burden of required 
disclosures when distributing research reports produced by a third-
party.\123\ The Commission considered the burden of disclosure in this 
context in light of maintaining the benefit of disclosure of 
information necessary for consumers to judge the content of research 
reports. The Commission has determined not to modify the rule in regard 
to third-party research disclosures. It believes that

[[Page 20183]]

third-party research reports distributed by a registrant may be 
interpreted as carrying the endorsement of the registrant and thus may 
present conflicts-of-interest issues in the same way as research 
reports originating with the registrant's own research analysts; 
accordingly, the same level of disclosure is appropriate.
---------------------------------------------------------------------------

    \123\ FIA, ISDA, SIFMA, JP Morgan, and EEI argued that the 
required disclosures with respect to third-party research reports 
are unnecessary because third-parties are, by definition, 
independent.
---------------------------------------------------------------------------

    Finally, commenters also contended that the phrase ``any other 
actual, material conflict of interest of the research analyst'' is 
vague and would be burdensome to implement, requiring coordination 
among various business units and the creation of special databases in 
order to comply with the rule. The Commission believes that the cost 
concerns of commenters are misplaced in this regard. The rules require 
disclosure of ``any other actual, material conflicts of interest of the 
research analyst or [SD, MSP, FCM, or IB] of which the research analyst 
has knowledge at the time of publication of the research report or at 
the time of the public appearance'' (emphasis added). Thus, the 
disclosure requirement is limited to conflicts of which the research 
analyst has knowledge, and the SD, MSP, FCM, or IB need not construct 
the databases suggested by commenters in order to comply with the rule.
15. Separation of Clearing Unit From Business Trading Unit
    As proposed, Sec.  23.605(d) and Sec.  1.71(d) prohibited 
interference by an SD or MSP with the decisions of clearing members, 
including FCMs, regarding the provision of clearing services and 
activities. The proposed rules also required informational partitions 
between business trading units and clearing member personnel. In 
addition, the proposals prohibited any employee of a business trading 
unit from supervising or controlling any employee of a clearing member. 
The Commission believes the benefits of the rules are that, to the 
extent practicable, the rules protect fair and open access to clearing 
by ensuring that decisions to accept clearing customers are not 
motivated solely by considerations of trading profits.
    Commenters raised a number of cost concerns related to operation of 
the rule, as follows:
    <bullet> Sales personnel should be able to act for both the trading 
unit and the clearing unit to offer a full range of services to 
customers efficiently; \124\
---------------------------------------------------------------------------

    \124\ FIA/ISDA/SIFMA and JP Morgan argue that sales personnel 
should be permitted to act for both units. UBS Securities LLC also 
argued that the rule inhibits the ability of a financial services 
firm to operate its swap clearing business as a partnership with its 
trading business in order to serve clients. Similarly, the FHLBs 
argued that the proposed rule overly restricts the ability of SDs 
and MSPs to run their trading and clearing operations and 
effectively serve the needs of their end-user counterparties.
---------------------------------------------------------------------------

    <bullet> The rules will impair a registrant's ability to follow 
risk management best practices by requiring independent risk 
assessments in the trading unit and clearing unit for the same 
counterparty, rather than a consolidated risk assessment; \125\
---------------------------------------------------------------------------

    \125\ FIA/ISDA/SIFMA and the FHLBs argued that the proposed 
rules would impair an SD's/MSP's ability to follow risk management 
best practices. NFA commented that Sec.  1.71(d) is too broad and 
may negatively impact a firm's ability to share information about 
customers to make credit and risk determinations.
---------------------------------------------------------------------------

    <bullet> The rule should be limited to prohibiting a trading unit 
from obtaining information about the transactions or positions of 
customers of the clearing unit; \126\
---------------------------------------------------------------------------

    \126\ FIA/ISDA/SIFMA recommended that the Commission not adopt 
the proposed rules, but instead adopt a rule that prohibits an 
affiliated SD or MSP from obtaining information from an affiliated 
FCM's clearing personnel concerning transactions conducted by FCM 
clients with either their own clients or with independent SDs or 
MSPs.
---------------------------------------------------------------------------

    No commenter provided any quantitative information regarding the 
expected costs of complying with the rules.
    Having considered the costs of compliance as presented by 
commenters in light of the benefits of open access to clearing, the 
Commission has determined it appropriate to promulgate the rules 
largely as they were originally proposed. Despite the varying 
incremental costs of any needed corporate structure reorganization and 
instituting informational partitions, the Commission believes the 
separation of the FCM clearing unit from the interference or influence 
of an affiliated SD or MSP is crucial to promoting open access to 
clearing and securing the benefits to market participants and the 
stability of the financial system itself expected to follow from 
increased central clearing.\127\ Open access to clearing will be 
essential for the expansion of client clearing needed for market 
participants to comply with the mandatory clearing of swaps as 
determined by the Commission under section 723 of the Dodd-Frank Act. 
Specifically, the Commission does not believe that the rule language 
should be changed to permit sales personnel to act for both the trading 
unit and the clearing unit. The risks associated with this approach, in 
terms of potential undue influence and interference with clearing 
decisions, has been well-supported by commenters.\128\
---------------------------------------------------------------------------

    \127\ In September 2009, the G-20 Leaders agreed in Pittsburgh 
that ``all standardised OTC derivative contracts should be traded on 
exchanges or electronic trading platforms, where appropriate, and 
cleared through central counterparties by end-2012 at the latest.''
    \128\ MFA and Pierpont Securities Holdings LLC commented that 
they support the Commission's proposals. Swaps and Derivatives 
Market Association contended that that the restrictions correctly 
address key areas where conflicts arise, and that the independence 
of clearing members is essential to accomplish several policy goals 
of the Dodd-Frank Act. Michael Greenberger also expressed support 
for Sec.  23.605(d), noting that attempts to tie clearing decisions 
to trade execution decisions would raise potential conflicts of 
interest, which could serve to block access to clearing and prevent 
competition among execution venues.
---------------------------------------------------------------------------

    However, in response to commenters' concerns about an FCM's ability 
to manage a default scenario without the benefit of the trading 
expertise in the business trading unit, the Commission is modifying 
proposed Sec.  1.71(d)(2)(i) to permit the business trading unit of an 
affiliated SD or MSP to participate in the activities of an FCM during 
an event of default. Specifically, the business trading unit personnel 
would be permitted to participate in the activities of the FCM, as 
necessary, during any default management undertaken by a derivatives 
clearing organization and for the purposes of transferring, 
liquidating, or hedging any proprietary or customer positions as a 
result of an event of default.
16. Undue Influence on Customers
    As proposed, Sec.  1.71(e) required that FCMs and IBs adopt and 
implement written policies and procedures that mandate the disclosure 
of any material incentives and any material conflicts of interest 
regarding the decision of a customer as to trade execution and/or 
clearing of a derivatives transaction. Proposed Sec.  23.605(e) 
mandated that SDs and MSPs adopt policies and procedures requiring 
disclosure to counterparties of any material incentives and conflicts 
of interest regarding the decision of a counterparty: (1) Whether to 
execute a derivative on a swap execution facility or designated 
contract market; or (2) whether to clear a derivative through a 
derivatives clearing organization. The Commission believes that the 
rules benefit counterparties by ensuring that they are adequately 
informed of any material incentives or conflicts prior to the execution 
of a transaction, and benefit the market by promoting the efficient use 
of trading facilities and clearing for swap transactions.
    Some commenters objected to the rule on the grounds that existing 
Commission regulations already impose risk disclosure requirements on 
FCMs and IBs. FIA, ISDA, SIFMA, and JP Morgan argued that the 
Commission could reduce the burden of the rules by

[[Page 20184]]

requiring SDs and MSPs to provide customers with an annual disclosure 
document describing potential conflicts that may exist among the firm, 
its affiliates, clients, and employees.
    After considering costs of compliance with the rule in light of the 
benefits outlined above, and the underlying statutory requirements, the 
Commission has determined it appropriate to adopt the rules as 
originally proposed. The Commission believes that the disclosure of 
conflicts of interest in this context are materially different from the 
risk disclosures required of FCMs and IBs under existing Commission 
regulations and, therefore, existing regulations are inadequate to 
secure the benefits of the rule outlined above. In addition, the 
Commission notes that the rule does not prohibit an SD or MSP from 
providing its customers with an annual disclosure document, and the 
Commission confirms that such would be permitted assuming that such 
document is sufficient to meet the requirements of the rule.
Costs
    Sections 4d(c) and 4s(j)(5) of the CEA require FCMs, IBs, SDs, and 
MSPs, to adopt and implement certain conflict of interest systems, 
procedures and safeguards, including research firewalls. The costs and 
benefits that necessarily result from these basic statutory 
requirements are considered to be the ``baseline'' against which the 
costs and benefits of the Commission's final rules are compared or 
measured. The ``baseline'' level of costs includes the costs that 
result from the following activities required by the statute:
    <bullet> FCMs and IBs must establish structural and institutional 
safeguards to ensure that the activities of any person within the firm 
relating to research or analysis of the price or market for any 
commodity are separated by appropriate informational partitions within 
the firm from the review, pressure, or oversight of persons whose 
involvement in trading or clearing activities might potentially bias 
the judgment or supervision of the persons.
    <bullet> SDs and MSPs must establish structural and institutional 
safeguards to ensure that the activities of any person within the firm 
relating to research or analysis of the price or market for any 
commodity or swap are separated by appropriate informational partitions 
within the firm from the review, pressure, or oversight of persons 
whose involvement in pricing, trading, or clearing activities might 
potentially bias their judgment or supervision and contravene the core 
principles of open access and the business conduct standards described 
in the CEA.
    <bullet> SDs and MSPs must establish structural and institutional 
safeguards to ensure that the activities of any person within the firm 
acting in a role of providing clearing activities or making 
determinations as to accepting clearing customers are separated by 
appropriate informational partitions within the firm from the review, 
pressure, or oversight of persons whose involvement in pricing, 
trading, or clearing activities might potentially bias their judgment 
or supervision and contravene the core principles of open access and 
the business conduct standards described in the CEA.
    Compliance with the statutory baseline alone would result in costs 
for FCMs, IBs, SDs, and MSPs. For example, the requirement to establish 
informational partitions would include the cost of identifying 
personnel involved in research or analysis of the price or market for 
any commodity or swap, identifying personnel involved in pricing, 
trading, or clearing activities, and designing and implementing 
communication policies and procedures.
    Congress mandated that the Commission adopt rules to implement each 
of the statutory provisions. With regard to its implementation 
decisions, the Commission has determined the following to be potential 
costs to FCMs, IBs, SDs, and MSPs to comply with the final regulations 
regarding conflicts-of-interest policies and procedures:
    <bullet> Identifying reports that qualify as research reports;
    <bullet> Maintaining records of public appearances by research 
analysts; and
    <bullet> Designing and implementing policies and procedures 
regarding:
    <bullet> Legal or compliance participation in communications 
between research analysts and non-research personnel regarding the 
content of research reports;
    <bullet> Oversight of research analyst communications regarding 
omissions of material facts or qualifications that would cause the 
communication to be misleading to a reasonable person;
    <bullet> Communication of any client or customer feedback on 
research analyst performance from the business trading unit or clearing 
unit to research department management;
    <bullet> Implementing the prohibition on promises of favorable 
research by research analysts;
    <bullet> Discovering, monitoring, and disclosing financial 
interests maintained by research analysts;
    <bullet> Implementing the prohibition on retaliation against 
research analysts;
    <bullet> Implementing the prohibition of interference with or 
influence on decisions with regard to the provision of clearing 
services or activities; and
    <bullet> Disclosing material incentives and conflicts-of-interest 
regarding exchange trading or clearing decisions by counterparties.
    In adhering to its mandate from Congress, where possible the 
Commission has attempted to alleviate the burdens on affected entities. 
The Commission has narrowed the definitions of ``business trading 
unit'' and ``clearing unit'' to include fewer registrant personnel 
affected by the rules. The Commission has narrowed the definition of 
``public appearance'' to include fewer appearances by research analysts 
that would require the disclosures mandated by the rules. The 
Commission has broadened the number of exclusions from the definition 
of ``research report'' such that there are fewer subject areas that 
would be covered by the rules. The Commission has provided a separate 
regulatory standard for small IBs that will lessen the compliance 
burden on such firms. The Commission also has narrowed the prohibition 
on non-research personnel involvement in producing content of research 
reports, and removed the need to police internal communications from 
research analysts for omissions of material facts or qualifications. 
The Commission has permitted trading and clearing units to provide 
client and customer feedback on research analyst performance to 
research department management and removed the need to determine and 
document financial interests of research analysts maintained ``from 
time to time'' for disclosure purposes. Finally, the Commission has 
permitted business trading unit personnel to participate in the 
activities of an FCM, as necessary, during any default management 
undertaken by a derivatives clearing organization and for the purposes 
of transferring, liquidating, or hedging any proprietary or customer 
positions as a result of an event of default.
    Other than costs resulting from collections of information subject 
to the Paperwork Reduction Act, incorporated by reference herein, the 
Commission has no reliable quantitative data from which to reasonably 
estimate the costs of compliance with these conflict of interest 
rules.\129\ No commenter provided any quantitative data on the costs of 
compliance with the rules as

[[Page 20185]]

proposed. The Commission's review of applicable academic literature 
yielded no research reports or studies directly relevant to its 
considerations of costs of the final rules.
---------------------------------------------------------------------------

    \129\ Although the rules were adapted from NASD rule 2711, that 
rule was promulgated by an SRO (now FINRA), which was not required 
to conduct a cost-benefit analysis of the rule prior to 
promulgation.
---------------------------------------------------------------------------

    The Commission anticipates that many entities may currently have, 
pursuant to other regulation, the informational partitions required by 
the rules in place. The Commission notes that dually registered FCMs 
and BDs are more likely to have implemented such informational 
partitions under other regulatory regimes \130\ than entities that are 
subject to such requirements for the first time. Costs, therefore, are 
expected to be higher for those entities not currently dually 
registered or not currently implementing conflicts of interest policies 
and procedures. Certain of the costs associated with these conflict of 
interest rules result from collections of information subject to the 
Paperwork Reduction Act. Costs attributable to collections of 
information subject to the PRA are discussed further in section V.B.3. 
below. The Commission has also considered these costs, which it 
incorporates by reference herein, in its section 15(a) analysis.
---------------------------------------------------------------------------

    \130\ In this respect, the Commission observes that 55% of 
current FCMs are also registered as BDs with the SEC, and thus may 
already have informational partitions between research and trading 
as required under the rules of FINRA. See letter from NFA, dated 
Jan. 18, 2011 (comment file for 75 FR 70881 (Designation of a Chief 
Compliance Officer; Required Compliance Polices; and Annual Report 
of a FCM, SD, or MSP)). The Commission also notes that in 2003 the 
UK FSA conducted a cost benefit analysis when promulgating conflicts 
of interest rules and guidance with respect to investment research 
and issues of securities. The UK FSA concluded that because UK firms 
were required to comply with their existing statutory obligations 
including management of conflicts of interest when carrying out 
regulated activity, the ``total compliance costs relating to [the 
FSA's] new proposed rule and supporting guidance on objective 
investment research will be of no more than minimal significance.'' 
See FSA Consultation Paper 205, Conflicts of Interest: Investment 
Research and Issues of Securities, Annex 1 (October 2003); FSA 
Consultation Paper 171, Conflicts of Interest: Investment Research 
and Issues of Securities, Annex 5 (February 2003).
---------------------------------------------------------------------------

Benefits
    The Commission believes that the proper informational partitions 
between research and trading and between clearing and trading, 
including restrictions on communications, supervision, and compensation 
oversight, help to ensure that research being released by SDs, MSPs, 
FCMs, and IBs and decisions related to trade execution and clearing are 
not tainted by inappropriate incentives. Because this research may be 
relied upon by a public that views such entities as experts in 
derivatives markets by virtue of their intimate knowledge of the 
products and markets, it is imperative that the information released 
therein is as accurate and free of conflicts of interest as possible. 
Similarly, because the importance of central clearing in derivatives 
markets necessitates free and open access to clearing, unrestrained by 
any potential conflicts of interest, it is imperative that access to 
clearing is not impeded by any inappropriate motivation. The rules 
adopted in this release require entities to establish appropriate 
policies and procedures to accomplish these benefits.
    In addition, by ensuring that decisions on clearing activities 
remain separate from decisions relating to trade execution and other 
proprietary activities, the final regulations promote competitiveness 
in futures and swaps markets by ensuring open access to clearing. 
Central clearing is a pillar of derivatives reform initiatives, 
contributing heavily to the efficiency and safety of derivatives 
markets; barriers to clearing access may have an adverse effect on that 
efficiency and safety.
    To the extent that a research report informs the financial 
investment in derivatives markets, protecting the integrity of that 
report aids in the protection of the financial integrity of markets.
    Moreover, requiring registrants to disclose any potential conflicts 
of interest further affords the public the opportunity to make 
judgments regarding the information provided to them in the written 
reports and public appearances of research analysts. The Commission's 
mission to ensure fair and orderly markets relies in part on the 
transparency of certain market information, in order to provide 
potential investors the accurate information necessary to make informed 
decisions.
Section 15(a) Determination
1. Protection of Market Participants and the Public
    The Commission believes that, as a result of these rules, market 
participants and the public are better protected from the potential 
harm that may occur when financial research reports are not insulated 
from the bias of registrants' own financial interests. This bias holds 
strong potential to operate as an incentive for registrants to produce 
and distribute research reports tainted by misleading, unbalanced, and/
or inaccurate information. Such tainted reports, in turn, may induce 
market participants to engage in a financial transaction that they 
otherwise would not. Thus, the Commission believes that these 
regulations perform an important consumer protection function in the 
markets it regulates. While, in theory regulation could discourage some 
SDs, MSPs, FCMs, or IBs from making research reports public, the 
Commission believes the rules are carefully tailored to minimize costs 
beyond those required by the statute. The Commission also believes that 
SDs, MSPs, FCMs, and IBs likely will use research reports as a tool to 
differentiate themselves from competitors. In addition, the Commission 
believes that by insulating clearing services from pricing and trading 
bias, the regulations foster fair and open access to central clearing.
2. Efficiency, Competitiveness, and Financial Integrity of Markets 
\131\
---------------------------------------------------------------------------

    \131\ Although by its terms CEA section 15(a)(2)(B) applies to 
futures markets only, the Commission finds this factor useful in 
analyzing regulations pertaining to swaps markets as well.
---------------------------------------------------------------------------

    The final rules promote the efficiency, competitiveness, and 
financial integrity of futures and swaps markets \132\ by prohibiting 
an entity's trading personnel from manipulating research reports or 
otherwise biasing the information contained in research reports to 
their own financial advantage. To the extent the research produced by 
registrants is used to inform financial strategies, the integrity of 
that research is beneficial to the financial integrity of derivatives 
markets. The final rules strive to ensure the integrity of research 
performed by Commission registrants. Sound research also promotes 
market efficiency insofar as the increased dissemination of reliable, 
unbiased market information is acted upon by market participants in 
their decision-making. As discussed above, the Commission does not 
believe that the costs of these regulations, as carefully tailored to 
minimize costs beyond those required by the statute, will materially 
decrease market efficiency by leading to less sharing of relevant 
market information, particularly in light of the competitive incentives 
to do so.
---------------------------------------------------------------------------

    \132\ Although by its terms CEA section 15(a)(2)(B) applies to 
futures markets only, the Commission finds this factor useful in 
analyzing regulations pertaining to swaps markets as well.
---------------------------------------------------------------------------

    Because the final rules promote fair and open access to central 
clearing, they also promote the financial integrity of derivatives 
markets--both futures and swaps markets. Greater access to central 
clearing ensures that more market participants will have the option to 
mitigate the counterparty credit risk that they face when entering into 
derivatives transactions. Protecting market participants from 
discrimination in the provision of clearing services will foster

[[Page 20186]]

a competitive environment for the provision of clearing services and 
afford market participants greater choice in clearing members. While 
the Commission recognizes that some costs are attendant to the required 
firewall between trading and clearing, the Commission does not believe 
that these costs, as carefully tailored to minimize costs beyond those 
required by the statute, are sufficient to materially inhibit the 
provision of clearing services.
3. Price Discovery
    To the extent that insulating research reports from registrant 
financial bias results in hedgers and investors making more accurately 
informed investment decisions, reported trade and transaction prices 
should better reflect the intrinsic value. This promotes the price 
discovery function of derivative markets. In contrast, where there is 
no check on the integrity of registrant research materials and market 
actors transact on the basis of misleading or inaccurate information, 
resulting prices may be distorted. Because the rules are carefully 
tailored to minimize costs, the Commission does not believe these rules 
will reduce liquidity to hinder price discovery.
4. Sound Risk Management
    The final rules regarding informational partitions between clearing 
and trading will contribute to sound risk management because the 
separation of the FCM clearing unit from the interference or influence 
of an affiliated SD or MSP promotes open access to clearing. Open 
access to clearing will be essential for the expansion of client 
clearing needed for market participants to comply with the mandatory 
clearing of swaps as determined by the Commission under section 723 of 
the Dodd-Frank Act. The mandatory central clearing of swaps is one of 
the primary responses to the 2008 financial crisis, as central clearing 
is believed to promote sound risk management in the swap markets. While 
the Commission recognizes that some costs are attendant to the required 
firewall between trading and clearing, the Commission does not believe 
that these costs, as carefully tailored to minimize costs beyond those 
required by the statute, are sufficient to materially inhibit the 
provision of clearing services and the risk management benefit these 
services afford.
5. Other Public Interest Considerations
    The Commission has not identified any other public interest 
considerations impacted by these conflicts-of-interest rules.

G. Designation of a Chief Compliance Officer, Required Compliance 
Policies, and Annual Report of an FCM, SD, or MSP

    The CCO NPRM proposed several rules addressing chief compliance 
officer (CCO) designation and certain CCO requirements:
    <bullet> Proposed Sec.  3.3(a) codified the statutory requirements 
that each FCM, SD, and MSP designate a CCO and prescribed certain 
qualifications for the position.\133\
---------------------------------------------------------------------------

    \133\ Section 4d(d) of the CEA requires that each FCM designate 
an individual to serve as its chief compliance officer (CCO). 
Likewise, section 4s(k) of the CEA requires that each SD and MSP 
designate an individual to serve as its CCO.
---------------------------------------------------------------------------

    <bullet> Proposed Sec.  3.3(d) codified the CCO duties defined in 
section 4s(k)(2) for SDs and MSPs, and extended their application to 
FCMs.\134\
---------------------------------------------------------------------------

    \134\ Section 4d(d) of the CEA authorizes the Commission to 
promulgate rules concerning the duties of a CCO of an FCM.
---------------------------------------------------------------------------

    <bullet> Proposed Sec.  3.3([e]) \135\ codified the requirements of 
section 4s(k)(3) of the CEA for SDs and MSPs--i.e., that the CCO 
annually prepare and sign a report containing descriptions of: (i) The 
registrant's compliance with the CEA and regulations promulgated under 
the CEA, and (ii) each policy and procedure of the CCO, including the 
code of ethics and conflicts-of-interest policies--and extended their 
application to FCMs pursuant section 4d(d) of the CEA.
---------------------------------------------------------------------------

    \135\ The proposed regulations mis-numbered the subsections of 
Sec.  3.3 such that two subsections were designated as ``(d).'' To 
avoid confusion, this release re-designates such sections correctly 
in brackets.
---------------------------------------------------------------------------

    Of the 25 comment letters the Commission received on the CCO NPRM, 
17 raised issues relevant to the consideration of the proposed rules' 
material costs and benefits; two of these provided some quantitative 
data relevant to costs and benefits.
    The comments relevant to costs and benefits can be classified with 
respect to the following 10 aspects, each of which is discussed 
below.\136\
---------------------------------------------------------------------------

    \136\ A more detailed discussion of the comments can be found in 
section II.N. above.
---------------------------------------------------------------------------

1. Decision To Extend Same Requirements to FCMs as SDs and MSPs
    The Commission proposed uniform rules applicable to SDs, MSPs, and 
FCMs. After reviewing the comments received,\137\ the Commission is 
adopting the same requirements for SDs, MSPs, and FCMs. The Commission 
recognizes commenters' concerns (though not substantiated with 
quantitative data) that subjecting FCMs to the same CCO requirements as 
applied to SDs and MSPs by section 4s(k) of the CEA (as codified in 
these rules) may increase costs for FCMs as compared to a less 
prescriptive approach. The Commission believes these costs may vary 
widely among FCMs, depending on the activities in which an FCM engages 
and the size and complexity of an FCM's operations.\138\ Lacking 
quantitative information requested of commenters, the Commission has 
looked to public sources to estimate the boundaries of this range. In 
this regard, it finds the estimates contained in the SEC's 2003 
published final compliance program rules for investment companies and 
investment advisers informative and, in lieu of FCM-specific 
information, a reasonable proxy for estimating an FCM compliance cost 
range.\139\ The SEC estimated costs for developing a compliance 
program, depending on the manner chosen, ranging from $1,000 to 
$200,000.\140\
---------------------------------------------------------------------------

    \137\ Comments from Rosenthal, Newedge, and NFA advocated 
separate treatment for FCMs, given the Commission's separate 
statutory authority over them. A number of other commenters, 
including Better Markets, NSCP, and CII generally supported 
extension of the same duties to FCMs (provided that certain 
modifications were made to the proposed rules).
    \138\ In this respect, the Commission observes that 55% of 
current FCMs are also registered as BDs with the SEC, and thus will 
already have a CCO and significant compliance regimes as required 
under the rules of FINRA. See letter from NFA, dated Jan. 18, 2011 
(comment file for 75 FR 70881 (Designation of a Chief Compliance 
Officer; Required Compliance Polices; and Annual Report of a FCM, 
SD, or MSP)). FCMs that do not currently have a CCO or a compliance 
program may choose to develop a program in-house if their activities 
are limited and the regulatory requirements well-understood. Other 
FCMs may choose to purchase an off-the-shelf compliance manual and 
adjust it to correspond to their regulatory requirements. Still 
others may hire a third-party compliance firm, a law firm, or an 
accounting firm to draft a firm-specific manual. As of 2003, when 
the SEC published final compliance program rules for investment 
companies and investment advisers, the costs for these options 
ranged from $1,000 to $200,000. See Compliance Programs of 
Investment Companies and Investment Advisers, 68 FR 74714 (Dec. 24, 
2003).
    \139\ See Compliance Programs of Investment Companies and 
Investment Advisers, 68 FR 74714 (Dec. 24, 2003).
    \140\ The SEC considered the same three alternative compliance 
avenues as noted above for FCMs. See id.
---------------------------------------------------------------------------

    Notwithstanding these costs, the Commission believes the same 
considerations and benefits, discussed further below, that warrant 
these regulations for SDs and MSPs, warrant them for FCMs as well. As 
recent Congressional hearings in the wake of the MF Global bankruptcy 
have highlighted, an FCM's conduct holds potential to cause severe 
negative impact to market participants and the public.\141\ In that the 
statutory

[[Page 20187]]

requirements of the CEA and Commission regulations under it seek to 
prevent harm to market participants and the public by FCMs, the 
Commission believes that requiring a robust CCO function within FCMs is 
an important benefit of these regulations. A CCO will serve as a focal 
point to better monitor and assure FCM legal compliance. Moreover, the 
Commission believes the role of FCMs likely will grow in importance as 
client clearing of swaps increases, fostering commensurate growth in 
the benefits of active compliance monitoring by CCOs of FCMs to the 
security and stability of swaps markets. The Commission also expects 
that consistent regulation of its registrants is likely to benefit the 
Commission's regulatory mission by increasing the efficiency of 
registrant oversight.
---------------------------------------------------------------------------

    \141\ See Press Release, Senate Committee on Agriculture, 
Nutrition & Forestry, Senator Pat Roberts: We Need Answers on MF 
Global * * * Futures Still Critical to Risk Management (Dec. 1, 
2011), available at http://www.ag.senate.gov/hearings/continuing-oversight-of-the-wall-street-reform-and-consumer-protection-act 
(prepared remarks of Sen. Pat Roberts, ranking subcommittee member, 
at December 1, 2011 Senate Committee on Agriculture, Nutrition & 
Forestry).
---------------------------------------------------------------------------

2. Harmonization With Other Regulatory Regimes
    After reviewing comments,\142\ the Commission is modifying its 
proposal to reduce the cost burden by harmonizing the CCO requirements 
for SDs, MSPs, and FCMs with the traditional compliance model as 
reflected in other regulatory regimes--including regimes established by 
FINRA for broker-dealers (BDs), the FHFA, and by the Commission for 
RFEDs--to the extent consistent with section 4s(k) of the CEA.\143\ 
Specifically, the Commission has modified the rule to (1) require that 
the CCO ``administer'' the compliance policies of the registrant 
(rather than establish compliance polices); (2) confirm, as suggested 
by commenters, that the CCO's role in ``resolving'' conflicts of 
interest may involve actions other than making the final decision; (3) 
provide that the CCO must take ``reasonable steps to ensure 
compliance'' (rather than simply ``ensure compliance''); and (4) permit 
either the CCO or the CEO to make the required certification of the 
annual report.
---------------------------------------------------------------------------

    \142\ See e.g., NFA's comment letter and representatives of 
market participants in a May meeting with SEC and Commission staff 
(see http://comments.cftc.gov/PublicComments/) were concerned with 
differences between the Commission's proposed rules and FINRA's 
rules and recommended harmonization. The FHLBs commented that they 
are subject to FHFA regulation and requested that the Commission not 
impose duplicative regulations for them. Edison Electric Institute 
(EEI) urged the Commission to follow the Federal Energy Regulatory 
Commission's approach by setting forth principles of an effective 
compliance program while leaving the details to the registrant. FIA 
and SIFMA noted that the more traditional compliance model-- RFEDs 
are required to designate a CCO and prepare an annual compliance 
certification under current Commission regulations (see 17 CFR 
5.18(j).)--would be consistent with the approach the Commission took 
with regard to RFEDs. FIA and SIFMA, along with Newedge and 
Rosenthal, argued that the Commission should harmonize its rules 
with those of FINRA and defer to NFA's experience in determining the 
proper role for the CCO.
    \143\ To the extent the other regulatory regimes prescribe CCO 
rules more general than those specifically required by section 
4s(k), they do not conform to statutory requirements and are not 
implemented in the final rules. However, the Commission believes the 
more specific requirements of section 4s(k) are supplemental--not 
contradictory--to the more general ``policies, procedures, and 
testing'' requirements of the rules of the other regulatory regimes.
---------------------------------------------------------------------------

3. Flexibility in Rule's Structure
    In the CCO NPRM, the Commission requested comment on whether the 
structure of the proposed rules allows for sufficient flexibility, 
thereby permitting FCMs, SDs, and MSPs to control costs by tailoring 
their compliance programs to their individual circumstances. The 
comments received raised the following issues with cost-benefit 
implications:
    <bullet> Allowing a CCO to perform other duties in addition to 
compliance duties; \144\
---------------------------------------------------------------------------

    \144\ NFA and the FHLBs commented that the rules explicitly 
should permit the CCO to share any other executive role, such as 
CEO, to provide flexibility for smaller firms.
---------------------------------------------------------------------------

    <bullet> Designation of multiple CCOs with defined areas of 
responsibility; \145\
---------------------------------------------------------------------------

    \145\ NFA also argued that the rules should recognize that 
compliance expertise may reside with more than one individual, and 
thus the Commission should consider allowing an entity to designate 
multiple CCOs, so that each CCO's primary area of responsibility is 
defined, and each CCO should be required to perform duties and 
responsibilities with respect to their defined area.
---------------------------------------------------------------------------

    <bullet> Allowing a single officer to be CCO for multiple 
affiliated entities; \146\
---------------------------------------------------------------------------

    \146\ Newedge, Hess, and The Working Group argued that 
affiliated FCMs, SDs, and MSPs that are separate legal entities 
should be permitted to share the same CCO to increase compliance 
efficiency.
---------------------------------------------------------------------------

    <bullet> Allowing CCOs of multiple affiliated entities to report to 
the board of a holding company that controls all affiliated entities; 
\147\
---------------------------------------------------------------------------

    \147\ The Working Group also argued and that the CCO of 
affiliated registrants should be allowed to report to a board of an 
affiliated entity that controls both entities.
---------------------------------------------------------------------------

    <bullet> Allowing CCOs to consult with other employees, outside 
consultants, lawyers, and accountants in fulfilling their duties; \148\
---------------------------------------------------------------------------

    \148\ NFA also recommended that CCOs explicitly be permitted to 
consult with other employees, outside consultants, lawyers, and 
accountants.
---------------------------------------------------------------------------

    <bullet> Requiring a senior CCO to have responsibility for multiple 
affiliated entities, even if each has its own CCO; and \149\
---------------------------------------------------------------------------

    \149\ Better Markets commented that a senior CCO should have 
overall responsibility of each affiliated and controlled entity, 
even if individual entities within the group have CCOs.
---------------------------------------------------------------------------

    <bullet> Requiring the CCO to be located remotely from the business 
trading unit.\150\
---------------------------------------------------------------------------

    \150\ Better Markets recommended that the rule require the CCO 
office to be located remotely from the trading floor.
---------------------------------------------------------------------------

    Having considered these comments, the Commission has taken steps to 
reduce the cost burden on registrants by expanding the flexibility 
allowed under the proposed rule. Specifically, the Commission agrees 
that firms, especially small firms, could reduce costs if a CCO were 
permitted to perform additional duties and therefore confirms that a 
CCO may share additional executive responsibilities and/or be an 
existing officer within the entity. In addition, the final rule would 
allow registrants to recognize cost savings by not prohibiting multiple 
legal entities from designating the same individual as CCO. The 
Commission also is not requiring the CCO to be remotely located from 
the business trading unit. Moreover, the Commission is modifying the 
rule to permit either the CCO or the CEO to make the certification 
required in the annual report, as requested by commenters. This change 
will reduce the compliance costs insofar as it may make it easier to 
recruit and retain qualified candidates for CCO. In response to NFA's 
concern about CCOs being able to rely on the expertise of others, 
presumably in part to reduce the cost of personally developing the 
requisite expertise, the Commission confirms that the qualifying 
language ``to the best of his or her knowledge and reasonable belief'' 
in the annual report certification required by the rule permits the CCO 
or CEO to rely on other experts for statements made in the annual 
report.
    With respect to two of the above-noted issues, however, the 
statutory language does not afford the Commission flexibility to relax 
requirements. Specifically, section 4s(k) of the CEA requires the CCO 
to report to each registrant's board or senior officer, rather than to 
the board or senior officer of a consolidated corporate parent, so the 
Commission is unable to adjust the rule to permit the CCOs of multiple 
affiliated entities to report to the board of a holding company. 
Similarly, the statutory language of sections 4d(d) and 4s(k) of the 
CEA--requiring FCMs, SDs, and MSPs to ``designate an individual to 
serve as chief compliance officer''--provides the

[[Page 20188]]

Commission no latitude to permit designation of multiple CCOs with 
delineated areas of responsibility. The Commission notes that any costs 
of these requirements are directly attributable to the statutory 
requirements of Congress, and not to Commission action.
4. Limited Scope of the Rule
    Proposed Sec.  3.3(a) required each SD, MSP, and FCM to designate 
an individual as a CCO and provide the CCO with the full responsibility 
and authority to develop and enforce, in consultation with the board or 
senior officer, appropriate policies and procedures to fulfill the 
duties set forth in the CEA and regulations. The proposed rule also 
required the CCO to establish policies and procedures required to be 
established by a registrant pursuant to the CEA and Commission 
regulations. The Commission believes that the benefits of the rule 
consist of consolidating oversight of compliance by FCMs, SDs, and MSPs 
in a single individual, thereby reducing the risk that compliance 
matters will be subject to inconsistent policies and procedures or that 
compliance matters will not receive the attention necessary to be 
effective.
    Commenters \151\ criticized the proposed rule for two reasons, each 
presumably based in part on the cost of expanding the traditional role 
of a CCO:
---------------------------------------------------------------------------

    \151\ Rosenthal commented that the Commission's rules should be 
revised in a manner that reflects the view that the CCO is only an 
advisor to management and should not be viewed as an enforcer of 
policies within the FCM. EEI and Newedge argued that the proposed 
rules go beyond what is required by the CEA by inappropriately 
imposing upon the CCO full responsibility to develop and enforce all 
policies.
---------------------------------------------------------------------------

    <bullet> A CCO should not be viewed as an enforcer of compliance 
polices; and
    <bullet> A CCO should not be required to develop all compliance 
policies.
    The Commission agrees with commenters that the rule could be 
modified to maintain the benefits identified above while imposing less 
burden on registrants. The Commission is therefore narrowing proposed 
Sec.  3.3(a) by (i) removing the requirement that a CCO be provided 
with ``full'' responsibility and authority; (ii) removing the 
requirement that a CCO ``enforce'' policies and procedures; (iii) 
limiting the responsibilities of the CCO to (a) the ``swaps 
activities'' of SDs and MSPs and (b) FCMs' derivatives activities 
included in the definition of FCM under section 1(a)(28) of the CEA; 
and (iv) clarifying that a CCO need only develop policies and 
procedures to fulfill the duties set forth in, and ensure compliance 
with, the CEA and Commission regulations. The Commission believes that 
the rule as modified will achieve the benefits of consolidated 
compliance oversight without imposing costs on registrants that are 
unnecessary to achieve this goal.
5. CCO Reporting Line
    Proposed Sec.  3.3(a)(1) required that the CCO report to the board 
of directors or the senior officer of a registrant, that the board or 
senior officer approve the compensation of the CCO, and that the board 
or senior officer meet with the CCO at least once a year to discuss the 
effectiveness of compliance policies and their administration by the 
CCO. Proposed Sec.  3.3(a)(2) also prohibited the board or senior 
officer of a registrant from delegating its authority over the CCO, 
including the authority to remove the CCO. The Commission believes that 
these aspects of the rule will ensure CCO independence from influence, 
interference, or retaliation from business trading unit personnel and 
freedom from conflicts of interest in performance of the CCO's duties. 
The Commission believes CCO independence is crucial to achieving the 
benefits of the CCO role as envisioned under the statutory provisions 
of the CEA because an independent CCO is more likely to: (i) Question 
business line decisions, (ii) speak out on non-compliance issues and 
raise them with senior management and the board, and (iii) have stature 
within the firm to successfully institute a culture of compliance.
    Commenters raised the following issues with respect to the above-
described aspects of the proposed rule:
    <bullet> The CCO should be permitted to report to the governing 
body or senior officer of a division, rather than to the board; \152\
---------------------------------------------------------------------------

    \152\ Cargill recommended that the definition of board of 
directors be expanded to include a governing body of a division, 
such as a management committee, and that the Commission add a 
definition of ``senior officer'' to include a senior officer of a 
division, because a division might be more familiar with the swaps 
activities of an SD.
---------------------------------------------------------------------------

    <bullet> The CCO should be permitted to report to a board 
committee, rather than to the whole board; \153\
---------------------------------------------------------------------------

    \153\ MetLife requested that the definition of board of 
directors include expert committees of the whole board.
---------------------------------------------------------------------------

    <bullet> The CCO should be permitted to report to the board of a 
holding company; \154\
---------------------------------------------------------------------------

    \154\ The Working Group argued that the CCO should be allowed to 
report to a board of an affiliated entity.
---------------------------------------------------------------------------

    <bullet> The CCO should be permitted to report to an officer other 
than the senior officer; \155\
---------------------------------------------------------------------------

    \155\ EEI, FIA, SIFMA, NFA, and The Working Group argued that 
the CCO should be permitted to operate under the direction of 
corporate officers other than the senior officer, as long as 
independence and authority as a control function is maintained.
---------------------------------------------------------------------------

    <bullet> CCO compensation and termination decisions should be 
reserved to the independent members of the board; \156\
---------------------------------------------------------------------------

    \156\ Better Markets and Chris Barnard recommended that 
decisions to designate or terminate a CCO, as well as compensation 
decisions, be prescribed solely by independent members of the board, 
acting by majority vote.
---------------------------------------------------------------------------

    <bullet> The CCO should be permitted to report to the full board at 
any time, without interference; \157\ and
---------------------------------------------------------------------------

    \157\ NWC recommended that (1) the term ``senior officer'' be 
defined as the CEO or chairman of the board, (2) the rule should 
permit the CCO to report to the full board at any time with no 
interference from a board committee or a CEO, and (3) that the rule 
should prohibit termination of the CCO unless the CCO is presented 
the opportunity to address the board.
---------------------------------------------------------------------------

    <bullet> The CCO should have the right to address the board prior 
to termination.\158\
---------------------------------------------------------------------------

    \158\ Id.
---------------------------------------------------------------------------

    Having considered the costs and benefits implications of these 
issues, the Commission is adopting the rule as proposed. Section 4s(k) 
of the CEA requires the CCO to ``report directly'' to the board or the 
senior officer of the SD or MSP. The Commission believes, therefore, 
that despite the costs imposed the statutory requirement that the CCO 
report directly to the board or senior officer does not permit a firm 
to have its CCO report to a board committee, the independent members of 
the board, the board of a holding company, or any officer other than 
the senior officer.
    The Commission recognizes that adopting some commenters' 
recommendations would increase the independence of the CCO. The 
Commission has declined to modify the rule to include such 
recommendations because it believes the benefits outlined above will be 
sufficiently assured by the rule as adopted herein and thus the 
additional burden of more stringent independence requirements is 
unnecessary at this time.
6. Qualifications of the CCO
    As proposed, Sec.  3.3(b) required the CCO to have the background 
and skills appropriate for fulfilling the responsibilities of the 
position, and prohibited an individual who is statutorily disqualified 
under sections 8a(2) or 8a(3) of the CEA from serving. The Commission 
rationale for this is that a well-qualified CCO, without a history of 
disqualifying attributes, is

[[Page 20189]]

more likely to fulfill the duties of the position successfully and have 
the stature and experience to demand the respect necessary to instill a 
culture of compliance. The Commission believes that an effective CCO 
serves an important role in guarding against registrant failures and 
misfeasance, and the resulting losses to customers and other market 
participants.
    Commenters criticized the above-described aspects of the proposed 
rule as follows, but no commenter provided any quantitative data to 
justify their arguments:
    <bullet> It is unnecessary to include statutory disqualification as 
a qualification for the CCO; \159\
---------------------------------------------------------------------------

    \159\ NFA argued that the prohibition on individuals who are 
disqualified by statute is unnecessary because an SD, MSP, or FCM's 
registration could be denied or revoked under section 8a(2)-(3) of 
the CEA if any principal of the registrant is subject to a statutory 
disqualification.
---------------------------------------------------------------------------

    <bullet> ``Background and skills appropriate for fulfilling the 
responsibilities of the position'' is too vague a standard--
qualifications should be left to the discretion of the firm; \160\
---------------------------------------------------------------------------

    \160\ Cargill commented that the requirement for a CCO to have 
``the background and skills appropriate'' is a commendable 
aspirational goal but is too vague a standard for Federal law, and 
is best reserved as a business decision. The Working Group also 
commented that wide latitude for qualifications of a CCO is 
necessary.
---------------------------------------------------------------------------

    <bullet> The Commission should require CCOs to pass a specific 
compliance examination and be licensed; \161\ and
---------------------------------------------------------------------------

    \161\ Newedge recommended that CCOs be required to pass a 
specific compliance examination and obtain a specific compliance 
license, as is the case in the securities world.
---------------------------------------------------------------------------

    <bullet> The Commission should prohibit members of a firm's legal 
department from acting as CCO due to potential conflicts of 
interest.\162\
---------------------------------------------------------------------------

    \162\ Better Markets argued that a CCO should not be permitted 
to be an attorney that represents the SD, MSP, or FCM, or its board 
because the potential conflict would disqualify such an attorney.
---------------------------------------------------------------------------

    Based on the issues raised by commenters, the Commission presumes 
that commenters are concerned about the cost of locating, recruiting, 
and compensating a CCO that meets the necessary qualifications, or 
about the costs to the market if CCOs are not well-qualified and fail 
to fulfill their duties under the CEA and rule. The Commission 
estimates that a well-qualified CCO for an FCM, SD, or MSP is likely to 
be compensated at approximately $216,000 per year.\163\
---------------------------------------------------------------------------

    \163\ The Commission staff estimates concerning the wage rates 
are based on salary information for the securities industry compiled 
by SIFMA. The salary estimate was taken from SIFMA Report on 
Management & Professional Earnings in the Securities Industry 2010. 
Staff took an average of the last two years of salary estimates for 
Chief Compliance Officers, modified to account for inflation as well 
as overhead and other benefits, then adjusted upward based on the 
additional responsibility demanded from SD, MSP, and FCM CCOs as 
required by the CEA (as noted by commenters).
---------------------------------------------------------------------------

    Having considered the costs and benefits implications of these 
issues, the Commission is adopting the rule as proposed. Given the 
duties and responsibilities of the CCO as set forth in the CEA and the 
rule, the Commission believes that the cost to FCMs, SDs, and MSPs to 
hire a well-qualified person to act as CCO are appropriate given the 
critical role the CCO will play in ensuring registrants comply with the 
CEA and Commission regulations. Moreover, the Commission believes the 
qualifications required by the rule as proposed are sufficient to 
ensure the necessary level of CCO qualification without need to adopt 
the more restrictive CCO qualifications (e.g., an examination and 
licensing requirement and/or legal counsel bar) recommended by some 
commenters. To maintain flexibility in the rule for the wide variety of 
registrants that will be affected, the Commission also is not defining 
what the ``background and skills appropriate for fulfilling the 
responsibilities of the position'' would be, leaving this determination 
to the discretion of the registrant as appropriate to their unique 
circumstances.
7. Role of the CCO
    As proposed, Sec.  3.3 established a number of duties for the CCO. 
Proposed Sec.  3.3(d)(1) required the CCO to establish the registrant's 
compliance policies in consultation with the board of directors or 
senior officer. Proposed Sec.  3.3(d)(2) required the CCO, in 
consultation with the board or senior officer, to resolve any conflicts 
of interest that may arise. Proposed Sec.  3.3(d)(3) required the CCO 
to review and ``ensure compliance'' by the registrant with the 
registrant's compliance policies and all applicable laws and 
regulations.
    Commenters criticized the above-described aspects of the proposed 
rule as follows:
    <bullet> Responsibility for resolving conflicts of interest belongs 
more appropriately to the board or senior officer, not a CCO; \164\
---------------------------------------------------------------------------

    \164\ NFA commented that resolution of conflicts of interest 
should rest with the board or the senior officer, in consultation 
with the CCO. FIA and SIFMA argued that when Congress used the term 
``resolve any conflicts of interest that may arise,'' Congress did 
not mean resolve in the executive or managerial sense. Newedge 
commented that the CEO and business line supervisors are in a better 
position than the CCO to resolve conflicts. Participants in the May 
Meeting with Commission staff stated that resolving a conflict would 
traditionally be interpreted as eliminating the conflict, but that 
elimination is not always preferable and the compliance officer 
should not be the actual decision maker in the resolution.
---------------------------------------------------------------------------

    <bullet> Responsibility for ensuring compliance belongs more 
appropriately to the board or senior officer, not a CCO; \165\
---------------------------------------------------------------------------

    \165\ NSCP argued that ``ensure compliance'' imposes a level of 
responsibility on a CCO that cannot be discharged and is 
inconsistent with the customary role of a compliance officer. Hess 
argued that the proposal concentrates too much of the compliance 
function on a single individual and recommended that the CCO should 
remain the monitor of the compliance monitors. FIA, SIFMA, The 
Working Group, Newedge, and NFA each argued that requiring the CCO 
to ensure compliance goes beyond existing compliance models and 
creates a standard that is impossible to satisfy. FIA and SIFMA 
further argued that the requirement to remediate non-compliance 
issues acknowledges that instances of noncompliance are not wholly 
preventable by any person. FIA and SIFMA recommended that ``ensure 
compliance'' should mean taking reasonable steps to adopt, review, 
test, and modify compliance policies. EEI and participants in the 
May Meeting with Commission staff stated that ensuring compliance 
could mean that the CCO escalates a problem that has not been 
resolved.
---------------------------------------------------------------------------

    <bullet> The transfer of regulatory responsibility from executive 
officers to the CCO may result in executive officers spending less time 
and attention to compliance matters; \166\
---------------------------------------------------------------------------

    \166\ Newedge believes that any transfer of regulatory 
responsibility currently held by executive officers to the CCO could 
have the unintended effect of reducing the amount of time such 
officers spend on compliance matters.
---------------------------------------------------------------------------

    <bullet> Firms will have difficulty retaining a CCO who is willing 
to perform the duties set forth in the rule.\167\
---------------------------------------------------------------------------

    \167\ NFA also argued that the rules improperly redefine a CCO's 
duties, and registrants will have difficulty retaining CCOs who are 
willing to perform these duties.
---------------------------------------------------------------------------

    Having considered the cost and benefit implications of these 
issues, the Commission presumes that commenters are concerned in part 
about the cost of expanding their compliance departments to fulfill 
duties currently or traditionally handled by other executive officers 
or departments. In response to this concern, the Commission is adopting 
the final rule as follows: (1) The Commission is revising proposed 
Sec.  3.3(d)(1) to track more closely the statutory language of section 
4s(k) and require that the CCO ``administer'' the compliance policies 
of the registrant; (2) the Commission is not removing the requirement 
that the CCO ``resolve'' conflicts of interest from the rule because 
the requirement is provided for in section 4s(k)(2)(C) of the CEA, but 
confirms, as suggested by commenters, that the CCO's role in 
``resolving'' conflicts of interest may involve actions other than 
making the final decision; and (3) the Commission is modifying proposed 
Sec.  3.3(d)(3) to provide that the CCO must take ``reasonable steps to 
ensure compliance.''

[[Page 20190]]

    The foregoing changes align the rule to the duties of the CCO for 
SDs and MSPs as set forth in the CEA, and, thus, the costs of these 
requirements are directly attributable to the statutory requirements of 
Congress, and not to Commission action. The Commission's decision to 
extend the same requirements to CCOs for FCMs is explained in detail 
above.
8. Certification of the Annual Report by the CCO ``Under Penalty of 
Law''
    Proposed Sec.  3.3(d)(6) required the CCO of an SD, MSP, or FCM to 
prepare, sign, and certify, under penalty of law, the annual report 
specified in section 4s(k)(3) of the CEA.
    Commenters criticized the above-described aspects of the proposed 
rule as follows:
    <bullet> The CEO, not the CCO, should certify the annual report; 
\168\
---------------------------------------------------------------------------

    \168\ Rosenthal commented that FINRA's approach to certification 
is preferable, i.e., the CEO certifies that the firm has processes 
to establish, maintain, review, test, and modify written compliance 
policies and written supervisory procedures reasonably designed to 
achieve compliance with securities laws, regulations, and FINRA 
rules. FIA, SIFMA, and Newedge each argued that section 4s(k)(3) of 
the CEA requires the CCO to sign the annual report, but does not 
require the CCO to certify the report. FIA, SIFMA, MFA, Newedge, and 
NFA all recommended that the rule be revised to require the CEO to 
certify the report. Participants in the May Meeting with Commission 
staff stated that requiring the CEO to make the certification 
appropriately shares responsibility between compliance and business 
management. FIA and SIFMA recommended that, with respect to any 
Commission registrant that is also a BD, the Commission should 
require the CEO to make the certification.
---------------------------------------------------------------------------

    <bullet> Requiring the CCO to certify the annual report under 
penalty of law will make it difficult for registrants to retain a CCO 
and, thus, should not be required; \169\ and
---------------------------------------------------------------------------

    \169\ FIA and SIFMA felt that imposing criminal liability for 
annual report certifications would hinder the ability to fill the 
position of CCO. FIA and SIFMA requested that the Commission clarify 
that criminal liability for the certification will not apply (absent 
a knowing and willful materially false and misleading statement) 
because there is no indication that Congress ever thought CCOs 
should be subject to criminal liability. Similarly, NSCP requested 
that the Commission clarify whether ``under penalty of law'' means 
liability under 18 U.S.C. 1001 for a false statement to a Federal 
officer. Rosenthal argued that requiring the CCO to certify under 
penalty of law will make the CCO liable for firm infractions and 
will give disgruntled customers a roadmap for frivolous lawsuits. 
Newedge also believes that the requirement to certify under penalty 
of law is not fair or practicable because whoever certifies will 
have to rely on many individuals to compile the report. On the other 
hand, Hess commented that the certification language strikes an 
appropriate balance such that strict liability is not imposed for 
inadvertent errors.
---------------------------------------------------------------------------

    <bullet> The required certification should be subject to a 
materiality qualifier.\170\
---------------------------------------------------------------------------

    \170\ NSCP commented that the certification that the report is 
accurate and complete should have a materiality qualifier added to 
it. Participants in the May Meeting with Commission staff urged the 
Commission to adopt a standard for the annual report certification 
that is reasonably attainable.
---------------------------------------------------------------------------

    Having considered the cost-benefit implications of these issues and 
the arguments raised by commenters, the Commission is modifying the 
requirement that the CCO make the required certification of the annual 
report to allow the registrant the discretion to choose whether the CCO 
or the CEO makes the certification. As explained by commenters, this 
change will make it easier and less costly for registrants to recruit 
and retain candidates for the position of CCO.
    However, consistent with the statutory text in section 
4s(k)(3)(B)(ii) of the CEA, the Commission is also declining to add a 
materiality qualifier to the certification, as suggested by commenters. 
Moreover, not qualifying certification on materiality is consistent 
with the approach taken in final rules for SDRs \171\ and DCOs,\172\ 
and with proposed CCO rules for SEFs; \173\ the Commission expects 
consistent regulation of its registrants and registered entities to 
benefit the Commission's regulatory mission by increasing the 
efficiency of oversight. The Commission believes that limiting the 
CCO's certification requirement with the qualifier ``to the best of his 
or her knowledge and reasonable belief'' sufficiently mitigates 
commenters' liability costs concerns because the rule would not impose 
liability for compliance matters that are beyond the certifying 
officer's knowledge and reasonable belief at the time of certification.
---------------------------------------------------------------------------

    \171\ See Swap Data Repositories: Registration Standards, Duties 
and Core Principles, 76 FR at 54584.
    \172\ See Derivatives Clearing Organization General Provisions 
and Core Principals, 76 FR at 69435.
    \173\ See Core Principles and Other Requirements for Swap 
Execution Facilities, 76 FR 1214, 1252 (Jan. 7, 2011).
---------------------------------------------------------------------------

    Having modified the rule as described above, and otherwise confined 
the rule to the requirements of the CEA, the Commission believes that 
the costs of these requirements are directly attributable to the 
statutory requirements of Congress, and not to Commission action. The 
Commission's decision to extend the same requirements to CCOs for FCMs 
is explained in detail above.
9. Content of the Annual Report
    The proposed regulation required the annual report to contain (1) a 
description of the compliance by the registrant with respect to the CEA 
and regulations; (2) a description of each of the registrant's 
compliance policies; (3) a review of each applicable requirement under 
the CEA and regulations, and, with respect to each, identification of 
the policies that ensure compliance, an assessment as to the 
effectiveness of the policies, discussion of areas of improvement, and 
recommendations of potential or prospective changes or improvements to 
its compliance program and resources devoted to compliance; (4) a 
description of the registrant's financial, managerial, operational, and 
staffing resources set aside for compliance with the CEA and 
regulations, including any deficiencies in such resources; (5) a 
delineation of the roles and responsibilities of a registrant's board 
of directors or senior officer, relevant board committees, and staff in 
addressing any conflicts of interest, including any necessary 
coordination with, or notification of, other entities, including 
regulators; and (6) a certification of compliance with sections 619 and 
716 of the Dodd-Frank Act (the Volcker Rule and Derivatives Push-Out), 
and any rules adopted pursuant to these sections. The proposed rule 
also required FCMs, SDs, and MSPs to maintain records of its compliance 
policies, materials provided to the board in connection with its review 
of the annual compliance report, and work papers that form the basis of 
the annual compliance report.
    The Commission believes the benefits of the annual report result 
from the focus on compliance with the CEA and Commission regulations. 
The annual requirement to compile in a single document the results of a 
registrant's compliance policies and procedures should serve as an 
efficient means to focus the registrant's board and senior management 
on areas requiring additional compliance resources or changes to 
business practices; it also will provide the Commission with a detailed 
overview of the state of compliance of the industry as a whole. This 
annual and ongoing compliance focus will result in increased industry 
compliance, thereby increasing market security and stability. A secure 
and stable market fosters increased market confidence and increased 
activity by investors and hedgers managing risk.
    Commenters raised the following issues with respect to the above-
described aspects of the proposed rule:
    <bullet> Overbreadth concerns with the requirements for the content 
of the annual report; \174\
---------------------------------------------------------------------------

    \174\ NSCP, The Working Group, EEI, and Hess each argued that 
the level of detail contemplated by the rule would impose 
unnecessary burdens on the CCO with little offsetting benefits. NSCP 
argued that a better approach would be to follow the SEC 
requirements for annual reviews of compliance by registered 
investment advisers. NSCP believes the proposed rule is overbroad 
and discourages reporting of compliance issues to the CCO. Newedge 
argued that thousands of Federal, SRO, and internal rules apply, so 
the report should contain a summation of compliance, with details 
only for areas of material noncompliance. FIA and SIFMA argued that 
a one-size-fits-all approach to the annual report requirements is 
not appropriate because registrants vary in size and focus. FIA, 
SIFMA, and The Working Group recommended that the Commission specify 
the material issues that should be discussed, or provide a standard 
form. FIA, SIFMA, and NFA also argued that the report should 
identify the policies that are reasonably designed to result in 
compliance, not that ensure compliance. Hess recommended that the 
annual report contain only a summary of the registrant's compliance 
policies and procedures. CMC commented that the scope of activities 
included in the annual report should be limited to those directly 
triggering the requirement of a CCO. EEI argued that inclusion of 
descriptions of violations in the report should be decided on a 
case-by-case basis by the registrant's governing body. NFA requested 
that a materiality qualifier be added to the requirement that 
registrants include a description of non-compliance. FIA and SIFMA 
argued that the CCO is not in a position to describe the financial, 
material, operational, and staffing resources set aside for 
compliance, rather the CCO only should be required to describe the 
resources of the compliance department and any recommendations that 
the CCO has made to senior management with regard to the same. FIA 
and SIFMA argued that the Sarbanes-Oxley Act already requires public 
companies to report the roles and responsibilities of its board, 
senior officers, and committees in resolving conflicts of interest, 
so the Commission should allow such reporting to satisfy this 
content requirement for the annual report. NFA also recommended that 
the reporting of any necessary coordination with, or notification of 
other entities, including regulators, should be deleted. NFA, FIA, 
and SIFMA recommended that the certification of compliance with 
sections 619 and 716 of the Dodd-Frank Act be deleted, arguing that 
the Commission should wait for the implementing rulemakings for such 
sections before determining certification requirements.

---------------------------------------------------------------------------

[[Page 20191]]

    <bullet> Concern that the annual report is not subject to board 
approval or a board addendum noting any disagreement with the report; 
\175\
---------------------------------------------------------------------------

    \175\ Better Markets recommended that the board approve the 
annual report in its entirety or specify where and why it disagrees 
with any provision, and then CCOs should provide the report to the 
Commission either as approved or with statements of disagreement.
---------------------------------------------------------------------------

    <bullet> Concern that some requirements for the content of the 
annual report are inappropriate for a document that may be publicly 
available; \176\ and
---------------------------------------------------------------------------

    \176\ The Working Group argued that a description of 
deficiencies in resources dedicated to compliance would require a 
CCO to identify potential shortcomings and report them in a document 
likely to be available to the public, which could materially hinder 
the CCO's ability to function as an integral member of the 
management team.
---------------------------------------------------------------------------

    <bullet> Concern that, absent a materiality qualifier, the 
recordkeeping obligations will be unduly burdensome.\177\
---------------------------------------------------------------------------

    \177\ The Working Group argued that retaining all materials 
relating to the preparation of the report will cause the CCO to 
retain all materials for fear of an audit that second-guesses the 
CCO's materiality judgments, or the CCO will limit his or her 
inquiries to avoid making a determination of materiality. The 
Working Group recommended that materials to be retained should be 
only those germane to the content of the compliance report.
---------------------------------------------------------------------------

    In response to comments, the Commission has reduced the cost burden 
of the annual report by modifying the rule as follows: (1) Requiring a 
description of the registrant's policies and procedures, rather than a 
description of the compliance of the registrant; (2) requiring 
identification of the registrant's policies and procedures that ``are 
reasonably designed'' to ensure compliance, rather than those that 
ensure compliance; (3) including a required description of material 
non-compliance issues; (4) including a materiality standard with 
respect to the description of any deficiency in compliance resources; 
(5) deleting the proposed delineation of the roles and responsibilities 
of a registrant's board of directors or senior officer, relevant board 
committees, and staff in addressing any conflicts of interest; and (6) 
removing the requirement to certify compliance with sections 619 and 
716. The Commission has not modified the recordkeeping requirement 
because it believes the rule sufficiently qualifies the materials that 
must be retained by stating that the records must be ``relevant'' to 
the annual report.
    The Commission observes that section 4s(k) of the CEA requires the 
annual report and specifies that it contain a description of the 
compliance of the SD or MSP with respect to the CEA, and a description 
of each policy and procedure of the SD or MSP of the CCO (including the 
code of ethics and conflict-of-interest policies). To the extent that 
the rule also requires these descriptions, the Commission believes that 
the costs of these requirements are attributable to statutory 
requirements not subject to Commission discretion. The Commission's 
decision to extend the same requirements to CCOs for FCMs is explained 
in detail above. Therefore, the Commission believes the modified rule 
would impose modest costs, attributable to the narrow requirements of: 
(i) Listing any material changes to compliance policies and procedures; 
and (ii) describing the financial, managerial, operational, and 
staffing resources set aside for compliance, including any material 
deficiencies. The Commission believes the benefits of these 
requirements warrant the limited incremental costs to comply.
Costs
    Section 4s(k) requires SDs and MSPs to designate a CCO and 
undertake certain other compliance measures. The costs and benefits 
that necessarily result from these basic statutory requirements are 
considered to be the ``baseline'' against which the costs and benefits 
of the Commission's final rules are compared or measured. The 
``baseline'' level of costs includes the costs that result from the 
following activities required by the statute:
    <bullet> Designating a CCO;
    <bullet> Corporate governance changes to require the CCO to report 
directly to the board or senior officer;
    <bullet> Reviewing the compliance of the SD and MSP with section 4s 
of the CEA;
    <bullet> Requiring the CCO, in consultation with the board or the 
senior officer, to resolve any conflicts of interest;
    <bullet> Administration of each policy and procedure required to be 
established under section 4s;
    <bullet> Ensuring compliance with the CEA and Commission 
regulations relating to swaps;
    <bullet> Establishing procedures for the handling, management 
response, remediation, retesting, and closing of non-compliance issues;
    <bullet> Preparing and signing a compliance report containing a 
description of compliance and a description of each policy and 
procedure of the SD or MSP; and
    <bullet> Furnishing the annual report to the Commission along with 
each appropriate financial report.
    Similarly Section 4d(d) defines a statutory ``baseline'' against 
which the costs and benefits of the Commission's final rules are to be 
measures with respect to FCMs. That ``baseline'' cost level is defined 
by those costs that result from an FCM's CCO designation.
    Compliance with the statutory baselines alone will result in costs 
for FCMs, SDs and MSPs. For example, designating a CCO that reports to 
the board or senior officer could include the cost of board action and 
the salary of the CCO. Similarly, preparing and signing a compliance 
report containing a description of compliance and each compliance 
policy and procedure entails the cost of the CCO's time.
    Congress mandated that the Commission adopt rules to implement each 
of the statutory provisions. The following implementation decisions may 
cause affected entities to incur costs to comply with the final 
regulations regarding designation of a CCO, the duties of the CCO, and 
the annual report:
    <bullet> Extending the statutory and rule requirements applicable 
to SDs and MSPs to FCMs;
    <bullet> Providing the CCO with authority to develop, in 
consultation with the board

[[Page 20192]]

or senior officer, appropriate policies and procedures;
    <bullet> Requiring the board or senior officer to appoint the CCO, 
approve the CCO's compensation, and meet with the CCO once a year;
    <bullet> Requiring designation of a CCO with the background and 
skills appropriate for fulfilling the responsibilities of the position 
and that is not statutorily disqualified;
    <bullet> Submission of a Form 8-R to the Commission for the CCO as 
a principal of the firm;
    <bullet> Listing any material changes to compliance policies and 
procedures in the annual report; and
    <bullet> Describing the financial, managerial, operational, and 
staffing resources set aside for compliance, including any material 
deficiencies, in the annual report.
    As discussed, the Commission has attempted, wherever possible, to 
alleviate burdens for registrants while remaining consistent with the 
CEA. The Commission has taken steps to reduce the responsibilities of 
the CCO and lower staffing and corporate governance costs for the 
entity by permitting the CCO to perform other duties and act as the CCO 
for more than one entity. The Commission has removed the requirement 
that the CCO be provided with the authority to enforce compliance 
policies and procedures, limited the CCO's duties to those directly 
required by the CEA and Commission regulations relating only to the 
swaps activities of SDs and MSPs and the derivatives activities 
included in the definition of FCM under section 1(a)(28) of the CEA, 
and required the CCO be responsible for administering, not 
establishing, compliance policies. The Commission also is permitting 
either the CCO or the CEO to certify the annual report.
    The Commission estimates a base salary for a Chief Compliance 
Officer in the financial services industry at approximately $216,000 
per year, as explained above. Because entities may designate a current 
employee as the CCO, some SDs, MSPs, or FCMs may not need to hire an 
additional member of staff. For example, entities currently regulated 
by prudential authorities already may have a CCO or another employee 
who could serve as a CCO; other entities may determine it is more cost-
effective based on their current business models to designate a current 
employee as CCO, perhaps adjusting that individual's salary 
accordingly. Because of the wide variety of possibilities in 
determining the compensation of a CCO, the Commission finds it is 
impossible to estimate a cost burden for the industry of the statutory 
requirement to designate a CCO.
    One commenter presented a report prepared by NERA stating that 
designation of a CCO and preparation of an annual compliance report by 
certain entities would entail average incremental start-up costs of 
$445,000 and average incremental ongoing annual costs of $760,000.\178\ 
The Commission observes that the incremental average costs provided by 
NERA do not differentiate between the costs of compliance with proposed 
Sec.  3.3 and the costs of compliance with sections 4d(d) and 4s(k) of 
the CEA absent Commission rulemaking. Accordingly, the Commission 
believes that the cost estimates presented by NERA exceed the 
incremental costs attributable to Commission rulemaking. The NERA 
report, however, provides insufficient information to allow the 
Commission to assess the magnitude of the excess.
---------------------------------------------------------------------------

    \178\ NERA, Cost-Benefit Analysis of the CFTC's Proposed Swap 
Dealer Definition Prepared for the Working Group of Commercial 
Energy Firms, December 20, 2011. In this late-filed comment 
supplement, NERA concludes that cost-benefit considerations compel 
excluding entities ``engaged in production, physical distribution or 
marketing of natural gas, power, or oil that also engage in active 
trading of energy derivatives''--termed ``nonfinancial energy 
companies'' in the report--from regulation as swap dealers, 
including Sec.  3.3.
---------------------------------------------------------------------------

    Other than as indicated below with respect to CCO compensation and 
costs resulting from collections of information subject to the 
Paperwork Reduction Act, incorporated by reference herein, the 
Commission has no reliable quantitative data from which to reasonably 
estimate the costs of compliance associated with the CCO's duties and 
the annual report required by the rules in this release. After 
conducting a review of applicable academic literature, the Commission 
is not aware of any research reports or studies that are directly 
relevant to its considerations of costs and benefits of the final 
rules. The Commission anticipates that many entities may currently have 
a CCO pursuant to other regulations. The Commission notes that dually 
registered FCMs and BDs are more likely to have a CCO \179\ than 
entities that are subject to such requirement for the first time.\180\ 
Costs, therefore, are expected to be higher for those entities not 
currently dually registered. Registrants that do not currently have a 
CCO or a compliance program may choose to develop a program in-house if 
their activities are limited and the regulatory requirements well-
understood. Other registrants may choose to purchase an off-the-shelf 
compliance manual and adjust it to correspond to their regulatory 
requirements. Still others may hire a third-party compliance firm, a 
law firm, or an accounting firm to draft a firm-specific manual. As of 
2003, when the SEC published final compliance program rules for 
investment companies and investment advisers, the costs for these 
options ranged from $1,000 to $200,000.\181\
---------------------------------------------------------------------------

    \179\ In this respect, the Commission observes that 55% of 
current FCMs are also registered as BDs with the SEC, and thus may 
already have a CCO as required under the rules of FINRA. See letter 
from NFA, dated Jan. 18, 2011 (comment file for 75 FR 70881 
(Designation of a Chief Compliance Officer; Required Compliance 
Polices; and Annual Report of a FCM, SD, or MSP)).
    \180\ The Commission notes that in 2006 the UK FSA conducted a 
cost benefit analysis when promulgating requirements related to 
ensuring effective compliance with the applicable regulatory 
framework, including a requirement that a compliance officer be 
appointed that reports to the governing body and has the necessary 
authority and responsibility for the compliance oversight function. 
The UK FSA was adopting rules that replaced existing guidance and 
concluded from survey results that the incremental aggregate cost of 
compliance for approximately 2000-2500 firms was [pound]4.5 to 5.5 
million in one-off costs ($7.1 to 8.6 million at the current 
exchange rate, or $3,550 to $4,300 per firm) and [pound]6.5 to 8.5 
million in ongoing costs ($10.1 to 13.3 million at the current 
exchange rate, or $5,050 to $6,650 per firm). See FSA Consultation 
Paper 06/9, Organisational Systems and Controls: Common Platform for 
Firms, Annex 2 (May 2006).
    \181\ See Compliance Programs of Investment Companies and 
Investment Advisers, 68 FR 74714 (Dec. 24, 2003). The Commission 
notes that significant differences in the activities and structures 
of investment advisors and SDs/MSPs/FCMs may create significant 
differences in the costs incurred by the respective entities; these 
SEC estimates provide at best an imperfect measure from which to 
very roughly attempt to gauge compliance costs for affected 
entities.
---------------------------------------------------------------------------

    Certain of the costs associated with these CCO, compliance policy, 
and annual report rules result from collections of information subject 
to the Paperwork Reduction Act. Costs attributable to collections of 
information subject to the PRA are discussed further in section V.B.3. 
below. The Commission has also considered these costs, which it 
incorporates by reference herein, in its section 15(a) analysis.
Benefits
    The Commission believes that the CCO rules will protect market 
participants and the public by promoting compliance with the CEA and 
Commission regulations through (1) the designation and effective 
functioning of the CCO, and (2) the establishment of a framework for 
preparation of a meaningful annual review of an FCM's, SD's, and MSP's 
compliance program. As a qualified, impartial, accountable focal point, 
the CCO is an effective vehicle to ensure that vital market actors--
SDs, MSPs, and FCMs--comply with the law and

[[Page 20193]]

regulations, including those designed to contain systemic risk through 
appropriate risk management efforts. In this way, these rules foster 
financial integrity and responsible risk management practices to 
protect the public from the adverse consequences of FCM, SD, or MSP 
failure or misfeasance that an effective compliance program may help to 
prevent.
    The annual compliance report will help FCMs, SDs, MSPs, and the 
Commission to assess whether the registrant has mechanisms in place to 
address adequately compliance problems that could lead to a failure of 
the registrant. It also will assist the Commission in determining 
whether the registrant remains in compliance with the CEA and the 
Commission's regulations, including the customer protection regime for 
segregation of customer funds, supervision of trading activities, and 
risk management. Such compliance will protect market participants and 
the public from market disruptions and financial losses resulting from 
the failure or misfeasance of a registrant.
Section 15(a) Determination
1. Protection of Market Participants and the Public
    The Commission believes that the compliance measures specified in 
these rules reinforce the CEA's protections for swap market 
participants, futures markets participants, and the public. Just as the 
CEA's regulation of futures and swaps transactions promotes the 
``national public interest by providing a means for managing and 
assuming price risks, discovering prices, or disseminating pricing 
information through trading in liquid, fair, and financially secure 
trading facilities'' \182\ so do these rules by ensuring, through a 
CCO, that entities are in compliance with CEA regulations. 
Concentrating compliance responsibility in one individual with 
independent authority, rather than dispersing it throughout an 
organization (and thus potentially diminishing accountability), is one 
example of this. Compliance evaluation and preparation of an annual 
report are other examples. Thus, taken together, these requirements set 
out a compliance regime that endeavors to ensure protection for market 
participants and public that the CEA is intended to provide. Moreover, 
to the extent that provisions of the CEA diminish the potential for 
harmful market disruptions and attendant financial losses to market 
participants and the general public as Congress intended in enacting 
the Dodd-Frank Act, these rules enhance that protection.
---------------------------------------------------------------------------

    \182\ Section 3(a) of the CEA.
---------------------------------------------------------------------------

    While the Commission recognizes there are costs associated with 
this rulemaking and the mandate from Congress it represents, the 
Commission believes that, as discussed above, it has included measures 
to afford firms flexibility in the designation of a CCO, as well as 
other made other burden-reducing changes to the proposed rules. It 
believes these measures minimize the costs attributable to 
implementation decisions within its statutory authority. The Commission 
does not believe that any such incremental costs undermine effective 
protection of market participants and the public, but rather will be a 
worthwhile investment toward enhancing that protection.
2. Efficiency, Competitiveness, and Financial Integrity of Markets 
<SUP>183</SUP>
    Secure and stable SDs, MSPs, and FCMs are critical components of 
the efficient, competitive, and financially sound functioning of 
derivatives markets--futures and swaps. The financial integrity of 
these markets, in particular, is achieved through layers of protection. 
Requirements for an effective FCM, SD, and MSP compliance program will 
add a new layer of protection to ensure that registrants remain 
compliant with the CEA and Commission regulations, and in particular 
those relating to risk management, diligent supervision, and system 
safeguards.
---------------------------------------------------------------------------

    \183\ Although by its terms CEA section 15(a)(2)(B) applies to 
futures markets only, the Commission finds this factor useful in 
analyzing regulations pertaining to swaps markets as well.
---------------------------------------------------------------------------

    An effective CCO will provide benefits to FCMs, SDs, and MSPs and 
the markets they serve by implementing and overseeing compliance 
measures that enhance the safety and efficiency of registrants and 
reduce systemic risk. Reliable and financially sound FCMs, SDs, and 
MSPs are essential for the stability of the derivatives markets they 
serve, and for the greater public, which benefits from a sound 
financial system.
    The Commission believes that to the extent there are any 
incremental costs associated with these rules attributable to the 
implementation decisions within its statutory authority, they are 
competitively neutral. They do not favor or disfavor any class of 
market participant over others. In other words, no entity should have a 
greater advantage over another based on these rules alone.
3. Price Discovery
    The Commission has identified no likely material impact on price 
discovery from the costs and benefits of these rules pertaining to CCO 
designation and related compliance requirements.
4. Sound Risk Management
    The Commission believes these rules promote sound risk management. 
The regulatory provisions that interpret or implement the statutory 
requirements for the CCO and annual report serve to reinforce and 
ensure the effectiveness of FCM, SD, and MSP compliance programs, 
including their risk management components. Compliance with Sec.  
23.600 (risk management program) and related regulations encompasses, 
among other things, policies and procedures for monitoring and managing 
of credit exposures to counterparties, market risk, liquidity risk, 
settlement risk, and other applicable risk exposures. Compliance with 
Sec.  1.14 (risk assessment recordkeeping requirements for FCMs) and 
related regulations encompasses, among other things, policies and 
procedures for monitoring and managing of credit risk, market risk, and 
other applicable risk exposures. The CCO has responsibility to ensure 
that the FCM, SD, or MSP is compliant with these regulations. Costs 
attendant to satisfying CCO and annual report requirements in these 
rules represent an investment towards improved risk management, not a 
diminution from them.
5. Other Public Interest Considerations
    The Commission does not believe that the rule will have a material 
effect on public interest considerations other than those identified 
above.

H. Conclusion

    Having considered the costs and benefits of the final rules in 
light of the factors enumerated in section 15(a)(2) of the CEA, the 
Commission is adopting the rules as set forth in this release.

V. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) \184\ requires that agencies 
consider whether the rules they propose will have a significant 
economic impact on a substantial number of small entities and if so, 
provide a regulatory flexibility analysis respecting the impact. The 
Commission has already established certain definitions of ``small 
entities'' to

[[Page 20194]]

be used in evaluating the impact of its rules on such small entities in 
accordance with the RFA.\185\ SDs and MSPs are new categories of 
registrant. Accordingly, the Commission noted in the proposals that it 
had not previously addressed the question of whether such persons were, 
in fact, small entities for purposes of the RFA.
---------------------------------------------------------------------------

    \184\ 5 U.S.C. 601 et seq.
    \185\ 47 FR 18618 (Apr. 30, 1982).
---------------------------------------------------------------------------

    In this regard, the Commission explained that it previously had 
determined that FCMs should not be considered to be small entities for 
purposes of the RFA, based, in part, upon FCMs' obligation to meet the 
minimum financial requirements established by the Commission to enhance 
the protection of customers' segregated funds and protect the financial 
condition of FCMs generally. Like FCMs, SDs will be subject to minimum 
capital and margin requirements, and are expected to comprise the 
largest global financial firms--and the Commission is required to 
exempt from designation as an SD entities that engage in a de minimis 
level of swaps dealing in connection with transactions with or on 
behalf of customers. Accordingly, for purposes of the RFA for the 
proposals and future rulemakings, the Commission proposed that SDs not 
be considered ``small entities'' for essentially the same reasons that 
it had previously determined FCMs not to be small entities.
    The Commission further explained that it had also previously 
determined that large traders are not ``small entities'' for RFA 
purposes, with the Commission considering the size of a trader's 
position to be the only appropriate test for the purpose of large 
trader reporting. The Commission then noted that MSPs maintain 
substantial positions in swaps, creating substantial counterparty 
exposure that could have serious adverse effects on the financial 
stability of the United States banking system or financial markets. 
Accordingly, for purposes of the RFA for the proposals and future 
rulemakings, the Commission proposed that MSPs not be considered 
``small entities'' for essentially the same reasons that it previously 
had determined large traders not to be small entities.
    The Commission concluded its RFA analysis applicable to SDs and 
MSPs as follows: ``The Commission is carrying out Congressional 
mandates by proposing these rules. The Commission is incorporating 
registration of SDs and MSPs into the existing registration structure 
applicable to other registrants. In so doing, the Commission has 
attempted to accomplish registration of SDs and MSPs in the manner that 
is least disruptive to ongoing business and most efficient and 
expeditious, consistent with the public interest, and accordingly 
believes that these registration rules will not present a significant 
economic burden on any entity subject thereto.''
    The Commission did not receive any comments on its analysis of the 
application of the RFA to SDs and MSPs.
    The final rules will also impact FCMs and IBs, each of which is 
addressed separately in the following paragraphs.
    In its proposals, the Commission explained that it had previously 
established certain definitions of ``small entities'' to be used in 
evaluating the impact of the Commission's rules on such small entities 
in accordance with the RFA. In the Commission's ``Policy Statement and 
Establishment of Definitions of `Small Entities' for Purposes of the 
Regulatory Flexibility Act,'' \186\ the Commission concluded that 
registered FCMs should not be considered to be small entities for 
purposes of the RFA. The Commission's determination in this regard was 
based, in part, upon the obligation of registered FCMs to meet the 
capital requirements established by the Commission. Likewise, the 
Commission determined ``that, for the basic purpose of protection of 
the financial integrity of futures trading, Commission regulations can 
make no size distinction among registered FCMs.'' \187\ Thus, with 
respect to registered FCMs, the Commission believes that the proposed 
regulations will not have a significant economic impact on a 
substantial number of small entities.
---------------------------------------------------------------------------

    \186\ 47 FR 18618, Apr. 30, 1982.
    \187\ Id. at 18619.
---------------------------------------------------------------------------

    The Commission previously has determined that, for purposes of the 
RFA, the Commission should ``evaluate within the context of a 
particular rule proposal whether all or some [IBs] should be considered 
to be small entities and, if so, to analyze the economic impact on 
[IBs] of any such rule at that time. Specifically, the Commission 
recognizes that the [IB] definition, even as narrowed to exclude 
certain persons, undoubtedly encompasses many business enterprises of 
variable size.'' \188\ At present, IBs are subject to various existing 
rules that govern and impose minimum requirements on their internal 
compliance operations, based on the nature of their business. The 
Commission believes that the amendments will merely augment the 
existing compliance requirements of such persons to address potential 
conflicts of interest within such firms. To the extent that certain IBs 
may be considered to be small entities, the Commission believes that 
the final rules will not have a significant economic impact.
---------------------------------------------------------------------------

    \188\ 48 FR 35248, 35276, Aug. 3, 1983.
---------------------------------------------------------------------------

    The Commission did not receive any comments on its analysis of the 
application of the RFA to FCMs and IBs.
    Accordingly, pursuant to Section 605(b) of the RFA, 5 U.S.C. 
605(b), the Chairman, on behalf of the Commission, certifies that these 
rules and rule amendments will not have a significant economic impact 
on a substantial number of small entities.

B. Paperwork Reduction Act

    The Commission may not conduct or sponsor, and a registrant is not 
required to respond to, a collection of information unless it displays 
a currently valid Office of Management and Budget (OMB) control number. 
The Commission's adoption of Sec. Sec.  23.200 through 23.205 
(Reporting, Recordkeeping, and Daily Trading Records), 23.600 (Risk 
Management Program), 23.601 (Monitoring of Position Limits), 23.602 
(Diligent Supervision), 23.603 (Business Continuity and Disaster 
Recovery), 23.605 (Conflicts of Interest Policies and Procedures for 
SDs and MSPs), 23.606 (General Information: Availability for Disclosure 
and Inspection), 23.607 (Antitrust Considerations), 3.3 (Chief 
Compliance Officer), and 1.71 (Conflicts of Interest Policies and 
Procedures for FCMs and IBs) impose new information collection 
requirements on registrants within the meaning of the Paperwork 
Reduction Act.\189\
---------------------------------------------------------------------------

    \189\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

    Accordingly, the Commission requested and OMB assigned control 
numbers for the required collections of information. The Commission has 
submitted this notice of final rulemaking along with supporting 
documentation for OMB's review in accordance with 44 U.S.C. 3507(d) and 
5 CFR 1320.11. The title for these collections of information are 
``Reporting, Recordkeeping, and Daily Trading Records Requirements for 
Swap Dealers and Major Swap Participants, OMB control number 3038-
0087,'' ``Regulations Establishing and Governing the Duties of Swap 
Dealers and Major Swap Participants, OMB control number 3038-0084,'' 
``Conflicts of Interest Policies and Procedures by Swap Dealers and 
Major Swap

[[Page 20195]]

Participants, OMB control number 3038-0079,'' ``Annual Report for Chief 
Compliance Officer of Registrants, OMB control number 3038-0080,'' and 
``Conflicts of Interest Policies and Procedures by Futures Commission 
Merchants and Introducing Brokers, OMB control number 3038-0078.'' 
\190\ Many of the responses to this new collection of information are 
mandatory.
---------------------------------------------------------------------------

    \190\ These collections include certain collections required 
under the Business Conduct Standards with Counterparties rulemaking, 
as stated in that rulemaking. See Business Conduct Standards for 
Swap Dealers and Major Swap Participants with Counterparties, 77 FR 
9734 (Feb. 17, 2012).
---------------------------------------------------------------------------

    The Commission protects proprietary information according to the 
Freedom of Information Act and 17 CFR part 145, ``Commission Records 
and Information.'' In addition, Section 8(a)(1) of the CEA strictly 
prohibits the Commission, unless specifically authorized by the Act, 
from making public ``data and information that would separately 
disclose the business transactions or market positions of any person 
and trade secrets or names of customers.'' The Commission also is 
required to protect certain information contained in a government 
system of records according to the Privacy Act of 1974, 5 U.S.C. 552a.
    The regulations require each respondent to furnish certain 
information to the Commission and to maintain certain records.\191\ The 
Commission invited the public and other Federal agencies to comment on 
any aspect of the information collection requirements discussed in the 
Recordkeeping NPRM, the Duties NPRM, the CCO NPRM, the SD/MSP Conflicts 
NPRM, and the FCM/IB Conflicts NPRM. Pursuant to 44 U.S.C. 
3506(c)(2)(B), the Commission solicited comments in order to: (i) 
Evaluate whether the proposed collections of information were necessary 
for the proper performance of the functions of the Commission, 
including whether the information will have practical utility; (ii) 
evaluate the accuracy of the Commission's estimates of the burden of 
the proposed collections of information; (iii) determine whether there 
are ways to enhance the quality, utility, and clarity of the 
information to be collected; and (iv) minimize the burden of the 
collections of information on those who are to respond, including 
through the use of automated collection techniques or other forms of 
information technology.
---------------------------------------------------------------------------

    \191\ See 75 FR at 76674 (maintain transaction and position 
records of swaps, including daily trading records of swaps and 
related cash and forward transactions; business records; records of 
data and information reported to SDRs and for real time public 
reporting purposes).
    See 75 FR at 71404 (establish a risk management program, 
including specific policies for compliance with position limits and 
to ensure business continuity and disaster recovery; policies to 
prevent unreasonable restraints of trade and anticompetitive 
burdens; establish systems to diligently supervise the activities 
relating to its business; and make certain information available for 
disclosure and inspection by the Commission).
    See 75 FR at 71395 (adopt conflicts of interest policies and 
procedures; recordkeeping obligations related to implementation of 
policies and procedures designed to ensure compliance with 
Commission regulations; document certain communications between non-
research and research personnel; record of the basis for 
determination of research personnel compensation; provision of 
certain disclosures to recipients of research reports).
    See 76 FR at 70887 (prepare a Form 8-R designating a CCO; draft 
and maintain certain compliance policies and procedures; annually 
prepare and furnish to the Commission an annual report describing 
the registrant's compliance policies and resources and compliance 
with the CEA and Commission regulations; amend previously furnished 
annual reports, if necessary; and maintain records related to 
compliance policies and annual reports).
    See 75 FR at 70157 (adopt conflicts of interest policies and 
procedures; recordkeeping obligations related to implementation of 
policies and procedures designed to ensure compliance with 
Commission regulations; document certain communications between non-
research and research personnel; record of the basis for 
determination of research personnel compensation; provision of 
certain disclosures to recipients of research reports).
---------------------------------------------------------------------------

    It is not currently known how many SDs and MSPs will become subject 
to these rules, and this will not be known to the Commission until the 
registration requirements for these entities become effective. In its 
rule proposals, the Commission took ``a conservative approach'' to 
calculating the burden hours of this information collection by 
estimating that as many as 300 SDs and MSPs would register.\192\ Since 
publication of the proposals in late 2010, the Commission has met with 
industry participants and trade groups, discussed extensively the 
universe of potential registrants with NFA, and reviewed public 
information about SDs active in the market and certain trade groups. 
Over time, and as the Commission has gathered more information on the 
swaps market and its participants, the estimate of the number of SDs 
and MSPs has decreased. In its FY 2012 budget drafted in February 2011, 
the Commission estimated that 140 SDs might register with the 
Commission.\193\ After recently receiving additional specific 
information from NFA on the regulatory program it is developing for SDs 
and MSPs,\194\ however, the Commission believes that approximately 125 
SDs and MSPs, including only a handful of MSPs, will register. While 
the Commission originally estimated there might be approximately 300 
SDs and MSPs, based on new estimates provided by NFA, the Commission 
now estimates that there will be a combined number of 125 SDs and MSPs 
that will be subject to new information collection requirements under 
these rules.\195\
---------------------------------------------------------------------------

    \192\ 75 FR at 76671, 75 FR at 71402, 75 FR at 71394, and 75 FR 
70885.
    \193\ CFTC, President's Budget and Performance Plan Fiscal Year 
2010, p. 13-14 (Feb. 2011), available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/cftcbudget2012.pdf. The 
estimated 140 SDs includes ``[a]pproximately 80 global and regional 
banks currently known to offer swaps in the United States;'' 
``[a]pproximately 40 non-bank swap dealers currently offering 
commodity and other swaps;'' and ``[a]pproximately 20 new potential 
market makers that wish to become swap dealers.'' Id.
    \194\ Letter from Thomas W. Sexton, Senior Vice President and 
General Counsel, NFA to Gary Barnett, Director, Division of Swap 
Dealer and Intermediary Oversight, CFTC (Oct. 20, 2011) (NFA Cost 
Estimates Letter).
    \195\ NFA Letter (Oct. 20, 2011) (estimating that there will be 
125 SDs and MSPs required to register with NFA).
---------------------------------------------------------------------------

    For purposes of the PRA, the term ``burden'' means the ``time, 
effort, or financial resources expended by persons to generate, 
maintain, or provide information to or for a Federal Agency.''
    In each of the NPRMs the Commission estimated the cost burden of 
the proposed regulations based upon an average salary of $100 per hour. 
In response to this estimate, The Working Group commented that, 
inclusive of benefit costs and allocated overhead, the per hour average 
salary estimate for compliance and risk management personnel should be 
significantly higher than $120. FIA and SIFMA stated that some of the 
compliance policies required by the proposed regulations will be 
drafted by both in-house lawyers and outside counsel, so the blended 
hourly rate should be roughly $400.
    The Commission notes that its estimate of $100 per hour was based 
on recent Bureau of Labor Statistics findings, including the mean 
hourly wage of an employee under occupation code 23-1011, ``Lawyers,'' 
that is employed by the ``Securities and Commodity Contracts 
Intermediation and Brokerage Industry,'' which is $82.22. The mean 
hourly wage of an employee under occupation code 11-3031, ``Financial 
Managers,'' (which includes operations managers) in the same industry 
is $74.41.\196\ Taking these data, the Commission then increased its 
hourly wage estimate in recognition of the fact that some registrants 
may be large financial institutions whose employees' salaries may 
exceed the mean wage. The Commission also observes that SIFMA's 
``Report on

[[Page 20196]]

Management & Professional Earnings in the Securities Industry--2010'' 
estimates the average wage of a compliance attorney and a compliance 
staffer in the U.S. at only $46.31 per hour.
---------------------------------------------------------------------------

    \196\ See http://www.bls.gov/oes/2099/mayowe23.1011.htm and 
http://www.bls.gov/oes/current/oes113031.htm.
---------------------------------------------------------------------------

    The Commission recognizes that some registrants may hire outside 
counsel with expertise in the various regulatory areas covered by the 
regulations discussed herein. While the Commission is uncertain about 
the billing rates that registrants may pay for outside counsel, the 
Commission believes that such counsel may bill at a rate of several 
hundred dollars per hour. Outside counsel may be able to leverage its 
expertise to reduce substantially the number of hours needed to fulfill 
a requested assignment, but a registrant that uses outside counsel may 
incur higher costs than a registrant that does not use outside counsel. 
Any determination to use outside counsel is at the discretion of the 
registrant. Having considered the comments received and having reviewed 
the available data, the Commission has determined that $100 per hour 
remains a reasonable estimate of the per hour average salary for 
purposes of its PRA analysis. The Commission also notes that this 
determination is consistent with the Commission's estimate for the 
hourly wage for CCOs under the recently adopted DCO final rules.\197\
---------------------------------------------------------------------------

    \197\ See Derivatives Clearing Organization General Provisions 
and Core Principals, 76 FR at 69428.
---------------------------------------------------------------------------

    The Commission received comments related to the PRA for three of 
its notices of proposed rulemaking: Recordkeeping, Duties, and CCO. No 
comments were received with regard to the two Conflicts proposals.
1. Recordkeeping NPRM
    With respect to the voice recording requirements of the 
Recordkeeping NPRM, as explained in more detail above, ATA commented 
that telephone recording systems that are compliant with all of these 
requirements would impose a significant additional cost to dealers. The 
Working Group commented that the long-term electronic storage of 
significant amounts of pre-execution communications will prove costly 
over the proposed five-year period. The Working Group also commented 
that requiring records of physical positions linked with related swap 
transactions would impose very expensive and burdensome requirements on 
millions of physical transactions that are undertaken by commercial 
energy firms that are also parties to swap transactions.
    With respect to the record retention requirements in the 
Recordkeeping NPRM, MFA commented that maintaining records of 
transactions for 5 years following the termination, expiration, or 
maturity of the transactions would constitute an additional 
administrative burden and entail substantial additional cost. ISDA & 
SIFMA also believe that recordkeeping of all oral and written 
communications that may lead to execution of a swap for the life of a 
swap plus five years could impose a heavy cost burden to implement and 
maintain, for only a small incremental benefit and would be more 
supportive of a voice recording obligation to retain recordings for a 
minimum period of six months. The Commission notes that it is modifying 
the retention period for voice recordings to one year, which should 
minimize the burden on SDs and MSPs.
    Notably, none of these commenters suggested specific revised 
calculations with regard to the Commission's burden estimate. 
Accordingly, the only change that the Commission is making to its 
estimation of burdens associated with its Recordkeeping rules is the 
change to reflect the new estimate of the number of SDs and MSPs. The 
Commission now estimates the burden to be 2096 hours, at an annual cost 
of $209,600 [2096 x $100 per hour] for each SD and MSP, and the 
aggregate hour burden cost for all registrants is 262,000 burden hours 
and $26,200,000 [262,000 x $100 per hour].
    In addition to the per hour burden discussed above, the Commission 
anticipated that SDs and MSPs may incur certain start-up costs in 
connection with the proposed recordkeeping obligations. Such costs 
would include the expenditures related to developing and installing new 
technology or reprogramming or updating existing recordkeeping 
technology and systems to enable the SD or MSP to collect, capture, 
process, maintain, and re-produce any newly required records. Based on 
comments received regarding system installation or upgrades that may be 
needed to meet the requirements of the rules, the Commission is 
doubling its estimate of programming burden hours associated with 
technology improvements to be 320 hours, rather than 160 hours.
    The Commission received no comments with respect to its programming 
wage estimate of $60 per hour. Accordingly, the Commission has revised 
only the estimate of the start-up burden associated with the required 
technological improvements with respect to the number of burden hours. 
The Commission estimates that the start-up burden would be $19,200 [$60 
x 320 hours] per affected registrant or $2,400,000 in the aggregate for 
all registrants.
2. Duties NPRM
    The burden associated with regulations proposed in the Duties NPRM 
will result from the development of the required policies and 
procedures, satisfaction of various reporting obligations, and the 
documentation of required testing.
    The Working Group commented that the Commission's average personnel 
cost estimate of $20,450 per effected entity significantly understates 
the cost of compliance with the proposed rules for commercial firms 
that are deemed SDs or MSPs. Specifically, the Working Group stated 
that a commercial energy firm will require at least five new fulltime 
employees at 1,800 hours per year, not the 204.5 hours per year 
estimated by the Commission; and the Commission's analysis does not 
consider any necessary information technology expenditures or third-
party costs.
    The Working Group also commented that quarterly documentation of 
risk management testing should be 200 personnel-hours per quarter at a 
cost of $96,000 per year for each registrant, rather than 1 personnel-
hour per quarter at a cost of $400 per year as estimated by the 
Commission.
    With respect to the reporting requirements proposed in the Duties 
NPRM, The Working Group argued that Risk Exposure Reports should be 
provided to senior management and governing body annually, not 
quarterly because quarterly reporting would be too costly and 
burdensome.
    With respect to the documentation of testing requirements proposed 
in the Duties NPRM, The Working Group recommended that both the 
frequency and the scope of audits of the risk management program be 
left to the discretion of registrants in order to lessen the cost and 
administrative burden imposed by the proposed rules. Cargill 
recommended that testing of the risk management program be required 
annually rather than quarterly. Cargill stated that a quarterly 
requirement is excessive and unduly expensive. MetLife stated that 
monthly testing of position limit monitoring procedures and quarterly 
testing of the risk management program may be excessive, costly, and 
overly burdensome for some MSPs and that the frequency of testing 
should be determined by the MSP based on the extent of its swap 
activities.
    In the Duties NPRM, the burden per registrant was estimated to be 
204.5

[[Page 20197]]

hours per year, at an annual cost of $20,450. Based on comments 
received, as discussed above, the Commission is changing the required 
risk management testing from quarterly to annually. The Commission also 
is accepting The Working Group's contention that it will take more than 
160 hours annually to draft, file, and update the Risk Management 
Program materials, including the entity's position limit procedures and 
its business continuity and disaster recovery plan. While the 
Commission does not agree with the estimate that the new rules will 
require at least five new fulltime employees at 1,800 hours per year, 
the Commission accepts that on average it will take 900 hours to comply 
with the information collection required by these provisions. The 
Commission also agrees with The Working Group's revised estimation of 
200 hours for documentation of risk management testing and is 
increasing its estimate from four hours. Finally, the Commission is 
increasing its estimate of the burden hours associated with quarterly 
documentation of position limit compliance from two hours to 10 hours 
to account for the required testing. Accordingly, the Commission has 
revised its overall burden estimate to be 1148.5 hours per year per 
registrant, at an annual cost of $114,850. The aggregate cost for all 
registrants (with a revised estimate of 125 SDs and MSPs) is 143,562.5 
burden hours and $14,356,250 [143,562.5 x $100 per hour].
3. SD/MSP Conflicts NPRM and FCM/IB Conflicts NPRM
    The Commission received no comments related to its estimates of the 
information collection burden with respect to either the SD/MSP 
Conflicts NPRM or the FCM/IB Conflicts NPRM. Accordingly, the only 
change that the Commission is making to its estimation of burdens 
associated with its Conflicts rules is the change to reflect the new 
estimate of the number of SDs and MSPs. The Commission estimates the 
overall burden to be 44.5 hours per year per SD and MSP, at an annual 
cost of $4,450 [44.5 x $100 per hour], and the aggregate cost for all 
SDs and MSPs (with a revised estimate of 125 SDs and MSPs) is 5562.5 
burden hours and $556,250 [5562.5 x $100 per hour]. There are currently 
159 registered FCMs and 1,645 registered IBs that will be required to 
comply with the proposed conflicts of interest provisions (or a total 
of 1,804 registrants). The Commission estimates the burden to be 44.5 
hours, at an annual cost of $4,450 for each FCM and IB, and the 
aggregate cost for all FCMs and IBs is 80,278 burden hours and 
$8,027,800 [80,278 burden hours x $100 per hour].
4. CCO NPRM
    With respect to the annual compliance report requirement in the CCO 
NPRM, NSCP commented the level of detail required by the annual report 
would impose unnecessary burdens on the CCO with little offsetting 
benefits. NSCP argues that a better approach would be to require a 
review of the adequacy of policies and the effectiveness of their 
implementation. EEI commented that the annual report requirements would 
be so lengthy and detailed that the usefulness of the annual report 
would be greatly diminished. The Working Group recommended that the 
Commission provide a standardized form for the annual report because 
such would mutually benefit the Commission and registrants. The Working 
Group also believes the annual report as proposed would be 
unnecessarily exhaustive, and without a materiality limitation, the 
report would be of limited use to the Commission and costly for firms 
to produce. The Working Group also objected to the requirement that 
firms preserve all materials relating to the preparation of an annual 
report because such would not promote any compliance policy other than 
facilitating regulatory enforcement actions. The Working Group believes 
that the scope of provisions means that a firm will spend considerable 
resources to meet its obligations under the compliance report, and 
preparation of the report will be quite expensive because the scope of 
policies and procedures will be very broad. The Working Group estimates 
that the burden of preparing a report is, at a minimum, 160 hours, 4 
times the Commission's estimate.
    FIA and SIFMA provided the following revised cost assessment: Form 
8-R and related matters are 10 hours, not 1 hour; preparing, updating 
and maintaining policies and procedures is 1000 hours, not 80 hours; 
preparing the annual report is 500 hours not 40 hours; annually 
amending the annual report is 50 hours and not 5 hours; and 
recordkeeping is closer to 500 hours, not 10 hours. Therefore, FIA and 
SIFMA estimate that the total cost per registrant is closer to $800,000 
and the total to the industry is $350 million.
    Despite the fact that FIA and SIFMA did not provide an explanation 
for any of their revised burden estimates, the Commission is accepting 
their arguments, in part, and is revising its burden estimate to 
reflect some of their comments.
    The Commission is not modifying the amount of time required to 
prepare and file a Form 8-R designating the chief compliance officer. 
This form requests only the information necessary about the individual 
designated as CCO that is necessary for the Commission to appropriately 
exercise its statutory registration and compliance oversight functions. 
This information generally includes the name, addresses, location of 
records, regulatory and disciplinary histories, and other similarly 
straightforward matters--all of which should be in the possession of 
the applicant and readily available for the applicant to provide. Most 
notably, the PRA estimates provided for these forms are averages that 
do not necessarily reflect the actual time expended by each and every 
individual to complete the forms.
    The Commission is modifying its burden estimate for the amount of 
time it will take to draft and update compliance policies from 80 hours 
annually to 900 hours, which reflects half of a full-time employee's 
time. Additionally, the Commission is revising the burden estimate 
associated with preparing and furnishing to the Commission an annual 
report that describes the respondent's compliance policies and 
resources and the respondent's compliance with the CEA and Commission 
regulations. The Commission had estimated that it would take 40 hours 
per year. The revised estimate would double that number to 80 hours per 
year, which is in line with estimates made by the DCO final rulemaking. 
The Commission is maintaining its original estimate for the time 
required to amend a previously furnished annual report when material 
errors or omissions are identified at 5 hours annually, but the 
Commission is doubling the time estimate required to maintain records 
related to respondent's compliance policies and annual reports from 10 
hours to 20 hours. With regard to recordkeeping required under the CCO 
rules, the Commission notes that much of the burden associated with 
this requirement has been included in the overall recordkeeping 
estimates for SDs and MSPs, and in existing regulations for FCMs, all 
of which require general business records to be kept.
    There are 159 FCMs currently registered with the Commission and it 
is anticipated that there will be approximately 125 SDs and MSPs that 
will register with the Commission. Thus, the total number of 
respondents is expected to be 284. Based on comments received and the 
changes to the rules discussed above, the Commission has revised its 
estimate of the burden

[[Page 20198]]

associated with the regulations to be 1,006 hours, at a cost of 
$100,600 annually for each respondent. Based upon the above, the 
aggregate cost for all respondents is 285,704 burden hours [1,006 hours 
x 284 respondents] and $28,570,400 [285,704 burden hours x $100 per 
hour].

List of Subjects

17 CFR Part 1

    Brokers, Commodity futures, Conflicts of interest, Reporting and 
recordkeeping requirements.

17 CFR Part 3

    Administrative practice and procedure, Brokers, Commodity futures, 
Major swap participants, Reporting and recordkeeping requirements, Swap 
dealers.

17 CFR Part 23

    Antitrust, Commodity futures, Conduct standards, Conflict of 
Interests, Major swap participants, Reporting and recordkeeping, Swap 
dealers, Swaps.

    For the reasons stated in the preamble, the CFTC amends 17 CFR 
parts 1, 3, and 23 as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

0
1. The authority citation for part 1 is revised to read as follows:

    Authority:  7 U.S.C. 1a, 2, 2a, 5, 6, 6a, 6b, 6b-1, 6c, 6d, 6e, 
6f, 6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 
7b, 7b-3, 8, 9, 9a, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 18, 19, 
21, 23 and 24, as amended by Title VII of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 
(July 21, 2010).


0
2. Section 1.71 is added to read as follows:


Sec.  1.71  Conflicts of interest policies and procedures by futures 
commission merchants and introducing brokers.

    (a) Definitions. For purposes of this section, the following terms 
shall be defined as provided.
    (1) Affiliate. This term means, with respect to any person, a 
person controlling, controlled by, or under common control with, such 
person.
    (2) Business trading unit. This term means any department, 
division, group, or personnel of a futures commission merchant or 
introducing broker or any of its affiliates, whether or not identified 
as such, that performs, or personnel exercising direct supervisory 
authority over the performance of, any pricing (excluding price 
verification for risk management purposes), trading, sales, marketing, 
advertising, solicitation, structuring, or brokerage activities on 
behalf of a futures commission merchant or introducing broker or any of 
its affiliates.
    (3) Clearing unit. This term means any department, division, group, 
or personnel of a futures commission merchant or any of its affiliates, 
whether or not identified as such, that performs, or personnel 
exercising direct supervisory authority over the performance of, any 
proprietary or customer clearing activities on behalf of a futures 
commission merchant or any of its affiliates.
    (4) Derivative. This term means:
    (i) A contract for the purchase or sale of a commodity for future 
delivery;
    (ii) A security futures product;
    (iii) A swap;
    (iv) Any agreement, contract, or transaction described in section 
2(c)(2)(C)(i) or section 2(c)(2)(D)(i) of the Act; and
    (v) Any commodity option authorized under section 4c of the Act; 
and (vi) any leverage transaction authorized under section 19 of the 
Act.
    (5) Non-research personnel. This term means any employee of the 
business trading unit or clearing unit, or any other employee of the 
futures commission merchant or introducing broker, other than an 
employee performing a legal or compliance function, who is not directly 
responsible for, or otherwise not directly involved in, research or 
analysis intended for inclusion in a research report.
    (6) Public appearance. This term means any participation in a 
conference call, seminar, forum (including an interactive electronic 
forum) or other public speaking activity before 15 or more persons 
(individuals or entities), or interview or appearance before one or 
more representatives of the media, radio, television or print media, or 
the writing of a print media article, in which a research analyst makes 
a recommendation or offers an opinion concerning a derivatives 
transaction. This term does not include a password-protected Webcast, 
conference call or similar event with 15 or more existing customers, 
provided that all of the event participants previously received the 
most current research report or other documentation that contains the 
required applicable disclosures, and that the research analyst 
appearing at the event corrects and updates during the public 
appearance any disclosures in the research report that are inaccurate, 
misleading, or no longer applicable.
    (7) Research analyst. This term means the employee of a futures 
commission merchant or introducing broker who is primarily responsible 
for, and any employee who reports directly or indirectly to such 
research analyst in connection with, preparation of the substance of a 
research report relating to any derivative, whether or not any such 
person has the job title of ``research analyst.''
    (8) Research department. This term means any department or division 
that is principally responsible for preparing the substance of a 
research report relating to any derivative on behalf of a futures 
commission merchant or introducing broker, including a department or 
division contained in an affiliate of a futures commission merchant or 
introducing broker.
    (9) Research report. This term means any written communication 
(including electronic) that includes an analysis of the price or market 
for any derivative, and that provides information reasonably sufficient 
upon which to base a decision to enter into a derivatives transaction. 
This term does not include:
    (i) Communications distributed to fewer than 15 persons;
    (ii) Commentaries on economic, political or market conditions;
    (iii) Statistical summaries of multiple companies' financial data, 
including listings of current ratings;
    (iv) Periodic reports or other communications prepared for 
investment company shareholders or commodity pool participants that 
discuss individual derivatives positions in the context of a fund's 
past performance or the basis for previously-made discretionary 
decisions;
    (v) Any communications generated by an employee of the business 
trading unit that is conveyed as a solicitation for entering into a 
derivatives transaction, and is conspicuously identified as such; and
    (vi) Internal communications that are not given to current or 
prospective customers.
    (b) Policies and procedures. (1) Except as provided in paragraph 
(b)(2) of this section, each futures commission merchant and 
introducing broker subject to this rule must adopt and implement 
written policies and procedures reasonably designed to ensure that the 
futures commission merchant or introducing broker and its employees 
comply with the provisions of this rule.
    (2) Small Introducing Brokers. An introducing broker that has 
generated, over the preceding 3 years, $5 million or less in aggregate 
gross revenues from its activities as an introducing broker must 
establish structural and institutional safeguards reasonably

[[Page 20199]]

designed to ensure that the activities of any person within the firm 
relating to research or analysis of the price or market for any 
commodity or derivative are separated by appropriate informational 
partitions within the firm from the review, pressure, or oversight of 
persons whose involvement in trading or clearing activities might 
potentially bias the judgment or supervision of the persons.
    (c) Research analysts and research reports. (1) Restrictions on 
relationship with research department. (i) Non-research personnel shall 
not direct a research analyst's decision to publish a research report 
of the futures commission merchant or introducing broker, and non-
research personnel shall not direct the views and opinions expressed in 
a research report of the futures commission merchant or introducing 
broker.
    (ii) No research analyst may be subject to the supervision or 
control of any employee of the futures commission merchant's or 
introducing broker's business trading unit or clearing unit, and no 
employee of the business trading unit or clearing unit may have any 
influence or control over the evaluation or compensation of a research 
analyst.
    (iii) Except as provided in paragraph (c)(1)(iv) of this section, 
non-research personnel, other than the board of directors and any 
committee thereof, shall not review or approve a research report of the 
futures commission merchant or introducing broker before its 
publication.
    (iv) Non-research personnel may review a research report before its 
publication as necessary only to verify the factual accuracy of 
information in the research report, to provide for non-substantive 
editing, to format the layout or style of the research report, or to 
identify any potential conflicts of interest, provided that:
    (A) Any written communication between non-research personnel and 
research department personnel concerning the content of a research 
report must be made either through authorized legal or compliance 
personnel of the futures commission merchant or introducing broker or 
in a transmission copied to such personnel; and
    (B) Any oral communication between non-research personnel and 
research department personnel concerning the content of a research 
report must be documented and made either through authorized legal or 
compliance personnel acting as an intermediary or in a conversation 
conducted in the presence of such personnel.
    (2) Restrictions on communications. Any written or oral 
communication by a research analyst to a current or prospective 
customer relating to any derivative must not omit any material fact or 
qualification that would cause the communication to be misleading to a 
reasonable person.
    (3) Restrictions on research analyst compensation. A futures 
commission merchant or introducing broker may not consider as a factor 
in reviewing or approving a research analyst's compensation his or her 
contributions to the futures commission merchant's or introducing 
broker's trading or clearing business. Except for communicating client 
or customer feedback, ratings and other indicators of research analyst 
performance to research department management, no employee of the 
business trading unit or clearing unit of the futures commission 
merchant or introducing broker may influence the review or approval of 
a research analyst's compensation.
    (4) Prohibition of promise of favorable research. No futures 
commission merchant or introducing broker may directly or indirectly 
offer favorable research, or threaten to change research, to an 
existing or prospective customer as consideration or inducement for the 
receipt of business or compensation.
    (5) Disclosure requirements. (i) Ownership and material conflicts 
of interest. A futures commission merchant or introducing broker must 
disclose in research reports and a research analyst must disclose in 
public appearances whether the research analyst maintains a financial 
interest in any derivative of a type, class, or category that the 
research analyst follows, and the general nature of the financial 
interest.
    (ii) Prominence of disclosure. Disclosures and references to 
disclosures must be clear, comprehensive, and prominent. With respect 
to public appearances by research analysts, the disclosures required by 
paragraph (c)(5) of this section must be conspicuous.
    (iii) Records of public appearances. Each futures commission 
merchant and introducing broker must maintain records of public 
appearances by research analysts sufficient to demonstrate compliance 
by those research analysts with the applicable disclosure requirements 
under paragraph (c)(5) of this section.
    (iv) Third-party research reports. (A) For the purposes of 
paragraph (c)(5)(iv) of this section, ``independent third-party 
research report'' shall mean a research report, in respect of which the 
person or entity producing the report:
    (1) Has no affiliation or business or contractual relationship with 
the distributing futures commission merchant or introducing broker, or 
that futures commission merchant's or introducing broker's affiliates, 
that is reasonably likely to inform the content of its research 
reports; and
    (2) Makes content determinations without any input from the 
distributing futures commission merchant or introducing broker or from 
the futures commission merchant's or introducing broker's affiliates.
    (B) Subject to paragraph (c)(5)(iv)(C) of this section, if a 
futures commission merchant or introducing broker distributes or makes 
available any independent third-party research report, the futures 
commission merchant or introducing broker must accompany the research 
report with, or provide a web address that directs the recipient to, 
the current applicable disclosures, as they pertain to the futures 
commission merchant or introducing broker, required by this section. 
Each futures commission merchant and introducing broker must establish 
written policies and procedures reasonably designed to ensure the 
completeness and accuracy of all applicable disclosures.
    (C) The requirements of paragraph (c)(5)(iv)(B) of this section 
shall not apply to independent third-party research reports made 
available by a futures commission merchant or introducing broker to its 
customers:
    (1) Upon request; or
    (2) Through a Web site maintained by the futures commission 
merchant or introducing broker.
    (6) Prohibition of retaliation against research analysts. No 
futures commission merchant or introducing broker, and no employee of a 
futures commission merchant or introducing broker who is involved with 
the futures commission merchant's or introducing broker's trading or 
clearing activities, may, directly or indirectly, retaliate against or 
threaten to retaliate against any research analyst employed by the 
futures commission merchant or introducing broker or its affiliates as 
a result of an adverse, negative, or otherwise unfavorable research 
report or public appearance written or made, in good faith, by the 
research analyst that may adversely affect the futures commission 
merchant's or introducing broker's present or prospective trading or 
clearing activities.
    (7) Small Introducing Brokers. An introducing broker that has 
generated, over the preceding 3 years, $5 million or less in aggregate 
gross revenues from its activities as an introducing broker is

[[Page 20200]]

exempt from the requirements set forth in this paragraph (c).
    (d) Clearing activities. (1) No futures commission merchant shall 
permit any affiliated swap dealer or major swap participant to directly 
or indirectly interfere with, or attempt to influence, the decision of 
the clearing unit personnel of the futures commission merchant to 
provide clearing services and activities to a particular customer, 
including but not limited to a decision relating to the following:
    (i) Whether to offer clearing services and activities to a 
particular customer;
    (ii) Whether to accept a particular customer for the purposes of 
clearing derivatives;
    (iii) Whether to submit a customer's transaction to a particular 
derivatives clearing organization;
    (iv) Whether to set or adjust risk tolerance levels for a 
particular customer;
    (v) Whether to accept certain forms of collateral from a particular 
customer; or
    (vi) Whether to set a particular customer's fees for clearing 
services based upon criteria that are not generally available and 
applicable to other customers of the futures commission merchant.
    (2) Each futures commission merchant shall create and maintain an 
appropriate informational partition between business trading units of 
an affiliated swap dealer or major swap participant and clearing unit 
personnel of the futures commission merchant to reasonably ensure 
compliance with the Act and the prohibitions specified in paragraph 
(d)(1) of this section. At a minimum, such informational partitions 
shall require that:
    (i) No employee of a business trading unit of an affiliated swap 
dealer or major swap participant may review or approve the provision of 
clearing services and activities by clearing unit personnel of the 
futures commission merchant, make any determination regarding whether 
the futures commission merchant accepts clearing customers, or in any 
way condition or tie the provision of trading services upon or to the 
provision of clearing services or otherwise participate in the 
provision of clearing services by improperly incentivizing or 
encouraging the use of the affiliated futures commission merchant. Any 
employee of a business trading unit of an affiliated swap dealer or 
major swap participant may participate in the activities of the futures 
commission merchant as necessary for (A) participating in default 
management undertaken by a derivatives clearing organization during an 
event of default; and (B) transferring, liquidating, or hedging any 
proprietary or customer positions during an event of default;
    (ii) No employee of a business trading unit of an affiliated swap 
dealer or major swap participant shall supervise, control, or influence 
any employee of a clearing unit of the futures commission merchant; and
    (iii) No employee of the business trading unit of an affiliated 
swap dealer or major swap participant shall influence or control 
compensation or evaluation of any employee of the clearing unit of the 
futures commission merchant.
    (e) Undue influence on customers. Each futures commission merchant 
and introducing broker must adopt and implement written policies and 
procedures that mandate the disclosure to its customers of any material 
incentives and any material conflicts of interest regarding the 
decision of a customer as to the trade execution and/or clearing of the 
derivatives transaction.
    (f) Records. All records that a futures commission merchant or 
introducing broker is required to maintain pursuant to this regulation 
shall be maintained in accordance with Commission Regulation Sec.  1.31 
and shall be made available promptly upon request to representatives of 
the Commission.

PART 3--REGISTRATION

0
3. The authority citation for part 3 is revised to read as follows:

    Authority:  5 U.S.C. 552, 552b; 7 U.S.C. 1a, 2, 6a, 6b, 6b-1, 
6c, 6d, 6e, 6f, 6g, 6h, 6i, 6k, 6m, 6n, 6o, 6p, 6s, 8, 9, 9a, 12, 
12a, 13b, 13c, 16a, 18, 19, 21, and 23, as amended by Title VII of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. 
L. 111-203, 124 Stat. 1376 (Jul. 21, 2010).

0
4. Amend Sec.  3.1 by revising paragraph (a)(1) and by adding 
paragraphs (h) and (i) to read as follows:


Sec.  3.1  Definitions.

    (a) * * *
    (1) If the entity is organized as a sole proprietorship, the 
proprietor and chief compliance officer; if a partnership, any general 
partner and chief compliance officer; if a corporation, any director, 
the president, chief executive officer, chief operating officer, chief 
financial officer, chief compliance officer, and any person in charge 
of a principal business unit, division or function subject to 
regulation by the Commission; if a limited liability company or limited 
liability partnership, any director, the president, chief executive 
officer, chief operating officer, chief financial officer, chief 
compliance officer, the manager, managing member or those members 
vested with the management authority for the entity, and any person in 
charge of a principal business unit, division or function subject to 
regulation by the Commission; and, in addition, any person occupying a 
similar status or performing similar functions, having the power, 
directly or indirectly, through agreement or otherwise, to exercise a 
controlling influence over the entity's activities that are subject to 
regulation by the Commission;
* * * * *
    (h) Swaps activities. Swaps activities means, with respect to a 
registrant, such registrant's activities related to swaps and any 
product used to hedge such swaps, including, but not limited to, 
futures, options, other swaps or security-based swaps, debt or equity 
securities, foreign currency, physical commodities, and other 
derivatives.
    (i) Board of directors. Board of directors means the board of 
directors, board of governors, or equivalent governing body of a 
registrant.

0
5. Add Sec.  3.3 to read as follows:


Sec.  3.3  Chief compliance officer.

    (a) Designation. Each futures commission merchant, swap dealer, and 
major swap participant shall designate an individual to serve as its 
chief compliance officer, and provide the chief compliance officer with 
the responsibility and authority to develop, in consultation with the 
board of directors or the senior officer, appropriate policies and 
procedures to fulfill the duties set forth in the Act and Commission 
regulations relating to the swap dealer's or major swap participant's 
swaps activities, or to the futures commission merchant's business as a 
futures commission merchant and to ensure compliance with the Act and 
Commission regulations relating to the swap dealer's or major swap 
participant's swaps activities, or to the futures commission merchant's 
business as a futures commission merchant.
    (1) The chief compliance officer shall report to the board of 
directors or the senior officer of the futures commission merchant, 
swap dealer, or major swap participant. The board of directors or the 
senior officer shall appoint the chief compliance officer, shall 
approve the compensation of the chief compliance officer, and shall 
meet with the chief compliance officer at least once a year and at the 
election of the chief compliance officer.
    (2) Only the board of directors or the senior officer of the 
futures commission merchant, swap dealer, or major swap participant may 
remove the chief compliance officer.

[[Page 20201]]

    (b) Qualifications. The individual designated to serve as chief 
compliance officer shall have the background and skills appropriate for 
fulfilling the responsibilities of the position. No individual 
disqualified, or subject to disqualification, from registration under 
section 8a(2) or 8a(3) of the Act may serve as a chief compliance 
officer.
    (c) Submission with registration. Each application for registration 
as a futures commission merchant under Sec.  3.10, a swap dealer under 
Sec.  23.21, or a major swap participant under Sec.  23.21, must 
include a designation of a chief compliance officer by submitting a 
Form 8-R for the chief compliance officer as a principal of the 
applicant pursuant to Sec.  3.10(a)(2).
    (d) Chief compliance officer duties. The chief compliance officer's 
duties shall include, but are not limited to:
    (1) Administering the registrant's policies and procedures 
reasonably designed to ensure compliance with the Act and Commission 
regulations;
    (2) In consultation with the board of directors or the senior 
officer, resolving any conflicts of interest that may arise;
    (3) Taking reasonable steps to ensure compliance with the Act and 
Commission regulations relating to the swap dealer's or major swap 
participant's swaps activities, or to the futures commission merchant's 
business as a futures commission merchant;
    (4) Establishing procedures, in consultation with the board of 
directors or the senior officer, for the remediation of noncompliance 
issues identified by the chief compliance officer through a compliance 
office review, look-back, internal or external audit finding, self-
reported error, or validated complaint;
    (5) Establishing procedures, in consultation with the board of 
directors or the senior officer, for the handling, management response, 
remediation, retesting, and closing of noncompliance issues; and
    (6) Preparing and signing the annual report required under 
paragraphs (e) and (f) of this section.
    (e) Annual report. The chief compliance officer annually shall 
prepare a written report that covers the most recently completed fiscal 
year of the futures commission merchant, swap dealer, or major swap 
participant, and provide the annual report to the board of directors or 
the senior officer. The annual report shall, at a minimum:
    (1) Contain 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;
    (2) Review each applicable requirement under the Act and Commission 
regulations, and with respect to each:
    (i) Identify the policies and procedures that are reasonably 
designed to ensure compliance with the requirement under the Act and 
Commission regulations;
    (ii) Provide an assessment as to the effectiveness of these 
policies and procedures; and
    (iii) Discuss areas for improvement, and recommend potential or 
prospective changes or improvements to its compliance program and 
resources devoted to compliance;
    (3) List any material changes to compliance policies and procedures 
during the coverage period for the report;
    (4) Describe the financial, managerial, operational, and staffing 
resources set aside for compliance with respect to the Act and 
Commission regulations, including any material deficiencies in such 
resources; and
    (5) Describe any material non-compliance issues identified, and the 
corresponding action taken.
    (f) Furnishing the annual report to the Commission. (1) Prior to 
furnishing the annual report to the Commission, the chief compliance 
officer shall provide the annual report to the board of directors or 
the senior officer of the futures commission merchant, swap dealer, or 
major swap participant for its review. Furnishing the annual report to 
the board of directors or the senior officer shall be recorded in the 
board minutes or otherwise, as evidence of compliance with this 
requirement.
    (2) The annual report shall be furnished electronically to the 
Commission not more than 90 days after the end of the fiscal year of 
the futures commission merchant, swap dealer, or major swap 
participant, simultaneously with the submission of Form 1-FR-FCM, as 
required under Sec.  1.10(b)(2)(ii), simultaneously with the Financial 
and Operational Combined Uniform Single Report, as required under Sec.  
1.10(h), or simultaneously with the financial condition report, as 
required under section 4s(f) of the Act, as applicable.
    (3) The report shall include a certification by the chief 
compliance officer or chief executive officer of the registrant that, 
to the best of his or her knowledge and reasonable belief, and under 
penalty of law, the information contained in the annual report is 
accurate and complete.
    (4) The futures commission merchant, swap dealer, or major swap 
participant shall promptly furnish an amended annual report if material 
errors or omissions in the report are identified. An amendment must 
contain the certification required under paragraph (f)(3) of this 
section.
    (5) A futures commission merchant, swap dealer, or major swap 
participant may request from the Commission an extension of time to 
furnish its annual report, provided the registrant's failure to timely 
furnish 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.
    (6) A futures commission merchant, swap dealer, or major swap 
participant may incorporate by reference sections of an annual report 
that has been furnished within the current or immediately preceding 
reporting period to the Commission. If the futures commission merchant, 
swap dealer, or major swap participant is registered in more than one 
capacity with the Commission, and must submit more than one annual 
report, an annual report submitted as one registrant may incorporate by 
reference sections in the annual report furnished within the current or 
immediately preceding reporting period as the other registrant.
    (g) Recordkeeping. (1) The futures commission merchant, swap 
dealer, or major swap participant shall maintain:
    (i) A copy of the registrant's policies and procedures reasonably 
designed to ensure compliance with the Act and Commission regulations;
    (ii) Copies of materials, including written reports provided to the 
board of directors or the senior officer in connection with the review 
of the annual report under paragraph (e) of this section; and
    (iii) Any records relevant to the annual report, including, but not 
limited to, work papers and other documents that form the basis of the 
report, and memoranda, correspondence, other documents, and records 
that are created, sent or received in connection with the annual report 
and contain conclusions, opinions, analyses, or financial data related 
to the annual report.
    (2) All records or reports that a futures commission merchant, swap 
dealer, or major swap participant are required to maintain pursuant to 
this section shall be maintained in accordance with Sec.  1.31 and 
shall be made available promptly upon request to representatives of the 
Commission and to representatives of the applicable prudential 
regulator, as defined in 1a(39) of the Act.

[[Page 20202]]

PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

0
6. The authority citation for part 23 is revised to read as follows:

     Authority:  7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 
6t, 9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, and 21 as amended by the 
Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 
111-203, 124 Stat. 1376 (Jul. 21, 2010).


0
7. Add Subpart F, Sec. Sec.  23.200, 23.201, 23.202, 23.203, 23.204, 
23.205, and 23.206 to read as follows:
Subpart F--Reporting, Recordkeeping, and Daily Trading Records 
Requirements for Swap Dealers and Major Swap Participants
Sec.
23.200 Definitions.
23.201 Required records.
23.202 Daily trading records.
23.203 Records; retention and inspection.
23.204 Reporting to swap data repositories.
23.205 Real-time public reporting.
23.206 Delegation of authority to the Director of the Division of 
Swap Dealer and Intermediary Oversight to establish an alternative 
compliance schedule to comply with daily trading records.

Subpart F--Reporting, Recordkeeping, and Daily Trading Records 
Requirements for Swap Dealers and Major Swap Participants


Sec.  23.200  Definitions.

    For purposes of subpart F, the following terms shall be defined as 
provided.
    (a) Business trading unit means any department, division, group, or 
personnel of a swap dealer or major swap participant or any of its 
affiliates, whether or not identified as such, that performs, or 
exercises supervisory authority over the performance of, any pricing 
(excluding price verification for risk management purposes), trading, 
sales, purchasing, marketing, advertising, solicitation, structuring, 
or brokerage activities on behalf of a registrant.
    (b) Clearing unit means any department, division, group, or 
personnel of a registrant or any of its affiliates, whether or not 
identified as such, that performs any proprietary or customer clearing 
activities on behalf of a registrant.
    (c) Complaint means any formal or informal complaint, grievance, 
criticism, or concern communicated to the swap dealer or major swap 
participant in any format relating to, arising from, or in connection 
with, any trading conduct or behavior or with the swap dealer or major 
swap participant's performance (or failure to perform) any of its 
regulatory obligations, and includes any and all observations, 
comments, remarks, interpretations, clarifications, notes, and 
examinations as to such conduct or behavior communicated or documented 
by the complainant, swap dealer, or major swap participant.
    (d) Executed means the completion of the execution process.
    (e) Execution means, with respect to a swap, an agreement by the 
parties (whether orally, in writing, electronically, or otherwise) to 
the terms of a swap that legally binds the parties to such swap terms 
under applicable law.
    (f) Governing body. This term means:
    (1) A board of directors;
    (2) A body performing a function similar to a board of directors;
    (3) Any committee of a board or body; or
    (4) The chief executive officer of a registrant, or any such board, 
body, committee, or officer of a division of a registrant, provided 
that the registrant's swaps activities for which registration with the 
Commission is required are wholly contained in a separately 
identifiable division.
    (g) Prudential regulator has the meaning given to such term in 
section 1a(39) of the Commodity Exchange Act and includes 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 Association, and the Federal Housing Finance Agency, as 
applicable to the swap dealer or major swap participant.
    (h) Registered entity has the meaning given to such term in section 
1a(40) of the Commodity Exchange Act, and includes boards of trade 
designated as contract markets, derivatives clearing organizations, 
swap execution facilities, and swap data repositories.
    (i) Related cash or forward transaction means a purchase or sale 
for immediate or deferred physical shipment or delivery of an asset 
related to a swap where the swap and the related cash or forward 
transaction are used to hedge, mitigate the risk of, or offset one 
another.
    (j) Swaps activities means, with respect to a registrant, such 
registrant's activities related to swaps and any product used to hedge 
such swaps, including, but not limited to, futures, options, other 
swaps or security-based swaps, debt or equity securities, foreign 
currency, physical commodities, and other derivatives.
    (k) Swap confirmation means the consummation (electronically or 
otherwise) of legally binding documentation (electronic or otherwise) 
that memorializes the agreement of the parties to all the terms of the 
swap. A confirmation must be in writing (whether electronic or 
otherwise) and must legally supersede any previous agreement 
(electronically or otherwise).


Sec.  23.201  Required records.

    (a) Transaction and position records. Each swap dealer and major 
swap participant shall keep full, complete, and systematic records, 
together with all pertinent data and memoranda, of all its swaps 
activities. Such records shall include:
    (1) Transaction records. Records of each transaction, including all 
documents on which transaction information is originally recorded. Such 
records shall be kept in a form and manner identifiable and searchable 
by transaction and by counterparty, and shall include:
    (i) All documents customarily generated in accordance with market 
practice that demonstrate the existence and nature of an order or 
transaction, including, but not limited to, records of all orders 
(filled, unfilled, or cancelled); correspondence; journals; memoranda; 
ledgers; confirmations; risk disclosure documents; statements of 
purchase and sale; contracts; invoices; warehouse receipts; documents 
of title; and
    (ii) The daily trading records required to be kept in accordance 
with Sec.  23.202.
    (2) Position records. Records of each position held by each swap 
dealer and major swap participant, identified by product and 
counterparty, including records reflecting whether each position is 
``long'' or ``short'' and whether the position is cleared. Position 
records shall be linked to transaction records in a manner that permits 
identification of the transactions that established the position.
    (3) Records of transactions executed on a swap execution facility 
or designated contract market or cleared by a derivatives clearing 
organization. Records of each transaction executed on a swap execution 
facility or designated contract market or cleared by a derivatives 
clearing organization maintained in compliance with the Act and 
Commission regulations.
    (b) Business records. Each swap dealer and major swap participant 
shall keep full, complete, and systematic records of all activities 
related to its business as a swap dealer or major swap participant, 
including but not limited to:
    (1) Governance. (i) Minutes of meetings of the governing body and 
relevant committee minutes, including handouts and presentation 
materials;
    (ii) Organizational charts for its governing body and relevant

[[Page 20203]]

committees, business trading unit, clearing unit, risk management unit, 
and all other relevant units or divisions;
    (iii) Biographies or resumes of managers, senior supervisors, 
officers, and directors;
    (iv) Job descriptions for manager, senior supervisor, officer, and 
director positions, including job responsibilities and scope of 
authority;
    (v) Internal and external audit, risk management, compliance, and 
consultant reports (including management responses); and
    (vi) Business and strategic plans for the business trading unit.
    (2) Financial records. (i) Records reflecting all assets and 
liabilities, income and expenses, and capital accounts as required by 
the Act and Commission regulations; and
    (ii) All other financial records required to be kept under the Act 
and Commission regulations.
    (3) Complaints. (i) A record of each complaint received by the swap 
dealer or major swap participant concerning any partner, member, 
officer, employee, or agent. The record shall include the complainant's 
name, address, and account number; the date the complaint was received; 
the name of all persons identified in the complaint; a description of 
the nature of the complaint; the disposition of the complaint, and the 
date the complaint was resolved.
    (ii) A record indicating that each counterparty of the swap dealer 
or major swap participant has been provided with a notice containing 
the physical address, email or other widely available electronic 
address, and telephone number of the department of the swap dealer or 
major swap participant to which any complaints may be directed.
    (4) Marketing and sales materials. All marketing and sales 
presentations, advertisements, literature, and communications, and a 
record documenting that the swap dealer or major swap participant has 
complied with, or adopted policies and procedures reasonably designed 
to establish compliance with, all applicable Federal requirements, 
Commission regulations, and the rules of any self-regulatory 
organization of which the swap dealer or major swap participant is a 
member.
    (c) Records of data reported to a swap data repository. With 
respect to each swap, each swap dealer and major swap participant shall 
identify, retain, and produce for inspection all information and data 
required to be reported in accordance with part 45 of this chapter, 
along with a record of the date and time the swap dealer or major swap 
participant made the report.
    (d) Records of real-time reporting data. Each swap dealer and major 
swap participant shall identify, retain, and produce for inspection all 
information and data required to be reported in accordance with part 43 
of this chapter, along with a record of the date and time the swap 
dealer or major swap participant made the report.


Sec.  23.202  Daily trading records.

    (a) Daily trading records for swaps. Each swap dealer and major 
swap participant shall make and keep daily trading records of all swaps 
it executes, including all documents on which transaction information 
is originally recorded. Each swap dealer and major swap participant 
shall ensure that its records include all information necessary to 
conduct a comprehensive and accurate trade reconstruction for each 
swap. Each swap dealer and major swap participant shall maintain each 
transaction record in a manner identifiable and searchable by 
transaction and counterparty.
    (1) Pre-execution trade information. Each swap dealer and major 
swap participant shall make and keep pre-execution trade information, 
including, at a minimum, records of all oral and written communications 
provided or received concerning quotes, solicitations, bids, offers, 
instructions, trading, and prices, that lead to the execution of a 
swap, whether communicated by telephone, voicemail, facsimile, instant 
messaging, chat rooms, electronic mail, mobile device, or other digital 
or electronic media. Such records shall include, but are not limited 
to:
    (i) Reliable timing data for the initiation of the trade that would 
permit complete and accurate trade reconstruction; and
    (ii) A record of the date and time, to the nearest minute, using 
Coordinated Universal Time (UTC), by timestamp or other timing device, 
for each quotation provided to, or received from, the counterparty 
prior to execution.
    (2) Execution trade information. Each swap dealer and major swap 
participant shall make and keep trade execution records, including:
    (i) All terms of each swap, including all terms regarding payment 
or settlement instructions, initial and variation margin requirements, 
option premiums, payment dates, and any other cash flows;
    (ii) The trade ticket for each swap (which, together with the time 
of execution of each swap, shall be immediately recorded electronically 
for further processing);
    (iii) The unique swap identifier, as required by Sec.  45.4(a), for 
each swap;
    (iv) A record of the date and time of execution of each swap, to 
the nearest minute, using Coordinated Universal Time (UTC), by 
timestamp or other timing device;
    (v) The name of the counterparty with which each such swap was 
executed, including its unique counterparty identifier, as required by 
Sec.  45.4(b);
    (vi) The date and title of the agreement to which each swap is 
subject, including but not limited to, any swap trading relationship 
documentation and credit support arrangements;
    (vii) The product name of each swap, including its unique product 
identifier, as required by Sec.  45.4(c);
    (viii) The price at which the swap was executed;
    (ix) Fees or commissions and other expenses, identified by 
transaction; and
    (x) Any other information relevant to the swap.
    (3) Post-execution trade information. Each swap dealer and major 
swap participant shall make and keep records of post-execution trade 
information containing an itemized record of all relevant post-trade 
processing and events.
    (i) Records of post-trade processing and events shall include all 
of the following, as applicable:
    (A) Confirmation;
    (B) Termination;
    (C) Novation;
    (D) Amendment;
    (E) Assignment;
    (F) Netting;
    (G) Compression;
    (H) Reconciliation;
    (I) Valuation;
    (J) Margining;
    (K) Collateralization; and
    (L) Central clearing.
    (ii) Each swap dealer and major swap participant shall make and 
keep a record of all swap confirmations, along with the date and time, 
to the nearest minute, using Coordinated Universal Time (UTC), by 
timestamp or other timing device; and
    (iii) Each swap dealer and major swap participant shall make and 
keep a record of each swap portfolio reconciliation, including the 
number of portfolio reconciliation discrepancies and the number of swap 
valuation disputes (including the time-to-resolution of each valuation 
dispute and the age of outstanding valuation disputes, categorized by 
transaction and counterparty);
    (iv) Each swap dealer and major swap participant shall make and 
keep a

[[Page 20204]]

record of each swap portfolio compression exercise in which it 
participates, including the dates of the compression, the swaps 
included in the compression, the identity of the counterparties 
participating in the exercise, the results of the compression, and the 
name of the third-party entity performing the compression, if any; and
    (v) Each swap dealer and major swap participant shall make and keep 
a record of each swap that it centrally clears, categorized by 
transaction and counterparty.
    (4) Ledgers. Each swap dealer and major swap participant shall make 
and keep ledgers (or other records) reflecting the following:
    (i) Payments and interest received;
    (ii) Moneys borrowed and moneys loaned;
    (iii) The daily calculation of the value of each outstanding swap;
    (iv) The daily calculation of current and potential future exposure 
for each counterparty;
    (v) The daily calculation of initial margin to be posted by the 
swap dealer or major swap participant for each counterparty and the 
daily calculation of initial margin to be posted by each counterparty;
    (vi) The daily calculation of variation margin payable to or 
receivable from each counterparty;
    (vii) The daily calculation of the value of all collateral, before 
and after haircuts, held by or posted by the swap dealer or major swap 
participant;
    (viii) All transfers of collateral, including any substitutions of 
collateral, identifying in sufficient detail the amounts and types of 
collateral transferred; and
    (ix) All charges against and credits to each counterparty's 
account, including funds deposited, withdrawn, or transferred, and 
charges or credits resulting from losses or gains on transactions.
    (b) Daily trading records for related cash and forward 
transactions. Each swap dealer and major swap participant shall make 
and keep daily trading records of all related cash or forward 
transactions it executes, including all documents on which the related 
cash or forward transaction information is originally recorded. Each 
swap dealer and major swap participant shall ensure that its records 
include all information necessary to conduct a comprehensive and 
accurate trade reconstruction for each related cash or forward 
transaction. Each swap dealer and major swap participant shall maintain 
each transaction record in a manner identifiable and searchable by 
transaction and by counterparty. Such records shall include, but are 
not limited to:
    (1) A record of all oral and written communications provided or 
received concerning quotes, solicitations, bids, offers, instructions, 
trading, and prices, that lead to the conclusion of a related cash or 
forward transaction, whether communicated by telephone, voicemail, 
facsimile, instant messaging, chat rooms, electronic mail, mobile 
device, or other digital or electronic media;
    (2) Reliable timing data for the initiation of the transaction that 
would permit complete and accurate trade reconstruction;
    (3) A record of the date and time, to the nearest minute, using 
Coordinated Universal Time (UTC), by timestamp or other timing device, 
for each quotation provided to, or received from, the counterparty 
prior to execution;
    (4) A record of the date and time of execution of each related cash 
or forward transaction, to the nearest minute, using Coordinated 
Universal Time (UTC), by timestamp or other timing device;
    (5) All terms of each related cash or forward transaction;
    (6) The price at which the related cash or forward transaction was 
executed; and
    (7) A record of the daily calculation of the value of the related 
cash or forward transaction and any other relevant financial 
information.


Sec.  23.203  Records; retention and inspection.

    (a) Location of records. (1) Records. All records required to be 
kept by a swap dealer or major swap participant by the Act and by 
Commission regulations shall be kept at the principal place of business 
of the swap dealer or major swap participant or such other principal 
office as shall be designated by the swap dealer or major swap 
participant. If the principal place of business is outside of the 
United States, its territories or possessions, then upon the request of 
a Commission representative, the swap dealer or major swap participant 
must provide such records as requested at the place in the United 
States, its territories, or possessions designated by the 
representative within 72 hours after receiving the request.
    (2) Contact information. Each swap dealer and major swap 
participant shall maintain for each of its offices a listing, by name 
or title, of each person at that office who, without delay, can explain 
the types of records the swap dealer or major swap participant 
maintains at that office and the information contained in those 
records.
    (b) Record retention. (1) The records required to be maintained by 
this chapter shall be maintained in accordance with the provisions of 
Sec.  1.31, except as provided in paragraphs (b)(2) and (3) of this 
section. All records required to be kept by the Act and by Commission 
regulations shall be kept for a period of five years from the date the 
record was made and shall be readily accessible during the first two 
(2) years of the five-year period. All such records shall be open to 
inspection by any representative of the Commission, the United States 
Department of Justice, or any applicable prudential regulator. Records 
relating to swaps defined in section 1a(47)(A)(v) shall be open to 
inspection by any representative of the Commission, the United States 
Department of Justice, the Securities and Exchange Commission, or any 
applicable prudential regulator.
    (2) Records of any swap or related cash or forward transaction 
shall be kept until the termination, maturity, expiration, transfer, 
assignment, or novation date of the transaction, and for a period of 
five years after such date. Such records shall be readily accessible 
until the termination, maturity, expiration, transfer, assignment, or 
novation date of the transaction and during the first two years of the 
5-year period following such date. Provided, however, that records of 
oral communications communicated by telephone, voicemail, mobile 
device, or other digital or electronic media pursuant to Sec.  
23.202(a)(1) and (b)(1) shall be kept for a period of one year. All 
such records shall be open to inspection by any representative of the 
Commission, the United States Department of Justice, or any applicable 
prudential regulator. Records relating to swaps defined in section 
1a(47)(A)(v) shall be open to inspection by any representative of the 
Commission, the United States Department of Justice, the Securities and 
Exchange Commission, or any applicable prudential regulator.
    (3) Records of any swap data reported in accordance with part 45 of 
this chapter shall be maintained in accordance with the requirements of 
Sec.  45.2 of this chapter.


Sec.  23.204  Reports to swap data repositories.

    (a) Reporting of swap transaction data to swap data repositories. 
Each swap dealer and major swap participant shall report all 
information and data in accordance with part 45 of this chapter.
    (b) Electronic reporting of swap transaction data. Each swap dealer 
and major swap participant shall have the electronic systems and 
procedures

[[Page 20205]]

necessary to transmit electronically all information and data required 
to be reported in accordance with part 45 of this chapter.


Sec.  23.205  Real-time public reporting.

    (a) Real-time public reporting of swap transaction and pricing 
data. Each swap dealer and major swap participant shall report all 
information and swap transaction and pricing data required to be 
reported in accordance with the real-time public recording requirements 
in part 43 of this chapter.
    (b) Electronic reporting of swap transaction data. Each swap dealer 
and major swap participant shall have the electronic systems and 
procedures necessary to transmit electronically all information and 
data required to be reported in accordance with part 43 of this 
chapter.


Sec.  23.206  Delegation of authority to the Director of the Division 
of Swap Dealer and Intermediary Oversight to establish an alternative 
compliance schedule to comply with daily trading records.

    (a) The Commission hereby delegates to the Director of the Division 
of Swap Dealer and Intermediary Oversight or such other employee or 
employees as the Director may designate from time to time, the 
authority to establish an alternative compliance schedule for 
requirements of Sec.  23.202 that are found to be technologically or 
economically impracticable for an affected swap dealer or major swap 
participant that seeks, in good faith, to comply with the requirements 
of Sec.  23.202 within a reasonable time period beyond the date on 
which compliance by such swap dealer or major swap participant is 
otherwise required.
    (b) A request for an alternative compliance schedule under this 
section shall be acted upon by the Director of the Division of Swap 
Dealer and Intermediary Oversight within 30 days from the time such a 
request is received, or it shall be deemed approved.
    (c) Relief granted under this section shall not cause a registrant 
to be out of compliance or deemed in violation of any registration 
requirements.
    (d) Notwithstanding any other provision of this section, in any 
case in which a Commission employee delegated authority under this 
section believes it appropriate, he or she may submit to the Commission 
for its consideration the question of whether an alternative compliance 
schedule should be established. Nothing in this section shall be deemed 
to prohibit the Commission, at its election, from exercising the 
authority delegated in this section.

0
8. Add Subpart J, consisting of Sec. Sec.  23.600 through 23.607, to 
read as follows:
Subpart J--Duties of Swap Dealers and Major Swap Participants
Sec.
23.600 Risk Management Program for swap dealers and major swap 
participants.
23.601 Monitoring of position limits.
23.602 Diligent supervision.
23.603 Business continuity and disaster recovery.
23.604 [Reserved]
23.605 Conflicts of interest policies and procedures.
23.606 General information: availability for disclosure and 
inspection.
23.607 Antitrust considerations.

Subpart J--Duties of Swap Dealers and Major Swap Participants


Sec.  23.600  Risk Management Program for swap dealers and major swap 
participants.

    (a) Definitions. For purposes of subpart J, the following terms 
shall be defined as provided.
    (1) Affiliate. This term means, with respect to any person, a 
person controlling, controlled by, or under common control with, such 
person.
    (2) Business trading unit. This term means any department, 
division, group, or personnel of a swap dealer or major swap 
participant or any of its affiliates, whether or not identified as 
such, that performs, or personnel exercising direct supervisory 
authority over the performance of any pricing (excluding price 
verification for risk management purposes), trading, sales, marketing, 
advertising, solicitation, structuring, or brokerage activities on 
behalf of a registrant.
    (3) Clearing unit. This term means any department, division, group, 
or personnel of a registrant or any of its affiliates, whether or not 
identified as such, that performs, or personnel exercising direct 
supervisory authority over the performance of any proprietary or 
customer clearing activities on behalf of a registrant.
    (4) Governing body. This term means:
    (1) A board of directors;
    (2) A body performing a function similar to a board of directors;
    (3) Any committee of a board or body; or
    (4) The chief executive officer of a registrant, or any such board, 
body, committee, or officer of a division of a registrant, provided 
that the registrant's swaps activities for which registration with the 
Commission is required are wholly contained in a separately 
identifiable division.
    (5) Prudential regulator. This term has the same meaning as section 
1a(39) of the Commodity Exchange Act and includes 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 Association, and the Federal Housing Finance Agency, as 
applicable to the swap dealer or major swap participant.
    (6) Senior management. This term means, with respect to a 
registrant, any officer or officers specifically granted the authority 
and responsibility to fulfill the requirements of senior management by 
the registrant's governing body.
    (7) Swaps activities. This term means, with respect to a 
registrant, such registrant's activities related to swaps and any 
product used to hedge such swaps, including, but not limited to, 
futures, options, other swaps or security-based swaps, debt or equity 
securities, foreign currency, physical commodities, and other 
derivatives.
    (b) Risk management program. (1) Purpose. Each swap dealer and 
major swap participant shall establish, document, maintain, and enforce 
a system of risk management policies and procedures designed to monitor 
and manage the risks associated with the swaps activities of the swap 
dealer or major swap participant. For purposes of this regulation, such 
policies and procedures shall be referred to collectively as a ``Risk 
Management Program.''
    (2) Written policies and procedures. Each swap dealer and major 
swap participant shall maintain written policies and procedures that 
describe the Risk Management Program of the swap dealer or major swap 
participant.
    (3) Approval by governing body. The Risk Management Program and the 
written risk management policies and procedures shall be approved, in 
writing, by the governing body of the swap dealer or major swap 
participant.
    (4) Furnishing to the Commission. Each swap dealer and major swap 
participant shall furnish a copy of its written risk management 
policies and procedures to the Commission, or to a futures association 
registered under section 17 of the Act, if directed by the Commission, 
upon application for registration and thereafter upon request.
    (5) Risk management unit. As part of its Risk Management Program, 
each swap dealer and major swap participant shall establish and 
maintain a risk management unit with sufficient authority; qualified 
personnel; and financial, operational, and other resources to carry out 
the risk management program established pursuant to this regulation. 
The risk management unit shall report directly to senior management and 
shall be

[[Page 20206]]

independent from the business trading unit.
    (c) Elements of the Risk Management Program. The Risk Management 
Program of each swap dealer and major swap participant shall include, 
at a minimum, the following elements:
    (1) Identification of risks and risk tolerance limits. (i) The Risk 
Management Program should take into account market, credit, liquidity, 
foreign currency, legal, operational, settlement, and any other 
applicable risks together with a description of the risk tolerance 
limits set by the swap dealer or major swap participant and the 
underlying methodology in written policies and procedures. The risk 
tolerance limits shall be reviewed and approved quarterly by senior 
management and annually by the governing body. Exceptions to risk 
tolerance limits shall be subject to written policies and procedures.
    (ii) The Risk Management Program shall take into account risks 
posed by affiliates and the Risk Management Program shall be integrated 
into risk management at the consolidated entity level.
    (iii) The Risk Management Program shall include policies and 
procedures for detecting breaches of risk tolerance limits set by the 
swap dealer or major swap participant, and alerting supervisors within 
the risk management unit and senior management, as appropriate.
    (2) Periodic Risk Exposure Reports. (i) The risk management unit of 
each swap dealer and major swap participant shall provide to senior 
management and to its governing body quarterly written reports setting 
forth the market, credit, liquidity, foreign currency, legal, 
operational, settlement, and any other applicable risk exposures of the 
swap dealer or major swap participant; any recommended or completed 
changes to the Risk Management Program; the recommended time frame for 
implementing recommended changes; and the status of any incomplete 
implementation of previously recommended changes to the Risk Management 
Program. For purposes of this regulation, such reports shall be 
referred to as ``Risk Exposure Reports.'' The Risk Exposure Reports 
also shall be provided to the senior management and the governing body 
immediately upon detection of any material change in the risk exposure 
of the swap dealer or major swap participant.
    (ii) Furnishing to the Commission. Each swap dealer and major swap 
participant shall furnish copies of its Risk Exposure Reports to the 
Commission within five (5) business days of providing such reports to 
its senior management.
    (3) New product policy. The Risk Management Program of each swap 
dealer and major swap participant shall include a new product policy 
that is designed to identify and take into account the risks of any new 
product prior to engaging in transactions involving the new product. 
The new product policy should include the following elements:
    (i) Consideration of the type of counterparty with which the new 
product will be transacted; the product's characteristics and economic 
function; and whether the product requires a novel pricing methodology 
or presents novel legal and regulatory issues.
    (ii) Identification and analysis of all relevant risks associated 
with the new product and how they will be managed. The risk analysis 
should include an assessment, if relevant, of any product, market, 
credit, liquidity, foreign currency, legal, operational, settlement, 
and any other risks associated with the new product. Product risk 
characteristics may include, if relevant, volatility, non-linear price 
characteristics, jump-to-default risk, and any correlation between the 
value of the product and the counterparty's creditworthiness.
    (iii) An assessment, signed by a supervisor in the risk management 
unit, as to whether the new product would materially alter the overall 
entity-wide risk profile of the swap dealer or major swap participant. 
If the new product would materially alter the overall risk profile of 
the swap dealer or major swap participant, the new product must be pre-
approved by the governing body before any transactions are effectuated.
    (iv) A requirement that the risk management unit review the risk 
analysis to identify any necessary modifications to the Risk Management 
Program and implement such modifications prior to engaging in 
transactions involving the new product.
    (v) Notwithstanding the foregoing, a swap dealer's or major swap 
participant's new product policy may include provisions permitting 
limited preliminary approval of new products--
    (A) At a risk level that would not be material to the swap dealer 
or major swap participant; and
    (B) Solely in order to provide the swap dealer or major swap 
participant with the opportunity to facilitate development of 
appropriate operational and risk management processes for such product.
    (4) Specific risk management considerations. The Risk Management 
Program of each swap dealer and major swap participant shall include, 
but not be limited to, policies and procedures necessary to monitor and 
manage the following risks:
    (i) Market risk. Market risk policies and procedures shall take 
into account, among other things:
    (A) Daily measurement of market exposure, including exposure due to 
unique product characteristics, volatility of prices, basis and 
correlation risks, leverage, sensitivity of option positions, and 
position concentration, to comply with market risk tolerance limits;
    (B) Timely and reliable valuation data derived from, or verified 
by, sources that are independent of the business trading unit, and if 
derived from pricing models, that the models have been independently 
validated by qualified, independent external or internal persons; and
    (C) Periodic reconciliation of profits and losses resulting from 
valuations with the general ledger.
    (ii) Credit risk. Credit risk policies and procedures shall take 
into account, among other things:
    (A) Daily measurement of overall credit exposure to comply with 
counterparty credit limits;
    (B) Monitoring and reporting of violations of counterparty credit 
limits performed by personnel that are independent of the business 
trading unit; and
    (C) Regular valuation of collateral used to cover credit exposures 
and safeguarding of collateral to prevent loss, disposal, 
rehypothecation, or use unless appropriately authorized.
    (iii) Liquidity risk. Liquidity risk policies and procedures shall 
take into account, among other things:
    (A) Daily measurement of liquidity needs;
    (B) Assessing procedures to liquidate all non-cash collateral in a 
timely manner and without significant effect on price; and
    (C) Application of appropriate collateral haircuts that accurately 
reflect market and credit risk.
    (iv) Foreign currency risk. Foreign currency risk policies and 
procedures shall take into account, among other things:
    (A) Daily measurement of the amount of capital exposed to 
fluctuations in the value of foreign currency to comply with applicable 
limits; and
    (B) Establishment of safeguards against adverse currency 
fluctuations.
    (v) Legal risk. Legal risk policies and procedures shall take into 
account, among other things:
    (A) Determinations that transactions and netting arrangements 
entered into have a sound legal basis; and

[[Page 20207]]

    (B) Establishment of documentation tracking procedures designed to 
ensure the completeness of relevant documentation and to resolve any 
documentation exceptions on a timely basis.
    (vi) Operational risk. Operational risk policies and procedures 
shall take into account, among other things:
    (A) Secure and reliable operating and information systems with 
adequate, scalable capacity, and independence from the business trading 
unit;
    (B) Safeguards to detect, identify, and promptly correct 
deficiencies in operating and information systems; and
    (C) Reconciliation of all data and information in operating and 
information systems.
    (vii) Settlement risk. Settlement risk policies and procedures 
shall take into account, among other things:
    (A) Establishment of standard settlement instructions with each 
counterparty;
    (B) Procedures to track outstanding settlement items and aging 
information in all accounts, including nostro and suspense accounts; 
and
    (C) Procedures to ensure timely payments to counterparties and to 
resolve any late payments.
    (5) Use of central counterparties. Each swap dealer and major swap 
participant shall establish policies and procedures relating to its use 
of central counterparties. Such policies and procedures shall:
    (i) Require the use of central counterparties where clearing is 
required pursuant to Commission regulation or order, unless the 
counterparty has properly invoked a clearing exemption under Commission 
regulations;
    (ii) Set forth the conditions for the voluntary use of central 
counterparties for clearing when available as a means of mitigating 
counterparty credit risk; and
    (iii) Require diligent investigation into the adequacy of the 
financial resources and risk management procedures of any central 
counterparty through which the swap dealer or major swap participant 
clears.
    (6) Compliance with margin and capital requirements. Each swap 
dealer and major swap participant shall satisfy all capital and margin 
requirements established by the Commission or prudential regulator, as 
applicable.
    (7) Monitoring of compliance with Risk Management Program. Each 
swap dealer and major swap participant shall establish policies and 
procedures to detect violations of the Risk Management Program; to 
encourage employees to report such violations to senior management, 
without fear of retaliation; and to take specified disciplinary action 
against employees who violate the Risk Management Program.
    (d) Business trading unit. Each swap dealer and major swap 
participant shall establish policies and procedures that, at a minimum:
    (1) Require all trading policies be approved by the governing body 
of the swap dealer or major swap participant;
    (2) Require that traders execute transactions only with 
counterparties for whom credit limits have been established;
    (3) Provide specific quantitative or qualitative limits for traders 
and personnel able to commit the capital of the swap dealer or major 
swap participant;
    (4) Monitor each trader throughout the trading day to prevent the 
trader from exceeding any limit to which the trader is subject, or from 
otherwise incurring unauthorized risk;
    (5) Require each trader to follow established policies and 
procedures for executing and confirming all transactions;
    (6) Establish means to detect unauthorized trading activities or 
any other violation of policies and procedures;
    (7) Ensure that all trade discrepancies are documented and, other 
than immaterial, clerical errors, are brought to the immediate 
attention of management of the business trading unit;
    (8) Ensure that broker statements and payments to brokers are 
periodically audited by persons independent of the business trading 
unit;
    (9) Ensure that use of trading programs is subject to policies and 
procedures governing the use, supervision, maintenance, testing, and 
inspection of the program; and
    (10) Require the separation of personnel in the business trading 
unit from personnel in the risk management unit.
    (e) Review and testing. (1) Risk Management Programs shall be 
reviewed and tested on at least an annual basis, or upon any material 
change in the business of the swap dealer or major swap participant 
that is reasonably likely to alter the risk profile of the swap dealer 
or major swap participant.
    (2) The annual reviews of the Risk Management Program shall include 
an analysis of adherence to, and the effectiveness of, the risk 
management policies and procedures, and any recommendations for 
modifications to the Risk Management Program. The annual testing shall 
be performed by qualified internal audit staff that are independent of 
the business trading unit being audited or by a qualified third party 
audit service reporting to staff that are independent of the business 
trading unit. The results of the quarterly reviews of the Risk 
Management Program shall be promptly reported to and reviewed by, the 
chief compliance officer, senior management, and governing body of the 
swap dealer or major swap participant.
    (3) Each swap dealer and major swap participant shall document all 
internal and external reviews and testing of its Risk Management 
Program and written risk management policies and procedures including 
the date of the review or test; the results; any deficiencies 
identified; the corrective action taken; and the date that corrective 
action was taken. Such documentation shall be provided to Commission 
staff, upon request.
    (f) Distribution of risk management policies and procedures. The 
Risk Management Program shall include procedures for the timely 
distribution of its written risk management policies and procedures to 
relevant supervisory personnel. Each swap dealer and major swap 
participant shall maintain records of the persons to whom the risk 
management policies and procedures were distributed and when they were 
distributed.
    (g) Recordkeeping. (1) Each swap dealer and major swap participant 
shall maintain copies of all written approvals required by this 
section.
    (2) All records or reports that a swap dealer or major swap 
participant is required to maintain pursuant to this regulation shall 
be maintained in accordance with Commission Regulation Sec.  1.31 and 
shall be made available promptly upon request to representatives of the 
Commission and to representatives of applicable prudential regulators.


Sec.  23.601  Monitoring of position limits.

    (a) Each swap dealer and major swap participant shall establish and 
enforce written policies and procedures that are reasonably designed to 
monitor for and prevent violations of applicable position limits 
established by the Commission, a designated contract market, or a swap 
execution facility, and to monitor for and prevent improper reliance 
upon any exemptions or exclusions from such position limits. For 
purposes of this regulation, such policies and procedures shall be 
referred to as ``Position Limit Procedures.'' The Position Limit 
Procedures shall be incorporated into

[[Page 20208]]

the Risk Management Program of the swap dealer or major swap 
participant.
    (b) For purposes of the Position Limit Procedures, each swap dealer 
and major swap participant shall convert all swap positions into 
equivalent futures positions using the methodology set forth in 
Commission regulations.
    (c) Each swap dealer and major swap participant shall provide 
training to all relevant personnel on applicable position limits on an 
annual basis and shall promptly notify personnel upon any change to 
applicable position limits. Each swap dealer and major swap participant 
shall maintain records of such training and notifications including the 
substance of the training, the identity of those receiving training, 
and the identity of those notified of changes to applicable position 
limits.
    (d) Each swap dealer and major swap participant shall diligently 
monitor its trading activities and diligently supervise the actions of 
its partners, officers, employees, and agents to ensure compliance with 
the Position Limit Procedures of the swap dealer or major swap 
participant.
    (e) The Position Limit Procedures of each swap dealer and major 
swap participant shall implement an early warning system designed to 
detect and alert its senior management when position limits are in 
danger of being breached (such as when trading has reached a percentage 
threshold of the applicable position limit, and when position limits 
have been exceeded). Any detected violation of applicable position 
limits shall be reported promptly to the firm's governing body. Any 
detected violation of applicable position limits, other than on-
exchange violations reported to the Commission by a designated contract 
market or a swap execution facility, shall be reported promptly to the 
Commission. Each swap dealer and major swap participant shall maintain 
a record of any early warning received, any position limit violation 
detected, any action taken as a result of either, and the date action 
was taken.
    (f) Each swap dealer and major swap participant that transacts in 
instruments for which position limits have been established by the 
Commission, a designated contract market, or a swap execution facility 
shall test its Position Limit Procedures for adequacy and effectiveness 
at least once each calendar quarter and maintain records of such tests; 
the results thereof; any action that is taken as a result thereof 
including, without limitation, any recommendations for modifications to 
the firm's Position Limit Procedures; and the date action was taken.
    (g) Each swap dealer and major swap participant shall document its 
compliance with applicable position limits established by the 
Commission, a designated contract market, or a swap execution facility 
in a written report on a quarterly basis. Such report shall be promptly 
reported to and reviewed by the chief compliance officer, senior 
management, and governing body of the swap dealer or major swap 
participant, and shall include, without limitation, a list of all early 
warnings received, all position limit violations, the action taken in 
response, the results of the quarterly position limit testing required 
by this regulation, any deficiencies in the Position Limit Procedures, 
the status of any pending amendments to the Position Limit Procedures, 
and any action taken to amend the Position Limit Procedures to ensure 
compliance with all applicable position limits. Each swap dealer and 
major swap participant shall retain a copy of this report.
    (h) On an annual basis, each swap dealer and major swap participant 
shall audit its Position Limit Procedures as part of the audit of its 
Risk Management Program required by Commission regulations.
    (i) All records required to be maintained pursuant to these 
regulations shall be maintained in accordance with Commission 
Regulation Sec.  1.31 and shall be made available promptly upon request 
to representatives of the Commission and to representatives of 
applicable prudential regulators.


Sec.  23.602  Diligent supervision.

    (a) Supervision. Each swap dealer and major swap participant 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). Such 
system shall be reasonably designed to achieve compliance with the 
requirements of the Commodity Exchange Act and Commission regulations.
    (b) Supervisory System. Such supervisory system shall provide, at a 
minimum, for the following:
    (1) The designation, where applicable, of at least one person with 
authority to carry out the supervisory responsibilities of the swap 
dealer or major swap participant for all activities relating to its 
business as a swap dealer or major swap participant.
    (2) The use of reasonable efforts to determine that all supervisors 
are qualified and meet such standards of training, experience, 
competence, and such other qualification standards as the Commission 
finds necessary or appropriate.


Sec.  23.603  Business continuity and disaster recovery.

    (a) Business continuity and disaster recovery plan required. Each 
swap dealer and major swap participant shall establish and maintain a 
written business continuity and disaster recovery plan that outlines 
the procedures to be followed in the event of an emergency or other 
disruption of its normal business activities. The business continuity 
and disaster recovery plan shall be designed to enable the swap dealer 
or major swap participant to continue or to resume any operations by 
the next business day with minimal disturbance to its counterparties 
and the market, and to recover all documentation and data required to 
be maintained by applicable law and regulation.
    (b) Essential components. The business continuity and disaster 
recovery plan of a swap dealer or major swap participant shall include 
the following components:
    (1) Identification of the documents, data, facilities, 
infrastructure, personnel and competencies essential to the continued 
operations of the swap dealer or major swap participant and to fulfill 
the obligations of the swap dealer or major swap participant.
    (2) Identification of the supervisory personnel responsible for 
implementing each aspect of the business continuity and disaster 
recovery plan and the emergency contacts required to be provided 
pursuant to this regulation.
    (3) A plan to communicate with the following persons in the event 
of an emergency or other disruption, to the extent applicable to the 
operations of the swap dealer or major swap participant: employees; 
counterparties; swap data repositories; execution facilities; trading 
facilities; clearing facilities; regulatory authorities; data, 
communications and infrastructure providers and other vendors; disaster 
recovery specialists and other persons essential to the recovery of 
documentation and data, the resumption of operations, and compliance 
with the Commodity Exchange Act and Commission regulations.
    (4) Procedures for, and the maintenance of, back-up facilities, 
systems, infrastructure, alternative staffing and other resources to 
achieve the timely recovery of data and documentation and to resume 
operations as soon as reasonably

[[Page 20209]]

possible and generally within the next business day.
    (5) Maintenance of back-up facilities, systems, infrastructure and 
alternative staffing arrangements in one or more areas that are 
geographically separate from the swap dealer's or major swap 
participant's primary facilities, systems, infrastructure and personnel 
(which may include contractual arrangements for the use of facilities, 
systems and infrastructure provided by third parties).
    (6) Back-up or copying, with sufficient frequency, of documents and 
data essential to the operations of the swap dealer or major swap 
participant or to fulfill the regulatory obligations of the swap dealer 
or major swap participant and storing the information off-site in 
either hard-copy or electronic format.
    (7) Identification of potential business interruptions encountered 
by third parties that are necessary to the continued operations of the 
swap dealer or major swap participant and a plan to minimize the impact 
of such disruptions.
    (c) Distribution to employees. Each swap dealer and major swap 
participant shall distribute a copy of its business continuity and 
disaster recovery plan to relevant employees and promptly provide any 
significant revision thereto. Each swap dealer and major swap 
participant shall maintain copies of the business continuity and 
disaster recovery plan at one or more accessible off-site locations. 
Each swap dealer and major swap participant shall train relevant 
employees on applicable components of the business continuity and 
disaster recovery plan.
    (d) Commission notification. Each swap dealer and major swap 
participant shall promptly notify the Commission of any emergency or 
other disruption that may affect the ability of the swap dealer or 
major swap participant to fulfill its regulatory obligations or would 
have a significant adverse effect on the swap dealer or major swap 
participant, its counterparties, or the market.
    (e) Emergency contacts. Each swap dealer and major swap participant 
shall provide to the Commission the name and contact information of two 
employees who the Commission can contact in the event of an emergency 
or other disruption. The individuals identified shall be authorized to 
make key decisions on behalf of the swap dealer or major swap 
participant and have knowledge of the firm's business continuity and 
disaster recovery plan. The swap dealer or major swap participant shall 
provide the Commission with any updates to this information promptly.
    (f) Review and modification. A member of the senior management of 
each swap dealer and major swap participant shall review the business 
continuity and disaster recovery plan annually or upon any material 
change to the business. Any deficiencies found or corrective action 
taken shall be documented.
    (g) Testing and audit. Each business continuity and disaster 
recovery plan shall be tested annually by qualified, independent 
internal personnel or a qualified third party service. The date the 
testing was performed shall be documented, together with the nature and 
scope of the testing, any deficiencies found, any corrective action 
taken, and the date that corrective action was taken. Each business 
continuity and disaster recovery plan shall be audited at least once 
every three years by a qualified third party service. The date the 
audit was performed shall be documented, together with the nature and 
scope of the audit, any deficiencies found, any corrective action 
taken, and the date that corrective action was taken.
    (h) Business continuity and disaster recovery plans required by 
other regulatory authorities. A swap dealer or major swap participant 
shall comply with the requirements of this regulation in addition to 
any business continuity and disaster recovery requirements that are 
imposed upon the swap dealer or major swap participant by its 
prudential regulator or any other regulatory or self-regulatory 
authority.
    (i) Recordkeeping. The business continuity and disaster recovery 
plan of the swap dealer and major swap participant and all other 
records required to be maintained pursuant to this section shall be 
maintained in accordance with Commission Regulation Sec.  1.31 and 
shall be made available promptly upon request to representatives of the 
Commission and to representatives of applicable prudential regulators.


Sec.  23.604  [Reserved]


Sec.  23.605  Conflicts of interest policies and procedures.

    (a) Definitions. For purposes of this section, the following terms 
shall be defined as provided.
    (1) Affiliate. This term means, with respect to any person, a 
person controlling, controlled by, or under common control with, such 
person.
    (2) Business trading unit. This term means any department, 
division, group, or personnel of a swap dealer or major swap 
participant or any of its affiliates, whether or not identified as 
such, that performs, or personnel exercising direct supervisory 
authority over the performance of, any pricing (excluding price 
verification for risk management purposes), trading, sales, marketing, 
advertising, solicitation, structuring, or brokerage activities on 
behalf of a swap dealer or major swap participant or any of its 
affiliates.
    (3) Clearing unit. This term means any department, division, group, 
or personnel of a swap dealer or major swap participant or any of its 
affiliates, whether or not identified as such, that performs, or 
personnel exercising direct supervisory authority over the performance 
of, any proprietary or customer clearing activities on behalf of a swap 
dealer or major swap participant or any of its affiliates.
    (4) Derivative. This term means:
    (i) A contract for the purchase or sale of a commodity for future 
delivery;
    (ii) A security futures product;
    (iii) A swap;
    (iv) Any agreement, contract, or transaction described in section 
2(c)(2)(C)(i) or section 2(c)(2)(D)(i) of the Act;
    (v) Any commodity option authorized under section 4c of the Act; 
and
    (vi) Any leverage transaction authorized under section 19 of the 
Act.
    (5) Non-research personnel. This term means any employee of the 
business trading unit or clearing unit, or any other employee of the 
swap dealer or major swap participant, other than an employee 
performing a legal or compliance function, who is not directly 
responsible for, or otherwise not involved in, research or analysis 
intended for inclusion in a research report.
    (6) Public appearance. This term means any participation in a 
conference call, seminar, forum (including an interactive electronic 
forum) or other public speaking activity before 15 or more persons 
(individuals or entities), or interview or appearance before one or 
more representatives of the media, radio, television or print media, or 
the writing of a print media article, in which a research analyst makes 
a recommendation or offers an opinion concerning a derivatives 
transaction. This term does not include a password-protected Webcast, 
conference call or similar event with 15 or more existing customers, 
provided that all of the event participants previously received the 
most current research report or other documentation that contains the 
required applicable disclosures, and that the research analyst 
appearing at the event corrects and updates during the public 
appearance any disclosures in the research report that are

[[Page 20210]]

inaccurate, misleading, or no longer applicable.
    (7) Research analyst. This term means the employee of a swap dealer 
or major swap participant who is primarily responsible for, and any 
employee who reports directly or indirectly to such research analyst in 
connection with, preparation of the substance of a research report 
relating to any derivative, whether or not any such person has the job 
title of ``research analyst.''
    (8) Research department. This term means any department or division 
that is principally responsible for preparing the substance of a 
research report relating to any derivative on behalf of a swap dealer 
or major swap participant, including a department or division contained 
in an affiliate of a swap dealer or major swap participant.
    (9) Research report. This term means any written communication 
(including electronic) that includes an analysis of the price or market 
for any derivative, and that provides information reasonably sufficient 
upon which to base a decision to enter into a derivatives transaction. 
This term does not include:
    (i) Communications distributed to fewer than 15 persons;
    (ii) Commentaries on economic, political, or market conditions;
    (iii) Statistical summaries of multiple companies' financial data, 
including listings of current ratings;
    (iv) Periodic reports or other communications prepared for 
investment company shareholders or commodity pool participants that 
discuss individual derivatives positions in the context of a fund's 
past performance or the basis for previously-made discretionary 
decisions;
    (v) Any communications generated by an employee of the business 
trading unit that is conveyed as a solicitation for entering into a 
derivatives transaction, and is conspicuously identified as such; and
    (vi) Internal communications that are not given to current or 
prospective customers.
    (b) Policies and procedures. Each swap dealer and major swap 
participant subject to this rule must adopt and implement written 
policies and procedures reasonably designed to ensure that the swap 
dealer or major swap participant and its employees comply with the 
provisions of this rule.
    (c) Research analysts and research reports. (1) Restrictions on 
relationship with research department. (i) Non-research personnel shall 
not direct a research analyst's decision to publish a research report 
of the swap dealer or major swap participant, and non-research 
personnel shall not direct the views and opinions expressed in a 
research report of the swap dealer or major swap participant.
    (ii) No research analyst may be subject to the supervision or 
control of any employee of the swap dealer's or major swap 
participant's business trading unit or clearing unit, and no employee 
of the business trading unit or clearing unit may have any influence or 
control over the evaluation or compensation of a research analyst.
    (iii) Except as provided in paragraph (c)(1)(iv) of this section, 
non-research personnel, other than the board of directors and any 
committee thereof, shall not review or approve a research report of the 
swap dealer or major swap participant before its publication.
    (iv) Non-research personnel may review a research report before its 
publication as necessary only to verify the factual accuracy of 
information in the research report, to provide for non-substantive 
editing, to format the layout or style of the research report, or to 
identify any potential conflicts of interest, provided that:
    (A) Any written communication between non-research personnel and 
research department personnel concerning the content of a research 
report must be made either through authorized legal or compliance 
personnel of the swap dealer or major swap participant or in a 
transmission copied to such personnel; and
    (B) Any oral communication between non-research personnel and 
research department personnel concerning the content of a research 
report must be documented and made either through authorized legal or 
compliance personnel acting as an intermediary or in a conversation 
conducted in the presence of such personnel.
    (2) Restrictions on communications. Any written or oral 
communication by a research analyst to a current or prospective 
counterparty relating to any derivative must not omit any material fact 
or qualification that would cause the communication to be misleading to 
a reasonable person.
    (3) Restrictions on research analyst compensation. A swap dealer or 
major swap participant may not consider as a factor in reviewing or 
approving a research analyst's compensation his or her contributions to 
the swap dealer's or major swap participant's trading or clearing 
business. Except for communicating client or customer feedback, 
ratings, and other indicators of research analyst performance to 
research department management, no employee of the business trading 
unit or clearing unit of the swap dealer or major swap participant may 
influence the review or approval of a research analyst's compensation.
    (4) Prohibition of promise of favorable research. No swap dealer or 
major swap participant may directly or indirectly offer favorable 
research, or threaten to change research, to an existing or prospective 
counterparty as consideration or inducement for the receipt of business 
or compensation.
    (5) Disclosure requirements. (i) Ownership and material conflicts 
of interest. A swap dealer or major swap participant must disclose in 
research reports and a research analyst must disclose in public 
appearances:
    (A) Whether the research analyst maintains a financial interest in 
any derivative of a type, class, or, category that the research analyst 
follows, and the general nature of the financial interest; and
    (B) Any other actual, material conflicts of interest of the 
research analyst or swap dealer or major swap participant of which the 
research analyst has knowledge at the time of publication of the 
research report or at the time of the public appearance.
    (ii) Prominence of disclosure. Disclosures and references to 
disclosures must be clear, comprehensive, and prominent. With respect 
to public appearances by research analysts, the disclosures required by 
this paragraph (c)(5) must be conspicuous.
    (iii) Records of public appearances. Each swap dealer and major 
swap participant must maintain records of public appearances by 
research analysts sufficient to demonstrate compliance by those 
research analysts with the applicable disclosure requirements under 
this paragraph (c)(5).
    (iv) Third-party research reports. (A) For the purposes of this 
paragraph (c)(5)(iv), ``independent third-party research report'' shall 
mean a research report, in respect of which the person or entity 
producing the report:
    (1) Has no affiliation or business or contractual relationship with 
the distributing swap dealer or major swap participant, or that swap 
dealer's or major swap participant's affiliates, that is reasonably 
likely to inform the content of its research reports; and
    (2) Makes content determinations without any input from the 
distributing swap dealer or major swap participant or that swap 
dealer's or major swap participant's affiliates.
    (B) Subject to paragraph (c)(5)(iv)(C) of this section, if a swap 
dealer or major swap participant distributes or makes available any 
independent third-party

[[Page 20211]]

research report, the swap dealer or major swap participant must 
accompany the research report with, or provide a Web address that 
directs the recipient to, the current applicable disclosures, as they 
pertain to the swap dealer or major swap participant, required by this 
section. Each swap dealer and major swap participant must establish 
written policies and procedures reasonably designed to ensure the 
completeness and accuracy of all applicable disclosures.
    (C) The requirements of paragraph (c)(5)(iv)(B) of this section 
shall not apply to independent third-party research reports made 
available by a swap dealer or major swap participant to its customers:
    (1) Upon request; or
    (2) Through a Web site maintained by the swap dealer or major swap 
participant.
    (6) Prohibition of retaliation against research analysts. No swap 
dealer or major swap participant, and no employee of a swap dealer or 
major swap participant who is involved with the swap dealer's or major 
swap participant's pricing, trading, or clearing activities, may, 
directly or indirectly, retaliate against or threaten to retaliate 
against any research analyst employed by the swap dealer or major swap 
participant or its affiliates as a result of an adverse, negative, or 
otherwise unfavorable research report or public appearance written or 
made, in good faith, by the research analyst that may adversely affect 
the swap dealer's or major swap participant's present or prospective 
pricing, trading, or clearing activities.
    (d) Clearing activities. (1) No swap dealer or major swap 
participant shall directly or indirectly interfere with or attempt to 
influence the decision of the clearing unit of any affiliated clearing 
member of a derivatives clearing organization to provide clearing 
services and activities to a particular customer, including but not 
limited to a decision relating to the following:
    (i) Whether to offer clearing services and activities to a 
particular customer;
    (ii) Whether to accept a particular customer for the purposes of 
clearing derivatives;
    (iii) Whether to submit a customer's transaction to a particular 
derivatives clearing organization;
    (iv) Whether to set or adjust risk tolerance levels for a 
particular customer;
    (v) Whether to accept certain forms of collateral from a particular 
customer; or
    (vi) Whether to set a particular customer's fees for clearing 
services based upon criteria that are not generally available and 
applicable to other customers of the swap dealer or major swap 
participant.
    (2) Each swap dealer and major swap participant shall create and 
maintain an appropriate informational partition, as specified in 
section 4s(j)(5)(A) of the Act, between business trading units of the 
swap dealer or major swap participant and clearing units of any 
affiliated clearing member of a derivatives clearing organization to 
reasonably ensure compliance with the Act and the prohibitions 
specified in paragraph (d)(1) of this section. At a minimum, such 
informational partitions shall require that no employee of a business 
trading unit of a swap dealer or major swap participant shall 
supervise, control, or influence any employee of the clearing unit of 
any affiliated clearing member of a derivatives clearing organization.
    (e) Undue influence on counterparties. Each swap dealer and major 
swap participant must adopt and implement written policies and 
procedures that mandate the disclosure to its counterparties of any 
material incentives and any material conflicts of interest regarding 
the decision of a counterparty:
    (1) Whether to execute a derivative on a swap execution facility or 
designated contract market; or
    (2) Whether to clear a derivative through a derivatives clearing 
organization.
    (f) All records that a swap dealer or major swap participant is 
required to maintain pursuant to this regulation shall be maintained in 
accordance with Commission Regulation Sec.  1.31 and shall be made 
available promptly upon request to representatives of the Commission 
and to representatives of the applicable prudential regulator, as 
defined in 7 U.S.C. 1a(39).


Sec.  23.606  General information: availability for disclosure and 
inspection.

    (a) Disclosure of information. (1) Each swap dealer and major swap 
participant shall make available for disclosure to and inspection by 
the Commission and its prudential regulator, as applicable, all 
information required by, or related to, the Commodity Exchange Act and 
Commission regulations, including:
    (i) The terms and condition of its swaps;
    (ii) Its swaps trading operations, mechanisms, and practices;
    (iii) Financial integrity and risk management protections relating 
to swaps; and
    (iv) Any other information relevant to its trading in swaps.
    (2) Such information shall be made available promptly, upon 
request, to Commission staff and the staff of the applicable prudential 
regulator, at such frequency and in such manner as is set forth in the 
Commodity Exchange Act, Commission regulations, or the regulations of 
the applicable prudential regulator.
    (b) Ability to provide information. (1) Each swap dealer and major 
swap participant shall establish and maintain reliable internal data 
capture, processing, storage, and other operational systems sufficient 
to capture, process, record, store, and produce all information 
necessary to satisfy its duties under the Commodity Exchange Act and 
Commission regulations. Such systems shall be designed to produce the 
information within the time frames set forth in the Commodity Exchange 
Act and Commission regulations or upon request, as applicable.
    (2) Each swap dealer and major swap participant shall establish, 
implement, maintain, and enforce written procedures for the capture, 
processing, recording, storage, and production of all information 
necessary to satisfy its duties under the Commodity Exchange Act and 
Commission regulations.
    (c) Record retention. All records or reports that a swap dealer or 
major swap participant is required to maintain pursuant to this 
regulation shall be maintained in accordance with Commission Regulation 
Sec.  1.31 and shall be made available promptly upon request to 
representatives of the Commission and to representatives of applicable 
prudential regulators.


Sec.  23.607  Antitrust considerations.

    (a) No swap dealer or major swap participant shall 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, unless necessary or appropriate to achieve the purposes of 
the Commodity Exchange Act.
    (b) Consistent with its obligations under paragraph (a) of this 
section, each swap dealer and major swap participant shall adopt 
policies and procedures to prevent actions that result in unreasonable 
restraint of trade, or impose any material anticompetitive burden on 
trading or clearing.

    Issued in Washington, DC, on February 23, 2012, by the 
Commission.
David A. Stawick,
Secretary of the Commission.

    Note: The following appendices will not appear in the Code of 
Federal Regulations:


[[Page 20212]]



Appendices to Swap Dealer and Major Swap Participant Recordkeeping and 
Reporting, Duties, and Conflicts of Interest Policies and Procedures; 
Futures Commission Merchant and Introducing Broker Conflicts of 
Interest Policies and Procedures; Swap Dealer, Major Swap Participant, 
and Futures Commission Merchant Chief Compliance Officer--Commission 
Voting Summary and Statements of Commissioners

Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Chilton and 
Wetjen voted in the affirmative; Commissioners Sommers and O'Malia 
voted in the negative.

Appendix 2--Statement of Chairman Gary Gensler

    I support the internal business conduct rule, which will lower 
the risk that swap dealers pose to the rest of the economy. These 
rules are the result of a critical reform in the Dodd-Frank Wall 
Street reform and Consumer Protection Act (Dodd-Frank Act) where 
Congress gave the Commodity Futures Trading Commission (CFTC) 
authority to write rules overseeing swap dealer business conduct. 
This rule is a collection of five CFTC proposals in four key areas.
    First, the final rule establishes a number of duties for swap 
dealers (SDs) and major swap participants (MSPs), including a risk 
management program with policies and procedures to monitor and 
manage the risks associated with their swap activities. Among the 
requirements are: (a) Ensuring the risk management program takes 
into account market risk, credit risk, liquidity risk, foreign 
currency risk, legal risk, operational risk, settlement risk, and 
risk posed by traders; (b) establishing a system of diligent 
supervision by qualified personnel over the SD and MSP activities; 
and (c) ensuring risk management issues are elevated within 
management.
    Second, the final rule establishes firewalls to protect against 
conflicts of interest that can arise between trading and research 
units of SDs, MSPs, futures commission merchants (FCMs), and 
introducing brokers. In addition, the rules establish a firewall 
between clearing and trading that will protect against conflicts of 
interest relating to a firm's clearing activities. A 2009 Commission 
study on harmonization between the Securities and Exchange 
Commission and the CFTC recommended that the Commission establish 
these firewalls, which are based upon similar protections in the 
securities markets.
    Third, the final rule establishes the reporting, recordkeeping 
and daily trading requirements for SDs and MSPs. Importantly, this 
section creates an audit trail detailing the full history of trades 
so the SD or MSP can better ensure compliance internally, and, when 
appropriate, the CFTC can be a more effective cop on the beat.
    Fourth, the final rule establishes requirements for the 
designation of a chief compliance officer of SDs, MSPs and FCMs. 
This compliance officer will ensure that the firm's policies and 
procedures comply with the CEA and Commission regulations. The 
officer will prepare an annual report describing the registrant's 
compliance with its own policies, as well as CEA and Commission 
regulations.

Appendix 3--Statement of Commissioner Scott O'Malia

    The latest issue of The Economist features an article titled 
``Over-regulated America'' \198\ that features as its archetype for 
excessive and badly-written regulation our own Dodd-Frank Act. The 
problem, the article points out, is that rules that sound reasonable 
on their own may impose a huge collective burden due, in part, to 
their complexity. Part of the problem is that we, as The Economist 
points out, are under the impression that we can anticipate and 
regulate for every eventuality. In our hubris, The Economist warns, 
our overreaching tends to defeat our good intentions and creates 
loopholes and perhaps unintentional safe-harbors, leaving our rules 
ineffectual and subject to abuse. The solution The Economist offers 
isn't so unfamiliar, at least to this Commissioner. It is rather 
simple. It is just that: Rules need to be simple. Echoing President 
Obama's 2011 Executive Order 13563 ``Improving Regulation and 
Regulatory Review'' \199\ (which applies equally to independent 
Federal agencies such as the Commodity Futures Trading Commission 
(the ``Commission'' or ``CFTC'') per a subsequent Executive Order 
\200\), The Economist advises that we ought to cut out the verbiage 
and focus on writing rules that articulate broad goals and prescribe 
only what is strictly necessary to achieve them.
---------------------------------------------------------------------------

    \198\ Over-regulated America, Economist, Feb. 18, 2012, at 9.
    \199\ Exec. Order No. 13,563, 76 FR 3821 (Jan. 21, 2011).
    \200\ Exec. Order No. 13,579, 76 FR 41,587 (July 14, 2011).
---------------------------------------------------------------------------

    In my own words, in several prior statements, I have argued that 
we must ensure that regulations are accessible, consistent, written 
in plain language, guided by empirical data, and are easily 
understood. I cautioned that, with each piecemeal rulemaking, we 
risk creating redundancies and inconsistencies that result in 
costs--both opportunity costs and economic costs--without 
corresponding benefits. Consistent with Executive Order 13563, which 
reaffirms prior guidance on the subject of regulatory review issued 
in the 1993 Executive Order 12866 \201\ as well as Office of 
Management and Budget (``OMB'') guidance to Federal agencies with 
respect to said Executive Order,\202\ agencies like the CFTC must go 
out of their way to ensure responsible rulemaking by, among other 
things, undertaking thorough cost-benefit analyses, both 
qualitatively and quantitatively, to ensure that new rules do not 
impose unreasonable costs.
---------------------------------------------------------------------------

    \201\ Exec. Order No. 12,866, 58 FR 51,735 (Oct. 4, 1993).
    \202\ OMB Circular A-4, available at http://www.whitehouse.gov/sites/default/files/omb/assets/regulatory_matters_pdf/a-4.pdf.
---------------------------------------------------------------------------

    I accepted wholeheartedly the mission put upon this 
administration by the President to ``[T]o root out regulations that 
conflict, that are not worth the cost, or that are just plain 
dumb.'' \203\ Today, in furtherance of that mission, I will not 
support the final rules governing various internal business conduct 
standards for futures commission merchants, introducing brokers, 
swap dealers and major swaps participants (the ``Internal Business 
Conduct Rules''). These rules fail to articulate necessary and clear 
performance objectives, are needlessly complex, and create a 
collective burden without the benefit of even an appropriate 
baseline cost-benefit analysis. The fact that OMB's Office of 
Information and Regulatory Affairs \204\ has concurred \205\ with 
our determination that this set of rules qualifies as a ``Major 
Rule'' under the Congressional Review Act with an annual effect on 
the economy of more than $100 million without a fulsome discussion 
of anticipated costs, let alone an analysis based on reasoned 
assumptions or evaluation of the impacts of this rulemaking against 
the pre-statutory baseline, is regulatory malpractice in my book. 
While we set the bar low here at the Commission for our cost-benefit 
analyses, and accept what is ``reasonably feasible,'' this 
rulemaking is nothing but unreasonably feeble.
---------------------------------------------------------------------------

    \203\ Barack Obama, Toward a 21st-Century Regulatory System, 
Wall St. J., Jan. 18, 2011, at A17.
    \204\ The Office of Information and Regulatory Affairs 
(``OIRA''), among other things, reviews draft regulations under 
Executive Order 12866. See Office of Information and Regulatory 
Affairs (``OIRA'') Q & As, available at: http://www.whitehouse.gov/omb/OIRA_QsandAs.
    \205\ I use this term loosely since the only verification we 
received at the Commission was a perfunctory email from an OMB 
employee stating, ``OMB concurs that the rule is major.'' It is 
unclear as to what data OMB could have relied upon in reaching its 
conclusion.
---------------------------------------------------------------------------

    After reviewing the Internal Business Conduct Rules, I have 
reached a tipping point and can no longer tolerate the application 
of such weak standards to analyzing the costs and benefits of our 
rulemakings. Our inability to develop a quantitative analysis, or to 
develop a reasonable comparative analysis of legitimate options, 
hurts the credibility of this Commission and undermines the quality 
of our rules. I believe it is time for professional help, and I will 
be following up this statement with a letter to the Director of the 
OMB seeking an independent review of the Internal Business Conduct 
Rules to determine whether or not this rulemaking fully complies 
with the President's Executive Orders and the OMB guidance found in 
OMB Circular A-4. To the extent that OMB finds any concerns with the 
Commission's economic analysis, I hope that it will provide specific 
recommendations as to how the Commission can improve its cost-
benefit analysis and analytical capabilities.
    Lest anyone think that I am inadvertently waiving a work-product 
or other privilege, the Commission's May 13, 2011 internal Staff 
Guidance on Cost-Benefit Considerations for Final Rulemakings under 
the Dodd-Frank Act (``Staff Guidance'') was made public as Exhibit 2 
to the CFTC's Office of Inspector General's June 13, 2011 Review of 
Cost-Benefit Analyses Performed by the CFTC in

[[Page 20213]]

Connection with Rulemakings Undertaken Pursuant to the Dodd-Frank 
Act, which is available on the CFTC's Web site.\206\ While it is not 
my intent to walk you through the Staff Guidance (or the Inspector 
General's report for that matter), I do think it warrants attention 
for the inattention it gives to both the principles of Executive 
Orders 13563 and 12866 and OMB guidance found in Circular A-4 (``OMB 
Circular A-4''). More specifically, and among other things, the 
Staff Guidance provides that each rulemaking team should, 
``incorporate the principles of Executive Order 13563 to the extent 
they are consistent with section 15(a) [of the Commodity Exchange 
Act] and it is reasonably feasible to do so.'' Keep in mind that 
while Section 15(a) of the Commodity Exchange Act requires the CFTC 
to consider the costs and benefits of its proposed regulations, the 
Commission has interpreted the language of section 15(a) to neither 
require quantification of such costs and benefits, nor to require 
the agency to determine whether the benefits exceed costs or whether 
the proposed rules are the most cost-effective means of reaching 
goals.\207\ ``Rather, section 15 simply requires the Commission to 
`consider the costs and benefits' of its action.'' \208\ That was a 
direct quote from the Federal Register.
---------------------------------------------------------------------------

    \206\ Office of the Inspector General of the Commodity Futures 
Trading Commission, A Review of Cost-Benefit Analyses performed by 
the Commodity Futures Trading Commission in Connection with 
Rulemakings Undertaken Pursuant to the Dodd-Frank Act, June 13, 
2011, available at: www.cftc.gov/ucm/groups/public/@aboutcftc/documents/file/oig_investigation_061311.pdf.
    \207\ A New Regulatory Framework for Trading Facilities, 
Intermediaries and Clearing Organizations, 66 FR 14,262, 14,267 
(March 9, 2001).
    \208\ Id.
---------------------------------------------------------------------------

    Further, under the Staff Guidance--and clearly consistent with 
the Commission's interpretation of section 15--rulemaking teams need 
only quantify costs and benefits ``to the extent it is reasonably 
feasible and appropriate to address comments received.'' As 
additional guidance, staff is advised that ``reasonably feasible and 
appropriate'' means ``the extent to which (i) certain analyses, 
quantitative or qualitative, is [sic] needed to address comments 
received (``appropriate'') and (ii) whether such an analysis may be 
performed with available resources (``reasonably feasible''). 
Accordingly, our interpretation of our duties pursuant to section 
15(a) and Staff Guidance provides that we need not quantify the 
costs or benefits of our rules unless we need to do so in order to 
respond to comments, and that we can do so with whatever resources 
are immediately at our fingertips. As for the Executive Orders, it 
appears that we will incorporate their principles only when they 
neatly align with our own interpretation of section 15(a), and only 
when we can do so without utilizing the resources immediately within 
our coffers.
    Setting the bar this low is pretty remarkable. Indeed, former 
Commissioner and Acting Chairman William P. Albrecht recently 
remarked that expecting any detailed cost-benefit analysis of the 
proposed Dodd-Frank rules is impossible in part because, ``[T]he 
CFTC has never had to develop CBA expertise.'' \209\ Commissioner 
Albrecht advised that, ``A good starting point might be to require 
more detailed analysis of the costs of alternative means of 
accomplishing a particular goal. This would help the agency develop 
CBA expertise and should, over time, lead to a deeper understanding 
of the costs of regulation.'' \210\
---------------------------------------------------------------------------

    \209\ William P. Albrecht, Cost Benefit Analysis and the 
Commodity Futures Trading Commission (``CFTC''), Discussion Paper, 
May 2011, available at http://www.rff.org/RFF/Documents/RFF-DP-11-24.pdf.
    \210\ Id. at 9.
---------------------------------------------------------------------------

    I believe that Commissioner Albrecht's advice is already well-
articulated in both Executive Orders and OMB Circular A-4 as 
incorporated directly into the Staff Guidance. However, the 
Commission skirts these requirements and apparently refuses to 
develop expertise. Instead, the Commission limits itself to 
responding to comments, but only when it doesn't require any 
analysis beyond that which it did for the proposal.
    Additionally, as in today's final rulemaking, the Commission has 
determined, in contradiction of OMB guidance directly on point, that 
in setting the baseline for comparison of the costs and benefits of 
regulatory alternatives, it may set the ``baseline'' to incorporate 
the costs of statutorily mandated rulemakings, regardless of how the 
CFTC has interpreted the statutory goals and regardless of the 
existence of alternative means to comply with such goals. Thereby, 
the Commission is relying on an arbitrary presumption that, ``To the 
extent that * * * new regulations reflect the statutory requirements 
of the Dodd-Frank Act, they will not create costs and benefits 
beyond those resulting from Congress's statutory mandates in the 
Dodd-Frank Act.'' \211\ What does this mean? Well, according to the 
Commission in this rulemaking, it means that for commenters who 
``posit that there is no benefit to be derived from internal 
business conduct standards as mandated by Congress and that the 
mandated provisions do not generate sufficient benefits relative to 
costs or contribute to the purposes (e.g. mitigating systemic risk 
and enhancing transparency) of the Dodd-Frank Act. * * * these 
commenters' concerns fall outside the Commission's regulatory 
discretion to implement sections 4s and 4d of the CEA and fail to 
raise issues subject to consider[ation] under section 15(a).'' \212\ 
That is, the Commission will ignore comments related to required 
rulemaking provisions that mirror statutory language in spite of the 
fact that the Commission always has some level of discretion in 
determining the means to achieve such mandates. Rather the 
Commission will consider comments on new regulations ``that reflect 
the Commission's own determinations regarding implementation of the 
Dodd-Frank Act's provisions. * * * It is these other costs and 
benefits * * * that the Commission considers with respect to the 
section 15(a) factors.'' \213\ It is unacceptable that the 
Commission ignores pre-Dodd-Frank reality and establishes its own 
economic baseline for its rulemakings. This practice defies not only 
common sense, but rigorous and competent economic analysis as well.
---------------------------------------------------------------------------

    \211\ See Swap Dealer and Major Swap Participant Recordkeeping 
and Reporting, Duties, and Conflicts of Interest Policies and 
Procedures; Futures Commission Merchant and Introducing Broker 
Conflicts of Interest Policies and Procedures; Swap Dealer, Major 
Swap Participant, and Futures Commission Merchant Chief Compliance 
Officer, Final Rule, at Section IV of the Preamble.
    \212\ Id. at Section IV of the Cost Benefit Considerations, note 
64.
    \213\ Id. at Section IV of the Preamble.
---------------------------------------------------------------------------

    I will briefly highlight how these rules not only fail to 
include a rational, rigorous, and sustainable cost-benefit analysis, 
but fail to articulate necessary and clear performance objectives, 
are complex, and create an unjustifiable cumulative burden within 
this rule and when considered with other CFTC regulations and those 
of prudential regulators.
    I believe the Commission has failed to carefully and precisely 
identify a clear baseline against which the Commission measured 
costs and benefits and the range of alternatives under consideration 
in this rule. Specifically, the Commission's cost-benefit analysis 
with regard to this rule fails to comply with the basic direction in 
OMB Circular A-4 to establish an appropriate baseline that includes 
an evaluation of the pre-statutory baseline in light of the range of 
Commission discretion as to the manner in which the rules implement 
the statutory goals of section 4s.\214\ The circular also directs 
the Commission to consider alternatives available ``for the key 
attributes or provisions of the rule.'' \215\ The Circular goes on 
to recommend that, ``It is not adequate simply to report a 
comparison of the agency's preferred option to the chosen baseline. 
Whenever you report the benefits and the costs of alternative 
options, you should present both total and incremental benefits and 
costs.'' \216\ It is at this most basic level of analysis where the 
Commission has failed to provide alternative options for 
consideration or has failed to justify its choice of regulation with 
a specific cost-benefit analysis.
---------------------------------------------------------------------------

    \214\ OMB Circular A-4 at 15-16.
    \215\ Id. at 16.
    \216\ Id.
---------------------------------------------------------------------------

    In two examples articulated by the Commission, the Internal 
Business Conduct Rules dismisses out of hand, and without specific 
justification the concerns raised by two commenters: (1) The Federal 
Home Loan Banks who raised concerns regarding compliance burdens and 
duplicative nature of regulations for comparably regulated entities; 
and (2) The Working Group of Commercial Energy Firms, which raised 
concerns that the rules failed to provide benefits with regard to 
risk management and compliance that matched, much less exceeded, the 
cost of compliance. Both concerns were dismissed without 
consideration of alternatives and without any attempt to quantify 
the cited costs.
    With regard to recordkeeping requirements, the Internal Business 
Conduct Rules impose a substantial burden on Swap

[[Page 20214]]

Dealers (``SDs'') and Major Swap Participants (``MSPs'') to maintain 
extensive audio recordings including the requirement to tag each 
taped conversation and make it searchable by transaction and 
counterparty. Understandably, section 4s(g) does require the 
maintenance of such daily trading records for each counterparty and 
that they be identifiable with each swap transaction. However, in 
spite of enormous technological challenges it is unclear as to 
whether or not the Commission undertook any independent effort to 
determine the technical challenges of implementing such a system, 
including, whether such technology currently exists, the costs of 
acquiring and installing such technology, and whether such a system 
could be developed and/or installed within the timetable set by the 
Commission. The Commission has failed the fundamental test in 
Circular A-4 to establish an appropriate baseline and consider a 
range of alternatives with associated costs and benefits. Although 
the Commission modified its original proposal to not require each 
telephone record to be kept as a single file, it fails to quantify 
the specific cost of complying with a costly and technically 
challenging mandate. Moreover, in determining that such audio 
recordings are to be maintained for a one-year period, the 
Commission provides no analytical support for this retention period 
over a more reasonable six-month period other than to say that such 
period will be ``most useful for the Commission's enforcement 
purposes.'' \217\
---------------------------------------------------------------------------

    \217\ See Swap Dealer and Major Swap Participant Recordkeeping 
and Reporting, Duties, and Conflicts of Interest Policies and 
Procedures; Futures Commission Merchant and Introducing Broker 
Conflicts of Interest Policies and Procedures; Swap Dealer, Major 
Swap Participant, and Futures Commission Merchant Chief Compliance 
Officer, Final Rule, at Section IV of the Preamble.
---------------------------------------------------------------------------

    Further, the Commission also ignored commenters' requests to 
allow firms to rely on swap data repositories (``SDRs'') for 
recordkeeping requirements. The analysis states:
    The Commission considered this alternative to its recordkeeping 
rules, but determined that it is premature at this time to permit 
SDs and MSPs to rely solely on SDRs to meet their recordkeeping 
obligations under the rules. * * * At present, SDRs are new entities 
under the Dodd-Frank Act with no track record of operations; and, 
for particular swap asset classes, SDRs have yet to be 
established.\218\
---------------------------------------------------------------------------

    \218\ Id.
---------------------------------------------------------------------------

    In addition to finalizing rules governing registration 
standards, duties and core principles for SDRs,\219\ the Commission 
has already voted on the final rules that establish and compel the 
reporting of swap transaction information to SDRs for purposes of 
real-time public reporting (the ``Real-Time Reporting Rule'') and to 
ensure that complete data concerning swaps is available to 
regulators throughout the existence of each swap and for fifteen 
years following termination.\220\ In addition, the track record of 
entities that will likely be our first registered SDRs is considered 
proven as data from these repositories in both rates and credit have 
been used to establish the foundation for today's re-proposal of 
Procedures to Establish Appropriate Minimum Block Sizes For Large 
Notional Off-Facility Swaps and Block Trades; Further Measures to 
Protect the Identities of Parties to Swap Transactions (the ``Block 
Proposal'').
---------------------------------------------------------------------------

    \219\ Swap Data Repositories: Registration Standards, Duties and 
Core Principles, 76 FR 54,538 (Sept. 1, 2011) (to be codified at 17 
CFR partart 49).
    \220\ Real-Time Public Reporting of Swap Transaction Data, 76 FR 
1,182 (Jan. 9, 2012) (to be codified at 17 CFR part 43); Swap Data 
Recordkeeping and Reporting Requirements, 76 FR 2,136 (Jan. 13, 
2012) (to be codified at 17 CFR partpart 45).
---------------------------------------------------------------------------

    If the Commission truly has doubts as to the fidelity and 
reliability SDR data, then it ought not to have relied upon it in a 
proposed rulemaking. That being said, although the analysis seems to 
indicate that the Commission considered alternatives, it is curious 
as to how the Commission came to the conclusion that the Internal 
Business Conduct Rules are cost-effective, given that they require 
firms to keep duplicative and redundant trade records when all 
trades must be reported to an SDR and stored by the SDR for the life 
of the swap, plus an additional fifteen years--which is ten years 
more than our rules require that such records be kept by 
registrants.
    I would also point out that the Real-Time Reporting Rule 
provides that a party to a publicly-reportable swap transaction 
satisfies its real-time reporting requirements by executing the swap 
on or pursuant to the rules of an exchange or swap execution 
facility.\221\ That is, SDs and MSPs, among others, may rely on 
exchanges and swap execution facilities to report all on-exchange 
trades; there is no mandated separate reporting requirement. 
However, the Internal Business Conduct Rules undermine this relief 
by requiring redundant recordkeeping and by mandating that SDs and 
MSPs save all transaction records and by failing to trust our own 
regulatory-creation to actually serve as a repository for all trade 
data as envisioned by Dodd-Frank Act. I have serious concerns about 
the Commission's ability to monitor and reconcile two sets of 
records, which is the rationale put forth in this final rule.
---------------------------------------------------------------------------

    \221\ Real-Time Public Reporting of Swap Transaction Data, 76 FR 
1,182, 1,244 (Jan. 9, 2012) (to be codified at 17 CFR part 43).
---------------------------------------------------------------------------

    Ironically, the SDRs were created in the Dodd-Frank Act to 
facilitate market transparency and reporting. The Commission could 
provide greater transparency into its own cost-benefit analysis by 
disclosing its assumptions and data to support its conclusions. OMB 
Circular A-4 outlines standards for transparency with the following 
direction, ``A good analysis should be transparent and your results 
must be reproducible. You should clearly set out the basic 
assumptions, methods and data underlying the analysis and discuss 
the uncertainties associated with your estimates.'' \222\ It goes on 
to recommend that, ``To provide greater access to your analysis, you 
should generally post it, with all the supporting documents, on the 
internet so the public can review the findings.'' \223\ I presume 
the Commission feels that this level of compliance is not 
appropriate, given that the commenters failed to demand it, and is 
simply not reasonably feasible.
---------------------------------------------------------------------------

    \222\ OMB Circular A-4 at 17.
    \223\ Id.
---------------------------------------------------------------------------

    One of my major criticisms is that the Internal Business Conduct 
Rules, and, in particular, section 23.600--Risk Management Program 
for Swap Dealers and Major Swap Participants, attempt to cover every 
possible contingency instead of articulating goals and performance 
objectives. Section 4s(j)(2) simply requires that the SD or MSP 
``establish robust and professional risk management systems adequate 
for managing the day-to-day business of the swap dealer or major 
swap participant.'' Could anyone truly argue that that provision 
could not stand largely on its own as a performance objective? Did 
the Commission need to specify to the nth degree the behavior and 
manner of compliance that SDs and MSPs must adopt in order to meet 
that objective? And in doing so, has the Commission created 
loopholes and unintentional safe harbors for those who meet the 
regulatory requirements, but still manage to violate other 
provisions of the Commodity Exchange Act and regulations?
    Another concern is that the Internal Business Conduct Rules do 
not provide for substituted compliance with any of these 
requirements for SDs and MSPs for which the CFTC is not their 
prudential regulator. While one distinct part of the preamble 
regarding rules pertaining to business continuity and disaster 
recovery suggest that if an SD or MSP is subject to other rules that 
meet the requirements of the Commission's rule, then such SD or MSP 
would be in compliance with the Commission's rule, the rules 
themselves do not evidence any attempts to coordinate our regulatory 
requirements with those of our fellow prudential regulators through 
the explicit provision for substituted compliance. More egregiously, 
section 23.603(h)--Business Continuity and Disaster Recovery Plans 
Required by Other Regulatory Authorities, specifically requires SDs 
and MSPs to comply with the business continuity and disaster 
recovery requirements of this regulation ``in addition to any 
business continuity and disaster recovery requirements that are 
imposed on the swap dealer or major swap participant by its 
prudential regulator or any other regulatory or self-regulatory 
authority.'' \224\ There is no quantification or qualification of 
costs and benefits of this regulatory decision, and I am not 
surprised.
---------------------------------------------------------------------------

    \224\ Swap Dealer and Major Swap Participant Recordkeeping and 
Reporting, Duties, and Conflicts of Interest Policies and 
Procedures; Futures Commission Merchant and Introducing Broker 
Conflicts of Interest Policies and Procedures; Swap Dealer, Major 
Swap Participant, and Futures Commission Merchant Chief Compliance 
Officer, Final Rule, at Sec.  23.603(h).
---------------------------------------------------------------------------

    I believe our reasonably ``feasible standard'' as articulated in 
our own Staff Guidance has caused us to miss any marker for 
identifying and using the best, most innovative and least burdensome 
tools to meet the regulatory ends laid out in section 4s of the 
Commodity Exchange Act. We

[[Page 20215]]

should be held accountable for not only failing to even attempt to 
meet the goals set by the President, but for deliberately eschewing 
them. I agree with Chairman Albrecht that the CFTC ought to be 
required to undertake more rigorous cost-benefit analyses. I believe 
all of our analyses should be more rigorous. While it may not solve 
all of our problems with putting out complex and inefficient 
regulations, as noted by Chairman Albrecht, it should help.\225\ I 
will be sending a letter to Acting OMB Director Jeffrey Zients 
requesting his assistance in determining just how far off the 
baseline the Commission has fallen. If OMB Circular A-4 means 
anything at all, then OMB should take action and hold the Commission 
to the Circular's standards.
---------------------------------------------------------------------------

    \225\ Albrecht, supra, at 10.
---------------------------------------------------------------------------

Appendix 4--Statement of Chairman Gensler and Commissioners Chilton and 
Wetjen

    The Commission fully considered all comments and the costs and 
benefits of its actions in this rulemaking. The preamble of this 
Federal Register release specifically addresses issues concerning 
compliance burdens and recordkeeping requirements. Indeed, the 
preamble addresses the comments received in response to, and 
proffers the Commission's rationale for, each of the final rules 
promulgated herein. The final rules also contain numerous examples 
in which the recommendations of commenters have been adopted and 
incorporated into the final rule text. Further, all comments 
relevant to the Commission's consideration of costs and benefits 
were expressly addressed in the Commission's discussion of its cost-
benefit considerations.
    With respect to comments received in response to the 
recordkeeping rules, for example, the Commission is aware that the 
technology exists to implement a recording system as required under 
section 4s(g) of the Commodity Exchange Act (CEA). Indeed, other 
regulatory regimes across the globe already require such recording. 
As explained in the preamble to the proposed recordkeeping rules, in 
2008, the United Kingdom's Financial Services Authority (FSA) 
implemented rules relating to the recording and retention of voice 
conversations and electronic communications, including a recent 
determination that all financial service firms will be required to 
record any relevant communication by employees on their work cell 
phones.\226\ The FSA implemented this requirement based on 
significant technological advancements in recent years, particularly 
with respect to the cost of capturing and retaining copies of 
electronic material, including telephone communications, which have 
made recordkeeping requirements for digital and electronic 
communications more economically feasible and systemically prudent. 
Similar rules mandating the recording of certain voice and/or 
telephone conversations have been promulgated by the Hong Kong 
Securities and Futures Commission and by the Autorit[eacute] des 
March[eacute]s Financiers in France, and have been recommended by 
the International Organization of Securities Commissions 
(IOSCO).\227\ Moreover, as noted on the Commission's Web site, 
Commission staff met with two firms that provide elements of the 
technology needed for compliance with the recording rules under 
section 4s(g). These meetings, as well as the international 
requirements, informed the Commission's response to comments 
received.
---------------------------------------------------------------------------

    \226\ 75 FR 76666, 76668-69 (Dec. 9, 2010) (Reporting, 
Recordkeeping, and Daily Trading Records Requirements for Swap 
Dealers and Major Swap Participants) (citing Financial Services 
Authority, ``Policy Statement: Telephone Recording: Recording of 
voice conversations and electronic communications,'' (March 2008)).
    \227\ Id. at 76669 (citing Code of Conduct for Persons Licensed 
by or Registered with the Securities and Futures Commission para. 
3.9 (2010) (H.K.); General Regulation of the Autorit[eacute] des 
March[eacute]s Financiers art. 313-51 (2010) (Fr.); and Press 
Release, International Organization of Securities Commissions, 
``IOSCO Publishes Recommendations to Enhance Commodity Futures 
Markets Oversight,'' (Mar. 5, 2009), http://www.iosco.org/news/pdf/IOSCONEWS137.pdf).
---------------------------------------------------------------------------

    In addition, one commenter asked that swap dealers (SDs) and 
major swap participants (MSPs) be permitted to rely upon swap data 
repositories (SDRs) to retain records beyond the time periods that 
registrants currently retain such records. In concluding that SDs 
and MSPs must retain their own records as well as submit a certain 
subset of data to SDRs, the Commission did not call into question 
the integrity of its final swap data reporting rules or SDRs 
themselves; rather, the Commission determined that the retention of 
such records by SDs and MSPs is necessary for purposes of risk 
management and monitoring the entity's trading activities for 
unlawful conduct, among other things. Certain trade execution 
information that is critical for risk management and monitoring 
purposes, such as reconciliations to the general ledger, will not be 
retained at SDRs.
    With regard to cost-benefit considerations of these elements of 
the recordkeeping rules, as well as for all of the final rules, the 
Commission strove to limit the burden on SDs and MSPs to the extent 
reasonably possible. For instance, as originally proposed, the 
recording requirement (discussed above) included a provision that 
would have required each transaction record to be maintained as a 
separate electronic file. The Commission dropped this requirement 
and clarified that the rule permits the data to be stored in 
databases that do not need to be tagged with transaction and 
counterparty identifiers so long as the SD or MSP can readily access 
and identify records by running a search on the data. By making this 
change, the Commission responded to comments and limited the rule's 
requirements to those dictated by statute,\228\ reducing the burden 
to the extent reasonably possible.
---------------------------------------------------------------------------

    \228\ See, e.g., CEA Sec.  4s(g)(3) (``Each registered swap 
dealer and major swap participant shall maintain daily trading 
records for each counterparty in a manner and form that is 
identifiable with each swap transaction.'').
---------------------------------------------------------------------------

    Additionally, during the February 23, 2011 public meeting at 
which the Commission adopted these final rules, there was discussion 
of a concern relating to the technological and economic feasibility 
of the recordkeeping requirements. Responding to the concern, the 
Commission adopted 5 CFR 23.206, which delegates to the Director of 
the Division of Swap Dealer and Intermediary Oversight ``the 
authority to establish an alternative compliance schedule for 
requirements of Sec.  23.202 that are found to be technologically or 
economically impracticable for an affected swap dealer or major swap 
participant that seeks, in good faith, to comply with the 
requirements of Sec.  23.202 within a reasonable time period beyond 
the date on which compliance by such swap dealer or major swap 
participant is otherwise required.''
    In sum, in this rulemaking the Commission has adequately 
addressed comments and considered the costs and benefits of its 
actions as required by section 15(a) of the CEA.

[FR Doc. 2012-5317 Filed 4-2-12; 8:45 am]
BILLING CODE 6351-01-P


</pre><script data-cfasync="false" src="/cdn-cgi/scripts/5c5dd728/cloudflare-static/email-decode.min.js"></script></body>
</html>