20128 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

1Commission regulations referred to herein are 

found at 17 CFR Ch. 1. 

2See 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)). 

3See 76 FR 25274 (May 4, 2011) (extending or reopening comment periods for multiple Dodd-Frank 

proposed rulemakings). 

4Comment files for each proposed rulemaking 

can be found on the Commission Web site, 

www.cftc.gov. 

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-ofinterest 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, ffisanich@cftc.gov, Division 

of Swap Dealer and Intermediary 

Oversight, Ward P. Griffin, Counsel, 

202–418–5425, wgriffin@cftc.gov, Office 

of the General Counsel, and Hannah 

Ropp, Economist, 202–418–5228, 

hropp@cftc.gov, 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—§ 23.201 

D. Daily Trading Records—§ 23.202 

E. Records; Retention and Inspection— 

§ 23.203 

F. Duties of Swap Dealers and Major Swap 

Participants 

G. Risk Management Program for SDs and 

MSPs—§ 23.600 

H. Monitoring of Position Limits—§ 23.601 

I. Diligent Supervision—§ 23.602 

J. Business Continuity and Disaster 

Recovery—§ 23.603 

K. General Information: Availability for 

Disclosure and Inspection—§ 23.606 

L. Antitrust Considerations—§ 23.607 

M. Conflicts of Interest Policies and 

Procedures by SDs, MSPs, FCMs, and 

IBs—§ 23.605, § 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 

§ 23.200 through § 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); 

§ 23.600 through § 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; § 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 

§ 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 § 3.1 to add chief 

compliance officers to the definition of 

‘‘principal’’ and to add a new definition 

of ‘‘board of directors.’’ 

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 reopened 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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20129 

5The Commission also reviewed the proposed 

rule of the Securities and Exchange Commission 

concerning business conduct standards for securitybased swap dealers and major security-based swap 

participants. See 76 FR 42396 (July 18, 2011). 

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. 

each of these comments in formulating 

the final regulations.5

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 informationsharing 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 marketmaking 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 § 23.600 to only the 

swap activities of SDs and MSPs; (ii) 

define the extent of the recordkeeping 

requirement in § 23.201; and (iii) limit 

the scope of the duties and 

responsibilities of the chief compliance 

officer of an SD or MSP in § 3.3 to the 

swaps activities of SDs and MSPs.6

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 DoddFrank 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 

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20130 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

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— 

§ 23.201 

Proposed § 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 

§ 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 

§ 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 § 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—§§ 23.201(a)(1), 

23.202(a), and 23.202(b) 

Proposed § 23.201(a)(1) required SDs 

and MSPs to keep transaction records in 

a form identifiable and searchable by 

transaction and by counterparty. 

Proposed §§ 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 § 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 § 23.202(a) and § 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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20131 

7See 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. 

requirements of § 1.31, as required 

under § 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—§ 23.201(b) 

As proposed, § 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 

§ 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— 

§ 23.201(b) 

Proposed § 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

6. Records of Marketing and Sales 

Materials—§ 23.201(b)(4) 

Proposed § 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—§ 23.201(c) and 

§ 23.201(d) 

Proposed § 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 § 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 § 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—§ 23.201(d)(2) & 

(3) 

Proposed § 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. 

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20132 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

8See 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. 9See Recordkeeping NPRM, 75 FR at 76668. 

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 § 23.201. 

D. Daily Trading Records—§ 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 

§ 23.202 prescribed daily trading record 

requirements, which would include 

trade information related to preexecution, execution, and postexecution data. 

1. Records of Pre-Execution Trade 

Information—§ 23.202(a)(1) 

Proposed § 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 

§ 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 § 23.202 

that are found to be technologically and 

economically impracticable for an SD or 

MSP affected by § 23.202. The purpose 

of § 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 § 23.202. 

In order to obtain relief under 

§ 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 § 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 § 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 § 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 

§ 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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20133 

10See Real-Time Public Reporting of Swap 

Transaction Data, 77 FR 1182, 1251 (Jan. 9, 2012). 

11See Swap Data Recordkeeping and Reporting 

Requirements, 77 FR 2136, 2212 (Jan. 13, 2012). 

12See Swap Data Recordkeeping and Reporting 

Requirements, 77 FR 2136, 2212, 2215 (Jan. 13, 

2012). 

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. 

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—§ 23.202(a)(1)(ii) 

Proposed § 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)— 

§ 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 § 23.202, the 

Commission is ensuring that the 

requirements of Part 23, Part 43, and 

Part 45 remain consistent to the extent 

possible. 

4. Records of Time of Execution— 

§ 23.202(a)(2)(iv) 

Proposed § 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 § 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 § 1.35. 

5. Records of Reconciliation Processes— 

§ 23.202(a)(3)(iii) 

Proposed § 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 

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20134 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

13See Confirmation, Portfolio Reconciliation, and 

Portfolio Compression Requirements for Swap 

Dealers and Major Swap Participants, 75 FR 81519, 

81531 (Dec. 28, 2010). 

14See Adaptation of Commission Regulations to 

Accommodate Swaps, 76 FR 33066, 33088 (June 7, 

2011). 

15See 17 CFR 45.2, Swap Data Recordkeeping and 

Reporting Requirements, 77 FR 2136, 2198 (Jan. 13, 

2012). 

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 § 23.502 on 

portfolio reconciliation.13 Thus, the 

Commission is adopting the rule as 

proposed. 

6. Daily Trading Records for Cash and 

Forward Transactions Related to a 

Swap—§ 23.202(b) 

Proposed § 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 § 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 

§ 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 

§ 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— 

§ 23.203 

1. Swap and Related Cash or Forward 

Record Retention Period—§ 23.203(b)(2) 

Proposed § 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 

§ 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 § 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. 

2. ‘‘Readily Accessible’’—§ 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 § 1.31 of 

the Commission’s regulations for several 

years. Specifically, § 1.31 requires that 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20135 

16Regulation 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.’’ 

17See Adaptation of Commission Regulations to 

Accommodate Swaps, 76 FR 33066, 33088 (June 7, 

2011). 

18This 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. 19No comments were received on the proposed 

§ 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]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

3. Records To Be Retained in 

Accordance With Commission 

Regulation 1.31—§ 23.203(b) 

Proposed § 23.203(b) required SDs 

and MSPs to maintain records in 

accordance with existing § 1.31. 

The Working Group commented that 

§ 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 § 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 § 1.31 have been 

addressed by a subsequent rule proposal 

to amend § 1.31 to reflect current 

technologies and industry practices 

related to digitized data storage.17 If 

these amendments are finalized, the 

Commission believes that § 1.31 will be 

compatible with electronic records in a 

trading system and other records that do 

not originate from a written document. 

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. 

G. Risk Management Program for SDs 

and MSPs—§ 23.600 

The Commission proposed § 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 § 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—§ 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 § 23.600(a) will apply only to 

provisions contained in § 23.600. The 

Commission is adopting the definitions 

largely as proposed, with the exceptions 

discussed below. 

a. Business Trading Unit—§ 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—§ 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. 

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20136 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

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— 

§ 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 § 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 § 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 § 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 § 23.600(c)(1)(ii) through 

its participation in a consolidated entity 

risk management program. 

3. Flexibility To Design Risk 

Management Program—§ 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 § 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—§ 23.600(b)(2) 

Proposed § 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 

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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— 

§ 23.600(b)(5) 

Proposed § 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 marketregulated 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 § 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 § 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, § 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 § 23.605 to ensure research analysts 

are free from conflicts of interest, as 

proposed by the Better Markets 

comment. 

6. Risk Measurement Frequency— 

§ 23.600(c)(4) 

Proposed § 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—§ 23.600(c)(1)(i) 

Proposed § 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. 

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In response to SIFMA’s comments, 

the Commission is revising proposed 

§ 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—§ 23.600(c)(3) 

Proposed § 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 § 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 § 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—§ 23.600(c)(2)(ii) 

Proposed § 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— 

§ 23.600(c)(2)(ii) 

Proposed § 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—§ 23.600(e) 

Proposed § 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 

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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 

§ 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—§ 23.600(c)(4) 

As proposed, § 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 § 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—§ 23.600(c)(4)(i) 

Proposed § 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— 

§ 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—§ 23.600(d)(2) 

Proposed § 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— 

§ 23.600(c)(4)(ii)(A) 

Proposed § 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—§ 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, 

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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 noncash collateral in a timely manner 

without significant effect on price. 

18. Foreign Currency Risk— 

§ 23.600(c)(4)(iv) 

Proposed § 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—§ 23.600(c)(4)(v) 

Proposed § 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—§ 23.600(c)(4)(vi) 

Proposed § 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 § 23.600(d)(9), as 

discussed further below. 

21. Use of Central Counterparties— 

§ 23.600(c)(5) 

Proposed § 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 § 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—§ 23.600(d) 

As proposed, § 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. 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20141 

The Commission thus has made no 

changes to the rule. 

23. Transaction Entry by Traders— 

§ 23.600(d)(5) 

Proposed § 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 midoffice 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— 

§ 23.600(d)(4) & (d)(9) 

As proposed, § 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 

§ 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—§ 23.600(d)(8) 

Proposed § 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 

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20142 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

20See 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). 

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— 

§ 23.601 

To implement section 4s(j)(1) of the 

CEA, the Commission proposed § 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 § 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—§ 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 

§ 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 § 151.7 of the final position 

limit rules for guidance when 

establishing the Position Limit 

Procedures required by this rule. 

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-thefact 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—§ 23.601(c) 

SIFMA recommended that the 

Commission revise § 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— 

§ 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—§ 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 § 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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 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 onexchange 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—§ 23.601(f) and (h) 

With respect to monthly testing of 

Position Limit Procedures required 

under proposed § 23.601(f) and annual 

audit required under proposed 

§ 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 § 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—§ 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 § 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—§ 23.602 

Proposed § 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 

§ 23.602 (Diligent Supervision) is 

similar to the NFA’s supervision rule for 

FCMs (Compliance Rule 2–9), and MFA 

is concerned that § 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 § 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—§ 23.603 

Proposed § 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 

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20144 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

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 nonsystemically 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 § 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—§ 23.606 

Proposed § 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—§ 23.607 

Proposed § 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 

§ 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 § 23.607(a) and 

instead rely upon the policies and 

procedures requirement included in 

§ 23.607(b). 

Having considered SIFMA’s 

comments, the Commission is adopting 

the rule as proposed. The blanket 

prohibition in § 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—§ 23.605, § 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 

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21 17 CFR 140.99. 

22 17 CFR 13.2. 

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 

§ 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 

§ 1.71, as set forth in the FCM/IB 

Conflicts NPRM, addressed the statutory 

mandate of section 4d(c). 

As proposed, §§ 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 SelfRegulatory Organizations (SROs) 

Although proposed §§ 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-ofinterest 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-ofinterest 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-ofinterest 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-ofinterest 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, noaction 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

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 

§ 23.605 and § 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—§ 23.605(a), § 1.71(a) 

a. Business Trading Unit— 

§ 23.605(a)(2), § 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 

§ 23.605(a)(2) and § 1.71(a)(2) apply to 

traditional ‘‘front office’’ functions and 

not to those functions that support the 

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20146 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

23The 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). 

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 § 23.605(a)(5) and 

§ 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—§ 23.605(a)(3), 

§ 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 

§ 23.605 and § 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 § 23.605(a)(5) and 

§ 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— 

§ 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 nonresearch 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—§ 23.605(a)(6), 

§ 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.’’ 

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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 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—§ 23.605(a)(8), 

§ 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—§ 23.605(a)(9), 

§ 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 § 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 § 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 § 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 

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20148 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

24The 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). 

25This language is being adopted by the 

Commission as proposed; however, the provision 

has been renumbered as § 23.605(a)(9)(vi). 

classes, economic variables commonly 

referenced in derivatives, and on-therun 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

5. Policies and Procedures—§ 23.605(b) 

As proposed, § 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 § 23.605(b) without revision. 

6. Research Analysts and Research 

Reports—§ 23.605(c), § 1.71(c) 

a. Separation of Research Analysts From 

Business Trading Unit and Clearing 

Unit—§ 23.605(c)(1) 

Proposed §§ 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 § 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

b. Conflicts of Interest Adequately 

Addressed by Existing Commission and 

NFA Rules 

Proposed § 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 § 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, § 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 

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26The provisions of § 1.71(d) are applicable only 

to FCMs. 

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, § 1.71(c) of the rule would 

not apply. Further, § 1.71(b) has been 

changed to set forth a separate policies 

and procedures requirement for small 

IBs. The recommended language of new 

§ 1.71(b)(2) largely mirrors the statutory 

requirement of section 4d(c). However, 

the Commission believes that small IBs 

should be subject to § 1.71(e) (policies 

and procedures mandating disclosure of 

material incentives and conflicts of 

interest) and § 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. 

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 § 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 StewartPeterson 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 conflictof-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 § 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 § 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 

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20150 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

27See, 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/. 

28The 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 § 180.1 of Commission regulations, among 

other fraudulent, deceptive, and manipulative 

practices protections under the CEA and 

Commission regulations. 

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 § 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. 

g. Restriction on Non-Research 

Personnel From ‘‘Influencing the 

Content’’ of Research Reports— 

§ 23.605(c)(1)(i), § 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 § 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 § 23.605 and § 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—§ 23.605(c)(1)(ii), 

§ 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 § 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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20151 

this issue and may incorporate such a 

restriction in a future rulemaking. 

j. Requirement That Legal/Compliance 

Personnel Supervise Communication 

Between Research and Non-Research 

Personnel—§ 23.605(c)(1)(iv) 

The proposed rule permitted nonresearch 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 nonresearch personnel will act in an 

unlawful manner, inadvertently or 

otherwise. 

k. Restrictions on Research Analyst 

Communications—§ 23.605(c)(2), 

§ 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 §§ 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— 

§ 23.605(c)(3), § 1.71(c)(3) 

Proposed §§ 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 nonresearch 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 

§§ 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-ofinterest 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 

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20152 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

29The 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. 

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—§ 1.71(c)(4) 

As proposed, § 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—§ 23.605(c)(5), 

§ 1.71(c)(5) 

Proposed §§ 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 §§ 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’’ (§ 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 §§ 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. 

o. Disclosure of Conflicts in Third-Party 

Research Reports—§ 23.605(c)(5)(iv), 

§ 1.71(c)(5)(iv) 

As proposed, §§ 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 securitiesrelated. 

FIA, ISDA, and SIFMA, in a joint 

comment, questioned how § 23.605 and 

§ 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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 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-ofinterest 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 § 23.605 or 

§ 1.71 and securities regulations must 

only comply with § 23.605 or § 1.71 

when acting in the capacity as a 

‘‘research analyst,’’ as defined by 

§ 23.605 or § 1.71. FIA/ISDA/SIFMA 

also raised concerns with respect to 

inconsistencies between §§ 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 § 23.605 or § 1.71 and 

securities regulations must only comply 

with § 23.605 or § 1.71 when acting in 

the capacity of a ‘‘research analyst,’’ as 

defined by § 23.605 or § 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-ofinterest policies and procedures 

mandated by new sections 4d(c) and 

4s(j)(5) of the CEA. 

7. Clearing Activities—§ 23.605(d), 

§ 1.71(d) 

a. Separation of Clearing Unit From 

Business Trading Unit—§ 23.605(d)(1) 

and (2); Separation of Business Trading 

Unit and Clearing Unit—§ 1.71(d)(1) 

and (2) 

As proposed, § 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 § 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 § 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 § 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 § 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 § 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 § 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 

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20154 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

30See Requirements for Processing, Clearing, and 

Transfer of Customer Positions, 76 FR 13101, 13109 

(Mar. 10, 2011). 

31See Customer Clearing Documentation and 

Timing of Acceptance for Clearing, 76 FR 45730, 

45737 (Aug. 1, 2011). 

32See Clearing Member Risk Management, 76 FR 

45724, 45729 (Aug. 1, 2011). 

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 § 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, § 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. 

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 § 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 § 23.605(a), in the relevant 

provisions of § 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 onboarding 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 SelfClearing 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 subunits 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—§ 23.605(d)(2); 

Restrictions on SD and MSP Business 

Trading Unit Supervision of Clearing 

Unit of Affiliated FCM—§ 1.71(d)(2)(ii) 

As proposed, § 23.605(d)(2) provided 

that, at a minimum, the § 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, 

§ 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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20155 

33The 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 § 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 

§ 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 § 1.71(d)(1). 

34See Business Conduct Standards for SDs and 

MSPs with Counterparties, 75 FR 80638, 80659 

(Dec. 22, 2010). 

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, §§ 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 §§ 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 § 1.71(d), the 

Commission is making certain changes 

to clarify the intent of the rule. In 

particular, § 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 

§ 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. 

8. Undue Influence on Customers— 

§ 1.71(e) 

As proposed, § 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 § 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 § 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— 

§ 23.605(e) 

As proposed, § 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. 

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 

§ 23.605(e), as proposed. 

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20156 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

35The proposed regulations misnumbered the 

subsections of § 3.3 such that two subsections were 

designated as ‘‘(d).’’ To avoid confusion, this release 

re-designates such sections correctly in brackets. 

36RFEDs are required to designate a CCO and 

prepare an annual compliance certification under 

current Commission regulations. See 17 CFR 5.18(j). 

37See 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). 

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 § 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 § 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 § 3.3([e]) 35 codified 

this requirement and applied these 

requirements to CCOs of FCMs as well. 

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

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. 

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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20157 

38Representatives 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/. 

consultation with the senior officer (as 

permitted under § 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. 

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 

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20158 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

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 § 145.5. 

In response to these comments, the 

Commission notes that a registrant may 

request confidential treatment under 

§ 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 § 145.9 if it wants 

the Commission to determine that a 

particular annual report should be 

subject to confidentiality. 

5. Definitions—§ 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 

§ 3.1(a)(1), and added definitions of 

‘‘compliance policies’’ and ‘‘board of 

directors’’ at § 3.1(g) and (h), 

respectively. 

a. Definition of ‘‘Principal’’—§ 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— 

§ 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 nonretaliation 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. 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 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—§ 3.3(a) 

Proposed § 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 § 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 

§ 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—§ 3.3(a)(1) & (2) 

Proposed § 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 § 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 

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20160 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

39These 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. 

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 

§ 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—§ 3.3(b) 

As proposed, § 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. 

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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20161 

40See Swap Data Repositories: Registration 

Standards, Duties and Core Principles, 76 FR 54538, 

54584 (Sept. 1, 2011). 41See 17 CFR 39.10; Derivatives Clearing 

Organization General Provisions and Core 

Principals, 76 FR 69334, 69434 (Nov. 8, 2011). 

42See Business Conduct Standards for SecurityBased 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’’). 

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. 

9. Duty To Establish Compliance 

Policies—§ 3.3(d)(1) 

Proposed § 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—§ 3.3(d)(2) 

Following section 4s(k)(2)(C) of the 

CEA, proposed § 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

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43See 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’’). 

44See 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’’). 

45See Business Conduct Standards for SecurityBased 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’’). 

11. Duty To Review and Ensure 

Compliance—§ 3.3(d)(3) 

Following the statutory text of section 

4s(k)(2)(E) of the CEA, proposed 

§ 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

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 

§ 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 DoddFrank Act, as implemented through 

these regulations. 

12. Duty To Prepare, Sign, and Certify 

Compliance Annual Report—§ 3.3(d)(6) 

Proposed § 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, 

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46See Swap Data Repositories: Registration 

Standards, Duties and Core Principles, 76 FR at 

54584. 

47See Derivatives Clearing Organization General 

Provisions and Core Principals, 76 FR at 69435. 

48See Core Principles and Other Requirements for 

Swap Execution Facilities, 76 FR 1214, 1252 (Jan. 

7, 2011). 

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

13. Description and Review of 

Compliance in Annual Report— 

§ 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 onesize-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 

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20164 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

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 noncompliance. 

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 § 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—§ 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 PushOut 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— 

§ 3.3([e])(6) 

Proposed § 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— 

§ 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 § 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 § 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—§ 3.3([g]) 

Proposed § 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 

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

§ 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 §§ 23.600 

through 23.607 for at least two years, 

not require compliance with proposed 

§§ 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 § 3.3 for one year after 

registration. With respect to § 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 futuresequivalents, substantially more time 

will be required for firms to design and 

implement procedures to monitor 

compliance with position limits. With 

respect to proposed § 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 

§§ 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 § 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 §§ 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 § 3.3. 

MetLife recommended that the 

Commission allow one year from 

registration as an MSP to comply with 

the proposed §§ 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 § 3.3. 

NSCP stated that 18 months was 

necessary for registrants that do not 

currently have a CCO to comply with 

proposed § 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— 

§§ 23.200–23.205 

The effective date of §§ 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 §§ 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 § 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 

§§ 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 § 3.10. 

2. Duties of SDs and MSPs—§§ 23.600 

Through 23.607 

The effective date of §§ 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 § 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 § 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 § 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 

§ 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 

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20166 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

49As 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. 

51CEA section 1(a)(49)(A). 

52CEA section 1(a)(33)(A)(ii). 

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

54CEA section 4s(j)(2). 

55CEA section 4s(j)(1). 

56CEA section 4s(h)(1). 

57CEA section 4s(j)(3). 

58CEA section 4s(j)(6). 

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

60CEA section 4s(k). 

on which SDs and MSPs are required to 

apply for registration pursuant to § 3.10. 

With respect to § 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 

§ 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 § 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 § 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 § 3.10. 

With respect to § 23.601 (Monitoring 

of Position Limits), § 23.602 (Diligent 

Supervision), § 23.605 (Conflicts of 

Interest Policies and Procedures), 

§ 23.606 (General Information: 

Availability for Disclosure and 

Inspection), and § 23.607 (Antitrust 

Considerations), SDs and MSPs must 

comply with §§ 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 § 3.10. 

3. Conflicts of Interest Policies and 

Procedures by FCMs and IBs—§ 1.71 

The effective date of § 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 § 1.71 by 

such effective date except that such 

FCMs need not comply with § 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 § 3.10. FCMs and IBs that 

are not registered with the Commission 

as of the effective date of this rule must 

comply with § 1.71 upon registration 

with the Commission, except that such 

FCMs need not comply with § 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 § 3.10. 

4. Chief Compliance Officer of FCMs, 

SDs, and MSPs—§ 3.3 

The effective date of § 3.3 and the 

amendments to § 3.1 will be the date 

that is 60 days after publication of the 

final rule in the Federal Register. 

With respect to § 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 § 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 § 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 

§ 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 § 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 § 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 § 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 § 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. 

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: 

• Establishes reporting, 

recordkeeping, and daily trading records 

requirements for SDs and MSPs.53

• 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

• Establishes conflicts-of-interest 

requirements for SDs and MSPs to 

establish information partitions between 

research and trading and between 

trading and clearing.59

• 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

Additionally, Dodd-Frank Act section 

732 amends section 4d of the CEA to 

add conflict of interest requirements for 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20167 

61CEA section 4d(c). 

62CEA section 4d(d). 

63 7 U.S.C. 19(a). 

64Certain 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). 

65See 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. 

67These 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. 

68See 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. 

69See 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. 

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. 

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 DoddFrank 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 DoddFrank 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. 

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 DoddFrank 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. 

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

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 

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20168 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

70The 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. 

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 DoddFrank Act do not generate benefits to justify their 

costs. As noted above, this concern falls beyond the 

Commission’s implementation discretion. 

72SIFMA made a similar argument with respect 

to all SDs and MSPs that are subject to regulation 

by a prudential regulator. 73See CEA section 4s(e). 

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: 

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. 

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

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. 

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 

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74Presumably, 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. 

75The 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. 

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. 

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. 

D. Recordkeeping, Reporting, and Daily 

Trading Records Requirements for Swap 

Dealers and Major Swap Participants 

As added by section 731 of the DoddFrank 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 § 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. 

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 DoddFrank 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 § 23.201(a)(1) required SDs 

and MSPs to keep transaction records in 

a form identifiable and searchable by 

transaction and by counterparty. 

Proposed §§ 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 

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77ATA 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. 

78See Real-Time Public Reporting of Swap 

Transaction Data, 77 FR 1182, 1251 (Jan. 9, 2012). 

79See Swap Data Recordkeeping and Reporting 

Requirements, 77 FR 2136, 2212 (Jan. 13, 2012). 

80Straight-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://fcicstatic.law.stanford.edu/cdn_media/fcic-docs/2005-

07-25%20Counterparty%20Risk%20

Management%20Policy%20Group-%20Toward%20

Greater%20Financial%20Stability.pdf. 

81See definition under proposed § 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. 

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 § 23.202(a) and § 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. 

4. Form of Maintaining Business 

Records 

As proposed, § 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 § 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 § 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. 

7. Timestamp for Quotations Using 

Universal Coordinated Time (UTC) 

Proposed § 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 § 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 straightthrough-processing.80

8. Daily Trading Records for Cash and 

Forward Transactions Related to a Swap 

Proposed § 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 § 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 

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83See Adaptation of Commission Regulations to 

Accommodate Swaps, 76 FR 33066, 33088 (June 7, 

2011). 

84See Swap Data Recordkeeping and Reporting 

Requirements, 77 FR 2136, 2212 (Jan. 13, 2012). 

85See 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. 

86See Swap Data Recordkeeping and Reporting 

Requirements, 77 FR 2136 (Jan. 13, 2012); and RealTime Public Reporting of Swap Transaction Data, 

77 FR 1182 (Jan. 9, 2012). 

87To 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. 

Commission is adopting the rule as 

proposed. 

9. Record Retention Period 

Proposed § 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 § 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 § 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 preexecution 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. 

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: 

• 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; 

• 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; 

• Maintaining daily trading records 

for each counterparty in a manner and 

form that is identifiable with each swap; 

• 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: 

• Compiling transaction, position, 

and business records; 

• Compiling records of data reported 

to an SDR; 

• Compiling records of real-time 

reporting data; 

• 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; 

• 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; 

• Data storage, in physical and/or 

digital format, in most cases for the term 

of a swap plus five years; 

• Telephonic recording system (to 

record voice calls related to 

transactions); and 

• 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

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 

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88See OTC Derivatives Dealers, 63 FR 59362, 

59391 (Nov. 3, 1998). 

89NERA, 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. 

90Although 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. 

91See 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-barclaysexecutive-says.html (reporting on testimony 

provided in previously cited Lehman bankruptcy 

proceeding). 

(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. 

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. 

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: 

• It facilitates a firm’s ability to 

recognize and manage its risk, thereby 

enhancing the risk management of the 

market as a whole. 

• It acts as a disincentive to engage in 

unduly risky or injurious conduct in 

that the conduct will be traceable. 

• 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. 

• It provides a basis for efficiently 

resolving transactional disputes. 

• 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

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. 

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 

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92Although not expressly stated by these 

commenters, the Commission presumes that burden 

concerns motivate their limitation requests, at least 

in part. 

93More 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. 

94Comments of The Working Group, SIFMA, EEI, 

and MetLife, each of whom suggested that proposed 

§ 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. 

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-ofinterest 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 § 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 

§ 23.600. 

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 organizationwide 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. 

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. 

Risk Tolerance Limits: With respect to 

risk tolerance limit exceptions, the 

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20174 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

95With 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. 

96See OCC’s Comptroller’s Handbook, Risk 

Management of Financial Derivatives at 7 (Jan. 

1997); Federal Reserve Board’s Trading and CapitalMarkets Activities Manual. 

97SIFMA 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. 

98The 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. 

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. 

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. 

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. 

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

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 § 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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20175 

99NERA 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 § 23.601. 

100SIFMA 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 

§ 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. 

significant and is warranted by the 

benefit of Commission oversight and 

early risk detection capability. 

4. Frequency of Risk Management 

Program Testing 

Proposed § 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 

§ 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 § 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 § 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 § 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. 

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 onexchange 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). 

With respect to quarterly reporting of 

compliance with position limits to the 

chief compliance officer, senior 

management, and governing body under 

proposed § 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 § 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 

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20176 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

101See section V.B. below for a discussion of the 

Commission’s use of this hourly wage rate. 

102The 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. 

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 § 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

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: 

• Monitoring of trading in swaps to 

prevent violations of applicable position 

limits; 

• Establishing robust and professional 

risk management systems; 

• Disclosing to the Commission and 

applicable prudential regulators general 

information related to swaps and 

establishing internal systems and 

procedures to provide such information; 

• 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: 

• Compiling and reporting certain 

risk assessment reports; 

• Establishing, implementing, testing, 

and reviewing risk management policies 

and procedures; 

• Auditing of policies and 

procedures; 

• Ensuring the monitoring of traders 

and of applicable position limits; 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20177 

103See section V.B. below for a discussion of the 

Commission’s use of this wage rate. 

104The 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 

£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 £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). 

105NERA, 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. 

106See Position Limits for Futures and Swaps, 76 

FR 71626, 71667 (Nov. 18, 2011). 

107These 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. 

108NERA, 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. 

109Although the rules were adapted from existing 

risk management guidance from a variety of sources 

Continued 

• Implementing diligent supervision 

policies and procedures; and 

• 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

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 § 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

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 riskmanagement rules.109 The 

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20178 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

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. 

110Although 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. 

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 § 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. 

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

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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20179 

111See SD/MSP Conflicts NPRM, 75 FR at 71395 

and FCM/IB Conflicts NPRM, 75 FR at 70157. 

112FIA, 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. 

113The proposed rule defined the term ‘‘nonresearch 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.’’ 

114See 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 (‘nonresearch personnel’), other than legal or compliance 

personnel, may review or approve a research report 

of the member before its publication’’). 

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 DoddFrank 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. 

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. 

2. Non-Research Personnel 

EEI argued that the Commission 

should limit the definition of nonresearch 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 

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20180 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

115The 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 * * *.’’ 

116FIA, 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 § 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. 

incremental cost to registrants, the 

Commission believes that ensuring 

unbiased registrant research reports 

accords with statutory intent and 

justifies the increased burden. 

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. 

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-therun swap rates—and thus be susceptible 

to bias. 

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 

§ 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 wellestablished 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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20181 

117NFA, 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. 

118The 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. 

119FIA, 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. 

120The Commission further modified the rules in 

response to commenters to provide that nonresearch 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. 

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. 

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 § 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

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 nonresearch 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

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 nonresearch 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 

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20182 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

121FIA, 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. 

122FIA, ISDA, and SIFMA argued that 

§§ 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. 

123FIA, ISDA, SIFMA, JP Morgan, and EEI argued 

that the required disclosures with respect to thirdparty research reports are unnecessary because 

third-parties are, by definition, independent. 

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 §§ 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 nondiscriminatory and non-prejudicial 

firm-wide compensation guidelines. 

14. Disclosure of Conflicts by Research 

Analysts in Research Reports and Public 

Appearances; Disclosure of Conflicts in 

Third-Party Research Reports 

Proposed §§ 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, 

§§ 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 §§ 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. 

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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20183 

124FIA/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. 

125FIA/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 § 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. 

126FIA/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. 

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 end2012 at the latest.’’ 

128MFA 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 § 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. 

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. 

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, § 23.605(d) and § 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: 

• 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

• 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

• 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

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 wellsupported by commenters.128

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 § 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, § 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 § 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 

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20184 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

129Although 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. 

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: 

• 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. 

• 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. 

• 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-ofinterest policies and procedures: 

• Identifying reports that qualify as 

research reports; 

• Maintaining records of public 

appearances by research analysts; and 

• Designing and implementing 

policies and procedures regarding: 

• Legal or compliance participation 

in communications between research 

analysts and non-research personnel 

regarding the content of research 

reports; 

• Oversight of research analyst 

communications regarding omissions of 

material facts or qualifications that 

would cause the communication to be 

misleading to a reasonable person; 

• Communication of any client or 

customer feedback on research analyst 

performance from the business trading 

unit or clearing unit to research 

department management; 

• Implementing the prohibition on 

promises of favorable research by 

research analysts; 

• Discovering, monitoring, and 

disclosing financial interests maintained 

by research analysts; 

• Implementing the prohibition on 

retaliation against research analysts; 

• Implementing the prohibition of 

interference with or influence on 

decisions with regard to the provision of 

clearing services or activities; and 

• 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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20185 

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). 

131Although 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. 

132Although 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. 

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. 

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. 

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

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. 

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 

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20186 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

133Section 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. 

134Section 4d(d) of the CEA authorizes the 

Commission to promulgate rules concerning the 

duties of a CCO of an FCM. 

135The proposed regulations mis-numbered the 

subsections of § 3.3 such that two subsections were 

designated as ‘‘(d).’’ To avoid confusion, this release 

re-designates such sections correctly in brackets. 

136A more detailed discussion of the comments 

can be found in section II.N. above. 

137Comments 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 wellunderstood. 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 firmspecific 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). 

139See Compliance Programs of Investment 

Companies and Investment Advisers, 68 FR 74714 

(Dec. 24, 2003). 

140The SEC considered the same three alternative 

compliance avenues as noted above for FCMs. See 

id. 

141See Press Release, Senate Committee on 

Agriculture, Nutrition & Forestry, Senator Pat 

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: 

• Proposed § 3.3(a) codified the 

statutory requirements that each FCM, 

SD, and MSP designate a CCO and 

prescribed certain qualifications for the 

position.133

• Proposed § 3.3(d) codified the CCO 

duties defined in section 4s(k)(2) for 

SDs and MSPs, and extended their 

application to FCMs.134

• Proposed § 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. 

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

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

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 

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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-streetreform-and-consumer-protection-act (prepared 

remarks of Sen. Pat Roberts, ranking subcommittee 

member, at December 1, 2011 Senate Committee on 

Agriculture, Nutrition & Forestry). 

142See 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. 

143To 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. 

144NFA 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. 

145NFA 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. 

146Newedge, 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. 

147The 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. 

148NFA also recommended that CCOs explicitly 

be permitted to consult with other employees, 

outside consultants, lawyers, and accountants. 

149Better 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. 

150Better Markets recommended that the rule 

require the CCO office to be located remotely from 

the trading floor. 

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. 

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. 

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 costbenefit implications: 

• Allowing a CCO to perform other 

duties in addition to compliance 

duties; 144

• Designation of multiple CCOs with 

defined areas of responsibility; 145

• Allowing a single officer to be CCO 

for multiple affiliated entities; 146

• Allowing CCOs of multiple 

affiliated entities to report to the board 

of a holding company that controls all 

affiliated entities; 147

• Allowing CCOs to consult with 

other employees, outside consultants, 

lawyers, and accountants in fulfilling 

their duties; 148

• Requiring a senior CCO to have 

responsibility for multiple affiliated 

entities, even if each has its own CCO; 

and 149

• Requiring the CCO to be located 

remotely from the business trading 

unit.150

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 abovenoted 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 

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20188 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

151Rosenthal 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. 

152Cargill 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. 

153MetLife requested that the definition of board 

of directors include expert committees of the whole 

board. 

154The Working Group argued that the CCO 

should be allowed to report to a board of an 

affiliated entity. 

155EEI, 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. 

156Better 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. 

157NWC 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. 

158 Id. 

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 § 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: 

• A CCO should not be viewed as an 

enforcer of compliance polices; and 

• 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 § 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 § 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 § 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 abovedescribed aspects of the proposed rule: 

• The CCO should be permitted to 

report to the governing body or senior 

officer of a division, rather than to the 

board; 152

• The CCO should be permitted to 

report to a board committee, rather than 

to the whole board; 153

• The CCO should be permitted to 

report to the board of a holding 

company; 154

• The CCO should be permitted to 

report to an officer other than the senior 

officer; 155

• CCO compensation and termination 

decisions should be reserved to the 

independent members of the board; 156

• The CCO should be permitted to 

report to the full board at any time, 

without interference; 157 and 

• The CCO should have the right to 

address the board prior to 

termination.158

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, § 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 

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159NFA 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. 

160Cargill 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. 

161Newedge 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. 

162Better 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. 

163The 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). 

164NFA 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. 

165NSCP 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. 

166Newedge 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. 

167NFA 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. 

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 abovedescribed aspects of the proposed rule 

as follows, but no commenter provided 

any quantitative data to justify their 

arguments: 

• It is unnecessary to include 

statutory disqualification as a 

qualification for the CCO; 159

• ‘‘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

• The Commission should require 

CCOs to pass a specific compliance 

examination and be licensed; 161 and 

• The Commission should prohibit 

members of a firm’s legal department 

from acting as CCO due to potential 

conflicts of interest.162

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 wellqualified and fail to fulfill their duties 

under the CEA and rule. The 

Commission estimates that a wellqualified CCO for an FCM, SD, or MSP 

is likely to be compensated at 

approximately $216,000 per year.163

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 wellqualified 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, § 3.3 established a 

number of duties for the CCO. Proposed 

§ 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 § 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 § 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 abovedescribed aspects of the proposed rule 

as follows: 

• Responsibility for resolving 

conflicts of interest belongs more 

appropriately to the board or senior 

officer, not a CCO; 164

• Responsibility for ensuring 

compliance belongs more appropriately 

to the board or senior officer, not a 

CCO; 165

• 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

• Firms will have difficulty retaining 

a CCO who is willing to perform the 

duties set forth in the rule.167

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 

§ 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 § 3.3(d)(3) to provide that the 

CCO must take ‘‘reasonable steps to 

ensure compliance.’’ 

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20190 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

168Rosenthal 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. 

169FIA 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. 

170NSCP 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. 171See Swap Data Repositories: Registration 

Standards, Duties and Core Principles, 76 FR at 

54584. 172See Derivatives Clearing Organization General 

Provisions and Core Principals, 76 FR at 69435. 

173See Core Principles and Other Requirements 

for Swap Execution Facilities, 76 FR 1214, 1252 

(Jan. 7, 2011). 

174NSCP, 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 

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 § 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 abovedescribed aspects of the proposed rule 

as follows: 

• The CEO, not the CCO, should 

certify the annual report; 168

• 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 

• The required certification should be 

subject to a materiality qualifier.170

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. 

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 abovedescribed aspects of the proposed rule: 

• Overbreadth concerns with the 

requirements for the content of the 

annual report; 174

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20191 

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. 

175Better 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. 

176The 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. 

177The 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. 

• Concern that the annual report is 

not subject to board approval or a board 

addendum noting any disagreement 

with the report; 175

• Concern that some requirements for 

the content of the annual report are 

inappropriate for a document that may 

be publicly available; 176 and 

• Concern that, absent a materiality 

qualifier, the recordkeeping obligations 

will be unduly burdensome.177

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 noncompliance 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: 

• Designating a CCO; 

• Corporate governance changes to 

require the CCO to report directly to the 

board or senior officer; 

• Reviewing the compliance of the SD 

and MSP with section 4s of the CEA; 

• Requiring the CCO, in consultation 

with the board or the senior officer, to 

resolve any conflicts of interest; 

• Administration of each policy and 

procedure required to be established 

under section 4s; 

• Ensuring compliance with the CEA 

and Commission regulations relating to 

swaps; 

• Establishing procedures for the 

handling, management response, 

remediation, retesting, and closing of 

non-compliance issues; 

• 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 

• 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: 

• Extending the statutory and rule 

requirements applicable to SDs and 

MSPs to FCMs; 

• Providing the CCO with authority to 

develop, in consultation with the board 

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20192 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

178NERA, 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 § 3.3. 

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)). 

180The 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 

£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 £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). 

181See 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. 

or senior officer, appropriate policies 

and procedures; 

• Requiring the board or senior officer 

to appoint the CCO, approve the CCO’s 

compensation, and meet with the CCO 

once a year; 

• Requiring designation of a CCO 

with the background and skills 

appropriate for fulfilling the 

responsibilities of the position and that 

is not statutorily disqualified; 

• Submission of a Form 8–R to the 

Commission for the CCO as a principal 

of the firm; 

• Listing any material changes to 

compliance policies and procedures in 

the annual report; and 

• 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 § 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. 

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 firmspecific 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

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 

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182Section 3(a) of the CEA. 

183Although 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. 184 5 U.S.C. 601 et seq. 

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. 

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 burdenreducing 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 183

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. 

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 § 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 § 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 

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185 47 FR 18618 (Apr. 30, 1982). 

186 47 FR 18618, Apr. 30, 1982. 

187 Id. at 18619. 

188 48 FR 35248, 35276, Aug. 3, 1983. 189 44 U.S.C. 3501 et seq. 

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. 

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. 

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. 

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 §§ 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

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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20195 

190These 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). 

191See 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). 

192 75 FR at 76671, 75 FR at 71402, 75 FR at 

71394, and 75 FR 70885. 

193CFTC, 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. 

194Letter 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). 

195NFA Letter (Oct. 20, 2011) (estimating that 

there will be 125 SDs and MSPs required to register 

with NFA). 

196See http://www.bls.gov/oes/2099/ 

mayowe23.1011.htm and http://www.bls.gov/oes/ 

current/oes113031.htm. 

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. 

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. 

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

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 

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197See Derivatives Clearing Organization General 

Provisions and Core Principals, 76 FR at 69428. 

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. 

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

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 × 

$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 × $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 

× 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 

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

$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 

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20198 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

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 × 284 respondents] and 

$28,570,400 [285,704 burden hours × 

$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 

■ 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). 

■ 2. Section 1.71 is added to read as 

follows: 

§ 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 passwordprotected 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 previouslymade 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 

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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) Nonresearch 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 nonsubstantive 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 

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20200 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

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 § 1.31 and shall be made 

available promptly upon request to 

representatives of the Commission. 

PART 3—REGISTRATION 

■ 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). 

■ 4. Amend § 3.1 by revising paragraph 

(a)(1) and by adding paragraphs (h) and 

(i) to read as follows: 

§ 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. 

■ 5. Add § 3.3 to read as follows: 

§ 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. 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 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 § 3.10, a 

swap dealer under § 23.21, or a major 

swap participant under § 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 

§ 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, selfreported 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 noncompliance 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 § 1.10(b)(2)(ii), 

simultaneously with the Financial and 

Operational Combined Uniform Single 

Report, as required under § 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 § 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. 

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PART 23—SWAP DEALERS AND 

MAJOR SWAP PARTICIPANTS 

■ 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 DoddFrank Wall Street Reform and Consumer 

Protection Act, Pub. L. 111–203, 124 Stat. 

1376 (Jul. 21, 2010). 

■ 7. Add Subpart F, §§ 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 

§ 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). 

§ 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 § 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 

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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. 

§ 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 preexecution 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 § 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 § 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 § 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-toresolution 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 

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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. 

§ 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 

§ 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 § 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 

§ 45.2 of this chapter. 

§ 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 

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necessary to transmit electronically all 

information and data required to be 

reported in accordance with part 45 of 

this chapter. 

§ 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 realtime 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. 

§ 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 § 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 § 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. 

■ 8. Add Subpart J, consisting of 

§§ 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 

§ 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 

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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 

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(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 § 1.31 and shall be made 

available promptly upon request to 

representatives of the Commission and 

to representatives of applicable 

prudential regulators. 

§ 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 

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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 § 1.31 and shall be made 

available promptly upon request to 

representatives of the Commission and 

to representatives of applicable 

prudential regulators. 

§ 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. 

§ 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 

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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 selfregulatory 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 § 1.31 and shall be made 

available promptly upon request to 

representatives of the Commission and 

to representatives of applicable 

prudential regulators. 

§ 23.604 [Reserved] 

§ 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 passwordprotected 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 

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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 previouslymade 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) Nonresearch personnel shall not direct a 

research analyst’s decision to publish a 

research report of the swap dealer or 

major swap participant, and nonresearch 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 nonsubstantive 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 

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

§ 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 § 1.31 and shall 

be made available promptly upon 

request to representatives of the 

Commission and to representatives of 

applicable prudential regulators. 

§ 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: 

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20212 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

198Over-regulated America, Economist, Feb. 18, 

2012, at 9. 

199Exec. Order No. 13,563, 76 FR 3821 (Jan. 21, 

2011). 

200Exec. Order No. 13,579, 76 FR 41,587 (July 14, 

2011). 

201Exec. Order No. 12,866, 58 FR 51,735 (Oct. 4, 

1993). 

202OMB Circular A–4, available at http:// 

www.whitehouse.gov/sites/default/files/omb/assets/ 

regulatory_matters_pdf/a-4.pdf. 

203Barack Obama, Toward a 21st-Century 

Regulatory System, Wall St. J., Jan. 18, 2011, at A17. 

204The 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. 

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 DoddFrank 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. 

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. 

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 prestatutory 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. 

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 CostBenefit Analyses Performed by the CFTC in 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20213 

206Office 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. 

207A New Regulatory Framework for Trading 

Facilities, Intermediaries and Clearing 

Organizations, 66 FR 14,262, 14,267 (March 9, 

2001). 

208 Id. 

209William 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. 

211See 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. 

214OMB Circular A–4 at 15–16. 

215 Id. at 16. 

216 Id. 

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. 

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

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. 

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 costbenefit analysis. 

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 

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20214 Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 

217See 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. 

218 Id. 

219Swap Data Repositories: Registration 

Standards, Duties and Core Principles, 76 FR 54,538 

(Sept. 1, 2011) (to be codified at 17 CFR partart 49). 

220Real-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). 

221Real-Time Public Reporting of Swap 

Transaction Data, 76 FR 1,182, 1,244 (Jan. 9, 2012) 

(to be codified at 17 CFR part 43). 

222OMB Circular A–4 at 17. 

223 Id. 

224Swap 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 § 23.603(h). 

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 oneyear 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

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

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’’). 

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. 

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. 

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. 

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 

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Federal Register / Vol. 77, No. 64 / Tuesday, April 3, 2012 / Rules and Regulations 20215 

225Albrecht, supra, at 10. 

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 Autorite ́ des 

Marche ́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). 

228See, e.g., CEA § 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.’’). 

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. 

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 Autorite ́ des Marche ́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. 

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. 

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 § 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 

§ 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 

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