9734 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

COMMODITY FUTURES TRADING 

COMMISSION 

17 CFR Parts 4 and 23 

RIN 3038–AD25 

Business Conduct Standards for Swap 

Dealers and Major Swap Participants 

With Counterparties 

AGENCY: Commodity Futures Trading 

Commission. 

ACTION: Final rules. 

SUMMARY: The Commodity Futures 

Trading Commission (‘‘Commission’’ or 

‘‘CFTC’’) is adopting final rules to 

implement Section 4s(h) of the 

Commodity Exchange Act (‘‘CEA’’) 

pursuant to Section 731 of Title VII of 

the Dodd-Frank Wall Street Reform and 

Consumer Protection Act of 2010 (the 

‘‘Dodd-Frank Act’’). These rules 

prescribe external business conduct 

standards for swap dealers and major 

swap participants. 

DATES: Effective Date: These final rules 

will become effective on April 17, 2012. 

Compliance Date: Swap dealers and 

major swap participants must comply 

with the rules in subpart H of part 23 

on the later of 180 days after the 

effective date of these rules or the date 

on which swap dealers or major swap 

participants are required to apply for 

registration pursuant to Commission 

rule 3.10. 

FOR FURTHER INFORMATION CONTACT: 

Phyllis J. Cela, Chief Counsel, Division 

of Enforcement; Katherine Scovin 

Driscoll, Senior Trial Attorney, Division 

of Enforcement; Theodore M. Kneller, 

Attorney Advisor, Division of 

Enforcement; Mary Q. Lutz, Attorney 

Advisor, Division of Enforcement; Barry 

McCarty, Attorney Advisor, Division of 

Enforcement; Michael Solinsky, Chief 

Trial Attorney, Division of Enforcement; 

Mark D. Higgins, Counsel, Office of 

General Counsel; and Peter Sanchez, 

Special Counsel, Division of Swap 

Dealer and Intermediary Oversight, 

Commodity Futures Trading 

Commission, 1155 21st Street NW., 

Washington, DC 20581. Telephone 

number: (202) 418–7642. 

SUPPLEMENTARY INFORMATION: The 

Commission is adopting final rules 

§§ 23.400–402, 23.410, 23.430–434, 

23.440, and 23.450–451 under Section 

4s(h) of the CEA and § 4.6(a)(3) under 

Section 1a(12) of the CEA. 

Table of Contents 

I. Introduction 

II. Regulatory Intersections 

A. Securities and Exchange Commission 

Business Conduct Standards for 

Security-Based Swap Dealers and Major 

Security-Based Swap Participants 

B. Department of Labor ERISA Fiduciary 

Regulations 

C. Securities and Exchange Commission 

Municipal Advisor Registration 

D. Commodity Trading Advisor Status for 

Swap Dealers 

III. Final Rules for Swap Dealers and Major 

Swap Participants Dealing With 

Counterparties Generally 

A. Sections 23.400, 23.401 and 23.402— 

Scope, Definitions and General 

Provisions 

1. Section 23.400—Scope 

a. Proposed § 23.400—Scope 

b. Comments and Final § 23.400—Scope 

2. Section 23.401—Definitions 

a. Proposed § 23.401 

b. Comments 

c. Final § 23.401 

3. Section 23.402—General Provisions 

a. Section 23.402(a)—Policies and 

Procedures to Ensure Compliance and 

Prevent Evasion 

b. Section 23.402(b)—Know Your 

Counterparty 

c. Section 23.402(c)—True Name and 

Owner 

d. Section 23.402(d)—Reasonable Reliance 

on Representations 

e. Section 23.402(e)—Manner of Disclosure 

f. Section 23.402(f)—Disclosures in a 

Standard Format 

g. Section 23.402(g)—Record Retention 

B. Section 23.410—Prohibition on Fraud, 

Manipulation and Other Abusive 

Practices 

1. Sections 23.410(a) and (b) 

a. Proposed § 23.410(a) 

b. Comments 

c. Final § 23.410(a) and (b) 

2. Section 23.410(c)—Confidential 

Treatment of Counterparty Information 

a. Proposed § 23.410(b) 

b. Comments 

c. Final § 23.410(c) 

3. Proposed Section 23.410(c)—Trading 

Ahead and Front Running Prohibited— 

Not Adopted as Final Rule 

a. Proposed § 23.410(c) 

b. Comments 

c. Commission Determination 

C. Section 23.430—Verification of 

Counterparty Eligibility 

1. Proposed § 23.430 

2. Comments 

3. Final § 23.430 

D. Section 23.431—Disclosure of Material 

Risks, Characteristics, Material 

Incentives and Conflicts of Interest 

Regarding a Swap 

1. Proposed § 23.431—Generally 

2. Comments—Generally 

3. Final § 23.431—Generally 

a. Section 23.431(a)(1)—Material Risk 

Disclosure 

b. Section 23.431(b)—Scenario Analysis 

c. Section 23.431(a)(2)—Material 

Characteristics 

d. Section 23.431(a)(3)—Material 

Incentives and Conflicts of Interest 

e. Section 23.431(d)—Daily Mark 

E. Section § 23.432—Clearing Disclosures 

1. Proposed § 23.432 

2. Comments 

3. Final § 23.432 

F. Section 23.433—Communications—Fair 

Dealing 

1. Proposed § 23.433 

2. Comments 

3. Final § 23.433 

G. Section 23.434—Recommendations to 

Counterparties—Institutional Suitability 

1. Proposed § 23.434 

2. Comments 

3. Final § 23.434 

IV. Final Rules for Swap Dealers and Major 

Swap Participants Dealing With Special 

Entities 

A. Definition of ‘‘Special Entity’’ Under 

Section 4s(h)(2)(C) 

1. Section 23.401—Proposed Definition of 

‘‘Special Entity’’ 

2. Comments 

a. State and Municipal Special Entities 

b. Employee Benefit Plans and 

Governmental Plans 

c. Master Trusts 

d. Endowments 

e. Collective Investment Vehicles: The 

‘‘look through’’ Issue 

3. Final § 23.401(c) Special Entity 

Definitions 

a. Federal Agency 

b. State and Municipal Special Entities 

c. Employee Benefit Plans and 

Governmental Plans 

d. Endowment 

e. Collective Investment Vehicles: The 

‘‘look through’’ Issue 

B. Section 23.440—Requirements for Swap 

Dealers Acting as Advisors to Special 

Entities 

1. Proposed § 23.440 

2. Comments 

a. Scope of the Proposed ‘‘Acts as an 

Advisor to a Special Entity’’ and 

‘‘Recommendation’’ Definitions 

b. Meaning of ‘‘Best Interests’’ 

c. Comments on § 23.440(b)(2)—Duty to 

Make Reasonable Efforts 

3. Final § 23.440 

a. Acts as an Advisor to a Special Entity 

b. Commenters’ Alternative Approaches 

c. Best Interests 

d. Commenters’ Alternative ‘‘Best 

Interests’’ Approaches 

e. Final § 23.440(c)(2)—Duty to Make 

Reasonable Efforts 

f. Final § 23.440(d)—Reasonable Reliance 

on Representations 

C. Section 23.450—Requirements for Swap 

Dealers and Major Swap Participants 

Acting as Counterparties to Special 

Entities 

1. Proposed § 23.450 

2. Comments 

a. Types of Special Entities Included in 

Section 4s(h)(5)(A)(i) 

b. Duty to Assess the Qualifications of a 

Special Entity’s Representative 

c. Representative Qualifications 

d. Reasonable Reliance on Representations 

e. Unqualified Representatives 

f. Disclosure of Capacity 

g. Transaction Costs and Risks 

3. Final § 23.450 

a. Types of Special Entities Included in 

Section 4s(h)(5)(A)(i) 

b. ERISA Plan Representatives That Are 

ERISA Fiduciaries 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9735 

1See Dodd-Frank Wall Street Reform and 

Consumer Protection Act, Public Law 111–203, 124 

Stat. 1376 (2010). 

2 7 U.S.C. 1 et seq., as amended by the DoddFrank Act. All references to the CEA are to the CEA 

as amended by the Dodd-Frank Act except where 

otherwise noted. 

3Title VII of the Dodd-Frank Act also amended 

the federal securities laws to establish a similar 

comprehensive new regulatory framework for 

security-based swaps. 

4Proposed Rules for Business Conduct Standards 

for Swap Dealers and Major Swap Participants With 

Counterparties, 75 FR 80638, Dec. 22, 2010 

(‘‘proposing release’’). 

5Reopening and Extension of Comment Periods 

for Rulemakings Implementing the Dodd-Frank 

Wall Street Reform and Consumer Protection Act, 

76 FR 25274, May 4, 2011 (‘‘Extension of Comment 

Periods’’). As reflected in the public comment file, 

the Commission continued to receive comments 

and meet with commenters after the comment 

period officially closed. 

6Proposing release, 75 FR at 80648–49 and 

80662. 

7 7 U.S.C. 6s(h). 

8Section 4s(h)(2)(C) defines Special Entity as: ‘‘(i) 

A Federal Agency; (ii) a State, State agency, city, 

county, municipality, or other political subdivision 

of a State; (iii) an employee benefit plan, as defined 

in section 3 of the Employee Retirement Income 

Security Act of 1974 (29 U.S.C. 1002); (iv) any 

governmental plan, as defined in section 3 of the 

Employee Retirement Income Security Act of 1974; 

or (v) any endowment, including an endowment 

that is an organization described in section 

501(c)(3) of the Internal Revenue Code of 1986.’’ 

9See Section 4s(h)(3)(D) (‘‘Business conduct 

requirements adopted by the Commission shall 

establish such other standards and requirements as 

the Commission may determine are appropriate in 

the public interest, for the protection of investors, 

or otherwise in furtherance of the purposes of [the 

CEA.]’’); see also Sections 4s(h)(1)(D), 4s(h)(5)(B) 

and 4s(h)(6). The proposed and final rules are 

informed by existing requirements for market 

intermediaries under the CEA and Commission 

Regulations, the federal securities laws, selfregulatory organization (‘‘SRO’’) rules, prudential 

regulator standards for banks, industry ‘‘best 

practices’’ and requirements applicable under 

foreign regulatory regimes. See proposing release, 

75 FR at 80639 for further discussion of the sources 

the Commission considered in drafting the 

proposing release. 

10Section 712(a)(1) of the Dodd-Frank Act 

requires that the Commission consult with SEC and 

prudential regulators in promulgating rules 

pursuant to Section 4s(h). Section 752(a) of the 

Dodd-Frank Act states in part, that the Commission, 

SEC, and the prudential regulators ‘‘shall consult 

and coordinate with foreign regulatory authorities 

on the establishment of consistent international 

standards with respect to the regulation (including 

fees) of swaps * * *.’’ 

11See proposing release, 75 FR at 80640 for 

further discussion of the Commission’s consultation 

and coordination with the SEC before issuing the 

proposing release. 

12See proposing release, 75 FR at 80640 for 

further discussion of the Commission’s consultation 

with foreign authorities. See generally European 

Union Markets in Financial Instruments Directive 

(‘‘MiFID’’), Directive 2004/39/EC of the European 

Parliament and of the Council of 21 April 2004 on 

markets in financial instruments; see also European 

Union Market Abuse Directive (‘‘Market Abuse 

Directive’’), Directive 2006/6/EC of the European 

Parliament and of the Council of 28 January 2003 

on market abuse; Proposal for a Directive of the 

European Parliament and of the Council on markets 

in financial instruments repealing Directive 2004/ 

39/EC, COM (2011) 656 final (Oct. 20, 2011) 

(‘‘MiFID II Proposal’’). 

13Subsequent to the issuance of the proposing 

release, the Commission received written 

submissions from the public, available in the 

comment file on www.cftc.gov, including, but not 

limited to those listed in the table in Appendix 1 

to this adopting release. 

c. Duty to Assess the Qualifications of a 

Special Entity’s Representative 

d. Representative Qualifications 

e. Reasonable Reliance on Representations 

f. Chief Compliance Officer Review 

g. Disclosure of Capacity 

D. Section 23.451—Political Contributions 

by Certain Swap Dealers 

1. Proposed § 23.451 

2. Comments 

3. Final § 23.451 

V. Implementation 

A. Effective Dates and Compliance Dates 

B. Comments 

C. Commission Determination 

VI. Related Matters 

A. Regulatory Flexibility Act 

B. Paperwork Reduction Act 

C. Cost-Benefit Considerations 

I. Introduction 

On July 21, 2010, President Obama 

signed the Dodd-Frank Act.1 Title VII of 

the Dodd-Frank Act amended the CEA 2

to establish a comprehensive new 

regulatory framework for swaps.3 The 

legislation was enacted to reduce risk, 

increase transparency and promote 

market integrity within the financial 

system by, among other things: (1) 

Providing for the registration and 

comprehensive regulation of swap 

dealers and major swap participants; (2) 

imposing clearing and trade execution 

requirements on standardized derivative 

products; (3) creating robust 

recordkeeping and real-time reporting 

regimes; and (4) enhancing the 

Commission’s rulemaking and 

enforcement authorities with respect to, 

among others, all registered entities and 

intermediaries subject to the 

Commission’s oversight. 

On December 22, 2010, the 

Commission published in the Federal 

Register proposed subpart H of part 23 

of the Commission’s Regulations to 

implement new Section 4s(h) of the 

CEA pursuant to Section 731 of the 

Dodd-Frank Act (the ‘‘proposed rules’’ 

or ‘‘proposing release’’).4 There was a 

60-day period for the public to comment 

on the proposing release, which ended 

on February 22, 2011. On May 4, 2011, 

the Commission published in the 

Federal Register a notice to re-open the 

public comment period for an 

additional 30 days, which ended on 

June 3, 2011.5 The Commission has 

determined to adopt the proposed rules 

with a few exceptions and with certain 

modifications, discussed below, to 

address the comments the Commission 

received. One rule that the Commission 

has determined not to adopt at this time 

is proposed § 155.7, which would have 

required Commission registrants to 

comply with swap execution 

standards.6 Should the Commission 

determine to consider execution 

standards at a later date, it would repropose such rules. 

Section 731 of the Dodd-Frank Act 

amends the CEA by adding Section 

4s(h).7 Section 4s(h) provides the 

Commission with both mandatory and 

discretionary rulemaking authority to 

impose business conduct standards on 

swap dealers and major swap 

participants in their dealings with 

counterparties, including Special 

Entities.8 The proposing release 

included rules mandated by Section 

4s(h) as well as discretionary rules that 

the Commission determined were 

appropriate in the public interest, for 

the protection of investors and in 

furtherance of the purposes of the CEA.9

In compliance with Sections 712(a)(1) 

and 752(a) 10 of the Dodd-Frank Act, 

Commission staff consulted and 

coordinated with the Securities and 

Exchange Commission (‘‘SEC’’),11

prudential regulators and foreign 

authorities. Commission staff also 

consulted informally with staff from the 

Department of Labor (‘‘DOL’’) and the 

Internal Revenue Service (‘‘IRS’’) with 

respect to certain Special Entity 

definitions and the intersection of their 

regulatory requirements with the DoddFrank Act business conduct standards 

provisions. This ongoing consultation 

and coordination effort is described 

more fully in Section II of this adopting 

release. 

In addition, Commission staff 

consulted with foreign authorities, 

specifically European Commission and 

United Kingdom Financial Services 

Authority staff. Commission staff also 

considered the existing and ongoing 

work of the International Organization 

of Securities Commissions (‘‘IOSCO’’). 

Staff consultations with foreign 

authorities revealed similarities in the 

proposed rules and foreign regulatory 

requirements.12

The Commission received more than 

120 written submissions on the 

proposing release from a range of 

commenters.13 Commission staff also 

met with representatives from at least 33 

of the commenters and other members 

of the public. Commenters included 

members of Congress, dealers, advisors, 

large asset managers, consumer 

advocacy groups and pension 

beneficiaries, end-users, trade or 

professional organizations and Special 

Entities such as State and municipal 

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9736 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

14Prior to the publication of the proposing 

release, the Commission received several written 

submissions from the public, available in the 

comment file on www.cftc.gov, including, but not 

limited to: American Benefits Council letter, dated 

Sept. 8, 2010; American Benefits Council and the 

Committee on the Investment of Employee Benefit 

Assets letter, dated Oct. 19, 2010; National Futures 

Association letter, dated Aug. 25, 2010 (‘‘NFA Aug. 

25, 2010 Letter’’); New York City Bar Association 

letter, dated Nov. 29, 2010; Ropes & Gray letter, 

dated Sept. 2, 2010; Securities Industry and 

Financial Markets Association and International 

Swaps and Derivatives Association letter, dated 

Oct. 22, 2010 (‘‘SIFMA/ISDA Oct. 22, 2010 Letter’’); 

Swap Financial Group letter, dated Aug. 9, 2010; 

Swap Financial Group presentation entitled 

‘‘Briefing for SEC/CFTC Joint Working Group,’’ 

dated Aug. 9, 2010; and Morgan Stanley letter, 

dated Dec. 3, 2010. 

15See proposed § 23.400. 

16See proposed § 23.401. 

17See proposed § 23.402. 

18See proposed §§ 23.410, 23.430, 23.431, 23.432, 

23.433, and 23.434. 

19See proposed §§ 23.440, 23.450 and 23.451. 

20The requirements under Section 4s(h), 

generally, do not distinguish between swap dealers 

and major swap participants. However, the 

Commission has considered the nature of the 

business done by swap dealers and major swap 

participants and determined that certain of the final 

rules will not apply to major swap participants. In 

particular, major swap participants will not be 

subject to the institutional suitability, ‘‘know your 

counterparty’’ and scenario analysis requirements, 

or to a pay-to-play restriction. This is discussed 

further in the sections below addressing those rules. 

21The Commission is not adopting a diligent 

supervision rule in this rulemaking, finding that 

such a rule would be duplicative of the proposed 

diligent supervision rule in a separate rulemaking. 

See Regulations Establishing and Governing the 

Duties of Swap Dealers and Major Swap 

Participants, 75 FR 71397, Nov. 23, 2010 

(‘‘Governing the Duties of Swap Dealers’’) 

(proposed § 23.602 imposing additional diligent 

supervision requirements on swap dealers and 

major swap participants). The final rules also do not 

include a free standing prohibition against front 

running or trading ahead of counterparty 

transactions as proposed in § 23.410(c) because the 

Commission has determined that such trading, 

depending on the facts and circumstances, would 

violate the Commission’s prohibitions against 

fraudulent, deceptive or manipulative practices, 

including Sections 4b, 4s(h)(4)(A) and 6(c)(1) of the 

Act and Regulations §§ 23.410 and 180.1. 

22 15 U.S.C. 78a et seq. All references to the 

Exchange Act are to the Exchange Act as amended 

by the Dodd-Frank Act. 

23 15 U.S.C. 78o–10(h). 

24Section 712(a)(1) of the Dodd-Frank Act 

requires that the Commission consult with the SEC 

and prudential regulators in promulgating rules 

pursuant to Section 4s(h). 

25SEC proposed rules, Business Conduct 

Standards for Security-Based Swap Dealers & Major 

Security-Based Swap Participants, 76 FR 42396, Jul. 

18, 2011. 

26See, e.g., FIA/ISDA/SIFMA Sept. 14 Letter, at 

passim; CFA/AFR Aug. 29 Letter, at passim. 

27See proposing release, 75 FR at 80640 

(Commission staff and SEC staff jointly held 

numerous external consultations with stakeholders 

prior to publication of the proposed rules in the 

Federal Register). 

28A list of Commission staff consultations in 

connection with this final rulemaking is posted on 

the Commission’s Web site, available at http:// 

www.cftc.gov/. 

29 29 U.S.C. 1002. 

30 29 U.S.C. 1001 et seq.; History of EBSA and 

ERISA, available at http://www.dol.gov/ebsa/ 

aboutebsa/history.html. 

governmental entities, ERISA pension 

plan sponsors and administrators, 

government pension plan administrators 

and endowments. These comments and 

meetings were in addition to seven 

written submissions received by the 

Commission and at least 33 meetings 

held by Commission staff with 

commenters and other members of the 

public prior to the publication of the 

proposing release.14 The proposed rules 

included a scope provision,15

definitions,16 general compliance 

provisions,17 rules that would apply to 

dealings with all counterparties 18 and 

rules that would apply to dealings with 

Special Entities.19 While the comments 

touched on all aspects of the proposing 

release, many of them concerned the 

proposed requirements for swap dealers 

and major swap participants in their 

dealings with Special Entities. 

The Commission has reviewed and 

considered the comments and, in 

Sections III and IV below, has 

endeavored to address both the primary 

themes running throughout the 

comment letters and the significant 

points made by individual commenters. 

The final rules, like the statute and 

proposed rules, are principles based and 

generally follow the framework of the 

proposed rules.20 The text has been 

clarified in a number of respects to take 

into account the comments received by 

the Commission and to harmonize with 

the SEC’s and DOL’s regulatory 

approaches. The Commission discusses 

each of the final rules in separate 

sections below, which address the 

changes from the proposed rules, if any, 

and the content of the final rules.21 The 

discussions address comments 

concerning costs and benefits, as well as 

alternative approaches proposed by 

commenters. The Commission also 

provides guidance, where appropriate, 

to assist swap dealers and major swap 

participants in complying with their 

new duties. The Commission also states 

that it does not view the business 

conduct standards statutory provisions 

or rules in subpart H of part 23 to 

impose a fiduciary duty on a swap 

dealer or major swap participant with 

respect to any other party. 

II. Regulatory Intersections 

A. Securities and Exchange Commission 

Business Conduct Standards for 

Security-Based Swap Dealers and Major 

Security-Based Swap Participants 

In addition to CEA Section 4s(h), 

which was added by Section 731 of the 

Dodd-Frank Act, Section 764 of the 

Dodd-Frank Act added virtually 

identical business conduct standards 

provisions in Section 15F(h) of the 

Securities Exchange Act of 1934 

(‘‘Exchange Act’’).22 Section 15F(h) 23 of 

the Exchange Act provides the SEC with 

rulemaking authority to impose 

business conduct standards on securitybased swap dealers (‘‘SBS Dealers’’) and 

major security-based swap participants 

(‘‘Major SBS Participants’’ and 

collectively ‘‘SBS Entities’’) in their 

dealings with counterparties, including 

Special Entities. Furthermore, Section 

712(a)(1) of the Dodd-Frank Act requires 

that the Commission and SEC consult 

with one another in promulgating 

certain rules including business conduct 

standards.24

On July 18, 2011, the SEC published 

in the Federal Register proposed rules 

for Business Conduct Standards for SBS 

Entities (‘‘SEC’s proposed rules’’).25 The 

comment period for the SEC’s proposed 

rules closed on August 29, 2011. 

Following publication of the SEC’s 

proposed rules, commenters requested 

that the Commission work with the SEC 

to harmonize the rules for swap dealers, 

major swap participants, and SBS 

Entities.26

Commission staff worked closely with 

SEC staff in the development of the 

Commission’s proposed rules,27 the 

SEC’s proposed rules, and these final 

rules. Additionally, the Commission 

and SEC staffs held thirteen joint 

external consultations on business 

conduct standards with interested 

parties following the publication of the 

SEC’s proposed rules.28 The 

Commission’s objective was to establish 

consistent requirements for CFTC and 

SEC registrants to the extent practicable 

given the differences in existing 

regulatory regimes and approaches. At 

this time, the SEC’s business conduct 

standards rules for SBS Entities remain 

at the proposal stage; however, the 

Commission believes it has 

appropriately harmonized its final rules 

with the SEC’s proposed rules, to the 

extent practicable, and will continue to 

work with the SEC as it approaches 

finalization of the SEC’s proposed rules. 

B. Department of Labor ERISA Fiduciary 

Regulations 

Special Entities defined in Section 

4s(h)(2)(C) of the CEA include ‘‘any 

employee benefit plan, as defined in 

Section 3’’ 29 of the Employee 

Retirement Income Security Act of 1974 

(‘‘ERISA’’). DOL is the federal agency 

responsible for administering and 

enforcing Title I of ERISA.30

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9737 

31 Definition of the Term ‘‘Fiduciary,’’ 75 FR 

65263, Oct. 22, 2010 (‘‘DOL’s proposed fiduciary 

rule’’). 

32 29 U.S.C. 1002(21)(A)(ii). 

33 29 CFR 2510.3–21(c); see also DOL’s proposed 

fiduciary rule, 75 FR at 65264. 

34See id., at 65264. The 5-part test states in 

relevant part: 

For advice to constitute ‘‘investment advice,’’ an 

adviser * * * must—(1) Render advice as to the 

value of securities or other property, or make 

recommendations as to the advisability of investing 

in, purchasing or selling securities or other property 

(2) On a regular basis (3) Pursuant to a mutual 

agreement, arrangement or understanding, with the 

plan or a plan fiduciary, that (4) The advice will 

serve as a primary basis for investment decisions 

with respect to plan assets, and that (5) The advice 

will be individualized based on the particular needs 

of the plan. 

35 DOL’s proposed fiduciary rule provided that, 

unless the person has expressly represented that it 

is acting as a fiduciary, it will not be treated as one 

if it: 

[C]an demonstrate that the recipient of the advice 

knows or, under the circumstances, reasonably 

should know, that the person is providing the 

advice or making the recommendation in its 

capacity as a purchaser or seller of a security or 

other property, or as an agent of, or appraiser for, 

such a purchaser or seller, whose interests are 

adverse to the interests of the plan or its 

participants or beneficiaries, and that the person is 

not undertaking to provide impartial investment 

advice. 

DOL’s proposed fiduciary rule, 29 CFR 2310.3– 

21(c)(2), 75 FR at 65277. 

36See, e.g., ERIC Feb. 22 Letter, at passim; 

SIFMA/ISDA Feb. 17 Letter, at 5; AMG–SIFMA Feb. 

22 Letter, at 8; ABC/CIEBA Feb. 22 Letter, at 2–3. 

37See, e.g., ABC/CIEBA Feb. 22 Letter, at 2–3; 

SIFMA/ISDA Feb. 17 Letter, at 5; AMG–SIFMA Feb. 

22 Letter, at 8. 

38Section 406(b) of ERISA (29 U.S.C. 1106(b)) 

states that an ERISA fiduciary with respect to an 

ERISA plan shall not—(1) deal with the assets of the 

plan in his own interest or for his own account, (2) 

in his individual or in any other capacity act in any 

transaction involving the plan on behalf of a party 

(or represent a party) whose interests are adverse to 

the interests of the plan or the interests of its 

participants or beneficiaries, or (3) receive any 

consideration for his own personal account from 

any party dealing with such plan in connection 

with a transaction involving the assets of the plan. 

39 In addition to other statutory exemptions, 

Section 408(a) of ERISA (29 U.S.C. 1108(a)) gives 

DOL authority to grant administrative exemptions 

from prohibited transactions prescribed in Section 

406 of ERISA. 

40See, e.g., AMG–SIFMA Feb. 22 Letter, at 8 

(‘‘This substantial penalty would serve as a serious 

disincentive for swap dealers and [major swap 

participants] from engaging in swap transactions 

with Special Entities subject to ERISA.’’); SIFMA/ 

ISDA Feb. 17 Letter, at 5–6 (‘‘there is a serious risk 

that [swap dealers] will refuse to engage in swap 

transactions with an ERISA plan to avoid the risks 

of costly ERISA violations’’). 

41See, e.g., SIFMA/ISDA Oct. 22, 2010 Letter, at 

8 fn. 19 (A swap dealer ‘‘should not be an advisor 

in circumstances where it is not a fiduciary under 

[DOL’s proposed] standard.’’). 

42Proposing release, 75 FR at 80640 and 80650 

fn. 101. 

43See, e.g., ABC/CIEBA Feb. 22 Letter, at passim; 

ERIC Feb. 22 Letter, at passim. 

44SIFMA/ISDA Feb. 17 Letter, at 5; AMG–SIFMA 

Feb. 22 Letter, at 8; ABC/CIEBA Feb. 22 Letter, at 

2–3. 

45SIFMA/ISDA Feb. 17 Letter, at 5 fn. 13; AMG– 

SIFMA Feb. 22 Letter, at 6; ERIC Feb. 22 Letter, at 

14; see also DOL Amendment to Prohibited 

Transaction Exemption (PTE) 84–14 for Plan Asset 

Transactions Determined by Independent Qualified 

Professional Asset Managers, 75 FR 38837, Jul. 6, 

2010 (‘‘DOL QPAM PTE 84–14’’). 

46See, e.g., ABC/CIEBA Feb. 22 Letter, at 5–6; 

SIFMA/ISDA Feb. 17 Letter, at 32. 

47See, e.g., SIFMA/ISDA Feb. 17 Letter, at 5 fn. 

13; AMG–SIFMA Feb. 22 Letter, at 6; ERIC Feb. 22 

Letter, at 14. 

On October 22, 2010, DOL published 

in the Federal Register proposed 

revisions (‘‘DOL’s proposed fiduciary 

rule’’) to the regulatory definition of 

‘‘fiduciary’’ under Section 3(21)(A)(ii) of 

ERISA.31 Section 3(21)(A)(ii) states that 

a person is a fiduciary (‘‘ERISA 

fiduciary’’) to an employee benefit plan 

subject to Title I of ERISA (‘‘ERISA 

plan’’) ‘‘to the extent it renders 

investment advice for a fee or other 

compensation, direct or indirect, with 

respect to any moneys or other property 

of such plan, or has any authority or 

responsibility to do so.’’ 32 In 1975, DOL 

issued a regulation that defines the 

circumstances under which a person 

renders ‘‘investment advice’’ to a plan 

within the meaning of Section 

3(21)(A)(ii).33 The regulation 

established a 5-part test that must be 

satisfied for a person to be treated as an 

ERISA fiduciary by reason of rendering 

investment advice.34 DOL’s proposed 

fiduciary rule would have revised the 5- 

part test and created a counterparty 

exception or ‘‘limitation’’ for a person 

acting in its capacity as a purchaser or 

seller.35

The Commission received numerous 

comments concerning the intersection 

between ERISA, DOL’s proposed 

fiduciary rule, and existing fiduciary 

regulation with the business conduct 

standards under the CEA and the 

Commission’s proposed rules.36 Many 

commenters, including ERISA plan 

sponsors, swap dealers and institutional 

asset managers, stated that although 

many ERISA plans currently use swaps 

as part of their overall hedging or 

investment strategy, the statutory and 

regulatory intersections of ERISA and 

the CEA could prevent ERISA plans 

from participating in swap markets in 

the future.37

Commenters were primarily 

concerned that compliance with the 

business conduct standards under the 

CEA or the Commission’s proposed 

rules would cause a swap dealer or 

major swap participant to be an ERISA 

fiduciary to an ERISA plan and subject 

to ERISA’s prohibited transaction 

provisions.38 Thus, if a swap dealer or 

major swap participant were to become 

an ERISA fiduciary to an ERISA plan, it 

would be prohibited from entering into 

a swap with that ERISA plan absent an 

exemption.39 Commenters stated that 

the penalties for violating ERISA’s 

prohibited transaction provisions are 

significant and would discourage swap 

dealers or major swap participants from 

dealing with ERISA plans.40

Prior to proposing the business 

conduct standards rules, the 

Commission received submissions from 

stakeholders concerning the interaction 

with ERISA, DOL’s proposed fiduciary 

rule and current regulation regarding 

the definition of ERISA fiduciaries.41

Thus, Commission and DOL staffs 

consulted on issues regarding Special 

Entity definitions that reference ERISA 

and the intersection of ERISA fiduciary 

status with the Dodd-Frank Act business 

conduct provisions.42

Informed by discussions between the 

Commission and DOL staffs, the 

Commission published its proposed 

business conduct standards rules. Many 

commenters, however, expressed 

ongoing concern that the proposed 

business conduct standards rules, if 

adopted in final form without 

clarification, could have unintended 

consequences for swap dealers and 

major swap participants dealing with 

ERISA plans. Commenters remained 

concerned that compliance with the 

business conduct standards could cause 

a swap dealer or major swap participant 

to be an ERISA fiduciary to an ERISA 

plan, which would trigger the 

prohibited transaction provisions of 

ERISA.43 Specifically, commenters 

expressed concerns that the business 

conduct standards could: (1) Cause a 

swap dealer or major swap participant 

to become an ERISA fiduciary under 

current law; 44 (2) require a swap dealer 

or major swap participant to cause a 

third-party advisor to fail to meet DOL’s 

Qualified Professional Asset Manager 

(‘‘QPAM’’) prohibited transaction class 

exemption; 45 (3) require a swap dealer 

or major swap participant to perform 

certain activities that could make it an 

ERISA fiduciary under DOL’s proposed 

fiduciary rule, such as calculating and 

providing a daily mark that is the midmarket value of a swap or providing a 

scenario analysis of a swap; 46 (4) 

require a swap dealer or major swap 

participant to engage in advisor-like 

activities such as those required under 

proposed § 23.401(c)—Know your 

counterparty, proposed § 23.434— 

Institutional suitability, or proposed 

§ 23.440—Swap dealers acting as 

advisors to Special Entities; 47 or (5) 

cause a swap dealer to fail to satisfy the 

counterparty exception or ‘‘limitation’’ 

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9738 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

48See, e.g., SIFMA/ISDA Feb. 17 Letter, at 5–6, 

19–21, 23–24, and 39; ABC/CIEBA Feb. 22 Letter, 

at passim; ERIC Feb. 22 Letter, at passim. 

49AFSCME Feb. 22 Letter, at 4; BlackRock Feb. 

22 Letter, at 2 and 5; AMG–SIFMA Feb. 22 Letter, 

at 9; ERIC Feb. 22 Letter, at 2 and 4; Sen. Kerry May 

18 Letter, at 1; Sen. Harkin May 3 Letter, at 1–2; 

Rep. Bachus Mar. 15 Letter, at 2; Rep. Smith July 

25 Letter, at 1–2; Sen. Johnson Oct. 4 Letter, at 2. 

50 DOL Apr. 28 Letter. 

51 DOL Apr. 28 Letter, at 1. 

52 DOL Apr. 28 Letter, at 3. 

53See, e.g., ABC/CIEBA June 3 Letter, at 3. 

54Office of Public Affairs News Release, U.S. 

Dept. of Labor, U.S. Labor Department’s EBSA to repropose rule on definition of a fiduciary (Sept. 19, 

2011). 

55 Id. 

56Final § 23.440—Requirements for swap dealers 

acting as advisors to Special Entities and § 23.450— 

Requirements for swap dealers and major swap 

participants acting as counterparties to Special 

Entities address the issues raised by commenters. 

See Sections IV.B. and IV.C. of this adopting release 

for a discussion of final §§ 23.440 and 23.450. 

57A copy of the statement is included as 

Appendix 2 of this adopting release. 

58Section 4s(h)(2)(C)(ii) of the CEA (7 U.S.C. 

6s(h)(2)(C)(ii)). 59The definition of ‘‘municipal advisor’’ means a 

person (who is not a municipal entity or an 

employee of a municipal entity) (i) that provides 

advice to or on behalf of a municipal entity with 

respect to municipal financial products (including 

municipal derivatives) or the issuance of municipal 

securities, including advice with respect to the 

structure, timing, terms, and other similar matters 

concerning such financial products or issues, or (ii) 

that undertakes a solicitation of a municipal entity. 

The definition includes financial advisors, thirdparty marketers, and swap advisors that engage in 

municipal advisory activities. 15 U.S.C. 78o–4(e)(4). 

60Section 975 of the Dodd-Frank Act amended 

Section 15B(e)(8) of the Exchange Act to define the 

term ‘‘municipal entity’’ as any State, political 

subdivision of a State, or municipal corporate 

instrumentality of a State, including (A) any agency, 

authority, or municipal corporate instrumentality; 

(B) any plan, program, or pool of assets sponsored 

or established by the State, political subdivision, or 

municipal corporate instrumentality or any agency, 

authority, or instrumentality thereof, and (C) any 

other issuer of municipal securities. 15 U.S.C. 78o– 

4(e)(8). 

61 15 U.S.C. 78o–4(a)(1). 

62 15 U.S.C. 78o–4(b)(2). 

63SEC Proposed Registration of Municipal 

Advisors, 76 FR 824, Jan. 6, 2011 (‘‘SEC Proposed 

MA Rules’’). 

64Section 4s(h)(5) of the CEA (7 U.S.C. 6s(h)(5)). 

provision in DOL’s proposed fiduciary 

rule.48

Many commenters also requested that 

the Commission and DOL publicly 

coordinate the respective proposed rules 

to avoid swap dealers and major swap 

participants being deemed ERISA 

fiduciaries.49 On April 28, 2011, DOL 

submitted a letter to the Chairman of the 

CFTC regarding its views on DOL’s 

proposed fiduciary rule and potential 

intersections with the business conduct 

standards statutory provisions and the 

Commission’s proposed rules.50 The 

letter stated that DOL’s proposed 

fiduciary rule ‘‘is not broadly intended 

to impose ERISA fiduciary obligations 

on persons who are merely 

counterparties to plans in arm’s length 

commercial transactions * * * [and] is 

not intended to upend these 

expectations by imposing ERISA 

fiduciary norms on parties who are on 

the opposite side of plans in such arm’s 

length deals.’’ 51 The letter concludes, 

‘‘[in DOL’s] view, with careful attention 

to fairly straightforward drafting issues, 

we can ensure that the DOL regulation 

and the CFTC business conduct 

standards are appropriately 

harmonized.’’ 52 Subsequently, the 

Commission received additional 

comments stating that, although 

supportive of DOL’s statement of intent 

and analysis of DOL’s proposed 

fiduciary rule, the letter did not resolve 

all of their concerns and was nonbinding.53

On September 19, 2011, DOL 

announced that it would re-propose its 

rule on the definition of fiduciary and 

expected the new proposed rule to be 

issued in early 2012.54 DOL also stated 

that it ‘‘will continue to coordinate 

closely with the * * * Commission to 

ensure that this effort is harmonized 

with other ongoing rulemakings.’’ 55 The 

Commission has continued to 

coordinate with DOL to ensure that the 

final business conduct standards rules 

are appropriately harmonized with 

ERISA and DOL regulations.56 DOL has 

reviewed the Commission’s final 

business conduct standards rules for 

swap dealers and major swap 

participants and provided the 

Commission with the following 

statement: 

The Department of Labor has reviewed 

these final business conduct standards and 

concluded that they do not require swap 

dealers or major swap participants to engage 

in activities that would make them 

fiduciaries under the Department of Labor’s 

current five-part test defining fiduciary 

advice 29 CFR § 2510.3–21(c). In the 

Department’s view, the CFTC’s final business 

conduct standards neither conflict with the 

Department’s existing regulations, nor 

compel swap dealers or major swap 

participants to engage in fiduciary conduct. 

Moreover, the Department states that it is 

fully committed to ensuring that any changes 

to the current ERISA fiduciary advice 

regulation are carefully harmonized with the 

final business conduct standards, as adopted 

by the CFTC and the SEC, so that there are 

no unintended consequences for swap 

dealers and major swap participants who 

comply with these business conduct 

standards.57

After considering the comments and 

DOL’s statement, the Commission has 

determined that the final business 

conduct standards are appropriately 

harmonized with ERISA and DOL 

regulations. The Commission 

understands from DOL that compliance 

with the business conduct standards 

statutory provisions and Commission 

rules will not, by itself, cause a swap 

dealer or major swap participant to be 

an ERISA fiduciary to an ERISA plan. 

Furthermore, DOL stated its intention to 

continue to coordinate and 

appropriately harmonize with 

Commission rules when it re-proposes 

its rule on the definition of fiduciary. 

Thus, the Commission has determined 

that issues and concerns raised by 

commenters regarding ERISA 

requirements have been addressed 

appropriately. 

C. Securities and Exchange Commission 

Municipal Advisor Registration 

The amendments to the CEA in 

Section 731 of the Dodd-Frank Act also 

direct the Commission to adopt business 

conduct standards rules for swap 

dealers and major swap participants 

dealing with Special Entities, which 

include ‘‘a State, State agency, city, 

county, municipality, or other political 

subdivision of a State’’ (‘‘State and 

municipal Special Entities’’).58 In 

addition, Section 975 of the Dodd-Frank 

Act amended Section 15B of the 

Exchange Act to provide for new 

regulatory oversight of ‘‘municipal 

advisors,’’ 59 that provide advice to a 

‘‘municipal entity’’ 60 with respect to, 

among other things, municipal financial 

products, which include municipal 

derivatives. Municipal advisors are 

required to register with the SEC61 and 

are subject to the rules of the Municipal 

Securities Rulemaking Board (‘‘MSRB’’), 

a self-regulatory organization (‘‘SRO’’).62

On January 6, 2011, the SEC published 

in the Federal Register proposed rules 

for the Registration of Municipal 

Advisors (‘‘SEC Proposed MA Rules’’).63

The intersection of the business 

conduct standards provisions under 

Section 731 of the Dodd-Frank Act and 

the municipal advisor provisions under 

Section 975 raises two important issues. 

The first issue concerns the regulatory 

intersection of requirements for SECregistered municipal advisors and 

Commission-registered commodity 

trading advisors (‘‘CTA’’) that may serve 

as qualified independent representatives 

to a Special Entity under Section 

4s(h)(5) and proposed § 23.450. Section 

4s(h)(5) of the CEA mandates the 

Commission to establish a duty for swap 

dealers or major swap participants that 

offer to or enter into a swap with a 

Special Entity to have a reasonable basis 

to believe that the Special Entity has a 

qualified independent representative.64

Thus, an independent representative 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9739 

65Section 1a(12) of the CEA (7 U.S.C. 1a(12)) 

defines ‘‘commodity trading advisor’’ to be any 

person who for compensation or profit, engages in 

the business of advising others, either directly or 

through publications, writings, or electronic media, 

as to the value of or the advisability of trading in 

any swap, among other CEA jurisdictional products. 

66The exclusion includes ‘‘any commodity 

trading advisor registered under the Commodity 

Exchange Act or persons associated with a 

commodity trading advisor who are providing 

advice related to swaps.’’ 15 U.S.C. 78o-4(e)(4)(C). 

67To the extent that a registered CTA engages in 

any municipal advisory activities other than advice 

related to swaps, registration may still be required 

with the SEC. See SEC Proposed MA Rules, 76 FR 

at 833; see also proposed rule 17 CFR 15Ba1– 

1(d)(2)(iii), 76 FR at 882. 

68See, e.g., SFG Feb. 22 Letter, at 2 (‘‘[t]here is 

a need for a single, harmonized regulatory scheme 

for credentialing and registering swap advisors’’); 

GFOA Feb. 22 Letter, at 2. 

69See, e.g., SIFMA/ISDA Feb. 17 Letter, at 6, 19– 

21, 24, and 34–35; BDA Feb. 22 Letter, at 2. 

70See, e.g., SIFMA/ISDA Feb. 17 Letter, at 24 and 

34 (the Commission and SEC should adopt a 

unified standard for recognizing when ‘‘advice’’ is 

being given). 71Proposing release, 75 FR at 80647–48. 

72 7 U.S.C. 6m and 6o. 

73See Commodity Trend Serv., Inc. v. CFTC, 233 

F.3d 981, 990 (7th Cir. 2000). 

74CEF Feb. 22 Letter, at 17. 

75SIFMA/ISDA Feb. 17 Letter, at 32 fn. 75. 

76 Id., at 34. 

77Section 1a(12) of the CEA (7 U.S.C. 1a(12)). 

under Section 4s(h)(5) that advises State 

and municipal Special Entities will be 

subject to registration with the 

Commission as a CTA,65 except for 

those independent representatives who 

are employees of such entity or 

otherwise excluded or exempt under the 

CEA or Commission rules. Similarly, 

municipal advisors include financial 

advisors and swap advisors that engage 

in municipal advisory activities, 

including providing advice with respect 

to municipal derivatives, with 

municipal entities, which include all 

State and municipal Special Entities. 

Additionally, registered CTAs ‘‘who are 

providing advice related to swaps’’ are 

expressly excluded from the definition 

of ‘‘municipal advisor.’’ 66 Accordingly, 

a registered CTA would be subject to the 

Commission’s regulatory requirements, 

but not those of the SEC or MSRB, even 

if such CTA registration were required 

solely for swap advice provided to a 

municipal entity.67 Given these 

intersections, commenters requested 

that the Commission coordinate with 

the SEC to appropriately harmonize the 

regulatory regime for Commissionregistered CTAs that advise 

municipalities with the regulatory 

regime for SEC-registered municipal 

advisors.68

A second issue raised by commenters 

concerns whether compliance with the 

proposed business conduct standards 

rules would cause a swap dealer or 

major swap participant dealing with a 

State or municipal Special Entity to be 

deemed to be a municipal advisor.69 For 

example, some commenters asked 

whether a swap dealer that complies 

with Section 4s(h)(4)(B) and proposed 

§ 23.440, which requires a swap dealer 

that ‘‘acts as an advisor to a Special 

Entity’’ to ‘‘act in the best interests’’ of 

the Special Entity, would trigger the 

municipal advisor definition. These 

commenters opposed such an outcome 

and requested that the Commission and 

SEC coordinate and harmonize the 

proposed rules.70

After considering the comments, the 

Commission has taken steps to ensure 

that the business conduct standards 

provisions are appropriately 

harmonized with the SEC and MSRB 

regulatory regime for municipal 

advisors. Commission staff has engaged 

in several consultations with the staffs 

of the SEC, MSRB, and the National 

Futures Association (‘‘NFA’’) regarding 

the regulatory regimes for municipal 

advisors and CTAs that provide advice 

to municipal entities with respect to 

swaps. The Commission is considering 

several options with respect to CTAs 

and municipal advisors, including 

proposing a CTA registration exemption 

for CTAs that are registered municipal 

advisors whose CTA activity is limited 

to swap advice to municipal entities. 

The Commission is also considering 

developing rules for CTAs that would be 

comparable to those adopted by the SEC 

and MSRB for municipal advisors. Such 

rules could be adopted by the 

Commission or, for CTAs that are 

members of NFA, by NFA. Commission 

staff continues to consult with SEC staff 

regarding municipal advisor registration 

requirements to address the treatment of 

swap dealers and major swap 

participants that comply with the 

Commission’s business conducts 

standards rules. At this time, the rules 

for the registration of municipal 

advisors remain at the proposal stage. 

Therefore, the Commission believes it 

has appropriately harmonized these 

final rules and will continue to work 

with the SEC as it approaches 

finalization of the SEC’s Proposed MA 

Rules. 

D. Commodity Trading Advisor Status 

for Swap Dealers 

The Commission noted in its 

proposed rules that swap dealers would 

likely be acting as CTAs when they 

make recommendations to their 

counterparties, and particularly 

recommendations that are tailored to the 

needs of their counterparty.71

Classification as a CTA under the CEA 

subjects a person to various statutory 

and regulatory requirements including, 

among others, the anti-fraud provisions 

of Section 4o of the CEA and 

registration with the Commission.72 In 

addition, a CTA, depending on the 

nature of the relationship, may also owe 

fiduciary duties to its clients under 

applicable case law.73

Commenters expressed concerns 

about the implications of swap dealers 

being treated as CTAs and urged the 

Commission to make clear that a swap 

dealer would not be a CTA solely by 

virtue of providing swap 

‘‘recommendations’’ to counterparties. 

One of these commenters noted that a 

swap dealer operates in a principal-toprincipal market and plays a different 

role than that of a typical CTA that 

provides advice to ‘‘retail’’ clients.74

This commenter contended that a swap 

dealer should not be required to register 

as a CTA in addition to registering in its 

capacity as a swap dealer. A second 

commenter stated that by using the term 

‘‘advisor’’ rather than ‘‘commodity 

trading advisor’’ in the relevant 

provisions of Section 4s(h)(4), Congress 

likely regarded the provisions of the 

CEA regulating CTAs as unrelated to 

those adopted under Section 4s(h)(4).75

This commenter requested that the 

Commission specifically state that no 

requirement or combination of 

requirements under the proposed rules 

would cause a swap dealer, including a 

swap dealer that makes a 

recommendation to a Special Entity, to 

be treated as a CTA.76

A ‘‘commodity trading advisor’’ 

includes any person who, for 

compensation or profit, engages in the 

business of advising others, either 

directly or through publications, 

writings, or electronic media, as to the 

value of or the advisability of trading in 

any swap.77 The CEA, however, 

excludes from the CTA definition banks, 

floor brokers, and futures commission 

merchants (‘‘FCMs’’), among others, 

whose advice is ‘‘solely incidental to the 

conduct of their business or profession.’’ 

Section 1a(12)(B)(vii) of the CEA also 

grants the Commission authority to 

exclude ‘‘such other persons not within 

the intent of [the CTA definition] as the 

Commission may specify * * *’’; 

however, such exclusion is limited to 

advice that is ‘‘solely incidental to the 

conduct of their business or profession.’’ 

The Commission has determined to 

provide a similar exclusion for swap 

dealers whose advice is solely 

incidental to their business as swap 

dealers. In determining that a swap 

dealer’s recommendations to a 

counterparty regarding proposed swap 

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9740 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

78Section 1a(49) of the CEA (7 U.S.C. 1a(49)). 

79While swap dealers that make 

recommendations will be excluded from the CTA 

definition, they must comply with other applicable 

provisions (i.e., § 23.434–Suitability and § 23.440– 

Requirements for swap dealers acting as advisors to 

Special Entities). 

80 ‘‘Associated person of a swap dealer or major 

swap participant’’ is a defined term in Section 1a(4) 

of the CEA (7 U.S.C. 1a(4)). 

81See Section III.G. of this adopting release for a 

discussion of the term ‘‘recommendation’’ in 

connection with the institutional suitability rule in 

§ 23.434. 

82The ‘‘solely incidental’’ exclusion also would 

encompass providing information to a counterparty 

that is general transaction, financial, or market 

information, or swap terms in response to a request 

for quote. 

83The ‘‘solely incidental’’ CTA exclusion for 

swap dealers is promulgated in part 4 of the 

Commission’s Regulations. 

84Proposing release, 75 FR at 80640. 85 In the proposing release, the Commission 

commented that the external business conduct 

standards rules would be most applicable when 

swap dealers and major swap participants have a 

pre-trade relationship with their counterparty. 

Proposing release, 75 FR at 80641. The Commission 

noted that for swaps initiated on a designated 

contract market (‘‘DCM’’) or swap execution facility 

(‘‘SEF’’) where the swap dealer or major swap 

participant does not know the counterparty’s 

identity prior to execution, the disclosure and due 

diligence obligations would not apply. See Section 

III.D.3. and fn. 338 of this adopting release for a 

discussion of final § 23.431–Disclosures of material 

information, which address the disclosure duties of 

swap dealers and major swap participants pursuant 

to Section 4s(h)(3)(B) with respect to bilateral swaps 

and swaps executed on a DCM or SEF. 

transactions or trading strategies should 

be considered ‘‘solely incidental’’ to the 

conduct of its business, the Commission 

considered the definition of ‘‘swap 

dealer.’’ Section 1a(49) of the CEA 

defines the term ‘‘swap dealer’’ as a 

person who (1) holds itself out as a 

dealer in swaps; (2) makes a market in 

swaps; (3) regularly enters into swaps 

with counterparties as an ordinary 

course of business for its own account; 

or (4) engages in any activity causing the 

person to be commonly known in the 

trade as a dealer or market maker in 

swaps.78

Based on the types of activities that 

define a swap dealer’s business, 

commenters’ views and the statutory 

scheme under Section 4s(h), the 

Commission has determined that 

making swap related recommendations 

to counterparties is most appropriately 

considered ‘‘solely incidental’’ to the 

conduct of a swap dealer’s business as 

a dealer or market maker in swaps, 

including customized swaps, and is not 

CTA business. Specifically, the 

Commission has determined that, when 

making recommendations to a 

counterparty with respect to an 

otherwise arm’s length principal-toprincipal swap transaction with a 

counterparty a swap dealer will be 

acting solely incidental to its business 

as a swap dealer as defined in the CEA 

and Commission rules. Thus, the 

Commission has determined to exercise 

its authority under Section 1a(12)(B)(vii) 

to add a new exclusion from the CTA 

definition applicable to swap dealers, 

including swap dealers that may be 

excluded or exempt from registration 

under the CEA or Commission rules, in 

existing § 4.6. Under new § 4.6(a)(3) a 

swap dealer is excluded from the 

definition of the term ‘‘commodity 

trading advisor’’ provided that its 

‘‘advisory activities’’ are solely 

incidental to its business as a swap 

dealer.79 ‘‘Swap dealer’’ is defined for 

purposes of the rule by reference to the 

definitions in Section 1a(49) of the CEA 

and § 1.3, and would include 

‘‘associated persons’’ 80 acting on behalf 

of a swap dealer. 

With respect to the scope of the 

‘‘solely incidental’’ exclusion for swap 

dealers, the Commission is generally of 

the view that making recommendations 

to a counterparty would not cause a 

swap dealer to be a CTA.81 The 

exclusion would cover customizing a 

swap for a counterparty in response to 

a counterparty’s expressed interest or on 

the swap dealer’s own initiative.82 Also, 

preparing a term sheet for purposes of 

outlining proposed terms of a swap for 

negotiation or otherwise would be an 

activity solely incidental to a swap 

dealer’s business. 

There are advisory activities that the 

Commission would consider to be 

beyond the scope of the ‘‘solely 

incidental’’ exclusion, and depending 

on the facts and circumstances could 

cause a swap dealer to be a CTA within 

the statutory definition. For example, a 

swap dealer that has general discretion 

to trade the account of, or otherwise act 

for or on behalf of, a counterparty would 

be engaging in activity that is not solely 

incidental to the business of a swap 

dealer. Limited discretion related to the 

execution of a particular counterparty 

order, however, would not cause a swap 

dealer to be a CTA. Also, the exclusion 

would not apply if a swap dealer 

received separate compensation for, or 

otherwise profited primarily from, 

advice provided to a counterparty. 

Furthermore, a swap dealer that enters 

into an agreement with its counterparty 

to provide advisory services or a swap 

dealer that otherwise holds itself out to 

the public as a CTA would also not be 

within the ‘‘solely incidental’’ 

exclusion. These examples are not 

exhaustive. There may be other 

circumstances in which a swap dealer’s 

activity would fall outside the available 

exclusion. A determination of whether 

activity is ‘‘solely incidental’’ would 

necessarily need to be viewed in context 

based on the particular facts and 

circumstances. 

III. Final Rules for Swap Dealers and 

Major Swap Participants Dealing With 

Counterparties Generally 

The final business conduct standards 

rules dealing with counterparty 

relationships are contained in subpart H 

of new part 23 of the Commission’s 

Regulations.83 This section of the 

adopting release discusses the following 

rules that apply to swap dealers’ and, 

unless otherwise indicated, major swap 

participants’ dealings with 

counterparties generally: § 23.400— 

Scope; § 23.401—Definitions; § 23.402— 

General provisions; § 23.410— 

Prohibition on fraud, manipulation and 

other abusive practices; § 23.430— 

Verification of counterparty eligibility; 

§ 23.431—Disclosures of material 

information; § 23.432—Clearing 

disclosures; § 23.433—Communicationsfair dealing; and § 23.434— 

Recommendations to counterpartiesinstitutional suitability. A section-bysection description of the final rules 

follows. 

A. Sections 23.400, 23.401 and 23.402— 

Scope, Definitions and General 

Provisions 

1. Section 23.400—Scope 

a. Proposed § 23.400—Scope 

Proposed § 23.400 set forth the scope 

of subpart H of new part 23 of the 

Commission’s Regulations, which stated 

that the rules contained in subpart H 

were not intended to limit or restrict the 

applicability of other provisions of the 

CEA, Commission rules and regulations, 

or any other applicable laws, rules and 

regulations.84 Moreover, the proposed 

rule provided that subpart H would 

apply to swap dealers and major swap 

participants in connection with swap 

transactions, including swaps that are 

offered but not entered into.85 Some of 

the proposed rules required compliance 

prior to entering into a swap, while 

others, such as the requirement to 

provide a daily mark, were to be in 

effect during the entire life of a swap. 

b. Comments and Final § 23.400—Scope 

The Commission received numerous 

comments regarding issues that relate to 

the general scope of the proposed 

business conduct standards, though not 

necessarily concerning the text of the 

proposed ‘‘scope’’ rule. One commenter 

requested that the Commission clarify 

that the business conduct standards 

rules would not apply to unexpired 

swaps executed prior to the effective 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9741 

86SIFMA/ISDA Feb. 17 Letter, at 8. 

87See CFA/AFR Aug. 29 Letter, at 11. 

88Although certain rules do not impose an 

ongoing duty on a swap dealer or major swap 

participant with respect to the swap, a swap dealer 

or major swap participant would still be required 

to comply with the duty with respect to subsequent 

swaps offered or entered into with a counterparty. 

89See, e.g. SIFMA/ISDA Feb. 17 Letter, at 3 and 

25–26. 

90See, e.g. SIFMA/ISDA Feb. 17 Letter, at 26; 

NACUBO Feb. 22 Letter, at 3–4; VRS Feb. 22 Letter, 

at 3–4; HOOPP Feb. 22 Letter, at 3; NFP Energy End 

Users, Ex Parte Communication, Jan. 19, 2011 

(citing NFP Energy End Users Sept. 20, 2010 Letter, 

at 14–15). 

91See, e.g., AMG–SIFMA Jan. 18 Letter, at 2–3; 

MFA Feb. 22 Letter, at 1–4; CEF Feb. 22 Letter, at 

5–6; BlackRock Apr. 12 Letter, at 1–5. 

92See, e.g., Societe Generale Feb. 18 Letter, at 8– 

13; Barclays Jan. 11 Letter, at 5–7; Bank of Tokyo 

May 6 Letter, at 5–6; Barclays Feb. 17 Letter, at 

passim. 

93See, e.g., VRS Feb. 22 Letter, at 3; ABC/CIEBA 

Feb. 22 Letter, at 9–10; SIFMA/ISDA Feb. 17 Letter, 

at 4, 5–6, 10, and 34–35; FHLBanks June 3 Letter, 

at 6 and 8; AMG–SIFMA Feb. 22 Letter, at 4–5 and 

7–8; CEF Feb. 22 Letter, at 3–4 and 9–10; Exelon 

Feb. 22 Letter, at 3. 

94See, e.g., final § 23.430(a)—Verification of 

counterparty eligibility (‘‘before offering to enter 

into * * * a swap with that counterparty’’); final 

§ 23.450(b)(1)—Requirements for swap dealers and 

major swap participants acting as counterparties to 

Special Entities (‘‘Any swap dealer or major swap 

participant that offers to enter or enters into a swap 

with a Special Entity * * *’’). 

95See APPA/LPPC Feb. 22 Letter, at 4; SIFMA/ 

ISDA Feb. 17 Letter, at 35–36. 

96See SIFMA/ISDA Feb. 17 Letter, at 35 fn. 84. 

97See, e.g., Restatement (Second) of Contracts 

§ 24 (1981) (‘‘An offer is the manifestation of 

willingness to enter into a bargain, so made as to 

justify another person in understanding that his 

assent to that bargain is invited and will conclude 

it.’’). In addition, as stated in § 23.400, nothing in 

these rules is intended to limit or restrict the 

applicability of other applicable laws, rules and 

regulations, including the federal securities laws. 

98See Section III.G. of this adopting release for a 

discussion of § 23.434—Recommendations to 

Counterparties—Institutional Suitability. 

99See Section III.F.3. of this adopting release for 

a discussion of final § 23.433. 

100For example, the verification of counterparty 

eligibility, know your counterparty and the 

verification of a Special Entity’s independent 

representative would be completed prior to any 

recommendation or offer. Other forms of 

documentation may suffice depending on the 

circumstances. For instance, if a counterparty 

requests a quote from a swap dealer with which it 

does not have relationship documentation, the 

counterparty could book the swap through its prime 

broker with which the swap dealer may have prenegotiated documentation. 

101See proposing release, 75 FR at 80639. 

102See BlackRock Feb. 22 Letter, at 1–2; Encana 

Feb. 22 Letter, at 2. 

103CFA/AFR Feb. 22 Letter, at 18. 

date of the final rules.86 Another 

commenter asked the Commission to 

clarify that certain business conduct 

standards rules impose duties for swap 

dealers and major swap participants that 

continue after the execution of a swap.87

The Commission confirms that the 

business conduct standards will not 

apply to unexpired swaps executed 

before the effective date of this adopting 

release and will apply in accordance 

with the implementation schedule set 

forth in Section V.C. of this adopting 

release; however, the Commission will 

consider a material amendment to the 

terms of a swap to be a new swap and 

subject to subpart H of part 23 of the 

Commission’s Regulations. For swaps 

that are subject to the business conduct 

standards rules, the Commission 

clarifies that certain rules by their terms 

impose ongoing duties on the swap 

dealer or major swap participant (e.g., 

§ 23.410(a)—Prohibitions on fraud, 

§ 23.410(c)—Confidential treatment of 

counterparty information, and 

§ 23.433—Communications—fair 

dealing); however, other rules by their 

terms do not impose ongoing duties on 

the swap dealer or major swap 

participant (e.g., § 23.430—Verification 

of counterparty eligibility).88

Another concern raised by 

commenters was the meaning of the 

word ‘‘offer’’ in the context of 

negotiating a swap transaction because 

certain requirements are triggered when 

an offer occurs. Other commenters 

expressed views on the Commission’s 

decision to use the authority granted by 

Congress to draft discretionary rules for 

swap transactions instead of solely 

drafting rules that are explicitly 

mandated by statute. There were 

comments suggesting that the 

discretionary rules should be delegated 

to an SRO.89 Commenters also suggested 

that the rules should not apply to 

certain sophisticated counterparties or 

that counterparties be afforded the 

opportunity to opt in or opt out of these 

rules.90 Some believed that swap dealers 

and major swap participants should be 

subject to different regulations.91 Others 

were concerned about the 

extraterritorial reach of the 

Commission’s Regulations.92 Some 

commentators were concerned that 

violating the rules could be a basis for 

a private right of action under the 

CEA.93 The Commission addresses these 

issues in the discussion below. 

i. Meaning of ‘‘Offer’’ 

Certain of the business conduct 

standards duties under the rules are 

triggered at the time an ‘‘offer’’ is 

made.94 Two commenters suggested that 

the rules should be modified to clarify 

when an ‘‘offer’’ occurs.95 One of the 

commenters suggested that the 

Commission should define ‘‘offer’’ to 

mean when sufficient terms are offered 

that, if accepted, would create a binding 

agreement under contract law.96 They 

believe that this is necessary because, 

unlike in securities or futures, the terms 

of the product are not preset but can be 

negotiated. 

The Commission confirms that the 

term ‘‘offer,’’ as used in the business 

conduct standards rules in subpart H, 

has the same meaning as in contract 

law, such that, if accepted, the terms of 

the offer would form a binding 

contract.97 The Commission notes, 

however, that not all of the rules are 

triggered when an offer is made. For 

example, the suitability duty is triggered 

when a swap dealer makes a 

‘‘recommendation.’’ 98 The final fair 

dealing rule 99 will apply to all 

communications by a swap dealer or 

major swap participant in connection 

with a swap, including communications 

made prior to an offer. Other final rules 

(e.g., the anti-fraud and confidential 

treatment rules) will be triggered as 

indicated by their terms. In addition, the 

Commission expects that for practical 

purposes swap dealers and major swap 

participants will comply with certain of 

their business conduct standards duties 

through counterparty relationship 

documentation negotiated with their 

counterparties well before an ‘‘offer’’ or 

a ‘‘recommendation’’ is made.100

Swap dealers and major swap 

participants will be permitted to arrange 

with third parties, such as the 

counterparty’s prime broker, a method 

of providing disclosures or verifying 

that a Special Entity has an independent 

representative to satisfy its obligations 

under the rules. But the swap dealer or 

major swap participant will remain 

responsible for compliance with the 

rules. 

ii. Discretionary Rules 

In the proposing release, the 

Commission noted that some of the 

requirements and duties in the proposed 

rules were mandated by specific 

provisions in the Dodd-Frank Act, while 

others were proposed under the 

Commission’s discretionary 

authority.101 Some commenters 

recommended that the final rules be 

limited to what is mandated by statute 

until the CFTC gains more familiarity 

with these markets as they develop.102

Another commenter expressed a 

contrary view that Congress intended 

the Commission to use its discretionary 

authority because, if it did not, such 

authority would not have been 

granted.103 A commenter suggested that 

the rules that are promulgated based on 

the Commission’s discretionary 

authority, such as suitability and 

scenario analysis, should apply only to 

a subset of eligible contract participants 

(‘‘ECPs’’) that require additional 

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9742 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

104CEF Feb. 22 Letter, at 4–5. 

105SIFMA/ISDA Feb. 17 Letter, at 3 and 25–26. 

106CFA/AFR Feb. 22 Letter, at 19. 

107See also Sections 4s(h)(1)(D), 4s(h)(5)(B) and 

4s(h)(6). 

108For further discussions of SRO guidance see 

Section III.A.3.b. of this release at fn. 188 discussing 

final § 23.402(b) (know your counterparty), Section 

III.F.3. of this release at fn. 500 discussing final 

§ 23.433 (communications-fair dealing), and Section 

III.G.3. of this release at fn. 542 discussing final 

§ 23.434 (recommendations to counterparties— 

institutional suitability). 

109The SEC has taken a consistent approach in 

its proposed business conduct standards rules. For 

example, the SEC’s ‘‘know your counterparty,’’ 

suitability and fair communications rules are based 

on similar requirements under the rules of the 

Financial Industry Regulatory Authority (‘‘FINRA’’). 

See SEC’s proposed rules, 76 FR at 42414 fn. 125, 

42415 fn. 128, and 42418 fn. 151. See also FINRA 

Rule 2090 (know your customer), FINRA Rule 2111 

(suitability), and NASD Rule 2210 (communications 

with the public). 

110See AMG–SIFMA Jan. 18 Letter, at 2–3; MFA 

Feb. 22 Letter, at 1–4; CEF Feb. 22 Letter, at 5–6; 

BlackRock Apr. 12 Letter, at 1–5; BlackRock June 

3 Medero and Prager Letter, at 4–5. 

111MetLife Feb. 22 Letter, at 4–5, contra CFA/ 

AFR Nov. 3 Letter, at 7. 

112MetLife Feb. 22 Letter, at 4–5. 

113 Id. 

protections.104 Another commenter 

suggested that if the Commission does 

adopt the discretionary rules, it should 

implement any such additional 

proposals as SRO rules and allow 

sophisticated counterparties to opt out 

of the heightened protections that they 

may not need or want.105

One commenter stated that the 

Commission’s approach in proposing 

discretionary rules that used industry 

best practices was reasonable because 

the proposals have already been 

endorsed by the industry as workable 

and achievable.106 The commenter 

stated that the Commission should go 

further, however, because the industry’s 

standards of conduct have been so poor 

that the industry’s own suggestions may 

not go far enough. 

The Commission has determined to 

adopt the rules proposed under the 

Commission’s discretionary authority 

along with the mandatory rules, albeit 

with the changes and for the reasons 

discussed in the applicable sections of 

this adopting release that address each 

final rule. In exercising that discretion, 

the Commission has acted consistently 

with the intent of Congress as expressed 

in Section 4s(h)(3)(D) to establish 

business conduct standards that the 

Commission determines are appropriate 

in the public interest, for the protection 

of investors, or otherwise in furtherance 

of the purposes of the CEA.107 Many of 

the discretionary rules adopted by the 

Commission are based generally on 

existing Commission and SRO rules for 

registrants and industry best practices, 

and extending them to swap dealers 

and, where appropriate, to major swap 

participants will promote regulatory 

consistency. As such, the discretionary 

rules reflect existing business conduct 

standards that are time-tested, 

appropriate for swap dealers and major 

swap participants, and are well within 

the Commission’s broad discretionary 

rulemaking authority under Section 

4s(h). As a result, the final rules strike 

an appropriate balance between 

protecting the public interest and 

providing a workable compliance 

framework for market participants. With 

regard to the comments that suggest the 

Commission should implement any 

discretionary rules as SRO rules, the 

Commission declines to take such an 

approach. The Commission has relied in 

the past on SROs to fulfill a number of 

important functions in the derivatives 

market, and it will continue to do so in 

the future. Moreover, the Commission 

will consider SRO guidance, where 

relevant and appropriate, in interpreting 

the Commission’s final rules that are 

based on SRO rules.108 If, in the future, 

it becomes beneficial to delegate certain 

functions regarding the business 

conduct standards to SROs, the 

Commission will do so at that time. 

Delegating all discretionary rules to the 

SROs now, however, is premature and 

not consistent with the regulatory 

scheme that was mandated by 

Congress.109

iii. Different Rules for Swap Dealers and 

Major Swap Participants 

Some commenters recommended that 

there be different business conduct 

standards rules for swap dealers and 

major swap participants.110 Another 

commenter stated that the rules 

concerning ‘‘know your counterparty,’’ 

treatment of confidential information, 

trading ahead and front running, the 

requirement to provide a daily mark, 

fair dealing, and the determination of 

counterparty suitability should not 

apply to major swap participants.111

This commenter believed that major 

swap participants, however, should 

receive the benefits of those rules when 

acting as counterparties to swap dealers. 

They argued that major swap 

participants, regardless of their size, 

cannot be presumed to possess a level 

of market or product information equal 

to that of swap dealers and are less 

likely than swap dealers to be members 

of a swap execution facility (‘‘SEF’’), a 

designated contract market (‘‘DCM’’) or 

a derivatives clearing organization 

(‘‘DCO’’). The commenter believed that 

major swap participants are unlikely to 

have systems and personnel comparable 

to that of a swap dealer to allow them 

to model and value complex 

instruments.112 As a result, they argued 

that major swap participants, when 

dealing with swap dealers, should be 

able to: (1) Elect where to clear trades; 

(2) receive risk disclosure, the required 

scenario analyses for complex high-risk 

bilateral swaps, information about 

incentives or compensation the dealer is 

getting, and any new product analysis 

that the swap dealer does for its risk 

management purposes; and (3) receive 

the protection from the suitability 

provision the same as any other 

counterparty would receive. 

The statutory business conduct 

standards requirements, generally, do 

not distinguish between swap dealers 

and major swap participants. However, 

the Commission has considered the 

definitions of swap dealer and major 

swap participant, which are based on 

the nature of their swap related 

businesses, including marketing 

activities, and has determined, where 

appropriate, not to apply certain 

discretionary rules to major swap 

participants. The final rules for major 

swap participants do not include the 

suitability duty, pay-to-play, ‘‘know 

your counterparty’’ and scenario 

analysis provisions. Removing these 

requirements alleviates some of the 

regulatory burden on major swap 

participants without materially 

impacting the protections for 

counterparties envisioned by Congress. 

This is discussed further in the sections 

below that address these relevant rules. 

With respect to one commenter’s 

request that major swap participants be 

the beneficiaries of the business conduct 

standards rules,113 Congress appears to 

have made a contrary determination as 

indicated, for example, in Section 

4s(h)(3), which explicitly relieves swap 

dealers from the duty to provide 

disclosures to major swap participants. 

Following this approach in the statute, 

the Commission has determined not to 

require that swap dealers provide major 

swap participants with the same 

protections afforded to other 

counterparties. Nor is the Commission 

requiring swap dealers to allow major 

swap participants to opt in to receive 

certain protections, such as a daily 

mark, suitability or scenario analysis, 

that are afforded to counterparties 

generally. That would impose a burden 

on swap dealers that is not 

contemplated by the statutory scheme. 

Of course, major swap participants are 

free to negotiate with swap dealers for 

such protections on a contractual basis. 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9743 

114See VRS Feb. 22 Letter, at 4; SIFMA/ISDA Feb. 

17 Letter, at 26; NACUBO Feb. 22 Letter, at 3–4. 

115 17 CFR 230.144A. 

116 15 U.S.C. 77a et seq. All references to the 

Securities Act are to the Securities Act, as amended 

by the Dodd-Frank Act. 

117See NFP Energy End Users, Ex Parte 

Communication, Jan. 19, 2011 (citing NFP Energy 

End Users Sept. 20, 2010 Letter, at 14–15). 

118 VRS Feb. 22 Letter, at 3 (business conduct 

standards rules should not apply to sophisticated 

Special Entities). 

119HOOPP Feb. 22 Letter, at 3 (business conduct 

standards rules should not apply to sophisticated 

non-ERISA plans such as HOOPP). 

120 VRS Feb. 22 Letter, at 3–4; EEI June 3 Letter, 

at 6. 

121 VRS Feb. 22 Letter, at 3–4. 

122Section 4s(h) distinguishes among 

counterparties in the Special Entity provisions 

(Sections 4s(h)(4) and (5)), and among swaps 

transactions where the counterparty to the swap 

dealer or major swap participant is a swap dealer, 

major swap participant, or SBS Entity (Section 

4s(h)(3)). 

123For example, swap dealers will be able to rely 

on counterparty representations with respect to 

sophistication, among other things, to tailor their 

compliance with the suitability rule—§ 23.434. To 

promote efficiency and lower costs, the rules allow 

swap dealers and major swap participants to 

incorporate, as appropriate, material information 

covered by the disclosure requirements in 

counterparty relationship documentation or other 

standardized formats to avoid having to make 

repetitious disclosures on a transaction-bytransaction basis. 

124Section 23.402(e)—Manner of disclosure. The 

Commission notes, however, that the disclosure 

rules are principles based and set standards for 

required disclosures. The standards apply to each 

swap covered by the rules. Therefore, whether any 

particular disclosure or format (e.g., custom tailored 

or standardized in counterparty relationship 

documentation) meets the standard in connection 

with any particular swap will depend on the facts 

and circumstances. Swap dealers and major swap 

participants will be responsible for complying with 

the disclosure standards for each swap. 

125One commenter suggested that the 

Commission should impose a minimum 

comprehension requirement on counterparties. See 

Copping Jan. 12 Submission. The Commission 

declines to do so as it is beyond the scope of the 

business conduct standards rules, which govern 

swap dealer and major swap participant behavior 

and not counterparties. Moreover, Congress 

determined to limit swaps trading, except on a 

DCM, to ECPs, implicitly finding ECPs to be 

qualified to engage in such transactions. 

Nevertheless, the final rules follow the statutory 

scheme, which establishes a robust disclosure 

regime and Special Entity protections, among 

others. The Commission has determined to use its 

discretionary rulemaking authority to provide for 

suitability and scenario analysis, in particular. 

Taken together, the final rules materially enhance 

the ability of counterparties to assess the merits of 

entering into any particular swap transaction and 

reduce information asymmetries between swap 

dealers and major swap participants and their 

counterparties. 

126See, e.g., First American Discount Corp. v. 

CFTC, 222 F. 3d 1008, 1016–17 (D.C. Cir. 2000) (the 

Commission contended that permitting introducing 

brokers to waive the required guarantee agreement 

with its FCM would undermine the protections 

provided by Commission Regulation § 1.10(j) (17 

CFR 1.10(j))). 

127See SIFMA/ISDA Feb. 17 Letter, at 7 (asserting 

that the Commission should clarify that the 

following proposed exceptions would be available 

to a swap dealer or major swap participant in an 

RFQ system where the counterparty’s identity is 

known only immediately prior to the execution of 

the swap: § 23.430(c)—Verification of counterparty 

eligibility, § 23.431(b)—Disclosures of material 

information, § 23.450(g)—Acting as counterparties 

to Special Entities, and § 23.451(b)(2)(iii)—Pay-toplay prohibitions); State Street Feb. 22 Letter, at 2– 

3; SWIB Feb. 22 Letter, at 2. 

128ABC/CIEBA June 3 Letter, at 6–7. 

129See proposed § 23.430(c). 

130See proposed § 23.450(g). 

iv. Opt In or Opt Out for Certain Classes 

of Counterparties 

Some commenters suggested that the 

Commission should (1) provide an 

exemption from the external business 

conduct standards for swap dealers 

when they transact with certain 

sophisticated investors, which might 

include certain Special Entities, or (2) 

narrowly tailor the external business 

conduct standards to make them 

elective for the counterparty.114 These 

commenters suggested that the 

Commission should set the threshold for 

parties that decide to opt out to include 

‘‘qualified institutional buyers’’ as 

defined in Rule 144A 115 under the 

Securities Act of 1933 (‘‘Securities 

Act’’) 116 and corporations having assets 

under management of $100 million or 

more. 

Another commenter suggested that 

the Special Entity provisions should not 

be applicable to certain not-for-profit 

electricity and natural gas providers 

because of their sophistication in 

dealing with swaps concerning such 

commodities.117 One commenter 

believed that the business conduct 

standards rules should not apply to 

sophisticated Special Entities,118 and 

another commenter suggested that they 

should not apply to non-ERISA pension 

plans.119 According to these 

commenters, many of the protections in 

place for Special Entities will slow 

down the process for entering into 

swaps and make it more difficult for 

Special Entities to do business. Two 

other commenters believed that the 

rules will increase the price of swaps 

without any material benefit.120 One of 

them suggested that the Commission 

instead should (1) provide an exemption 

from the external business conduct 

standards rules for swap dealers when 

transacting with certain sophisticated 

investors, which would include certain 

government plans such as the 

commenter, or (2) narrowly tailor the 

rules to make them elective for the 

counterparty.121

That is not the approach that Congress 

took in Section 4s(h) of the CEA. With 

a few exceptions not relevant here, the 

statute does not distinguish among 

counterparties or types of 

transactions.122 Nevertheless, as 

discussed below in connection with the 

relevant rules, the Commission has 

determined to permit means of 

compliance with the final rules that 

should promote efficiency and reduce 

costs and, where appropriate, allow the 

parties to take into account the 

sophistication of the counterparty.123

The final rules grant swap dealers and 

major swap participants, with approval 

of their counterparties, discretion in 

selecting a reliable, cost-effective means 

for providing required information, 

including using Web sites with 

password protection.124 Additionally, 

the Commission adopted approaches for 

swap dealers and major swap 

participants dealing with Special 

Entities to streamline the process for 

complying with the Special Entity 

provisions without undermining the 

intent of Congress in enacting those 

provisions. 

In addition, an opt in or opt out 

regime for counterparties could create 

incentives for swap dealers and major 

swap participants that would be 

inconsistent with congressional intent 

in enacting the business conduct 

standards. Rather than raising 

standards, pressure from swap dealers 

or major swap participants could 

discourage counterparties from electing 

to receive such protections and could 

effectively force counterparties to waive 

their rights or be shut out of many 

swaps transactions.125 Moreover, the 

Commission generally frowns on 

attempts to get customers to waive 

protections under its rules.126 As a 

result, the Commission declines to 

adopt such an opt in or opt out regime. 

v. SEF Transactions 

Some commenters stated that certain 

business conduct standards rules should 

not apply to SEF transactions where the 

swap dealer or major swap participant 

learns the identity of the counterparty 

only immediately prior to the execution 

of the swap such as in a request for 

quote (‘‘RFQ’’) system.127 Another 

commenter opined that Section 4s(h)(7) 

is intended to exclude certain 

transactions from all of the requirements 

of the Commission’s business conduct 

standards rules.128 The commenter 

stated that, because the Commission 

only mentions the exemption with 

respect to verification of counterparty 

eligibility 129 and the requirements for 

swap dealers acting as counterparties to 

Special Entities,130 the exclusion could 

be read as applying only to those rules. 

The commenter believed that the proper 

reading of Section 4s(h)(7) requires that 

all transactions initiated by a Special 

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9744 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

131ABC/CIEBA June 3 Letter, at 6–7. 

132 Id. 

133Swap market participants should be aware 

that the Commission’s anti-evasion rule in 

§ 23.402(a) requires swap dealers or major swap 

participants to have policies and procedures to 

prevent them from evading or facilitating an 

evasion of any provision of the Act or Commission 

Regulation. The Commission expects such policies 

and procedures to preclude routing pre-arranged 

trades through a SEF or DCM for the purpose of 

avoiding compliance with the business conduct 

standards rules. For example, where a swap dealer 

or major swap participant has a relationship with 

a counterparty and has discussed a transaction prior 

to ‘‘anonymous’’ execution on a SEF, the 

Commission will consider whether the transaction 

was structured to avoid compliance with the 

business conduct standards rules in determining 

whether to bring an action for failure to have or 

comply with written policies and procedures to 

prevent evasion under § 23.402(a). 

134Providing required disclosures under § 23.431 

through such mechanisms will not be considered 

evasion under § 23.402(a). 

135See, e.g., Societe Generale Feb. 18 Letter, at 8– 

13; Barclays Jan. 11 Letter, at 5; Bank of Tokyo May 

6 Letter, at 5–6; Barclays Feb. 17 Letter, at 8–9. 

136See Bank of Tokyo May 6 Letter, at 6. 

137See Societe Generale Feb. 18 Letter, at 8. 

138 Id. 

139See VRS Feb. 22 Letter, at 3; ABC/CIEBA Feb. 

22 Letter, at 9–10; SIFMA/ISDA Feb. 17 Letter, at 

4, 5–6, 10 and 34–35; FHLBanks June 3 Letter, at 

6 and 8; AMG–SIFMA Feb. 22 Letter, at 4–5 and 

7–8; CEF Feb. 22 Letter, at 3–4 and 9–10; Exelon 

Feb. 22 Letter, at 3. 

140For example, Section 22 of the CEA provides 

a private right of action for any violation of the 

CEA, and Section 4s(h)(l) states that ‘‘[e]ach 

registered swap dealer and major swap participant 

shall conform with such business conduct 

standards * * * as may be prescribed by the 

Commission by rule or regulation. * * *’’ 

141Shell June 3 Letter, at 1. 142Bank of Tokyo May 3 Letter, at 4–5. 143Real Time Public Reporting, 77 FR 1182 at 

1187, Jan. 9, 2012. 

Entity on a SEF or DCM are excluded 

from the business conduct standards 

rules, not merely those that are initiated 

by a Special Entity where the identity of 

the counterparty is not known.131 The 

commenter believed the two prongs are 

intended to be disjunctive and carve out 

from the business conduct standards 

rules (1) any transaction a Special Entity 

enters into on a SEF or DCM, or (2) all 

SEF or DCM transactions where the 

swap dealer or major swap participant 

does not know the identity of the 

counterparty.132

Based on the statutory language, the 

Commission’s view is that Section 

4s(h)(7) creates an exclusion that 

applies when two conditions are met: 

(1) When a transaction is initiated by a 

Special Entity on a DCM or SEF; and (2) 

the swap dealer or major swap 

participant does not know the identity 

of the counterparty to the transaction. 

Consistent with Section 4s(h)(7), the 

Commission has determined that certain 

of the business conduct standards rules 

will apply only where the swap dealer 

or major swap participant knows the 

identity of the counterparty prior to 

execution. These are the provisions for 

‘‘know your counterparty,’’ true name 

and owner, verification of eligibility, 

disclosures, suitability, and the Special 

Entity rules.133

For uncleared swaps executed on a 

SEF, swap dealers and major swap 

participants have ongoing duties to 

counterparties the same as they would 

in uncleared non-SEF transactions. For 

example, the duties to provide a daily 

mark, engage in fair dealing, and 

maintain confidentiality of counterparty 

information will continue to apply. 

For swaps where the identity of the 

counterparty is known just prior to 

execution on a SEF, the Commission has 

determined that the business conduct 

standards rules, including the 

disclosure duties, will apply. Section 

4s(h)(7), which limits application of the 

Special Entity provisions of the business 

conduct standards in anonymous DCM 

and SEF transactions, informs the 

applicability of other business conduct 

standards that are also anonymous DCM 

or SEF transactions. It would be 

inconsistent with the statutory language 

and blur the line of when disclosures 

are required, for example, to exempt 

swaps from the business conduct 

standards duties where the identity of 

the counterparty is known just prior to 

execution on a SEF. Under the final 

rules, swap dealers and major swap 

participants will have to develop 

mechanisms for making disclosures in 

connection with such transactions on a 

SEF, which may include working with 

the SEF itself, to develop functionality 

to facilitate disclosures.134

vi. Extraterritoriality 

A few commenters addressed the 

international reach of the proposed 

rules. Some commenters stated that the 

business conduct standards rules should 

apply only to swaps with a U.S. 

customer and a U.S. based 

salesperson.135 For other swaps, the 

commenters stated the Commission 

should defer to foreign regulators 136

and exercise supervision through 

memoranda of understanding.137 One 

commenter also recommended a new 

registration category for foreign 

dealers.138

The Commission expects to address 

extraterritorial issues under the DoddFrank Act in a separate release, which 

will include the issues raised by these 

commenters concerning the application 

of the business conduct standards rules 

to foreign customers and dealers. 

vii. Private Rights of Action 

Several commenters voiced concerns 

over the potential for litigation that 

could arise because of the business 

conduct standards rules.139 They are 

concerned that litigation costs will 

increase as a result and be passed on to 

counterparties. Commenters noted that 

the proposed rules may indirectly 

subject swap dealers and major swap 

participants to private rights of action 

because of the statutory language in 

Section 4s(h).140 While the Commission 

cannot exempt swap dealers and major 

swap participants from private rights of 

action under Section 22 of the CEA, and 

issues related to private rights of action 

are beyond the scope of this rulemaking, 

in this adopting release and in the rule 

text, the Commission has provided 

guidance to swap dealers and major 

swap participants for complying with 

the final rules. In addition, in the 

absence of fraud, the Commission will 

consider good faith compliance with 

policies and procedures reasonably 

designed to comply with the business 

conduct standards rules as a mitigating 

factor when exercising its prosecutorial 

discretion for violation of the rules. 

viii. Inter-Affiliate Transactions 

One commenter suggested that the 

Commission clarify that certain of the 

requirements applicable to swap 

transactions and swap dealing activities 

do not apply to transactions among 

affiliated entities because such interaffiliate transactions do not implicate 

the concerns for systemic risk and 

market integrity that the Dodd-Frank 

Act is intended to address and there is 

very limited potential for fraudulent 

conduct.141 Another commenter 

suggested that, with regard to banks, the 

Commission should provide relief from 

the business conduct standards with 

respect to transactions among bank 

group members when the transaction is 

with a group member that is a registered 

swap dealer or major swap 

participant.142

The Commission confirms that swap 

dealers and major swap participants 

need not comply with the subpart H 

external business conduct standards 

rules for swaps entered into with their 

affiliates where the transactions would 

not be ‘‘publicly reportable swap 

transactions.’’ Under § 43.2, recently 

adopted in the real time reporting 

rulemaking, a publicly reportable swap 

transaction means, among other things, 

any executed swap that is an arm’s 

length transaction between two parties 

that results in a corresponding change 

in the market risk position between the 

two parties.143 The definition of a 

publicly reportable swap transaction 

provides, by way of example, that 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9745 

144See Section IV.A. of this adopting release for 

a discussion of the comment letters received and 

the Commission’s determination regarding the 

definition of the term ‘‘Special Entity.’’ 

145See Further Definition of ‘‘Swap Dealer,’’ 

‘‘Security-Based Swap Dealer,’’ Major Swap 

Participant,’’ ‘‘Major Security-Based Swap 

Participant,’’ and ‘‘Eligible Contract Participant,’’ 75 

FR 80174, Dec. 21, 2010. 

146A commenter urged the Commission to refine 

the definition of ECP so that the discretionary rules 

would provide protections only for a subset of 

unsophisticated ECPs. Alternatively, this 

commenter asked the Commission to exempt swap 

dealers and major swap participants from 

compliance with the external business conduct 

standards when they face counterparties who are 

sophisticated enough to evaluate swap transactions 

without support from the swap dealer or major 

swap participant. CEF Feb. 22 Letter, at 4–5, see 

also Wells Fargo May 11 Letter, at passim. See 

Section III.A.1. of this adopting release for a 

discussion of § 23.400–Scope, including how the 

Commission addressed these issues. 

147CEF Feb. 22 Letter, at 7–8. 

148 Id. 

149The Commission proposed § 23.402(b)— 

Diligent supervision, but has determined not to 

adopt it as a final rule. See fn. 21. As a result, the 

paragraphs in final § 23.402 have been renumbered 

as reflected in the final rules. 

150The Commission has proposed that swap 

dealers and major swap participants adopt policies 

and procedures regarding compliance with the CEA 

and Commission Regulations. See, e.g., Governing 

the Duties of Swap Dealers, 75 FR 71397; 

Designation of a Chief Compliance Officer, 

Required Compliance Policies, and Annual Report 

of a Futures Commission Merchant, Swap Dealer, 

Major Swap Participant, 75 FR 70881, Nov. 19, 2010 

(‘‘CCO proposed rules’’); Implementation of 

Conflict-of-Interest Standards by Swap Dealers and 

Major Swap Participants, 75 FR 71391, Nov. 23, 

2010 (‘‘Conflict-of-Interest Standards by Swap 

Dealers’’). 

151CEF Feb. 22 Letter, at 19 (Appendix A). 

152 Id. 

153SIFMA/ISDA Feb. 17 Letter, at 11 (discussing 

proposed § 23.410(b)—Confidential Treatment of 

Counterparty Information); see also FIA/ISDA/ 

SIFMA Aug. 26 Letter, at 17 (discussing the SEC’s 

proposed institutional suitability requirements and 

supporting the implementation of the SEC’s 

proposed ‘‘know your counterparty’’ rule through 

policies and procedures). 

154CFA/AFR Aug. 29 Letter, at 12 (also noting, 

however, ‘‘it is certainly appropriate for the [SEC] 

to require SBS Entities to establish, maintain, 

document and enforce policies and procedures 

reasonably designed to achieve compliance with 

business conduct rules’’). 

155As part of the materials submitted in an 

application for registration as a swap dealer or 

major swap participant, an applicant may submit its 

written policies and procedures to ‘‘demonstrate, 

concurrently with or subsequent to the filing of 

their Form 7–R with the National Futures 

Association, compliance with regulations adopted 

by the Commission pursuant to section[] * * * 

4s(h) * * * of the [CEA] * * *’’ The Commission 

adopted final registration rules on the same day as 

these business conduct standards rules. See also 

proposed § 3.10(a)(1)(v)(A), Proposed Rules for 

Registration of Swap Dealers and Major Swap 

Participants, 75 FR 71379, Nov. 23, 2010. 

internal transactions to move risk 

between wholly-owned subsidiaries of 

the same parent, without having credit 

exposure to the other party would not 

require public dissemination because 

such swaps are not arm’s-length 

transactions. Such transactions, 

however, are subject to the anti-evasion 

requirements of § 23.402(a) and the antifraud provisions in § 23.410. 

2. Section 23.401—Definitions 

a. Proposed § 23.401 

Proposed § 23.401 contained 

definitions for several terms that are 

relevant to the Commission’s proposed 

business conduct standards rules. These 

include the terms ‘‘counterparty,’’ 

‘‘major swap participant,’’ ‘‘Special 

Entity’’ 144 and ‘‘swap dealer.’’ The term 

counterparty was defined to include 

prospective counterparties. The 

proposed definitions of ‘‘swap dealer’’ 

and ‘‘major swap participant’’ 

incorporated by reference the proposed 

definitions in the Commission’s entity 

definitions rulemaking.145 In addition, 

these terms included, as appropriate 

under this subpart, anyone acting for or 

on behalf of such persons, including 

associated persons as defined in Section 

1a(4) of the CEA. 

b. Comments 

The Commission did not receive any 

comments regarding the proposed 

definitions of swap dealer or major 

swap participant.146 One commenter 

stated that the Commission should 

revise the proposed definition of 

counterparty to exclude swap dealers 

and major swap participants.147 The 

commenter asserted that the 

Commission should revise the 

definition of counterparty and clarify 

that none of the business conduct 

standards rules applies where swap 

dealers or major swap participants 

transact with another swap dealer or 

major swap participant.148

c. Final § 23.401 

The Commission has determined to 

adopt the definitions of counterparty, 

swap dealer and major swap participant 

as proposed (renumbered as 

§ 23.401(a)—Counterparty, § 23.401(b)— 

Major swap participant and 

§ 23.401(d)—Swap dealer). The 

Commission declines to revise the 

definition of counterparty to exclude 

swap dealers and major swap 

participants. Certain rules by their 

terms, such as § 23.431—Disclosures of 

Material Information and § 23.434— 

Institutional Suitability, do not apply to 

transactions among swap dealers or 

major swap participants. However, the 

Commission has determined that it 

would be inappropriate and 

inconsistent with the statute to exclude 

such transactions from other rules, such 

as § 23.433–Communications—fair 

dealing. 

3. Section 23.402—General 

Provisions 149

a. Section 23.402(a)—Policies and 

Procedures To Ensure Compliance and 

Prevent Evasion 

i. Proposed § 23.402(a) 

Proposed § 23.402(a) required swap 

dealers and major swap participants to 

have policies and procedures reasonably 

designed to ensure compliance and 

prevent evasion of any provision of the 

CEA or any Commission Regulation, 

and to implement and monitor 

compliance with such policies and 

procedures as part of their supervision 

and risk requirements under subpart J of 

part 23.150

ii. Comments 

One commenter directly addressed 

proposed § 23.402(a) and asserted that 

the rule would require a swap dealer or 

major swap participant to have a policy 

with respect to each statutory provision 

or regulation that potentially applies to 

a swap dealer or major swap 

participant.151 According to the 

commenter, because many regulations 

only apply in limited circumstances, the 

scope of a swap dealer or major swap 

participant’s policies and procedures 

should be limited to material provisions 

of the CEA and Commission 

Regulations.152

Another commenter, while not 

directly addressing proposed 

§ 23.402(a), recommended that the 

Commission convert certain prescriptive 

requirements of the proposed rules and 

permit swap dealers and major swap 

participants to comply by establishing 

and enforcing policies and 

procedures.153 Conversely, another 

commenter opposed an approach that 

would deem swap dealers or major 

swap participants to be in compliance 

with the business conduct standards for 

complying with policies and 

procedures.154

iii. Final § 23.402(a) 

The Commission has considered the 

comments and has determined to adopt 

§ 23.402(a) as proposed. The 

Commission clarifies, however, that a 

swap dealer or major swap participant 

may consider the nature of its particular 

business in developing its policies and 

procedures and tailor such policies and 

procedures accordingly.155 A swap 

dealer or major swap participant, 

however, remains responsible for 

complying with all applicable 

provisions of the CEA and Commission 

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9746 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

156Proposing release, 75 FR at 80641. 

157 Id., at 80657. 

158 Id., at 80641; 7 U.S.C. 6c(a)(7). 

159Proposing release, 75 FR at 80641 fn. 25 (citing 

NFA Interpretive Notice 9013—NFA Compliance 

Rule 2–30: Customer Information and Risk 

Disclosure (Staff, Nov. 30, 1990; revised Jul. 1, 

2000)). 

160See, e.g., ABC/CIEBA Feb. 22 Letter, at 13–14; 

SIFMA/ISDA Feb. 17 Letter, at 8–9. 

161MetLife Feb. 22 Letter, at 4–5. 

162See, e.g., ABC/CIEBA Feb. 22 Letter, at 14; 

SIFMA/ISDA Feb. 17 Letter, at 9; HOOPP Feb. 22 

Letter, at 3; BlackRock June 3 Medero and Prager 

Letter, at 5. 

163See, e.g., SIFMA/ISDA Feb. 17 Letter, at 9. 

164See, e.g., MFA Feb. 22 Letter, at 5. 

165See, e.g., ABC/CIEBA Feb. 22 Letter, at 14; 

AMG–SIFMA Feb. 22 Letter, at 10. 

166See, e.g., SIFMA/ISDA Feb. 17 Letter, at 8; 

MFA Feb. 22 Letter, at 3. 

167 Id. 

168 Id. 

169 Id. 

170See, e.g., FHLBanks June 3 Letter, at 6. 

171 Id. 

172CFA/AFR Feb. 22 Letter, at 6 and 19. 

Regulations, including subpart H of part 

23. 

A swap dealer or major swap 

participant will be expected to have 

policies and procedures reasonably 

designed both to ensure compliance and 

avoid evasion of the applicable 

requirements of the CEA and 

Commission Regulations, including 

subpart H of part 23. Good faith 

compliance with such policies and 

procedures will be considered by the 

Commission in exercising its 

prosecutorial discretion in connection 

with violations of the CEA and 

Commission Regulations. To be 

considered good faith compliance, the 

Commission will consider, among other 

things, whether the swap dealer or 

major swap participant made reasonable 

inquiry and took appropriate action 

where the swap dealer or major swap 

participant had information that would 

cause a reasonable person to believe that 

any person acting for or on behalf of the 

swap dealer, major swap participant or 

any counterparty was violating the CEA 

or the Commission’s Regulations in 

connection with the swaps related 

business of the swap dealer or major 

swap participant. 

b. Section 23.402(b)—Know Your 

Counterparty 

i. Proposed § 23.402(c) 

Among the Commission’s proposed 

business conduct rules was a ‘‘know 

your counterparty’’ requirement.156

Proposed § 23.402(c) (renumbered as 

final § 23.402(b)) required swap dealers 

and major swap participants to use 

reasonable due diligence to know and 

retain a record of the essential facts 

concerning each counterparty and the 

authority of any person acting for such 

counterparty, including facts necessary 

to: (1) Comply with applicable laws, 

regulations and rules; (2) effectively 

service the counterparty; (3) implement 

any special instructions from the 

counterparty; and (4) evaluate the 

previous swaps experience, financial 

wherewithal and flexibility, trading 

objectives and purposes of the 

counterparty.157

The Commission stated that, among 

other purposes, proposed § 23.402(c) 

would assist swap dealers and major 

swap participants in avoiding violations 

of Section 4c(a)(7) of the CEA, which 

makes it ‘‘unlawful for any person to 

enter into a swap knowing, or acting in 

reckless disregard of the fact, that its 

counterparty will use the swap as part 

of a device, scheme, or artifice to 

defraud any third party.’’ 158 In 

proposing § 23.402(c), the Commission 

noted that it was guided by NFA 

Compliance Rule 2–30, Customer 

Information and Risk Disclosure, which 

NFA has interpreted to impose ‘‘know 

your customer’’ duties and has been a 

key component of NFA’s customer 

protection regime.159

ii. Comments 

The Commission received several 

comments representing a diversity of 

views on proposed § 23.402(c). As a 

general matter, some commenters 

believed the ‘‘know your counterparty’’ 

rule should not be adopted because it 

was not mandated by the Dodd-Frank 

Act.160 These commenters expressed 

concern about a number of specific 

issues as well. 

One commenter stated that the 

application of proposed § 23.402(c) and 

certain other proposed rules to major 

swap participants in connection with 

their trading with swap dealers and 

other registered market intermediaries is 

inappropriate because they are 

customers of swap dealers or registered 

market intermediaries and should be 

treated as such rather than as dealers or 

quasi-dealers.161

Commenters stated that proposed 

§ 23.402(c) seemed to transform swap 

dealers and major swap participants 

into ‘‘service providers,’’ which they 

contend is a departure from their actual 

status as counterparties.162 In this 

regard, these commenters believed the 

Commission erred by misapplying 

principles of agency to arm’s length, 

principal-to-principal relationships.163

These commenters contend that, to the 

extent swap dealers and major swap 

participants are transacting with 

counterparties at arm’s length, the 

Commission should clarify that the 

‘‘know your counterparty’’ and 

corresponding recordkeeping 

requirements do not apply.164 Similarly, 

these commenters expressed concern 

that requiring swap dealers and major 

swap participants to obtain financial 

information from their counterparties 

would be inconsistent with ordinary 

business practice and would place the 

counterparties at a severe negotiating 

and informational disadvantage to the 

swap dealer or major swap 

participant.165

Commenters opposed to proposed 

§ 23.402(c) also took issue with the 

Commission’s reference to NFA 

Compliance Rule 2–30 (Customer 

Information and Risk Disclosure).166 In 

their view, the Commission’s proposal 

to require a swap dealer or major swap 

participant to conduct an independent 

investigation in order to obtain 

information necessary to evaluate a 

counterparty’s flexibility is unclear and 

a costly departure from NFA 

Compliance Rule 2–30 and FINRA Rule 

2090 (Know Your Customer).167 The 

commenters stated that the SRO rules 

are intended to protect retail customers 

and are ill-suited to a sophisticated 

institutional market.168 By transforming 

an SRO rule into a Commission 

regulation, these commenters believed 

that the Commission’s proposal exposes 

swap dealers and major swap 

participants to unnecessary and 

significant private litigation risk and 

associated costs.169

The concern regarding the proposal’s 

potential to increase legal risk and 

transaction costs extended to those 

commenters who were generally 

supportive of the requirement in 

proposed § 23.402(c) that swap dealers 

and major swap participants use 

reasonable due diligence to know and 

retain a record of the essential facts 

concerning each counterparty.170 As one 

commenter stated, ‘‘if the derivatives 

markets are unduly constrained on 

account of increased legal risk, the 

intended benefits of the external 

business conduct rules will not be 

realized.’’ 171

Another commenter strongly 

supported proposed § 23.402(c) as an 

essential component of an effective 

business conduct standards rule regime 

and urged the Commission to strengthen 

the recordkeeping requirements 

associated with the proposed ‘‘know 

your counterparty’’ rule.172 However, 

the commenter agreed with those 

generally opposed to the proposal on 

one point: That it may be appropriate to 

scale any ‘‘know your counterparty’’ 

requirements according to the nature of 

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173Compare CFA/AFR Feb. 22 Letter, at 19, with 

SIFMA/ISDA Feb. 17 Letter, at 8–9. 174See, e.g., FIA/ISDA/SIFMA Sept. 14 Letter, at 

2–3. 

175 Id., at 2. 

176 Id. 

177Section 4s(h)(3)(D); see also Sections 

4s(h)(1)(D), 4s(h)(5)(B) and 4s(h)(6). 

178See Derivatives Policy Group, ‘‘Framework for 

Voluntary Oversight,’’ at Section V.III.B. (Mar. 

1995) (‘‘DPG Framework’’). 

179See, e.g., NFA Compliance Rule 2–30; see also 

FINRA Rule 2090. 

180See also Trading & Capital-Markets Activities 

Manual, sections 2050.3, 2050.4, 2060.3, 2060.4, 

3030.1, and 3030.3 (Bd. of Gov. Fed. Reserve Sys. 

Jan. 2009). 

181SEC’s proposed rules, 76 FR at 42414. 

182See FIA/ISDA/SIFMA Aug. 26 Letter, at 3. 

183The definition of ‘‘major swap participant’’ 

states that the term ‘‘means any person who is not 

a swap dealer.’’ Section 1a(33) of the CEA (7 U.S.C. 

1a(33)). 

184See, e.g., ABC/CIEBA Feb. 22 Letter, at 14. 

185See, e.g., MFA Feb. 22 Letter, at 4. 

186See Section III.G. of this adopting release for 

a discussion of § 23.434. 

187Section 4c(a)(7) of the CEA makes it ‘‘unlawful 

for any person to enter into a swap knowing, or 

acting in reckless disregard of the fact, that its 

counterparty will use the swap as part of a device, 

scheme or artifice to defraud any third party.’’ See 

also discussion at fn. 158. 

188See, e.g., NFA Interpretive Notice 9004—NFA 

Compliance Rule 2–30: Customer Information and 

Risk Disclosure (Board of Directors, effective June 

1, 1986; revised January 3, 2011). 

189See DPG Framework, at Section V.III.B. 

the relationship between the 

counterparties. Accordingly, the 

commenter agreed that, where a truly 

arm’s length relationship exists, for 

example, it may be appropriate to limit 

the ‘‘know your counterparty’’ 

obligation to information necessary to 

comply with the law.173

In connection with the ‘‘know your 

counterparty’’ rule, commenters urged 

the Commission to harmonize its rules 

with those proposed by the SEC.174

These commenters stated their belief 

that Congress sought to assure through 

Section 712(a) of the Dodd-Frank Act 

that the CFTC and SEC adopt 

comparable and consistent 

regulations.175 These commenters also 

highlighted that, from a cost-benefit 

perspective, inconsistent or conflicting 

requirements would increase the costs 

to market participants of implementing 

the measures necessary to comply with 

the CEA.176

iii. Final § 23.402(b) 

The Commission has determined to 

adopt proposed § 23.402(c) (renumbered 

as § 23.402(b)) with changes to reflect 

certain of the comments it received. In 

making this determination, the 

Commission concluded that final 

§ 23.402(b) is fully authorized by the 

discretionary rulemaking authority 

vested in the Commission by Section 

4s(h). In Section 4s(h), Congress granted 

the Commission broad discretionary 

authority to promulgate business 

conduct requirements, as appropriate in 

the public interest, for the protection of 

investors or otherwise in furtherance of 

the purposes of the CEA.177 The 

Commission considers the rule to be an 

appropriate exercise of its discretionary 

authority because a ‘‘know your 

counterparty’’ requirement is an integral 

component of, and consistent with, 

sound principles of legal and regulatory 

compliance and operational and credit 

risk management.178 Many of the 

entities that will be subject to this 

requirement should already have in 

place, as a matter of normal business 

practices, ‘‘know your counterparty’’ 

policies and procedures by way of their 

membership in an SRO 179 or, for banks, 

compliance with standards set forth by 

their prudential regulators.180 Given this 

fact, the Commission believes the 

additional costs of complying with this 

requirement, if any, will be minimal. 

Final § 23.402(b) seeks to harmonize 

the Commission’s approach with the 

SEC’s proposed rules.181 As one 

commenter noted, the SEC’s ‘‘know 

your counterparty’’ proposal benefited 

from the comments the Commission 

received on proposed § 23.402(c).182

This same commenter highlighted the 

congressional mandate in Section 712(a) 

of the Dodd-Frank Act that the 

Commission and the SEC consult for the 

purposes of assuring regulatory 

consistency and comparability, to the 

extent possible. The Commission 

believes that the ‘‘know your 

counterparty’’ rule is an area where the 

Commission and the SEC can achieve 

consistency. At the same time, there 

will be some variation to account for the 

comments received on the 

Commission’s proposal and the fact that 

the Commission regulates different 

products, participants, and markets. 

The Commission agrees with 

comments calling for the exclusion of 

major swap participants from the ‘‘know 

your counterparty’’ requirements. In 

most cases, major swap participants will 

themselves be counterparties to or 

customers of swap dealers. By 

definition, their business will not be 

dealing in or making a market in 

swaps.183 Accordingly, the Commission 

is deleting major swap participants from 

final § 23.402(b). 

With respect to the requirement in 

proposed § 23.402(c) that the swap 

dealer evaluate the previous swap 

experience, financial wherewithal and 

flexibility, trading objectives and 

purposes of the counterparty, 

commenters expressed several 

objections. Rather than fostering 

counterparty protections, commenters 

asserted, this requirement could 

actually place counterparties at a 

negotiating and information 

disadvantage relative to swap dealers.184

Further, commenters claimed that such 

protections are unnecessary when swap 

dealers and counterparties are dealing 

in arm’s length transactions and are 

more appropriate when swap dealers 

make recommendations to 

counterparties.185

In light of the foregoing comments, 

the Commission believes that certain of 

the protections provided for in proposed 

§ 23.402(c) are better addressed in 

connection with § 23.434— 

Recommendations to counterparties— 

institutional suitability.186 Accordingly, 

the Commission is removing from final 

§ 23.402(b) the requirements in 

proposed § 23.402(c) to ‘‘effectively 

service the counterparty’’ and 

‘‘implement any special instructions 

from the counterparty.’’ Through these 

changes, the Commission clarifies that 

the final ‘‘know your counterparty’’ rule 

does not, by itself, create an ‘‘advisor’’ 

status or impose a fiduciary duty on a 

swap dealer. 

The Commission believes comments 

opposing proposed § 23.402(c) on the 

basis that it transforms NFA Compliance 

Rule 2–30 (Customer Information and 

Risk Disclosure) from an SRO rule to a 

Commission regulation are misplaced. 

The Commission was guided by NFA 

Compliance Rule 2–30 as a model for 

the proposal, with modification where 

appropriate to achieve the 

Commission’s policy objectives, 

including assisting swap dealers to 

avoid violations of Section 4c(a)(7) of 

the CEA.187 The Commission believes 

that NFA Compliance Rule 2–30 and the 

precedent developed under it will serve 

as useful guidance to the Commission 

and the public in the application of the 

final rule.188 However, as stated above, 

final § 23.402(b), which essentially 

codifies sound business practices,189 is 

an important component of the 

Commission’s overall business conduct 

standards framework. The Commission 

views NFA’s and the Commission’s 

‘‘know your counterparty’’ requirements 

as complementary. 

Given the changes from the proposal 

to final § 23.402(b), the Commission 

believes it has ameliorated much of the 

burden commenters attributed to 

compliance risk associated with the 

‘‘know your counterparty’’ 

requirements. Based on the foregoing, 

the Commission is promulgating final 

§ 23.402(b) with modification from the 

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9748 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

190Final § 23.402(b) will not apply to swaps that 

are executed on a SEF or DCM where the swap 

dealer does not know the identity of the 

counterparty to the transaction. 191SEC’s proposed rules, 76 FR at 42414. 192See Section IV.C.3. of this adopting release for 

a discussion of final § 23.450. 

193Proposing release, 75 FR at 80641. 

194 17 CFR 1.37(a)(1). 

195Proposing release, 75 FR at 80641. 

196See, e.g., ABA/ABC Feb. 22 Letter, at 2–3; 

ABC/CIEBA Feb. 22 Letter, at passim; AMG–SIFMA 

Feb. 22 Letter, at 9–11; APGA Feb. 22 Letter, at 2– 

3 and 6–7; APPA/LPPC Feb. 22 Letter, at 4; 

BlackRock Feb. 22 Letter, at 3; CalPERS Oct. 4 

Letter, at 1; CEF Feb. 22 Letter, at 12, 16, 19–20, 

and 23; CFA/AFR Feb. 22 Letter, at 6, 8 and 13; 

Comm. Cap. Mkts. May 3 Letter, at 2; Davis & 

Harman Mar. 25 Letter, at 5–6; FHLBanks Feb. 22 

Letter, at 4–5; Ropes & Gray Feb. 22 Letter, at 3– 

4; SIFMA/ISDA Feb. 17 Letter, at 12, 15–16, 27, 27 

fn. 59, 35–36 and 36 fn. 85; SWIB Feb. 22 Letter, 

at 4–5; VRS Feb. 22 Letter, at 5. See also NFA Aug. 

25, 2010 Letter, at 2. 

197See, e.g., SIFMA/ISDA Feb. 17 Letter, at 36; 

proposing release, 75 FR at 80660. 

198See, e.g., SIFMA/ISDA Feb. 17 Letter, at 35– 

36; ABC/CIEBA Feb. 22 Letter, at 9–10; BlackRock 

Feb. 22 Letter, at 3; see also SIFMA/ISDA Feb. 17 

Letter, at 15–16 (discussing proposed § 23.430, 

Verification of Counterparty Eligibility, ‘‘an SD/ 

MSP must conduct affirmative diligence in order to 

determine whether it is reasonable to rely on 

provided representations. Such an approach 

effectively makes the relevant representation(s) 

superfluous.’’). 

199See, e.g., SIFMA/ISDA Feb. 17 Letter, at 15– 

16 (‘‘[swap dealers] should be permitted to * * * 

rely[] on a written representation by the 

counterparty * * * absent actual notice of 

countervailing facts (or facts that reasonably should 

have put the [swap dealer or major swap 

participant] on notice), which would trigger a 

proposal to account for the specific 

comments received and to conform, 

where appropriate, to the SEC’s 

proposed ‘‘know your counterparty’’ 

rule. Accordingly, final § 23.402(b) 

requires that each swap dealer shall 

implement policies and procedures 

reasonably designed to obtain and retain 

a record of the essential facts concerning 

each counterparty whose identity is 

known to the swap dealer that are 

necessary for conducting business with 

such counterparty.190 For purposes of 

final § 23.402(b), the essential facts 

concerning a counterparty are: (1) Facts 

required to comply with applicable 

laws, regulations and rules; (2) facts 

required to implement the swap dealer’s 

credit and operational risk management 

policies in connection with transactions 

entered into with such counterparty; 

and (3) information regarding the 

authority of any person acting for such 

counterparty. 

In adopting this final rule, the 

Commission makes clear that 

recordkeeping, in accordance with final 

§ 23.402(g), must be sufficient so as to 

enable the Commission to determine 

compliance with final § 23.402(b). 

Unlike the SEC proposed rule, the 

Commission has determined not to 

include the following as an essential 

fact in final § 23.402(b): ‘‘If the 

counterparty is a Special Entity, such 

background information regarding the 

independent representative as the swap 

dealer reasonably deems 

appropriate.’’ 191 This requirement is 

specifically addressed in Section 

4s(h)(5) of the CEA as well as in the 

final rules that address the independent 

representative requirement.192

As with other business conduct 

standards rules, final § 23.402(b) does 

not allow counterparties to opt out. 

However, swap dealers will be able to 

reduce the costs of compliance by 

receiving written representations from 

their counterparties at the outset of the 

relationship rather than on a 

transaction-by-transaction basis, where 

appropriate, and in accordance with the 

requirements of final § 23.402(d)— 

Reasonable Reliance on 

Representations. 

c. Section 23.402(c)—True Name and 

Owner 

i. Proposed § 23.402(d) 

Proposed § 23.402(d) (renumbered as 

final § 23.402(c)) required swap dealers 

and major swap participants to keep 

records that show the true name, 

address, and principal occupation or 

business of each counterparty, as well as 

the name and address of any other 

person guaranteeing the performance of 

such counterparty and any person 

exercising any control with respect to 

the positions of such counterparty.193

This rule was proposed under the 

Commission’s discretionary rulemaking 

authority in Section 4s(h). 

ii. Comments 

The Commission did not receive any 

comments regarding proposed 

§ 23.402(d). 

iii. Final § 23.402(c) 

As stated in the proposing release, 

proposed § 23.402(d) was based on 

existing Commission Regulation 

§ 1.37(a)(1),194 which applies to FCMs, 

introducing brokers, and members of a 

DCM. The Commission has determined 

that it is in the public interest to hold 

swap dealers and major swap 

participants to this same standard. 

Further, the Commission has 

determined that the recordkeeping 

requirements under this rule will assist 

swap dealers and major swap 

participants in meeting their other 

duties pursuant to the business conduct 

standards in subpart H of part 23 (e.g., 

the ‘‘verification of counterparty 

eligibility’’ requirement of final 

§ 23.430). Accordingly, the Commission 

is adopting proposed § 23.402(d) 

(renumbered as § 23.402(c)). 

d. Section 23.402(d)—Reasonable 

Reliance on Representations 

i. Proposed § 23.402(e) 

Proposed § 23.402(e) (renumbered as 

final § 23.402(d)) stated that swap 

dealers and major swap participants that 

seek to rely on counterparty 

representations to satisfy any of the 

business conduct standards rules must 

have a reasonable basis to believe that 

the representations are reliable under 

the circumstances.195 In other words, 

proposed § 23.402(e) would have 

allowed swap dealers and major swap 

participants, as appropriate, to 

reasonably rely, absent red flags, on 

representations of counterparties to 

meet due diligence obligations. The 

counterparty’s representations must 

have included information that was 

sufficiently detailed for the swap dealer 

or major swap participant to form a 

reasonable conclusion that the relevant 

requirement was satisfied. 

ii. Comments 

The Commission did not receive 

comments directly addressing proposed 

§ 23.402(e). However, many commenters 

addressed the concept in proposed 

§ 23.402(e) of reasonable reliance on 

representations in connection with the 

due diligence requirements under 

certain other proposed rules, such as 

proposed § 23.430—Verification of 

Counterparty Eligibility, proposed 

§ 23.434—Recommendations to 

Counterparties—Institutional 

Suitability, and proposed § 23.450(d)— 

Requirements for Swap Dealers and 

Major Swap Participants Acting as 

Counterparties to Special Entities.196

Commenters were particularly 

concerned with the language in these 

proposed rules that the representations 

be reliable ‘‘taking into consideration 

the facts and circumstances of a 

particular relationship, assessed in the 

context of a particular transaction’’ and 

that the representations be ‘‘sufficiently 

detailed.’’ 197 According to some 

commenters, the proposed rules that 

permitted reliance on representations, 

including proposed § 23.402(e), would 

require transaction-by-transaction 

diligence that would delay execution 

and increase costs for swap dealers, 

major swap participants and their 

counterparties.198 Several commenters 

also asserted that a swap dealer or major 

swap participant should not have an 

affirmative duty to investigate the 

counterparty’s representations.199

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9749 

consequent duty to inquire further’’); ABC/CIEBA 

Feb. 22 Letter, at 10–11 fn. 3 (asserting the 

Commission should adopt a standard used under 

Rule 144A of the federal securities laws, which 

would not impose a duty to inquire further ‘‘unless 

circumstances existed giving reason to question the 

veracity of a certification’’); AMG–SIFMA Feb. 22 

Letter, at 10–11 (‘‘A swap dealer or [major swap 

participant] should be able to rely on an investment 

adviser’s representation unless the swap dealer or 

[major swap participant] has information to the 

contrary.’’); Comm. Cap. Mkts. May 3 Letter, at 2 

(‘‘The dealer should be required to probe beyond 

that representation only if it has reason to believe 

that the Special Entity’s representations with 

respect to its independent representative are 

inaccurate.’’); BlackRock Feb. 22 Letter, at 3 (‘‘The 

CFTC should specifically permit the [swap dealer] 

to rely, absent notice of facts that would require 

further inquiry * * *.’’). 

200See Sections III.A.3.b., III.C., III.G., IV.B., and 

IV.C. in this adopting release for a discussion of the 

following final rules, respectively: § 23.402(b)— 

Know your counterparty; § 23.430—Verification of 

counterparty eligibility; § 23.434—Institutional 

suitability; § 23.440—Requirements for swap 

dealers acting as advisors to Special Entities; and 

§ 23.450—Requirements for swap dealers and major 

swap participants acting as counterparties to 

Special Entities. 

201Such an agreement to update representations 

contained in counterparty relationship 

documentation is only with respect to subsequent 

(i.e., new) swaps offered or entered into. The 

requirement to update representations is in the 

context of the execution of the subsequent swap. 

The Commission does not intend to require an 

ongoing duty to update representations except in 

connection with a new transaction. 

202CCO proposed rules, 75 FR at 70887. 

203Proposing release, 75 FR at 80642. 

204Markit Feb. 22 Letter, at 3. 

205 Id. 

206CFA/AFR Nov. 3 Letter, at 6. 

207See proposing release, 75 FR at 80646 fn. 62. 

208 Id. 

209Markit Feb. 22 Letter, at 3. 

210See proposed §§ 3.3, 23.600, 23.602 and 

23.606, Governing the Duties of Swap Dealers, 75 

FR 71397. 

iii. Final § 23.402(d) 

The Commission has considered the 

comments discussed above and, as a 

result, has determined to refine the 

language in proposed § 23.402(e) 

(renumbered as § 23.402(d)). The 

revised language permits a swap dealer 

or major swap participant to rely on the 

written representations of a 

counterparty to satisfy its due diligence 

requirements under subpart H of part 

23. The Commission has determined, 

however, that a swap dealer or major 

swap participant cannot rely on a 

representation if the swap dealer or 

major swap participant has information 

that would cause a reasonable person to 

question the accuracy of the 

representation. In other words, a swap 

dealer or major swap participant cannot 

ignore red flags when relying on 

representations to satisfy its due 

diligence obligations. 

The nature and specificity of the 

representations required under subpart 

H of part 23 vary depending on the 

specific rule. Therefore, the Commission 

has separately described in the 

discussion of the relevant provisions the 

content and level of detail a particular 

representation must have to satisfy the 

due diligence obligation of a particular 

rule.200

The Commission reaffirms that, if 

agreed to by the counterparty, 

counterparty representations may be 

contained in counterparty relationship 

documentation and may be deemed 

renewed with each subsequent offer or 

transaction. However, a swap dealer or 

major swap participant may only rely on 

representations in the counterparty 

relationship documentation if the 

counterparty agrees to timely update 

any material changes to the 

representations.201 In addition, the 

Commission expects swap dealers and 

major swap participants to review the 

representations on a periodic basis to 

ensure that they remain appropriate for 

the intended purpose. The Commission 

believes that ‘‘best practice’’ would be at 

least an annual review in connection 

with the required annual compliance 

review by the chief compliance officer 

pursuant to proposed § 3.3.202

e. Section 23.402(e)—Manner of 

Disclosure 

i. Proposed § 23.402(f) 

Proposed § 23.402(f) (renumbered as 

final § 23.402(e)) provided flexibility to 

swap dealers and major swap 

participants by allowing them to 

provide information required by subpart 

H of part 23, including required 

disclosures, by any reliable means 

agreed to in writing by the 

counterparty.203

ii. Comments 

One commenter suggested that the 

Commission establish minimum 

requirements defining ‘‘reliable means’’ 

within the rule.204 In addition, the use 

of password protected web pages to 

satisfy the daily mark obligation was 

identified as a potential area of concern. 

The commenter recommended that 

permitted interfaces should provide 

counterparties with tools to initiate, 

track and close valuation disputes and 

the interfaces should be designed to 

prevent any unintentional or fraudulent 

addition, modification, or deletion of a 

valuation record.205 Another commenter 

opposed permitting pre-transaction oral 

disclosures to satisfy a disclosure 

obligation, even where such disclosures 

are supplemented by post-transaction 

written documentation.206

iii. Final § 23.402(e) 

The Commission is adopting 

proposed § 23.402(f) (renumbered as 

§ 23.402(e)) with a change to account for 

disclosures for certain swaps initiated 

on a SEF or DCM. For such swaps, no 

written agreement by the counterparty 

regarding the manner of disclosure is 

necessary, but the manner of disclosure 

must be reliable. Otherwise, for swaps 

executed bilaterally and not on a SEF or 

DCM, the rule requires counterparties to 

agree, in writing, to the manner of 

disclosure. 

In addition, the Commission is 

clarifying in this adopting release that 

oral disclosures are permitted if agreed 

to by the counterparty and the 

disclosures are confirmed in writing. To 

avoid confusion and misunderstanding 

among the parties, however, written 

disclosures are the preferred manner of 

disclosure. Written disclosures also 

facilitate diligent supervision and 

auditing of compliance with the 

disclosure duties and record retention 

rule. 

In response to comments received 

prior to the publication of the proposing 

release, daily marks may be provided by 

password protected web pages.207 This 

approach is consistent with industry 

suggestions and reflects cost of 

compliance concerns.208 Regarding the 

concerns raised by the commenter,209

the Commission’s internal business 

conduct rules in new subpart J of part 

23 of the Commission’s Regulations 210

require swap dealers and major swap 

participants to have policies and 

procedures in place that ensure 

communications, including the daily 

mark, are reliable and timely. 

Final § 23.402(e) provides flexibility 

to swap dealers and major swap 

participants to take advantage of 

technological innovations while 

accommodating industry practice and 

counterparty preferences. The 

Commission anticipates that technology 

will be adapted to expedite and reduce 

the costs associated with satisfying the 

disclosure requirements in the 

Commission’s business conduct 

standards generally. 

f. Section 23.402(f)—Disclosures in a 

Standard Format 

i. Proposed § 23.402(g) 

Proposed § 23.402(g) (renumbered as 

final § 23.402(f)) allowed swap dealers 

and major swap participants to use, 

where appropriate, standardized formats 

to make certain required disclosures of 

material information to their 

counterparties and to include such 

standardized disclosures in a master or 

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9750 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

211Proposing release, 75 FR at 80642. 

212See FHLBanks Feb. 22 Letter, at 3–4; ABC/ 

CIEBA Feb. 22 Letter, at 13; ABC Aug. 29 Letter, 

at 2 and 10–11; CEF Feb. 22 Letter, at 13; BlackRock 

Feb. 22 Letter, at 6–7; APGA Feb. 22 Letter, at 3; 

ATA Feb. 22 Letter, at 3; State Street Feb. 22 Letter, 

at 3–4; SIFMA/ISDA Feb. 17 Letter, at 16–18; NY 

City Bar Feb. 22 Letter, at 2–3; CFA/AFR Feb. 22 

Letter, at 8. 

213See, e.g., FHLBanks Feb. 22 Letter, at 3–4. 

214NY City Bar Feb. 22 Letter, at 2–3. 

215See, e.g., APGA Feb. 22 Letter, at 3; ATA Feb. 

22 Letter, at 3; State Street Feb. 22 Letter, at 3–4; 

CEF Feb. 22 Letter, at 13. In addition, the NY City 

Bar recommended standardized disclosures similar 

to those currently used for listed options rather than 

the federal securities law model, which is directed 

at retail investors and not sophisticated ECPs in the 

swaps market. NY City Bar Feb. 22 Letter, at 2. See 

also 17 CFR 1.55. 

216CEF Feb. 22 Letter, at 13. 

217See, e.g., FHLBanks Feb. 22 Letter, at 3; ABC/ 

CIEBA Feb. 22 Letter, at 13; ABC Aug. 29 Letter, 

at 2 and 10–11; CEF Feb. 22 Letter, at 4; BlackRock 

Feb. 22 Letter, at 6–7. 

218Proposing release, 75 FR at 80643. 

219SIFMA/ISDA Feb. 17 Letter, at 18. 

220CFA/AFR Feb. 22 Letter, at 8. 

221FHLBanks Feb. 22 Letter, at 4. 

222 Id. 

223 Id. 

224 Id. 

225 17 CFR 1.55. 

226The Commission has proposed a swap risk 

disclosure statement for commodity pool operators 

(‘‘CPOs’’) and CTAs. See Commodity Pool 

Operators and Commodity Trading Advisors: 

Amendments to Compliance Obligations, 76 FR 

7976, Feb. 11, 2011. The proposed swap risk 

disclosure statement for CPOs and CTAs does not 

affect the swap disclosure requirements under 

Section 4s(h)(3)(B) or any rules promulgated 

pursuant to that statutory provision. 

other written agreement between the 

parties, if agreed to by the parties.211

ii. Comments 

The Commission received letters from 

several commenters regarding proposed 

§ 23.402(g).212 Generally, the 

commenters endorsed the proposed 

rule, but raised a variety of concerns, 

including the scope, substance, timing, 

frequency and cost of the standardized 

disclosures. Regarding scope and 

substance, some commenters suggested 

that the Commission promote or 

develop standardized disclosures to 

ensure adequate and consistent 

information, which would streamline 

the disclosure process, foster legal 

certainty and reduce costs.213 One 

commenter proposed, as an alternative 

to disclosing material information, 

limiting the required disclosure to the 

provision of robust market risk scenario 

analyses, defined in scope, in advance 

of all swaps.214 Several commenters 

requested that the form of disclosure be 

specified by the Commission as it has 

done for futures trading under § 1.55.215

One commenter suggested that DCOs 

prepare certain standardized disclosures 

for cleared swaps.216

Regarding the timing and frequency of 

standard form disclosures, virtually all 

commenters agreed that, for 

standardized swaps, disclosures by 

swap dealers and major swap 

participants to counterparties should be 

allowed on a relationship basis and not 

required on a transaction-by-transaction 

basis.217 For non-standardized swaps, 

one commenter challenged the 

statement in the proposing release that 

‘‘the Commission believes that most 

bespoke transactions * * * will require 

some combination of standardized and 

particularized disclosures[ ]’’ 218

asserting that bespoke issues can be 

anticipated and included in 

standardized disclosures as part of 

counterparty relationship 

documentation or other written 

agreements.219 A different commenter 

commended the Commission for 

recognizing that standardized 

disclosures alone would not be adequate 

to elucidate the risks in customized 

swaps.220 Another commenter 

acknowledged that there are certain 

instances in which standardized 

disclosures may not provide adequate 

information and requested that the 

Commission clarify that counterparties 

may require additional disclosure from 

swap dealers and major swap 

participants.221

In addition, a commenter requested 

guidance regarding the required 

disclosures and customary non-reliance 

language in swap documents.222 This 

commenter stated: ‘‘It is anomalous to 

require swap dealers and major swap 

participants to make certain disclosures 

to their end-user counterparties 

pursuant to the proposed rule while 

those swap dealers and major swap 

participants continue to include nonreliance agreements in swap transaction 

documentation providing their end-user 

counterparties may not rely on 

disclosures.’’ 223 The commenter 

requested that the Commission clarify 

that any non-reliance provisions 

contained in swap transaction 

documentation must exclude any 

disclosure mandated by the Dodd-Frank 

Act and the rules promulgated 

thereunder.224

iii. Final § 23.402(f) 

The Commission is adopting 

proposed § 23.402(g) (renumbered as 

§ 23.402(f)) with a slight modification 

for clarity purposes. The language 

referencing ‘‘a standard format, 

including in a master * * * agreement 

* * *’’ was changed to ‘‘counterparty 

relationship documentation.’’ 

Regarding comments related to scope 

and substance and the request that the 

Commission develop a standardized 

disclosure form for swaps, the 

Commission has determined that a 

§ 1.55 225 type disclosure form for swaps 

would be inconsistent with the 

requirements of Section 4s(h)(3). 

Because the types of swaps covered by 

the disclosure duties will not be limited 

to standardized products and will 

include negotiated, bilateral 

transactions, swap dealers and major 

swap participants are required to 

develop the disclosures appropriate to 

the transactions that they offer to and 

enter into with counterparties. Unlike 

standardized exchange traded futures 

and options, swaps can be bespoke 

instruments with a wide range of nonstandardized economic features that 

materially influence cash flows, which 

do not lend themselves to a single form, 

futures-style risk disclosure statement 

developed by the Commission.226

In addition, commenters suggested 

that the Commission provide 

standardized disclosure to promote legal 

certainty. On the contrary, such a 

disclosure could increase uncertainty 

because it would necessarily have to be 

general enough to cover all conceivable 

swaps, to such an extent that the 

purpose of disclosure would not be 

served. Congress enacted this robust 

disclosure regime to reduce information 

asymmetry and give counterparties the 

material information to make an 

informed and reasoned decision before 

placing assets at risk. A Commission 

generated standard disclosure also runs 

the risk of offering a roadmap for 

evasion, or it would require constant 

updates to maintain pace with 

innovations that are engineered and 

may not be covered by the standard 

language. 

To address legal certainty concerns, 

the Commission is clarifying in this 

adopting release that, in the absence of 

fraud, it will consider good faith 

compliance with policies and 

procedures reasonably designed to 

comply with the business conduct 

standards rules as a mitigating factor 

when exercising its prosecutorial 

discretion for violation of the rules. 

The Commission expects that swap 

dealers and major swap participants 

will develop their own standard 

disclosures to meet certain aspects of 

the disclosure requirements, where 

appropriate, that will be tailored to the 

types of swaps that they offer and will 

be provided to counterparties in 

counterparty relationship 

documentation or through other reliable 

means. Such an approach will help to 

minimize costs without diminishing the 

quality of risk disclosures provided to 

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227The leverage characteristic is particularly 

relevant when the swap includes an embedded 

option, including one in which the counterparty 

has sold an option to the dealer or the dealer retains 

the option to alter the terms of the swap under 

certain circumstances. Such features can 

significantly increase counterparty risk exposure in 

ways that are not transparent. 

228 ‘‘The aforementioned characteristics are 

neither an exhaustive list nor should they be 

assumed to provide a strict definition of high-risk, 

complex instruments, which the Policy Group 

believes should be avoided. Instead, market 

participants should establish procedures for 

determining, based on the key characteristics 

discussed above, whether an instrument is to be 

considered high-risk and complex and thus require 

the special treatment outlined in this section.’’ The 

Counterparty Risk Management Policy Group, 

‘‘Containing Systemic Risk: The Road to Reform, 

The Report of the CRMPG III,’’ at 56 (Aug. 6, 2008) 

(‘‘CRMPG III Report’’). 

229 Id. 

230See Section III.D.3.b. of this adopting release 

for a discussion of final § 23.431(b); see also 

discussion of Section 2(h)(8) of the CEA and swaps 

‘‘made available for trading’’ on a DCM or SEF at 

infra fn. 394. 

231See NY City Bar Feb. 22 Letter, at 2–3. 

232 17 CFR 1.31. 233Proposing release, 75 FR at 80642. 

234CEF Feb. 22 Letter, at 19. 

235CFA/AFR Feb. 22 Letter, at 6, 7, 13, 18 and 

20. 

236Swap dealers and major swap participants will 

have to retain a record of all required information 

irrespective of the method used to convey such 

information. 

237 In addition, Section 753 of the Dodd-Frank 

Act provided the Commission with expanded antimanipulative and deceptive practices authority by 

amending Section 6(c) of the CEA. (7 U.S.C. 9). On 

July 14, 2011, the Commission published in the 

Federal Register final rules to implement the new 

anti-manipulative and deceptive practices 

authority. Prohibition on the Employment, or 

Attempted Employment, of Manipulative and 

Deceptive Devices and Prohibition on Price 

Manipulation, 76 FR 41398, Jul. 14, 2011 

(‘‘Prohibition on Manipulative and Deceptive 

Devices’’) (to be codified at 17 CFR part 180). 

counterparties. Where such 

standardized disclosures are inadequate 

to meet the requirements of final 

§ 23.402(f), swap dealers and major 

swap participants will have to make 

particularized disclosures in a timely 

manner that are sufficient to allow the 

counterparty to assess the material risks 

and characteristics of the swap. In 

addition, swap dealers and major swap 

participants will need to have policies 

and procedures to address when and 

how disclosures will be provided to 

counterparties, including particularized 

disclosures in connection with complex 

swaps. Factors that would be relevant 

include, but are not limited to, the 

complexity of the transaction, the 

degree and nature of any leverage,227 the 

potential for periods of significantly 

reduced liquidity, and the lack of price 

transparency.228 This approach is 

consistent with over-the-counter 

(‘‘OTC’’) industry best practice 

recommendations for high-risk, complex 

financial instruments.229

With respect to scenario analysis, 

counterparties will be able to opt in to 

receive scenario analysis for swaps that 

are not ‘‘made available for trading’’ on 

a DCM or SEF.230 The Commission 

declines, however, to determine, as 

suggested by commenters, that standard 

form scenario analysis is sufficient to 

meet all business conduct standards 

disclosure requirements, which include 

material risks, characteristics, incentives 

and conflicts of interest.231

Regarding the suggestion that DCOs 

be required to provide certain 

standardized disclosures (other than the 

daily mark) for cleared swaps, the 

Commission is not mandating such a 

rule in this rulemaking because Section 

4s(h) of the CEA and subpart H of part 

23 only govern swap dealers and major 

swap participants. Swap dealers and 

major swap participants will be 

permitted, however, to arrange with 

third parties, including DCOs and SEFs, 

to provide disclosures to a counterparty 

to satisfy the swap dealer’s or major 

swap participant’s obligation under 

§ 23.431. The Commission expects that 

a DCO or SEF may make available 

certain information, such as the material 

economic terms of cleared swaps, 

similar to the contract specifications 

provided by DCMs today. Swap dealers 

and major swap participants may make 

arrangements so that such information 

from the DCO or SEF satisfies certain 

disclosure obligations (e.g., material 

characteristics of the swap). Regardless, 

the swap dealer or major swap 

participant will remain responsible for 

compliance with § 23.431. Lastly, the 

Commission is providing guidance that 

non-reliance provisions routinely 

included in counterparty relationship 

documentation will not relieve swap 

dealers and major swap participants of 

their duty to comply in good faith with 

the business conduct standards 

requirements. It will be up to the 

adjudicator in a particular case to 

determine the extent of any liability of 

the swap dealer or major swap 

participant to a counterparty under the 

business conduct standards rules, 

depending on the facts and 

circumstances. 

g. Section 23.402(g)—Record Retention 

i. Proposed § 23.402(h) 

Proposed § 23.402(h) (renumbered as 

final § 23.402(g)) required swap dealers 

and major swap participants to create 

and retain a written record of their 

compliance with the requirements of the 

external business conduct rules in 

subpart H. Such requirements would be 

(1) part of the overall recordkeeping 

obligations imposed on swap dealers 

and major swap participants in the CEA 

and subpart F of part 23 of the 

Commission’s Regulations, (2) 

maintained in accordance with § 1.31 232

of the Commission’s Regulations, and 

(3) accessible to applicable prudential 

regulators.233

ii. Comments 

A commenter requested clarification 

regarding the requirement to create a 

written record of compliance with the 

external business conduct rules. In 

particular, guidance was requested 

regarding whether master agreements, 

which contain certain counterparty 

representations, qualify as a ‘‘written 

record of compliance’’ within the 

rule.234 Another commenter suggested 

that the Commission strengthen the 

recordkeeping requirements throughout 

to ensure that records are detailed 

enough to allow regulators to easily 

determine compliance.235

iii. Final § 23.402(g) 

After considering the comments, the 

Commission has determined to adopt 

§ 23.402(h) as proposed (renumbered as 

§ 23.402(g)). In addition, the 

Commission confirms that counterparty 

relationship documentation containing 

standard form disclosures, other 

material information and counterparty 

representations may be part of the 

written record of compliance with the 

external business conduct rules that 

require certain disclosures and due 

diligence. Further, swap dealers and 

major swap participants may choose to 

use internet based applications to 

provide disclosures and daily marks.236

Swap dealers and major swap 

participants are required to have 

policies and procedures for 

documenting disclosures and due 

diligence. Recordkeeping policies and 

procedures should ensure that records 

are sufficiently detailed to allow 

compliance officers and regulators to 

determine compliance. 

B. Section 23.410—Prohibition on 

Fraud, Manipulation and Other Abusive 

Practices 

1. Sections 23.410(a) and (b) 

a. Proposed § 23.410(a) 

Section 4s(h)(1) grants the 

Commission discretionary authority to 

promulgate rules applicable to swap 

dealers and major swap participants 

related to, among other things, fraud, 

manipulation and abusive practices.237

To implement this provision, the 

Commission proposed several rules, 

including proposed § 23.410(a), which 

incorporated the statutory text in 

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9752 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

238The Commission also proposed §§ 23.410(b) 

and 23.410(c), which prohibited swap dealers and 

major swap participants from disclosing 

confidential counterparty information and trading 

ahead and front running counterparty orders, 

respectively. See proposing release, 75 FR at 80642. 

239 In addition to the proposed antifraud rule, 

swap dealers and major swap participants are 

subject to all other applicable provisions of the CEA 

and Commission Regulations, including those 

dealing with fraud and manipulation (e.g., Sections 

4b, 6(c)(1) and (3), and 9(a)(2) of the CEA (7 U.S.C. 

6b, 9(c)(1) and (3), and 13(a)(2)), and §§ 180.1 and 

180.2 (17 CFR 180.1 and 180.2)). 

240Section 4s(h)(4)(A) states: (A) In general. It 

shall be unlawful for a swap dealer or major swap 

participant—(i) to employ any device, scheme, or 

artifice to defraud any Special Entity or prospective 

customer who is a Special Entity; (ii) to engage in 

any transaction, practice, or course of business that 

operates as a fraud or deceit on any Special Entity 

or prospective customer who is a Special Entity; or 

(iii) to engage in any act, practice, or course of 

business that is fraudulent, deceptive or 

manipulative. 

241Proposing release, 75 FR at 80642. 

242This language mirrored the language in 

Section 206(4) of the Investment Advisers Act of 

1940 (‘‘Advisers Act’’) (15 U.S.C. 80b–1 et seq.), 

which does not require scienter to prove liability. 

See SEC v. Steadman, 967 F.2d 636, 647 (D.C. Cir. 

1992) (‘‘[S]ection 206(4) uses the more neutral ‘act, 

practice, or course or business’ language. This is 

similar to [Securities Act] section 17(a)(3)’s 

‘transaction, practice, or course of business,’ which 

‘quite plainly focuses upon the effect of particular 

conduct * * * rather than upon the culpability of 

the person responsible.’ Accordingly, scienter is not 

required under section 206(4), and the SEC did not 

have to prove it in order to establish the appellants’ 

liability. * * *’’) (internal citations omitted). 

243SIFMA/ISDA Feb. 17 Letter, at 10. 

244 Id. 

245 15 U.S.C. 80b–6. 

246 17 CFR 240.10b–5. 

247SIFMA/ISDA Feb. 17 Letter, at 10. 

248 Id. 

249See CEF Feb. 22 Letter, at 12; Barnard May 23 

Letter, at 2. 

250Exelon Feb. 22 Letter, at 4. 

251CII Feb. 10 Letter, at 1 (citing A Report by the 

Investors’ Working Group, An Independent 

Taskforce Sponsored by CFA Institute Centre for 

Financial Market Integrity and Council of 

Institutional Investors, U.S. Financial Regulatory 

Reform: The Investors’ Perspective (July 2009)). 

252CFA/AFR Feb. 22 Letter, at 1. 

253 Id., at 6–7. 

254 Id. 

255See discussion at fn. 242. 

256 7 U.S.C. 25. 

Section 4s(h)(4)(A).238 The statutory 

provision prohibits fraudulent, 

deceptive and manipulative practices by 

swap dealers and major swap 

participants.239 While the heading of 

Section 4s(h)(4) reads ‘‘Special 

Requirements for Swap Dealers Acting 

as Advisors,’’ the plain language of the 

statutory text within that section 

includes both more general and more 

specific restrictions. The fraudulent, 

deceptive and manipulative practices 

provision in Section 4s(h)(4)(A), by its 

own terms, is not limited to the advisory 

context or to swap dealers.240

Proposed § 23.410(a) followed the 

statutory text and applied to swap 

dealers and major swap participants 

acting in any capacity, e.g., as an 

advisor or counterparty.241 The first two 

paragraphs of the proposed rule focused 

on Special Entities and prohibited swap 

dealers and major swap participants 

from (1) employing any device, scheme 

or artifice to defraud any Special Entity, 

and (2) engaging in any transaction, 

practice or course of business that 

operates as a fraud or deceit on any 

Special Entity. The third paragraph of 

the proposed rule was not limited to 

conduct with Special Entities and 

prohibited swap dealers and major swap 

participants from engaging in any act, 

practice or course of business that is 

fraudulent, deceptive or 

manipulative.242

b. Comments 

The Commission received a number 

of comments both supporting and 

opposing aspects of proposed 

§ 23.410(a). One commenter urged that 

the fraud prohibition in Section 4s(h)(4) 

should apply only when a swap dealer 

is acting as an advisor to a Special 

Entity.243 The commenter asserted that, 

while the prohibitions of Section 

4s(h)(4)(A) do not themselves contain 

language limiting them to instances 

where a swap dealer is an advisor, the 

title ‘‘Special Requirements for Swap 

Dealers Acting as Advisors’’ should be 

read as limiting the scope of any rules 

promulgated thereunder.244 The 

commenter further asserted that the lack 

of scienter in proposed § 23.410(a)(3) is 

particularly misplaced as the language 

of Section 4s(h)(4)(A)(iii) mirrors 

Section 206(4) of the Investment 

Advisers Act of 1940 (‘‘Advisers 

Act’’),245 which is in the context of an 

advisor relationship, and that in cases 

where there is not an advisor 

relationship, the scienter standards of 

Rule 10b–5 246 under the Exchange Act 

should prevail.247 This commenter 

stated that the Commission should 

adopt a scienter requirement when a 

swap dealer or major swap participant 

acts merely as a counterparty to a nonSpecial Entity and does not act as an 

advisor as it would be unfair to subject 

swap dealers or major swap 

participants, not acting as advisors, to 

liability without a showing of bad 

faith.248 The Commission also received 

comments urging that proposed 

§ 23.410(a) not be adopted as it is 

redundant of the rules promulgated in 

part 180.249

Other commenters supported 

proposed § 23.410(a). One commenter 

asserted that the rule prohibiting fraud 

and manipulation by swap dealers and 

major swap participants is appropriate 

as long as these principles are properly 

applied to swap markets.250 Another 

commenter supported the proposed rule 

because it believed the rule was largely 

consistent with the recommendations 

contained in the July 2009 report of the 

Investors’ Working Group,251 and 

another commenter believed it would 

strengthen the protection of market 

participants, encourage investor 

confidence and promote integrity within 

the financial system.252 One commenter 

asserted that the title ‘‘Special 

Requirements for Swap Dealers Acting 

as Advisors’’ should not limit the scope 

of the rule where the statutory language 

is broad, applying to ‘‘any device, 

scheme or artifice to defraud,’’ and that 

Congress intended to apply these 

principles to the broad range of conduct 

engaged in by swap dealers and major 

swap participants with regard to 

counterparties generally and Special 

Entities in particular.253 This 

commenter believed that, under the 

proposed rule, it should be considered 

an abusive practice to recommend a 

swap or trading strategy that achieves 

the counterparty’s aim in a way that 

includes risks to the counterparty 

greater than those it seeks to hedge and 

to recommend customized swaps where 

the counterparty could achieve the same 

result at a lower cost through 

standardized swaps.254

c. Final § 23.410(a) and (b) 

After considering the comments, the 

Commission decided to adopt 

§ 23.410(a) as proposed. Inclusion of the 

rule in subpart H of part 23 of the 

Commission’s Regulations provides 

swap dealers, major swap participants 

and counterparties with easy reference 

to the business conduct requirements 

under Section 4s(h) of the CEA without 

any additional cost to market 

participants. 

With respect to the concern regarding 

the rule’s protections for counterparties 

other than Special Entities, § 23.410(a) 

mirrors the language of the statute. In 

addition, the prohibition against 

engaging in ‘‘any act, practice, or course 

of business that is fraudulent, deceptive, 

or manipulative’’ has been interpreted 

by the courts as imposing a non-scienter 

standard under the Advisers Act.255

Even if the Commission were to limit 

the rule to require proof of scienter and 

apply the rule only when a swap dealer 

is acting as an advisor to a Special 

Entity, that would not restrict a court 

from taking a plain meaning approach to 

the language in Section 4s(h)(4) in a 

private action under Section 22 of the 

CEA.256 In addition, because 

comparable non-scienter fraudulent and 

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257Section 763(g) of the Dodd-Frank Act 

amended the Exchange Act by adding Section 9(j), 

which states in relevant part that ‘‘It shall be 

unlawful for any person * * * to effect any 

transaction in * * * any security-based swap, in 

connection with which such person * * * engages 

in any transaction, practice, or course of business 

which operates as a fraud or deceit upon any 

person.’’ Courts have interpreted ‘‘operates as a 

fraud’’ provisions under a non-scienter standard. 

On November 8, 2010, the SEC published proposed 

rule 17 CFR 240.9j–1 in the Federal Register to 

clarify that the provisions of Section 9(j) apply to 

fraud in connection with (1) entering into a 

security-based swap and (2) the exercise of any 

right or performance of any obligation under a 

security-based swap. Prohibition Against Fraud, 

Manipulation, and Deception in Connection With 

Security-Based Swaps, 75 FR 68560, Nov. 8, 2010. 

258This provision mirrors Section 4s(h)(4) of the 

CEA. 

259One commenter stated that that the CFTC and 

SEC should harmonize their regulatory structures 

for combating disruptive and manipulative 

activities. SIFMA/ISDA Feb. 17 Letter, at 10. 

260 In the release promulgating Commission 

Regulation § 180.1, the Commission stated: ‘‘In 

response to commenters requesting that front 

running and similar misuse of customer 

information be considered a form of fraud-based 

manipulation under final Rule 180.1, the 

Commission declines to adopt any per se rule in 

this regard, but clarifies that final Rule 180.1 

reaches all manner of fraud and manipulation 

within the scope of the statute it implements, CEA 

section 6(c)(1).’’ Prohibition on Manipulative and 

Deceptive Devices, 76 FR at 41401. 

261Proposing release, 75 FR at 80642. 

262Senator Lincoln noted in a colloquy that the 

Commission should adopt rules to ensure that swap 

dealers maintain the confidentiality of hedging and 

portfolio information provided by Special Entities, 

and prohibit swap dealers from using information 

received from a Special Entity to engage in trades 

that would take advantage of the Special Entity’s 

positions or strategies. 156 Cong. Rec. S5923 (daily 

ed. July 15, 2010) (statement of Sen. Lincoln). In 

consultations with stakeholders, Commission staff 

learned that these concerns are shared by 

counterparties more generally. As a result, the 

Commission proposed that the business conduct 

rules include prohibitions on these types of 

activities in all transactions between swap dealers 

or major swap participants and their counterparties. 

See proposing release, 75 FR at 80658. 

263SIFMA/ISDA Feb. 17 Letter, at 11. 

264 Id. 

265 Id. 

266 Id., at 10–11. 

267 Id., at 11. 

268MetLife Feb. 22 Letter, at 4–5. 

269CFA/AFR Feb. 22 Letter, at 12. 

270The Commission has determined to impose 

the final rule on both swap dealers and major swap 

participants, which is consistent with the 

application of Section 4s(h)(4)(A), prohibiting 

manipulative, deceptive and fraudulent practices, 

to both swap dealers and major swap participants. 

manipulative practices provisions will 

apply to SBS Entities in enforcement 

actions under Sections 9(j) 257 and 

15F(h)(4) 258 of the Exchange Act and 

Sections 17(a)(2) and (3) of the 

Securities Act, it would be inconsistent 

to impose a different intent standard for 

swap dealers and major swap 

participants.259

Finally, in response to commenters 

who urged that it would be unfair to 

subject swap dealers or major swap 

participants to the non-scienter 

provision of the rule, the Commission 

decided to provide an affirmative 

defense in final § 23.410(b) for swap 

dealers and major swap participants in 

cases alleging non-scienter violations of 

§ 23.410(a)(2) and (3) based solely on 

violations of the business conduct 

standards rules in subpart H. The 

affirmative defense enables swap 

dealers and major swap participants to 

defend against such claims by 

establishing that they complied in good 

faith with written policies and 

procedures reasonably designed to meet 

the requirements of the particular rule 

that is the basis for the alleged 

§ 23.410(a)(2) or (3) violation. Whether 

the affirmative defense is established 

will depend on the facts and 

circumstances of the case. However, by 

way of non-exclusive example, a swap 

dealer or major swap participant would 

be unable to establish that it acted in 

good faith if the evidence showed that 

it acted intentionally or recklessly in 

connection with the violation. 

Similarly, policies and procedures that 

were outdated or failed to address the 

scope of swap business conducted by 

the swap dealer or major swap 

participant would not be considered 

reasonable. 

With respect to whether any 

particular type of conduct would be 

abusive within the prohibitions under 

final § 23.410(a) as urged by 

commenters, the Commission will 

evaluate the facts and circumstances of 

any particular case in light of the 

elements of an offense under the final 

rule. This is consistent with the 

approach that the Commission took in 

adopting § 180.1.260

2. Section 23.410(c)—Confidential 

Treatment of Counterparty Information 

a. Proposed § 23.410(b) 

The Commission proposed § 23.410(b) 

(renumbered as final § 23.410(c)), which 

prohibited swap dealers and major swap 

participants from disclosing 

confidential counterparty 

information,261 using its discretionary 

rulemaking authority under Section 

4s(h)(1)(A).262 The proposed rule 

extended existing Commission 

standards that protect the 

confidentiality of customer orders. 

b. Comments 

The Commission received comments 

regarding the proposed prohibition 

against disclosing confidential 

counterparty information. One 

commenter stated that the 

confidentiality of counterparty 

information should be left to private 

negotiation rather than imposed by 

Commission rule.263 The commenter 

urged that if the Commission 

determines to promulgate a rule 

protecting the confidentiality of such 

information, the Commission should 

alternatively require swap dealers and 

major swap participants to establish, 

maintain and enforce policies and 

procedures reasonably designed to 

prevent the improper use or disclosure 

of any counterparty information that the 

swap dealer or major swap participant 

has agreed with the counterparty to 

keep confidential.264 The commenter 

also stated that the confidentiality rule 

should be implemented as an SRO rule 

and should allow sophisticated 

counterparties to opt out of heightened 

protections they may not want or 

need.265 The commenter expressed 

concern that the proposed rule would 

restrict swap dealers and major swap 

participants in properly servicing 

counterparties through discussions with 

the swap dealer’s or major swap 

participant’s affiliates.266 Further, the 

commenter asserted that there would be 

facts and circumstances that would 

warrant particular disclosures in certain 

contexts.267

Another commenter asserted that the 

confidential treatment and trading 

ahead rules should not apply to major 

swap participants because they are 

customers of swap dealers and should 

be treated as such, rather than as dealers 

or quasi-dealers.268 Another commenter 

stated that the Commission should 

avoid specifying in detail the conduct 

that would violate the rule because 

doing so could have unintended 

consequences of limiting its scope. This 

commenter stated that a broad, 

enforceable principles based approach 

is the best approach for promoting 

market integrity.269

c. Final § 23.410(c) 

Upon consideration, the Commission 

has determined to adopt proposed 

§ 23.410(b) (renumbered as § 23.410(c)) 

with several changes. First, the final 

rule has been changed to also permit 

swap dealers and major swap 

participants 270 to disclose confidential 

information to an SRO designated by the 

Commission or as required by law. The 

proposed rule addressed disclosure only 

to the CFTC, Department of Justice 

(‘‘DOJ’’) and applicable prudential 

regulators. Second, the Commission has 

clarified that the final rule will protect 

confidential counterparty information 

from disclosure to third parties, as well 

as from improper use by the swap dealer 

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9754 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

271The final rule is aimed at improper disclosure 

of the counterparty’s position, the transaction and 

the counterparty’s intentions to enter or exit the 

market, which may be detrimental to the interests 

of the counterparty. 

272The Commission notes by analogy that Section 

621 of the Dodd-Frank Act, to be codified at Section 

27B of the Securities Act (15 U.S.C. 77z–2a), 

provides for exceptions to the conflict of interest 

prohibitions in that section for risk-mitigating 

hedging activities in connection with an assetbacked security, purchases or sales made consistent 

with commitments to the underwriter or others to 

provide liquidity for the asset-backed security, or 

bona-fide market making in the asset-backed 

security. The Commission’s final § 23.410(c) 

provides for exceptions for disclosure and use for 

effective execution of the order, risk mitigation and 

hedging, and when authorized in writing by the 

counterparty. 

273For example, the Commission expects that the 

swap dealer would generally have information 

barriers between its sales desk and proprietary 

trading desk. 

274The financial industry has long-held standards 

relating to confidential treatment of counterparty 

information similar to those set forth in the final 

rule. While not endorsing any particular industry 

practice, the Commission notes, for example, that 

one industry group has recommended that financial 

institutions ‘‘have internal written policies and 

procedures in place governing the use of and access 

to proprietary information provided to them by 

trading counterparties as a basis for credit 

evaluations.’’ Improving Counterparty Risk 

Management Practices, Counterparty Risk 

Management Policy Group (June 1999) (‘‘CRMPG I 

Report’’), at 5; see also Toward a Greater Financial 

Stability: A Private Sector Perspective, 

Counterparty Risk Management Policy Group (July 

2005) (‘‘CRMPG II Report’’), at 47 (recommending 

that firms evaluate operational risks with 

customized legal documents that deviate from a 

firm’s existing procedures for handing confidential 

counterparty information). Also without 

endorsement by the Commission, one firm’s code of 

conduct states that employees ‘‘must maintain the 

confidentiality of the information with which you 

are entrusted, including complying with 

information barriers procedures applicable to your 

business. The only exception is when disclosure is 

authorized or legally mandated. * * * Confidential 

or proprietary information * * * provided by a 

third party [is provided with] the expectation that 

the information will be kept confidential and used 

solely for the business purpose for which it was 

conveyed.’’ Goldman Sachs Code of Business 

Conduct and Ethics (amended, effective January 11, 

2011). 

275See SIFMA/ISDA Feb. 17 Letter, at 10–11. 

276See id., at 11. 

277See SIFMA/ISDA Feb. 17 Letter, at 11. 

278See Section III.A.1. of this adopting release for 

a discussion of ‘‘Discretionary Rules’’ and ‘‘Opt in 

or Opt out for Certain Classes of Counterparties.’’ 

279See SIFMA/ISDA Feb. 17 Letter, at 11 (stating 

that the definition, treatment, use and disclosure of 

confidential information are routinely the subject of 

negotiation between the parties). 

or major swap participant. It is not 

intended to restrict the necessary and 

appropriate use of the information by 

the swap dealer or major swap 

participant, but is intended to address 

material conflicts of interest that must 

be identified and managed to avoid 

trading or other activities on the basis of 

confidential counterparty information 

that would tend to be materially adverse 

to the interests of the counterparty.271

By promulgating final § 23.410(c), the 

Commission does not intend to prohibit 

legitimate trading activities, which, 

depending on the facts and 

circumstances, would include, among 

other things, (1) bona fide riskmitigating and hedging activities in 

connection with the swap, (2) purchases 

or sales of the same or similar types of 

swaps consistent with commitments of 

the swap dealer or major swap 

participant to provide liquidity for the 

swap, or (3) bona-fide market-making in 

the swap.272

The final rule requires swap dealers 

and major swap participants to have 

written policies and procedures 

reasonably designed to protect material 

confidential information provided by or 

on behalf of a counterparty from 

disclosure and use by any person acting 

for or on behalf of the swap dealer or 

major swap participant. Such policies 

and procedures should be designed to 

identify and manage material conflicts 

of interest between a swap dealer or 

major swap participant and a 

counterparty through, for example, 

information barriers and restrictions on 

access to confidential counterparty 

information on a ‘‘need-to-know’’ 

basis.273 Information barriers can be 

used to restrict the dissemination of 

information within a complex 

organization and to prevent material 

conflicts by limiting knowledge and 

coordination of specific business 

activities among different units of the 

entity. Examples of information barriers 

include restrictions on information 

sharing, limits on types of trading and 

greater separation between various 

functions of the firm. Such information 

barriers have been recognized in the 

federal securities laws and rules as a 

means to address or mitigate potential 

conflicts of interest or other 

inappropriate activities within an 

organization. 

Depending on the facts and 

circumstances, the Commission would 

consider it to be an abuse of confidential 

counterparty information for a swap 

dealer or major swap participant to 

disclose or use such information for its 

own benefit if such use or disclosure 

would tend to be materially adverse to 

the interests of the counterparty.274

Final § 23.410(c) does not prohibit 

disclosure or use that is necessary for 

the effective execution of any swap for 

or with the counterparty, to hedge or 

mitigate any exposure created by such 

swap or to comply with a request of the 

Commission, DOJ, any SRO designated 

by the Commission, or applicable 

prudential regulator, or is otherwise 

required by law. 

In response to the commenter that 

expressed concern that the proposed 

rule would restrict swap dealers and 

major swap participants in properly 

servicing counterparties through 

discussions with the swap dealer’s or 

major swap participant’s affiliates,275 it 

is not the intent of the rule to prohibit 

certain interactions needed to execute 

the swap but is to ensure that the 

counterparty’s confidential information 

is disseminated only on a ‘‘need to 

know’’ basis. Further, in response to a 

commenter that stated that there may be 

facts or circumstances that would 

warrant particular disclosures or uses in 

certain contexts,276 the Commission 

included a provision in the rule that 

allows for use or disclosure of 

confidential counterparty information if 

authorized in writing by the 

counterparty. 

The Commission decided it is 

appropriate to establish an explicit 

confidential treatment duty for swap 

dealers and major swap participants 

with respect to confidential 

counterparty information. Because swap 

dealers and major swap participants 

principally act as counterparties rather 

than as agents or brokers (unlike FCMs), 

in the absence of such an explicit duty, 

it could be more difficult to establish 

that disclosure or misuse of confidential 

counterparty information is fraudulent, 

deceptive or manipulative. Depending 

on the facts and circumstances, 

however, as set forth in final § 23.410(b), 

good faith compliance with reasonably 

designed policies and procedures will 

constitute an affirmative defense to a 

non-scienter violation of final 

§ 23.410(a)(2) or (3) for improper 

disclosure or abuse of counterparty 

information. 

The Commission considered the 

commenter’s suggestion that 

confidential treatment of counterparty 

information should be left to negotiation 

between counterparties or, alternatively, 

be implemented as an SRO rule or on 

an opt in or opt out basis.277 The 

Commission determined that such 

alternatives would be inconsistent with 

Congress’ intent that the Commission 

promulgate rules that raise business 

conduct standards for the protection of 

all counterparties.278 The final rule is in 

accordance with current industry 

practices where confidential treatment 

is routinely part of negotiations among 

the parties that is then incorporated into 

the counterparty relationship 

documentation.279

Adopting a confidential treatment 

rule will ensure that all counterparties, 

irrespective of their negotiating power, 

will be able to protect their confidential 

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280Proposing release, 75 FR at 80642. 

281See, e.g., 17 CFR 155.3–4. 

282SIFMA/ISDA Feb. 17 Letter, at 13. 

283 Id., at 12. 

284 Id. 

285 Id., at 13. 

286 Id. 

287 Id. 

288 Id., at 13–14. 

289 Id. 

290CEF Feb. 22 Letter, at 10–11. 

291 Id. 

292 Id., at 11. 

293 Id. 

294 Id. 

295 Id. 

296Exelon Feb. 22 Letter, at 3. 

297 Id. 

298HOOPP Feb. 22 Letter, at 2. 

299 Id. 

300CFA/AFR Feb. 22 Letter, at 7. 

301 Id. 

information from disclosure and abuse 

by swap dealers and major swap 

participants. Counterparties will 

continue to be free to negotiate 

additional protections based on their 

individual needs. By establishing such a 

duty, the Commission is not changing 

the ‘‘counterparty’’ nature of the 

relationship between a swap dealer or 

major swap participant and a 

counterparty. Nor is the Commission 

imposing a general fiduciary duty on 

swap dealers or major swap 

participants. Violation of the 

confidential treatment duty, however, 

depending on the facts and 

circumstances, could constitute a 

fraudulent, deceptive or manipulative 

practice. 

3. Proposed § 23.410(c)—Trading Ahead 

and Front Running Prohibited—Not 

Adopted as Final Rule 

a. Proposed § 23.410(c) 

The Commission proposed 

§ 23.410(c), which prohibited swap 

dealers and major swap participants 

from front running or trading ahead of 

counterparty swap transactions.280 The 

proposed rule was based on trading 

standards applicable to FCMs and 

introducing brokers that prohibit trading 

ahead of customer orders.281

b. Comments 

One commenter urged that the 

Commission not adopt the trading ahead 

and front running rule or, in the 

alternative, apply the rule only when 

the swap dealer or major swap 

participant has an executable order and 

not when a swap is still under 

negotiation.282 The commenter asserted 

that the prohibition on trading during 

the negotiation of a swap fails to 

appreciate the distinction between 

bilateral swaps and orders for 

standardized products, as bilateral swap 

terms must be negotiated, which can 

take weeks or months, and 

counterparties may negotiate with 

multiple dealers to obtain the best 

price.283 The commenter further 

asserted that enforcement of a front 

running ban would be untenable, 

disruptive to the market and prevent 

hedging activity related either to the 

pending transaction or the other 

liabilities of the swap dealer or major 

swap participant.284 The commenter 

urged that, if the Commission were to 

adopt the proposed rule, then it should 

prohibit only a transaction (1) that is 

entered into for a non-hedging purpose 

on the basis of actual knowledge of a 

non-public, executable order of a 

counterparty, (2) that exhibits consistent 

and estimable positive price correlation 

to the pending executable counterparty 

swap transaction, and (3) whose 

execution is substantially likely to 

materially affect the price of that 

pending executable swap transaction.285

The commenter asserted that, without 

an actual knowledge standard, the 

proposed rule would prohibit 

transactions by other parts of an 

organization not privy to the order.286

Finally, the commenter urged the 

Commission to clarify its proposed 

‘‘specific’’ consent standard and the 

duration of the prohibition.287

In addition, the commenter urged the 

Commission to clarify that the following 

trades would not be considered front 

running under proposed § 23.410(c): (1) 

When a swap dealer or major swap 

participant enters a trade at the request 

of another customer; (2) when the 

specifics of a pending counterparty 

transaction are as yet undefined; (3) 

when a swap dealer or major swap 

participant trades in the ordinary course 

of hedging other transactions, assets or 

liabilities; (4) when there is not a clear 

price-related nexus to the pending swap 

transaction; (5) if the transaction would 

not affect the counterparty; and (6) if the 

transaction is an anticipatory hedge of 

the subject transaction and disclosed to 

the counterparty.288 The commenter 

also urged that the prohibition should 

only exist until the transaction is 

executed or cancelled, or the relevant 

information ceases to be material, nonpublic information, and the proposed 

rule should not require further specific 

consent to trade with respect to specific 

transactions at specific times.289

Another commenter stated that it did 

not object to applying the front running 

prohibition to trades executable on a 

DCM and for which a swap dealer or 

major swap participant is merely an 

intermediary.290 However, the 

commenter believed proprietary trading 

desks should be able to trade freely as 

long as they are unaware of the 

counterparty’s order.291 Without such a 

limitation, the commenter asserted, 

swap dealers may have little incentive 

to accept swap orders that can be 

executed electronically or may refuse to 

accept orders for such transactions 

altogether.292

Further, the commenter urged that the 

proposed front running prohibition 

should not apply to bilaterally 

negotiated and settled swaps. Since 

some swaps take months to negotiate, 

the commenter believed front running 

rules would severely limit a swap 

dealer’s ability to be in the market.293

The commenter stated that front 

running should be defined in a manner 

more appropriate for the swaps markets 

as the present definition could be 

interpreted to force a swap dealer to 

stop, or severely limit, physical trading 

related to the swap.294 The commenter 

urged the Commission to eliminate the 

front running rules or to exclude swap 

markets with actual physical underlying 

commodities from such rules.295

Another commenter stated that the 

proposed rule is tailored to a securities 

broker-dealer model and is not suited to 

the commodities market.296 The 

commenter asserted that instruments 

relating to derivatives of an underlying 

physical market are not susceptible to 

insider trading or broker-dealer abuses, 

and that the disclosures required in 

proposed § 23.410(c) would chill the 

open interaction that occurs between 

counterparties in a competitive swaps 

market.297

Another commenter stated that 

prohibiting front running would have 

unintended consequences that would, 

along with other proposed rules, 

increase the administrative and 

compliance burden on swap dealers.298

The combined effect of the proposed 

rules, the commenter asserted, would 

slow the process of swap trading and 

increase costs by requiring additional 

time, effort, and risks taken in trading 

swaps.299

One commenter that generally 

supported the proposed rule 

recommended imposing a time limit on 

the trading ahead prohibition for swaps 

under negotiation and believed swap 

dealers should be required to disclose 

the time limit to counterparties.300

Alternatively, the commenter urged that 

swap dealers should have reasonable 

grounds for believing the counterparty 

does not intend to enter into the 

transaction in the near future.301

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302CEF Feb 22 Letter, at 12; see also Prohibition 

on Manipulative and Deceptive Devices, 76 FR 

41398. 

303The Commission’s other deceptive and 

manipulative practices provisions, including 

Sections 4b and 6(c)(1) of the CEA and § 180.1 of 

the Commission’s Regulations also prohibit trading 

ahead and front running. 

304 ‘‘Eligible contract participant’’ is a defined 

term in Section 1a(18) of the CEA. (7 U.S.C. 1a(18)). 

305See Section 2(e) of the CEA. (7 U.S.C. 2(e)). 

306Proposing release, 75 FR at 80643. 

307This provision was informed by the statutory 

language in Sections 2(e) and 4s(h)(7). 

308See SIFMA/ISDA Feb. 17 Letter, at 15–16; 

CFA/AFR Feb. 22 Letter, at 8; CEF Feb. 22 Letter, 

at 12, 19 and 20; FHLBanks Feb. 22 Letter, at 4– 

5; APGA Feb. 22 Letter, at 2–3. 

309See SIFMA/ISDA Feb. 17 Letter, at 16 

(recommending no affirmative duty to investigate 

representations or obtain detailed factual 

representations). Accord CEF Feb. 22 Letter, at 12, 

19 and 20. 

310SIFMA/ISDA Feb. 17 Letter, at 16 fn. 35 (citing 

Regulation D (17 CFR 230.501–508) and Rule 144A 

(17 CFR 230.144A) transactional practice under the 

federal securities laws). 

311CFA/AFR Feb. 22 Letter, at 8. 

312See, e.g., NFA Aug. 25, 2010 Letter, at 2; 

SIFMA/ISDA Feb. 17 Letter, at 16; APGA Feb. 22 

Letter, at 2–3. 

313FHLBanks Feb. 22 Letter, at 4. 

314SIFMA/ISDA Feb. 17 Letter, at 16. In addition, 

the commenter questioned whether the loss of ECP 

status would limit the counterparty’s ability to 

terminate, modify or novate the swap. 

Another commenter that supported 

the proposed rule urged that the entire 

front running section be removed 

because it is duplicative of the rules 

promulgated by the Commission under 

Section 6(c)(1) of the CEA (the new 

general fraudulent, deceptive and 

manipulative practices provision).302

c. Commission Determination 

The Commission has considered the 

comments and has determined not to 

promulgate proposed § 23.410(c). The 

fraudulent, deceptive and manipulative 

practices rule in final § 23.410(a), 

coupled with the confidential treatment 

rule in final § 23.410(c), should 

effectively protect counterparties from 

abuse of their material confidential 

information by swap dealers and major 

swap participants.303 The Commission 

agrees with the commenter that stated 

that, depending on the facts and 

circumstances, improperly trading 

ahead or front running counterparty 

orders would constitute fraudulent, 

deceptive or manipulative conduct 

under final § 23.410(a) and § 180.1, 

among other fraudulent, deceptive and 

manipulative practices protections 

under the CEA and Commission 

Regulations. 

In response to commenters seeking 

clarity as to the types of transactions 

that would constitute illegal trading 

ahead or front running by a swap dealer 

or major swap participant, the 

Commission declines to adopt the 

request of certain commenters to list the 

trades or specific situations that would 

not be considered illegal trading ahead 

or front running in violation of the antifraud and confidential treatment rules 

in final § 23.410(a) and final § 23.410(c), 

respectively. The Commission expects 

swap dealers and major swap 

participants to implement policies and 

procedures, including establishing 

appropriate information barriers and 

other means to protect material 

confidential counterparty information, 

that would allow the swap dealer or 

major swap participant to continue to 

provide liquidity in the swap or engage 

in bona-fide market-making in the swap. 

The Commission states, however, that 

use of confidential counterparty 

information to trade ahead of or front 

run a counterparty’s order would tend 

to be materially adverse to the interests 

of the counterparty, depending on the 

facts and circumstances, and would be 

considered an abuse of final §§ 23.410(a) 

and (c), among other similar protections 

under the CEA and Commission 

Regulations. 

The Commission’s decision not to 

adopt proposed § 23.410(c) was 

informed by commenters who stated 

that the proposed rule would have 

unintended consequences of severely 

hampering the ability of swap dealers 

and major swap participants to conduct 

swaps business and would have the 

potential to impose additional costs on 

swap transactions. While abuse of 

counterparty information, including 

trading ahead, will still be prohibited 

under the manipulative, deceptive and 

fraudulent practices rule in final 

§ 23.410(a) and the confidential 

treatment rule in final § 23.410(c), 

among other provisions, the approach 

adopted by the Commission should 

eliminate the uncertainties identified by 

commenters in the proposed trading 

ahead and front running rule, and allow 

legitimate trading by swap dealers and 

major swap participants. The 

Commission, however, will continue to 

monitor market conduct to determine 

whether, in the future, there is a need 

to address explicitly abuses related to 

trading ahead and front running of 

counterparty swap transactions. 

C. Section 23.430—Verification of 

Counterparty Eligibility 

1. Proposed § 23.430 

The Dodd-Frank Act makes it 

unlawful for any person, other than an 

ECP,304 to enter into a swap unless it is 

executed on or subject to the rules of a 

DCM.305 Section 4s(h)(3)(A) also 

requires the Commission to establish a 

duty for swap dealers and major swap 

participants to verify that any 

counterparty meets the eligibility 

standards for an ECP. Proposed § 23.430 

required swap dealers and major swap 

participants to verify that a counterparty 

meets the definition of an ECP prior to 

offering to enter into or entering into a 

swap and to determine whether the 

counterparty is a Special Entity as 

defined in Section 4s(h)(2)(C) and 

proposed § 23.401.306

The Commission contemplated that, 

in the absence of ‘‘red flags,’’ and as 

provided in proposed § 23.402(e), a 

swap dealer or major swap participant 

would be permitted to rely on 

reasonable written representations of a 

potential counterparty to establish its 

eligibility as an ECP. In addition, under 

proposed § 23.402(g), such written 

representations could be expressed in a 

master agreement or other written 

agreement and, if agreed to by the 

parties, could be deemed to be renewed 

with each subsequent swap transaction, 

absent any facts or circumstances to the 

contrary. Finally, as set forth in 

proposed § 23.430(c), a swap dealer or 

major swap participant would not be 

required to verify the ECP or Special 

Entity status of the counterparty for any 

swap initiated on a SEF where the swap 

dealer or major swap participant does 

not know the identity of the 

counterparty.307

2. Comments 

The Commission received several 

comments regarding proposed 

§ 23.430.308 Two commenters 

recommended that swap dealers and 

major swap participants be able to rely 

principally on counterparty 

representations regarding eligibility.309

It was asserted that only actual notice of 

countervailing facts or facts that 

reasonably put the swap dealer or major 

swap participant on notice should 

trigger a duty to inquire further, 

consistent with industry practice.310

One commenter supported sufficiently 

detailed representations to facilitate 

eligibility determinations and regulatory 

compliance audits.311 Other 

commenters requested that the proposed 

rule be amended to specifically allow 

counterparties to make eligibility 

representations in master agreements.312

A different commenter recommended 

that the Commission sponsor and 

promote standardized due diligence 

documentation to facilitate compliance, 

reduce costs and promote legal 

certainty.313 Certain commenters 

questioned whether the verification 

duty was an ongoing duty throughout 

the life of the swap.314 Two commenters 

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315CFA/AFR Feb. 22 Letter, at 8; SIFMA/ISDA 

Feb. 17 Letter, at 16 (asserting that swap dealers and 

major swap participants should be able to rely on 

eligibility representations deemed to be made at the 

inception of each swap transaction and covenant to 

notify if ECP status ceases). 

316CFA/AFR Feb. 22 Letter, at 8. 

317CEF Feb. 22 Letter, at 12. 

318This addition is related to the Commission’s 

determinations regarding the final Special Entity 

definition relating to certain Special Entities 

defined in Section 3 of ERISA. See Section IV.A. of 

this adopting release. 

319OTC derivatives industry best practice advises 

professional intermediaries, prior to entering into 

any transaction, to evaluate the counterparty’s legal 

capacity, transactional authority and credit. See 

DPG Framework, at Section V.III.B. 

320The Commission expects swap dealers and 

major swap participants to have policies and 

procedures in place that require the review of 

counterparty relationship documentation to ensure 

that representations and disclosures under subpart 

H of part 23 remain accurate. Such review should 

be part of its annual compliance review in 

accordance with subpart J of part 23. See proposed 

§§ 23.600 and 23.602, Governing Duties of Swap 

Dealers, 75 FR 71397. 

321Proposing release, 75 FR at 80643; cf. CFTC v. 

R.J. Fitzgerald & Co., 310 F.3d 1321, 1328–29 (11th 

Cir. 2002) (‘‘A representation or omission is 

‘material’ if a reasonable investor would consider it 

important in deciding whether to make an 

investment.) (citing Affiliated Ute Citizens of Utah 

v. United States, 406 U.S. 128, 153–54 (1972)). 

322Proposing release, 75 FR at 80643. 

323Additionally, under proposed § 23.402(h), 

swap dealers and major swap participants were 

required to maintain a record of their compliance 

with the proposed rules. 

suggested amending the rule to require 

an update whenever there is a change 

impacting a counterparty’s eligibility or 

status.315 A commenter recommended 

additional guidance regarding red flags 

and the nature and timing of evidence 

necessary to establish ECP status.316

Lastly, a commenter supported the 

proposed exemption from the 

verification duty for SEF and DCM 

transactions.317

3. Final § 23.430 

After considering the comments, the 

Commission has determined to adopt 

the rule with three changes. First, the 

Commission is adding a new 

§ 23.430(c), Special Entity election, 

which will require a swap dealer or 

major swap participant to determine 

whether a counterparty is eligible to 

elect to be a Special Entity and notify 

such counterparty as provided for in the 

Special Entity definition in final 

§ 23.401(c)(6).318 Second, the 

Commission has added a new safe 

harbor, § 23.430(d), to clarify that a 

swap dealer or major swap participant 

may rely on written representations of 

counterparties to meet the requirements 

in the rule. Third, the Commission is 

clarifying that the exemption from 

verification applies to all transactions 

on a DCM and to anonymous 

transactions on a SEF. 

In addition, the Commission is 

providing the following guidance in 

response to the comments it received. A 

swap dealer or major swap participant 

must determine ECP and Special Entity 

status before offering to enter into or 

entering into a swap.319 Counterparties 

will be able to make representations 

about their status at the outset of a 

transaction or in counterparty 

relationship documentation and update 

that representation if there is a change 

in status.320 Parties will not be required 

to terminate a swap based solely on a 

change in the counterparty’s ECP status 

during the term of the swap. 

In addition, swap dealers and major 

swap participants may rely on the 

written representations of 

counterparties in the absence of red 

flags. With respect to the level of detail 

required in the representation, a swap 

dealer or major swap participant will be 

deemed to have a ‘‘reasonable basis’’ to 

rely on a representation that a 

counterparty is eligible under the rule if 

the counterparty identifies the 

paragraph of the ECP definition plus, in 

the case of a Special Entity, the 

paragraph of the Special Entity 

definition that applies to it, and the 

swap dealer or major swap participant 

does not have a reason to believe the 

representation is inaccurate. In the 

absence of counterparty representations, 

the swap dealer or major swap 

participant will have to engage in 

sufficient due diligence to have a 

reasonable basis to believe that the 

counterparty meets the eligibility 

standards for an ECP and whether it is 

a Special Entity. 

Further, the Commission is not 

adopting standardized due diligence 

documentation at this time. The rule is 

principles based and allows the parties 

flexibility in developing efficient means 

to address the requirements of the rule. 

By providing non-exclusive guidance as 

to the types of representations that will 

meet the ‘‘reasonable basis’’ standard, 

the Commission believes that the parties 

will be able to comply with the rule 

without incurring undue cost. Lastly, 

the Commission is confirming that, with 

respect to transactions initiated on a 

SEF, the verification exemption is only 

applicable to anonymous transactions 

consistent with Section 4s(h)(7). The 

proposed exemption from the 

verification duty did not mention DCM 

transactions, unlike Section 4s(h)(7) of 

the CEA, because Section 2(e) of the 

CEA does not limit participation in 

DCM swap transactions to ECPs. 

However, for the sake of clarity, the 

Commission has added language to final 

§ 23.430 that confirms that swap dealers 

and major swap participants do not 

have to verify ECP status for DCM 

transactions, whether anonymous or 

otherwise. 

D. Section 23.431—Disclosure of 

Material Risks, Characteristics, Material 

Incentives and Conflicts of Interest 

Regarding a Swap 

Proposed § 23.431 is a multipart rule 

that tracks Section 4s(h)(3)(B) of the 

CEA. Based on the structure of and 

comments relating to proposed § 23.431, 

the following discussion is divided into 

six sections: Proposed § 23.431— 

generally; material risk disclosure; 

scenario analysis; material 

characteristics; material incentives and 

conflicts of interest; and daily mark. 

Each of the six sections includes a 

summary of the proposed subsections of 

§ 23.431, public comments, and a 

description of the final rule and 

Commission guidance. 

1. Proposed § 23.431—Generally 

Section 4s(h)(3)(B) of the CEA 

requires swap dealers and major swap 

participants to disclose to their 

counterparties material information 

about the risks, characteristics, 

incentives and conflicts of interest 

regarding the swap. The requirements 

do not apply if both counterparties are 

any of the following: Swap dealer; major 

swap participant; or SBS Entities. 

Proposed § 23.431 implemented the 

statutory disclosure requirements and 

provided specificity with respect to 

certain types of material information 

that must be disclosed under the rule. 

The Commission stated that information 

is material if there is a substantial 

likelihood that a reasonable 

counterparty would consider it 

important in making a swap-related 

decision.321 The Dodd-Frank Act does 

not address the timing and form of the 

required disclosures. To satisfy its 

disclosure obligation, swap dealers and 

major swap participants would be 

required to make such disclosures at a 

time prior to entering into the swap and 

in a manner that was reasonably 

sufficient to allow the counterparty to 

assess the disclosures.322 Swap dealers 

and major swap participants would 

have flexibility to make these 

disclosures using reliable means agreed 

to by the counterparties, as provided in 

proposed § 23.402(f).323 The proposed 

rules allowed standardized disclosure of 

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9758 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

324Cf. SIFMA/ISDA Oct. 22, 2010 Letter, at 12 

(recommending the use of standard disclosure 

templates that could be adopted on an industrywide basis, with disclosure requirements satisfied 

by a registrant on a relationship (rather than a 

transaction-by-transaction) basis in cases where 

prior disclosures apply to and adequately address 

the relevant transaction). 

325Proposing release, 75 FR at 80643. 326See SIFMA/ISDA Feb. 17 Letter, at 3–4 and 18; 

COPE Feb. 22 Letter, at 3–5; VRS Feb. 22 Letter, at 

3–4; Exelon Feb. 22 Letter, at 2–4; CEF Feb. 22 

Letter, at 2–4; NY City Bar Feb. 22 Letter, at 2. 327See VRS Feb. 22 Letter, at 1 and 4; NACUBO 

Feb. 22 Letter, at 3–4; HOOPP Feb. 22 Letter, at 3; 

CEF Feb. 22 Letter, at 4–5. 328See VRS Feb. 22 Letter, at 4; NACUBO Feb. 

22 Letter, at 3–4; ABC/CIEBA Feb. 22 Letter, at 13. 

329See BlackRock Feb. 22 Letter, at 2; CEF Feb. 

22 Letter, at 3–4 and 8. 

330See Rep. Bachus Mar 15 Letter, at 1–3; SIFMA/ 

ISDA Feb. 17 Letter, at 9; BlackRock Feb. 22 Letter, 

at 2 and 6; ABC/CIEBA Feb. 22 Letter, at 2–3; ERIC 

Feb. 22 Letter, at 2–3; AFSCME Feb. 22 Letter, at 

4–5; AMG–SIFMA Feb. 22 Letter, at 8–9. 

331See BlackRock Feb. 22 Letter, at 2; SIFMA/ 

ISDA Feb. 17 Letter, at 3; CEF Feb. 22 Letter, at 8. 

332See MFA Feb. 22 Letter, at 1–3; BlackRock 

Feb. 22 Letter, at 2; MetLife Feb. 22 Letter, at 1 and 

4–5; CEF Feb. 22 Letter, at 5–6. 

333See, e.g., FHLBanks Feb. 22 Letter, at 3–4; 

FHLBanks June 3 Letter, at 8–9; NY City Bar Feb. 

22 Letter, at 2; SIFMA/ISDA Feb. 17 Letter, at 4 and 

16–18. Contra CFA/AFR Feb. 22 Letter, at 18. 

334See BlackRock Feb. 22 Letter, at 6–7; VRS Feb. 

22 Letter, at 3–4; MFA Feb. 22 Letter, at 5–6; 

HOOPP Feb. 22 Letter, at 2–3; ABC/CIEBA Feb. 22 

Letter, at 13; COPE Feb. 22 Letter, at 2–4; COPE 

June 3 Letter, at 5–6; Exelon Feb. 22 Letter, at 2– 

3; ETA June 3 Letter, at 20–21; CalPERS Feb. 18 

Letter, at 3–4; CEF Feb. 22 Letter, at 2. 

335Proposing release, 75 FR at 80639. 

336See DPG Framework, supra fn. 178; CRMPG I 

Report, supra fn. 274; CRMPG II Report, supra fn. 

274; CRMPG III Report, supra fn. 228. 

337See FHLBanks Feb. 22 Letter, at 2. 

338The Commission also has clarified that the 

§ 23.431 disclosure obligations do not apply to 

transactions that are initiated on a SEF or DCM 

where the swap dealer or major swap participant 

does not know the identity of the counterparty to 

the transaction. See final § 23.431(c) (previously 

numbered as proposed § 23.431(b)). See also 

Section 4s(h)(7) of the CEA with respect to the 

Special Entity provisions. 

339See Section III.A.1. of this adopting release for 

a discussion of ‘‘Opt in or Opt out for Certain 

Classes of Counterparties.’’ 

340Several commenters urged the Commission to 

coordinate with the SEC and DOL to ensure that the 

final rule does not trigger ERISA fiduciary or 

municipal advisor status. The Commission confirms 

that it continues to coordinate with both agencies 

on these issues. See Section II of this adopting 

release for a discussion of ‘‘Regulatory 

Intersections.’’ See also Section III.A.1. of this 

adopting release for a discussion of ‘‘Discretionary 

Rules’’ and ‘‘Different Rules for Swap Dealers and 

Major Swap Participants.’’ Regarding the relative 

costs and benefits of the disclosure rules, see 

Section VI.C.4. of this adopting release for a 

discussion of § 23.431. 

341The Commission is amending § 4.6 to exclude 

swap dealers from the CTA definition, which the 

Dodd-Frank Act amended to include swaps, when 

their advice is solely incidental to its business as 

a swap dealer. See Section II.D. of this adopting 

release. See also Section II.B. of this adopting 

release for a discussion of how compliance with the 

business conduct standards rules, including the 

disclosure duties, will be considered by DOL. 

342See supra at fn. 336 and accompanying text. 

343The CRMPG III Report provides the following 

best practice guidance regarding disclosure: 

[I]t is critical that participants in the markets for 

high-risk complex instruments must understand the 

risks that they face. An investor or derivative 

counterparty should have the information needed to 

make informed decisions. While the Policy Group 

has recommended that each participant must 

develop a degree of independence in decisionmaking, large integrated financial intermediaries 

have a responsibility to provide their counterparties 

with appropriate documentation and disclosures. 

Disclosures must meet the standards established by 

the relevant regulatory jurisdiction. The Policy 

some required information, where 

appropriate, if the information is 

applicable to multiple swaps of a 

particular type or class.324 The 

Commission noted, however, that most 

bespoke transactions would require 

some combination of standardized and 

particularized disclosures.325

2. Comments—Generally 

Commenters had a variety of general 

concerns with the disclosure rules 

including: (1) The proposed rules 

should be tailored to the institutional 

swaps market, not retail futures or 

securities markets; 326 (2) the proposed 

rules should not apply when a 

counterparty is a certain size and level 

of sophistication; 327 (3) counterparties 

should be able to opt in to or opt out 

of the proposed rules; 328 (4) the 

proposed rules alter the relationship 

between counterparties and swap 

dealers or major swap participants; 329

(5) the Commission should coordinate 

with the SEC and DOL to ensure that the 

proposed rules do not trigger ERISA 

fiduciary status or municipal advisor 

status; 330 (6) only mandatory statutory 

rules should be promulgated at this time 

and discretionary rules (e.g., scenario 

analysis) should be delayed; 331 (7) the 

statute does not require the same rules 

for both swap dealers and major swap 

participants; different, less burdensome 

rules consistent with the statute should 

be drawn for major swap 

participants; 332 (8) uncertainty 

regarding compliance with principles 

based disclosure rules; 333 and (9) the 

costs outweigh the benefits of the 

proposed rule.334

3. Final § 23.431—Generally 

Regarding the comment that the 

proposed rule should be tailored to the 

institutional swaps market, not retail 

futures or securities market, as indicated 

in the proposing release, the disclosure 

rules follow the statute and are 

informed by industry practices and best 

practice recommendations. The 

Commission reviewed OTC derivatives 

industry reports, as well as futures and 

securities regulations and related SRO 

business conduct rules, prior to drafting 

the rule.335 In particular, reports by the 

Derivatives Policy Group (‘‘DPG’’) and 

Counterparty Risk Management Policy 

Group (‘‘CRMPG’’) included industry 

best practice recommendations 

regarding product disclosures.336 These 

OTC derivatives industry reports 

confirmed that the industry is familiar 

with product disclosure. In addition, a 

commenter reported that: 

Swap dealers also generally distribute to 

their end-user counterparties at the outset of 

a new swap relationship standardized 

documentation setting forth the material 

characteristics, risks and conflicts of interest 

with respect to the swaps to be entered into 

with such end-user counterparty under an 

ISDA Master Agreement or other master 

documentation.337

Moreover, the plain language of Section 

4s(h)(3)(B) requires disclosure of the 

material risks, characteristics, incentives 

and conflicts of interest relating to the 

swap. Based on the statutory language, 

industry practice and industry best 

practice recommendations, the 

Commission believes that the final rule 

is tailored appropriately to the swaps 

market. 

With respect to whether the 

disclosure duties should apply when a 

counterparty is a certain size and level 

of sophistication, and whether 

counterparties should be able to opt in 

to or opt out of the protections of the 

disclosure rule, the Commission notes 

that Section 4s(h)(3)(B) only limits the 

disclosure duty when a swap 

transaction is between swap dealers, 

major swap participants, and/or SBS 

Entities. The only exception in Section 

4s(h)(3)(B) allows counterparties to 

obtain the daily mark for cleared swaps 

upon request.338 Given that the statute 

provides such limited opt in/opt out for 

disclosures, the final rule is consistent 

with the plain language of the statute by 

not allowing counterparties to opt in to 

or opt out of the disclosure rule other 

than as provided by the statute.339

Commenters claimed that the 

proposed disclosure rule alters the 

relationship between counterparties and 

swap dealers or major swap participants 

from arm’s length dealings to advisory 

relationships.340 The Commission 

disagrees and confirms that the business 

conduct standards rules alone do not 

cause a swap dealer or major swap 

participant to assume advisory 

responsibilities or become a 

fiduciary.341 The final rule tracks the 

statute and includes explanatory 

language regarding the timing and 

content of the statutory, principles 

based disclosure duty, and was 

informed by industry practices 342 and 

industry best practice 

recommendations.343 The statute and 

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Group believes that appropriate disclosures should 

often go beyond those minimum standards, both 

through enhancement for instruments currently 

requiring disclosure, and by establishing 

documentation standards for instruments that 

currently require little or none. 

CRMPG III Report, at 59. 

344See Section III.A.3.f. of this adopting release 

for a discussion of proposed § 23.402(g)— 

Disclosures in a standard format (renumbered as 

final § 23.402(f)). 

345This characteristic is particularly relevant 

when the swap includes an embedded option that 

increases leverage. Such features can significantly 

increase counterparty risk exposure in ways that are 

not transparent. See also fn. 227. 

346CRMPG III Report, at 56; see also text at fn. 

228. 

347CRMPG III Report, at 56. 

348See Section III.A.1.b.ii. and iii. of this 

adopting release for a discussion of ‘‘Discretionary 

Rules’’ and ‘‘Different Rules for Swap Dealers and 

Major Swap Participants.’’ 

349Market risk refers to the risk to a 

counterparty’s financial condition resulting from 

adverse movements in the level or volatility of 

market prices. 

350Credit risk refers to the risk that a party to a 

swap will fail to perform on an obligation under the 

swap. 

351Operational risk refers to the risk that 

deficiencies in information systems or internal 

controls, including human error, will result in 

unexpected loss. 

352Liquidity risk is the risk that a counterparty 

may not be able to, or cannot easily, unwind or 

offset a particular position at or near the previous 

market price because of inadequate market depth, 

unique trade terms or remaining party 

characteristics or because of disruptions in the 

marketplace. 

353See CRMPG III Report, at 60. 

354See, e.g., SIFMA/ISDA Feb. 17 Letter, at 17. 

355CFA/AFR Aug. 29 Letter, at 19. 

356 Id., at 2–5 and 12. 

357The report concludes that transactions 

involving structured collateralized debt obligations 

(‘‘CDOs’’) were problematic because they were 

designed to fail and the disclosures omitted and/or 

misrepresented the material risks, characteristics, 

incentives and conflicts of interest related to these 

types of transactions. 

the disclosure rules are intended to 

level the information playing field by 

requiring swap dealers and major swap 

participants to provide sufficient 

information about a swap to enable 

counterparties to make their own 

informed decisions about the 

appropriateness of entering into the 

swap. The additional language in the 

rule, including ‘‘at a reasonably 

sufficient time prior to entering into a 

swap’’ and ‘‘information reasonably 

designed to allow a counterparty to 

assess,’’ along with the material risks 

and characteristics standards in the rule, 

is intended to provide guidance to swap 

dealers and major swap participants in 

complying with the rule. This guidance 

will assist swap dealers and major swap 

participants in designing reasonable 

policies and procedures to comply with 

the requirements of the statute and the 

final rule. 

The Commission has promoted 

efficiency and reduced costs by 

allowing swap dealers and major swap 

participants to use standardized formats 

to make required disclosures, as 

appropriate, in counterparty 

relationship documentation.344

Depending on the facts and 

circumstances, disclosures in a standard 

format may be appropriate if the 

information is applicable to multiple 

swaps of a particular type and class, 

particularly standardized swaps. 

Similarly, whether standard form 

disclosures are appropriate for certain 

bespoke swaps will depend on the facts 

and circumstances. Factors that would 

be relevant are the complexity of the 

transaction, including, but not limited 

to, the degree and nature of any 

leverage,345 the potential for periods of 

significantly reduced liquidity, and the 

lack of price transparency.346 This 

approach is consistent with OTC 

derivatives industry best practice 

recommendations for high-risk, complex 

financial instruments.347 Given the 

evolutionary nature of swaps, and 

especially bespoke swaps, swap dealers 

and major swap participants will be 

required to have and implement 

reasonably designed policies and 

procedures concerning when and how 

to make particularized disclosures on a 

transactional basis to account for 

changing characteristics, as well as 

different and newly identified risks, 

incentives and conflicts of interest. The 

statute is unequivocal regarding the 

duty to provide disclosures of the 

material risks, characteristics, incentives 

and conflicts of interest for each swap. 

Regarding commenters’ 

recommendations to delay discretionary 

rules and urging different rules for 

major swap participants, the 

Commission has addressed those issues 

above.348 In response to commenters 

concerns about compliance with 

principles based disclosure duties, the 

Commission will, in the absence of 

fraud, consider good faith compliance 

with policies and procedures reasonably 

designed to comply with the disclosure 

rules as a mitigating factor when 

exercising its prosecutorial discretion 

for violation of the disclosure rule. 

a. Section 23.431(a)(1)—Material Risk 

Disclosure 

i. Proposed § 23.431(a)(1) 

The proposed rule tracked the 

statutory obligations under Section 

4s(h)(3)(B)(i) and required the swap 

dealer or major swap participant to 

disclose information to enable a 

counterparty to assess the material risks 

of a particular swap. The Commission 

anticipated that swap dealers and major 

swap participants typically would rely 

on a combination of standardized 

disclosures and more particularized 

disclosures to satisfy this requirement. 

The proposed rule identified certain 

types of risks that are associated with 

swaps generally, including market,349

credit,350 operational,351 and liquidity 

risks.352 Required risk disclosure 

included sufficient information to 

enable a counterparty to assess its 

potential exposure during the term of 

the swap and at expiration or upon early 

termination. The Commission noted 

that, consistent with industry ‘‘best 

practices,’’ information regarding 

specific material risks had to identify 

the material factors that influence the 

day-to-day changes in valuation, as well 

as the factors or events that might lead 

to significant losses.353 As described in 

the proposing release, disclosures under 

the proposed rule should consider the 

effect of future economic factors and 

other material events that could cause 

the swap to experience such losses. 

Disclosures also should identify, to the 

extent possible, the sensitivities of the 

swap to those factors and conditions, as 

well as the approximate magnitude of 

the gains or losses the swap will likely 

experience. The Commission noted that 

swap dealers and major swap 

participants also should consider the 

unique risks associated with particular 

types of swaps, asset classes and trading 

venues, and tailor their disclosures 

accordingly. 

ii. Comments 

The Commission received comments 

on a variety of issues related to 

proposed § 23.431(a)(1). Comments 

included claims that disclosures would 

increase costs, delay execution, expose 

parties to additional market risk, intrude 

on counterparty confidential 

information and result in ever longer 

lists of hypothetical risks.354 However, 

one commenter specifically disagreed, 

arguing that the statute requires material 

risk disclosure and not limited utility, 

generalized disclosure.355 With respect 

to the importance of a robust risk 

disclosure duty, the commenter356

referenced transactions profiled in the 

report from the U.S. Senate Permanent 

Subcommittee on Investigations, 

Committee on Homeland Security and 

Governmental Affairs, ‘‘Wall Street and 

the Financial Crisis: Anatomy of a 

Financial Collapse,’’ issued April 13, 

2011 (‘‘Senate Report’’).357

Another commenter stated that the 

proposed rule was too vague regarding 

what material risks must be disclosed, 

creating legal uncertainty, potential 

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9760 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

358FHLBanks June 3 Letter, at 8–9. 

359 Id. 

360See, e.g., SIFMA/ISDA Feb. 17 Letter, at 17 

(e.g., a particular event in the Middle East that 

could impact currency markets). 

361See, e.g., MetLife Feb. 22 Letter, at 5; ATA 

Feb. 22 Letter, at 3; APGA Feb. 22 Letter, at 3; 

FHLBanks Feb. 22 Letter, at 1 and 3–4; FHLBanks 

June 3 Letter, at 8–9; CII Feb. 10 Letter, at 2. 

362See COPE Feb. 22 Letter, at 3–4; Exelon Feb. 

22 Letter, at 2–3; BlackRock Feb. 22 Letter, at 7. 

363See Better Markets Feb. 22 Letter, at 3 and 7; 

Barnard May 23 Letter, at 2. 

364NY City Bar Feb. 22 Letter, at 2. 

365 Id. 

366 Id. 

367As stated in the proposing release, consistent 

with industry ‘‘best practices,’’ information 

regarding specific material risks must identify the 

material factors that influence the day-to-day 

changes in valuation, as well as the factors or events 

that might lead to significant losses. Proposing 

release, 75 FR at 80644 (citing CRMPG III Report, 

at 60). Appropriate disclosures should consider the 

effect of future economic factors and other material 

events that could cause the swap to experience such 

losses. Disclosures should also identify, to the 

extent possible, the sensitivities of the swap to 

those factors and conditions, as well as the 

approximate magnitude of the gains or losses the 

swap will likely experience. Proposing release, 75 

FR at 80644. See also proposed 17 CFR 240.15Fh– 

3(b)(1), SEC’s proposed rules, 76 FR at 42454 (SEC 

rule regarding material risks requires disclosure, 

including, but not limited to, ‘‘the material factors 

that influence the day-to-day changes in valuation, 

the factors or events that might lead to significant 

losses, the sensitivities of the security-based swap 

to those factors and conditions, and the 

approximate magnitude of the gains or losses the 

security-based swap will experience under 

specified circumstances’’). Accordingly, the 

Commission’s interpretation is consistent with the 

text of the SEC’s proposed risk disclosure rule, 

which furthers the harmonization goal of the 

Commission and the SEC. 

368See SIFMA/ISDA Feb. 17 Letter, at 17. 

369Such economic terms would include payout 

structures that embed volatility or optionality 

features into the transaction, including, but not 

limited to, caps, collars, floors, knock-in or knockout rights, or range accrual features. As noted 

above, disclosures concerning these features would 

need to provide sufficient information about these 

features to enable counterparties to make their own 

informed decisions about the appropriateness of 

entering into the swap. 

370Such a requirement is not intended to create, 

and does not create, any general trading prohibition 

or general disclosure requirement concerning 

‘‘inside information’’ under the CEA. This guidance 

addresses circumstances where information 

concerning the risks of the underlying asset 

generally are not publicly available. For example, 

where a swap dealer offered a total return swap on 

a broad-based index based on unique assets that it 

created or acquired, any potential counterparty 

would be unable to evaluate that transaction absent 

some form of disclosure by the swap dealer. This 

rule would require such disclosure. In contrast, 

where a swap dealer offers a swap on an underlying 

asset for which it has nonpublic information, for 

example, harvest information about an agricultural 

commodity or production information about an 

energy commodity, and the asset is one for which 

risk information is publicly available, the swap 

dealer or major swap participant would not be 

required to disclose the nonpublic information it 

holds. However, depending on the facts and 

circumstances, the swap dealer might have to 

disclose nonpublic information as part of its duty 

to disclose material incentives and conflicts of 

interest. See Section III.D.3.d.iii. of this release for 

a discussion of the duty to disclose material 

incentives and conflicts of interest. In addition, as 

part of its obligation to disclose the material 

economic terms of the swap, the swap dealer would 

have to provide information about the factors that 

would cause the value of the swap to change 

including any correlations with the value of the 

underlying asset. Of course, swap dealers and major 

swap participants also will be subject to the fair 

dealing rule and antifraud provisions with respect 

to their communications with counterparties. See 

Sections III.B. and III.F. of this release for a 

discussion of § 23.410–Prohibition on Fraud, 

Manipulation and Other Abusive Practices, and 

§ 23.433–Communications–Fair Dealing, 

respectively. In addition, as stated in § 23.400, 

nothing in these rules is intended to limit or restrict 

the applicability of other applicable laws, rules and 

regulations, including the federal securities laws. 

371With respect to the request by certain 

commenters that the Commission require material 

risk disclosures regarding volatility, historic 

liquidity, and value at risk, the Commission 

declines to prescribe specific parameters for 

compliance with the risk disclosure rule beyond the 

explanatory text of the final rule. Nevertheless, the 

Commission believes that, depending on the facts 

and circumstances, including whether the 

counterparty has elected to receive scenario 

analysis, disclosure of these risk factors may be 

appropriate. 

372See, e.g., Sen. Levin Aug. 29 Letter, at passim; 

CFA/AFR Feb. 22 Letter, at 2, 10 and 12; CFA/AFR 

Aug. 29 Letter, at 3–8, 18 and 20. 

hindsight enforcement, and private 

rights of action.358 The commenter 

claimed that, without guidance, swap 

dealers and major swap participants 

may over disclose risks and/or limit the 

number of their swap counterparties.359

Certain commenters recommended that 

the Commission clarify that the 

‘‘material risks’’ of a swap are limited to 

the economic terms of the product and 

not risks associated with the underlying 

asset.360

Several commenters supported 

standardized risk disclosures.361

However, others were skeptical of the 

value of mandatory boilerplate 

disclosures.362 Other commenters 

recommended that the Commission 

specifically require risk disclosures 

regarding volatility, historic liquidity 

and value at risk.363 One commenter 

recommended that, in lieu of proposed 

§ 23.431, the Commission limit the 

disclosure duty to a predefined scenario 

analysis.364 It was suggested, for 

example, regarding interest rate 

sensitivity, that the rule could mandate 

an analysis of interest rate conditions up 

to a certain number of standard 

deviations away from expected interest 

rate movements based on historical 

interest rates.365 It was asserted that 

such objective standards would promote 

marketplace and legal certainty.366

iii. Final § 23.431(a)(1) 

After considering the comments on 

proposed § 23.431(a)(1), the 

Commission has determined to adopt 

the rule as proposed. In addition, the 

Commission is confirming that the rule 

will be interpreted consistently with 

industry best practice regarding the 

disclosure of material risks.367 This 

guidance will assist swap dealers and 

major swap participants in designing 

policies and procedures to comply with 

the final rule. The final rule is tailored 

to give effect to the plain language of the 

statute by requiring swap dealers and 

major swap participants to provide 

material risk disclosure that allows a 

counterparty to assess the risks of the 

swap. 

Certain commenters recommended 

that the Commission clarify that the 

material risk disclosure requirement 

under § 23.431(a)(1) is limited to 

disclosures about the risks associated 

with the economic terms of the product 

and not risks associated with the 

underlying asset.368 The Commission 

believes that for most swaps information 

about the material risks and 

characteristics of the swap will relate to 

the risks and characteristics of the 

economic terms of the swap.369 For 

certain swaps, however, where 

payments or cash-flows are materially 

affected by the performance of an 

underlying asset for which there is not 

publicly available information (or the 

information is not otherwise accessible 

to the counterparty), final § 23.431 

would require disclosures about the 

material risks and characteristics that 

affect the value of the underlying asset 

to enable a counterparty to assess the 

material risks of the swap.370 For 

example, for a total return swap whose 

value is based on the performance of a 

broad-based index consisting of unique 

assets that it created or acquired, a swap 

dealer or major swap participant would 

be required to disclose information 

about the material risks and 

characteristics of the broad-based index, 

unless such information is accessible to 

the counterparty. Disclosure regarding 

an underlying asset in such 

circumstances is consistent with the 

duty to communicate in a fair and 

balanced manner based on principles of 

fair dealing and good faith as required 

by Section 4s(h)(3)(C) and final § 23.433. 

In connection with a swap based on the 

price of oil, for example, a swap dealer 

or major swap participant would not 

have to disclose information about the 

drivers of oil prices because such 

information is readily available to 

market participants.371

Without commenting on the Senate 

Report’s findings, the Commission 

considered how the final disclosure 

rules would address transactions similar 

to those profiled in the Senate Report, 

as requested by commenters.372 The 

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373NY City Bar Feb. 22 Letter, at 2–3. 

374See CRMPG III Report, at 60. 

375See Section III.A.3.f. of this adopting release 

for a discussion of final § 23.402(f)–Disclosures in 

a standard format. 

376Scenario analysis was proposed in addition to 

required disclosures for swaps that do not qualify 

as high-risk complex. Such required disclosures 

included a clear explanation of the economics of 

the instrument. 

377CRMPG III Report, at 60–61. 

378See fn. 227 and 345 discussing risks regarding 

leverage. 

379CRMPG III Report, at 56; see also text at fn. 

228. 

380These value changes originate from changes or 

shocks to the underlying risk factors affecting the 

given swap, such as interest rates, foreign currency 

exchange rates, commodity prices and asset 

volatilities. 

381Material assumptions included (1) the 

assumptions of the valuation model and any 

parameters applied and (2) a general discussion of 

the economic state that the scenario is intended to 

illustrate. 

382The Commission proposed that swap dealers 

and major swap participants adopt policies and 

procedures regarding a new product policy as part 

of their risk management system. See proposed 

§ 23.600(c)(3), Governing the Duties of Swap 

Dealers, 75 FR at 71405. 

383See DPG Framework, at Section V.II.G.; 

CRMPG III Report, at 59–61 and Appendix A, Bullet 

5; but see SIFMA/ISDA Feb. 17 Letter, at 13–14. 

final rule addresses the types of 

concerns raised by the Senate Report 

and by commenters by requiring the 

disclosure of material risks, 

characteristics, incentives and conflicts 

of interest, as well the duty to 

communicate in a fair and balanced 

manner based on principles of fair 

dealing and good faith. These duties are 

consistent with longstanding legal, 

regulatory and industry best practice 

standards, which are familiar to the 

financial services industry and the OTC 

derivatives industry. 

The Commission declines to limit the 

disclosure duty to a predefined scenario 

analysis as suggested by one 

commenter. The Commission recognizes 

the benefits of, and encourages the use 

of, an analysis such as the one suggested 

by the commenter 373 to satisfy, in part, 

the material risk disclosure requirement. 

In fact, the Commission believes that the 

use of historical data in tabular form to 

illustrate specific swap and/or asset 

prices, volatility, sensitivity, liquidity 

risks and characteristics is consistent 

with industry practice.374 However, the 

Commission has determined that such 

analyses may not satisfy all aspects of 

the principles based disclosure 

requirement in Section 4s(h)(3)(B) for all 

swaps. Accordingly, the Commission 

has determined not to adopt a 

predefined scenario analysis in lieu of 

proposed § 23.431. 

In response to commenters asking that 

the Commission develop standardized 

risk disclosures, the Commission 

decided not to adopt futures style 

standard form swap disclosure for the 

reasons discussed in connection with 

§ 23.402(f)–Disclosures in a standard 

format.375

b. Section 23.431(b)—Scenario Analysis 

i. Proposed § 23.431(a)(1)(i)–(v) 

The Commission’s scenario analysis 

rule in proposed § 23.431(a)(1)(i)–(v) 

(renumbered as § 23.431(b)) required 

swap dealers and major swap 

participants to provide scenario 

analyses when offering to enter into a 

high-risk complex bilateral swap to 

allow the counterparty to assess its 

potential exposure in connection with 

the swap.376 In addition, the proposed 

rule allowed counterparties to elect to 

receive scenario analysis when they 

were offered bilateral swaps not 

available for trading on a DCM or SEF. 

The elective aspect of the rule reflected 

the expectation that there would be 

circumstances where scenario analysis 

would be helpful for certain 

counterparties, even for swaps that are 

not high-risk complex. Proposed 

§ 23.431(a)(1) was modeled on the 

CRMPG III industry best practices 

recommendation for high-risk complex 

financial instruments.377

Like the CRMPG III industry best 

practices recommendation, the term 

‘‘high-risk complex bilateral swap’’ was 

not defined in the proposed rule; rather, 

certain flexible characteristics were 

identified to prevent concerns about 

over- or under-inclusivity. The 

characteristics included: The degree and 

nature of leverage,378 the potential for 

periods of significantly reduced 

liquidity and the lack of price 

transparency.379 The proposed rule 

required swap dealers and major swap 

participants to establish reasonable 

policies and procedures to identify 

high-risk complex bilateral swaps and, 

in connection with such swaps, provide 

the additional risk disclosure specified 

in proposed § 23.431(a)(1). 

Scenario analysis, as required by the 

proposed rule, would be an expression 

of potential losses to the fair value of the 

swap in market conditions ranging from 

normal to severe in terms of stress.380

Such analyses would be designed to 

illustrate certain potential economic 

outcomes that might occur and the 

effect of these outcomes on the value of 

the swap. The proposed rule required 

that these outcomes or scenarios be 

developed by the swap dealer or major 

swap participant in consultation with 

the counterparty. In addition, the 

proposed rule required that all material 

assumptions underlying a given 

scenario and their impact on swap 

valuation be disclosed.381 In requiring 

such disclosures, however, the 

Commission did not require swap 

dealers or major swap participants to 

disclose proprietary information about 

pricing models. 

The Commission did not propose to 

define the parameters of the scenario 

analysis in order to provide flexibility to 

the parties in designing the analyses in 

accordance with the characteristics of 

the bespoke swap at issue and any 

criteria developed in consultations with 

the counterparty. Further, the proposed 

rule required swap dealers and major 

swap participants to consider relevant 

internal risk analyses, including any 

new product reviews, when designing 

the analyses.382 As for the format, the 

proposed rule required both narrative 

and tabular expressions of the analyses. 

To ensure fair and balanced 

communications and to avoid 

misleading counterparties, swap dealers 

and major swap participants also were 

required to state the limitations of the 

scenario analysis, including cautions 

about the predictive value of the 

scenario analysis, and any limitations 

on the analysis based on the 

assumptions used to prepare it. The 

Commission aligned the proposed rule 

with longstanding industry best practice 

recommendations.383

ii. Comments 

The Commission received comments 

on a broad range of issues regarding the 

proposed scenario analysis rule. One 

commenter raised a host of concerns, 

including: (1) That Section 4s(h)(3)(B) 

does not require scenario analysis; (2) 

codifying industry best practice will 

discourage future private sector 

initiatives; (3) scenario analysis is a 

broad concept encompassing many 

potential analyses that are not relevant 

for individual transactions and, absent a 

definition or guidance regarding the 

parameters of the analysis, it is possible 

that scenario analysis will be 

misleading; (4) scenario analysis may 

cause swap dealers and major swap 

participants to become ERISA 

fiduciaries, municipal advisors and/or 

CTAs; (5) swap dealers and major swap 

participants may have liability for 

failing to provide mandatory scenario 

analysis even though they have 

reasonable policies and procedures for 

identifying high-risk complex bilateral 

swaps; (6) the highly subjective 

definition of high-risk complex bilateral 

swap is problematic from a liability 

perspective, particularly for hindsight 

enforcement actions and private rights 

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384See SIFMA/ISDA Feb. 17 Letter, at 18–21. 385See MFA Feb. 22 Letter, at 6; CEF Feb. 22 

Letter, at 9; SIFMA/ISDA Feb. 17 Letter, at 19. 386CEF Feb. 22 Letter, at 9–10. 387 Id. 388MetLife Feb. 22 Letter, at 5. 389CFA/AFR Feb. 22 Letter, at 9. 

390 Id. 

391Markit Feb. 22 Letter, at 3–4; Markit June 3 

Letter, at 7. 

392 Id. 

393See COPE Feb. 22 Letter, at 4; SIFMA/ISDA 

Feb. 17 Letter, at 21; Exelon Feb. 22 Letter, at 4; CEF 

Feb. 22 Letter, at 10. 

394Under Section 2(h)(8) of the CEA, a swap that 

is subject to the clearing requirement of Section 

2(h)(1) must be executed on a DCM or SEF unless 

no DCM or SEF ‘‘makes the swap available to trade’’ 

or the swap is subject to the clearing exception 

under Section 2(h)(7) (i.e., the end-user exception). 

See Proposed Rules, Swap Transaction Compliance 

and Implementation Schedule: Clearing and Trade 

Execution Requirements under Section 2(h) of the 

CEA, 76 FR 58186, 58191, Sept. 20, 2011 (‘‘Trade 

Execution Requirements’’); see also Proposed Rules, 

Process for a Designated Contract Market or Swap 

Execution Facility to Make a Swap Available to 

Trade, 76 FR 77728, Dec. 14, 2011 (‘‘Process to 

Make a Swap Available to Trade’’). Therefore, final 

§ 23.431(b) only requires a swap dealer to provide 

scenario analysis upon request for swaps that are 

not subject to the trade execution requirement 

under Section 2(h)(8). 

395See CRMPG III Report, at Appendix A, 

Bullet 5. 

396 Id. 

397Proposing release, 75 FR at 80645. 

398See DPG Framework, at Section V.II.G. 

399See CRMPG III Report, at 61. 

400See MetLife Feb. 22 Letter, at 5; CFA/AFR Feb. 

22 Letter, at 9; Better Markets Feb. 22 Letter, at 3 

and 7; Barnard May 23 Letter, at 2; Markit Feb. 22 

Letter, at 3–4. Accord COPE Feb. 22 Letter, at 4; CEF 

Feb. 22 Letter, at 10 (suggesting changing the rule 

from mandatory to elective by the counterparty). 

401See Section III.A.1.ii. of this adopting release 

for a discussion of ‘‘Discretionary Rules.’’ 

402SIFMA/ISDA Feb. 17 Letter, at 18. 

of action; (7) the rule mandates delivery 

of scenario analysis even if the 

counterparty neither requests nor wants 

the analysis; and (8) the mandatory 

delivery of scenario analysis will delay 

execution, which increases risk to the 

counterparty.384

Other commenters claimed that the 

scenario analysis rule would increase 

counterparty dependence on swap 

dealers and major swap participants 

thereby raising moral hazard 

concerns.385 Another commenter was 

concerned that scenario analysis, or 

portions thereof, is often proprietary, 

which raises confidentiality and 

liability issues.386 The commenter also 

claimed that the proposed scenario 

analysis rule is resource intensive and 

will increase the cost of swaps to 

counterparties.387

Certain commenters were in favor of 

the proposed scenario analysis rule. For 

example, a commenter said it would 

like to receive scenario analysis for the 

swaps covered by the proposed rule.388

Another commenter believed that 

scenario analysis should not be 

expensive in that swap dealers and 

major swap participants are expected to 

take the other side of the swap and 

already do the analysis, which is easily 

modified to the counterparty’s 

purpose.389 Moreover, the commenter 

asserted that swap dealers and major 

swap participants must do the analysis 

as part of the suitability or Special 

Entity ‘‘best interests’’ analysis.390

Another commenter supported the 

proposed rule, but suggested allowing 

swap dealers and major swap 

participants to delegate responsibility 

for the analysis to appropriately 

qualified independent third party 

providers.391 In addition, this 

commenter recommended that the 

scenario analysis be provided on a 

portfolio basis.392 Lastly, certain 

commenters suggested that the proposed 

scenario analysis only be required at the 

request of the counterparty.393

iii. Final § 23.431(b) 

After considering the comments, the 

Commission has determined to adopt 

proposed § 23.431(a)(1)(i)–(v) 

(renumbered as § 23.431(b)) with certain 

modifications. The Commission revised 

the proposed rule to eliminate the 

requirement to provide scenario 

analysis for ‘‘high-risk complex bilateral 

swaps.’’ Instead, the final rule requires 

scenario analysis only when requested 

by the counterparty for any swap not 

‘‘made available for trading’’ on a DCM 

or SEF.394 To comply with the rule, 

swap dealers will have to disclose to 

counterparties their right to receive 

scenario analysis and consult with 

counterparties regarding design. These 

changes eliminate both the mandatory 

element and definitional issues 

associated with the term ‘‘high-risk 

complex bilateral swap.’’ They also 

address counterparty concerns about 

execution delays and costs. In addition, 

major swap participants will not have to 

provide scenario analysis. Because 

modeling and providing scenario 

analysis is currently an industry best 

practice for dealers, the Commission is 

limiting the duty to swap dealers only. 

Regarding parameters for scenario 

analysis, the Commission decided to 

retain the language in proposed 

§ 23.431(a)(1)(ii), (iv) and (v). The rule is 

principles based and allows flexibility 

in designing the analysis. As guidance, 

the Commission directs swap dealers to 

industry best practices for scenario 

analysis for high-risk complex financial 

instruments.395 That best practice 

recommends: 

The analysis should be done over a range 

of assumptions, including severe downside 

stress scenarios. Scenario analysis should 

also include an analysis of what assumptions 

would result in a significant percentage loss 

(e.g., 50%) of principal or notional. All 

implicit and explicit assumptions should be 

clearly indicated and calculation 

methodologies should be explained. 

Significant assumptions should be stresstested with the results plainly disclosed.396

In addition, counterparties may request 

the type of information and scenario 

analyses they consider useful. Such 

flexibility enhances the benefits of 

scenario analysis to counterparties 

while limiting the costs of the final rule. 

The counterparty gets what it needs and 

the swap dealer has certainty about the 

type of analysis that will comply with 

the rule. As noted in the proposing 

release, swap dealers have informed 

Commission staff that they currently 

provide to counterparties scenario 

analysis upon request and without 

charge.397

Regarding comments that Section 

4s(h)(3)(B) does not require scenario 

analysis, the Commission notes that 

OTC derivatives industry best practice 

dating back to 1995 discusses the 

provision of scenario analysis to 

illustrate the risks of particular 

derivative products.398 In addition, a 

recent OTC derivatives industry best 

practice disclosure recommendation for 

high-risk complex financial instruments 

calls for ‘‘rigorous scenario analyses and 

stress tests that prominently illustrate 

how the instrument will perform in 

extreme scenarios, in addition to more 

probable scenarios.’’ 399 These industry 

reports, coupled with letters from 

commenters,400 are evidence of the 

value of scenario analysis in 

supplementing a counterparty’s ability 

to assess the risks and characteristics of 

swaps and support the Commission’s 

determination that requiring scenario 

analysis, as provided for in the final 

rule, is in the public interest. As 

discussed above in connection with 

final § 23.400–Scope, the Commission 

has ample discretionary authority to 

adopt the scenario analysis rule.401

The Commission is not persuaded by 

the assertion that codifying industry 

best practice will discourage future 

private sector initiatives and enhance 

the potential for hindsight enforcement 

actions and private rights of action.402

By adopting industry best practice 

recommendations, it can be argued that 

the Commission is encouraging industry 

efforts to try to shape regulatory 

solutions to industry problems. The 

Commission also is not persuaded that 

adopting industry best practice 

recommendations will cause hindsight 

enforcement actions and private suits 

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403The final rule does not distinguish between 

high risk complex swaps and other swaps. This and 

other changes in the final rule address commenters’ 

concerns about the meaning of ‘‘high-risk complex 

swap’’ and resulting potential liability issues. 

404See CRMPG III Report, at Appendix A, 

Bullet 5. 

405See discussion of Section 2(h)(8) and swaps 

‘‘made available for trading’’ on a DCM or SEF at 

fn. 394. 

406Proposing release, 75 FR at 80645. 

407See CEF Feb. 22 Letter, at 9–10. 

408See DPG Framework, at Section V.II.G.; 

CRMPG III Report, at A2. 

409See Section III.F. of this adopting release for 

a discussion of § 23.433—Communications—fair 

dealing. 

410See, e.g., Exelon Feb. 22 Letter, at 4; COPE 

Feb. 22 Letter, at 4; SIFMA/ISDA Feb. 17 Letter, 

at 21. 

411See Markit Feb. 22 Letter, at 2–4; Markit June 

3 Letter, at 7. 

412 Id. 

413See Section II of this adopting release for a 

discussion of ‘‘Regulatory Intersections,’’ including 

DOL ERISA Fiduciary, SEC Municipal Advisor and 

CTA status issues. 

414Proposing release, 75 FR at 80645. 

filed against swap dealers. The 

Commission notes that litigation risk is 

not new to swap dealers. Numerous 

private and enforcement actions 

involving derivatives have been filed 

based on theories that existed prior to 

the enactment of the Dodd-Frank Act. 

With regard to the claim that scenario 

analysis needs a definition and 

parameters to avoid potentially 

misleading counterparties, the 

Commission notes that the final rule, 

unlike the proposed rule, will require 

scenario analysis only as requested by 

the counterparty.403 The final rule also 

will require consultation with the 

counterparty and disclosure of the 

material assumptions and calculation 

methodologies. These aspects of the 

rule, coupled with the other disclosure 

and fair dealing duties, should 

ameliorate the potential for misleading 

the counterparty. In addition, the 

Commission has determined to adopt 

the CRMPG III Report description of 

scenario analysis, which provides an 

appropriate, principles based standard 

for swap dealers under the final rule.404

This principles based standard should 

provide sufficient guidance to swap 

dealers to achieve consistency regarding 

the minimum parameters of scenario 

analyses. As indicated in the final rule, 

counterparties may request additional 

information and analyses. 

The Commission is not persuaded by 

claims that the scenario analysis rule 

would increase counterparty 

dependence on swap dealers thereby 

raising moral hazard concerns. As 

discussed above, the scenario analysis 

rule has been revised to eliminate the 

mandatory provision in favor of a 

counterparty election. In addition, the 

counterparty election covers swaps that 

are not ‘‘made available for trading’’ on 

a DCM or SEF.405 This narrowing of the 

rule reduces both swap dealer and 

counterparty costs, including potential 

delays in execution. Only counterparties 

that want and request the scenario 

analysis will receive it. This approach is 

consistent with industry practice, which 

was confirmed during meetings with 

swap dealers, that upon request of 

counterparties scenario analysis is 

provided and without any additional 

charge.406 Therefore, the rule should not 

significantly change the existing 

practice by unduly increasing 

counterparty dependence on swap 

dealers or creating moral hazard 

concerns. 

With respect to claims that scenario 

analysis, or portions thereof, are often 

proprietary, which may raise 

confidentiality and liability issues,407

the Commission notes that the final rule 

does not require the disclosure of 

‘‘confidential, proprietary information 

about any model it may use to prepare 

the scenario analysis.’’ However, the 

rule does require the disclosure of all 

material assumptions and an 

explanation of the calculation 

methodologies. The Commission does 

not consider scenario analysis and its 

material assumptions and calculation 

methodologies to be confidential, 

proprietary information. This 

conclusion is based on several industry 

reports that confirm that scenario 

analysis and its material assumptions 

and calculation methodologies are best 

practice disclosure.408 Regarding 

commenter’s concerns relating to 

liability for the scenario analysis, the 

Commission believes that forwardlooking statements should not unduly 

expose swap dealers to liability where 

the scenario analysis is performed 

consistent with the rule, in consultation 

with the counterparty and subject to 

appropriate warnings about the 

assumptions and limitations underlying 

the scenario analysis. Such warnings 

also would be consistent with 

§ 23.433—Communications—fair 

dealing.409

The elective approach in the final rule 

ameliorates concerns that the proposed 

scenario analysis rule is resource 

intensive and will increase the cost of 

swaps to counterparties. This approach 

was supported by commenters and 

should be less burdensome.410 In 

addition, the final rule provides for 

counterparty consultation in the design 

of a requested scenario analysis. Where 

the counterparty does not specify the 

assumptions, the swap dealer will have 

discretion to design a scenario analysis 

consistent with the principles 

established in the rule. This approach 

should assist the swap dealer in limiting 

the costs associated with complying 

with the final scenario analysis rule. 

The Commission notes that swap 

dealers are already preparing some form 

of scenario analysis of the swap for their 

own purposes, including new product 

review, daily product pricing, margin 

analysis and risk management. 

The Commission agrees with the 

commenter that suggested that swap 

dealers be able to use appropriately 

qualified independent third party 

providers to perform the scenario 

analysis.411 However, swap dealers will 

remain responsible for ensuring 

compliance with the rule. With respect 

to the suggestion that the rule require 

that scenario analysis be provided on a 

portfolio basis,412 the Commission notes 

that the final rule is guided by the 

statute, which requires disclosure of 

information about the risks of ‘‘the 

swap.’’ As a result, the Commission has 

determined that it is appropriate to 

require swap dealers to provide scenario 

analysis, upon request, with respect to 

a particular swap. However, nothing in 

the rule precludes swap dealers from 

agreeing to provide scenario analysis on 

a portfolio basis, upon request. The 

Commission expects some 

counterparties may request scenario 

analysis based on a portfolio while 

others, for a variety of reasons, 

including confidentiality of portfolio 

positions, may not request that analysis. 

Lastly, the Commission addressed the 

commenters’ concern that scenario 

analysis may cause swap dealers to 

become ERISA fiduciaries, municipal 

advisors and/or CTAs elsewhere in this 

adopting release.413

c. Section 23.431(a)(2)—Material 

Characteristics 

i. Proposed § 23.431(a)(2) 

Proposed § 23.431(a)(2) required swap 

dealers and major swap participants to 

disclose the material characteristics of 

the swap, including the material 

economic terms of the swap, the 

material terms relating to the operation 

of the swap and the material rights and 

obligations of the parties during the 

term of the swap. Under the proposed 

rule, the material characteristics 

included the material terms of the swap 

that would be included in any 

‘‘confirmation’’ of a swap sent by the 

swap dealer or major swap participant 

to the counterparty upon execution.414

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9764 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

415See Exelon Feb. 22 Letter, at 3; SIFMA/ISDA 

Feb. 17 Letter, at 21–22. 

416SIFMA/ISDA Feb. 17 Letter, at 21–22. 

417See CFA/AFR Feb. 22 Letter, at 10; Better 

Markets Feb. 22 Letter, at 4–6; Better Markets June 

3 Letter, at 13; CFA/AFR Nov. 3 Letter, at 6. 

418CFA/AFR Feb. 22 Letter, at 11 (for example, 

situations where the proposed swap has basis risk 

and/or an interest rate mismatch). 

419See Sections III.A.3.e., f. and g. of this 

adopting release for a discussion of final 

§ 23.402(e)—Manner of disclosure, final 

§ 23.402(f)—Disclosures in a standard format, and 

final § 23.402(g)—Record retention, respectively. 

While the rules allow disclosures by any reliable 

means agreed to by the counterparty, pursuant to 

§ 23.402(f) written disclosures are the preferred 

method to avoid confusion and counterparty 

disputes. Written disclosures enhance the ability to 

monitor compliance and facilitate compliance with 

the record retention requirements in § 23.402(g). 

420See, e.g., Confirmation, Portfolio 

Reconciliation, and Portfolio Compression 

Requirements for Swap Dealers and Major Swap 

Participants, 75 FR 81519, Dec. 28, 2010. 

421SIFMA/ISDA Feb. 17 Letter, at 21–22. 

422See Section III.F. of this adopting release for 

a discussion of § 23.433—Communications—fair 

dealing. 

423Because § 23.431(a)(2) creates a flexible 

disclosure regime, the Commission declines, at this 

time, to interpret § 23.431(a)(2) as requiring, with 

respect to bespoke swaps, a separate detailing of all 

standardized components of the swap and the 

pricing of each component, including embedded 

credit, for forgone collateral, especially where the 

swap dealer has not made a recommendation to the 

counterparty. However, nothing in the final rule 

would preclude the parties from negotiating 

disclosures of this type. See Section III.D.3.d. of this 

adopting release for a discussion of disclosures in 

connection with a swap dealer’s recommendation. 

424See CFA/AFR Feb. 22 Letter, at 11. 

425See Section IV.C. of this adopting release for 

a discussion of § 23.450—Requirements for swap 

dealers and major swap participants acting as 

counterparties to Special Entities. 

ii. Comments 

Commenters raised objections to 

language in the proposing release 

concerning delivery of a summary of the 

material characteristics of the swap to 

be provided by swap dealers and major 

swap participants to counterparties 

prior to entering into a swap.415 One 

commenter claimed it would be both 

unnecessary given the ECP status of the 

counterparty and potentially confusing 

due to differences between a preexecution summary and the postexecution transaction 

documentation.416

Commenters that support the 

disclosure rule recommended that the 

rule be interpreted to require for 

bespoke swaps that disclosures 

separately detail standardized 

components of the swap and price of 

each component, including embedded 

credit for forgone collateral.417 In 

addition, a commenter recommended 

that the disclosure obligation include 

the features of the swap that could 

disadvantage the counterparty.418

iii. Final § 23.431(a)(2) 

After considering the comments, the 

Commission has determined to adopt 

§ 23.431(a)(2) as proposed. To address 

questions about the manner and 

substance of disclosure that must be 

provided prior to entering into a swap, 

and the nature of transaction 

documentation that will be required 

post execution, the Commission 

provides the following guidance. As 

noted above, for a counterparty to assess 

the merits of entering into a swap, it 

will need information about the material 

risks and characteristics of the swap at 

a reasonably sufficient time prior to 

entering into the swap. The disclosure 

rules grant discretion to swap dealers 

and major swap participants, consistent 

with the rules on manner of disclosure, 

disclosures in a standard format and 

record retention, to adopt a reliable 

means of disclosure agreed to by a 

counterparty.419

Disclosures made prior to entering 

into a swap should not be confused with 

transaction documentation. The final 

internal business conduct standards 

rules in subpart J of part 23 will apply 

to transaction documentation.420 The 

final external business conduct 

standards rules in subpart H of part 23 

establish requirements to make 

disclosures about the material 

characteristics, among other 

information, of the swap. The two sets 

of rules will work together. To the 

extent that the final internal business 

conduct standards rules require that 

swap dealers and major swap 

participants provide to counterparties 

pre-execution information about the 

characteristics of a swap, such 

information should be considered by 

swap dealers and major swap 

participants in determining what, if any, 

additional information must be 

provided to counterparties preexecution to comply with the material 

characteristics disclosure duty in 

§ 23.431(a)(2). 

One commenter requested that the 

Commission clarify that the disclosure 

requirement is satisfied when a 

counterparty has or is provided a copy 

of each item of documentation that 

governs the terms of its swap with the 

swap dealer or major swap 

participant.421 The Commission 

declines to make such a determination 

because whether the material 

characteristics disclosure requirement is 

met in any particular case will be a facts 

and circumstances determination, based 

on the standards set forth in the rule. 

This will be particularly true when 

certain features including, but not 

limited to, caps, collars, floors, knockins, knock-outs, range accrual features, 

embedded optionality or embedded 

volatility increase the complexity of the 

swap. The disclosure rule, coupled with 

§ 23.433—Communications—Fair 

Dealing,422 requires the swap dealer or 

major swap participant to provide a 

sound factual basis for the counterparty 

to assess how these features and others 

would impact the value of the swap 

under various market conditions during 

the life of the swap.423

Swap dealers and major swap 

participants will be permitted to include 

certain disclosures about material 

characteristics (other than information 

normally contained in a term sheet, 

such as price and dates) in counterparty 

relationship documentation, where 

appropriate, consistent with final 

§ 23.402(f)—Disclosures in a standard 

format. 

Commenters sought guidance on 

whether the material characteristics 

disclosure duty requires a swap dealer 

or major swap participant to determine 

and then disclose how the terms of a 

particular swap relate to the 

circumstances of a particular 

counterparty.424 The Commission 

believes that, for most swaps, 

information about the material 

characteristics of the swap will relate to 

the economic terms of the swap rather 

than the circumstances of the particular 

counterparty. However, if a swap dealer 

or major swap participant has 

contractually undertaken to do so, or a 

swap dealer has made a 

‘‘recommendation,’’ which triggers a 

suitability duty or is acting as an advisor 

to a Special Entity, the swap dealer or 

major swap participant will be required 

to act consistently with the relevant 

duty, including exercising reasonable 

due diligence and making appropriate 

disclosures. Of course, in all 

circumstances, swap dealers and major 

swap participants are required to 

communicate in a fair and balanced 

manner based on principles of fair 

dealing and good faith in accordance 

with final § 23.433. Additionally, for a 

Special Entity, the swap dealer or major 

swap participant will have to have a 

reasonable basis to believe that the 

qualified independent representative 

will act in the Special Entity’s best 

interests and evaluate the 

appropriateness of each swap based on 

the needs and characteristics of the 

Special Entity before the Special Entity 

enters into the swap with a swap dealer 

or major swap participant.425

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9765 

426Proposing release, 75 FR at 80645. 427This may exist, for example, when the swap 

dealer or major swap participant acts both as an 

underwriter in a bond offering and as counterparty 

to the swaps used to hedge such financing. In these 

circumstances, the swap dealer’s or major swap 

participant’s duties to the counterparty would vary 

depending on the capacities in which it is operating 

and should be disclosed. With respect to swaps 

entered into with Special Entities, swap dealers and 

major swap participants are required to disclose the 

capacity in which they are acting and, if they 

engage in multiple capacities, disclose the 

difference in such capacities in accordance with 

Section 4s(h)(5) of the CEA and proposed 

§ 23.450(f) (renumbered and adopted as final 

§ 23.450(g)). 

428See, e.g., MetLife Feb. 22 Letter, at 5; COPE 

Feb. 22 Letter, at 4; Exelon Feb. 22 Letter, at 4. 

429MetLife Feb. 22 Letter, at 5. 430COPE Feb. 22 Letter, at 4; Exelon Feb. 22 

Letter, at 3–4. 431CEF Feb. 22 Letter, at 13. 432CFA/AFR Feb. 22 Letter, at 11. 433SIFMA/ISDA Feb. 17 Letter, at 23. 434See Better Markets June 3 Letter, at 6–7. 435 Id. 

436See Better Markets June 3 Letter, at 13–17; 

CFA/AFR Feb. 22 Letter, at 11–12; CFA/AFR Nov. 

3 Letter, at 6. 

437 Id. 

438CEF Feb. 22 Letter, at 13. 

439 Id. 

440Further, the Commission confirms that ‘‘midmarket mark’’ can be determined through mark-tomodel calculations when a liquid market does not 

exist. 

d. Section 23.431(a)(3)—Material 

Incentives and Conflicts of Interest 

i. Proposed § 23.431(a)(3) 

Proposed § 23.431(a)(3) tracked the 

statutory language under Section 

4s(h)(3)(B)(ii) and required a swap 

dealer or major swap participant to 

disclose to any counterparty the 

material incentives and conflicts of 

interest that the swap dealer or major 

swap participant may have in 

connection with a particular swap. The 

Commission also proposed that swap 

dealers and major swap participants be 

required to include with the price of the 

swap, the mid-market value of the swap 

as defined in proposed § 23.431(c)(2). In 

addition, swap dealers and major swap 

participants were required to disclose 

any compensation or benefit that they 

receive from any third party in 

connection with the swap. The 

Commission also stated in the proposing 

release that, in connection with any 

recommended swap, swap dealers and 

major swap participants were expected 

to disclose whether their compensation 

related to the recommended swap 

would be greater than for another 

instrument with similar economic terms 

offered by the swap dealer or major 

swap participant.426 With respect to 

conflicts of interest, the Commission 

stated that it expected such disclosure 

would include the inherent conflicts in 

a counterparty relationship, particularly 

when the swap dealer or major swap 

participant recommends the transaction. 

The Commission also indicated it 

expected that a swap dealer or major 

swap participant that engages in 

business with the counterparty in more 

than one capacity should consider 

whether acting in multiple capacities 

creates material incentives or conflicts 

of interest that require disclosure.427

ii. Comments 

The Commission received comments 

addressing a variety of issues. Several 

commenters generally supported the 

disclosure requirement.428 One 

commenter stated that it wanted to 

receive information about incentives or 

compensation that the swap dealer was 

receiving.429 Two other commenters 

said they did not object to swap dealers 

being required to disclose conflicts of 

interest because such disclosures would 

seem to be embedded in the concept of 

fair dealing.430 Another commenter 

recommended allowing the use of 

standardized disclosures to satisfy 

conflicts of interest and compensation 

matters but supported specific 

disclosure on a transaction-bytransaction basis for any compensation 

received by the swap dealer or major 

swap participant in connection with a 

particular swap.431

A commenter approved of the 

proposed rule and the guidance in the 

proposing release requiring swap 

dealers and major swap participants to 

disclose whether their compensation for 

a recommended swap would be greater 

than for another instrument with similar 

economic terms offered by the swap 

dealer or major swap participant.432

However, a different commenter 

objected to, and requested withdrawal 

of, that same statement asserting that 

swap dealers and major swap 

participants should not be obligated to 

identify and evaluate comparable 

instruments on behalf of the 

counterparty as such a comparative 

analysis would be an advisory service 

that is the responsibility of the 

counterparty and its advisors.433

Another commenter urged full 

disclosure to counterparties of the 

incentives to swap dealers and major 

swap participants for use of various 

market infrastructures (swap data 

repositories (‘‘SDRs’’), DCOs, DCMs, and 

SEFs).434 Similarly, the commenter 

recommended prohibiting fee rebates, 

discounts, and revenue and profit 

sharing, which it asserts are 

substantively the same as preferential 

access to market infrastructures. The 

commenter maintained that such 

practices simply transfer costs to less 

influential participants who must follow 

the lead of large liquidity providers.435

In addition, certain commenters that 

supported the rule also would like the 

Commission to require separate pricing 

of each ‘‘amalgamated’’ standardized 

component of a customized swap and a 

comparison of the risks and costs of the 

customized swap with comparable 

standardized, listed swaps.436 The 

commenters identified, for example, 

embedded credit for forgone collateral 

as an amalgamated component that 

should be priced separately. These 

commenters also urged the Commission 

to clarify that the material incentives 

and conflicts of interest disclosure 

obligation applies not only to specific 

alternative instruments but also to 

alternative strategies.437

In addition, a commenter 

recommended that the Commission 

issue guidance that the following 

situations are not conflicts of interest 

that warrant disclosure because 

counterparties are aware of or expect 

these common business practices: (1) 

Simply taking the opposite side of a 

swap; (2) swap dealers, major swap 

participants or affiliates entering into 

other swaps that take an opposite view 

from that of the counterparty for reasons 

unrelated to the swap with the 

counterparty; and (3) swap dealers and 

major swap participants having a 

physical business that would benefit 

from a price movement that would be 

adverse to the counterparty’s economic 

position under the swap.438 This same 

commenter also requested that the final 

rules formally recognize that no 

disclosure obligation exists with respect 

to knowledge regarding a swap’s 

reference commodity (specifically, 

swaps referencing energy commodities), 

the physical markets in which it trades, 

or any particular entity’s positions or 

business in such commodity.439

iii. Final § 23.431(a)(3) 

After considering the comments, the 

Commission has determined to adopt 

the proposed rule with the following 

revision. In proposed § 23.431(a)(3)(i), 

when disclosing the price of a swap, 

swap dealers and major swap 

participants would have to disclose the 

‘‘mid-market value’’ of the swap. In the 

final rule, the Commission decided to 

change the term ‘‘mid-market value’’ to 

‘‘mid-market mark’’ 440 to more 

accurately describe the requirement and 

mitigate concerns that the duty would 

constitute valuation, appraisal or 

advisory services or impose a fiduciary 

status on swap dealers and major swap 

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9766 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

441The Commission has made the same change in 

proposed § 23.431(c)—Daily Mark (renumbered as 

§ 23.431(d)). 

442Proposing release, 75 FR at 80645. 

443 Id. 

444See SIFMA/ISDA Feb. 17 Letter, at 23. 

445See also Section III.G.3. of this adopting 

release and Appendix A to subpart H of part 23 of 

the Commission’s Regulations for a discussion of 

what constitutes a ‘‘recommendation.’’ 

446See, e.g., the Senate Report, at 518–531 ($2 

billion Hudson CDO deal included $1.2 billion in 

assets from Goldman’s balance sheet. The marketing 

materials did not disclose that $1.2 billion of the 

assets were from Goldman’s balance sheet.). 

447See, e.g., Section III.A.3.f. of this adopting 

release for a discussion of final § 23.402(f)— 

Disclosures in a standard format. 

448Such payments can be considered both 

incentives and conflicts of interest within the 

meaning of the statute and rule and, either way, 

must be disclosed. See Section 4s(h)(3)(C) of the 

CEA and final § 23.433—Communications-fair 

dealing. 

449See CEF Feb. 22 Letter, at 13. 

450Senate Report, at 513–636. 

participants.441 The Commission notes 

that information about the spread 

between the quote and mid-market mark 

is relevant to disclosures regarding 

material incentives and provides the 

counterparty with pricing information 

that facilitates negotiations and balances 

historical information asymmetry 

regarding swap pricing. 

In addition, the Commission is 

clarifying certain guidance provided in 

the proposing release regarding 

recommended swaps.442 The proposing 

release indicated that, in connection 

with the duty to disclose material 

incentives and conflicts of interest, 

swap dealers and major swap 

participants would be expected to 

disclose whether their compensation 

relating to a recommended swap would 

be greater than for another instrument 

with ‘‘similar economic terms’’ offered 

by the swap dealer or major swap 

participant.443 In response to 

commenter concerns that such 

disclosure would constitute advice,444

the Commission has determined to limit 

the guidance to instances where more 

than one swap and/or strategy is 

recommended to accomplish a 

particular financial objective.445

Generally, these multi-product 

presentations include a comparison of 

swaps or strategies. In addition, the 

Commission understands that 

counterparties often ask dealers for 

alternatives to a particular swap, which 

may lead to a comparison. Considering 

this common industry practice, which 

facilitates sales, the comparison should 

include the relative compensation 

related to the different alternatives. This 

information is material to the swap 

dealer’s or major swap participant’s 

incentives underlying the 

recommendations and should assist the 

counterparty in making an assessment. 

Lastly, the Commission notes that this 

guidance does not prevent 

counterparties from requesting, or swap 

dealers and major swap participants 

from providing, comparisons of other 

swaps or products that may or may not 

have similar economic terms. 

The Commission declines to state 

categorically that swap dealers and 

major swap participants will be required 

to separately price each standardized 

component of a customized swap, 

compare the risks and costs of 

customized swaps with those of 

standardized swaps, or disclose the 

embedded cost of credit for forgone 

collateral. Similarly, the Commission 

believes that facts and circumstances, 

including whether the swap dealer or 

major swap participant recommended 

the swap, will determine whether a 

swap dealer or major swap participant 

is required to disclose that it is trying to 

move a particular position off its books 

and that the swap is part of that 

strategy.446 Swap dealers and major 

swap participants will be required to 

have policies and procedures reasonably 

designed to identify material incentives 

and conflicts within the scope of 

§ 23.431(a)(3). The Commission will 

consider good faith compliance with 

such policies and procedures when 

exercising its prosecutorial discretion in 

connection with any violation of the 

rule. 

With respect to the use of 

standardized disclosures to satisfy 

conflicts of interest and incentives 

disclosures, the Commission reminds 

swap dealers and major swap 

participants, as it has with respect to 

other disclosure obligations, that 

whether such disclosures will be 

sufficient to satisfy the disclosure rule 

in connection with any particular swap 

will depend on the facts and 

circumstances.447 As discussed 

elsewhere in this adopting release, the 

statute places the disclosure duty on 

swap dealers and major swap 

participants to ensure that all material 

incentives and conflicts of interest 

relating to the swap are disclosed. 

Concerning disclosure to 

counterparties of the incentives to swap 

dealers and major swap participants for 

use of various market infrastructures 

(DCOs, SDRs, DCMs, and SEFs), the 

Commission agrees that incentives paid 

to swap dealers and major swap 

participants by various market 

infrastructures for a swap transaction 

are a required disclosure within the 

statute and § 23.431(a)(3).448 With 

respect to fee rebates, discounts, and 

revenue and profit sharing, the 

Commission has determined not to 

prohibit these payments at this time, but 

rather to require disclosure of such 

payments because the payments would 

constitute material incentives or 

conflicts of interest in conjunction with 

the swap. Such disclosure also is 

encompassed in the duty to 

communicate in a fair and balanced 

manner. Further, the failure to disclose 

this information or other material 

disclosures under the rule may be a 

material omission under the 

Commission’s anti-fraud provisions, 

including final § 23.410(a). 

The Commission declines the 

commenters’ request that the 

Commission issue guidance that certain 

enumerated situations are not conflicts 

of interest that warrant disclosure. The 

plain language of Section 4s(h)(3)(B)(ii) 

of the CEA requires disclosure of all 

material conflicts of interest that a swap 

dealer or major swap participant has in 

connection with the swap. Without 

assessing the list of situations provided 

by commenters, the Commission notes 

that the statute does not limit or exempt 

the disclosure of certain conflicts of 

interest where counterparties may be 

aware of or expect certain common 

business practices. 

One commenter requested 

confirmation that the material 

incentives and conflicts of interest 

disclosure obligation does not apply to 

information known by the swap dealer 

or major swap participant regarding a 

swap’s reference commodity, the 

physical markets in which it trades or 

any particular entity’s positions or 

business in such commodity.449 Based 

on the statutory language in Section 

4s(h)(3)(B)(ii), the Commission cannot 

confirm the commenter’s point. The 

statute requires swap dealers and major 

swap participants to disclose ‘‘any 

material incentives or conflicts of 

interest that the swap dealer or major 

swap participant may have in 

connection with the swap.’’ It is 

certainly possible, particularly in the 

energy context mentioned by the 

commenter, that activities of the swap 

dealer or major swap participant related 

to the underlying commodity could 

create material incentives or conflicts of 

interest ‘‘in connection with’’ the swap 

offered to a counterparty. In addition, 

the Commission believes that 

transactions similar to those described 

in the Senate Report 450 would warrant 

disclosures concerning activities related 

to the underlying commodity. Without 

commenting on the transactions 

themselves, the Commission notes that 

the Senate Report raised concerns 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9767 

451See Section III.D.3.a. of this adopting release 

for a discussion of § 23.431(a)(1)—Material risk 

disclosure. 

452Such a requirement is not intended to create, 

and does not create, any general trading prohibition 

or general disclosure requirement concerning 

‘‘inside information.’’ See discussion at fn. 370; see 

also fn. 499. 

453The Commission noted that the term ‘‘daily 

mark’’ is not defined in the statute and that the term 

‘‘mark’’ is used colloquially to refer to various types 

of valuation information. See proposing release, 75 

FR at 80645. 

454Proposing release, 75 FR at 80645–46. 

455 Id. at 80646. 456 Id. 457FHLBanks Feb. 22 Letter, at 5. 458 Id. 459 Id., at 6. 460See, e.g., Exelon Feb. 22 Letter, at 4; CEF Feb. 

22 Letter, at 15. 

461See, e.g., COPE Feb. 22 Letter, at 4; MFA Feb. 

22 Letter, at 6; SIFMA/ISDA Feb. 17 Letter, at 23. 

462See, e.g., ERIC Feb. 22 Letter, at 16–17; CEF 

Feb. 22 Letter, at 15; MFA Feb. 22 Letter, at 6. 

463Markit Feb. 22 Letter, at 2–3; Markit June 3 

Letter, at 7. 

464MFA Feb. 22 Letter, at 6. 

465See BlackRock Feb. 22 Letter, at 6; SIFMA/ 

ISDA Feb. 17 Letter, at 24; ABC/CIEBA Feb. 22 

Letter, at 5–6; AMG–SIFMA Feb. 22 Letter, at 7; 

ERIC Feb. 22 Letter, at 16–17. 

466SIFMA/ISDA Feb. 17 Letter, at 23–24. 

467CEF Feb. 22 Letter, at 14. 

468 Id., at 15. 

469 Id. 

470Markit Feb. 22 Letter, at 2–3. 

471The Commission has made the same change in 

final § 23.431(a)(3)—Disclosures of material 

information, which requires disclosures of material 

incentives and characteristics. The Commission 

repeats that, with respect to final § 23.431(d), the 

Dodd-Frank Act disclosures, including the daily 

mark and mid-market mark, alone do not cause a 

swap dealer or major swap participant to be an 

advisor to a counterparty, including a Special 

Entity. The Commission does not consider the 

Continued 

regarding proprietary trading and the 

limited transparency of underlying 

assets.451 Whether such disclosure is 

required in connection with any 

particular swap will depend on the facts 

and circumstances.452

e. Section 23.431(d)—Daily Mark 

i. Proposed § 23.431(c) 

Section 4s(h)(3)(B)(iii) directs the 

Commission to adopt rules that require: 

(1) For cleared swaps, upon request of 

the counterparty, receipt of the daily 

mark of the transaction from the 

appropriate DCO; and (2) for uncleared 

swaps, receipt of the daily mark of the 

swap transaction from the swap dealer 

or major swap participant.453

For cleared swaps, proposed 

§ 23.431(c)(1) required swap dealers and 

major swap participants to notify 

counterparties of their rights to receive, 

upon request, the daily mark from the 

appropriate DCO. For uncleared swaps, 

proposed § 23.431(c)(2) and (3) required 

swap dealers and major swap 

participants to provide a daily mark to 

their counterparties on each business 

day during the term of the swap as of 

the close of business, or such other time 

as the parties agree in writing. The 

Commission proposed to define daily 

mark for uncleared swaps as the midmarket value of the swap, which would 

specifically not include amounts for 

profit, credit reserve, hedging, funding, 

liquidity or any other costs or 

adjustments.454 Based on consultations 

with stakeholders, the consensus was 

that mid-market value was a transparent 

measure that would assist 

counterparties in calculating valuations 

for their own internal risk management 

purposes. Further, the Commission 

proposed that swap dealers and major 

swap participants disclose both the 

methodology and assumptions used to 

prepare the daily mark, and any 

material changes to the methodology or 

assumptions during the term of the 

swap. The Commission noted that the 

daily mark for certain bespoke swaps 

may be generated using proprietary 

models. The proposed rule did not 

require the swap dealer or major swap 

participant to disclose proprietary 

information relating to its model.455

Lastly, the Commission proposed that 

swap dealers and major swap 

participants provide appropriate 

clarifying statements relating to the 

daily mark.456 Such disclosures could 

include, as appropriate, that the daily 

mark may not necessarily be: (1) A price 

at which the swap dealer or major swap 

participant would agree to replace or 

terminate the swap; (2) the basis for a 

variation margin call; nor (3) the value 

of the swap that is marked on the books 

of the swap dealer or major swap 

participant. 

ii. Comments 

One commenter favored disclosure of 

a daily mark.457 The commenter 

concurred with the Commission’s 

definition of daily mark as the ‘‘midmarket value’’ of the swap.458 The 

commenter noted that many end-user 

counterparties already receive daily 

swap valuations at mid-market as 

determined under the definition of 

‘‘Exposure’’ included in the 1994 ISDA 

Credit Support Annex and requested 

that the Commission clarify that the 

daily mark valuations under the rule are 

to be determined by reference to the 

same definition.459 Some commenters 

recommended that the daily mark be 

calculated on a portfolio basis rather 

than for each individual swap because 

margin calls are based on a net or 

portfolio basis.460 Several commenters 

recommended that the rule be revised 

from a mandatory daily disclosure to 

‘‘upon request’’ by the counterparty 

model.461 Others asserted that daily 

mark disclosure should be negotiable, 

including an opt out alternative.462

One commenter recommended 

revising the rule to allow swap dealers 

and major swap participants to delegate 

responsibility for providing the daily 

mark to appropriately qualified 

independent third party providers.463

Another commenter stated that 

counterparties should not rely on swap 

dealers or major swap participants, but 

instead should seek marks from 

independent third parties.464 Several 

commenters expressed concern that 

requiring swap dealers and major swap 

participants to provide a daily mark 

may be considered appraisal services 

that trigger ERISA fiduciary status, 

which prohibits principal-to-principal 

swap transactions.465

One commenter recommended 

revising the rule to require swap dealers 

and major swap participants, upon 

request of a counterparty, to provide the 

mark used for determining either party’s 

mark-to-market margin obligation or 

entitlement under an outstanding swap 

because this approach is consistent with 

statutory text and the daily mark 

requirement for cleared swaps.466

A different commenter recommended 

deeming the daily mark obligation for 

cleared swaps satisfied if the 

counterparty can access the information 

directly from the DCO or its FCM.467 In 

addition, the commenter requested that 

the final rule provide that swap dealers 

and major swap participants, absent 

fraud, have no liability for a 

counterparty’s use of the provided daily 

mark.468 Further, the commenter 

asserted that requiring disclosure of the 

daily mark methodology and 

assumptions encourages improper 

reliance by the counterparty on the 

swap dealer or major swap 

participant.469 Lastly, one commenter 

suggested that the rule require swap 

dealers and major swap participants to 

deliver the daily mark via 

communication media that are secure, 

timely and auditable.470

iii. Final § 23.431(d) 

After considering the comments, the 

Commission has determined to adopt 

§ 23.431(c) (renumbered as § 23.431(d)) 

as proposed, but change the term ‘‘midmarket value’’ to ‘‘mid-market mark.’’ 

This change more accurately describes 

the requirement and mitigates concerns 

that the duty would constitute 

valuation, appraisal or advisory services 

or impose a fiduciary status on swap 

dealers and major swap participants.471

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9768 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

Dodd-Frank Act disclosures to be advice or a 

recommendation. See Section II of this adopting 

release for further discussion of the intersection of 

the subpart H requirements with DOL and SEC 

requirements. 

472Section 721(b)(2) of the Dodd-Frank Act. 

473See FHLBanks Feb. 22 Letter, at 6–7. In 

addition, the term ‘‘mid-market value’’ is used in 

CRMPG I Report, at 7. See also Bank One Corp. v. 

IRS, 120 T.C. 174 (U.S. Tax Court 2003). For a 

discussion of mid-market value and costs, see ISDA 

Research Notes, The Value of a New Swap, Issue 

3 (2010), available at http://www.isda.org/ 

researchnotes/pdf/NewSwapRN.pdf. 

474Section 4s(h)(3)(B)(iii) of the CEA states: ‘‘(I) 

for cleared swaps, upon the request of the 

counterparty, receipt of the daily mark of the 

transaction from the appropriate derivatives 

clearing organization; and (II) for uncleared swaps, 

receipt of the daily mark of the transaction from the 

swap dealer or major swap participant.’’ 

475See Section III.A.1. of this adopting release for 

a discussion of ‘‘Private Rights of Action.’’ 

476The Commission agrees with a commenter’s 

suggestion that the rule should require swap dealers 

and major swap participants to deliver the daily 

mark via communication media that are secure, 

timely and auditable. Markit Feb. 22 Letter, at 3. 

This is consistent with final § 23.431(d)—Daily 

mark, as well as final § 23.402(e)—Manner of 

disclosure. See Section III.A.3.e. of this adopting 

release for a discussion of final § 23.402(e). 

477Without commenting on the findings of the 

Senate Report, the Commission notes that the 

Senate Report included descriptions of certain 

conduct relating to marks where dealers 

purportedly refused to explain the basis and 

methodology for the mark. See Senate Report, at 

509–510. 

478See Section 2(h) of the CEA. (7 U.S.C. 2(h)). 

479With respect to these proposed disclosure 

requirements, the Commission noted that, as 

between the parties, the counterparty is entitled to 

choose whether and where to clear, but that no 

DCM or SEF is required to make clearing available 

through any DCO. In other words, it is up to the 

parties to take the swap to a DCM or SEF that 

provides for clearing through the counterparty’s 

The Commission has determined to 

define the term daily mark as the ‘‘midmarket mark’’ using its discretionary 

authority to define terms under the 

Dodd-Frank Act.472 Because ‘‘midmarket’’ represents an objective value, it 

provides counterparties with a baseline 

to assess swap valuations for other 

purposes, including margin or 

terminations. This term has been used 

by many industry participants since at 

least 1994.473

The Commission notes that certain 

comments conflict directly with the 

plain language of Section 

4s(h)(3)(B)(iii)(I) and (II) of the CEA. For 

example, the suggestion that the daily 

mark be provided on a portfolio basis 

rather than for each swap conflicts with 

the plain language of the statute.474 If 

counterparties want additional marks 

(e.g., marks on a portfolio basis or marks 

used to calculate margin), then they are 

free to negotiate the receipt of such 

information with swap dealers and 

major swap participants. 

With respect to the recommendation 

that a swap dealer or major swap 

participant be deemed to satisfy the 

daily mark duty for cleared swaps if the 

counterparty can access the information 

directly from the DCO or its FCM, the 

Commission agrees, provided that the 

swap dealer or major swap participant 

apprises the counterparty and the 

counterparty agrees to such substituted 

compliance. The Commission notes that 

the swap dealer’s or major swap 

participant’s daily mark obligation for 

cleared swaps is prompted by the 

request of the counterparty. As a result, 

under the statute, it is up to the 

counterparty to decide whether it 

wishes to receive the daily mark 

through access to the DCO or FCM or 

from the swap dealer or major swap 

participant. 

As to the request to limit the liability 

of swap dealers or major swap 

participants in relation to a 

counterparty’s use of a provided daily 

mark, the Commission considers the 

request to be beyond the scope of the 

rulemaking.475 Nevertheless, the 

Commission notes that it will consider 

good faith compliance with policies and 

procedures reasonably designed to meet 

the daily mark requirements, including 

the calculation of mid-market mark 

under final § 23.431(d), in exercising its 

prosecutorial discretion for violations of 

the rule.476

The Commission disagrees with the 

assertion that requiring disclosure of the 

daily mark methodology and 

assumptions will encourage improper 

reliance by the counterparty on the 

swap dealer or major swap participant. 

The statutory daily mark requirement is 

meaningless unless the counterparty 

knows the methodology and 

assumptions that were used to calculate 

the mark. To make its own assessment 

of the value of the swap for its own 

purposes, the counterparty has to have 

information from the swap dealer or 

major swap participant about how the 

mid-market mark was calculated. To 

satisfy the duty to disclose both the 

methodology and assumptions used to 

prepare the daily mark, swap dealers 

and major swap participants may 

choose to provide to counterparties 

methodologies and assumptions 

sufficient to independently validate the 

output from a model generating the 

daily mark, collectively referred to as 

the ‘‘reference model.’’ The Commission 

does not intend that disclosure of the 

‘‘reference model’’ would require swap 

dealers and major swap participants to 

disclose proprietary information. While 

the Commission does not define what 

currently constitutes proprietary 

information, the Commission is aware 

that, in light of the disclosure 

requirements relating to the 

methodology and assumptions used to 

prepare the daily mark, market 

participants may aid in the 

establishment of appropriate ‘‘reference 

models’’ and, in so doing, potentially 

alter the extent of undisclosed 

proprietary information in the future. 

With proper disclosures, counterparties 

should not be misled or unduly rely on 

the mid-market mark provided by the 

swap dealer or major swap 

participant.477 Therefore, the 

Commission’s final rule requires 

disclosure of the methodology and 

assumptions underlying the daily mark. 

The Commission’s determination is 

based on the statutory disclosure 

provisions as well as the duty to 

communicate in a fair and balanced 

manner based on principles of fair 

dealing and good faith. 

One commenter asked the 

Commission to confirm that the daily 

mark received by counterparties is to be 

determined by reference to the same 

mid-market valuations used in 

connection with the definition of 

‘‘Exposure’’ under the 1994 ISDA Credit 

Support Annex. The Commission 

declines to endorse any particular 

methodology given the principles based 

nature of the rule. 

Further, the Commission is providing 

guidance that the term ‘‘mid-market 

mark’’ can be determined through markto-model calculations when a liquid 

market does not exist. In addition, swap 

dealers and major swap participants can 

delegate daily mark responsibilities to 

third party vendors. However, swap 

dealers and major swap participants 

will remain responsible for compliance 

with the rule. 

E. Section § 23.432—Clearing 

Disclosures 

1. Proposed § 23.432 

The Commission’s proposed rule 

required certain disclosures regarding 

the counterparty’s right to select a DCO 

and to clear swaps that are not 

otherwise required to be cleared. For 

swaps where clearing is mandatory,478

proposed § 23.432(a) required a swap 

dealer or major swap participant to 

notify the counterparty of its right to 

select the DCO that would clear the 

swap. For swaps that are not required to 

be cleared, under proposed § 23.432(b), 

a swap dealer or major swap participant 

was required to notify a counterparty 

that the counterparty may elect to 

require the swap to be cleared and that 

it has the sole right to select the DCO 

for clearing the swap.479 Neither of 

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preferred DCO. See proposing release, 75 FR at 

80646. 

480Proposing release, 75 FR at 80646. 

481See Barclays Jan. 11 Letter, at 8 (clearing 

requirement should not apply to foreign swap 

transactions); SIFMA/ISDA Feb. 17 Letter, at 24–25; 

CEF Feb. 22 Letter, at 22 (the Commission should 

clarify that the election to clear a swap is meant to 

be exercised at the swap’s inception); id. 

(supporting the proposed clearing disclosure rule, 

but recommended that the election of the 

counterparty regarding where to clear that is made 

at the outset of the transaction should be binding 

unless both parties agree; to do otherwise might 

require the swap dealer or major swap participant 

to transfer a swap from bilateral clearing to central 

clearing at an economically disadvantageous 

moment); MetLife Feb. 22 Letter, at 5 (major swap 

participants should be treated like other customers 

of a swap dealer, and receive the same rights as 

other counterparties, including the right to elect 

where to clear trades). 

482See COPE Feb. 22 Letter, at 4; CEF Feb. 22 

Letter, at 22. 

483Proposing release, 75 FR at 80646. 

484See, e.g., 17 CFR 170.5 (‘‘A futures association 

must establish and maintain a program for * * * 

the adoption of rules * * * to promote fair dealing 

with the public.’’); NFA Compliance Rule 2–29— 

Communications with the Public and Promotional 

Material; NFA Interpretative Notice 9041— 

Obligations to Customers and Other Market 

Participants. 

485See, e.g., NFA Compliance Rule 2–29(b)(2) and 

(5); see also NFA Interpretive Notice 9043—NFA 

Compliance Rule 2–29: Use of Past or Projected 

Performance; Disclosing Conflicts of Interest for 

Security Futures Products (performance must be 

presented in a balanced manner). 

486See, e.g., NFA Interpretive Notice 9041, 

Obligations to Customers and Other Market 

Participants (‘‘Members * * * and their Associates 

should provide a sound basis for evaluating the 

facts regarding any particular security futures 

product * * *.’’). 

487See, e.g., NFA Compliance Rule 2–29(b)(4)– 

(5). 

488Proposing release, 75 FR at 80646. 

489 Id. 

490CFA/AFR Feb. 22 Letter, at 12. In addition, the 

commenter recognized the need for future guidance, 

if necessary, after implementation. 

491NY City Bar Feb. 22 Letter, at 3. 

492 Id. 

493FHLBanks Feb. 22 Letter, at 6. 

494MetLife Feb. 22 Letter, at 4–5. 

495See COPE Feb. 22 Letter, at 4. Accord, Exelon 

Feb. 22 Letter, at 3–4 (agreeing that holding swap 

dealers and major swap participants to standards 

that require fair dealing is appropriate as long as 

these principles are properly applied to commodity 

swap market). 

496The fair dealing communications rule applies 

to all communications between a counterparty and 

a swap dealer or major swap participant, including 

the daily mark and termination. See Section III.D. 

of this adopting release for a discussion of § 23.431. 

497See CFA/AFR Feb. 22 Letter, at 12; Sen. Levin 

Aug. 29 Letter, at 10–11. 

498Senate Report, at 376–636. 

these notification provisions applied 

where the counterparty was a registered 

swap dealer, major swap participant, 

security-based swap dealer or major 

security-based swap participant.480

2. Comments 

The comments submitted on proposed 

§ 23.432 were directed at issues related 

to the substantive rules for swaps not 

required to be cleared and, as such, 

were beyond the scope of this 

rulemaking.481 The only commenters on 

the disclosure requirement itself stated 

that they did not object to the proposed 

rule.482

3. Final § 23.432 

The Commission has determined to 

adopt § 23.432 as proposed. 

F. Section 23.433—Communications— 

Fair Dealing 

1. Proposed § 23.433 

The Dodd-Frank Act requires that the 

Commission establish a duty for swap 

dealers and major swap participants to 

communicate in a fair and balanced 

manner based on principles of fair 

dealing and good faith. Proposed 

§ 23.433 established a duty that, 

consistent with the statutory language, 

applies to all swap dealer and major 

swap participant communications with 

counterparties. As the Commission 

noted in the proposing release,483 these 

principles are well established in the 

futures and securities markets, 

particularly through SRO rules.484 The 

duty to communicate in a fair and 

balanced manner is one of the primary 

requirements of the NFA customer 

communications rule 485 and is designed 

to ensure a balanced treatment of 

potential benefits and risks. In 

determining whether a communication 

with a counterparty is fair and balanced, 

the Commission stated that it expects a 

swap dealer or major swap participant 

to consider factors such as whether the 

communication: (1) Provides a sound 

basis for evaluating the facts with 

respect to any swap; 486 (2) avoids 

making exaggerated or unwarranted 

claims, opinions or forecasts; 487 and (3) 

balances any statement that refers to the 

potential opportunities or advantages 

presented by a swap with statements of 

corresponding risks.488 The Commission 

also stated its expectation that to deal 

fairly requires the swap dealer or major 

swap participant to treat counterparties 

in such a way so as not to unfairly 

advantage a counterparty or group of 

counterparties over another. 

Additionally, communications are 

subject to the anti-fraud provisions of 

the CEA and Commission Regulations, 

as well as any applicable SRO rules.489

2. Comments 

The Commission received several 

letters from commenters regarding 

proposed § 23.433. One commenter 

found the principles based approach to 

the rule more appropriate than a 

prescriptive approach.490 However, a 

different commenter expressed concern 

regarding the rule’s lack of detail, 

stating that it could create uncertainty 

and risk for swap dealers and major 

swap participants.491 That commenter 

recommended that the Commission 

consider using safe harbors containing 

objective standards as a means to satisfy 

the statutory requirements.492 Another 

commenter urged the Commission to 

clarify the communications standards 

by reference to currently prevailing 

standards, such as FINRA and NFA 

standards, subject to appropriate 

modifications to reflect standards for 

participation in the swaps market.493

Another commenter requested that 

major swap participants not be subject 

to a good faith and fair dealing rule 

when transacting with swap dealers.494

It asserted that major swap participants 

in this particular context are customers 

of swap dealers and should not be 

treated as a dealer or quasi-dealer. 

Others had little or no concern 

regarding the fair dealing 

requirement.495

3. Final § 23.433 

The Commission has determined to 

adopt § 23.433 as proposed. In addition, 

the Commission is providing the 

following guidance regarding the final 

fair dealing rule. As discussed above 

regarding § 23.431—Disclosures, the fair 

dealing rule works in tandem with both 

the material disclosure and anti-fraud 

rules to ensure that counterparties 

receive material information that is 

balanced and fair at all times.496 The 

Commission intends these rules to 

address the concerns raised by 

commenters 497 regarding transactions 

similar to those profiled in the Senate 

Report.498 The Senate Report concludes 

that those transactions, which involved 

structured CDOs, were problematic 

because they were designed to fail and 

the disclosures omitted and/or 

misrepresented the material risks, 

characteristics, incentives and conflicts 

of interest. Under all circumstances, and 

particularly those akin to the Senate 

Report involving complex swaps, the 

Commission’s fair dealing rule will 

apply and operate as an independent 

basis for enforcement proceedings. 

The fair dealing rule, like the 

disclosure rules, is principles based and 

applies flexibly based on the facts and 

circumstances of a particular swap. For 

example, when addressing the risks and 

characteristics of a swap with features 

including, but not limited to, caps, 

collars, floors, knock-ins, knock-outs 

and range accrual features that increase 

its complexity, the fair dealing rule 

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9770 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

499Such a requirement is not intended to create, 

and does not create, any general trading prohibition 

or general disclosure requirement concerning 

‘‘inside information.’’ See discussion at fn. 370; see 

also fn. 452. 

500See, e.g., NFA Compliance Rule 2–29— 

Communications with the Public and Promotional 

Material; NFA Interpretative Notice 9041— 

Obligations to Customers and Other Market 

Participants; NFA Interpretive Notice 9043—NFA 

Compliance Rule 2–29: Use of Past or Projected 

Performance; Disclosing Conflicts of Interest for 

Security Futures Products. 

501Proposing release, 75 FR at 80647. 

502The proposed rule was proposed based on 

suitability duties for banks and broker dealers 

dealing with institutional clients. As such, the 

proposed rule also implied a general suitability 

duty such that a swap dealer would have to have 

a reasonable basis to believe that the recommended 

swap or swap trading strategy is suitable for at least 

some counterparties. 

503Proposing release, 75 FR at 80659. 

504 Id. 

505 Id., at 80647. 

506See, e.g., NFA Compliance Rule 2–30(c) and 

(j); see also NFA Interpretive Notice 9004. 

507Proposing release, 75 FR at 80647. 

508See, e.g., CFA/AFR Feb. 22 Letter, at 12–13; 

Better Markets Feb. 22 Letter, at 4–5; CFA/AFR 

Nov. 3 Letter, at 6–7. 

requires the swap dealer or major swap 

participant to provide a sound basis for 

the counterparty to assess how those 

features would impact the value of the 

swap under various market conditions 

during the life of the swap. In a complex 

swap, where the risks and 

characteristics associated with an 

underlying asset are not readily 

discoverable by the counterparty upon 

the exercise of reasonable diligence, the 

swap dealer or major swap participant 

is expected, under both the disclosure 

rule and fair dealing rule, to provide a 

sound basis for the counterparty to 

assess the swap by providing 

information about the risks and 

characteristics of the underlying 

asset.499 The fair dealing rule also will 

supplement requirements to inform 

counterparties of material incentives 

and conflicts of interest that would tend 

to be adverse to the interests of a 

counterparty in connection with a swap, 

particularly in situations like those 

referenced in the Senate Report. In this 

regard, a swap dealer or major swap 

participant will have to follow policies 

and procedures reasonably designed to 

ensure that the content and context of 

its disclosures are fair and complete to 

allow the counterparty to protect itself 

and make an informed decision. 

In addition, in response to the 

comments it received, the Commission 

is confirming that it will look to NFA 

guidance when interpreting § 23.433 

and, as appropriate, will consider 

providing further guidance, if necessary, 

after implementation.500 The 

Commission concludes that the futures 

and securities industry familiarity with 

these precedents considerably mitigates 

concerns about legal certainty as a result 

of the principles based rule. Also, in the 

absence of fraud, the Commission will 

consider good faith compliance with 

policies and procedures reasonably 

designed to comply with the business 

conduct standards rules as a mitigating 

factor when exercising its prosecutorial 

discretion in connection with a 

violation of the rules. Lastly, the 

Commission is not exempting major 

swap participants from the fair 

communication requirement when they 

transact with swap dealers. Such an 

exemption would undermine 

congressional intent to improve 

transparency and raise the business 

conduct standards applicable to the 

market. 

G. Section 23.434—Recommendations 

to Counterparties—Institutional 

Suitability 

1. Proposed § 23.434 

In proposed § 23.434, the Commission 

exercised its discretionary authority 

under new Section 4s(h) by proposing 

an institutional suitability obligation for 

any recommendation a swap dealer or 

major swap participant makes to a 

counterparty in connection with a swap 

or swap trading strategy.501 More 

precisely, proposed § 23.434 required a 

swap dealer or major swap participant 

to have a reasonable basis to believe that 

any swap or trading strategy involving 

swaps that it recommends to a 

counterparty is suitable for such 

counterparty.502 A swap dealer or major 

swap participant would be required to 

make this determination based on 

reasonable due diligence that would 

include obtaining information regarding 

the counterparty’s financial situation 

and needs, objectives, tax status, ability 

to evaluate the recommendation, 

liquidity needs, risk tolerance, ability to 

absorb potential losses related to the 

recommended swap or trading strategy, 

and any other information known by the 

swap dealer or major swap 

participant.503

Proposed § 23.434 provided that a 

swap dealer or major swap participant 

could fulfill its obligations if the 

following conditions were satisfied: 

(1) The swap dealer or major swap 

participant had a reasonable basis to 

believe that the counterparty (or a party 

to whom discretionary authority has 

been delegated) was capable of 

evaluating, independently, the risks 

related to the particular swap or trading 

strategy recommended; (2) the 

counterparty (or its discretionary 

advisor) affirmatively indicated that it 

was exercising independent judgment in 

evaluating the recommendations; and 

(3) the swap dealer or major swap 

participant had a reasonable basis to 

believe that the counterparty had the 

capacity to absorb any potential 

losses.504

Proposed § 23.434 made clear that it 

would not apply: To any 

recommendations made to another swap 

dealer, major swap participant, securitybased swap dealer, or major securitybased swap participant; where a swap 

dealer or major swap participant 

provides information that is general 

transaction, financial, or market 

information; or to swap terms in 

response to a competitive bid request 

from the counterparty. In proposing 

§ 23.434, the Commission explained that 

whether a swap dealer or major swap 

participant has made a recommendation 

and thus triggered its suitability 

obligation would depend on the facts 

and circumstances of the particular 

case. A recommendation would include 

any communication by which a swap 

dealer or major swap participant 

provides information to a counterparty 

about a particular swap or trading 

strategy that is tailored to the needs or 

characteristics of the counterparty.505

While recognizing that futures market 

professionals have not been subject to 

an explicit suitability obligation, the 

Commission stated that such 

professionals have long been required to 

meet a variety of related requirements as 

part of their NFA-imposed 

obligations.506 Further, in proposing 

§ 23.434, the Commission considered 

that a suitability obligation is a common 

requirement for professionals in other 

markets and in other jurisdictions, 

including the banking and securities 

markets. Thus, to promote regulatory 

consistency, the Commission proposed 

to adopt a suitability obligation for swap 

dealers and major swap participants, 

modeled, in part, on existing obligations 

for banks and broker-dealers dealing 

with institutional clients.507

2. Comments 

The Commission received several 

comments representing a diversity of 

views on proposed § 23.434. As a 

general matter, some commenters 

strongly supported the proposal as an 

important feature of the system of 

business conduct standards and directly 

responsive to the concerns raised by 

members of Congress regarding conflicts 

of interest, particularly as between 

investment banks and their 

customers.508 For example, one 

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509 GFOA Feb. 22 Letter, at 2. 

510See, e.g., Exelon Feb. 22 Letter, at 3; HETCO 

Feb. 22 Letter, at 1–4; CEF Feb. 22 Letter, at 8–9; 

SIFMA/ISDA Feb. 17 Letter, at 25; contra CFA/AFR 

Nov. 3 Letter, at 7. 

511See, e.g., MFA Feb. 22 Letter, at 2 and 4; 

MetLife Feb. 22 Letter, at 4–5. 

512See, e.g., MFA Feb. 22 Letter, at 3; MetLife 

Feb. 22 Letter, at 4–5; contra CFA/AFR Nov. 3 

Letter, at 7. 

513See, e.g., SIFMA/ISDA Feb. 17 Letter, at 26 

(‘‘The Commission’s proposal appears to assume 

that every ‘recommendation’ is, in essence, a 

recommendation to the counterparty that the 

identified transaction is a transaction that the 

counterparty should execute based on its 

circumstances. This is far from accurate.’’). 

514MFA Feb. 22 Letter, at 3. 

515FHLBanks Feb. 22 Letter, at 5. 

516 Id. 

517See, e.g., CFA/AFR Feb. 22 Letter, at 12; Better 

Markets Feb. 22 Letter, at 4–5. 

518CFA/AFR Feb. 22 Letter, at 20. 

519AMG–SIFMA Feb. 22 Letter, at 12. 

520HOOPP Feb. 22 Letter, at 2. 

521See, e.g., SIFMA/ISDA Feb. 17 Letter, at 26– 

27; HOOPP Feb. 22 Letter, at 2; Exelon Feb. 22 

Letter, at 3. 

522SIFMA/ISDA Feb. 17 Letter, at 27. 

523 Id. 

524 Id.; ABC/CIEBA Feb. 22 Letter, at 7. 

525See, e.g., FHLBanks June 3 Letter, at 7; VRS 

Feb. 22 Letter, at 3; HETCO Feb. 22 Letter, at 2; 

COPE Feb. 22 Letter, at 4. 

526See, e.g., SIFMA/ISDA Feb. 17 Letter, at 27; 

ABC/CIEBA Feb. 22 Letter, at 7; but see CFA/AFR 

Nov. 3 Letter, at 7. 

527See SIFMA/ISDA Feb. 17 Letter, at 27 fn. 59. 

528CFA/AFR Feb. 22 Letter, at 13; CFA/AFR Nov. 

3 Letter, at 7. 

529CFA/AFR Feb. 22 Letter, at 13. 

530 Id. 

531See proposed 17 CFR 240.15Fh–3(f), SEC’s 

proposed rules, 76 FR at 42455; FINRA Rule 2111 

(Suitability), 75 FR 71479, Nov. 23, 2010 (Order 

Approving Proposed Rule Change; File No. SR– 

FINRA–2010–039). 

commenter stated that, for both swap 

dealers and swap advisors, there should 

be some suitability standards in place so 

that those entities with the appropriate 

expertise and capabilities to engage 

knowledgeably in these transactions are 

able to do so, while protecting those 

entities that should not be engaged in 

these types of transactions.509 Other 

commenters, however, believed that the 

institutional suitability requirement is 

unnecessary and inappropriate for the 

swaps market, which is comprised of 

institutional market participants, not 

retail investors, and should remain an 

SRO rule, if at all.510

Of specific concern to some 

commenters was the proposal’s 

inclusion of major swap participants. 

These commenters stated that, 

regardless of size, major swap 

participants cannot be presumed to 

possess a level of market or product 

information equal to that of swap 

dealers. Further, they expressed concern 

that proposed § 23.434 would force 

major swap participants into a position 

of trust and confidence when, in fact, 

they are transacting with their 

counterparties on an arm’s length 

basis.511 These commenters urged the 

Commission to treat major swap 

participants like any other customer of 

a swap dealer.512

Several commenters expressed 

concern with the use of the term 

‘‘recommendation’’ in proposed 

§ 23.434.513 One commenter opined that 

the term is not defined and, therefore, 

could be overly broad.514 Another 

commenter was concerned that general 

marketing materials could qualify as a 

recommendation within the meaning of 

the proposal.515 That commenter 

requested the Commission clarify that 

such materials, as opposed to the 

recommendation of specific swaps to a 

customer based on the individual 

customer’s particular circumstances and 

needs, does not trigger the requirements 

of proposed § 23.434.516 Other 

commenters stated that unless swaps are 

disclosed in an understandable, 

disaggregated form, they cannot be 

suitable.517 Similarly, a commenter 

suggested the Commission strengthen or 

clarify protections against swap dealers 

recommending swaps that expose the 

hedger to risks that are greater than 

those they seek to hedge, either by 

identifying this as a violation of fraud 

standards or clarifying that it would be 

a violation of the suitability and best 

interests standards.518 In contrast, one 

commenter believed that the complexity 

associated with collective investment 

vehicles would make it impracticable to 

carry out suitability and diligence 

requirements under proposed 

§ 23.434.519 Similarly, another 

commenter stated that, without details 

of the customer’s business, staff, or 

other risks, it would be difficult for the 

swap dealer or counterparty to make a 

suitability determination.520

Related to the comments regarding the 

term ‘‘recommendation’’ was the more 

general concern that proposed § 23.434 

would increase costs to, and chill 

communications and transactions 

between, swaps market participants.521

The concern was that the proposal 

would cut the flow of information and 

transactional alternatives that fall short 

of advice and that non-swap dealer and 

non-major swap participants find 

beneficial.522 A related concern was that 

the term ‘‘recommendation’’ would 

encompass ordinary interactions, and, 

therefore, swap dealers would always be 

subject to an explicit fiduciary duty.523

According to some commenters, 

imposing such a fiduciary duty on swap 

dealers would result in either a blanket 

prohibition on swap dealers transacting 

with ERISA plans or place such plans at 

a negotiating disadvantage with swap 

dealers by operation of other 

requirements that would require the 

plans to provide their counterparty with 

financial information to enter into a 

swap.524 Regarding costs, some 

commenters believed that a suitability 

determination may be challenged in 

litigation as a possible defense against 

enforcement of a swap by a swap dealer, 

and the costs associated with defending 

such litigation would be passed on to 

counterparties and would be 

disproportionate to the benefits 

expected from proposed § 23.434.525

Several commenters suggested that, if 

the Commission were to adopt a 

suitability requirement, it could 

ameliorate some of the costs associated 

with such a requirement by permitting 

swap dealers and major swap 

participants to rely, absent notice of 

countervailing facts, upon a 

counterparty’s written representations 

rather than imposing an independent 

diligence requirement.526 These 

commenters contend that such an 

approach would prevent any suitability 

requirement from triggering fiduciary or 

other advisory status except in 

circumstances where that status reflects 

the reality of the parties’ relationship.527

In contrast, at least one commenter 

expressed reservation about the utility 

of representations because it could 

subvert the intent of the suitability 

standard.528 This commenter believed 

there was no value in permitting swap 

dealers and major swap participants to 

recommend swaps known to be 

unsuitable just because the customer is 

willing to enter into the transaction.529

For this and other reasons, the 

commenter urged the Commission to 

require a suitability analysis, properly 

documented, whenever the swap dealer 

or major swap participant is the initiator 

in recommending the transaction or 

whenever the swap dealer or major 

swap participant recommends a 

customized swap or trading strategy that 

involves a customized swap.530

3. Final § 23.434 

The Commission has determined to 

adopt § 23.434. The final rule text has 

been changed to harmonize with the 

SEC’s proposed rule and FINRA’s final 

institutional suitability rule.531 Through 

these changes, the Commission achieves 

its proposed regulatory objectives while 

reducing the cost of compliance 

associated with reconciliation of the 

suitability duties imposed by the 

Commission, the SEC and FINRA. 

There are two principal changes from 

proposed § 23.434. First, major swap 

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532One commenter disagreed with removing 

major swap participants from the suitability 

requirement. The commenter reasoned that, if a 

major swap participant makes a recommendation, 

the rule would provide protection for 

counterparties, but would not otherwise be 

burdensome if they do not make recommendations. 

See CFA/AFR Aug. 29 Letter, at 21–25. 

Notwithstanding the commenter’s view, the 

Commission has determined, in light of the 

definition of major swap participant and the nature 

of its business, to remove major swap participants 

from the suitability requirement. 

533Appendix A to subpart H provides guidance 

as to the meaning of the term recommendation as 

used in § 23.434 and § 23.440(a)—Acts as an 

Advisor to a Special Entity. The appendix also 

provides guidance related to the safe harbors for 

compliance with each final rule. 534Cf. proposing release, 75 FR at 80647 fn. 81 

(citing NASD Notice to Members 01–23 (April 2001) 

and FINRA Proposed Suitability Rule, 75 FR 52562, 

52564–69, Aug. 26, 2010). 535For example, if a swap dealer transmitted a 

research report to a counterparty at the 

counterparty’s request, that communication would 

not be subject to the suitability obligation; whereas, 

if the same swap dealer transmitted the very same 

research report with an accompanying message, 

either oral or written, that the counterparty should 

act on the report, the analysis would be different. 

536See, e.g., 12 CFR 13.4 (Office of the 

Comptroller of the Currency regulation for banks 

recommending government securities to customers); 

FINRA Rule 2111 (Suitability), 75 FR 71479; SEC’s 

proposed rules, 76 FR at 42455. 

537See Section II.B. of this adopting release for a 

discussion of ‘‘Regulatory Intersections— 

Department of Labor ERISA Fiduciary Regulations.’’ 

538The Commission notes, regarding 

counterparty-specific suitability, that reasonable 

diligence would include, for example, assessing 

whether a recommendation would expose a hedger 

to risks that are greater than those they seek to 

hedge. See CFA/AFR Feb. 22 Letter, at 20. 

Reasonable diligence to determine suitability of a 

bespoke swap might include, as suggested by 

commenters and depending on the facts and 

circumstances, consideration of hedge equivalents, 

evaluations of liquidity, or added price for 

embedded lines of credit. See Better Markets Feb. 

22 Letter, at 4–7; Better Markets June 3 Letter, at 

13. Depending on the facts and circumstances, a 

violation of the suitability duty may also violate 

participants are excluded from the 

institutional suitability requirement. 

Second, the final rule clarifies that the 

suitability duty requires a swap dealer 

to (1) understand the swap that it is 

recommending, and (2) make a 

determination that the recommended 

swap is suitable for the specific 

counterparty. Consistent with the 

institutional suitability requirements of 

the proposed rule, however, the swap 

dealer will still be able to satisfy the 

counterparty-specific suitability duty by 

complying with the safe harbor in 

§ 23.434(b) through the exchange of 

written representations. The 

Commission also deleted paragraph 

(c)(2), which excluded from the scope of 

the rule: (1) Information that is general 

transaction, financial, or market 

information; and (2) swap terms in 

response to a competitive bid request 

from the counterparty. The Commission 

has determined that, if a swap dealer 

were to communicate such information 

to a counterparty, without more, such 

communication would not be 

considered making a 

‘‘recommendation.’’ As a result, such 

exclusion in proposed § 23.434 was 

unnecessary and potentially confusing 

to the extent that it could be read to 

contain the only types of information 

that would be outside the scope of the 

suitability rule. The Commission agrees 

with the commenters that stated that 

major swap participants are unlikely, in 

the normal course of arm’s length 

transactions, to be making 

recommendations to counterparties and 

has removed major swap participants 

from the final rule. This determination 

is consistent with Section 4s(h)(4), 

which does not impose on major swap 

participants the same ‘‘acts as an 

advisor’’ to a Special Entity duty as it 

does on swap dealers.532

In response to the comments it 

received, the Commission is providing 

additional guidance as to the meaning of 

the term ‘‘recommendation’’ in the final 

suitability rule and adding Appendix A 

to subpart H, which clarifies the term 

and provides guidance as to compliance 

with the final rule.533 Final § 23.434 

requires a swap dealer that makes a 

‘‘recommendation’’ to a counterparty to 

have a reasonable basis for believing 

that the recommended swap or trading 

strategy involving swaps is suitable for 

the counterparty. While the 

determination of whether a swap dealer 

has made a recommendation that 

triggers a suitability obligation will turn 

on the facts and circumstances of the 

particular situation, there are certain 

factors the Commission will consider in 

reaching such a determination. The facts 

and circumstances determination of 

whether a communication is a 

‘‘recommendation’’ requires an analysis 

of the content, context, and presentation 

of the particular communication or set 

of communications. The determination 

of whether a ‘‘recommendation’’ has 

been made, moreover, is an objective 

rather than a subjective inquiry. An 

important factor in this regard is 

whether, given its content, context, and 

manner of presentation, a particular 

communication from a swap dealer to a 

counterparty reasonably would be 

viewed as a ‘‘call to action,’’ or 

suggestion that the counterparty enter 

into a swap.534 An analysis of the 

content, context, and manner of 

presentation of a communication 

requires examination of the underlying 

substantive information transmitted to 

the counterparty and consideration of 

any other facts and circumstances, such 

as any accompanying explanatory 

message from the swap dealer.535

Additionally, the more individually 

tailored the communication to a specific 

counterparty or a targeted group of 

counterparties about a swap, group of 

swaps or trading strategy involving the 

use of a swap, the greater the likelihood 

that the communication may be viewed 

as a ‘‘recommendation.’’ For example, a 

‘‘flip book’’ or ‘‘pitch book’’ that sets out 

a customized transaction tailored to the 

needs or characteristics of a specific 

counterparty will likely be a 

recommendation. In contrast, general 

marketing materials, without more, are 

unlikely to constitute a 

recommendation. Further, simply 

complying with the requirements of the 

business conduct standards (e.g., 

verification of ECP or Special Entity 

status, disclosures of material 

information, scenario analysis, 

disclosure of the daily mark, etc.), 

without more, would not cause a swap 

dealer to be deemed to have made a 

recommendation. 

This formulation of 

‘‘recommendation’’ is consistent with 

the institutional suitability obligation 

imposed on federally regulated banks 

acting as broker-dealers and making 

recommendations for government 

securities to institutional customers, 

FINRA guidance on determining 

whether a recommendation has been 

made in the suitability context for 

broker-dealers recommending securities, 

and the SEC’s proposed rules and the 

federal securities laws on suitability 

requirements.536 Further, DOL confirms 

that it does not view compliance with 

the Commission’s business conduct 

standards rules, including the suitability 

requirement, to cause swap dealers 

transacting with ERISA plans to become 

fiduciaries to those plans.537 The 

Commission also confirms that 

compliance with the suitability duty 

would not cause a swap dealer to owe 

fiduciary duties to its counterparty, 

including a Special Entity. 

The Commission has considered 

commenters’ statements about the 

potential costs of proposed § 23.434. 

With respect to concerns that the 

suitability requirement could chill 

communications or spawn vexatious 

litigation, the Commission notes that the 

final rule aims to minimize costs by 

allowing swap dealers to satisfy their 

due diligence duty ‘‘to have or obtain 

information about the counterparty’’ 

including its investment profile, trading 

objectives, and ability to absorb 

potential losses by relying on the 

representations from such counterparty 

consistent with final § 23.402(d).538

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other rules, including the anti-fraud and fair dealing 

rules. 

539See Section IV.C.3.e. at fn. 867 and 

accompanying text for a discussion of § 23.450(d). 540Prong (4) of the safe harbor clarifies that 

§ 23.434’s application is broader than § 23.440— 

Requirements for swap dealers acting as advisors to 

Special Entities. Final § 23.434 is triggered when a 

swap dealer recommends any swap or trading 

strategy that involves a swap to any counterparty. 

However, § 23.440 is limited to a swap dealer’s 

recommendations (1) to a Special Entity (2) of 

swaps that are tailored to the particular needs or 

characteristics of the Special Entity. See Section 

IV.B.3.a. at fn. 697 and accompanying text. Thus, 

a swap dealer that recommends a swap to a Special 

Entity that is tailored to the particular needs or 

characteristics of the Special Entity may comply 

with its suitability obligation by satisfying the safe 

harbor in § 23.434(b); however, the swap dealer 

must also comply with § 23.440 in such 

circumstances. 

541See SEC’s proposed rules, 76 FR at 42415 fn. 

133. 

Furthermore, the Commission is 

clarifying in this adopting release and in 

Appendix A to subpart H that, final 

§ 23.434(b) establishes a safe harbor 

whereby a swap dealer will satisfy its 

counterparty-specific duty under 

§ 23.434(a)(2) through the exchange of 

certain written representations between 

the swap dealer and the counterparty as 

provided in § 23.434(c). The 

Commission further clarifies the types 

of representations that would satisfy the 

requirements of final § 23.402(d) 

(Reasonable Reliance on 

Representations) in the context of the 

final suitability rule in § 23.434. 

A swap dealer may rely on 

representations to obtain information 

about the counterparty when complying 

with the counterparty-specific 

suitability obligation in § 23.434(a)(2). 

For example, to obtain information 

about the counterparty’s ‘‘ability to 

absorb potential losses associated with 

the recommended swap or trading 

strategy,’’ the swap dealer could rely on 

the counterparty’s representation that it 

has a risk management program and/or 

hedging policy to manage and monitor 

its ability to absorb potential losses, and 

that it has complied in good faith with 

its policies and procedures for diligent 

review of and compliance with its risk 

management program and/or hedging 

policy. 

Alternatively, a swap dealer could 

satisfy the safe harbor requirements in 

§ 23.434(b) to satisfy the counterpartyspecific suitability obligation. Final 

§ 23.434(b)(1) requires the swap dealer 

to assess whether the counterparty is 

capable of evaluating, independently, 

the risks related to a particular swap or 

swap trading strategy. To make its 

assessment, the swap dealer may rely on 

a counterparty’s representations as 

provided in § 23.434(c). Final 

§ 23.434(c)(1) describes the types of 

representations a swap dealer may rely 

on with respect to any counterparty 

other than a Special Entity, and 

§ 23.434(c)(2) describes the types of 

representations a swap dealer may rely 

on with respect to a Special Entity. 

Final § 23.434(c)(1) provides that a swap 

dealer will satisfy § 23.434(b)(1)’s 

requirement with respect to a 

counterparty other than a Special Entity 

if it receives representations that the 

counterparty has complied in good faith 

with its policies and procedures that are 

reasonably designed to ensure that the 

persons responsible for evaluating the 

recommendation and making trading 

decisions on behalf of the counterparty 

are capable of doing so. Final 

§ 23.434(c)(2) provides that a swap 

dealer will satisfy § 23.434(b)(1)’s 

requirement with respect to a Special 

Entity if it receives representations that 

satisfy the terms of § 23.450(d) regarding 

a Special Entity’s qualified independent 

representative.539

To satisfy the safe harbor in 

§ 23.434(b), the final rule provides that 

the swap dealer and counterparty must 

exchange representations that: (1) The 

counterparty is capable of 

independently evaluating investment 

risks with regard to the recommended 

swap, (2) the counterparty is exercising 

independent judgment and is not 

relying on the recommendation of the 

swap dealer, (3) the swap dealer is 

acting as a counterparty and is not 

undertaking to assess the suitability of 

the swap or trading strategy involving a 

swap for the customer, and (4) in the 

case of a counterparty that is a Special 

Entity, the swap dealer complies with 

§ 23.440 where the recommendation 

would cause the swap dealer to act as 

an advisor to a Special Entity within the 

meaning of § 23.440(a).540

The Commission believes that this 

approach will lower the costs of 

compliance that would result from a 

requirement that a swap dealer must 

always conduct counterparty-specific 

due diligence while encouraging 

counterparties that choose to make 

representations consistent with the final 

rule to have policies and procedures to 

ensure that they have their own advisors 

that are able to assess recommendations 

and make appropriate determinations as 

to suitability. To further address 

commenters’ concerns about the 

potential burden of compliance on swap 

dealers, the Commission clarifies that 

there is no duty to look behind such 

representations in the absence of ‘‘red 

flags.’’ In this context, the Commission 

interprets ‘‘red flags’’ to mean 

information known by the swap dealer 

that would cause a reasonable person to 

question the accuracy of the 

representation. 

Commenters requested that the 

Commission allow swap dealers to rely 

on representations made on a 

relationship basis (i.e., written 

representations in counterparty 

relationship documentation) rather than 

requiring a representation be made on a 

transaction-by-transaction basis. The 

Commission agrees and believes this 

approach addresses the needs that some 

market participants have to enter into 

recommended transactions in short time 

frames. Where such representations are 

made in counterparty relationship 

documentation, the documentation 

must comply with final § 23.402(d) and 

may be deemed renewed with each 

recommendation. 

The Commission has determined not 

to adopt suggestions from commenters 

that it exclude certain classes of 

‘‘sophisticated’’ counterparties from the 

protection of final § 23.434. 

Nevertheless, with respect to the 

counterparty-specific suitability duty, 

the swap dealer will be able to rely on 

appropriate representations from 

‘‘sophisticated’’ counterparties to satisfy 

the duty. The Commission stresses that 

the representations relied upon by the 

swap dealer in all cases must be 

documented in a manner that allows the 

Commission to assess compliance with 

the final suitability rule. 

In all cases, to meet the requirements 

of final § 23.434, a swap dealer must 

undertake reasonable diligence to 

understand the swap that it is 

recommending. In general, what 

constitutes reasonable diligence will 

vary depending on, among other things, 

the complexity of, and risks associated 

with, the swap or swap trading strategy 

and the swap dealer’s familiarity with 

the swap or swap trading strategy. At a 

minimum, a swap dealer’s reasonable 

diligence must provide it with an 

understanding of the potential risks and 

rewards associated with the 

recommended swap or swap trading 

strategy. A swap dealer that lacks this 

understanding would not be able to 

meet its obligations under § 23.434(a)(1). 

These clarifications regarding how the 

Commission intends to apply the 

suitability requirement are designed to 

address many of commenters’ 

statements, including that the 

Commission should ensure consistency 

with the approach proposed by the SEC 

and the long-standing guidance 

provided by FINRA.541 In so doing, the 

Commission states its intention to be 

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542See, e.g., NASD Notice to Members 01–23 

(April 2001) (discussing what constitutes a 

‘‘recommendation); see also FINRA Rule 2111 

(suitability). 

543Proposing release, 75 FR at 80649 and 80657. 

544APGA Feb. 22 Letter, at 2. 

545 Id.; see proposed §§ 23.450(b)(8) and 

23.451(a)(3), proposing release, 75 FR at 80660–61. 

546See, e.g., SIFMA/ISDA Feb. 17 Letter, at 30 fn. 

70 (asserting that other than U.S. governmental 

plans, the Special Entity definition should exclude 

(1) unfunded plans for highly compensated 

employees, (2) foreign pension plans, (3) church 

plans that have elected not to be subject to ERISA, 

and (4) Section 403(b) plans that accept only 

employee contributions). 

547SIFMA/ISDA Feb. 17 Letter, at 30; CPPIB Feb. 

22 Letter, at 3; OTPP Feb. 22 Letter, at 2. 

548See SIFMA/ISDA Feb. 17 Letter, at 30; ASF 

Feb. 22 Letter, at 2–3; OTPP Feb. 22 Letter, at 2; 

AMG–SIFMA Feb. 22 Letter, at 13 fn. 44; see also 

Societe Generale Feb. 18 Letter, at 12; Barclays Jan. 

11 Letter, at 9 fn. 9. 

549CPPIB Feb. 22 Letter, at 3–4. 

550CFA/AFR Feb. 22 Letter, at 14–15; AFSCME 

Feb. 22 Letter, at 5. 

551Church Alliance Feb. 22 Letter, at 4–5; Church 

Alliance Aug. 29 Letter, at 3–4. 

552Church Alliance Oct. 4 Letter, at 2 (also 

asserting that a ‘‘church benefit board’’ is an 

organization described in Section 3(33)(C)(i) of 

ERISA). 

553BlackRock Feb. 22 Letter, at 7; SIFMA/ISDA 

Feb. 17 Letter, at 30; see also Church Alliance Feb. 

22 Letter, at 5 (‘‘Church benefit boards may also be 

likened to a master trust that is established by 

several multiple-employer pension plans.’’). 554ERIC Feb. 22 Letter, at 2 and 4–5 (asserting 

that the assets of an employee benefit plan subject 

to ERISA generally must be held in trust and, 

although the trust is a separate entity from the plan, 

the trust exists solely to hold and invest the assets 

of the plan). 

555See ERIC Feb. 22 Letter, at 4–5. 556See, e.g., ERIC Feb. 22 Letter, at 5. 557Section 501(c)(3) of the Internal Revenue Code 

of 1986 exempts from federal taxes: ‘‘Corporations, 

and any community chest, fund, or foundation, 

organized and operated exclusively for religious, 

charitable, scientific, testing for public safety, 

literary, or educational purposes, or to foster 

national or international amateur sports 

competition * * * or for the prevention of cruelty 

to children or animals, no part of the net earnings 

of which inure to the benefit of any private 

shareholder or individual * * *.’’ 26 U.S.C. 

501(c)(3). 

558CFA/AFR Feb. 22 Letter, at 14. 

559SFG Feb. 22 Letter, at 2–3; SIFMA/ISDA Feb. 

17 Letter, at 30–31; NACUBO Feb. 22 Letter, at 1 

fn. 2. 

guided, but not controlled, by precedent 

arising under analogous SRO rules.542

IV. Final Rules for Swap Dealers and 

Major Swap Participants Dealing With 

Special Entities 

Swap dealers and major swap 

participants are also subject to certain 

business conduct standards rules when 

dealing with particular counterparties 

that are defined as Special Entities. This 

section of the adopting release discusses 

§ 23.401(c)–Definition of the term 

Special Entity; § 23.440–Requirements 

for swap dealers acting as advisors to 

Special Entities; § 23.450–Requirements 

for swap dealers and major swap 

participants acting as counterparties to 

Special Entities; and § 23.451–Political 

contributions by certain swap dealers. 

A. Definition of ‘‘Special Entity’’ Under 

Section 4s(h)(2)(C) 

1. Section 23.401—Proposed Definition 

of ‘‘Special Entity’’ 

Section 4s(h)(2)(C) and proposed 

§ 23.401 defined a ‘‘Special Entity’’ as: 

(i) A Federal agency; (ii) a State, State 

agency, city, county, municipality, or 

other political subdivision of a State; 

(iii) any employee benefit plan, as 

defined in Section 3 of ERISA; (iv) any 

governmental plan, as defined in 

Section 3 of ERISA; or (v) any 

endowment, including an endowment 

that is an organization described in 

Section 501(c)(3) of the Internal 

Revenue Code of 1986.543

2. Comments 

a. State and Municipal Special Entities 

One commenter requested the 

Commission clarify whether the 

proposed definition was intended to 

include instrumentalities of a State or 

municipality or a public corporation.544

The commenter noted that proposed 

§ 23.450(b) (Requirements for a Special 

Entity’s representative) and proposed 

§ 23.451 (Political contributions by 

certain swap dealers and major swap 

participants) referenced ‘‘municipal 

entities,’’ which included any agency, 

authority or instrumentality of a State or 

political subdivision of a State.545

b. Employee Benefit Plans and 

Governmental Plans 

Section 4s(h)(2)(C)(iii) refers to any 

employee benefit plan ‘‘as defined in’’ 

Section 3 of ERISA. Section 3 of ERISA, 

however, defines ‘‘employee benefit 

plan’’ broadly and also defines several 

subcategories of employee benefit plans 

that are excluded from regulation under 

Title I of ERISA, including 

‘‘governmental plans,’’ which are 

referenced in Section 4s(h)(2)(C)(iv). 

Some commenters requested that the 

final rule clarify that prong (iii) of the 

Special Entity definition only include 

employee benefit plans that are ‘‘subject 

to,’’ i.e., regulated under, Title I of 

ERISA.546 Commenters stated that the 

‘‘employee benefit plan’’ prong should 

be read narrowly and only include those 

plans ‘‘subject to’’ ERISA because 

Congress included a separate prong (iv) 

for ‘‘governmental plans’’ that are 

‘‘defined in’’ Section 3 of ERISA, but not 

‘‘subject to’’ ERISA.547 Commenters also 

asserted that the Commission should 

exclude foreign pension plans from the 

Special Entity definition548 and that 

such an exclusion would be consistent 

with congressional intent and would 

avoid conflicts with foreign law.549

Other commenters asserted that the 

Commission should not limit or exclude 

any governmental plans such as 

retirement and deferred compensation 

plans.550 Another commenter stated that 

church plans and church benefit boards 

that are ‘‘defined in’’ Section 3 of ERISA 

but not ‘‘subject to’’ ERISA should be 

included within the Special Entity 

definition.551 The commenter also 

asserted that the Commission should 

avoid legal uncertainty for employee 

benefit plans that are ‘‘defined in’’ but 

not ‘‘subject to’’ ERISA, such as church 

plans and church benefit boards, and 

permitting such plans to opt in to the 

Special Entities provisions of the 

business conduct standards rules would 

be a preferable approach.552

c. Master Trusts 

Two commenters asserted that the 

Commission should clarify that the 

definition of ‘‘Special Entity’’ should 

encompass master trusts holding the 

assets of one or more employee benefit 

plans of a single employer.553 Another 

commenter suggested that the definition 

apply to any trust that holds the assets 

of employee benefit plans sponsored by 

the same employer or related 

employers.554 These commenters assert 

that employers that maintain multiple 

employee benefit plans often pool their 

assets into a single trust called a ‘‘master 

trust’’ for efficiency purposes.555 The 

commenters also assert that the Special 

Entity provisions of the business 

conduct standards rules should apply 

with respect to the master trust and not 

on a plan-by-plan basis, which would be 

burdensome and negate some 

efficiencies achieved by a master 

trust.556

d. Endowments 

Section 4s(h)(2)(C)(v) refers to ‘‘any 

endowment, including an endowment 

that is an organization described in 

Section 501(c)(3)557 of the Internal 

Revenue Code of 1986.’’ One commenter 

recommended the Commission err on 

the side of inclusiveness and include 

charitable organizations as Special 

Entities.558 Other commenters 

recommended that the Commission 

clarify that the endowment prong of the 

Special Entity definition is limited to 

when an endowment itself enters into 

swaps, but does not include non-profit 

or charitable organizations that enter 

into swaps, even where such an 

organization has an endowment.559 One 

such commenter asserted that the 

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560SFG Feb. 22 Letter, at 2–3. 

561Barclays Jan. 11 Letter, at 9 fn. 9. 

562 29 CFR 2510.3–101. If plans subject to ERISA 

own 25% or more of the assets of a collective 

investment vehicle, any person who exercises 

authority or control respecting the management or 

disposition of the vehicle’s underlying assets, and 

any person who provides investment advice with 

respect to such assets for a fee, is a fiduciary to the 

investing ERISA plans. 

563See, e.g., AMG–SIFMA Feb. 22 Letter, at 12– 

13; BlackRock Feb. 22 Letter, at 7; ABC/CIEBA Feb. 

22 Letter, at 14; ASF Feb. 22 Letter, at 3–6; MFA 

Feb. 22 Letter, at 6–7; SIFMA/ISDA Feb. 17 Letter, 

at 29–30; AFSCME Feb. 22 Letter, at 5; Church 

Alliance Feb. 22 Letter, at 4–5. See also Church 

Alliance Oct. 4 Letter, at 3–6 (recommending that 

church benefit boards be allowed to opt in to 

Special Entity status). 

564See, e.g., AMG–SIFMA Feb. 22 Letter, at 12– 

13; BlackRock Feb. 22 Letter, at 7; ABC/CIEBA Feb. 

22 Letter, at 14; ASF Feb. 22 Letter, at 3–6; MFA 

Feb. 22 Letter, at 6–7; SIFMA/ISDA Feb. 17 Letter, 

at 29–30. 

565AFSCME Feb. 22 Letter, at 5. 

566See, e.g., AMG–SIFMA Letter, at 12; ASF Feb. 

22 Letter, at 3–6; BlackRock Feb. 22 Letter, at 7. 

567MFA Feb. 22 Letter, at 6–7; SIFMA/ISDA Feb. 

17 Letter, at 29–30; BlackRock Feb. 22 Letter, at 7. 

568See, e.g., SIFMA/ISDA Feb. 17 Letter, at 30. 

569AMG–SIFMA Feb. 22 Letter, at 12. 

570 Id., at 13. 

571See, e.g., ASF Feb. 22 Letter, at 4; AMG– 

SIFMA Feb. 22 Letter, at 13; MFA Feb. 22 Letter, 

at 6–7. 

572See AMG–SIFMA Feb. 22 Letter, at 13. 

573 In addition to the Commission’s discretionary 

rulemaking authority in Section 4s(h), Section 

721(b)(2) of the Dodd-Frank Act provides the 

Commission discretionary rulemaking authority to 

define terms included in an amendment to the CEA 

made by Title VII of the Dodd-Frank Act. 

574The definition of ‘‘swap’’ excludes ‘‘any 

agreement, contract or transaction a counterparty of 

which is a Federal Reserve bank, the Federal 

Government, or a Federal agency that is expressly 

backed by the full faith and credit of the United 

States.’’ Section 1a(47)(B)(ix) of the CEA. 

Accordingly, the Commission expects that Special 

Entities that are Federal agencies will be a narrow 

category for purposes of these rules. 

575 In refining prong (ii), the Commission has 

considered other provisions of the CEA such as the 

ECP definition for governmental entities, which 

includes ‘‘an instrumentality, agency, or 

department’’ of a State or political subdivision of 

a State. See Section 1a(18)(A)(vii)(III) of the CEA. 

576See Sections IV.C. and IV.D. of this adopting 

release for a discussion of §§ 23.450(b)(1)(vii) and 

23.451(a)(3), respectively. 

577See Senator Lincoln floor colloquy stating that 

the Special Entity provisions in the Dodd-Frank Act 

‘‘should help protect both tax payers and plan 

beneficiaries.’’ 156 Cong. Rec. S5923 (daily ed. Jul. 

15, 2010) (statement of Sen. Lincoln). 

Commission should clarify that prong 

(v) does not include non-profit 

organizations that enter into swaps to 

hedge operational risks, such as interest 

rate risk in connection with a bond 

offering, that is unrelated to its 

endowment’s investment fund.560

Additionally, one commenter stated that 

the Special Entity definition should not 

apply to foreign endowments or foreign 

entities generally.561

e. Collective Investment Vehicles: The 

‘‘Look Through’’ Issue 

DOL has a look through test for 

entities that have ERISA plan investors, 

such as collective investment vehicles, 

to determine whether the person 

operating the entity will be treated as an 

ERISA fiduciary with respect to the 

invested plan assets.562 Collective 

investment vehicles, such as commodity 

pools and hedge funds, typically 

include a variety of investors and may 

include organizations that fall within 

the Special Entity definition set forth in 

Section 4s(h)(2)(C). Because the 

statutory definition of Special Entity 

uses ERISA’s definition of ‘‘employee 

benefit plan,’’ commenters requested 

clarification of whether the Commission 

will apply a ‘‘look through’’ test like 

DOL’s to collective investment vehicles 

for purposes of the business conduct 

standards rules. 

The Commission also received several 

comments regarding collective 

investment vehicles and whether they 

should be included within the Special 

Entity definition.563 The majority of 

commenters who addressed this issue 

were opposed to the Commission 

adopting a DOL-type ‘‘look through’’ 

test for collective investment 

vehicles.564 One commenter asserted 

that investment vehicles that hold plan 

assets should not be provided relief 

from the business conduct standards.565

Certain commenters asserted that the 

omission of collective investment 

vehicles from the definition of Special 

Entity in the text of the Dodd-Frank Act 

was determinative of congressional 

intent.566 Other commenters pointed out 

that the statute addressed only direct 

counterparty relationships and not the 

indirect collective investment vehicle 

situation.567 In addition, it was argued 

that, because collective investment 

vehicles include non-ERISA investors, 

extending the definition would 

inappropriately cover investors who do 

not want or need Special Entity 

protection.568

Further, from a pragmatic standpoint, 

one commenter maintained that it 

would be highly impractical to 

discharge heightened duties on the 

broad range of investors that participate 

in such vehicles and expressed concern 

that proposed suitability and diligence 

requirements would be problematic 

under a ‘‘look through’’ regime.569 The 

commenter suggested that heightened 

standards for collective investment 

vehicles would inappropriately subject 

those vehicles and their investors to 

increased costs, decreased efficiency 

and execution delays, and a ‘‘look 

through’’ provision could limit Special 

Entities’ non-swap investment 

options.570 Other commenters believed 

collective investment vehicle managers 

would either limit or prohibit 

investments by Special Entities to avoid 

limitations on their swap trading 

activities.571 Such managers may be 

concerned that other non-Special Entity 

investors may redeem or not invest if 

they believe the fund may be subject to 

restrictions on trading due to 

investments by Special Entities.572

3. Final § 23.401(c) Special Entity 

Definitions 

The Commission has considered the 

comments and congressional intent, and 

has determined to clarify the scope of 

the Special Entity definitions and 

further refine prongs (ii) and (iii) of 

Section 4s(h)(2)(C).573 For prong (ii), the 

Commission has determined to clarify 

that the definition of State and political 

subdivisions of a State includes 

instrumentalities, agencies or 

departments of States or political 

subdivisions of a State. For prong (iii), 

the Commission has determined to 

interpret the statute to apply only to 

employee benefit plans subject to ERISA 

rather than those defined in ERISA. For 

plans defined in ERISA but not 

otherwise covered by the Special Entity 

definition, the Commission has 

determined to permit such plans to opt 

in to the Special Entity protections 

under subpart H of part 23. 

a. Federal Agency 

The Commission did not receive any 

comments on the Federal agency prong 

(i) of the Special Entity definition, and 

thus, the Commission is adopting the 

definition as proposed (renumbered as 

§ 23.401(c)(1)).574

b. State and Municipal Special Entities 

The Commission has determined to 

refine prong (ii) of Section 4s(h)(2)(C), 

State and municipal Special Entities, to 

clarify that it also includes ‘‘any 

instrumentality, agency, department, or 

a corporation of or established by’’ 

States or political subdivisions of a State 

(renumbered as § 23.401(c)(2)).575 This 

clarification is consistent with the 

Commission’s modifications to 

§ 23.450(b) (requirements for a Special 

Entity’s representative) and § 23.451 

(political contributions by certain swap 

dealers).576 The Commission also 

determined that including 

instrumentalities, agencies, departments 

or corporations of or established by 

States or political subdivisions of a State 

is consistent with congressional intent 

to provide heightened protections for 

institutions backed by taxpayers.577 In 

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578Astoria Fed. Sav. & Loan Assn. v. Solimino, 

501 U.S. 104, 112 (1991). 

579See generally 29 U.S.C. 1002(3) (‘‘employee 

benefit plan’’ means an employee welfare benefit 

plan or an employee pension benefit plan); 29 

U.S.C. 1002(1) (‘‘employee welfare benefit plan’’ 

means a plan, fund, or program established or 

maintained by an employer or by an employee 

organization, for the purpose of providing for its 

participants or their beneficiaries medical, surgical, 

or hospital care or benefits in the event of sickness, 

accident, disability, death or unemployment); 29 

U.S.C. 1002(2) (‘‘employee pension benefit plan’’ 

means any plan, fund, or program established or 

maintained by an employer or by an employee 

organization that provides retirement income to 

employees). 

580Section 4(b) of ERISA (29 U.S.C. 1003(b)) 

states that ERISA shall not apply to any employee 

benefit plan that is (1) a governmental plan (as 

defined in Section 3(32) of ERISA (29 U.S.C. 

1002(32)); (2) a church plan (as defined in Section 

3(33) of ERISA (29 U.S.C. 1002(33)) with respect to 

which no election has been made to be subject to 

ERISA under 26 U.S.C. 410(d); (3) plans maintained 

solely to comply with workmen’s compensation, 

unemployment compensation, or disability 

insurance laws; (4) plans maintained outside the 

United States primarily for the benefit of persons 

substantially all of whom are nonresident aliens 

(i.e., foreign pension plans); or (5) excess benefit 

plans (as defined in Section 3(36) of ERISA (29 

U.S.C. 1002(36)) that are unfunded. 

581Church Alliance Feb. 22 Letter, at 4. 

582This construction is similar to that of Section 

4(b)(2) of ERISA, which excludes church plans 

unless the church plan has elected to be subject to 

ERISA. (29 U.S.C. 1003(b)(2)). 

583See generally Section 403(a) of ERISA (in 

general, ‘‘assets of an employee benefit plan shall 

be held in trust by one or more trustees’’) (29 U.S.C. 

1103(a)); see also DOL Regulation 29 CFR 

2520.103–1(e) (requiring the plan administrator of 

a Plan which participates in a master trust to file 

an annual report on IRS Form 5500 in accordance 

with the instructions for the form relating to master 

trusts); see also IRS Form 5500 Instructions, at 9 

(‘‘For reporting purposes, a ‘master trust’ is a trust 

* * * in which the assets of more than one plan 

sponsored by a single employer or by a group of 

employers under common control are held.’’). 

considering commenters’ request for 

clarity on this issue, the Commission 

views § 23.401(c)(2) to apply broadly to 

State and local governmental entities 

that are entrusted with public funds, 

including public corporations. 

c. Employee Benefit Plans and 

Governmental Plans 

As a matter of statutory interpretation, 

Sections 4s(h)(2)(C)(iii) (employee 

benefit plans defined in Section 3 of 

ERISA) and 4s(h)(2)(C)(iv) 

(governmental plans defined in Section 

3 of ERISA) should be construed ‘‘to 

avoid rendering superfluous’’ the 

statutory language.578 Section 3(3) of 

ERISA defines ‘‘employee benefit plan’’ 

broadly to encompass plans, funds, or 

programs established or maintained by 

an employer or employee organization 

for the purpose of providing medical 

benefits or retirement income.579

Section 3 of ERISA (the definitional 

section) also defines specific types of 

employee benefit plans, including 

governmental plans, which are excluded 

from regulation under ERISA by Section 

4(b) (the coverage section of ERISA).580

Therefore, Section 4s(h)(2)(C)(iii) read 

literally as any employee benefit plan 

‘‘defined in’’ Section 3 of ERISA would 

render Section 4s(h)(2)(C)(iv) 

superfluous because a ‘‘governmental 

plan defined in section 3 of [ERISA]’’ is 

subsumed by the definition of 

‘‘employee benefit plan defined in 

section 3 of [ERISA].’’ 

To resolve this ambiguity, the 

Commission is refining the definition of 

‘‘any employee benefit plan defined in 

section 3 of [ERISA]’’ in proposed 

§ 23.401 as ‘‘any employee benefit plan 

subject to Title I of [ERISA]’’ 

(renumbered as § 23.401(c)(3)). This 

clarifies that employee benefit plans 

listed in Section 4(b) of ERISA (29 

U.S.C. 1003(b)) are not Special Entities 

within the meaning of 4s(h)(2)(C)(iii) or 

§ 23.401(c)(3). However, any employee 

benefit plan that is a governmental plan 

as defined in Section 3 of ERISA is a 

Special Entity within the meaning of 

Section 4s(h)(2)(C)(iv) and 

§ 23.401(c)(4). 

This refinement of the definition of 

‘‘employee benefit plan,’’ however, also 

excludes other types of employee 

benefit plans described in Section 4(b) 

of ERISA, including church plans and 

public and private foreign pension 

plans. In response to commenters who 

support providing protections broadly, 

including those commenters who assert 

that ‘‘a church plan should be treated as 

a Special Entity,’’ 581 the Commission 

has determined to add a sixth prong to 

the Special Entity definition. Under the 

new prong in § 23.401(c)(6), any 

employee benefit plan defined in 

Section 3 of ERISA, not otherwise 

defined as a Special Entity, may elect to 

be defined as a Special Entity by 

notifying its swap dealer or major swap 

participant of its election prior to 

entering into a swap with the particular 

swap dealer or major swap 

participant.582 Therefore, for example, 

under § 23.401(c)(6), any church plan 

defined in Section 3(33) of ERISA, 

including any plan described in Section 

3(33)(C)(i), such as a church benefit 

board, could elect to be defined as a 

Special Entity. 

The Commission has also considered 

the comments regarding the treatment of 

a master trust where the master trust 

holds the assets of more than one ERISA 

plan, as defined in § 23.401(c)(3), 

sponsored by a single employer or by a 

group of employers under common 

control.583 In this regard, the 

Commission clarifies that it would not 

find a swap dealer or major swap 

participant to have failed to comply 

with the requirements of subpart H of 

part 23 of the Commission’s Regulations 

with respect to an ERISA plan, if it 

otherwise complied with such 

requirements with respect to a master 

trust that holds the assets of such ERISA 

plan. The Commission understands that 

a single employer or a group of 

employers under common control may 

sponsor multiple ERISA plans that are 

combined into a master trust to achieve 

economies of scale and other 

efficiencies. In such cases, the 

Commission does not believe that any 

individual ERISA plan within the 

master trust would receive any 

additional protection if the swap dealer 

or major swap participant had to 

separately comply with requirements of 

subpart H of part 23 with respect to each 

ERISA plan whose assets are held in the 

master trust. 

d. Endowment 

The Commission agrees with 

commenters that the Special Entity 

prong with respect to endowments is 

limited to the endowment itself. 

Therefore, the endowment prong of the 

Special Entity definition under Section 

4s(h)(2)(C)(v) and § 23.401(c)(5) applies 

with respect to an endowment that is 

the counterparty to a swap with respect 

to its investment funds. The definition 

would not extend to counterparties that 

are charitable organizations generally. 

Additionally, where a charitable 

organization enters into a swap as a 

counterparty, the Special Entity 

definition would not apply where the 

organization’s endowment is 

contractually or otherwise legally 

obligated to make payments on the 

swap. The Commission believes that 

this determination is consistent with a 

plain reading of the statute and is 

consistent with the Commission’s 

determination regarding Special Entities 

and collective investment vehicles. 

Finally, the statute does not distinguish 

between foreign and domestic 

counterparties in Section 4s(h). 

Therefore, the Commission has 

determined that prong (v) of Section 

4s(h)(2)(C) and § 23.401(c)(5) will apply 

to any endowment, whether foreign or 

domestic. 

e. Collective Investment Vehicles: The 

‘‘Look Through’’ Issue 

The Commission has determined as a 

matter of statutory interpretation of 

Section 4s(h) that the definition of 

Special Entity does not include 

collective investment vehicles that have 

Special Entity participants. While DOL 

rules ‘‘look through’’ collective 

investment vehicles to determine 

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584However, nothing in the Dodd-Frank Act or 

the business conduct standards rules would affect 

the application of the ERISA look-through 

requirements. 

585The Commission clarifies, however, that this 

analysis is not intended to apply with respect to a 

master trust that holds the assets of more than one 

ERISA plan, as defined in § 23.401(c)(3), which 

includes a master trust in which the assets of more 

than one plan sponsored by a single employer or 

by a group of employers under common control are 

held. This determination is based on the language 

of Section 4s(h) of the CEA and ERISA’s treatment 

of master trusts as subject to regulation under 

ERISA, and is consistent with the unanimous 

position of the comments received. Thus, the 

Commission would consider such a master trust to 

be a Special Entity within the meaning of 

§ 23.401(c)(3). 

586Section 1a(10) of the CEA (7 U.S.C. 1a(10)). 

587See, e.g., Commodity Trend Serv., Inc. v. 

CFTC, 233 F.3d 981 (7th Cir. 2000); Savage v. CFTC, 

548 F.2d 192 (7th Cir. 1977). 

588Proposing release, 75 FR at 80650 and 80659. 

589The exclusions in proposed § 23.440(a)(1)–(2) 

for general transaction, financial or market 

information and swap terms in response to a 

competitive bid request are consistent with the 

exclusions in proposed § 23.434(c)(2)– 

Recommendations to counterparties-institutional 

suitability. Proposing release, 75 FR at 80647–48 

and 80659. 

590 In the proposing release, the Commission 

stated that whether a recommendation has been 

made depends on the facts and circumstances of the 

particular case, and includes any communication 

by which a swap dealer provides information to a 

counterparty about a particular swap or trading 

strategy that is tailored to the needs or 

characteristics of the counterparty, but would not 

include information that is general transaction, 

financial, or market information, swap terms in 

response to a competitive bid request from the 

counterparty. Proposing release, 75 FR at 80647. 

See id. at 80647 and fn. 81 (citing SRO guidance— 

NASD Notice to Members 01–23 (April 2001)— 

interpreting the meaning of the term 

‘‘recommendation’’ in the context of a securities 

suitability obligation). See Sections III.G. and IV.B. 

of this adopting release for a discussion of final 

§§ 23.434 and 23.440, respectively, and Appendix 

A to subpart H of part 23 for clarification of the 

term ‘‘recommendation.’’ 

591Proposing release, 75 FR at 80650 and 80659. 

592 Id., at 80650 fn. 98 (citing similar language in 

SEC v. Capital Gains Research Bureau, Inc., 375 

U.S. 180, 191–94 (1963)). 

593 Id. 

594 Id., at 80650 fn. 99 (citing 156 Cong. Rec. 

S5923 (daily ed. Jul. 15, 2010) (statement of Sen. 

Lincoln)). 

595 Id., at 80650. 

596Proposed § 23.440(b)(2); proposing release, 75 

FR at 80659–60. 

597Section 4s(h)(4)(C)(i)–(iii) of the CEA. 

598Section 4s(h)(4)(C)(iv) of the CEA. 

whether the managers and advisors of 

those vehicles that received plan assets 

should be subject to ERISA’s fiduciary 

rules, there is no indication that 

Congress intended the Commission to 

‘‘look through’’ collective investment 

vehicles to apply the Dodd-Frank Act 

Special Entity protections.584 Given that 

the statutory definition of Special Entity 

does not mention collective investment 

vehicles, the Commission is not 

convinced that extending the DoddFrank Act definition of Special Entities 

to collective investment vehicles based 

on a DOL-type look through test is 

appropriate or necessary.585

Moreover, collective investment 

vehicles that trade swaps, known as 

commodity pools,586 generally are 

operated by CPOs and traded by CTAs, 

which some courts have held owe a 

fiduciary duty to the pool and pool 

participants.587 Therefore, treating 

collective investment vehicles as 

Special Entities if they receive 

investment funds from Special Entities 

would not materially enhance the 

protections afforded to such pool 

participants, but likely would create 

administrative burdens for swap dealers 

and major swap participants seeking to 

determine those pool participants’ 

Special Entity status. 

B. Section 23.440—Requirements for 

Swap Dealers Acting as Advisors to 

Special Entities 

1. Proposed § 23.440 

Proposed § 23.440 follows the 

statutory framework in Section 

4s(h)(4)(B) of the CEA, which imposes a 

duty on any swap dealer that ‘‘acts as an 

advisor to a Special Entity’’ to ‘‘act in 

the best interests of the Special Entity.’’ 

Section 4s(h)(4)(C) also requires any 

swap dealer that ‘‘acts as an advisor to 

a Special Entity’’ to ‘‘make reasonable 

efforts to obtain such information as is 

necessary to make a reasonable 

determination that any swap 

recommended by the swap dealer is in 

the best interests of the Special Entity 

* * *.’’ The terms ‘‘act as an advisor to 

a Special Entity,’’ ‘‘best interests,’’ 

‘‘make reasonable efforts’’ and 

‘‘recommended’’ are not defined in the 

statute. 

Proposed § 23.440(a) defined the term 

‘‘acts as an advisor to a Special Entity’’ 

and stated the term ‘‘shall include 

where a swap dealer recommends a 

swap or trading strategy that involves 

the use of swaps to a Special Entity.’’ 588

Under proposed § 23.440(a)(1)–(2), the 

term does not include where a swap 

dealer provides (1) information to a 

Special Entity that is general 

transaction, financial or market 

information, or (2) swap terms in 

response to a competitive bid request 

from a Special Entity.589 The 

Commission also discussed the meaning 

of the term ‘‘recommendation’’ in the 

preamble to proposed § 23.434— 

Recommendations to counterparties— 

institutional suitability.590

Proposed § 23.440(b)(1) restated the 

statutory duty to ‘‘act in the best 

interests’’ but did not define the term 

‘‘best interests.’’ 591 The proposing 

release clarified that the meaning of the 

term would be informed by ‘‘established 

principles in case law under the CEA 

with respect to the duties of advisors, 

which will inform the meaning of the 

term on a case-by-case basis.’’ The ‘‘best 

interests’’ principles, in the context of a 

recommended swap or swap trading 

strategy, would impose affirmative 

duties to act in good faith and make full 

and fair disclosure of all material facts 

and conflicts of interest * * *.’’ 592 The 

proposing release also stated that best 

interests principles would impose 

affirmative duties ‘‘to employ 

reasonable care that any 

recommendation made to a Special 

Entity is designed to further the 

purposes of the Special Entity.’’593

The proposing release explained that 

the statutory language in Sections 

4s(h)(4) and (5) and congressional intent 

guided the proposal. The proposal 

would permit a swap dealer to both 

recommend a swap to a Special Entity, 

prompting the duty to act in the best 

interests, and then enter into the same 

swap with the Special Entity as a 

counterparty if the Special Entity had a 

representative independent of the swap 

dealer on which it could rely.594

Finally, the proposing release stated that 

Sections 4s(h)(4) and (5) of the CEA and 

proposed rules §§ 23.440 and 23.450, 

together, were ‘‘intended to allow 

existing business relationships to 

continue, albeit subject to the new, 

higher statutory standards of care.’’ 595

The proposed rule restated the duty in 

Section 4s(h)(4)(C) that ‘‘any swap 

dealer that acts as an advisor to a 

Special Entity shall make reasonable 

efforts to obtain such information as is 

necessary to make a reasonable 

determination that any swap 

recommended by the swap dealer is in 

the best interests of the Special 

Entity.’’ 596 The statute also states that 

‘‘such information’’ includes 

information relating to (1) the financial 

status, (2) the tax status, and (3) the 

investment or financing objectives of the 

Special Entity.597 The statute also grants 

the Commission discretionary authority 

to prescribe additional types of 

information to satisfy the ‘‘reasonable 

efforts’’ and ‘‘best interests’’ 

standards.598 As a result, the 

Commission proposed that the swap 

dealer also be required to make 

reasonable efforts to obtain the 

following information: (1) The authority 

of the Special Entity to enter into a 

swap; (2) the experience of the Special 

Entity with respect to entering into 

swaps; (3) whether the Special Entity 

has a representative as provided in 

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599Proposing release, 75 FR at 80650. 

600 Id., at 80660. 

601See proposed § 23.440(c)(2) requiring 

representations to be sufficiently detailed for the 

swap dealer to reasonably conclude that the Special 

Entity is (1) capable of evaluating independently 

the material risk inherent in the recommendation, 

(2) exercising independent judgment in evaluating 

the recommendation, and (3) capable of absorbing 

potential losses related to the recommended swap. 

Proposing release, 75 FR at 80660. The criteria in 

paragraph (c)(2) parallel and were modeled on the 

three criteria in § 23.434(b)(1)—Recommendations 

to counterparties—institutional suitability. Id., at 

80659. 

602See, e.g., CFA/AFR Feb. 22 Letter, at 15–16; 

AFSCME Feb. 22 Letter, at 2–5; CFA/AFR Nov. 3 

Letter, at 1. 

603See, e.g., APGA Feb. 22 Letter, at 3–5; APPA/ 

LPPC Feb. 22 Letter, at 3; CalSTRS Feb. 28 Letter, 

at 3–5; CEF Feb. 22 Letter, at 16; GFOA Feb. 22 

Letter, at 1–2; HOOPP Feb. 22 Letter, at 2–3; 

NACUBO Feb. 22 Letter, at 2–4; Ropes & Gray Feb. 

22 Letter, at 2–3; Russell Feb. 18 Letter, at 1; 

SIFMA/ISDA Feb. 17 Letter, at 31–35; ERIC Feb. 22 

Letter, at 13–16; SWIB Feb. 22 Letter, at 2–4; Texas 

VLB Feb. 22 Letter, at 1–2; and U. Tex. System Feb. 

22 Letter, at 1–3. 

604See, e.g., AFSCME Feb. 22 Letter, at 2–3; CFA/ 

AFR Feb. 22 Letter, at 14–15 and 19 (the goal of the 

statute was to ensure that swap dealers would act 

in the best interest of more vulnerable 

counterparties when providing advice and making 

recommendations). 

605See, e.g., VRS Feb. 22 Letter, at 5 (Congress 

did not intend for the Commission to impose duties 

on a relationship that is potentially principal-toprincipal); SIFMA/ISDA Feb. 17 Letter, at 4 

(Congress intended parties to a swap to clarify the 

nature of their relationship, and not to transform 

the nature of their relationship, noting the provision 

in 4s(h)(5)(A)(ii) that requires a swap dealer that 

offers to enter or enters into a swap with a Special 

Entity to disclose its capacity before initiation of the 

transaction); APPA/LPPC Feb. 22 Letter, at 3 (the 

Dodd-Frank Act does not mandate a 

‘‘recommendation’’ standard for the acts as an 

advisor provision); Ropes & Gray Feb. 22 Letter, at 

2 (the statute should be triggered when the dealer 

assumes a status, rather than simply performing a 

single act, and the phrase ‘‘acts as an advisor’’ 

intends a more formal relationship than providing 

advice); CalSTRS Feb. 28 Letter, at 4 (impairing 

Special Entities’ access to derivatives markets was 

contrary to congressional intent). 

606SIFMA/ISDA Feb. 17 Letter, at 4 fn. 11. 

607See BlackRock Feb. 22 Letter, at 2; AMG– 

SIFMA Feb. 22 Letter, at 6 fn. 16. 

608See, e.g., SIFMA/ISDA Feb. 17 Letter, at 2; 

SWIB Feb. 22 Letter, at 2–4; NACUBO Feb. 22 

Letter, at 2; U. Tex. System Feb. 22 Letter, at 1–2. 

609See, e.g., U. Tex. System Feb. 22 Letter, at 2; 

Russell Feb. 18 Letter, at 1; GFOA Feb. 22 Letter, 

at 1–2; AMG–SIFMA Feb. 22 Letter, at 3; ERIC Feb. 

22 Letter, at 15; ABC/CIEBA Feb. 22 Letter, at 7; 

SIFMA/ISDA Feb. 17 Letter, at 33 (providing 

specific information while negotiating a swap 

should not constitute advising others); cf. CFA/AFR 

Feb. 22 Letter, at 19–20. 

610SIFMA/ISDA Feb. 17 Letter, at 33; cf. Russell 

Feb. 18 Letter, at 1. 

611Ropes & Gray Feb. 22 Letter, at 2–3. 

612See, e.g., AFSCME Feb. 22 Letter, at 3; 

NACUBO Feb. 22 Letter, at 2; U. Tex. System Feb. 

22 Letter, at 2; Ropes & Gray Feb. 22 Letter, at 2– 

3; cf. SWIB Feb. 22 Letter, at 2–3 (the exclusion is 

too narrow because Special Entities do not always 

issue competitive bid requests); Texas VLB Feb. 22 

Letter, at 2. 

613See ERIC Feb. 22 Letter, at 2; CEF Feb. 22 

Letter, at 17; AGPA Feb. 22 Letter, at 4; Ropes & 

Gray Feb. 22 Letter, at 3; Russell Feb. 18 Letter, 

at 1. 

proposed § 23.450(b); (4) whether the 

Special Entity has the financial 

capability to withstand potential 

market-related changes in the value of 

the swap; and (5) such other 

information as is relevant to the 

particular facts and circumstances of the 

Special Entity.599

Proposed § 23.440(c) allowed a swap 

dealer to rely on the Special Entity’s 

written representations to satisfy its 

duty to ‘‘make reasonable efforts to 

obtain information’’ under proposed 

§ 23.440(b). The proposed rule required 

a swap dealer to have a reasonable basis 

to believe that the representations are 

reliable taking into consideration the 

facts and circumstances of a particular 

swap dealer-Special Entity relationship, 

assessed in the context of a particular 

transaction.600 The representations had 

to be sufficiently detailed.601

2. Comments 

The Commission received a 

significant number of comments 

regarding proposed § 23.440. The 

commenters raised a range of issues, 

including: What types of activities 

should fall within the scope of the rule; 

the definitions of the terms ‘‘act as an 

advisor to a Special Entity’’ and ‘‘best 

interests’’; whether Special Entities 

should be allowed to opt out of the 

protections; safe harbors for compliance; 

intersections with the CTA, ERISA 

fiduciary, investment adviser, and 

municipal advisor statutory and 

regulatory provisions; and the potential 

costs and benefits to swap dealers and 

Special Entities. The Commission also 

received late-filed comments comparing 

its proposed approach with the SEC’s 

proposed approach to ‘‘acts as an 

advisor to a Special Entity’’ for SBS 

Dealers. 

A few commenters supported the 

Commission’s proposed interpretation 

of Section 4s(h)(4)(B)–(C) and proposed 

§ 23.440.602 The overwhelming majority 

of commenters, however, raised 

concerns with the proposed rule and 

requested that the Commission further 

clarify the meaning of ‘‘acts as an 

advisor to a Special Entity.’’ 603

a. Scope of the Proposed ‘‘Acts as an 

Advisor to a Special Entity’’ and 

‘‘Recommendation’’ Definitions 

Commenters generally discussed the 

following issues: (1) Congressional 

intent regarding the meaning of ‘‘acts as 

an advisor to a Special Entity’’; (2) the 

definition of ‘‘advice’’ or 

‘‘recommendation’’; (3) whether 

activities other than advice or 

recommendations would trigger 

application of proposed § 23.440; (4) 

whether compliance with other business 

conduct standards would trigger 

proposed § 23.440; and (5) whether to 

permit an opt out or create a safe harbor 

for swap dealers dealing with Special 

Entities that meet certain criteria. 

The Commission received several 

comments discussing whether proposed 

§ 23.440 was consistent with 

congressional intent and Section 

4s(h)(4). Some commenters stated that 

‘‘recommendations’’ were an 

appropriate trigger for proposed 

§ 23.440 and consistent with 

congressional intent.604 Other 

commenters stated that proposed 

§ 23.440 was inconsistent with or went 

beyond congressional intent.605 One 

commenter stated that Congress sought 

to establish a clear, bright line between 

swap dealers that are advisors under 

Section 4s(h)(4) and those that are 

merely counterparties under Section 

4s(h)(5).606 Other commenters asserted 

that the proposed rule imposed a 

fiduciary status on swap dealers, a 

result that Congress expressly rejected 

in the legislative history of the DoddFrank Act.607

Several commenters stated that the 

Commission’s description of 

‘‘recommendation’’ in the proposed rule 

was too broad and would 

inappropriately limit communications 

between swap dealers and Special 

Entities.608 Similarly, some commenters 

stated that the rule creates a very low 

bar for tripping the ‘‘best interests’’ 

standard and would often apply in the 

normal course of interactions between 

swap dealers and Special Entities.609

Commenters asserted that a swap dealer 

that prepares a term sheet and 

recommends a swap for consideration is 

not necessarily providing advice as to 

whether or not to enter into the 

transaction.610 Another commenter 

asserted that the term ‘‘recommends’’ 

has the potential to be vastly expansive 

and should not extend to marketing 

activities.611 A number of commenters 

asserted that the enumerated exclusions 

from the term ‘‘acts as an advisor to a 

Special Entity’’ are too narrow and 

overlook circumstances that should not 

give rise to an advisory relationship.612

Several commenters have stated that 

the Commission should clearly define 

activities that are recommendations or 

provide an alternative that clearly 

establishes when a swap dealer acts as 

an advisor to a Special Entity.613

Commenters stated the Commission 

should issue guidance to clearly define 

when a swap dealer will be classified as 

an ‘‘advisor’’ to avoid inadvertently 

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614See ERIC Feb. 22 Letter, at 15; CEF Feb. 22 

Letter, at 17. 

615See Russell Feb. 18 Letter, at 1; VRS Feb. 22 

Letter, at 5; cf. Ropes & Gray Feb. 22 Letter, at 3 

(a bright line test would be more appropriate than 

a facts-and-circumstances approach to a rule 

focused on the existence of a specific relationship). 

616SIFMA/ISDA Feb. 17 Letter, at 31–32. 

617CFA/AFR Feb. 22 Letter, at 19–20; cf. SWIB 

Feb. 22 Letter, at 2–3 (a swap dealer should not be 

acting as an advisor where it provides research and 

recommendations that are not specifically designed 

for the specific Special Entity). 

618APGA Feb. 22 Letter, at 4 (a 

‘‘recommendation’’ should mean a firm indication 

by the swap dealer of a particular preferred 

transaction, swap or market strategy). 

619See CEF Feb. 22 Letter, at 17 

(‘‘recommending’’ a swap should not apply to the 

negotiation or the marketing of a swap); APGA Feb. 

22 Letter, at 5 (providing market color and alerting 

a Special Entity to a possible strategy or to new 

products that are being offered, even when based 

upon knowledge of the Special Entity’s hedge 

positions or market strategy, should not constitute 

making a recommendation that causes a swap 

dealer to be deemed an advisor to a Special Entity); 

SIFMA/ISDA Feb. 17 Letter, at 33–34. 

620See CEF Feb. 22 Letter, at 16; Ropes & Gray 

Feb. 22 Letter, at 2 (providing advice is a narrower 

category than making a mere recommendation; 

therefore, ‘‘acting as an advisor’’ should require 

acknowledged agency, in which the Special Entity 

places trust, confidence, or reliance on the swap 

dealer); but cf. AFSCME Feb. 22 Letter, at 3 (many 

non-swap dealer market participants often assume 

that the swap dealer is a trusted advisor and is 

accountable for its advice). 

621See SIFMA/ISDA Feb. 17 Letter, at 22; APGA 

Feb. 22 Letter, at 3; APPA/LPPC Feb. 22 Letter, at 

3; NACUBO Feb. 22 Letter, at 2; COPE Feb. 22 

Letter, at 2; U. Tex. System Feb. 22 Letter, at 2; VRS 

Feb. 22 Letter, at 5; Ohio STRS Feb. 18 Letter, at 

2–3; MHFA Feb. 22 Letter, at 2; Russell Feb. 18 

Letter, at 1; BlackRock Feb. 22 Letter, at 5; AMG– 

SIFMA Feb. 22 Letter, at 3. 

622See, e.g., SIFMA/ISDA Feb. 17 Letter, at 6 and 

33; VRS Feb. 22 Letter, at 5; U. Tex. System Feb. 

22 Letter, at 2; MHFA Feb. 22 Letter, at 2; Russell 

Feb. 18 Letter, at 1; APPA/LPPC Feb. 22 Letter, at 

3; Ohio STRS Feb. 18 Letter, at 2–3; BlackRock Feb. 

22 Letter, at 5; AMG–SIFMA Feb. 22 Letter, at 3; 

Texas VLB Feb. 22 Letter, at 1; NACUBO Feb. 22 

Letter, at 2; AMG–SIFMA Feb. 22 Letter, at 3. 

623Ropes & Gray Feb. 22 Letter, at 3. 

624U. Tex. System Feb. 22 Letter, at 2; APPA/ 

LPPC Feb. 22 Letter, at 3, APGA Feb. 22 Letter, at 

4; SWIB Feb. 22 Letter, at 3; Texas VLB Feb. 22 

Letter, at 3; SFG Feb. 22 Letter, at 3; MHFA Feb. 

22 Letter, at 3; ERIC Feb. 22 Letter, at 15. 

625COPE Feb. 22 Letter, at 2–3 (swap dealers may 

be forced to require personnel to read from an 

approved script to avoid violations; such 

compliance will require more compliance 

personnel and raise swap dealer costs); Ropes & 

Gray Feb. 22 Letter, at 3 (compliance with the 

proposed rule would require the swap dealer to 

make difficult distinctions between general 

information and specific trade data). 

626CalSTRS Feb. 28 Letter, at 3 and 5; ERIC Feb. 

22 Letter, at 3, 14 and 16; see proposing release, 75 

FR at 80650 (‘‘The proposed definition does not 

address what it means to act as an advisor in 

connection with any other dealings between a swap 

dealer and a Special Entity.’’). 

627See SIFMA/ISDA Feb. 17 Letter, at 4 and 32; 

AFSCME Feb. 22 Letter, at 3; NACUBO Feb. 22 

Letter, at 3; U. Tex. System Feb. 22 Letter, at 2–3; 

SWIB Feb. 22 Letter, at 3; CalPERS Feb. 18 Letter, 

at 3 fn. 4; BlackRock Feb. 22 Letter, at 6; ERIC Feb. 

22 Letter, at 15–16; ABC/CIEBA Feb. 22 Letter, 

at 7. 

628See, e.g., SIFMA/ISDA Feb. 17 Letter, at 5; 

Ropes & Gray Feb. 22 Letter, at 2; NACUBO Feb. 

22 Letter, at 2–3; U. Tex. System Feb. 22 Letter, at 

2 and 3; CEF Feb. 22 Letter, at 16; VRS Feb. 22 

Letter, at 5; CalSTRS Feb. 28 Letter, at 3; MHFA 

Feb. 22 Letter, at 2; Russell Feb. 18 Letter, at 1; ERIC 

Feb. 22 Letter, at 2; ABC/CIEBA Feb. 22 Letter, at 

7; ABA/ABC Feb. 22 Letter, at 2; Davis & Harman 

Mar. 25 Letter, at 4; Rep. Smith July 25 Letter, 

at 2. 

629SIFMA/ISDA Feb. 17 Letter, at 5. 

630See Ropes & Gray Feb. 22 Letter, at 2; 

NACUBO Feb. 22 Letter, at 2–3; CEF Feb. 22 Letter, 

at 16; VRS Feb. 22 Letter, at 5; CalSTRS Feb. 28 

Continued 

triggering that status.614 Other 

commenters stated that the proposed 

rule uses subjective criteria and is 

unworkable.615

Commenters also suggested that the 

definition of ‘‘advice’’ or 

‘‘recommendations’’ should be limited 

to communications that are 

individualized or tailored to the 

recipient. One commenter suggested 

that the ‘‘acts as an advisor to a Special 

Entity’’ definition should be limited to 

individualized advice based on the 

particular needs of the Special Entity.616

Another commenter suggested the 

Commission adopt a definition of advice 

as ‘‘recommendations related to a swap 

or a swap trading strategy that are made 

to meet the objectives or needs of a 

specific counterparty after taking into 

account the counterparty’s specific 

circumstances.’’ 617 Another commenter 

stated that the definition of 

‘‘recommendation’’ should turn on 

whether the swap dealer suggested or 

indicated a particular preferred course 

of action.618

Commenters also proposed 

alternatives to determining when a swap 

dealer ‘‘acts as an advisor to a Special 

Entity.’’ Some commenters requested 

the Commission specifically exclude 

certain activities from the meaning of 

‘‘advice’’ or ‘‘recommendation.’’ 619

Commenters also suggested the 

Commission should look to principles 

of agency to determine whether a swap 

dealer is acting as an advisor.620

Commenters asserted that broad 

application of the term ‘‘recommends’’ 

in proposed § 23.440, which imposes a 

best interests duty on a swap dealer, 

will chill normal commercial 

communications, restrict customary 

commercial interactions, and generally 

reduce market information shared 

between swap dealers and Special 

Entities.621 Commenters asserted that 

swap dealers will decline to propose 

transactions, provide term sheets or 

transaction-specific information tailored 

to the Special Entity, and will be 

discouraged from providing education, 

suggestions, or other information with 

respect to a current or potential 

transaction that is customarily provided 

in the normal course of the business 

relationship.622

Commenters asserted that swap 

dealers provide valuable information, 

but the broad application of the term 

‘‘recommends’’ will preclude Special 

Entities from receiving this information. 

One commenter asserted that such 

communications serve an important 

informational function; even where the 

prospective counterparty’s last 

inclination would be to follow guidance 

from the swap dealer, such 

communications can indicate where the 

dealer might be willing to execute 

before negotiation and the types of 

trades that are being circulated in the 

marketplace.623 Other commenters 

added that swap dealers provide 

valuable information that could not 

easily be obtained elsewhere, and 

informal and course-of-business 

communications where market ideas 

and structures are presented and 

discussed is invaluable.624 Other 

commenters asserted that the broad 

application of the term ‘‘recommends’’ 

will make compliance burdensome for 

swap dealers and will increase costs.625

Commenters requested the Commission 

clarify whether activities or conduct 

other than making a recommendation 

would cause a swap dealer to ‘‘act as an 

advisor to a Special Entity’’ within the 

meaning of § 23.440, because language 

in the proposing release was 

ambiguous.626 Several commenters 

raised concerns that compliance with 

other business conduct rules could 

cause a swap dealer to act as an advisor. 

Commenters identified the following 

examples: Providing tailored 

disclosures, scenario analyses, daily 

marks, assessing the qualifications of a 

Special Entity’s independent 

representative, the general provisions of 

proposed § 23.402, and verification of 

counterparty eligibility.627

Several commenters discussed 

whether the Commission should permit 

the intention of the parties, rather than 

a functional test, to determine whether 

a swap dealer ‘‘acts as an advisor to a 

Special Entity.’’ 628 One commenter 

asserted that it would be impossible 

under the proposed rules for a swap 

dealer to confirm to a Special Entity 

counterparty that it was acting only as 

a counterparty and not acting as an 

advisor.629 Several commenters 

supported an approach to permit the 

Special Entity and swap dealer to agree 

that the swap dealer is not acting as an 

advisor, and, therefore, not subject to 

proposed § 23.440.630 Another 

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9780 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

Letter, at 3; MHFA Feb. 22 Letter, at 2; Russell Feb. 

18 Letter, at 1; ERIC Feb. 22 Letter, at 2; ABC/CIEBA 

Feb. 22 Letter, at 7; ABA/ABC Feb. 22 Letter, at 2; 

Davis & Harman Mar. 25 Letter, at 4; Rep. Smith 

July 25 Letter, at 2; cf. U. Tex. System Feb. 22 

Letter, at 2–3 (a swap dealer should not be an 

advisor if (1) any swap dealer communications that 

would otherwise be deemed a recommendation 

were only made in response to the Special Entity’s 

solicitation for information, and (2) the Special 

Entity certifies to the swap dealer that an advisory 

relationship does not arise). 

631 VRS Feb. 22 Letter, at 5; see Section 

4s(h)(5)(A)(ii) of the CEA; proposing release, 

proposed § 23.450(f), 75 FR at 80661. 

632AFSCME Feb. 22 Letter, at 4. 

633Ropes & Gray Feb. 22 Letter, at 2 (the 

definition of ‘‘acts as an advisor’’ should require 

acknowledged agency in which the Special Entity 

places trust, confidence, or reliance on the swap 

dealer); SIFMA/ISDA Feb. 17 Letter, at 31–32 fn. 76; 

APGA Feb. 22 Letter, at 4; ATA Feb. 22 Letter, at 

5; AMG–SIFMA Feb. 22 Letter, at 3; ERIC Feb. 22 

Letter, at 16. 

634SIFMA/ISDA Feb. 17 Letter, at 31–32; APGA 

Feb. 22 Letter, at 4; ATA Feb. 22 Letter, at 5; AMG– 

SIFMA Feb. 22 Letter, at 3; cf. DOL’s current 

fiduciary regulation, which deems a person that 

renders investment advice to an ERISA plan a 

‘‘fiduciary’’ where ‘‘the advice will serve as a 

primary basis for investment decisions with respect 

to plan assets.’’ 29 CFR 2510.3–21(c); supra fn. 34. 

635SIFMA/ISDA Feb. 17 Letter, at 32 fn. 76 

(asserting that Commission precedent recognized 

‘‘the nature of the overall relationship between the 

customer and advisor—and the customer’s 

dependence on the advisor—that gives rise to a 

fiduciary relationship’’) citing In re Jack Savage, 

[1975–1977 Transfer Binder] Comm. Fut. L. Rep. 

(CCH) ¶ 20,139 (CFTC Mar. 1, 1976). 

636NACUBO Feb. 22 Letter, at 2–4; U. Tex. 

System Feb. 22 Letter, at 3; cf. VRS Feb. 22 Letter, 

at 4 (the Commission should exempt transactions 

between swap dealers and Special Entities that 

qualify as ‘‘qualified institutional buyers’’ as 

defined in Rule 144A under the Securities Act); 

CEF Feb. 22 Letter, at 5; SIFMA/ISDA Feb. 17 

Letter, at 3 fn. 17. (17 CFR 230.144A). Rule 144A 

exempts from certain federal securities law 

protections certain entities that own and invest on 

a discretionary basis at least $100 million in 

securities of issuers that are not affiliated with the 

entity. 

637See, e.g., CEF Feb. 22 Letter, at 16; VRS Feb. 

22 Letter, at 4. 

638ERIC Feb. 22 Letter, at 2. 

639SIFMA/ISDA Feb. 17 Letter, at 31; Ropes & 

Gray Feb. 22 Letter, at 2; NACUBO Feb. 22 Letter, 

at 4; CEF Feb. 22 Letter, at 16; APPA/LPPC Feb. 22 

Letter, at 3; APGA Feb. 22 Letter, at 5; SWIB Feb. 

22 Letter, at 5; CalPERS Feb. 18 Letter, at 4; 

CalSTRS Feb. 28 Letter, at 3; SFG Feb. 22 Letter, 

at 1; BlackRock Feb. 22 Letter, at 5; AMG–SIFMA 

Feb. 22 Letter, at 2 and 5; ERIC Feb. 22 Letter, at 

3 and 15; ABC/CIEBA Feb. 22 Letter, at 7; contra 

CFA/AFR Nov. 3 Letter, at 3. 

640NACUBO Feb. 22 Letter, at 4. 

641A qualified professional asset manager is 

defined in DOL prohibited transaction exemption 

84–14 as a bank, insurance company, or registered 

investment adviser that meets certain capital, net 

worth, or assets under management tests. DOL 

QPAM PTE 84–14, 75 FR 38837. 

642An in-house asset manager is defined in DOL 

prohibited transaction exemption 96–23, 61 FR 

15975, Apr. 10, 1996 (‘‘DOL In-House Asset 

Manager PTE 96–23’’), as a wholly-owned 

subsidiary of an ERISA plan sponsor that is a 

registered investment adviser that meets certain 

assets under management tests. 

643SIFMA/ISDA Feb. 17 Letter, at 31; BlackRock 

Feb. 22 Letter, at 5; ABC/CIEBA Feb. 22 Letter, 

at 7. 

644CalSTRS Feb. 28 Letter, at 4. 

645SEC’s proposed rules, 76 FR at 42423–25, 

42454, and 42456–57. 

646Proposing release, 75 FR at 80650–51 and 

80659–60. 

647SEC’s proposed rules, 76 FR at 42425–27 and 

42457. SEC proposed § 240.15Fh–5(a) is the parallel 

rule to the Commission’s proposed § 23.450– 

Requirements for swap dealers and major swap 

participants acting as counterparties to Special 

Entities. Both proposed rules further describe the 

duty for a swap dealer, major swap participant, or 

commenter stated that permitting the 

swap dealer and Special Entity to 

determine whether the swap dealer 

‘‘acts as an advisor to the Special 

Entity’’ is consistent with the business 

conduct standards requirement for a 

swap dealer to ‘‘disclose to the Special 

Entity in writing the capacity in which 

the swap dealer is acting.’’ 631 By 

contrast, however, one commenter 

opposed an approach that would permit 

a swap dealer to avoid any obligation for 

giving advice where it discloses that it 

is not impartial and has an interest in 

the transaction being recommended.632

Many commenters suggested that the 

Commission consider whether the 

Special Entity relied or depended on the 

swap dealer’s advice or 

recommendations to determine whether 

a swap dealer ‘‘acts as an advisor to a 

Special Entity.’’ 633 Commenters 

suggested a swap dealer should be 

deemed to ‘‘act as an advisor to a 

Special Entity’’ only where the advice 

will serve as a primary basis for the 

Special Entity’s decision to take or 

refrain from taking a particular 

action.634 One commenter asserted that 

‘‘[i]mposing a ‘best interests’ duty based 

only on recommendations in the context 

of particular transactions would 

effectively overturn * * * longstanding 

[Commission] precedent.’’ 635

Commenters suggested that the 

Commission permit Special Entities of a 

certain size or sophistication be 

exempted or permitted to opt out of the 

protections under Section 4s(h)(4)(B)– 

(C) and proposed § 23.440. Commenters 

suggested that Special Entities be 

permitted to represent to a swap dealer 

that an advisory relationship is not 

intended if the Special Entity meets a 

minimum threshold of assets under 

management, net financial assets, debt 

outstanding, or frequency of executing 

swaps.636 Commenters also asserted that 

the business conduct standards 

protections generally, and proposed 

§ 23.440 in particular, do not provide 

any benefit to sophisticated Special 

Entities.637 Additionally, one 

commenter suggested that the final rule 

should provide that a swap dealer is 

never an advisor to an ERISA plan.638

Many commenters suggested that the 

Commission create a safe harbor for 

compliance with proposed § 23.440 if 

the Special Entity is separately 

represented by a qualified independent 

representative as prescribed under 

Section 4s(h)(5) and proposed 

§ 23.450.639 Several commenters 

suggested different refinements for such 

a safe harbor, for example, if (1) the 

communications are in response to the 

advisor’s standing solicitation for 

information, and (2) the advisor certifies 

to the swap dealer that no advisory 

relationship is intended.640 Other 

commenters suggested the safe harbor 

should apply if the Special Entity is 

represented by a sophisticated, 

professional advisor such as a bank, 

registered investment adviser, insurance 

company, qualified professional asset 

manager 641 (‘‘QPAM’’), or in-house 

asset manager 642 (‘‘INHAM’’).643

Alternatively, the Special Entity’s 

fiduciary could agree to the safe harbor 

if it is in the Special Entity’s best 

interests, for example, where the Special 

Entity has the ability to solicit bids and 

trade with multiple counterparties.644

Following the release of SEC’s 

proposed business conduct standards 

for SBS Entities, the Commission 

received several comment letters 

addressing, among other things, a 

comparison of SEC’s proposed 

§ 240.15Fh–2(a) and § 240.15Fh–4,645

Special Requirements for SBS Dealers 

Acting as Advisors to Special Entities, 

and the Commission’s proposed 

§ 23.440,646 Requirements for Swap 

Dealers Acting as Advisors to Special 

Entities. 

The Commission’s proposed 

§ 23.440(a) and the SEC’s proposed 

§ 240.15Fh–2(a) both define a swap 

dealer or SBS Dealer, respectively, that 

recommends a swap, security-based 

swap or a trading strategy that uses a 

swap or security-based swap to a 

Special Entity to be ‘‘acting as an 

advisor to a Special Entity.’’ Under the 

Commission’s proposed § 23.440, a 

swap dealer that meets the definition of 

‘‘acts as an advisor to a Special Entity’’ 

then has a duty to act in the best 

interests of the Special Entity. Under the 

SEC’s proposed § 240.15h–2(a), a SBS 

Dealer that recommends a securitybased swap or trading strategy involving 

the use of a security-based swap meets 

the definition of ‘‘acts as an advisor to 

a Special Entity,’’ unless (1) the Special 

Entity represents in writing that: (i) It 

will not rely on recommendations 

provided by the SBS Dealer; and (ii) it 

will rely on advice from a qualified 

independent representative as defined 

in § 240.15Fh–5(a); 647 (2) the SBS 

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SBS Entity to have a reasonable basis to believe that 

a Special Entity has a qualified independent 

representative that meets certain statutory criteria 

described in Section 4s(h)(5) of the CEA or Section 

15F(h)(5) of the Exchange Act. 

648See, e.g., FIA/ISDA/SIFMA Aug. 26 Letter, at 

4–5; BlackRock Aug. 29 Letter, at 2 and 7; ABC Aug. 

29 Letter, at 2 and 6–8. 

649Better Markets Aug. 29 Letter, at 2 and 14–15; 

CFA/AFR Aug. 29 Letter, at 1–2, 9, 13 and 26–29. 

650See, e.g., BlackRock Aug. 29 Letter, at 2. 

651Better Markets Aug. 29 Letter, at 15; see also 

CFA/AFR Aug. 29 Letter, at 26–29. 

652CFA/AFR Aug. 29 Letter, at 26; CFA/AFR Nov. 

3 Letter, at 2. 

653Proposing release, 75 FR at 80651. 

654SIFMA/ISDA Feb. 17 Letter, at 4 (citing a 

Senate version of H.R. 4173); but cf. CFA/AFR Feb. 

22 Letter, at 15 (asserting that the original Senate 

version imposed a fiduciary duty on all interactions 

between swap dealers and Special Entities that was 

ultimately an unworkable approach. However, the 

legislative history provides an insight into 

congressional intent that the ‘‘best interests’’ 

standard of care should be broadly applied). 

655Ohio STRS Feb. 18 Letter, at 2; CPPIB Feb. 22 

Letter, at 3; AMG–SIFMA Feb. 22 Letter, at 4 and 

6; SIFMA/ISDA Feb. 17 Letter, at 6; NACUBO Feb. 

22 Letter, at 2; Calhoun Feb. 22 Letter, at 2–3. 

656SIFMA/ISDA Feb. 17 Letter, at 6; CalSTRS 

Feb. 28 Letter, at 3; AMG–SIFMA Feb. 22 Letter, at 

4; Comm. Cap. Mkts. May 3 Letter, at 3. 

657SIFMA/ISDA Feb. 17 Letter, at 6; CalSTRS 

Feb. 28 Letter, at 4. 

658ERIC Feb. 22 Letter, at 4; cf. BlackRock Feb. 

22 Letter, at 5 (recommending the Commission 

should specify that proposed § 23.440 is not 

intended to cause a swap dealer to be considered 

an ERISA fiduciary). 

659Proposing release, 75 FR at 80651. 

660BlackRock Feb. 22 Letter, at 5; Calhoun Feb. 

22 Letter, at 2–3; cf. CalSTRS Feb. 28 Letter, at 3 

(asserting that the term ‘‘best interests’’ is vague). 

661AMG–SIFMA Feb. 22 Letter, at 6. 

662SWIB Feb. 22 Letter, at 3. 

663CFA/AFR Feb. 22 Letter, at 15. 

664 Id. 

665SIFMA/ISDA Feb. 17 Letter, at 6 fn. 19. 

666SIFMA/ISDA Feb. 17 Letter, at 32 fn. 74 

(asserting that such a distinction exists in other 

legal contexts, for example, a broker that provides 

advice on particular occasions does not trigger an 

ongoing duty to advise in the future and monitor 

all data potentially relevant to a customer’s 

investment) (citing de Kwiatkowski v. Bears Stearns 

& Co., Inc., 306 F.3d 1293, 1302 (2d Cir. 2003); see 

id. (asserting that the Advisers Act generally does 

not apply to a person whose only advice consists 

of advising an issuer how to structure its financing) 

(citing SEC Staff Legal Bulletin No. 11 (Sept. 2000) 

and SEC no-action letter to David A. Kekich, The 

Arkad Company, 1992 WL 75601 (available Mar. 19, 

1992)). 

667CFA/AFR Feb. 22 Letter, at 13 (discussing 

customized swaps with respect to a suitability 

duty). 

dealer has a reasonable basis to believe 

that the Special Entity is advised by a 

qualified independent representative as 

defined in § 240.15Fh–5(a); and (3) the 

SBS Dealer discloses that it is not 

undertaking to act in the best interests 

of the Special Entity. Under the 

proposal, an SBS Dealer that exchanges 

the required representations with the 

Special Entity would not have a duty to 

act in the best interests of the Special 

Entity when making a recommendation. 

The Commission received comment 

letters in support of 648 and against 649

the SEC approach. The supporters 

generally asserted that the SEC’s 

proposed rules represent workable 

solutions to some of the industry’s 

concerns over the adverse consequences 

of the Commission’s proposed rules.650

Commenters opposed to the SEC’s 

approach generally asserted that it was 

inconsistent with congressional intent 

and would permit an SBS Entity to 

provide advice that may not be in the 

best interests of the Special Entity 

without accountability.651 Another 

commenter asserted that the SEC’s 

approach would result in Special 

Entities signing away their right to the 

‘‘best interests’’ protection as a 

condition of doing business.652

b. Meaning of ‘‘Best Interests’’ 

Several commenters raised issues 

concerning the duty to act in the best 

interests of the Special Entity imposed 

under Section 4s(h)(4) and § 23.440. 

Issues raised by commenters generally 

include: (1) Whether a ‘‘best interests’’ 

duty imposes a fiduciary duty; (2) 

whether imposing a ‘‘best interests’’ 

duty will improperly encourage Special 

Entities to rely on the swap dealer; (3) 

the meaning of the term ‘‘best interests’’; 

(4) whether a ‘‘best interests’’ duty also 

imposes specific disclosure obligations; 

and (5) whether swap dealers will 

continue to transact with Special 

Entities if they are subject to a ‘‘best 

interests’’ duty. 

The Commission sought comment on 

a number of questions regarding 

proposed § 23.440, including whether 

swap dealers should be subject to an 

explicit fiduciary duty when acting as 

an advisor to a Special Entity.653 Some 

commenters cited the legislative history 

to support the view that Congress 

rejected an express fiduciary duty for 

swap dealers entering into a swap with 

a Special Entity.654 A number of 

commenters assert that a ‘‘best 

interests’’ duty creates a fiduciary 

relationship,655 or could give rise to 

fiduciary duties under other bodies of 

law including the common law, state 

pension laws, the CEA, the Advisers 

Act, and ERISA.656 Commenters also 

asserted that the inherent conflicts of 

interest in a counterparty relationship 

are incompatible with a fiduciary 

duty.657 Similarly, another commenter 

asked the Commission to clarify that 

complying with §§ 23.440 and 23.450 do 

not cause a swap dealer to be a fiduciary 

under any other body of law, including 

the securities laws or common law.658

The Commission also sought 

comment in the proposing release on 

whether to define ‘‘best interests,’’ and 

if so, what should the definition be.659

Some commenters stated that the best 

interests duty should be removed from 

the final rules.660 One commenter 

suggested that the Commission revise 

the ‘‘best interests’’ standard to require 

only a duty of fair dealing and not 

import a fiduciary duty.661 Another 

commenter asserted that a ‘‘best 

interests’’ standard of care is 

appropriate where a swap dealer 

provides advice tailored to the Special 

Entity’s position; however, the standard 

would be inappropriate if the definition 

of ‘‘advice’’ was not sufficiently 

narrowed.662

Other commenters supported the 

proposed ‘‘best interests’’ standard and 

suggested that the Commission should 

clarify that a ‘‘best interests’’ duty is a 

higher standard than a suitability 

obligation.663 The commenter also 

requested that the Commission clarify 

that certain practices should be 

identified as inherent violations of the 

best interests standard, including (1) 

designing swaps with features that 

expose the Special Entity to risks that 

are greater than those it intends to 

hedge, and (2) recommending 

customized swaps when the Special 

Entity could attain the same results at a 

lower risk-adjusted cost using 

standardized swaps.664

Other commenters discussed the 

scope of the duty. A commenter 

asserted, in the context of trading with 

a municipality, a swap dealer that 

demanded additional collateral could 

arguably violate its best interests duty 

because obtaining collateral is in the 

interest of the swap dealer and not the 

municipality.665 The commenter also 

stated that the Commission should 

clarify the scope of the ‘‘best interests’’ 

standard and ‘‘distinguish advice that is 

fiduciary in nature from advice 

rendered in the context of soliciting, 

structuring or executing a particular 

transaction.’’ 666 Conversely, another 

commenter asserted that customization 

by its very nature implies that the swap 

has been designed with the particular 

needs of the counterparty in mind, and, 

therefore, there is no benefit to allowing 

swap dealers to avoid regulatory duties 

when recommending customized 

swaps.667

Some commenters raised concerns 

that the ‘‘best interests’’ duty will 

inappropriately encourage a Special 

Entity to rely on a swap dealer. 

Commenters claim that reliance could 

create confusion regarding the parties’ 

respective responsibilities and could 

inappropriately increase dependence on 

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668See, e.g., SIFMA/ISDA Feb. 17 Letter, at 2. 

669CFA/AFR Feb. 22 Letter, at 5 and 15; cf. 

AFSCME Feb. 22 Letter, at 3 (asserting that nonswap dealers will often assume that a swap dealer 

that represents itself as a ‘‘trusted advisor’’ will be 

accountable for the advice it provides). 

670Proposing release, 75 FR at 80651. 

671See Section III.D.3.d. of this adopting release 

for a discussion of § 23.431(a)(3). 

672CFA/AFR Feb. 22 Letter, at 16 (asserting a 

swap dealer must disclose if a swap is designed so 

that the dealer will profit if the transaction fails for 

the Special Entity); see id. (when recommending 

customized swaps, a swap dealer should be 

required to break out the pricing of the components 

of the swap, including the profit). 

673CFA/AFR Feb. 22 Letter, at 7 (asserting that an 

example of such a material conflict would be where 

the swap dealer was taking a major short position 

in a type of swap that it was also recommending 

a Special Entity take a long position, therefore the 

swap dealer should be required to disclose that fact 

and its reasons for believing the counter position is 

nonetheless in the best interests of the Special 

Entity). 

674SIFMA/ISDA Feb. 17 Letter, at 22 (asserting 

that such disclosure is not required by the statute 

and is inconsistent with congressional intent as 

Congress rejected such a requirement when 

enacting the Dodd-Frank Act); CEF Feb. 22 Letter, 

at 21. 

675See SWIB Feb. 22 Letter, at 4; SIFMA/ISDA 

Feb. 17 Letter, at 14–15 (opposing the disclosure of 

pre-existing positions because it could allow a 

counterparty to discern confidential information of 

the swap dealer’s other clients, the disclosure is 

potentially misleading, the requirement would 

discourage swap dealers from providing liquidity, 

and compliance would be difficult when 

considering whether disclosure is required for nonstandardized swaps whose relation to a pre-existing 

position of a recommended swap is a matter of 

degree). 

676Proposing release, 75 FR at 80651. 

677CFA/AFR Feb. 22 Letter, at 17; CFA/AFR Nov. 

3 Letter, at 3. 

678SWIB Feb. 22 Letter, at 4; GFOA Feb. 22 

Letter, at 2; Calhoun Feb. 22 Letter, at 2; ABC/ 

CIEBA Feb. 22 Letter, at 7; ABA/ABC Feb. 22 Letter, 

at 2. 

679SWIB Feb. 22 Letter, at 4; GFOA Feb. 22 

Letter, at 2; ABC/CIEBA Feb. 22 Letter, at 7; contra 

CFA/AFR Nov. 3 Letter, at 3. 

680See SIFMA/ISDA Feb. 17 Letter, at 5–6; Ohio 

STRS Feb. 18 Letter, at 2; CalSTRS Feb. 28 Letter, 

at 4; AMG–SIFMA Feb. 22 Letter, at 4; SWIB Feb. 

22 Letter, at 4; CalPERS Feb. 18 Letter, at 3–4; VRS 

Feb. 22 Letter, at 3; OTPP Feb. 22 Letter, at 3; GFOA 

Feb. 22 Letter, at 2; BlackRock Feb. 22 Letter, at 5; 

ERIC Feb. 22 Letter, at 2; ABC/CIEBA Feb. 22 Letter, 

at 2; Texas VLB Feb. 22 Letter, at 1; NACUBO Feb. 

22 Letter, at 2–3; HOOPP Feb. 22 Letter, at 2. 

681See, e.g., CEF Feb. 22 Letter, at 16; CalPERS 

Feb. 18 Letter, at 4; Ropes & Gray Feb. 22 Letter, 

at 2; COPE Feb. 22 Letter, at 2; VRS Feb. 22 Letter, 

at 3; BDA Feb. 22 Letter, at 2; AMG–SIFMA Feb. 

22 Letter, at 4. 

682See CEF Feb. 22 Letter, at 16; APGA Feb. 22 

Letter, at 1; ETA May 4 Letter, at 8; CalPERS Feb. 

18 Letter, at 4; SWIB Feb. 22 Letter, at 3; VRS Feb. 

22 Letter, at 4; CalSTRS Feb. 28 Letter, at 2 and 4; 

OTPP Feb. 22 Letter, at 3; ERIC Feb. 22 Letter, 

at 2. 

683Proposing release, 75 FR at 80651. 

684CFA/AFR Feb. 22 Letter, at 17. 

685 Id., at 16. 

686 Id. (asserting that some Special Entities may 

have incentives to evade the restrictions of their 

charters to hide the extent to which they are 

underfunded and, therefore, the Commission 

should ensure that the regulation does not provide 

a means for Special Entities to use swaps to assume 

unreasonably high investment risks to seek higher 

returns). 

the swap dealer and discourage 

counterparties from conducting their 

own investigations and taking 

responsibility for their own decisions 

and conduct.668 Conversely, other 

commenters stated that applying the 

‘‘best interests’’ duty to 

recommendations would strike a 

reasonable balance by limiting the duty 

to instances in which Special Entities 

relied on the swap dealer and the 

standard should be scalable depending 

on the degree of reliance.669

The Commission listed three 

questions in the proposing release 

requesting comment on whether a ‘‘best 

interests’’ duty should require 

additional specific disclosures regarding 

(1) conflicts of interest, (2) the profit the 

swap dealer expects to make on swaps 

it enters into with the Special Entity, 

and (3) any positions the swap dealer 

holds from which it may profit should 

the swap in question move against the 

Special Entity.670 Most commenters 

discussed material incentives and 

conflicts of interest generally in the 

context of proposed § 23.431(a)(3); 671

however, some commenters discussed 

the Commission’s request for comment 

in the context of a ‘‘best interests’’ duty. 

One commenter asserted that a swap 

dealer should provide conflict of 

interest disclosures that go beyond the 

issue of compensation and third-party 

payments when dealing with a Special 

Entity and consider the full range of 

conflicts that may exist that are relevant 

to a particular recommendation.672 The 

commenter also stated that it is not 

necessary to require a swap dealer in all 

instances to disclose its pre-existing 

positions; however, disclosure should 

be required if those positions create a 

material conflict of interest.673

Some commenters opposed requiring 

a swap dealer to disclose their profit or 

anticipated profit in connection with a 

particular swap.674 Commenters also 

opposed requirements for swap dealers 

to disclose pre-existing positions to any 

counterparty because swap dealers may 

choose not to enter into swaps with 

Special Entities if they are required to 

disclose proprietary positions.675

The Commission also requested 

comment on whether proposed § 23.440 

would preclude swap dealers from 

continuing their current practice of both 

recommending and entering into swaps 

with Special Entities.676 One 

commenter asserted that Special Entities 

would retain their ability to engage in 

transactions with swap dealers as 

counterparties.677 Conversely, several 

commenters asserted that a duty to act 

in the ‘‘best interests’’ is incompatible 

with a counterparty relationship.678

These commenters asserted that there 

are several problems for a swap dealer 

that both acts as a counterparty and is 

required to act in the best interests of its 

counterparty in the same transaction, 

including that: (1) The duty of care is 

fundamentally at odds with an arm’s 

length counterparty relationship, (2) it 

would result in an unresolvable conflict, 

and (3) the parties’ interests are by 

definition adverse.679

Several commenters asserted that a 

‘‘best interests’’ duty will discourage or 

prevent swap dealers from transacting 

with Special Entities.680 Commenters 

also asserted that a duty to act in the 

‘‘best interests’’ of a Special Entity will 

increase burdens, compliance costs and 

liability exposure to swap dealers, and 

the additional costs and risks will be 

passed on to Special Entities through 

increased pricing.681 Thus, several 

commenters asserted that the proposed 

rules could increase costs for Special 

Entities, preclude them from hedging 

their risks, and do not provide 

corresponding benefits to Special 

Entities.682

c. Comments on § 23.440(b)(2)—Duty to 

Make Reasonable Efforts 

The Commission sought comment in 

the proposing release on whether to 

prescribe additional information that 

would be relevant to a swap dealer’s 

‘‘reasonable efforts’’ and ‘‘best interests’’ 

duties under the proposed rule.683 One 

commenter suggested that the 

Commission should clarify whether 

there is certain information without 

which the swap dealer could not make 

a recommendation. The commenter also 

suggested that where a swap dealer 

makes a recommendation based on 

limited information, any disclosures 

about the limitations should be made to 

the board of the Special Entity and not 

simply to the investment officer.684 The 

commenter agreed that there should be 

a mechanism to allow a Special Entity 

to discuss various options with a swap 

dealer without divulging confidential 

information.685 The commenter warned, 

however, that an overly broad 

interpretation of proposed § 23.440(c) 

could undercut the protections of the 

best interests duty.686

Another commenter opposed 

requirements for swap dealers to seek 

extensive information about a Special 

Entity, including information for the 

swap dealer to reasonably conclude that 

the Special Entity has the financial 

capability to withstand potential 

market-related changes in the value of 

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687ABC/CIEBA Feb. 22 Letter, at 7–8. 

688 Id. 

689SIFMA/ISDA Feb. 17 Letter, at 6–7; Ohio 

STRS Feb. 18 Letter, at 2; BlackRock Feb. 22 Letter, 

at 5–6; ETA May 4 Letter, at 8. 

690SIFMA/ISDA Feb. 17 Letter, at 6–7 (asserting 

such requirements would reduce or eliminate swap 

transactions for Special Entities if the information 

gathering is required on a trade-by-trade basis). 

691 Id., at 35. 

692APPA/LPPC Feb. 22 Letter, at 3; APGA Feb. 

22 Letter, at 5. 

693 Id. 

694BlackRock Feb. 22 Letter, at 5–6; ETA May 4 

Letter, at 8. 

695An ERISA ‘‘fiduciary’’ is defined in Section 

3(21) of ERISA (29 U.S.C. 1002(21)) and DOL 

Regulations at 29 CFR 2510.3–21. 

696Swap dealers that choose to operate within the 

safe harbor would be permitted to recommend 

tailored swaps to a Special Entity, provided that the 

swap dealer does not express an opinion as to 

whether the Special Entity should enter into the 

particular swap or swap trading strategy. Therefore, 

the safe harbor carves out from the term ‘‘acts as 

an advisor to a Special Entity’’ recommendations 

that are trade ideas or alternatives, but does not 

carve out subjective opinions as to whether the 

Special Entity should enter into a particular 

bespoke swap or swap trading strategy. 

697Unlike § 23.440, the suitability rule § 23.434 

covers recommendations regarding any type of 

swap or trading strategy involving a swap and is not 

limited to recommendations of bespoke swaps. 

698Whether a swap is tailored to the particular 

needs or characteristics of the Special Entity will 

depend on the particular facts and circumstances. 

Swaps with terms that are tailored or customized 

to a specific Special Entity’s needs or objectives, or 

swaps with terms that are designed for a targeted 

group of Special Entities that share common 

characteristics, e.g., school districts, are likely to be 

viewed as tailored to the particular needs or 

characteristics of the Special Entity. Generally, 

however, the Commission would not view a swap 

that is ‘‘made available for trading’’ on a DCM or 

SEF, as provided in Section 2(h)(8) of the CEA, as 

tailored to the particular needs or characteristics of 

the Special Entity. See Section III.D.3.b. at fn. 394 

for a discussion of final § 23.431(b)’s requirement to 

provide scenario analysis when requested by the 

counterparty for any swap not ‘‘made available for 

trading’’ on a DCM or SEF; see also Proposed Rules, 

Trade Execution Requirements, 76 FR at 58191; 

Proposed Rules, Process to Make a Swap Available 

to Trade, 76 FR 77728. 

699The facts and circumstances determination of 

whether a communication is a ‘‘recommendation’’ 

requires an analysis of the content, context, and 

presentation of the particular communication or set 

of communications. The determination of whether 

a ‘‘recommendation’’ has been made is an objective 

rather than a subjective inquiry. An important 

factor in this regard is whether, given its content, 

context, and manner of presentation, a particular 

communication from a swap dealer to a 

counterparty reasonably would be viewed as a ‘‘call 

to action,’’ or suggestion that the counterparty enter 

into a swap. An analysis of the content, context, 

and manner of presentation of a communication 

requires examination of the underlying substantive 

information transmitted to the counterparty and 

consideration of any other facts and circumstances, 

such as any accompanying explanatory message 

from the swap dealer. Additionally, the more 

individually tailored the communication to a 

specific counterparty or a targeted group of 

counterparties about a swap, group of swaps or 

trading strategy involving the use of a swap, the 

greater the likelihood that the communication may 

be viewed as a ‘‘recommendation.’’ See Section 

III.G. of this adopting release for a discussion of the 

suitability obligation under § 23.434. 

700See, e.g., CFA/AFR Feb. 22 Letter, at 20 (‘‘an 

appropriate definition of advice might be: 

‘recommendations related to a swap or a swap 

trading strategy that are made to meet the objectives 

or needs of a specific counterparty after taking into 

account the counterparty’s specific 

circumstances’ ’’); CFA/AFR Nov. 3 Letter, at 2; 

SIFMA/ISDA Feb. 17 Letter, at 32 (advice is 

‘‘individualized based on the particular needs of the 

Special Entity’’); cf. SWIB Feb. 22 Letter, at 2–3; see 

also APGA Feb. 22 Letter, at 4 (‘‘a 

‘recommendation’ which would trigger the advisor 

obligations should mean a firm indication by the 

swap dealer of a particular preferred transaction, 

swap, or market strategy’’); id. (A presentation 

offering information concerning new products or 

services or new market strategies, without 

advancing a particular course of action, should not 

Continued 

the swap.687 The commenter asserted 

that if the Special Entity had to provide 

financial information as a prerequisite 

to enter into a swap, such a requirement 

would disadvantage the Special Entity 

and give swap dealers an informational 

advantage in negotiations.688

Other commenters asserted that the 

pre-execution duties to make reasonable 

efforts would require a swap dealer to 

undertake extensive diligence and 

obtain detailed representations.689 One 

commenter added that such 

requirements would significantly 

increase costs, delay execution, and 

leave Special Entities to pay more for 

swaps and expose them to extended 

periods of market risk.690 The 

commenter also requested that the 

Commission permit a swap dealer to 

rely on representations of the Special 

Entity to meet both its duty to act in the 

best interests and its obligation to make 

reasonable efforts to obtain necessary 

information.691 Other commenters asked 

the Commission to provide greater 

clarity as to what constitutes ‘‘a 

reasonable basis to believe that the 

representations are reliable.’’ 692 The 

commenters suggest that representations 

from the Special Entity’s authorized 

employee or independent representative 

should be conclusive unless the swap 

dealer has actual knowledge that such 

representations are untrue.693 Other 

commenters stated that the proposing 

release did not provide estimates of the 

costs of the proposed rule to Special 

Entities, and that the additional costs 

and burdens do not have corresponding 

benefits.694

3. Final § 23.440 

Considering the comments, statutory 

construction and legislative history, the 

Commission has determined to adopt 

§ 23.440 with certain modifications. 

Final § 23.440(a) defines the term ‘‘acts 

as an advisor to a Special Entity’’ to 

mean ‘‘when the swap dealer 

recommends a swap or trading strategy 

involving a swap that is tailored to the 

particular needs or characteristics of the 

Special Entity.’’ Final § 23.440(b) 

provides two safe harbors from the 

definition of ‘‘acts as an advisor to a 

Special Entity’’ for particular types of 

conduct: (1) Communications between a 

swap dealer and an ERISA plan that has 

an ERISA fiduciary; 695 and (2) 

communications to any Special Entity 

(including a Special Entity that is an 

ERISA plan) or its representative that do 

not express an opinion as to whether the 

Special Entity should enter into a 

recommended swap or trading strategy 

involving a swap that is tailored to the 

particular needs or characteristics of the 

Special Entity.696 Qualifying for either 

safe harbor requires an exchange of 

specified representations in writing by 

the swap dealer and Special Entity. 

The final rule adopts the statutory 

‘‘best interests’’ duty for swap dealers 

acting as advisors to Special Entities 

and ‘‘reasonable efforts’’ duty for swap 

dealers to make a determination that 

any swap or swap trading strategy is in 

the best interests of the Special Entity. 

The final rule allows a swap dealer to 

rely on the written representations of 

the Special Entity to satisfy its 

‘‘reasonable efforts’’ duty. Such 

representations can be made on a 

relationship basis in counterparty 

relationship documentation rather than 

on a transaction basis, where 

appropriate. This adopting release and 

Appendix A to subpart H provide 

guidance for compliance with the 

second safe harbor in § 23.440(b)(2). 

a. Acts as an Advisor to a Special Entity 

The Commission has determined that 

a swap dealer will act as an advisor to 

a Special Entity when it recommends a 

swap or swap trading strategy that is 

tailored to the particular needs or 

characteristics of the Special Entity. 

This approach differs from proposed 

§ 23.440 in two significant ways. First, 

the type of recommendation that will 

prompt the ‘‘best interests’’ duty in the 

final rule is limited to recommendations 

of bespoke swaps,697 i.e., swaps that are 

tailored to the particular needs or 

characteristics of the Special Entity.698

Second, in response to commenters’ 

concerns, the Commission clarified in 

the discussion of the institutional 

suitability rule, § 23.434, the types of 

communications that will be considered 

recommendations.699 These two 

changes clarify the circumstances that 

would cause a swap dealer to act as an 

advisor to a Special Entity, consistent 

with the statutory framework and 

considering the comments.700

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9784 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

be considered advice); SIFMA/ISDA Feb. 17 Letter, 

at 33 (‘‘in preparing a term sheet, recommending a 

swap for consideration by a counterparty, and in 

other similar conduct, [a swap dealer] may well not 

be providing advice as to the advisability of 

entering into the relevant swap transaction’’). 

701The Commission has considered commenters’ 

suggestions that different categories of Special 

Entities should not be treated differently. See, e.g., 

CalSTRS Feb. 28 Letter, at 2 fn. 1. The Commission 

disagrees. Congress has established a 

comprehensive federal regulatory framework for 

ERISA plans, but has not done so for other Special 

Entities, which are subject to a wide range of state 

and local laws. Therefore, the Commission believes 

it is appropriate and consistent with congressional 

intent to harmonize regulation under the DoddFrank Act and CEA with ERISA requirements. Such 

harmonization avoids unintended consequences 

while maintaining protections for ERISA plans. 

With respect to other Special Entities, the 

Commission has considered commenters concerns 

and has provided compliance mechanisms under 

the final rules to address potential costs without 

undermining the benefits Congress intended. 

702When dealing with an ERISA plan, a swap 

dealer may comply with either or both safe harbors 

under § 23.440(b)(1) and (b)(2). 

In addition, the Commission has 

determined to provide two safe harbors 

to the rule—one that will apply only to 

ERISA plans and another that would 

apply to all Special Entities (including 

a Special Entity that is an ERISA plan). 

These safe harbors reflect several 

considerations, including comments 

describing the benefits of a free flow of 

information between a swap dealer and 

Special Entity, clear congressional 

intent to raise the standard of care for 

swap dealers that transact with Special 

Entities, and the implications of the 

‘‘best interests’’ duty for swap dealers 

and Special Entities. 

First, under § 23.440(b)(1), a swap 

dealer will not be acting as an advisor 

to a Special Entity that is an ERISA plan 

if: (1) The ERISA plan represents in 

writing that it has an ERISA fiduciary; 

(2) the ERISA fiduciary represents in 

writing that it will not rely on 

recommendations provided by the swap 

dealer; and (3) the ERISA plan 

represents in writing that (A) it will 

comply in good faith with written 

policies and procedures reasonably 

designed to ensure that any 

recommendation the Special Entity 

receives from the swap dealer materially 

affecting a swap transaction is evaluated 

by a fiduciary before the transaction 

occurs, or (B) any recommendation the 

Special Entity receives from the swap 

dealer materially affecting a swap 

transaction will be evaluated by a 

fiduciary before that transaction occurs. 

In reaching this determination, the 

Commission has considered the 

comments, the comprehensive federal 

regulatory scheme that applies to ERISA 

fiduciaries, and the importance of 

harmonizing the Dodd-Frank Act 

requirements with ERISA to avoid 

unintended consequences.701 Therefore, 

§ 23.440(b)(1) both harmonizes the 

federal regulatory regimes and ensures 

appropriate protections for ERISA plans. 

Second, under § 23.440(b)(2), a swap 

dealer will not be ‘‘acting as an advisor’’ 

to any Special Entity (including a 

Special Entity that is an ERISA plan) 702

if: (1) The swap dealer does not express 

an opinion as to whether the Special 

Entity should enter into a recommended 

swap or swap trading strategy that is 

tailored to the particular needs or 

characteristics of the Special Entity; (2) 

the Special Entity represents in writing 

that it will not rely on the swap dealer’s 

recommendations and will rely on 

advice from a qualified independent 

representative within the meaning of 

§ 23.450; and (3) the swap dealer 

discloses that it is not undertaking to act 

in the best interests of the Special 

Entity. The Commission believes that 

this will provide greater clarity to the 

respective roles of the parties, and 

because a swap dealer must refrain from 

making statements or otherwise 

expressing an opinion to meet the safe 

harbor’s requirements, the provision 

also provides meaningful protections to 

Special Entities. 

Appendix A to subpart H provides 

additional guidance to market 

participants that choose to operate 

within the safe harbor. If a swap dealer 

complies with the terms of the safe 

harbor, it can be assured that the 

following types of communications, for 

example, would not be subject to the 

best interests duty: (1) Providing 

information that is general transaction, 

financial, educational, or market 

information; (2) offering a swap or 

trading strategy involving a swap, 

including swaps that are tailored to the 

needs or characteristics of a Special 

Entity; (3) providing a term sheet, 

including terms for swaps that are 

tailored to the needs or characteristics of 

a Special Entity; (4) responding to a 

request for a quote from a Special 

Entity; (5) providing trading ideas for 

swaps or swap trading strategies, 

including swaps that are tailored to the 

needs or characteristics of a Special 

Entity; and (6) providing marketing 

materials upon request or on an 

unsolicited basis about swaps or swap 

trading strategies, including swaps that 

are tailored to the needs or 

characteristics of a Special Entity. The 

list is illustrative and not exhaustive. It 

is intended to provide guidance to 

market participants. The safe harbor in 

§ 23.440(b)(2) allows a wide range of 

communications and interactions 

between swap dealers and Special 

Entities without invoking the ‘‘best 

interests’’ duty, provided that the swap 

dealer does not express its own 

subjective opinion to the Special Entity 

or its representative as to whether the 

Special Entity should enter into the 

swap or trading strategy that is 

customized or tailored to the Special 

Entity’s needs or circumstances and the 

appropriate representations and 

disclosures are exchanged. The 

Commission notes, however, that 

depending on the facts and 

circumstances, some of the examples on 

the list in Appendix A could be a 

‘‘recommendation’’ that would trigger a 

suitability obligation under § 23.434. 

However, the Commission has 

determined that such activities would 

not, by themselves, prompt the ‘‘best 

interests’’ duty in § 23.440 provided that 

the parties comply with the other 

requirements of § 23.440(b)(2). 

The safe harbor draws a clear 

distinction between the activities that 

will and will not cause a swap dealer to 

be acting as an advisor to a Special 

Entity. Thus, a swap dealer that wishes 

to avoid engaging in activities that 

trigger a ‘‘best interests’’ duty must 

appropriately manage its 

communications. To clarify the type of 

communications that they will make 

under the safe harbor, the Commission 

expects that swap dealers may 

specifically represent that they will not 

express an opinion as to whether the 

Special Entity should enter into a 

recommended swap or trading strategy, 

and that for such advice the Special 

Entity should consult its own advisor. 

Nothing in the final rule would 

preclude such a representation from 

being included in counterparty 

relationship documentation. However, 

such a representation would not act as 

a safe harbor under the rule where, 

contrary to the representation, the swap 

dealer does express an opinion to the 

Special Entity as to whether it should 

enter into a recommended swap or 

trading strategy. 

The safe harbor permits a swap dealer 

to engage in a wide variety of 

discussions and communications with a 

Special Entity about individually 

tailored swaps and trading strategies, 

including the advantages or 

disadvantages of different swaps or 

trading strategies, without invoking the 

‘‘best interests’’ duty. All of the swap 

dealer’s communications, however, 

must be made in a fair and balanced 

manner based on principles of fair 

dealing and good faith in compliance 

with § 23.433. Furthermore, where the 

communications are 

‘‘recommendations,’’ the swap dealer 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9785 

703Legislative history supports that 4s(h)(4) and 

4s(h)(5) are not mutually exclusive. ‘‘[N]othing in 

[CEA Section 4s(h)] prohibits a swap dealer from 

entering into transactions with Special Entities. 

Indeed, we believe it will be quite common that 

swap dealers will both provide advice and offer to 

enter into or enter into a swap with a special entity. 

However, unlike the status quo, in this case, the 

swap dealer would be subject to both the acting as 

advisor and business conduct requirements under 

subsections (h)(4) and (h)(5).’’ 156 Cong. Rec. S5923 

(daily ed. Jul. 15, 2010) (statement of Sen. Lincoln). 

704One commenter asserted that Commission 

precedent recognizes that dependence or reliance is 

necessary to give rise to an advisory relationship. 

SIFMA/ISDA Feb. 17 Letter, at 32 fn. 76 (citing In 

re Jack Savage, [1975–1977 Transfer Binder] Comm. 

Fut. L. Rep. (CCH) ¶ 20,139 (CFTC Mar. 1, 1976)). 

The Commission disagrees that Savage can be 

applied so broadly. In Savage, the Commission 

denied a newsletter publisher’s commodity trading 

advisor registration application. Although the 

Commission acknowledges in Savage that the 

duties attendant to an advisory relationship exist 

where a customer may rely on a commodity trading 

advisor’s advice, reliance is not a required element 

for the creation of an advisory status nor the duties 

that flow from it. The fact that a customer does not 

rely would have no bearing on a regulatory action. 

An advisory relationship and related duties do not 

arise by the subjective understanding of the 

customer but by operation of law. A person 

becomes a commodity trading advisor when 

advising others for compensation or profit as to the 

value or advisability of trading in a commodity for 

future delivery or swap, among others. Once the 

advice is rendered for compensation or profit, 

regardless of the customer’s reliance, the advisor 

owes the duties attendant to such advice. 

705See Section III.A.1. of this adopting release for 

a discussion of ‘‘Opt in or Opt out for Certain 

Classes of Counterparties.’’ 

must comply with the suitability 

obligations under § 23.434. 

Some commenters requested that the 

Commission clarify whether activities 

other than those described in § 23.440 

would cause a swap dealer to act as an 

advisor to a Special Entity. The 

Commission has determined that a swap 

dealer will only ‘‘act as an advisor to a 

Special Entity’’ as provided in final 

§ 23.440(a). Similarly, in response to 

commenters, the Commission confirms 

that compliance with the requirements 

of Section 4s(h) and the Commission’s 

business conduct standards rules in 

subpart H of part 23, will not, by itself, 

cause a swap dealer to ‘‘act as an 

advisor to a Special Entity’’ within the 

meaning of § 23.440. 

b. Commenters’ Alternative Approaches 

The Commission considered 

comments asserting that Sections 

4s(h)(4) and 4s(h)(5) of the CEA are 

mutually exclusive provisions and 

4s(h)(4) should not apply where a swap 

dealer acts as a counterparty to a Special 

Entity. Similarly, the Commission 

considered comments requesting that 

the Commission provide a safe harbor to 

§ 23.440 that would allow a swap dealer 

to avoid ‘‘acting as an advisor to a 

Special Entity’’ where the Special Entity 

is advised by a qualified independent 

representative. The Commission 

disagrees with commenters’ statutory 

interpretation and declines to provide a 

safe harbor for all communications 

between a swap dealer and Special 

Entity provided that the Special Entity 

is advised by a qualified independent 

representative. A plain reading of 

Section 4s(h) does not provide that a 

swap dealer acting as a counterparty to 

a Special Entity may avoid Section 

4s(h)(4)’s provisions.703 The 

Commission also believes that it would 

be inconsistent with the statutory 

language to allow a swap dealer to avoid 

Section 4s(h)(4)’s requirements when it 

provides subjective advice to a Special 

Entity, simply because the Special 

Entity has a representative on which it 

is relying. Such an interpretation of the 

statute would essentially render Section 

4s(h)(4) a nullity and grant swap dealers 

unfettered discretion to provide 

subjective advice. Such a result would 

be inconsistent with congressional 

intent to raise standards for the 

protection of Special Entities. 

Many commenters suggested that a 

swap dealer should only be deemed to 

‘‘act as an advisor’’ based on mutual 

agreement between the swap dealer and 

Special Entity. The Commission 

declines to adopt such an approach 

because it would be inconsistent with 

the statute. Section 4s(h)(4) is selfeffectuating and by its terms does not 

delegate the determination to the 

parties. The statute establishes an 

advisor test based on conduct–‘‘acting’’ 

as an advisor–not agreement. If the 

parties were permitted to agree that a 

swap dealer was not acting as an advisor 

subject to a ‘‘best interests’’ duty, 

irrespective of the swap dealer’s 

conduct, the rule would essentially 

immunize swap dealers from complying 

with the obligations imposed by the 

statute when acting as an advisor. A 

statutory protection would not be 

meaningful if the default position were 

that protection only applies where the 

entity regulated by the provision, the 

swap dealer, agrees to be regulated. 

Commenters also suggest that the 

Commission should look to whether the 

Special Entity relied on the swap 

dealer’s advice or recommendations or 

whether such communications were the 

primary basis for the Special Entity’s 

trading decision to determine whether 

the swap dealer acted as an advisor. The 

Commission declines to adopt such a 

standard. Final § 23.440 creates an 

objective test that analyzes the swap 

dealer’s communications. Such a 

standard is appropriate considering that 

the business conduct standards rules 

regulate the swap dealer’s conduct. The 

commenters’ suggestion would shift the 

inquiry from an analysis of the swap 

dealer’s conduct to an analysis of 

whether the Special Entity actually 

relied on the swap dealer.704 Such a 

shift would not achieve the purposes of 

the statue and would create uncertainty. 

Commenters also suggested that the 

Commission adopt rules that permit 

sophisticated Special Entities to opt out 

of the protections provided in Section 

4s(h)(4) and § 23.440. Neither the statute 

nor legislative history distinguishes 

between sophisticated and 

unsophisticated Special Entities. 

Congress intended to provide 

heightened protections to Special 

Entities, and the Commission is not 

convinced that there is an objective 

proxy for sophistication with respect to 

participants in the swaps markets.705

Therefore, the Commission has 

determined not to permit Special 

Entities to opt out of the protections of 

the statute and the rules. Instead, the 

Commission has adopted clear, 

objective criteria for a swap dealer to 

determine whether it is acting as an 

advisor to a Special Entity, subject to a 

‘‘best interests’’ duty, or operating 

within the safe harbors provided in the 

rule. 

Those commenters that advocated an 

opt out regime, a qualified independent 

representative safe harbor, or to limit 

application of the rule were primarily 

concerned that a broad application of 

the definition of ‘‘acts as an advisor to 

a Special Entity’’ and that potential new 

costs or liability could chill 

communications between swap dealers 

and Special Entities, raise hedging costs 

for Special Entities, or reduce the 

number of swap dealers that would be 

willing counterparties to Special 

Entities. The Commission believes that 

the final rule appropriately addresses 

these concerns. Under the final rule a 

swap dealer can appropriately manage 

its communications to its counterparties 

and can take reasonable steps to avoid 

‘‘act[ing] as an advisor to a Special 

Entity.’’ Thus, the Commission believes 

that § 23.440 is designed appropriately 

to mitigate costs associated with the 

statutory requirements and the rule. The 

rule also achieves the intended 

regulatory protections by either (1) 

limiting the types of communications 

from the swap dealer that could have 

the greatest potential to mislead a 

Special Entity, or (2) where the swap 

dealer ‘‘acts as an advisor,’’ subjecting 

such communications to the ‘‘best 

interests’’ standard of care. 

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9786 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

706 In the Senate bill, the business conduct 

standards provision stated ‘‘a swap dealer that 

provides advice regarding, or offers to enter into, or 

enters into a swap with [a Special Entity] shall have 

a fiduciary duty to the [Special Entity].’’ Restoring 

American Financial Stability Act of 2010, H.R. 

4173, Section 731 (May 20, 2010) (Public Print 

version as passed in the Senate of the United States 

May 27 (legislative day, May 26, 2010) (proposed 

amendments to Section 4s(h)(2)(A) and (B) of the 

CEA), available at http://www.gpo.gov). The House 

and Senate Conference Committee did not adopt the 

fiduciary duty language and instead adopted the 

following: ‘‘Any swap dealer that acts as an advisor 

to a Special Entity shall have a duty to act in the 

best interests of the Special Entity.’’ See Section 

4s(h)(4)(B) of the CEA. 

707Where a swap dealer ‘‘acts as an advisor to a 

Special Entity,’’ the nature and content of the 

conflicts of interest disclosures will depend on the 

facts and circumstances of the particular swap 

dealer–Special Entity relationship and the 

recommended swap or trading strategy. See Section 

III.D. of this adopting release for a discussion of 

§ 23.431–Disclosures of material information, 

including whether a swap dealer is required to 

disclose that it is trying to move a particular 

position off its books at Section III.D.3.d. 

708A swap dealer would be expected to evaluate 

the ‘‘best interests’’ in accordance with reasonably 

designed policies and procedures and document 

how it arrived at a ‘‘reasonable determination’’ that 

a recommended swap is in the best interests of the 

Special Entity. 

709See Section IV.B.3.a. at fn. 698 for a discussion 

of Section 2(h)(8) and swaps ‘‘made available for 

trading’’ on a DCM or SEF; see also Section 

III.D.3.b. for a related discussion of swaps ‘‘made 

available for trading’’ for scenario analysis 

disclosures under final § 23.431(b) at fn. 394 and 

accompanying text at fn. 405. 

710For example, the swap dealer may negotiate 

appropriate provisions relating to collateral calls 

and termination rights to manage its risks related 

to the swap. 

711Some commenters suggested that a swap 

dealer that ‘‘acts as an advisor to a Special Entity’’ 

should be required to break out the pricing 

components of the swap, including the profit. See, 

e.g., CFA/AFR Feb. 22 Letter, at 16. The 

Commission declines to require any particular 

disclosures under this principles based standard. 

Whether such disclosure would be required to 

comply with the duty to act in the best interests of 

the Special Entity will depend on the facts and 

circumstances of the particular recommended swap 

or trading strategy. 

712However, whenever the swap dealer engages 

in activity that would cause it to be acting as an 

advisor to the Special Entity, the best interests duty 

would be prompted. For example, if a swap dealer 

acted as an advisor in connection with a material 

amendment to, or termination of, a swap, the ‘‘best 

interests’’ duty would apply. 

713Compare Section 4s(h)(3)(C) (‘‘duty for a swap 

dealer * * * to communicate in a fair and balanced 

manner based on principles of fair dealing and good 

faith’’) with Section 4s(h)(4)(B) (‘‘a duty to act in the 

best interests’’). 

c. Best Interests 

The final rule (renumbered as 

§ 23.440(c)(1)) adopts the statutory ‘‘best 

interests’’ duty for swap dealers acting 

as advisors to Special Entities and 

‘‘reasonable efforts’’ duty for swap 

dealers making a determination that the 

swap or swap trading strategy is in the 

best interests of the Special Entity. The 

Commission has determined not to 

define the term ‘‘best interests,’’ but 

rather to provide further guidance as to 

the meaning of the term and the scope 

of the duty. 

The Commission has considered 

commenters’ views and the legislative 

history 706 in regard to whether Section 

4s(h)(4) imposes a fiduciary duty. The 

Commission has determined that the 

‘‘best interests’’ duty under Section 

4s(h)(4) is not a fiduciary duty. 

Additionally, the Commission does not 

view the business conduct standards 

statutory provisions or rules in subpart 

H of part 23 to impose a fiduciary duty 

on a swap dealer with respect to any 

other party. 

Whether a recommended swap is in 

the ‘‘best interests’’ of the Special Entity 

will turn on the facts and circumstances 

of the particular recommendation and 

particular Special Entity. However, the 

Commission will consider a swap dealer 

that ‘‘acts as an advisor to a Special 

Entity’’ to have complied with its duty 

under final § 23.440(c)(1) where the 

swap dealer (1) complies with final 

§ 23.440(c)(2) to make a reasonable 

effort to obtain necessary information, 

(2) acts in good faith and makes full and 

fair disclosure of all material facts and 

conflicts of interest with respect to the 

recommended swap,707 and (3) employs 

reasonable care that any 

recommendation made to a Special 

Entity is designed to further the Special 

Entity’s stated objectives.708

For a recommendation of a swap to be 

in the best interests of the Special 

Entity, the swap does not need to be the 

‘‘best’’ of all possible alternatives that 

might hypothetically exist, but should 

be assessed in comparison to other 

swaps, such as swaps offered by the 

swap dealer or ‘‘made available for 

trading’’ on a SEF or DCM.709 To be in 

the best interests of a Special Entity, the 

recommended bespoke swap would 

have to further the Special Entity’s 

hedging, investing or other stated 

objectives. Additionally, whether a 

recommended swap is in the best 

interests of the Special Entity will be 

analyzed based on information known 

to the swap dealer (after it has employed 

its reasonable efforts required under 

Section 4s(h)(4)(C) and final 

§ 23.440(c)(2)) at the time the 

recommendation is made. The ‘‘best 

interests’’ duty does not prohibit a swap 

dealer from negotiating swap terms in 

its own interests,710 nor does it prohibit 

a swap dealer from making a reasonable 

profit from a recommended 

transaction.711 Depending on the facts 

and circumstances, the ‘‘best interests’’ 

duty also does not require an ongoing 

obligation to act in the best interests of 

the Special Entity.712 For example, a 

swap dealer would be able to exercise 

its rights under the terms and 

conditions of the swap when 

determining whether to make additional 

collateral calls in response to the 

Special Entity’s deteriorating credit 

rating, whether or not such collateral 

calls would be, from the Special Entity’s 

perspective, in the Special Entity’s ‘‘best 

interests.’’ 

d. Commenters’ Alternative ‘‘Best 

Interests’’ Approaches 

The Commission declines some 

commenters’ suggestions that the 

Commission delete the best interests 

duty or interpret best interests to be a 

fair dealing standard. Such an approach 

is inconsistent with the statute which 

uses the terms, ‘‘fair dealing’’ and ‘‘best 

interests,’’ in different provisions, 

indicating that they impose different 

duties.713 Another commenter requested 

that the Commission identify certain 

practices as inherent violations of the 

‘‘best interests’’ duty including where a 

swap dealer designs a swap with 

features that expose the Special Entity 

to risks that are greater than those they 

intend to hedge. In the Commission’s 

view, a swap dealer that ‘‘acts as an 

advisor to a Special Entity’’ could not 

recommend a swap or trading strategy 

that is inconsistent with the Special 

Entity’s stated objectives. Where a swap 

dealer that is acting as an advisor 

concludes that the stated objectives are 

inconsistent with the Special Entity’s 

best interests, the swap dealer would be 

expected to so inform the Special Entity 

and its independent representative. 

The Commission has considered 

commenters’ assertions that a Special 

Entity may be less likely to undertake its 

own due diligence when dealing with a 

swap dealer that is subject to the ‘‘best 

interests’’ duty. The Commission, 

however, believes that final § 23.440 

appropriately clarifies the duties and 

roles of the parties consistent with 

congressional intent. The Commission 

also notes that prior to entering into any 

swap with a swap dealer, a Special 

Entity will have a qualified independent 

representative that will evaluate the 

swap dealer’s advice in light of the 

Special Entity’s ‘‘best interests.’’ 

e. Final § 23.440(c)(2)—Duty to Make 

Reasonable Efforts 

Consistent with Section 4s(h)(4)(C), 

proposed § 23.440(b)(2) (renumbered as 

§ 23.440(c)(2)) required a swap dealer 

that ‘‘acts as an advisor to a Special 

Entity’’ to make reasonable efforts to 

obtain information necessary to make a 

reasonable determination that any 

recommended swap or trading strategy 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9787 

714Proposing release, 75 FR at 80650 and 80659– 

60. 

715 Id., at 80659–60. 

716Under proposed § 23.440(b)(2)(i), a swap 

dealer would have to make reasonable efforts to 

obtain such information regarding ‘‘the authority of 

the Special Entity to enter into a swap.’’ Id., at 

80660. The Commission has determined that the 

regulatory objective intended by this provision is 

already achieved in final § 23.402(b)—Know your 

counterparty. 

717Under proposed § 23.440(b)(2)(vi), a swap 

dealer would have to make reasonable efforts to 

obtain such information regarding ‘‘whether the 

Special Entity has an independent representative 

that meets the criteria enumerated in [proposed] 

§ 23.450(b).’’ Id., at 80660. The Commission has 

determined that this would be duplicative of the 

requirements in § 23.450. 

718 Id., at 80660. The provision as adopted 

clarifies that a Special Entity’s objectives in using 

swaps may be broader than investment or financing 

needs. 

719 Id., at 80660. The provision as adopted 

clarifies that the intent of the provision concerns 

changes in market conditions. 

720See CFA/AFR Feb. 22 Letter, at 17. 

721 Id., at 16. 

722See proposed § 23.440(c)(1)–(3), proposing 

release, 75 FR at 80660 (‘‘(1) The swap dealer has 

a reasonable basis to believe that the 

representations are reliable taking into 

consideration the facts and circumstances of a 

particular swap dealer-Special Entity relationship, 

assessed in the context of a particular transaction; 

and (2) The representations include information 

sufficiently detailed for the swap dealer to 

reasonably conclude that the Special Entity is: (i) 

Capable of evaluating independently the material 

risks inherent in the recommendation; (ii) 

Exercising independent judgment in evaluating the 

recommendation; and (iii) Capable of absorbing 

potential losses related to the recommended swap; 

and (3) The swap dealer has a reasonable basis to 

believe that the Special Entity has a representative 

that meets the criteria enumerated in § 23.450(b).’’). 

723See, e.g., BlackRock Feb. 22 Letter, at 6. 

724The Commission’s determination is consistent 

with several commenters’ suggestions. See, e.g., 

SIFMA/ISDA Feb. 17 Letter, at 36 (‘‘[swap dealers] 

should be permitted to rely on a written 

representation * * * that the counterparty and/or 

its representative satisfies the standards * * * 

absent actual notice of countervailing facts (or facts 

that reasonably should have put [a swap dealer] on 

notice), which would trigger a consequent duty to 

inquire further.’’); ABC/CIEBA Feb. 22 Letter, at 10– 

11 fn. 3 (asserting the Commission should adopt a 

standard used under Rule 144A of the federal 

securities laws, which would not impose a duty to 

inquire further ‘‘unless circumstances existed 

giving reason to question the veracity of a 

certification’’); AMG–SIFMA Feb. 22 Letter, at 10– 

11 (‘‘A swap dealer or [major swap participant] 

should be able to rely on an investment adviser’s 

representation unless the swap dealer or [major 

swap participant] has information to the 

contrary.’’); Comm. Cap. Mkts. May 3 Letter, at 2 

(‘‘The dealer should be required to probe beyond 

that representation only if it has reason to believe 

that the Special Entity’s representations with 

respect to its independent representative are 

inaccurate.’’); BlackRock Feb. 22 Letter, at 3 (‘‘The 

CFTC should specifically permit the [swap dealer] 

to rely, absent notice of facts that would require 

further inquiry.’’). 

involving a swap is in the best interests 

of the Special Entity.714 The proposed 

rule listed eight specific types of 

information that the swap dealer must 

make reasonable efforts to obtain and 

consider when making a determination 

that a recommendation is in the best 

interests of the Special Entity.715 The 

Commission has determined to delete 

two of the listed types of information, 

proposed § 23.440(b)(2)(i) 716 and (vi).717

Additionally, the Commission is 

refining the criteria in proposed 

§ 23.440(b)(2)(iv) 718 and (vii) 719

(renumbered as § 23.440(c)(2)(iii) and 

(v)). These changes are for clarification 

only and do not substantively change 

the rule. 

The Commission also clarifies how a 

swap dealer can satisfy its best interests 

duty where a Special Entity does not 

provide complete information with 

respect to the criteria in final 

§ 23.440(c)(2). Commenters have 

asserted that Special Entities may be 

reluctant to provide complete 

information to swap dealers about their 

investment portfolio or other 

information that might be relevant to the 

appropriateness of a particular 

recommendation. Nothing in the rule is 

intended to disadvantage a Special 

Entity in its negotiations with a swap 

dealer or require it to disclose 

proprietary information. 

However, to comply with its ‘‘best 

interests’’ duty where the Special Entity 

does not provide complete information, 

the swap dealer must make clear to the 

Special Entity that the recommendation 

is based on the limited information 

known to the swap dealer and that the 

recommendation might be different if 

the swap dealer had more complete 

information. The Commission has also 

considered comments suggesting that 

disclosures about a recommendation’s 

limitations should be made to the board 

of the Special Entity and not to the 

investment officer.720 The Commission 

agrees that the best practice for a swap 

dealer that ‘‘acts as an advisor to a 

Special Entity’’ within the meaning of 

§ 23.440(a) would be to ensure that 

disclosures about the limitations of its 

recommendation are communicated to 

the governing board or to a person or 

persons occupying a similar status or 

performing similar functions. 

Furthermore, where a swap dealer’s 

reasonable efforts to obtain necessary 

information results in limited or 

incomplete information, the swap dealer 

must assess whether it is able to make 

a reasonable determination that a 

particular recommendation is in the 

‘‘best interests’’ of the Special Entity. 

For example, a fundamental 

requirement to making a determination 

that a recommendation is in the best 

interests is to understand the objectives 

of the Special Entity with respect to the 

swap. If, after the swap dealer makes 

reasonable efforts to obtain information 

about the Special Entity’s objectives, the 

Special Entity does not provide 

sufficient information to the swap 

dealer, then the swap dealer would be 

unable to make a determination that a 

recommendation is in the best interests 

of the Special Entity. Therefore, a swap 

dealer that ‘‘acts as an advisor to a 

Special Entity’’ would have to refrain 

from making a recommendation to the 

Special Entity in such circumstances. 

A commenter asserted that any 

mechanism to allow a Special Entity to 

avoid divulging confidential 

information should not be interpreted so 

broadly as to undercut the protections of 

a best interests duty or permit Special 

Entities to engage in swaps with 

unreasonably high risk.721 The 

Commission has considered the 

comment and has determined that the 

rule is designed to provide appropriate 

protections to Special Entities. 

f. Final § 23.440(d)—Reasonable 

Reliance on Representations 

Proposed § 23.440(c) (renumbered as 

§ 23.440(d)) permitted a swap dealer to 

rely on written representations of the 

Special Entity to satisfy its obligation to 

‘‘make reasonable efforts’’ to obtain 

necessary information. However, the 

proposed rule listed additional criteria 

that a swap dealer would have to 

consider to determine that the 

representations were reliable.722 The 

Commission has determined to delete 

from the final rule text the additional 

criteria that a swap dealer would be 

expected to consider. Commenters 

found the proposed rule text confusing 

and unworkable.723 In light of the 

comments, the Commission has 

determined to provide additional 

guidance as to when a swap dealer 

would not be able to rely on written 

representations. 

A swap dealer would be able to rely 

on representations unless it had 

information that would cause a 

reasonable person to question the 

accuracy of the representation.724 The 

Commission declines to adopt other 

commenters’ suggestion that a swap 

dealer or major swap participant be 

permitted to rely on representations 

unless it had actual knowledge that the 

representations were untrue. The 

Commission has determined that an 

actual knowledge standard may 

inappropriately encourage the swap 

dealer to ignore red flags. The 

Commission also confirms that such 

representations, where appropriate, can 

be contained in counterparty 

relationship documentation consistent 

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9788 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

725As the Commission stated in the proposing 

release, such representations can be included in 

counterparty relationship documentation or other 

written agreement between the parties and that the 

representations can be deemed applicable or 

renewed, as appropriate, to subsequent swaps 

between the parties if the representations continue 

to be accurate and relevant with respect to the 

subsequent swaps. Proposing release, 75 FR at 

80641–42. 

726Although the title of Section 4s(h)(5) refers 

only to swap dealers, the specific requirements in 

Section 4s(h)(5)(A) are imposed on both swap 

dealers and major swap participants that offer to or 

enter into a swap with a Special Entity. 

Accordingly, the Commission proposed to apply the 

counterparty requirements to major swap 

participants as well as to swap dealers. Proposing 

release, 75 FR at 80651 fn. 104. 

727The Commission interpreted the statute as 

imposing this duty on swap dealers and major swap 

participants in connection with swaps entered into 

with all categories of Special Entities. The statutory 

language is ambiguous as to whether the duty is 

intended to apply with respect to all types of 

Special Entity counterparties, or just a sub-group. 

The ambiguities arise, in part, from the reference to 

subclauses (I) and (II) of Section 1a(18)(A)(vii) of 

the CEA, which include certain governmental 

entities and multinational or supranational 

government entities. Yet, multinational and 

supranational government entities do not fall 

within the definition of Special Entity in Section 

4s(h)(2)(C), and State agencies, which are defined 

as Special Entities, are not included in Section 

1a(18)(A)(vii)(I) and (II) but are included in (III). 

The Commission’s interpretation is consistent with 

legislative history. See H.R. Rep. No. 111–517, at 

869 (June 29, 2010) (Conf. Rep.) (‘‘When acting as 

counterparties to a pension fund, endowment fund, 

or state or local government, dealers are to have a 

reasonable basis to believe that the fund or 

governmental entity has an independent 

representative advising them.’’). Proposing release, 

75 FR at 80651 fn. 106 and 108. 

728To guide swap dealers and major swap 

participants, the proposed rule defined ‘‘statutory 

disqualification’’ as grounds for refusal to register 

or to revoke, condition or restrict the registration of 

any registrant or applicant for registration as set 

forth in Sections 8a(2) and 8a(3) of the CEA. 

Proposing release, 75 FR at 80651. 

729The proposed rule clarified that 

‘‘independent’’ as it relates to a representative of a 

Special Entity means independent of the swap 

dealer or major swap participant, not independent 

of the Special Entity. Proposing release, 75 FR at 

80652 fn. 113 and 115. 

730The Commission did not define ‘‘best 

interests’’ in this context, but noted the scope of the 

duty would be related to the nature of the 

relationship between the independent 

representative and the Special Entity, and 

established principles in case law would inform the 

meaning of the term on a case-by-case basis. At a 

minimum, the swap dealer or major swap 

participant would have a reasonable basis for 

believing that the representative could assess: (1) 

How the proposed swap fits within the Special 

Entity’s investment policy; (2) what role the 

particular swap plays in the Special Entity’s 

portfolio; and (3) the Special Entity’s potential 

exposure to losses. The swap dealer or major swap 

participant would also need to have a reasonable 

basis for believing that the representative has 

sufficient information to understand and assess the 

appropriateness of the swap prior to the Special 

Entity entering into the transaction. Proposing 

release, 75 FR at 80652. 

731The proposed rule refined the criterion under 

Section 4s(h)(5)(A)(i)(V), ‘‘appropriate disclosures’’ 

to mean ‘‘appropriate and timely disclosures.’’ 

Proposing release, 75 FR at 80652. 

732The proposed rule refined the statutory 

language to provide that the representative 

‘‘evaluate[], consistent with any guidelines 

provided by the Special Entity, [the] fair pricing 

and * * * appropriateness of the swap.’’ Swap 

dealers and major swap participants could rely on 

appropriate legal arrangements between Special 

Entities and their independent representatives in 

applying this criterion. For example, where a 

pension plan has a plan fiduciary that by contract 

has discretionary authority to carry out the 

investment guidelines of the plan, the swap dealer 

or major swap participant would be able to rely, 

absent red flags, on the Special Entity’s 

representations regarding the legal obligations of 

the fiduciary. Evidence of the legal relationship 

between the plan and its fiduciary would enable the 

swap dealer or major swap participant to conclude 

that the fiduciary is evaluating fair pricing and the 

appropriateness of all transactions prior to entering 

into such transactions on behalf of the plan. To 

comply with this criterion, the swap dealer or major 

swap participant also would consider whether the 

independent representative is documenting its 

decisions about appropriateness and pricing of all 

swap transactions and that such documentation is 

being retained in accordance with any regulatory 

requirements that might apply to the independent 

representative. This approach was applied to inhouse independent representatives as well. 

Proposing release, 75 FR at 80652–53. 

733Notwithstanding comments from ERISA plans 

and their fiduciaries, the Commission determined 

that independent representatives of plans subject to 

ERISA would have to meet all the independent 

representative criteria in Section 4s(h)(5)(A). The 

Commission sought further comment on this 

interpretation of the statute. Proposing release, 75 

FR at 80653 fn. 122. 

734Criterion 8—restrictions on certain political 

contributions—is not in the statutory text under 

Section 4s(h)(5)(A)(i)(I)–(VII). The Commission 

proposed this criterion using its discretionary 

authority under Section 4s(h)(5)(B). The 

requirement would not apply to in-house 

independent representatives of a municipal entity 

following the definition of ‘‘municipal advisor’’ in 

Section 15B of the Exchange Act (15 U.S.C. 78o– 

4), which excludes employees of a municipal entity. 

For examples of pay-to-play rules, see, e.g., SEC 

Rule 206(4)–5 under the Advisers Act (17 CFR 

275.206(4)–5) (‘‘SEC Advisers Act Rule 206(4)–5’’); 

MSRB Rule G–37: Political Contributions and 

Prohibitions on Municipal Securities Business. The 

Commission proposed to impose comparable 

requirements on swap dealers and major swap 

participants that act as counterparties to Special 

Entities in proposed § 23.451. The Commission 

stated in the proposing release that it would 

propose comparable requirements on registered 

CTAs when they advise municipal entities in a 

separate release. Proposing release, 75 FR at 80653 

fn. 125. 

735See DOL QPAM PTE 84–14, 75 FR 38837. 

736See DOL In-House Asset Manager PTE 96–23, 

61 FR 15975; Proposed Amendment to PTE 96–23, 

75 FR 33642, June 14, 2010. 

737Proposing release, 75 FR at 80651; see also id., 

at 80660–61 (proposed § 23.450(d)(2)). 

738 17 CFR 3.1(a). 

with § 23.402(d) to avoid transaction-bytransaction compliance.725

C. Section 23.450—Requirements for 

Swap Dealers and Major Swap 

Participants Acting as Counterparties to 

Special Entities 

1. Proposed § 23.450 

Proposed § 23.450 followed the 

statutory language in Section 4s(h)(5) of 

the CEA, which requires swap dealers 

and major swap participants 726 that 

offer to enter or enter into swaps with 

Special Entities 727 to comply with any 

duty established by the Commission 

that they have a reasonable basis to 

believe that the Special Entity has an 

independent representative that meets 

certain enumerated criteria. The 

enumerated criteria include that a 

Special Entity representative: (1) Has 

sufficient knowledge to evaluate the 

transaction and risks; (2) is not subject 

to a statutory disqualification; 728 (3) is 

independent of the swap dealer or major 

swap participant; 729 (4) undertakes a 

duty to act in the best interests of the 

Special Entity it represents; 730 (5) 

makes appropriate and timely 

disclosures to the Special Entity; 731 (6) 

evaluates, consistent with any 

guidelines provided by the Special 

Entity, fair pricing and the 

appropriateness of the swap; 732 (7) in 

the case of employee benefit plans 

subject to ERISA, is a fiduciary as 

defined in Section 3 of ERISA (29 U.S.C. 

1002); 733 and (8) in the case of a 

municipal entity as defined in proposed 

§ 23.451, is subject to restrictions on 

certain political contributions imposed 

by the Commission, the SEC or an SRO 

subject to the jurisdiction of the 

Commission or the SEC.734

The proposed rule set out several 

factors to be considered by swap dealers 

and major swap participants in 

determining whether the Special 

Entity’s representative satisfies the 

enumerated criteria, including (1) the 

nature of the Special Entityrepresentative relationship; (2) the 

representative’s ability to make hedging 

or trading decisions; (3) the use of 

consultants or, with respect to employee 

benefit plans subject to ERISA, use of a 

Qualified Professional Asset Manager 735

or In-House Asset Manager; 736 (4) the 

representative’s general level of 

experience in the financial markets and 

particular experience with the type of 

product under consideration; (5) the 

representative’s ability to understand 

the economic features of the swap; (6) 

the representative’s ability to evaluate 

how market developments would affect 

the swap; and (7) the complexity of the 

swap.737

The proposed rule provided that a 

representative would be deemed to be 

independent if: (1) It was not (with a 

one-year look back) an associated 

person of the swap dealer or major swap 

participant within the meaning of 

Section 1a(4) of the CEA; (2) there was 

no ‘‘principal relationship’’ between the 

representative and the swap dealer or 

major swap participant within the 

meaning of § 3.1(a) 738 of the 

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739Proposing release, 75 FR at 80652. 740 Id. 741 Id. 742 Id., at 80653. 743 Id. 744 Id. 745For example, the Commission stated that 

when the swap dealer acts both as an advisor and 

a counterparty to the Special Entity, or when firms 

act both as underwriters in a bond offering and 

counterparties in swaps used to hedge such 

financing, a swap dealer’s duties to the Special 

Entity would vary depending on the capacities in 

which it is operating. Id., at 80653. 

746Proposed § 23.450(g) is informed by the 

statutory language in Section 4s(h)(7) of the CEA. 

747The comments related to representative 

qualifications address the following issues: (1) 

Regulated advisors; (2) independence; (3) best 

interests, disclosures, fair pricing and 

appropriateness; and (4) employee benefit plans 

subject to ERISA. 

748See, e.g., Ropes & Gray Feb. 22 Letter, at 4– 

5; CalPERS Feb. 18 Letter, at 5; ABC/CIEBA Feb. 22 

Letter, at 2–3 and 8; ERIC Feb. 22 Letter, at 6–7; 

Davis & Harman Mar. 25 Letter, at 2. 

749See, e.g., Ropes & Gray Feb. 22 Letter, at 4– 

5; CalPERS Feb. 18 Letter, at 5; ABC/CIEBA Feb. 22 

Letter, at 8. 

750See, e.g., Ropes & Gray Feb. 22 Letter, at 4– 

5; CalPERS Feb. 18 Letter, at 5; ERIC Feb. 22 Letter, 

at 6–7. 

751ABC/CIEBA Feb. 22 Letter, at 9 fn. 1; ABC 

Aug. 29 Letter, at 9. 

752Section 4s(h)(5)(A)(i)(VII). 753See, e.g., ERIC Feb. 22 Letter, at 6–9. 754AFSCME Feb. 22 Letter, at 5. 

755ABA/ABC Feb. 22 Letter, at 2; Davis & Harman 

Mar. 25 Letter, at 2–3; Rep. Smith July 25 Letter, 

at 2; ABC/CIEBA June 3 Letter, at 5–6; 

756See, e.g., SIFMA/ISDA Feb. 17 Letter, at 36; 

ABC/CIEBA Feb. 22 Letter, at 9; CEF Feb. 22 Letter, 

at 23; Calhoun Feb. 22 Letter, at 5. 

757ABC/CIEBA Feb. 22 Letter, at 9; ABA/ABC 

Feb. 22 Letter, at 2; AMG–SIFMA Feb. 22 Letter, at 

10. 

758See, e.g., BlackRock Feb. 22 Letter, at 3; 

CalPERS Feb. 18 Letter, at 3; Cityview Feb. 22 

Submission; Texas VLB Feb. 22 Letter, at 2; GFOA 

Feb. 22 Letter, at 1. 

759See, e.g., ASF Feb. 22 Letter, at 5; GFOA Feb. 

22 Letter, at 1. 

760CFA/AFR Feb. 22 Letter, at 17. 

Commission’s Regulations; and (3) the 

representative did not have a material 

business relationship with the swap 

dealer or major swap participant.739

However, if the representative received 

any compensation from the swap dealer 

or major swap participant within one 

year of an offer to enter into a swap, the 

swap dealer or major swap participant 

would have to ensure that the Special 

Entity is informed of the compensation 

and that the Special Entity agrees in 

writing, in consultation with the 

representative, that the compensation 

does not constitute a material business 

relationship between the representative 

and the swap dealer or major swap 

participant.740 The proposed rule 

defined a material business relationship 

as any relationship with a swap dealer 

or major swap participant, whether 

compensatory or otherwise, that 

reasonably could affect the independent 

judgment or decision making of the 

representative.741

To address concerns that the statute 

places undue influence in the hands of 

the swap dealer or major swap 

participant by allowing it to control who 

qualifies as an independent 

representative of a Special Entity, the 

proposed rule provided that negative 

determinations be reviewed by the swap 

dealer’s or major swap participant’s 

chief compliance officer.742 Under the 

proposed rule, if a swap dealer or major 

swap participant determined that an 

independent representative did not 

meet the enumerated criteria, the swap 

dealer or major swap participant would 

be required to make a written record of 

the basis for such determination and 

submit such determination to its chief 

compliance officer for review.743 Such 

review would ensure that the swap 

dealer or major swap participant had a 

substantial, unbiased basis for the 

determination.744

Proposed § 23.450(f) also required, as 

provided in Section 4s(h)(5)(A)(ii), that 

swap dealers and major swap 

participants disclose in writing to 

Special Entities the capacity in which 

they are acting before initiation of a 

swap transaction. In addition, if a swap 

dealer or major swap participant were to 

engage in business with the Special 

Entity in more than one capacity, the 

swap dealer or major swap participant 

would have to disclose the material 

differences between the capacities.745

Finally proposed § 23.450(g) stated 

that the rule would not apply with 

respect to a swap that is initiated on a 

DCM or SEF where the swap dealer or 

major swap participant does not know 

the Special Entity’s identity.746

2. Comments 

The Commission received many 

comments on the various aspects of 

proposed § 23.450. The Commission has 

grouped the comments by the following 

issues: (1) Types of Special Entities that 

should be included in final § 23.450; (2) 

duty to assess the qualifications of a 

Special Entity’s representative; (3) 

representative qualifications; 747 (4) 

reasonable reliance on representations; 

(5) unqualified representatives; and (6) 

disclosure of capacity. 

a. Types of Special Entities Included in 

Section 4s(h)(5)(A)(i) 

Several commenters asserted that 

Section 4s(h)(5)(A)(i) only applies to the 

governmental Special Entities that are 

described in Section 1a(18)(A)(vii)(I) 

and (II) of the CEA, contrary to the 

approach taken in proposed § 23.450.748

Commenters also asserted that it is 

unclear whether the Commission has 

the authority to apply the rule to swaps 

with ERISA plans, governmental plans, 

and endowments.749 Some commenters 

urged the Commission to resolve any 

ambiguity in the statutory language by 

applying the final rule only to the State 

and municipal Special Entities defined 

in Section 4s(h)(C)(2)(ii).750 One 

commenter stated that if the final rule 

is applied to ERISA plans, then such 

plans should only be subject to 

subclause (VII) of Section 

4s(h)(5)(A)(i),751 which requires a 

Special Entity that is an employee 

benefit plan subject to ERISA to have an 

independent representative that ‘‘is a 

fiduciary as defined in Section 3 of 

[ERISA].’’ 752 Commenters asserted that 

requirements for ERISA fiduciaries are 

comparable to those required in 

subclauses (I)–(VI) of Section 

4s(h)(5)(A)(i), rendering the protections 

of Section 4s(h)(5) and proposed 

§ 23.450 unnecessary, and potentially 

harmful.753 Conversely, one commenter 

opposed any carve-outs for ERISA plans 

and stated the Special Entity provisions 

are not served by deferring to ERISA’s 

regulatory regime.754

b. Duty To Assess the Qualifications of 

a Special Entity’s Representative 

Commenters asserted that proposed 

§ 23.450 will allow a swap dealer or 

major swap participant to veto a Special 

Entity’s decision to select a particular 

representative,755 and will unduly limit 

a Special Entity’s choice regarding its 

own advisor.756 Commenters also assert 

that proposed § 23.450 inappropriately 

gives additional leverage to a swap 

dealer or major swap participant dealing 

with Special Entities, undermines the 

representative’s ability or willingness to 

negotiate, and may be used to pressure 

Special Entities to share otherwise 

confidential information.757

Furthermore, commenters assert that the 

duty under the proposed rule is 

intrusive, creates an inherent conflict of 

interest, and undermines the Special 

Entity’s own selection process.758 Other 

commenters asserted that proposed 

§ 23.450 will not benefit Special Entities 

and will make dealing with swap 

dealers more costly and problematic.759

Conversely, one commenter asserted 

that proposed § 23.450 created a 

reasonable and workable approach that 

is consistent with congressional 

intent.760

Commenters also asserted that 

proposed § 23.450 may conflict with 

current law under ERISA or with DOL’s 

proposed fiduciary rule. The 

commenters asserted that proposed 

§ 23.450 requires a swap dealer or major 

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761ABA/ABC Feb. 22 Letter, at 1; Davis & Harman 

Mar. 25 Letter, at 1; ERIC Feb. 22 Letter, at 9; MFA 

Feb. 22 Letter, at 6–7 fn. 13; ABC/CIEBA June 3 

Letter, at 2. 762SIFMA/ISDA Feb. 17 Letter, at 39; ABC/CIEBA 

Feb. 22 Letter, at 5; ABA/ABC Feb. 22 Letter, at 1; 

Davis & Harman Mar. 25 Letter, at 1; ERIC Feb. 22 

Letter, at 9; ABC/CIEBA June 3 Letter, at 2. 

763See DOL QPAM PTE 84–14, 75 FR 38837. 

764SIFMA/ISDA Feb. 17 Letter, at 39; ABC/CIEBA 

June 3 Letter, at 5. 

765Cf. DOL In-House Asset Manager PTE 96–23, 

61 FR 15975. 

766See SIFMA/ISDA Feb. 17 Letter, at 36; ERIC 

Feb. 22 Letter, at 2 and 12; AMG–SIFMA Feb. 22 

Letter, at 2; BlackRock Feb. 22 Letter, at 3. 

767See, e.g., ERIC Feb. 22 Letter, at 6–9. 

768SIFMA/ISDA Feb. 17 Letter, at 36; Texas VLB 

Feb. 22 Letter, at 2. 

769CalSTRS Feb. 28 Letter, at 3. 

770APGA Feb. 22 Letter, at 6–7. 

771See, e.g., CalPERS Feb. 18 Letter, at 5–6; 

CalPERS Aug. 29 Letter, 4–6; SWIB Feb. 22 Letter, 

at 4; CEF Feb. 22 Letter, at 23; Cityview Feb. 22 

Submission; Riverside Feb. 22 Letter, at 1–2; SFG 

Feb. 22 Letter, at 1; CFA/AFR Aug. 29 Letter, at 23; 

CFA/AFR Nov. 3 Letter, at 5. 

772AFSCME Feb. 22 Letter, at 6. 

773Proposing release, 75 FR at 80652 fn. 113. 

774See CFA/AFR Feb. 22 Letter, at 17; ERIC Feb. 

22 Letter, at 3 and 9; APPA/LPPC Feb. 22 Letter, 

at 2; NACUBO Feb. 22 Letter, at 4; U. Tex. System 

Feb. 22 Letter, at 3–4; APGA Feb. 22 Letter, at 6. 

775See, e.g., NACUBO Feb. 22 Letter, at 4; U. Tex. 

System Feb. 22 Letter, at 3–4; ERIC Feb. 22 Letter, 

at 9. Cf. DOL In-House Asset Manager PTE 96–23, 

61 FR 15975. 

776See, e.g., AMG–SIFMA Feb. 22 Letter, at 11– 

12; SIFMA/ISDA Feb. 17 Letter, at 38; contra CFA/ 

AFR Feb. 22 Letter, at 17 (‘‘the proposed standard 

generally provides the appropriate level of 

independence’’). 

777See, e.g., AMG–SIFMA Feb. 22 Letter, at 11– 

12, fn. 38 (recommending the Commission consider 

‘‘standards of ownership’’ such as those in DOL’s 

QPAM exemption); see also DOL QPAM PTE 84– 

14, 75 FR 38837. 

778See, e.g., SIFMA/ISDA Feb. 17 Letter, at 37– 

38 (‘‘the Commission should adopt one of several 

other well-established and workable tests of 

independence (such as excluding all ‘affiliates,’ as 

* * * defined under * * * the CEA)’’); BlackRock 

Feb. 22 Letter, at 4. 

779See, e.g., SIFMA/ISDA Feb. 17 Letter, at 38; 

ABC/CIEBA Feb. 22 Letter, at 11; ERIC Feb. 22 

Letter, at 11–12; AMG–SIFMA Feb. 22 Letter, at 2; 

BlackRock Feb. 22 Letter, at 4. 

780ERIC Feb. 22 Letter, at 6 and 8; ABC/CIEBA 

Feb. 22 Letter, at 11 (‘‘we urge the CFTC to provide 

that a ‘major [sic] business relationship’ does not 

exist if the relationship between the dealer or 

[major swap participant] and the [ERISA] Plan 

* * * would not give rise to a prohibited 

transaction under ERISA’’); ABC Aug. 29 Letter, at 

14. 

781See, e.g., BlackRock Feb. 22 Letter, at 4; FIA/ 

ISDA/SIFMA Aug. 29 Letter, at 20; AMG–SIFMA 

Feb. 22 Letter, at 11–12 fn. 38; see also DOL QPAM 

PTE 84–14, Part (VI)(a), 75 FR at 38843 (a QPAM 

must be a bank, savings and loan association, 

insurance company, or registered investment 

adviser). 

782See, e.g., SIFMA/ISDA Feb. 17 Letter, at 38 

(‘‘the proposing standard is so broad and vague that 

[swap dealers] wary of the consequence of 

misinterpreting its requirements will likely simply 

abstain from affected trades’’); APPA/LPPC Feb. 22 

Letter, at 5 (the ‘‘standard is both broad and 

somewhat vague * * * and dealers may be 

reluctant to take on the potential liability related to 

this determination’’); AMG–SIFMA Feb. 22 Letter, 

at 11; BlackRock Feb. 22 Letter, at 11. 

783SIFMA/ISDA Feb. 17 Letter, at 38; ABC/CIEBA 

Feb. 22 Letter, at 11; AMG–SIFMA Feb. 22 Letter, 

at 11; BlackRock Feb. 22 Letter, at 4 fn. 9, but see 

CFA/AFR Nov. 3 Letter, at 3–4. 

784BlackRock Feb. 22 Letter, at 4 (‘‘an asset 

manager may trade securities through the broker 

affiliate of the swap dealer; use an affiliated broker 

dealer as distributor/underwriter for mutual funds 

swap participant to review the 

qualifications of the Special Entity’s 

representative which could be 

considered providing advice as to the 

selection of the Special Entity’s advisor. 

Commenters asserted this could make 

the swap dealer or major swap 

participant a fiduciary to an ERISA plan 

under ERISA and DOL’s existing 

regulations 761 or under DOL’s proposed 

fiduciary rule.762

Commenters also asserted that 

proposed § 23.450 may conflict with 

DOL’s QPAM prohibited transaction 

exemption.763 The QPAM exemption 

sets out several conditions an ERISA 

fiduciary must satisfy to be a ‘‘qualified 

professional asset manager’’ within the 

meaning of the exemption. According to 

commenters, proposed § 23.450 permits 

a swap dealer or major swap participant 

to veto or implicitly cause the Special 

Entity to replace its advisor which may 

render the QPAM exemption 

unavailable to ERISA plans and their 

ERISA fiduciaries.764

c. Representative Qualifications 

i. Regulated Advisors 

Several commenters recommended 

that the Commission deem 

representatives that have a particular 

regulatory status to meet some or all of 

independent representative criteria in 

proposed § 23.450(b). Several 

commenters suggested that banks, 

investment advisers, insurance 

companies, QPAMs, and INHAMs 765 be 

deemed to meet the statutory criteria.766

Commenters also stated that 

requirements under ERISA should 

automatically qualify an ERISA plan’s 

fiduciary under the proposed criteria.767

Other commenters asserted that 

municipal advisors,768 fiduciaries to 

governmental plans,769 and employees 

of a Special Entity should be deemed to 

satisfy the enumerated criteria.770

Several commenters requested that 

the Commission or an SRO develop a 

voluntary certification and proficiency 

examination program for independent 

representatives. The commenters 

proposed that the Commission should 

permit a swap dealer or major swap 

participant to conclude that any 

certified representative would 

automatically satisfy the criteria in 

proposed § 23.450(b).771 Conversely, 

one commenter asserted that 

representations and warranties from the 

representative should not amount to a 

waiver of compliance for a swap 

dealer.772

ii. Independence 

The proposing release clarified that 

the Special Entity’s representative must 

be ‘‘independent’’ of the swap dealer or 

major swap participant; however, the 

representative does not have to be 

independent of the Special Entity.773

Several commenters agreed with the 

Commission’s proposed 

interpretation.774 Commenters also 

requested that the Commission clarify 

that an independent representative may 

be an employee, officer, agent, associate, 

trustee, director, subsidiary, or affiliate, 

such as an INHAM.775

The Commission received comments 

concerning the proposed independence 

test in general and specifically regarding 

the ‘‘material business relationship’’ 

prong. Some commenters recommended 

that the Commission delete the 

‘‘material business relationship’’ 

requirement.776 Alternatively, 

commenters suggested the Commission 

consider other existing standards which, 

according to the commenters, would be 

more workable such as ownership 777 or 

affiliate tests.778 Commenters stated that 

the Commission’s proposed standard 

was unnecessarily duplicative of or not 

harmonized with other independence 

standards under the federal securities 

laws and ERISA.779 Commenters also 

asserted that the final regulation should 

permit a swap dealer or major swap 

participant to conclude that a plan’s 

representative is ‘‘independent’’ if the 

representative is an ERISA fiduciary,780

or at a minimum, if the representative 

is an ERISA fiduciary that is also a 

regulated entity such as a QPAM.781

Commenters also assert that the 

proposed ‘‘material business 

relationship’’ standard is unclear, vague 

and overly broad, and swap dealers will 

refrain from transacting with Special 

Entities without further clarifications.782

These commenters stated that the 

‘‘material business relationship’’ 

standard may inappropriately preclude 

many qualified asset managers from 

acting as independent 

representatives.783 According to the 

commenters, many asset managers have 

multiple relationships with financial 

services firms that have swap dealer 

affiliates, and a requirement to survey 

all business relationships to determine 

whether and what compensation was 

paid would be very burdensome, require 

the development of costly new 

recordkeeping systems not currently in 

place, and provide little or no benefit to 

Special Entities.784 The commenters 

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managed by the asset manager; or license an index 

from an affiliate of the dealer’’); SIFMA/ISDA Feb. 

17 Letter, at 38 (a swap dealer’s ‘‘affiliated brokerdealer [that] is the underwriter for mutual funds 

managed by the investment adviser’’ should not 

constitute a ‘‘material business relationship’’); ABC/ 

CIEBA Feb. 22 Letter, at 11 (requiring 

representatives to determine all compensation 

received from a swap dealer in connection with all 

other transactions worldwide would impose 

staggering administrative burdens and is likely 

impracticable); AMG–SIFMA Feb. 22 Letter, at 11 

(large investment advisers are affiliated with banks 

and broker-dealers that would also be, or be 

affiliated with, swap dealers and would be 

precluded from entering into trades with many 

swap dealers on behalf of their customers). 

785SIFMA/ISDA Feb. 17 Letter, at 38; AMG– 

SIFMA Feb. 22 Letter, at 11; BlackRock Feb. 22 

Letter, at 4; APPA/LPPC Feb. 22 Letter, at 5. 

786ABC/CIEBA Feb. 22 Letter, at 11; SIFMA/ISDA 

Feb. 17 Letter, at 38 (disclosure should not be 

required where a swap dealer in its capacity as 

broker provided soft dollar research unrelated to 

any swap transaction to a Special Entity’s 

investment adviser); BlackRock Feb. 22 Letter, at 4; 

APPA/LPPC Feb. 22 Letter, at 5; CEF Feb. 22 Letter, 

at 23. 

787Better Markets Feb. 22 Letter, at 8 (asserting 

swap dealers have provided advantageous 

allocations of securities in public offerings to 

influence advisors that should be disclosed). 

788Proposing release, 75 FR at 80652 and 80660. 

789CFA/AFR Feb. 22 Letter, at 17; Better Markets 

Feb. 22 Letter, at 4 and 8; Calhoun Feb. 22 Letter, 

at 2; see also CFA/AFR Nov. 3 Letter, at 4; but cf. 

APPA/LPPC Feb. 22 Letter, at 5 (limiting such 

arrangements may make it difficult for 

governmental entities to find qualified swap 

advisors). 

790Better Markets Feb. 22 Letter, at 7–8; Better 

Markets June 3 Letter, at 13; Calhoun Feb. 22 Letter, 

at 3. 

791Proposed § 23.450(a)(3), proposing release, 75 

FR at 80652 and 80660. 792CFA/AFR Aug. 29 Letter, at 33; Better Markets 

Feb. 22 Letter, at 8. 793BlackRock Aug. 29 Letter, at 6 (asserting that 

DOL eliminated a one-year look back rule in the 

QPAM Exemption in response to industry concerns 

regarding the workability in light of consolidation 

and changes in the financial services industry). 794Proposing release, 75 FR at 80660. 795CFA/AFR Feb. 22 Letter, at 17; CFA/AFR Nov. 

3 Letter, at 4. 796APPA/LPPC Feb. 22 Letter, at 5; AMG–SIFMA 

Feb. 22 Letter, at 4. 797The SEC proposed that a Special Entity’s 

representative would be ‘‘independent’’ of an SBS 

Entity if the representative does not have a 

relationship with the SBS Entity, whether 

compensatory or otherwise, that reasonably could 

affect the independent judgment or decisionmaking of the representative. The SEC’s proposal, 

however, would consider a representative deemed 

to be independent of the SBS Entity if, within one 

year, the representative was not an associated 

person of the SBS Entity and had not received more 

than ten percent of its gross revenues from the SBS 

Entity. SEC’s proposed rules, 76 FR at 42426. 

798See, e.g., CFA/AFR Aug. 29 Letter, at 33. 799 See, e.g., FIA/ISDA/SIFMA Aug. 26 Letter, 

at 6. 800See, e.g., FIA/ISDA/SIFMA Sept. 14 Letter, at 

passim; see also SIFMA/ISDA Feb. 17 Letter, at 

37–38. 

801Section 4s(h)(5)(A)(i)(IV)–(VI) of the CEA and 

proposed § 23.450(b)(4)–(6); proposing release, 75 

FR at 80652–53 and 80660. 

802Proposing release, 75 FR at 80652–53. Such 

legal arrangements could include, for example, a 

contract between a pension plan and a plan 

fiduciary that required the fiduciary to evaluate, 

consistent with any guidelines provided by the 

Special Entity, fair pricing and the appropriateness 

of the swap. 

803APGA Feb. 22 Letter, at 6; cf. CFA/AFR Aug. 

29 Letter, at 34 (asserting that a representative that 

is subject to separate legal requirements, such as an 

investment adviser or ERISA fiduciary, could be 

presumed to satisfy the ‘‘best interests’’ criterion). 

804See, e.g., ERIC Feb. 22 Letter, at 8–9; CalSTRS 

Feb. 28 Letter, at 3. 

805Proposing release, 75 FR at 80653. 

806SIFMA/ISDA Feb. 17 Letter, at 36–37; ERIC 

Feb. 22 Letter, at 2 and 6–9 (asserting that ERISA 

imposes ‘‘duties that are similar, but more 

Continued 

also assert that the ‘‘material business 

relationship’’ standard reduces Special 

Entities’ choices for qualified 

representatives and increases costs for 

representatives and Special Entities.785

A number of commenters also requested 

that the Commission clarify that the 

disclosure requirement is limited to 

compensation received in connection 

with the relevant swap transaction.786

Conversely, one commenter asserted the 

rule should require disclosure of all 

business relationships.787

The proposed definition of ‘‘material 

business relationship’’ also excluded 

payment of fees by the swap dealer or 

major swap participant to the Special 

Entity’s representative at the written 

direction of the Special Entity for 

services provided in connection with 

the swap.788 Some commenters 

expressed concerns that the exclusion 

could be used for abuse or would 

undermine the independence of their 

advice.789 These commenters stated the 

exclusion should be deleted and such 

practices should be prohibited.790

The proposed definition of ‘‘material 

business relationship’’ also stated that 

the term is subject to a one-year look 

back, including any compensation 

received within one year of an offer to 

enter into the swap.791 Some 

commenters recommended that the 

Commission extend the relevant time 

period.792 Conversely, another 

commenter stated that a one-year look 

back would be problematic in instances 

where corporate identities change 

through corporate transactions or 

consolidations.793

Under proposed § 23.450(c)(3), the 

Special Entity may agree in writing that 

any compensation the representative 

received from the swap dealer or major 

swap participant does not constitute a 

‘‘material business relationship.’’ 794

One commenter requested that the 

Commission clarify that the disclosure 

of any such compensation is made to 

the Special Entity’s board and the 

written agreement comes from the 

board.795 Other commenters asserted 

that a Special Entity may be reluctant to 

make a determination that a relationship 

was not a ‘‘material business 

relationship’’ because the Special Entity 

could be held liable if the determination 

is later deemed inaccurate.796

Following the release of the SEC’s 

proposed business conduct standards 

for SBS Entities, the Commission 

received comment letters addressing 

harmonization of the agencies’ 

independence tests.797 Some 

commenters requested that both 

agencies adopt the Commission’s 

proposed approach with ‘‘minor 

adjustments.’’ 798 Other commenters 

supported the SEC’s associated person 

and gross revenue tests 799 and 

requested that the agencies coordinate 

the independence tests.800

iii. Best Interests, Disclosures, Fair 

Pricing and Appropriateness 

Section 4s(h)(5) and proposed 

§ 23.450(b) would require a swap dealer 

or major swap participant to have a 

reasonable basis to believe that a Special 

Entity’s representative (1) undertakes a 

duty to act in the Special Entity’s ‘‘best 

interests’’; (2) makes appropriate 

disclosures; and (3) will provide written 

representations regarding fair pricing 

and appropriateness of the 

transaction.801 To assess the ‘‘best 

interests’’ criterion, the Commission 

proposed by example that a swap dealer 

or major swap participant would be able 

to rely, absent red flags, on duties 

established by appropriate legal 

arrangements between Special Entities 

and their independent 

representatives.802 One commenter 

requested that the Commission clarify 

that a swap dealer or major swap 

participant could also rely on an 

employment relationship to satisfy the 

‘‘best interests’’ duty, disclosure 

obligation, and duty to evaluate fair 

pricing and appropriateness of the 

swap.803 Other commenters similarly 

stated that legal obligations under 

ERISA or state law would require the 

fiduciary to an ERISA plan or 

governmental plan to comply with a 

best interests duty, disclosure 

obligations, and a duty to evaluate fair 

pricing and appropriateness.804

iv. Employee Benefit Plans Subject to 

ERISA 

The Commission sought comment on 

whether the statutory representative 

criteria under Section 4s(h)(5)(A)(i)(I)– 

(VI) were duplicative or inconsistent 

with ERISA’s fiduciary requirements.805

Commenters asserted that ERISA 

imposes comparable requirements to the 

statute and proposed § 23.450(b)(1)–(6), 

and the rule adds administrative costs 

without corresponding benefits.806

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9792 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

exacting,’’ with respect to the knowledge 

requirement, statutory disqualification, 

independence, best interests, disclosures, and fair 

pricing and appropriateness); ABC/CIEBA June 3 

Letter, at 6. 

807CalSTRS Feb. 28 Letter, at 6. 

808Two commenters noted that the rule text of 

proposed § 23.450(d) provided that a swap dealer 

may rely on written representations but was silent 

as to whether major swap participants could rely. 

See SIFMA/ISDA Feb. 17 Letter, at 36 fn. 85; ABC/ 

CIEBA Feb. 22 Letter, at 9 fn. 2. The Commission 

intended this provision to be available to both swap 

dealers and major swap participants and expressly 

references both in final § 23.450(e). 

809Proposing release, 75 FR at 80660. 

810SIFMA/ISDA Feb. 17 Letter, at 35–36; ABC/ 

CIEBA Feb. 22 Letter, at 9; BlackRock Feb. 22 

Letter, at 3; proposing release, 75 FR at 80660. 

811 Id. 

812CFA/AFR Feb. 22 Letter, at 6; CFA/AFR Nov. 

3 Letter, at 5. 

813See, e.g., SIFMA/ISDA Feb. 17 Letter, at 35– 

36; ABC/CIEBA Feb. 22 Letter, at 9–10; BlackRock 

Feb. 22 Letter, at 3; ABA/ABC Feb. 22 Letter, at 2– 

3; AMG–SIFMA Feb. 22 Letter, at 9; SWIB Feb. 22 

Letter, at 4–5; Ropes & Gray Feb. 22 Letter, at 3– 

4; APPA/LPPC Feb. 22 Letter, at 4. 

814See, e.g., Ropes & Gray Feb. 22 Letter, at 3– 

4; APPA/LPPC Feb. 22 Letter, at 4; SIFMA/ISDA 

Feb. 17 Letter, at 35–36; ABC/CIEBA Feb. 22 Letter, 

at 9–10. 

815SIFMA/ISDA Feb. 17 Letter, at 35–36; ABC/ 

CIEBA Feb. 22 Letter, at 10; SWIB Feb. 22 Letter, 

at 4–5; CEF Feb. 22 Letter, at 16 and 23; VRS Feb. 

22 Letter, at 5; APPA/LPPC Feb. 22 Letter, at 4; 

Comm. Cap. Mkts. May 3 Letter, at 2; Comm. Cap. 

Mkts. Aug. 29 Letter, at 2–3. 

816Ropes & Gray Feb. 22 Letter, at 4. 

817APGA Feb. 22 Letter, at 6–7. 

818CalPERS Oct. 4 Letter, at 1. 

819See, e.g., ABC/CIEBA Feb. 22 Letter, at 10–11; 

Davis & Harman Mar. 25 Letter, at 5–6; APGA Feb. 

22 Letter, at 6; SIFMA/ISDA Feb. 17 Letter, at 36; 

contra CFA/AFR Nov. 3 Letter, at 5. 

820See, e.g., SIFMA/ISDA Feb. 17 Letter, at 36 

(‘‘[swap dealers] should be permitted to rely on a 

written representation * * * that the counterparty 

and/or its representative satisfies the standards 

* * * absent actual notice of countervailing facts 

(or facts that reasonably should have put [a swap 

dealer] on notice), which would trigger a 

consequent duty to inquire further.’’); see also supra 

fn. 724. Contra CFA/AFR Nov. 3 Letter, at 5. 

821ABC/CIEBA Feb. 22 Letter, at 12–13 (asserting 

that a swap dealer faced with a highly volatile 

market and disadvantageous swap position could 

claim that a Special Entity provided inaccurate 

representations to avoid its obligations); AMG– 

SIFMA Feb. 22 Letter, at 10. 

822ABC/CIEBA Feb. 22 Letter, at 9; CalPERS Feb. 

18 Letter, at 3. 

823CFA/AFR Feb. 22 Letter, at 18. 

824SIFMA/ISDA Feb. 17 Letter, at 38–39. 

825 Id. 

826SIFMA/ISDA Feb. 17 Letter, at 39; ABC/CIEBA 

Feb. 22 Letter, at 11–12. 

Another commenter stated that it was 

unclear whether the criteria in Section 

4s(h)(5)(A)(i)(I)–(VI) apply to 

governmental plans that are defined in 

but not subject to ERISA. The 

commenter requested that the 

Commission clarify that a governmental 

plan’s representative does not need to 

satisfy the first six criteria if it is 

represented by a fiduciary under state or 

local law.807

d. Reasonable Reliance on 

Representations 

Proposed § 23.450(d) permitted a 

swap dealer or major swap 

participant 808 to rely on Special Entity 

representations to satisfy its duty to 

assess the qualifications of the Special 

Entity’s independent representative, if 

the representations were reliable and 

sufficiently detailed.809 Several 

commenters expressed concern with the 

language in proposed § 23.450(d)(1) that 

would require the swap dealer or major 

swap participant to ‘‘consider the facts 

and circumstances of a particular 

Special Entity-representative 

relationship, assessed in the context of 

a particular transaction.’’ 810 Similarly, 

several commenters expressed concern 

with the language in proposed 

§ 23.450(d)(2) that would require the 

representations to be ‘‘sufficiently 

detailed.’’ 811 Conversely, one 

commenter supported the Commission’s 

approach and requested that the 

Commission require record retention 

that would permit the Commission to 

determine compliance.812

A majority of commenters asserted 

that proposed § 23.450(d) would require 

extensive and burdensome transactionby-transaction diligence that would 

significantly delay execution and 

increase costs for swap dealers, major 

swap participants and Special 

Entities.813 Commenters also asserted 

that the conditions for reliance, which 

include a nonexclusive list of seven 

factors under proposed § 23.450(d)(2), 

were unnecessarily complex and could 

cause swap dealers or major swap 

participants to overreach in their 

requests for information.814 Many 

commenters requested that the 

Commission permit swap dealers and 

major swap participants to rely on 

representations from the Special Entity 

or the independent representative that 

simply repeat the enumerated criteria in 

proposed § 23.450(b).815 Commenters 

also requested that the Commission 

permit representations to be made on a 

relationship basis and only updated 

periodically 816 or upon a material 

change such as a change in the Special 

Entity’s representative.817 Another 

commenter stated that to avoid giving 

the swap dealer or major swap 

participant unfair leverage when dealing 

with Special Entities, the required 

representations must be unambiguous, 

and determinations of accuracy must be 

within the sole judgment of the Special 

Entity.818

A number of commenters also 

discussed the circumstances in which a 

swap dealer or major swap participant 

could rely on a representation without 

further inquiry. Some commenters 

suggested the Commission permit a 

swap dealer or major swap participant 

to rely if it did not have actual 

knowledge that the representations were 

incorrect.819 Conversely, some 

commenters suggested the Commission 

permit reliance unless the swap dealer 

or major swap participant knows of facts 

that reasonably should put it on notice 

that would trigger a duty to inquire 

further.820 Two commenters requested 

that the Commission clarify that the 

exchange of representations will not 

give any party any additional rescission, 

early termination, or monetary 

compensation rights.821

e. Unqualified Representatives 

Proposed § 23.450(e) provided that 

any swap dealer or major swap 

participant that determines a Special 

Entity’s representative does not meet the 

relevant criteria must submit a written 

record of the basis of its determination 

to the chief compliance officer for 

review that the determination was 

unbiased. Two commenters asserted 

that the proposed rule does not provide 

meaningful protection to Special 

Entities from a swap dealer or major 

swap participant that abuses its 

discretion.822 Another commenter 

recommended the Commission require 

the swap dealer or major swap 

participant to submit the written record 

to the Commission in addition to the 

chief compliance officer.823 A 

commenter also asserted the 

Commission should require the written 

determination be made to the trading 

supervisor rather than the chief 

compliance officer.824

A commenter requested that the 

Commission confirm that the swap 

dealer or major swap participant would 

not have any liability to the Special 

Entity or its representative as a result of 

its good faith determination that the 

representative was not qualified.825

f. Disclosure of Capacity 

Proposed § 23.450(f) requires a swap 

dealer or major swap participant to 

disclose to the Special Entity the 

capacity in which it is acting in 

connection with the swap and, if in 

more than one capacity, to disclose the 

material differences between such 

capacities in connection with the swap 

and any other financial transaction or 

service involving the Special Entity. 

Two commenters requested that the 

Commission clarify that required 

disclosures of other capacities be 

limited only to those capacities in 

connection with the swap.826

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827See, e.g., SIFMA/ISDA Feb. 17 Letter, at 39; 

ABC/CIEBA Feb. 22 Letter, at 11–12; APGA Feb. 22 

Letter, at 7. 

828ABC/CIEBA Feb. 22 Letter, at 12. 

829See, e.g., ABC/CIEA Feb. 22 Letter, at 3; ERIC 

Feb. 22 Letter, at 9; CalSTRS Feb. 28 Letter, at 2 

and 6; MFA Feb. 22 Letter, at 2; CalPERS Feb. 18 

Letter, at 3–4; CEF Feb. 22 Letter, at 16; HOOPP 

Feb. 22 Letter, at 2. 

830See, e.g., ABC/CIEBA Feb. 22 Letter, at 9–10; 

SIFMA/ISDA Feb. 17 Letter, at 39; VRS Feb. 22 

Letter, at 3; HOOPP Feb. 22 Letter, at 2; CEF Feb. 

22 Letter, at 16. 

831See, e.g., ABC/CIEBA Feb. 22 Letter, at 9–10; 

ERIC Feb. 22 Letter, at 9–10; CalSTRS Feb. 28 

Letter, at 2 and 6; MFA Feb. 22 Letter, at 2; CalPERS 

Feb. 18 Letter, at 3–4; CEF Feb. 22 Letter, at 16; 

HOOPP Feb. 22 Letter, at 2. 

832Section 23.450(b)(2) provides: ‘‘Any swap 

dealer or major swap participant that offers to enter 

or enters into a swap with a Special Entity as 

defined in § 23.401(c)(3) shall have a reasonable 

basis to believe that the Special Entity has a 

representative that is a fiduciary as defined in 

Section 3 of [ERISA] (29 U.S.C. 1002).’’ A swap 

dealer or major swap participant will have a 

reasonable basis to believe that an ERISA plan has 

a qualified independent representative under 

§ 23.450(b)(2) if it receives a representation in 

writing identifying the representative and stating 

that the representative is a fiduciary as defined in 

Section 3 of ERISA (29 U.S.C. 1002) as provided in 

§ 23.450(d)(2). 

833Section 23.450(d)(1) provides: Safe Harbor. (1) 

A swap dealer or major swap participant shall be 

deemed to have a reasonable basis to believe that 

the Special Entity, other than a Special Entity 

defined in § 23.401(c)(3), has a representative that 

satisfies the applicable requirements of paragraph 

(b)(1) of this section provided that: (i) The Special 

Entity represents in writing to the swap dealer or 

major swap participant that it has complied in good 

faith with written policies and procedures 

reasonably designed to ensure that it has selected 

a representative that satisfies the applicable 

requirements of paragraph (b) of this section, and 

that such policies and procedures provide for 

ongoing monitoring of the performance of such 

representative consistent with the requirements of 

paragraph (b) of this section; and (ii) The 

representative represents in writing to the Special 

Entity and swap dealer or major swap participant 

that the representative: (A) Has policies and 

procedures reasonably designed to ensure that it 

satisfies the applicable requirements of paragraph 

(b) of this section; (B) Meets the independence test 

in paragraph (c) of this section; and (C) Is legally 

obligated to comply with the applicable 

requirements of paragraph (b) of this section by 

agreement, condition of employment, law, rule, 

regulation, or other enforceable duty. 

834Section 23.450(c) provides: Independent. For 

purposes of paragraph (b)(1)(iii) of this section, a 

represenative of a Special Entity will be deemed to 

be independent of the swap dealer or major swap 

participant if: (1) The representative is not and, 

within one year of representing the Special Entity 

in connection with the swap, was not an associated 

person of the swap dealer or major swap participant 

within the meaning of Section 1a(4) of the Act; (2) 

There is no principal relationship between the 

representative of the Special Entity and the swap 

dealer or major swap participant; (3) The 

representative: (i) Provides timely and effective 

disclosures to the Special Entity of all material 

conflicts of interest that could reasonably affect the 

judgment or decision making of the representative 

with respect to its obligations to the Special Entity; 

and(ii) Complies with policies and procedures 

reasonably designed to manage and mitigate such 

material conflicts of interest; (4) The representative 

is not directly or indirectly, through one or more 

persons, controlled by, in control of, or under 

common control with the swap dealer or major 

swap participant; and (5) The swap dealer or major 

swap participant did not refer, recommend, or 

introduce the representative to the Special Entity 

within one year of the representative’s 

representation of the Special Entity in connection 

with the swap. 

835The Commission is persuaded, however, that 

with respect to ERISA plans, the swap dealer or 

major swap participant need only assess whether 

the plan representative is a fiduciary as defined in 

Section 3 of ERISA (29 U.S.C. 1002) as provided in 

Section 4s(h)(5)(A)(VII). See Section IV.C.3.d. for a 

discussion of qualification criteria for independent 

representatives. 

836See fn. 727 discussing the ambiguities in 

Section 4s(h)(5) of the CEA as to whether the duty 

is intended to apply with respect to all types of 

Special Entity counterparties or just a sub-group. 

837See H.R. Rep. No. 111–517 at 869 (June 29, 

2010) (Conf. Rep.) (‘‘When acting as counterparties 

to a pension fund, endowment fund, or state or 

local government, dealers are to have a reasonable 

basis to believe that the fund or governmental entity 

has an independent representative advising 

them.’’). 

838For ERISA plans, the Commission has 

determined that the statute deems a fiduciary as 

defined in Section 3 of ERISA (29 U.S.C. 1002) to 

be a qualified independent representative within 

the meaning of Section 4s(h)(5)(A). 

Commenters also requested the 

Commission clarify the meaning of 

‘‘before the initiation of a swap’’ and to 

confirm that such disclosures could be 

made in a master agreement.827 One 

commenter asserted that ERISA plans 

typically have many different types of 

relationships with swap dealers, and 

listing all such relationships prior to 

each transaction would impose 

significant burdens and not provide 

meaningful information to an ERISA 

plan.828

g. Transaction Costs and Risks 

Commenters asserted that compliance 

with proposed § 23.450 would be 

burdensome, costly, or impractical.829

Commenters also stated that the 

proposed rule may expose swap dealers 

and major swap participants to new 

litigation risks from Special Entities and 

representatives.830 Commenters asserted 

that swap dealers and major swap 

participants will either pass additional 

risk and compliance costs onto Special 

Entities or refuse to transact with 

Special Entities altogether, and such 

results are ultimately harmful to Special 

Entities and outweigh any benefits.831

3. Final § 23.450 

Based on consideration of the 

comments, the Commission has 

determined to adopt proposed § 23.450 

with several changes. The principal 

changes include, first, under 

§ 23.450(b)(2), a representative of an 

ERISA plan will have to meet only one 

criterion to qualify under the section: 

That it is a fiduciary as defined in 

Section 3 of ERISA (29 U.S.C. 1002).832

Second, under § 23.450(d)(1) certain 

counterparty representations will be 

deemed to provide a reasonable basis for 

a swap dealer or major swap participant 

to believe that a representative of a 

Special Entity, other than an ERISA 

plan, meets the enumerated criteria in 

§ 23.450(b).833 Third, under § 23.450(c) 

compliance with certain criteria will be 

deemed to establish that a 

representative is ‘‘independent’’ of the 

swap dealer or major swap participant 

within the meaning of 

§ 23.450(b)(1)(iii).834 The following 

discussion addresses comments on 

proposed § 23.450 and the changes in 

final § 23.450. 

a. Types of Special Entities Included in 

Section 4s(h)(5)(A)(i) 

The Commission has determined 

based on the statutory framework and 

legislative intent that final § 23.450, like 

the proposed rule, shall apply to swaps 

offered or entered into with all types of 

Special Entities. The Commission 

declines to adopt commenters’ position 

that the rule be limited to the entities 

described under Section 1a(18)(A)(vii)(I) 

and (II).835 The Commission also 

disagrees with commenters’ assertion 

that the Commission does not have the 

authority to apply the rule to swaps 

with all types of Special Entities. 

Requiring swap dealers or major swap 

participants to comply with § 23.450 

when dealing with all types of Special 

Entities resolves the ambiguities in the 

statutory text.836 The determination is 

also consistent with the legislative 

history 837 and the clear statutory intent 

to raise the standard of care for swap 

dealers and major swap participants 

dealing with Special Entities, generally. 

Finally, Section 4s(h)(5)(B) provides the 

Commission with discretionary 

rulemaking authority to establish such 

other standards and requirements as the 

Commission may determine are 

appropriate in the public interest, for 

the protection of investors, or otherwise 

in furtherance of the purposes of the 

CEA. The Commission believes that 

ensuring all Special Entities have a 

sufficiently knowledgeable and 

independent representative that is 

capable of providing disinterested, 

expert advice is an essential component 

of the statutory framework that Congress 

established for Special Entities.838

b. ERISA Plan Representatives That Are 

ERISA Fiduciaries 

The Commission has considered the 

statutory language in Section 4s(h)(5) 

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9794 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

839See, e.g., SIFMA/ISDA Feb. 17 Letter, at 36– 

37; ERIC Feb. 22 Letter, at 2 and 6; ABC/CIEBA June 

3 Letter, at 6. 

840See, e.g., ERIC Feb. 22 Letter, at 6–9. 

841AFSCME Feb. 22 Letter, at 5. 

842Section 23.450(d) supra fn. 833. See also 

Section IV.C.3.e. of this adopting release for a 

discussion of § 23.450(d). 

843The Commission’s determination that ERISA 

plan representatives that are ERISA fiduciaries will 

meet the requirements of the rule is premised on 

the statutory language referencing the 

comprehensive Federal regulatory scheme under 

ERISA. See also Section IV.C.3.b. of this adopting 

release for a discussion of representatives of ERISA 

plans. 

844The Commission is considering both legal and 

practical issues raised by commenters’ certification 

proposal. See, e.g., Section 4o(2) of the CEA makes 

it unlawful for any CTA or commodity pool 

operator registered under the CEA to ‘‘represent or 

imply in any manner whatsoever that such person 

has been sponsored, recommended, or approved by 

the United States or any agency or officer thereof.’’ 

From a practical standpoint, the proposal would 

depend on resources committed by an SRO or 

private certification board. 

845See Section IV.C.3.e. of this adopting release 

for a discussion of § 23.450(d) (under § 23.450(d), as 

adopted, a swap dealer or major swap participant 

shall have a reasonable basis to believe a Special 

Entity’s chosen representative complies with all 

criteria under § 23.450 where the swap dealer or 

major swap participant receives certain 

representations from the Special Entity and its 

representative). 

846Proposing release, 75 FR at 80653. 

847The Commission separately addressed 

comments regarding a Special Entity’s 

representative that holds a particular regulatory, 

state law or employment status. See Section 

IV.C.3.d.i. of this adopting release. 

848The proposed rule set out several factors to be 

considered by swap dealers and major swap 

participants in determining whether the Special 

Entity’s representative satisfies certain of the 

enumerated criteria, including (1) the nature of the 

Special Entity-representative relationship; (2) the 

representative’s ability to make hedging or trading 

and issues raised by commenters 839 and 

is persuaded that, for transactions with 

an ERISA plan under final § 23.450, 

swap dealers and major swap 

participants need only have a 

reasonable basis to believe that an 

ERISA plan representative is an ERISA 

fiduciary. This interpretation of Section 

4s(h)(5) of the CEA is informed by the 

comprehensive federal regulatory 

scheme that applies to plans subject to 

regulation under ERISA, the importance 

of harmonizing the Dodd-Frank Act 

requirements with ERISA to avoid 

unintended consequences, and the 

Commission’s view that ERISA plans 

will continue to benefit from the many 

other protections under subpart H of 

part 23 of the Commission’s rules. The 

Commission declines to opine on 

commenters claims that requirement’s 

under ERISA for plan fiduciaries are 

comparable,840 or not,841 to those 

criteria in subclauses (I)–(VI) of Section 

4s(h)(5)(A)(i). That is more 

appropriately addressed by DOL, the 

primary regulator of ERISA plans. 

Thus, the Commission is adopting 

proposed § 23.450(b)(7) (renumbered as 

§ 23.450(b)(2)) as a separate provision 

that applies only with respect to ERISA 

plans as defined in § 23.401(c)(3). A 

swap dealer or major swap participant 

that offers or enters into a swap with an 

ERISA plan need only have a reasonable 

basis to believe that the ERISA plan’s 

representative is an ERISA fiduciary. 

c. Duty To Assess the Qualifications of 

a Special Entity’s Representative 

The Commission has determined to 

clarify the final rule text to address 

commenters’ concerns that a swap 

dealer or major swap participant could 

use the statutory framework prescribed 

for assessing the qualifications of a 

Special Entity representative to 

overreach in requesting information 

from the Special Entity or to otherwise 

gain a negotiating advantage. Thus, the 

Commission has added § 23.450(d), 

which states that a swap dealer or major 

swap participant shall have a reasonable 

basis to believe a Special Entity’s 

chosen representative complies with all 

criteria under § 23.450 where the swap 

dealer or major swap participant 

receives certain representations from the 

Special Entity and its representative.842

The representations under § 23.450(d) 

may be made, as appropriate, on a 

relationship basis in counterparty 

relationship documentation consistent 

with §§ 23.402(d) and 23.450(e). Finally, 

§ 23.450(f) requires a swap dealer or 

major swap participant’s chief 

compliance officer to review any 

determination that the swap dealer or 

major swap participant does not have a 

reasonable basis to believe that a Special 

Entity’s representative meets the criteria 

in § 23.450. The chief compliance 

officer’s review must ensure that there 

is a substantial, unbiased basis for the 

determination. 

d. Representative Qualifications 

i. Regulated Entities and Suggested 

Certification Regime 

The Commission declines 

commenters’ suggestion that a swap 

dealer or major swap participant be 

permitted to conclude that a Special 

Entity’s representative is per se 

qualified because it has a particular 

status such as CTA, bank, investment 

adviser, insurance company, municipal 

advisor, state law pension fiduciary, or 

is an employee of the Special Entity.843

The statutory language does not 

reference any ‘‘status’’ other than a 

fiduciary as defined in ERISA. As a 

result the Commission is not inclined to 

conclude that regulatory status alone is 

a sufficient proxy for the enumerated 

criteria in Section 4s(h)(5)(A). 

The Commission is continuing to 

consider commenters’ suggestion that 

the Commission or an SRO develop a 

voluntary certification and proficiency 

examination program for independent 

representatives that would permit a 

swap dealer or major swap participant 

to rely on such certification as satisfying 

the enumerated criteria.844 In this 

regard, the Commission notes, that it 

has begun informal consultations with 

the staffs of the SEC, NFA, and MSRB 

to harmonize regulatory requirements 

for municipal advisors and CTAs that 

advise municipalities on swaps. The 

Commission intends to continue to 

explore whether such efforts could be 

incorporated into a broader application 

for the independent representatives of 

all Special Entities. 

In the meantime, however, the 

Commission believes that final § 23.450 

provides a manageable approach for 

qualifying Special Entity representatives 

that addresses the commenters’ 

concerns about the role of swap dealers 

and major swap participants under the 

statutory framework and proposed 

§ 23.450. The Commission has clarified 

the means of compliance for a swap 

dealer or major swap participant, 

including compliance through 

representations made on a relationship 

basis, as appropriate. Furthermore, the 

Commission is adopting an alternative 

means of compliance under 

§ 23.450(d) 845 with clear, objective 

criteria that will permit a swap dealer or 

major swap participant to form a 

reasonable basis to believe that a Special 

Entity’s representative meets the 

relevant criteria, without undue 

influence on the selection process. 

ii. Sufficiently Knowledgeable 

The Commission requested comment 

on whether there are other 

qualifications that should be considered 

regarding whether an independent 

representative has sufficient knowledge 

to evaluate the transaction and risks.846

The Commission did not receive 

comments addressing any additional 

qualifications other than a 

representative that holds a particular 

regulatory, state law, or employment 

status.847 Therefore, the Commission is 

adopting § 23.450(b)(1) as proposed 

(renumbered as § 23.450(b)(1)(i)). 

The Commission has determined to 

delete from the final rule text the list of 

factors that a swap dealer or major swap 

participant would be expected to 

consider in determining whether an 

independent representative meets the 

enumerated criteria in the proposed 

rule.848 Commenters found the 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9795 

decisions; (3) the use of consultants or, with respect 

to employee benefit plans subject to ERISA, use of 

a QPAM or INHAM; (4) the representative’s general 

level of experience in the financial markets and 

particular experience with the type of product 

under consideration; (5) the representative’s ability 

to understand the economic features of the swap; 

(6) the representative’s ability to evaluate how 

market developments would affect the swap; and 

(7) the complexity of the swap. These criteria will 

serve as guidance to swap dealers and major swap 

participants required to undertake due diligence to 

assess the sophistication of a Special Entity’s 

representative. 

849See, e.g., ABC/CIEBA Feb. 22 Letter, at 3. 

850The Commission does not intend to imply that 

each consideration is necessarily a prerequisite for 

a swap dealer or major swap participant to form a 

reasonable basis to believe the representative is 

sufficiently knowledgeable. For example, an 

employee of a Special Entity, in some cases, may 

not use one or more third party consultants. 

However, this would not mean, in and of itself, that 

the representative is not sufficiently knowledgeable. 

851Proposing release, 75 FR at 80651–52 and 

80660. 

852The definition of ‘‘associated person of a swap 

dealer or major swap participant’’ under Section 

1a(4) of the CEA (7 U.S.C. 1a(4)) is limited by its 

terms to natural persons. Section 1a(4) states in 

relevant part that the term ‘‘means a person who is 

associated with a swap dealer or major swap 

participant as a partner, officer, employee, or agent 

(or any person occupying a similar status or 

performing similar function) in any capacity that 

involves—(i) the solicitation or acceptance of 

swaps; or (ii) the supervision of any person or 

persons so engaged.’’ 

proposed rule text confusing and 

unworkable.849 In light of the 

comments, the Commission has 

determined that such considerations are 

more appropriate as guidance regarding 

whether a representative is sufficiently 

knowledgeable, and would be relevant 

where the Special Entity did not 

provide the representations specified in 

§ 23.450(d) for establishing the 

qualifications of a representative. 

Where a swap dealer or major swap 

participant is required to undertake due 

diligence to assess whether it has a 

reasonable basis to believe that a 

representative has sufficient knowledge 

to evaluate the transaction and risks, it 

should consider: (1) The 

representative’s capability to make 

hedging or trading decisions, and the 

resources available to the representative 

to make informed decisions; (2) the use 

by the representative of one or more 

consultants; (3) the general level of 

experience of the representative in 

financial markets and specific 

experience with the type of instruments, 

including the specific asset class, under 

consideration; (4) the representative’s 

ability to understand the economic 

features of the swap involved; (5) the 

representative’s ability to evaluate how 

market developments would affect the 

swap; and (6) the complexity of the 

swap or swaps involved. Additional 

considerations may also include the 

representative’s ability to analyze the 

credit risk, market risk, and other 

relevant risks posed by a particular 

swap and its ability to determine the 

appropriate methodologies used to 

evaluate relevant risks and the 

information which must be collected to 

do so. The listed considerations are 

illustrative guidance.850

iii. Statutory Disqualification 

The Commission did not receive any 

comments regarding this criterion under 

proposed § 23.450(b)(2); therefore, the 

Commission adopts § 23.450(b)(2) 

(renumbered as § 23.450(b)(1)(ii)) and 

the definition of ‘‘statutory 

disqualification’’ in § 23.450(a)(3) as 

proposed with respect to Special 

Entities other than ERISA plans. The 

Commission also clarifies that a 

representative must satisfy the criterion 

regardless of whether it is registered or 

is required to register with the 

Commission, such as an employee of the 

Special Entity. 

iv. Independence 

The Commission proposed a three 

prong test to determine whether the 

Special Entity representative was 

‘‘independent’’ of the swap dealer or 

major swap participant. A 

representative would be deemed to be 

independent if: (1) It was not, within 

one year, an associated person of the 

swap dealer or major swap participant 

(proposed § 23.450(c)(1)); (2) there was 

no ‘‘principal relationship’’ between the 

representative and the swap dealer or 

major swap participant (proposed 

§ 23.450(a)(2) and (c)(2)); and (3) the 

representative did not have a ‘‘material 

business relationship’’ with the swap 

dealer or major swap participant 

(proposed § 23.450(a)(1) and (c)(3)).851

a. Associated Person 

The Commission is adopting the 

‘‘associated person’’ prong in proposed 

§ 23.450(c)(1) and clarifies that ‘‘within 

one year’’ means ‘‘within one year of 

representing the Special Entity in 

connection with the swap.’’ The 

Commission clarifies that where the 

Special Entity’s representative is an 

entity, the representative could still 

satisfy the ‘‘associated person prong’’ in 

final § 23.450(c)(1) if the representative 

had an employee that was an associated 

person of the swap dealer or major swap 

participant within the preceding twelve 

months (‘‘restricted associated 

person’’).852 To satisfy the ‘‘associated 

person’’ prong in this situation, a 

Special Entity’s representative must 

comply with policies and procedures 

reasonably designed to manage and 

mitigate the conflict. Such policies and 

procedures, for example, should impose 

compensation restrictions to avoid 

having the restricted associated person 

benefit from the Special Entity’s 

transactions with the swap dealer or 

major swap participant and provide for 

informational barriers, as appropriate, 

between any restricted associated 

person and those employees that 

directly provide advice, make trading 

decisions or otherwise manage and 

supervise the Special Entity’s account 

with respect to swaps with the swap 

dealer or major swap participant. 

b. Principal Relationship 

The Commission is also adopting the 

‘‘principal relationship’’ prong of the 

proposed independence test with one 

clarification. Section 23.450(a)(2) 

(renumbered as § 23.450(a)(1)) is 

amended to clarify that the term 

‘‘principal,’’ with respect to any swap 

dealer, major swap participant, or 

Special Entity’s representative, means 

any person listed in § 3.1(a)(1)–(3) as 

opposed to a person defined in § 3.1(a). 

c. Material Business Relationship 

Proposed § 23.450(a)(1) defined 

‘‘material business relationship’’ as any 

relationship, whether compensatory or 

otherwise, that could reasonably affect 

the independent judgment or decision 

making of the representative. The 

Commission has determined to delete 

the ‘‘material business relationship’’ 

prong of the independence test in 

proposed § 23.450(a)(1) and (c)(3) and to 

substitute the following three criteria 

that were encompassed within the 

definition. 

First, under § 23.450(c)(3), to be 

deemed ‘‘independent,’’ a representative 

must (1) provide timely and effective 

disclosures of all material conflicts of 

interest that could reasonably affect the 

judgment or decision making of the 

representative with respect to its 

obligations to the Special Entity, and (2) 

comply with policies and procedures 

reasonably designed to manage and 

mitigate all such material conflicts of 

interest. In the Commission’s view, to be 

‘‘timely and effective’’ the disclosures 

would be have to be sufficient to permit 

the Special Entity to assess the conflict 

of interest and take steps to mitigate any 

materially adverse effect on the Special 

Entity that could be created by the 

conflict. In determining whether a 

conflict of interest exists, a 

representative would be expected to 

review its relationships with the swap 

dealer or major swap participant and 

their affiliates, including lines of 

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853For example, a representative may have 

separate lines of business in which it provides 

services to swap dealers, major swap participants, 

or their affiliates. The representative should 

consider whether such ongoing relationships where 

it has an interest in maintaining existing business 

or soliciting future business could reasonably affect 

its judgment or decision making with respect to its 

obligations to the Special Entity. 

854Similarly, the Special Entity and 

representative should consider the basis upon 

which the representative will be compensated by 

the Special Entity to ensure that the representative’s 

compensation is not contingent upon executing, for 

example, a particular swap, or a swap with a 

particular dealer or major swap participant. The 

Commission understands based on industry 

practice that representative fees are sometimes paid 

at the time of execution of the swap by the swap 

dealer or major swap participant at the direction of 

the Special Entity for services provided by the 

representative in connection with the swap. In the 

proposed rule, the Commission recognized that 

such transfer of payment on behalf of the Special 

Entity would not necessarily be a material conflict 

of interest between the representative and the swap 

dealer or major swap participant. See proposed 

definition of material business relationship in 

proposed § 23.450(a)(1). Proposing release, 75 FR at 

80660. However, Special Entities and 

representatives must ensure that the compensation 

arrangement does not undermine the independence 

and ‘‘best interests’’ duty of the representative as a 

result of the contingent nature of the fee 

arrangement. As a nonexclusive example, where a 

representative’s compensation is contingent on 

execution by the Special Entity of a specific 

transaction with a specific swap dealer, the 

representative will have a material conflict of 

interest and will not be incentivized to act in the 

best interests of the Special Entity. Special Entities 

should ensure that the fee arrangements with their 

representatives do not compromise the 

independence of the representative, create conflicts 

of interest or otherwise undermine the quality of 

the advice provided by the representative. 855See Section IV.C.3.b. of this adopting release. 

856 In making the representations specified in 

§ 23.450(d) for establishing the qualifications of a 

representative Special Entities are encouraged to 

ensure that their policies and procedures are 

sufficiently robust to evaluate the effectiveness and 

enforceability of the obligations of the 

representative to act in the best interests of the 

Special Entity, to make appropriate and timely 

disclosures, and to evaluate the appropriateness 

and pricing of any swaps entered into by the 

Special Entity. 

857This is also consistent with proposed 

§ 23.450(d)(2)(i), which stated that relevant 

considerations for a swap dealer or major swap 

participant include: ‘‘The nature of the relationship 

between the Special Entity and the representative 

and the duties of the representative, including the 

obligation to act in the best interests of the Special 

Entity.’’ As with proposed § 23.450(d)(2)(ii) (vii), the 

Commission has decided to delete proposed 

§ 23.450(d)(2)(i) and adopt it as guidance. 

858Section IV.B.3.c. of this adopting release. 

859See supra, fn. 856. 

business in which the representative 

will solicit business on an ongoing 

basis.853 Additionally, where 

applicable, the representative should 

review relationships of its principals 

and employees who could reasonably 

affect the judgment or decision making 

of the representative with respect to its 

obligations to the Special Entity. The 

representative must also manage and 

mitigate its material conflicts of interest 

to avoid having a materially adverse 

effect on the Special Entity. A 

representative should establish and 

comply in good faith with written 

policies and procedures that identify, 

manage and mitigate material conflicts 

of interest including, where appropriate, 

those arising from (1) compensation or 

incentives for employees that carry out 

the representative’s obligations to the 

Special Entity, and (2) lines of business, 

functions and types of activities 

conducted by the representative for the 

swap dealer or major swap 

participant.854

Second, the Commission has added 

§ 23.450(c)(4) to the independence test 

to clarify that a representative may not, 

directly or indirectly, control, be 

controlled by, or be under common 

control with the swap dealer or major 

swap participant. This provision is 

consistent with the ‘‘principal 

relationship’’ prong and clarifies that a 

representative would not be deemed 

‘‘independent’’ where there is indirect 

control through one or more persons or 

common control with the swap dealer or 

major swap participant. 

Finally, the Commission is adopting 

§ 23.450(c)(5), which clarifies that a 

representative will not be deemed 

independent if the swap dealer or major 

swap participant refers, recommends, or 

introduces the representative to the 

Special Entity within one year of the 

representative’s representation of the 

Special Entity in connection with the 

swap. The Commission believes a 

Special Entity should retain a 

representative without input from the 

swap dealer or major swap participant. 

If a swap dealer or major swap 

participant is asked by a Special Entity 

for a name or list of names of potential 

representatives, the swap dealer or 

major swap participant would be 

expected either to decline to answer or 

direct the Special Entity to, for example, 

an independently maintained repository 

of business listings such as a list of 

registrants with a relevant SRO, a trade 

association unaffiliated with the swap 

dealer or major swap participant, or a 

widely-available independent 

publication that provides industry 

contact information. 

The Commission has considered the 

comments and believes that deleting the 

‘‘material business relationship’’ prong 

and substituting the enumerated criteria 

in § 23.450(c) resolves commenters’ 

primary issues about clarity and 

workability. In addition, the 

reformulation of the treatment of ERISA 

plans under § 23.450(b)(2) eliminates 

any potential conflict with the 

independence test under ERISA.855 The 

final rule also resolves commenters’ 

concern that the standard would 

inappropriately preclude qualified asset 

managers with complex business 

relationships with swap dealers or 

major swap participants from acting as 

Special Entity representatives. 

Furthermore, any added costs associated 

with the duty to disclose and mitigate 

material conflicts of interest will only be 

incremental because many third party 

independent representatives will 

already be subject to similar or identical 

disclosure obligations by virtue of being 

a CTA, investment adviser, municipal 

advisor, or other fiduciary to the Special 

Entity. The Commission has also 

determined that a conflicts disclosure 

regime paired with an obligation to 

manage and mitigate conflicts 

appropriately balances the statutory 

independence criterion with any 

associated costs. 

v. Duty To Act in the Best Interests 

The Commission agrees with 

commenters that a swap dealer or major 

swap participant could rely 856 on 

evidence of legal arrangements between 

the Special Entity and its representative 

that the representative is obligated to act 

in the best interests of the Special 

Entity, including by contract, an 

employment agreement, or requirements 

under state or federal law.857 Having 

considered the comments, the 

Commission is adopting § 23.450(b)(4) 

as proposed (renumbered as 

§ 23.450(b)(1)(iv)). 

As more fully discussed in connection 

with § 23.440, the Commission has 

determined that a best interests duty 

under §§ 23.440 and 23.450 will be the 

duty to act in good faith, make full and 

fair disclosure of all material facts and 

conflicts of interest, and to employ 

reasonable care to advance the Special 

Entity’s stated objectives.858

vi. Appropriate and Timely Disclosures 

The Commission also agrees with 

commenters and confirms that a swap 

dealer or major swap participant could 

rely on appropriate legal arrangements 

between a Special Entity and its 

representative to form a reasonable basis 

to believe the representative makes 

appropriate and timely disclosures. 

Therefore, the Commission is adopting 

§ 23.450(b)(5) as proposed (renumbered 

as § 23.450(b)(1)(v)).859

The Commission expects that 

‘‘appropriate disclosures’’ will be 

assessed in the context of the Special 

Entity-representative relationship. For 

example, a third party advisor would be 

expected to disclose all compensation it 

receives, directly or indirectly, with 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9797 

860For example, where a representative’s fee is 

expressed as basis points on the notional amount 

of the transaction, the representative should also 

disclose a calculation of the fee in dollars. 

861The Commission encourages Special Entities 

to consider the factors discussed in this adopting 

release in developing appropriate policies and 

procedures for selecting a qualified representative 

and monitoring their ongoing performance. 

862Proposing release, 75 FR at 80652–53 and 

80660. A commenter requested that the 

Commission confirm that implementation of a 

hedge policy and periodic review of compliance 

with the policy would be sufficient to meet the fair 

pricing and appropriateness criterion. APGA Feb. 

22 Letter, at 6. The Commission declines to endorse 

any particular method of compliance with the 

statutory criteria in light of the principles based 

nature of the rule but believes such considerations 

would be relevant to an assessment of compliance 

with the criterion. 

863Although the Commission did not receive any 

comments regarding the requirements of proposed 

§ 23.450(b)(8), two commenters requested the 

Commission clarify the differences between the 

term ‘‘municipal entity’’ in proposed § 23.450(b)(8) 

and § 23.451 and the definition of Special Entity. 

See, APGA Feb. 22 Letter, at 2; AMG–SIFMA Feb. 

22 Letter, at 13. The Commission has addressed the 

substance of those comments in the definitions 

section (see Section IV.A.3.b. of this adopting 

release) and the section on § 23.451 (see Section 

IV.D.3. of this adopting release). 

864 Investment advisers registered with the SEC 

are currently subject to SEC Advisers Act Rule 

206(4)–5, Political Contributions by Certain 

Investment Advisers, effective date Sept. 13, 2010, 

17 CFR 275.206(4)–5; see also SEC’s proposed rules, 

76 FR 41018. Pending final adoption of the SEC’s 

registration rule for municipal advisors, the MSRB 

has withdrawn the Proposed Interpretive Notice 

Concerning the Application of Rule G–17, on 

Conduct of Municipal Securities and Municipal 

Advisory Activities, to Municipal Advisors, SR– 

MSRB–2011–15 (August 24, 2011). In a press 

release, the MSRB stated, ‘‘Upon the SEC’s adoption 

of a permanent definition of the term ‘municipal 

advisor’ under the Exchange Act, the MSRB plans 

to resubmit these rule proposals,’’ MSRB Notice 

2011–51 (Sept. 9, 2011). 

865See Section V at fn. 926 of this adopting 

release for a discussion of the implementation 

schedule for § 23.450(b)(1)(vii). 

866See, e.g., SIFMA/ISDA Feb. 17 Letter, at 36; 

proposing release, 75 FR at 80660. 

867Final § 23.450(d) and (e) provide: 

(d) Safe Harbor. (1) A swap dealer or major swap 

participant shall be deemed to have a reasonable 

basis to believe that the Special Entity, other than 

a Special Entity defined in § 23.401(c)(3), has a 

representative that satisfies the applicable 

requirements of paragraph (b)(1) of this section, 

provided that: (i) The Special Entity represents in 

writing to the swap dealer or major swap 

participant that it has complied in good faith with 

written policies and procedures reasonably 

designed to ensure that it has selected a 

representative that satisfies the applicable 

requirements of paragraph (b) of this section, and 

that such policies and procedures provide for 

ongoing monitoring of the performance of such 

representative consistent with the requirements of 

paragraph (b) of this section; and (ii) The 

representative represents in writing to the Special 

Entity and swap dealer or major swap participant 

that the representative: (A) Has policies and 

procedures reasonably designed to ensure that it 

satisfies the applicable requirements of paragraph 

(b) of this section; (B) Meets the independence test 

in paragraph (c) of this section; and (C) Is legally 

obligated to comply with the applicable 

requirements of paragraph (b) of this section by 

agreement, condition of employment, law, rule, 

regulation, or other enforceable duty. (2) A swap 

dealer or major swap participant shall be deemed 

to have a reasonable basis to believe that a Special 

Entity defined in § 23.401(c)(3) has a representative 

Continued 

respect to the swap, and it would be 

expected to disclose all material 

conflicts of interest. Disclosures should 

also include all fees and compensation 

structures in a manner that is clearly 

understandable to the Special Entity.860

A representative that is a Special 

Entity’s employee would be expected to 

disclose material information not 

otherwise known to a Special Entity 

through the employment relationship 

such as any material compensation the 

representative receives from a third 

party or where the representative trades 

for its own account in the same or a 

related market. The Commission also 

expects that a representative would 

timely disclose to the Special Entity (or 

to appropriate supervisors in the case of 

an employee), where appropriate, 

unexpected gains or losses, unforeseen 

changes in the market place, compliance 

irregularities or violations, and other 

material information.861

vii. Fair Pricing and Appropriateness 

Section 4s(h)(5)(A)(i)(VI) states that 

the representative will provide ‘‘written 

representations to the Special Entity 

regarding fair pricing and the 

appropriateness of the transaction.’’ 

Proposed § 23.450(b)(6) refined the 

statutory language to state that the 

representative ‘‘evaluates, consistent 

with any guidelines provided by the 

Special Entity, fair pricing and the 

appropriateness of the swap.’’862 Having 

considered the comments, the 

Commission is adopting § 23.450(b)(6) 

as proposed (renumbered as 

§ 23.450(b)(1)(vi)). 

The Commission also clarifies that 

this provision does not require that the 

representative provide transaction-bytransaction documentation to the 

Special Entity with respect to fair 

pricing and appropriateness of the 

swap. The Commission expects that in 

circumstances where the representative 

is given discretionary trading authority, 

for example, the representative could 

undertake in an investment 

management agreement or other 

agreement to ensure that the 

representative will evaluate pricing and 

appropriateness of each swap consistent 

with any guidelines provided by the 

Special Entity prior to entering into the 

swap. The Commission notes, however, 

that the independent representative 

would be expected to prepare and 

maintain adequate documentation of its 

evaluation of pricing and 

appropriateness to enable both the 

representative and Special Entity to 

audit for compliance with the duty. 

viii. Restrictions on Political 

Contributions by the Independent 

Representative of a Governmental 

Special Entity 

The Commission is adopting 

§ 23.450(b)(8) (renumbered as 

§ 23.450(b)(1)(vii)) with modifications to 

the term ‘‘municipal entity.’’ 863

Consistent with the modifications to 

§ 23.451, the phrase ‘‘municipal entity 

as defined in § 23.451’’ has been 

replaced with the phrase ‘‘Special Entity 

as defined in § 23.401(c)(2) or (4).’’ This 

modification clarifies that the rule only 

applies to representatives of State and 

municipal Special Entities and 

governmental plans. The Commission 

also clarifies that the exclusion for 

employees of such Special Entities is 

limited to paragraph § 23.450(b)(1)(vii). 

The Commission also notes that while 

the provision requires an assessment of 

whether the representative is subject to 

restrictions on certain political 

contributions imposed by the 

Commission, SEC, or an SRO, neither 

the Commission nor a registered futures 

association has, as of the adoption of 

these rules, promulgated such 

requirements for CTAs that advise State 

and municipal Special Entities or 

governmental plans.864 Therefore, the 

Commission has set a separate 

implementation schedule for 

§ 23.450(b)(1)(vii).865

e. Reasonable Reliance on 

Representations 

Final § 23.450 allows swap dealers 

and major swap participants to comply 

with the rule by relying on 

representations of counterparties with 

respect to the qualifications of their 

independent representatives. 

Commenters were particularly 

concerned with the language in 

proposed § 23.450(d) (renumbered as 

§ 23.450(e)) that the representations be 

reliable ‘‘taking into consideration the 

facts and circumstances of a particular 

Special Entity-representative 

relationship, assessed in the context of 

a particular transaction’’ and that the 

representations be ‘‘sufficiently 

detailed.’’ 866 New final § 23.450(d) (safe 

harbor) and final § 23.450(e) (reasonable 

reliance on representations of the 

Special Entities) together address many 

of the commenters’ concerns by 

clarifying the content of representations 

that will be deemed to provide a swap 

dealer or major swap participant a 

reasonable basis to believe a Special 

Entity’s representative meets the 

qualification criteria.867 The 

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9798 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

that satisfies the applicable requirements in 

paragraph (b)(2) of this section provided that the 

Special Entity provides in writing to the swap 

dealer or major swap participant the 

representative’s name and contact information, and 

represents in writing that the representative is a 

fiduciary as defined in Section 3 of the Employee 

Retirement Income Security Act of 1974 (29 U.S.C. 

1002). 

(e) Reasonable reliance on representations of the 

Special Entity. A swap dealer or major swap 

participant may rely on written representations of 

a Special Entity and, as applicable under this 

section, the Special Entity’s representative to satisfy 

any requirement of this section as provided in 

§ 23.402(d). 

868As the Commission stated in the proposing 

release, such representations can be included in 

counterparty relationship documentation or other 

written agreement between the parties and that the 

representations can be deemed applicable or 

renewed, as appropriate, to subsequent swaps 

between the parties if the representations continue 

to be accurate and relevant with respect to the 

subsequent swaps. Proposing release, 75 FR at 

80641. 

869See, e.g., SEC and DOL guidance—Selecting 

and Monitoring Pension Consultants: Tips for Plan 

Fiduciaries, available at http://www.dol.gov/ebsa/ 

newsroom/fs053105.html; also available at http:// 

www.sec.gov/investor/pubs/sponsortips.htm. 

870Such representations would also apply to 

representatives that are employees of the Special 

Entity. For example, the Special Entity could 

represent that it has (1) complied in good faith with 

policies and procedures reasonably designed to 

ensure that its representative employee meets the 

criteria, and (2) has reasonably designed policies 

and procedures that the employee must follow to 

ensure that it satisfies the criteria. The employee 

could represent that it has complied in good faith 

with the Special Entity’s policies and procedures 

and that it is legally obligated under its 

employment agreement or by law to comply with 

the applicable criteria of § 23.450(b). 

871The Commission’s determination is consistent 

with several commenters’ suggestions. See, e.g., 

SIFMA/ISDA Feb. 17 Letter, at 36 (‘‘[swap dealers] 

should be permitted to rely on a written 

representation * * * that the counterparty and/or 

its representative satisfies the standards * * * 

absent actual notice of countervailing facts (or facts 

that reasonably should have put [a swap dealer] on 

notice), which would trigger a consequent duty to 

inquire further.’’); see also supra fn. 724 and 820. 

872See Section III.A.3.d. of this adopting release 

for a discussion of § 23.402(d)—Reasonable reliance 

on representations. 

873See, e.g., ABC/CIEBA Feb. 22 Letter, at 12–13 

(asserting that a swap dealer faced with a highly 

volatile market and disadvantageous swap position 

could claim that a Special Entity provided 

inaccurate representations to avoid its obligations); 

AMG—SIFMA Feb. 22 Letter, at 10. 

874For the same reasons, the Commission 

declines to opine as to whether a swap dealer or 

major swap participant would have liability to the 

Special Entity or its representative as a result of its 

good faith determination that the representative was 

not qualified. See, e.g., SIFMA/ISDA Feb. 17 Letter, 

at 38–39. The Commission notes, however, that the 

duty under Section 4s(h)(5)(A) and final § 23.450 

only requires a swap dealer to have a reasonable 

basis to believe that a representative is qualified. 

Thus, any determination under proposed 

§ 23.450(e), as clarified in the final rule 

(renumbered as § 23.450(f)), would not be a 

determination by the swap dealer or major swap 

participant that the representative is unqualified. 

875The Commission believes that reviewing the 

determination is part of the CCO’s duty to ‘‘take 

reasonable steps to ensure compliance.’’ See 

proposed § 3.3(d)(3), CCO proposed rules, 75 FR at 

70887. 

Commission also confirms that such 

representations, where appropriate, can 

be contained in counterparty 

relationship documentation to avoid 

transaction-by-transaction 

compliance.868

Some commenters suggested that the 

Commission permit a simple 

representation that a Special Entity’s 

representative satisfies the criteria in the 

statute and rule. The Commission does 

not believe that such an approach is 

consistent with the statutory framework 

or the intent of Congress to provide 

meaningful protections for Special 

Entities. Nevertheless, the Commission 

believes it is appropriate to limit the 

ability of swap dealers and major swap 

participants to subvert the purpose of 

the independent representative 

provisions in Section 4s(h)(5). The 

Commission further believes that the 

final rule addresses commenters 

concerns while encouraging processes 

to ensure that the quality of 

representation is consistent with the 

statutory criteria. The Commission’s 

formulation of the representations will 

encourage Special Entities and 

independent representatives to 

undertake appropriate due diligence to 

ensure that they incorporate the 

statutory criteria in the selection and 

ongoing performance of the 

independent representative.869 For 

example, a representative with specific 

expertise in interest rate swaps might 

not be qualified to advise on an oil 

swap. Under the rule, the Special Entity 

and independent representative would 

have to undertake to ensure that their 

policies and procedures were 

sufficiently robust to take account of 

changing circumstances. In addition, 

Special Entities and their 

representatives should ensure that their 

policies and procedures require that the 

representations provided to the swap 

dealer or major swap participant are 

authorized at the appropriate decision 

making level of the Special Entity or 

representative.870

A swap dealer or major swap 

participant would be able to rely on 

representations unless it had 

information that would cause a 

reasonable person to question the 

accuracy of the representation.871 The 

Commission declines to adopt other 

commenters’ suggestion that swap 

dealers and major swap participants be 

permitted to rely on representations 

unless it had actual knowledge that the 

representations were untrue. The 

Commission has determined that an 

actual knowledge standard may 

inappropriately encourage the swap 

dealer or major swap participant to 

ignore red flags.872

Commenters requested that the 

Commission clarify that the exchange of 

representations will not give parties any 

additional rescission, early termination, 

or monetary compensation rights.873

The Commission declines to opine as to 

potential liability in disputes between 

private parties, which will depend on 

the facts and circumstances of the 

particular case and applicable law.874

f. Chief Compliance Officer Review 

The Commission has determined to 

adopt proposed § 23.450(e) (renumbered 

as § 23.450(f)) with one modification. 

The phrase ‘‘determines that the 

representative * * * does not meet the 

criteria’’ has been changed to read 

‘‘determines that [the swap dealer or 

major swap participant] does not have a 

reasonable basis to believe that the 

representative * * * meets the criteria.’’ 

This clarifies the Commission’s view 

that § 23.450 does not give swap dealers 

and major swap participants the 

authority to determine whether a 

representative meets the criteria under 

§ 23.450(b). Rather, consistent with the 

duty, a swap dealer or major swap 

participant is required to have a 

reasonable basis to believe the 

representative satisfies the criteria. The 

Commission has determined that the 

clarifications and modifications to 

§ 23.450 provide meaningful protections 

against commenters’ concerns that a 

swap dealer or major swap participant 

may overreach or otherwise gain a 

negotiating advantage when requesting 

information from the Special Entity. The 

Commission declines to adopt a 

commenter’s suggestion that the written 

determination be made by the trading 

supervisor instead of the chief 

compliance officer. As stated in the rule, 

the Commission expects the chief 

compliance officer to review such 

determination to ensure that the swap 

dealer or major swap participant has a 

substantial, unbiased basis for the 

determination.875 The Commission 

believes that a chief compliance officer 

is in a better position to review such a 

determination for compliance with the 

rules. A trading supervisor is more 

likely to be directly involved with the 

Special Entity and to have direct 

material incentives or bonus structures 

that could be affected by such a 

determination. 

One commenter also requested that 

the rule require the written record also 

be submitted to the Commission for 

review. The Commission notes that such 

records of compliance must be kept and 

made available to the Commission for 

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876Section 23.402(g) requires swap dealers and 

major swap participants to create a record of their 

compliance and retain and make available for 

inspection such records in accordance with § 1.31 

(17 CFR 1.31). 

877See Section 4s(k) of the CEA and proposed 

§ 3.3, CCO proposed rules, 75 FR at 70887. 

878See, e.g., Section III.D. of this adopting release 

for a discussion of § 23.431 (§ 23.431(a) requires 

disclosures ‘‘at a reasonably sufficient time prior to 

entering into a swap’’). 

879Proposing release, 75 FR at 80654. 

880 17 CFR 275.206(4)–5 (‘‘SEC Advisers Act Rule 

206(4)–5’’). 

881See MSRB Rule G–37, Political Contributions 

and Prohibitions on Municipal Securities Business; 

MSRB Rule G–38, Solicitation of Municipal 

Securities Business. 

882Proposing release, 75 FR at 80654 fn. 133. 

883 Id., at 80654. 

884 Id. 

885 Id. 

886The scope of this proposed exception was 

limited to the types of contributions that are less 

likely to raise pay-to-play concerns, and the 

exception is intended to provide swap dealers with 

the ability to undo certain mistakes. Because it 

would operate automatically, the proposed 

exception was subject to conditions that are 

objective and limited to capture only those 

contributions that are unlikely to raise pay-to-play 

concerns. See also SEC Final Rules, Political 

Contributions by Investment Advisors, 75 FR 

41035–36, Jul. 14, 2010. 

inspection.876 In addition, chief 

compliance officers are required under 

Section 4s(k) of the CEA and proposed 

§ 3.3 to report to the Commission 

annually about the firm’s compliance 

record.877 Thus, the Commission will be 

apprised of material compliance failures 

on an annual basis. 

g. Disclosure of Capacity 

The Commission is adopting 

§ 23.450(f) (renumbered as § 23.450(g)) 

as proposed. A swap dealer or major 

swap participant that acts in a capacity 

other than as a swap counterparty to a 

Special Entity must disclose the 

material differences between such 

capacities. For example, a swap dealer 

that is also a registered FCM would have 

to disclose that when it acts as an FCM 

it is the Special Entity’s agent with 

respect to executing orders; however, 

when it acts as a swap dealer it is the 

Special Entity’s counterparty and its 

interests are adverse to the Special 

Entity’s. Such disclosure would be 

required, at a minimum, at a reasonably 

sufficient time prior to entering into a 

swap.878 The Commission declines 

commenters’ suggestion that the 

required disclosure should be limited to 

different capacities in connection with 

the swap. Such a limitation would not 

address counterparty confusion that 

could arise when a swap dealer changes 

status from transaction to transaction. 

The Commission clarifies that such 

disclosures could be made on a 

relationship basis in counterparty 

relationship documentation, where 

appropriate. Permitting such disclosure 

on a relationship basis implements the 

statutory duty while appropriately 

mitigating associated costs. 

D. Section 23.451—Political 

Contributions by Certain Swap Dealers 

1. Proposed § 23.451 

Pursuant to the Commission’s 

discretionary rulemaking authority 

under Section 4s(h) of the CEA, 

proposed § 23.451 prohibited swap 

dealers and major swap participants 

from entering into swaps with 

‘‘municipal entities’’ if they make 

certain political contributions to 

officials of such entities.879 The 

Commission stated that the proposed 

rule was meant to deter undue influence 

and other fraudulent practices that harm 

the public and to promote consistency 

in the business conduct standards that 

apply to financial market professionals 

dealing with municipal entities. 

Proposed § 23.451 complemented 

existing pay-to-play prohibitions 

imposed by the SEC and the MSRB. 

In a manner similar to the 

prohibitions contained in SEC Advisers 

Act Rule 206(4)–5 880 and MSRB Rules 

G–37 and G–38,881 proposed § 23.451, 

generally, made it unlawful for a swap 

dealer or major swap participant to offer 

to enter or to enter into a swap with a 

municipal entity for a two-year period 

after the swap dealer or major swap 

participant or any of its covered 

associates makes a contribution to an 

official of the municipal entity. The 

proposed rule also prohibited a swap 

dealer or major swap participant from 

paying a third-party to solicit municipal 

entities to enter into a swap, unless the 

third-party is a ‘‘regulated person’’ that 

is itself subject to a so-called pay-to-play 

restriction under applicable law. 

The Commission proposed to define 

‘‘regulated person,’’ for purposes of 

§ 23.451, to mean, generally, a person 

that is subject to rules of the SEC, the 

MSRB, an SRO or the Commission 

prohibiting it from engaging in specified 

activities if certain political 

contributions have been made, or its 

officers or employees.882 Similar to SEC 

Advisers Act Rule 206(4)–5, the 

proposing release defined ‘‘covered 

associate’’ of a swap dealer or major 

swap participant as: ‘‘(i) any general 

partner, managing member or executive 

officer, or other individual with a 

similar status or function; (ii) any 

employee who solicits a municipal 

entity for the swap dealer or major swap 

participant and any person who 

supervises, directly or indirectly, such 

employee; and (iii) any political action 

committee controlled by the swap 

dealer or major swap participant or any 

of its covered associates.’’ 883

The proposed rule barred a swap 

dealer or major swap participant from 

soliciting or coordinating contributions 

to an official of a municipal entity with 

which the swap dealer or major swap 

participant is seeking to enter into or 

has entered into a swap, or payments to 

a political party of a state or locality 

with which the swap dealer or major 

swap participant is seeking to enter into 

or has entered into a swap.884 The 

proposed rule also included a provision 

that would make it unlawful for a swap 

dealer or major swap participant to do 

indirectly or through another person or 

means anything that would, if done 

directly, result in a violation of the 

prohibitions contained in the proposed 

rule.885

The Commission’s proposal included 

three exceptions. First, the proposed 

rule permitted an individual that is a 

covered associate to make aggregate 

contributions up to $350 per election, 

without being subject to the two-year 

time out period, to any one official for 

whom the individual is entitled to vote, 

and up to $150 per election to an official 

for whom the individual is not entitled 

to vote. Second, the proposed rule did 

not apply to contributions by an 

individual made more than six months 

prior to becoming a covered associate of 

the swap dealer or major swap 

participant, unless such individual 

solicits the municipal entity after 

becoming a covered associate. Third, the 

prohibitions did not apply to a swap 

that is initiated on a DCM or SEF, for 

which the swap dealer or major swap 

participant does not know the identity 

of the counterparty. 

In addition to the above-mentioned 

exceptions, proposed § 23.451 included 

an automatic exemption for those cases 

where (1) a contribution made by a 

covered associate did not exceed $150 

or $350, as applicable, (2) was 

discovered by the swap dealer or major 

swap participant within four months of 

the date of contribution, and (3) was 

returned to the contributor within 60 

calendar days of the date of 

discovery.886 In addition, the 

Commission proposed that a swap 

dealer or major swap participant could 

apply to the Commission for an 

exemption from the two-year ban and, 

when considering the exemption 

application, the Commission would 

consider certain factors enumerated in 

the proposing release, including, for 

example, whether the exemption is 

necessary or appropriate in the public 

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887 Id., at 80655. 

888 Id. 

889Cf. CFA/AFR Feb. 22 Letter, at 18, with 

SIFMA/ISDA Feb. 17 Letter, at 39–40. 

890SIFMA/ISDA Feb. 17 Letter, at 40. 

891 Id. 

892 Id. 

893See supra fn. 60 for a definition of the term 

‘‘municipal entity.’’ 

894See Section IV.A. of this adopting release for 

a discussion of municipal entities and Special 

Entities. 

895APGA Feb. 22 Letter, at 2. 

896AMG–SIFMA Feb. 22 Letter, at 13. 

897SIFMA/ISDA Feb. 17 Letter, at 40. 

898 Id. 

899 Id. 

900CEF Feb. 22 Letter, at 24. 

901 Id. 

902 In making this determination, the Commission 

concluded that final § 23.451 is fully authorized by 

the discretionary rulemaking authority vested in the 

Commission by Section 731 of the Dodd-Frank Act, 

which amended the CEA by adding Section 4s(h). 

See Section 4s(h)(3)(D) (‘‘Business conduct 

requirements adopted by the Commission shall 

establish such other standards and requirements as 

the Commission may determine are appropriate in 

the public interest, for the protection of investors, 

or otherwise in furtherance of the purposes of [the 

CEA].’’); see also Sections 4s(h)(1)(D), 4s(h)(5)(B) 

and 4s(h)(6). 

903SEC’s proposed rules, 76 FR at 42432–33. 

904Section 23.451(a)(3) defines ‘‘governmental 

Special Entity’’ as any Special Entity defined in 

§ 23.401(c)(2) (a State, State agency, city, county, 

municipality, other political subdivision of a State, 

or any instrumentality, department, or a corporation 

of or established by a State or political subdivision 

of a State) or § 23.401(c)(4) (any governmental plan, 

as defined in Section 3 of the Employee Retirement 

Income Security Act of 1974 (29 U.S.C. 1002)). 

interest and consistent with the 

protection of investors and the purposes 

of the CEA.887

The Commission sought general and 

specific comment on a number of 

questions regarding proposed § 23.451, 

including whether the term ‘‘municipal 

entity’’ was appropriately defined or 

whether certain alternatives should be 

considered. The Commission also 

sought comment on whether the 

proposed rule should apply only to 

swap dealers.888

2. Comments 

The Commission received several 

comments representing a diversity of 

views on proposed § 23.451. Where one 

commenter believed proposed § 23.451 

represented an indispensable element of 

the business conduct standards and 

should be strengthened to prohibit a 

swap dealer from making a political 

contribution after the completion of a 

transaction, another believed the 

proposed rule should be deleted as 

unduly burdensome for those swap 

dealers that are part of financial 

institutions that are not, or will not be, 

subject to the rules of the MSRB.889

Alternatively, it was suggested by the 

latter commenter that any final rule 

parallel in certain respects the MSRB 

regulations on political contributions 

made in connection with municipal 

securities business and, in so doing, 

limit the final rule’s scope to swap 

dealers and major swap participants 

already covered by the relevant MSRB 

regulations.890 In another alternative, 

this commenter requested that the 

Commission consider replacing as the 

triggering occasion for the application of 

the rule an ‘‘offer to enter into or enter 

into a swap or a trading strategy 

involving a swap’’ with the phrase 

‘‘engage in municipal swaps 

business.’’ 891 The commenter suggested 

that ‘‘municipal swap business’’ be 

defined to mean ‘‘the execution of a 

swap with a municipal entity.’’ 892

Regarding proposed § 23.451(a)(3)’s 

definition of municipal entity,893 one 

commenter requested the Commission 

clarify differences with the definition of 

a State and municipal Special Entity 

under Section 4s(h)(1)(C)(2)(ii) 894 and 

proposed § 23.401, which limits the 

definition of Special Entity to ‘‘a State, 

State agency, city, county, municipality, 

or other political subdivision of a 

State.’’ 895 Another commenter 

recommended excluding certain stateestablished plans that are run by thirdparty investment advisers, such as 529 

college savings plans, from the 

definition of ‘‘municipal entity’’ or, at a 

minimum, creating a safe harbor from 

the pay-to-play provision where a 

Special Entity is represented by a 

qualified financial advisor and that 

advisor affirmatively selects the swap 

dealer.896

Regarding the proposed rule’s 

definition of ‘‘solicit,’’ one commenter 

stated that the term could implicate 

communication by employees of a 

financial institution that do not have a 

role in the swaps business and who are 

already regulated by the MSRB.897 This 

commenter advocated that the 

Commission narrow the definition of 

‘‘solicit’’ to include only ‘‘direct 

communication by any person with a 

municipal entity for the purpose of 

obtaining or retaining municipal swaps 

business.’’ In so doing, the commenter 

stated that the proposed rule does not 

include an analogous provision of 

MSRB Rule G–37 (and MSRB Proposed 

Rule G–42, Political Contributions and 

Prohibitions on Municipal Advisory 

Activities) limiting the scope of the rule 

to municipal financial professionals 

‘‘primarily engaged in municipal 

financial representative activities 

* * *.’’ 898 The same commenter urged 

the Commission to include a provision, 

parallel to the relevant MSRB rules, 

which specifies an operative date for the 

rule, such that it only applies to 

contributions made on or after its 

effective date.899

Another commenter stated that it is 

unclear how regulated entities will 

monitor for compliance with the 

proposed rule and suggested a rewriting of the rule in a more targeted 

fashion prohibiting ‘‘political 

contributions with the intent to solicit 

swaps business.’’ 900 This commenter 

also stated that the term ‘‘offer’’ should 

be defined in a manner that is consistent 

with its traditional legal definition.901

3. Final § 23.451 

The Commission has determined to 

adopt proposed § 23.451 with changes 

to reflect certain of the comments and 

to harmonize its rule with the SEC’s 

proposed pay-to-play prohibition.902

The SEC’s proposed prohibition on 

certain political contributions by 

security-based swap dealers, proposed 

Rule 15Fh–6, would bar an SBS Dealer 

from entering into a security-based swap 

agreement with a ‘‘municipal entity’’ 

after they make contributions, with the 

aim of eliminating pay-to-play.903

Moreover, the Commission’s approach 

to final § 23.451 is also consistent with 

MSRB Rules G–37 and G–38. Through 

such harmonization, the Commission 

achieves its goal of preventing quid pro 

quo arrangements while avoiding 

unnecessary burdens associated with 

disparities between the SEC’s proposed 

rule and the Commission’s final rule 

and guidance. In this way, the 

incremental cost of complying with the 

Commission’s prohibition is expected to 

be minimal as many of the entities that 

will be subject to its restrictions should 

already have in place policies and 

procedures on political contributions by 

way of their compliance with existing 

requirements under SEC Advisers Act 

Rule 206(4)–5 and MSRB Rules G–37 

and G–38. 

There were two main changes made to 

proposed § 23.451 in final § 23.451. 

First, the Commission decided to 

exclude major swap participants from 

the pay-to-play prohibition because 

major swap participants, as defined, do 

not ‘‘solicit’’ swap transaction business 

within the meaning of the final rule and, 

as such, the Commission does not 

expect that major swap participants will 

assume a dealer-type role in the swap 

market. 

Second, in place of the term 

‘‘municipal entity’’ in § 23.451(a), the 

Commission used the term 

‘‘governmental Special Entity’’ as 

defined in final § 23.451(a)(3).904 This 

change clarifies that the pay-to-play 

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905See MFA Mar. 24 Letter, at Annex A p. 3; EEI 

June 3 Letter, at 7; NFA Aug. 31 Letter, at passim, 

NextEra Mar. 11 Letter, at 6; Comm. Cap. Mkts. June 

24 Letter, at 2; Financial Assns. May 26 Letter, at 

3; Financial Assns. June 10 Letter, at 8–9 (The 

business conduct standards rulemaking should 

occur after the definitions rulemakings because, in 

most places, the Dodd-Frank Act refers to ‘‘swap 

dealers’’ instead of ‘‘registered swap dealers,’’ and 

the statutory definition of swap dealer is vague. 

Many persons could unwittingly violate the 

business conduct standards rules because they 

would not have known that they were subject to the 

rules. Certain terms such as ‘‘Special Entity,’’ ‘‘best 

interests’’ and ‘‘acts as an advisor’’ must be clarified 

by rule prior to the effectiveness of the business 

conduct standards rules.); see also ISDA June 3 

Letter, at 2–4; WMBAA June 3 Letter, at 5; AGA 

June 3 Letter, at 3. 

906CME June 3 Letter, at 3–4 and 7 (Rulemaking 

should occur in three phases—‘‘early,’’ ‘‘middle’’ 

and ‘‘late.’’ The early phase rules should deal solely 

with systemic risk. Business conduct standards, by 

contrast, should be in the middle phase.). 

907BlackRock June 3 Medero, Prager and VedBrat 

Letter, at 2–3 (The Commission should publish a 

proposed sequencing plan that details both the 

sequence and implementation for all rules. 

Implementation should be divided into three 

phases and business conduct rules would be 

effective in the final phase.); see also BlackRock 

June 3 Medero and Prager Letter, at 6. 

908MFA Mar. 24 Letter, at Annex A p. 3 (Business 

conduct standards rules should be implemented 

Continued 

prohibition applies not just to 

municipalities, but to any contributions 

made for the purpose of obtaining state 

and/or local government business. It 

also addresses comments 

recommending that the Commission 

clarify that the prohibition only applies 

to certain Special Entities as defined in 

Section 4s(h) and final § 23.401. 

The Commission declined to make 

changes to proposed § 23.451 based on 

comments recommending the 

prohibition on pay-to-play be deleted as 

unduly burdensome for those swap 

dealers that are part of financial 

institutions that are not, or will not be, 

subject to the rules of the MSRB. Rather, 

the Commission believes that a pay-toplay prohibition is integral to the 

business conduct standards framework 

for the protection of governmental 

Special Entities. The final rule is 

intended to protect the public by 

ensuring that swap dealers solicit and 

compete for governmental Special 

Entity business on the merits of their 

proposals rather than on the basis of 

their ability and willingness to make 

political contributions. Similarly, the 

Commission declines, as one 

commenter suggested, to limit the 

prohibition to the ‘‘execution’’ of swap 

business because the final rule is 

designed to protect the public in all 

phases of the transaction, including the 

solicitation or offering stage. At the 

same time, the Commission is taking 

steps to mitigate costs by harmonizing 

the final rule with both the SEC’s and 

MSRB’s prohibitions on certain political 

contributions. 

The Commission does not believe that 

a safe harbor from the final rule is 

appropriate merely because a 

governmental Special Entity is being 

represented by a qualified financial 

advisor who selects the swap dealer. By 

its nature, pay-to-play is covert because 

participants do not broadcast that 

contributions or payments are being 

made or accepted for the purpose of 

influencing the selection of a particular 

financial services provider. Given the 

covert and nefarious purpose behind 

such contributions or payments, the 

Commission believes any potential 

loophole, or Commission parsing of the 

word ‘‘offer,’’ would only breed 

mischief by would-be wrongdoers and 

unnecessarily expose the public to 

fraudulent dealings. 

As the rule text makes clear, the final 

rule is designed to prevent ‘‘fraud.’’ 

Given this fact, the Commission believes 

that it is unnecessary, as some 

commenters requested, to fashion the 

prohibition to reach only those 

‘‘political contributions made with the 

intent to solicit swaps business.’’ Such 

an intent-based test in this context 

would again ignore the covert nature of 

such contributions or payments. Rather, 

the Commission believes that 

§ 23.451(b)(1)’s limiting principle (i.e., 

that it prohibits fraud), and the various 

exceptions to the prohibitions contained 

in § 23.451(b)(2), should ameliorate any 

concerns that the prohibition may be 

unduly burdensome to monitor for 

compliance. Presumably, swap dealers 

already have in place policies and 

procedures designed to prevent their 

employees and agents from perpetrating 

fraud of this sort. 

As with the other business conduct 

standards being promulgated in this 

adopting release, § 23.451 cannot be 

read in insolation. Of particular 

relevance here is the Commission’s antievasion rule § 23.402(a) which, together 

with § 23.451(c)’s provision that no 

swap dealer shall circumvent the 

prohibitions of the rule, will provide an 

effective safeguard against those who 

may be inclined to devise an end-run 

around final § 23.451. Given these 

protections, the Commission does not 

find it necessary, as one commenter 

recommended, to change the rule text to 

make sure that improper contributions 

do not occur both before and after the 

solicitation and consummation of the 

transaction. Further, § 23.451(d) 

provides a mechanism by which a swap 

dealer can apply for an exemption from 

the prohibitions of the final rule. 

Together, these rules ensure that 

§ 23.451 is balanced, flexible and 

capable of prohibiting multifarious 

forms of fraud while accommodating 

legitimate requests for relief based on 

various facts and circumstances. 

Similarly, § 23.451(e) specifies where 

prohibitions are inapplicable, including 

where the contribution does not exceed 

the dollar thresholds or timing 

considerations provided in the rule. 

V. Implementation 

A. Effective Dates and Compliance 

Dates 

In the proposing release, the 

Commission requested comment on 

whether it should delay the effective 

date of any of the proposed 

requirements to allow additional time to 

comply and, if so, commenters were 

asked to identify the particular 

requirement and compliance burden 

that should merit a delay. Under Section 

754 of the Dodd-Frank Act, the rules in 

subpart H of part 23 would be effective 

not less than 60 days after publication 

of the final rules implementing Section 

731, which adds Section 4s(h) to the 

CEA. 

B. Comments 

The Commission received comments 

concerning implementation of the final 

external business conduct standards 

rules. The majority of the comments 

urged the Commission to implement the 

external business conduct standards 

after the implementation of the entity 

definitions and registration rules 

applicable to swap dealers and major 

swap participants and to allow 

sufficient time to implement 

appropriate policies and procedures and 

execute counterparty relationship 

documentation.905

Other commenters suggested that the 

Commission’s rules, including the 

business conduct standards rules, be 

implemented in a certain number of 

phases. The suggestions varied from as 

few as three to as many as sixteen 

phases. From among the commenters 

who believed that the rules should be 

implemented in phases, one commenter 

stated that the Commission should 

divide the rulemakings into three 

phases, with business conduct 

standards in the middle phase.906

Another commenter believed that the 

business conduct rules should be 

effective in the third of three phases.907

Among the commenters who believed 

that the rules should be implemented in 

four phases, one commenter stated that 

the external business conduct rules 

should be implemented during the 

second of four phases, following the 

implementation of the definitions 

rules.908 Another commenter believed 

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9802 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

during the second of four phases, following the 

implementation of definitions rules. The second 

phase should include implementation of clearing 

rules, swap-data reporting rules and internal/ 

external business conduct standards for swap 

dealers and major swap participants. The third 

phase should prioritize SEF trading and segregation 

of uncleared swaps. The final phase should include 

real-time/public reporting and all other rulemaking, 

including antifraud and market manipulation 

rules.). 

909NextEra Mar. 11 Letter, at 6 and 8 (The 

Commission should issue definitional rules first, 

then proceed to the core substantive rules, and then 

turn to non-core and ancillary rules. The second 

phase of rule implementation, which would follow 

the first phase of definitional rules, would 

implement business conduct standards, registration, 

governance, and capital and margin rules. The third 

phase would implement clearing requirements, the 

fourth phase would cover reporting and recordkeeping standards, and the fifth phase would 

implement ancillary rules and necessary 

discretionary rules.). 

910EEI June 3 Letter, at 7 (The Commission: (i) 

Should build its final rules in a common-sense 

manner (to start with basic definitions of ‘‘swap,’’ 

‘‘swap dealer,’’ and ‘‘major swap participant’’); (ii) 

next build strong institutions such as SEFs, DCOs, 

and SDRs; (iii) then implement the mandatory 

clearing, exchange-trading, reporting, recordkeeping 

and other rules controlling those new markets; and 

(iv) then, finally, implement the obligations [e.g., 

business conduct standards] of swap dealers and 

major swap participants in a phased manner that is 

synchronized to the development of the new 

markets and the institutions that support them.). 

911Comm. Cap. Mkts. June 24 Letter, at 2 (The 

first phase would include definitions and 

standards, and the second phase would include 

rules to reduce systemic risk, such as central 

clearing. Business conduct standards would occur 

in the fourth phase.). 

912Financial Serv. Roundtable April 6 Letter, at 

4–5. 

913MGEX June 3 Letter, at 1–2; see also Extension 

of Comment Periods, 76 FR at 25276 Appendix 2. 

914MGEX June 3 Letter, at 1–2. 

915Better Markets June 3 Letter, at 20. 

916 Id. 

917Noble July 7 Letter, at 2. The Commission 

declines to reopen the comment period on this 

rulemaking. If the Commission were to delay the 

final rulemaking to allow additional comments to 

address changes that were a result of comments that 

are already part of the public record, then it would 

only be fair to allow further comments to changes 

made as a result of those subsequent comments. 

The result would be the indefinite delay of the final 

rules for so long as someone is willing to comment 

on changes that were made. 

918ETA May 4 Letter, at 2–5 (The rules should 

be implemented first for market infrastructure 

entities, then registration of market professionals, 

and finally registration of financial entities with 

new roles in each asset class.). 

919Financial Assns. May 4 Letter, at 2–3 (Phased 

implementation by type of market participant will 

also allow the Commission and market participants 

to use lessons learned from larger market 

participants when developing rules applicable to 

end users. In addition, the Commission should, 

within each asset class and type of market 

participant, prioritize implementation of 

requirements that reduce systemic risk ahead of 

other requirements. Implementation of 

requirements designed to achieve other goals, such 

as trade execution, should be phased in only once 

clearing has been successfully implemented. This 

commenter also submitted charts that would 

sequence rules over nine separate stages. The 

Associations propose that the CFTC ‘‘initiate’’ 

business conduct standards in the sixth stage and 

‘‘finalize’’ business conduct standards in the ninth 

and final stage.). 

920Commenters submitted alternatives to the 

proposed rule regarding independent 

representatives for Special Entities (proposed 

§ 23.450). See, e.g., CalPERS Feb. 18 Letter, at 5– 

6; CEF Feb. 22 Letter, at 23; Cityview Feb. 22 

Submission; Riverside Feb. 22 Letter, at 1–2; SFG 

Feb. 22 Letter, at 1; CFA/AFR Aug. 29 Letter, at 23. 

CalPERS suggested a testing regime for independent 

representatives but noted that it would take time to 

create the testing framework. CalPERS 

recommended that, should their proposal advance, 

it may be necessary to delay the effective date of 

the independent representative provision of the 

regulations to permit implementation of their 

alternative approach. The Commission has 

modified proposed § 23.450 to respond to 

commenters concerns, but has determined not to 

adopt a testing regime at this time. CalPERS Feb. 

18 Letter, at 4–6. See Section IV.C.3. of this 

adopting release for a discussion of final § 23.450. 

921ABC/CIEBA Feb. 22 Letter, at 2–3 (The 

proposed rules should not be finalized when there 

is any uncertainty regarding whether the DOL 

regulations will be compatible with the CFTC’s 

rules. If the DOL is not prepared to make the 

announcement when the CFTC is ready to finalize 

its proposed rules, the only workable solution is to 

delay the finalization of the business conduct 

standards with respect to ERISA plans until the 

DOL is prepared to act. Any other course of action 

would elevate timing issues over the retirement 

security of millions of Americans.). The 

Commission has harmonized the rulemaking with 

DOL requirements. See Section II of this adopting 

release for a discussion of ‘‘Regulatory 

Intersections.’’ 

922BlackRock Feb. 22 Letter, at 2 (The 

Commission should adopt only mandatory rules, 

and after the Commission has gained more 

familiarity with the swaps marketplace, it may 

consider changing those standards.); Encana Feb. 22 

Letter, at 2 (Some of the business conduct standards 

rules were not mandated by Congress and, in light 

of the compressed timeline for the implementation 

of the Dodd-Frank Act and current budgetary 

constraints, the Commission should reconsider its 

decision to impose non-mandatory requirements on 

swap dealers and major swap participants at this 

time. Encana suggests that, for swap dealers and 

major swap participants whose counterparties are 

normally end-users, the Commission should limit 

the rules to the requirements mandated by the 

Dodd-Frank Act. If, after a few years of experience, 

the Commission believes that additional business 

conduct standards are necessary, then the 

Commission could explore imposing additional 

the Commission should issue the 

business conduct standard rules in the 

second of four phases, but they 

recommended that the Commission 

should grant a ‘‘one year blanket 

exemption’’ for entities that engage in 

bilateral exempt commodity 

transactions.909 Another commenter 

suggested that the Commission should 

implement the business conduct 

standards during the last of four 

phases.910 One commenter suggested 

that the Commission’s swap rules 

should be implemented in the fourth of 

eight phases,911 while another 

commenter opined that the rules should 

be divided into 16 phases with business 

conduct standards being implemented 

in phase number seven.912

One commenter specifically 

mentioned the phases that were 

suggested by Commissioner O’Malia.913

The commenter stated that the 

Commission should adopt a schedule 

for implementation with each such 

phase. The commenter stated that if all 

the rules cited in Commissioner 

O’Malia’s Phase 2 were adopted 

simultaneously, then it would be a 

burden on the commenter and, 

therefore, the rules should be 

implemented in a staggered schedule.914

Some commenters did not suggest a 

specific number of phases, but had 

suggestions regarding the 

implementation of the rules. One 

commenter stressed the importance of 

the Commission providing a clear date 

for implementation and believed that 

market participants would work 

towards that date.915 The commenter 

also suggested that if documentation of 

customer relationships is a concern 

because of the large numbers of 

customers, some phasing in should be 

considered by the Commission.916

Another commenter believed that the 

public should be given an opportunity 

to review the rule changes that resulted 

from public comments and have an 

opportunity to comment on the changes 

prior to the final rules being 

promulgated.917

One commenter suggested that the 

Commission should sequence and 

implement the final rules by asset 

class.918 Another commenter opined 

that the Commission should require 

clearing, reporting and electronic 

execution for the ‘‘better-prepared’’ 

asset classes first (e.g., certain 

commodity and interest rate products 

that are already quite liquid and 

standardized) and should provide ample 

time for the maturation of those asset 

classes and products that are not yet at 

that stage.919

The Commission received numerous 

comments on other portions of the 

business conduct standards rules that 

deal with Special Entities. 920 With 

regard to the implementation and 

phasing of the Commission’s rules, one 

commenter stated that it is ‘‘critical’’ 

that, on or before finalization of the 

proposed rules, the Commission and 

DOL make a joint formal announcement 

that no action required by the business 

conduct standards will make a swap 

dealer or major swap participant an 

ERISA fiduciary.921

Two commenters believed that the 

rules should be phased in with the 

mandatory rulemaking being 

implemented first, followed by the 

implementation of rules issued using 

the Commission’s discretionary 

authority.922

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requirements on swap dealers and major swap 

participants at that time.). The Commission has 

determined to adopt both mandatory and 

discretionary rules. See Section III.A.1. of this 

adopting release for a discussion of § 23.400–Scope. 

923CEF June 3 Letter, at 2. 

924NY City Bar June 13 Letter, at 3. 

925Bank of Tokyo May 6 Letter, at 4. 

926Under § 23.450(b)(1)(vii), any swap dealer or 

major swap participant that offers to enter or enters 

into a swap with a Special Entity, other than a 

Special Entity defined in § 23.401(c)(3), shall have 

a reasonable basis to believe that the Special Entity 

has a representative that, in the case of a Special 

Entity as defined in § 23.401(c)(2) or (4), is subject 

to restrictions on certain political contributions 

imposed by the Commission, the SEC, or an SRO 

subject to the jurisdiction of the Commission or the 

SEC; provided however, that § 23.450(b)(1)(vii) 

shall not apply if the representative is an employee 

of the Special Entity. Because neither the 

Commission nor an SRO registered with the 

Commission has established restrictions on certain 

political contributions as provided in 

§ 23.450(b)(1)(vii), swap dealers and major swap 

participants will not have to have a reasonable basis 

to believe that a qualified independent 

representative of a Special Entity is subject to such 

restrictions on political contributions until the later 

of 180 days after the effective date of the final 

subpart H rules or the effective date of any rules 

promulgated by the Commission or an SRO 

registered with the Commission imposing such 

restrictions on political contributions that would 

apply to such qualified independent representative. 

927The compliance dates in this adopting release 

are subject to any superseding order of the 

Commission providing exemptive relief from 

certain requirements under the CEA pending 

completion of certain other rulemakings, including 

the entity and product definitions rulemakings. See, 

e.g. Effective Date for Swap Regulation, 76 FR 

42508, Jul. 19, 2011; Amendment to July 14, 2011 

Order for Swap Regulation, 76 FR 80233, Dec. 23, 

2011. 

928 5 U.S.C. 601 et seq. 

929 5 U.S.C. 601(2), 603, 604 and 605. 

930Proposing release, 75 FR at 80655–56. 

931See id. 

932Policy Statement and Establishment of 

Definitions of ‘‘Small Entities’’ for Purposes of the 

Regulatory Flexibility Act, 47 FR 18618, Apr. 30, 

1982. 

933See Section 1a(49)(D) of the CEA. 

934Proposed Rules for Registration of Swap 

Dealers and Major Swap Participants, 75 FR at 

71385. 

One commenter stated that the 

Commission should continue to apply 

the exclusion for swaps available under 

pre-Dodd-Frank Act Section 2(h) of the 

CEA to allow firms such as its members 

to facilitate an orderly transition to the 

new rules. The commenter suggested 

that the Commission’s rules be 

applicable first to bank holding 

companies, then later to other swaps 

participants.923

One commenter stated that, although 

Section 721 of the Dodd-Frank Act 

limits the Commission’s exemptive 

authority with regard to certain 

provisions of the CEA, the Commission 

still retains authority to exempt persons 

from its own implementing rules.924

This commenter asked that the 

Commission use its authority to exempt 

persons from its implementing 

regulations to address instances where 

such an exemption would be in the 

public interest. 

Another commenter suggested that 

the Commission should adopt 

implementing regulations deferring the 

effective date of the provisions of Title 

VII to be in line with the ongoing 

international effort to implement 

reforms of the OTC derivatives market 

by December 31, 2012, following the 

September 2009 meeting of the G20 in 

Pittsburgh.925

C. Commission Determination 

After considering the comments, the 

Commission has determined that the 

effective date of the rules in subpart H 

of part 23 will be 60 days after 

publication of the final rules in the 

Federal Register. Swap dealers and 

major swap participants must comply 

with the rules in subpart H of part 23 

on the later of 180 days after the 

effective date of these rules or the date 

on which swap dealers or major swap 

participants are required to apply for 

registration pursuant to Commission 

rule 3.10.926

The compliance schedule established 

by the Commission for the subpart H 

rules will allow swap dealers and major 

swap participants to, among other 

things, implement appropriate policies 

and procedures, train relevant 

personnel, execute any necessary 

amendments to counterparty 

relationship documentation, receive any 

representations from counterparties and 

enable Special Entities to ensure that 

they have qualified independent 

representatives as provided in 

§ 23.450.927 While the schedule does not 

distinguish among swap dealers, asset 

classes or counterparties as suggested by 

various commenters, the schedule does 

provide a time certain for compliance 

and a substantial lead time of a 

minimum of eight months to 

accommodate the tasks that must be 

completed by affected market 

participants. The Commission was not 

persuaded that the distinctions among 

swap dealers, asset classes, 

counterparties or mandatory versus 

discretionary rules provide a compelling 

basis for the Commission to phase-in the 

implementation of the bulk of the 

external business conduct standards 

rules. Rather, the Commission believes 

that swap dealers and major swap 

participants will be able to develop and 

implement the required compliance 

mechanisms efficiently by considering 

their affected business processes across 

the board. Within the time frame 

provided, swap dealers and major swap 

participants will be able to phase-in 

their compliance according to their own 

priorities, provided that the 

requirements are implemented by the 

applicable compliance date. 

VI. Related Matters 

A. Regulatory Flexibility Act 

The Regulatory Flexibility Act 

(‘‘RFA’’) requires Federal agencies to 

consider the impact of its rules on 

‘‘small entities.’’ 928 A regulatory 

flexibility analysis or certification 

typically is required for ‘‘any rule for 

which the agency publishes a general 

notice of proposed rulemaking pursuant 

to’’ the notice-and-comment provisions 

of the Administrative Procedure Act, 5 

U.S.C. 553(b).929 As the Commission 

stated in the proposing release, it 

previously has established that certain 

entities subject to its jurisdiction are not 

small entities for purposes of complying 

with the RFA.930 However, as the 

Commission also noted in the proposing 

release, swap dealers and major swap 

participants are new categories of 

registrant for which the Commission 

had not previously addressed the 

question of whether such persons are 

small entities.931

In this regard, the Commission 

explained in the proposing release that 

it previously had determined that FCMs 

should not be considered 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.932 Like FCMs, swap dealers 

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 a swap 

dealer entities that engage in a de 

minimis quantity of swap dealing in 

connection with transactions with or on 

behalf of customers.933 Accordingly, for 

purposes of the RFA for the proposing 

release and future rulemakings, the 

Commission proposed that swap dealers 

should not be considered small entities 

for essentially the same reasons that it 

had previously determined FCMs not to 

be small entities.934

The Commission further explained 

that it also had 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 a 

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935 Id., at 71385–86. 

936ETA June 3 Letter, at 20–21. 

937Small Business Administration, Table of 

Small Business Size Standards, (Nov. 5, 2010). 

938ETA June 3 Letter, at 20–21. 

939Section 1a(49)(D) of the CEA (7 U.S.C. 

1a(49)(D)). 

940Section 1a(33)(A)(ii) of the CEA (7 U.S.C. 

1a(33)(A)(ii)). See also Section 1a(33)(B) (7 U.S.C. 

1a(33)(B)) (requiring the application of a threshold 

for ‘‘substantial position,’’ below which an entity 

will not be required to register as an MSP). 

941 44 U.S.C. 3501 et seq. 

942See proposing release, 75 FR at 80656. The 

Business Conduct Standards—Internal rulemakings 

referenced in the proposing release and their 

proposing release citations are: Governing the 

Duties of Swap Dealers, 75 FR 71397; CCO 

proposed rules, 75 FR 70881; and Conflict-ofInterest Standards by Swap Dealers, 75 FR 71391. 

The Commission submitted these proposing 

releases to the Office of Management and Budget 

(OMB) for review in accordance with 44 U.S.C. 

3507(d) and 5 CFR 1320.11. The Commission 

requested that OMB approve, and assign a new 

control number for, the collections of information 

covered by the proposing releases. 

943See Adaptation of Regulations to Incorporate 

Swaps, 76 FR 33066, Jun. 7, 2011. The Commission 

requested that OMB approve amendments to 

existing collections of information in connection 

with this proposal. 

944ETA May 4 Letter. 

945 Id., at 8. 

person will be obligated to register as a 

major swap participant based upon its 

maintenance of 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 proposing 

release and future rulemakings, the 

Commission also proposed that major 

swap participants should not be 

considered to be small entities for 

essentially the same reasons that it 

previously had determined large traders 

not to be small entities.935

In response to the proposing release, 

one commenter, representing a number 

of market participants, submitted a 

comment related to the RFA, stating that 

‘‘[e]ach of the complex and interrelated 

regulations currently being proposed by 

the Commission has both an individual, 

and a cumulative, effect on [certain] 

small entities,’’ and that the Small 

Business Administration had 

determined some of its members to be 

small entities.936 These members, as the 

Commission understands, have been 

determined to be small entities by the 

SBA because they are ‘‘primarily 

engaged in the generation, transmission, 

and/or distribution of electric energy for 

sale and [their] total electric output for 

the preceding fiscal year did not exceed 

4 million megawatt hours.’’ 937 Thus, the 

commenter concluded that the 

Commission should conduct a 

regulatory flexibility analysis for each of 

its rulemakings under the Dodd-Frank 

Act, including this rulemaking 

applicable to Business Conduct 

Standards for Swap Dealers and Major 

Swap Participants with 

Counterparties.938

This commenter did not provide any 

information on how the proposing 

release may have a significant economic 

effect on a substantial number of small 

entities. Nonetheless, the Commission 

has reevaluated this rulemaking in light 

of the statements made to it by this 

commenter. After further consideration 

of those statements, the Commission has 

again determined that this final 

rulemaking, which is applicable to swap 

dealers and major swap participants, 

will not have a significant economic 

effect on a substantial number of small 

entities. 

In terms of affecting a substantial 

number of small entities, the 

Commission is statutorily required to 

exempt from registration as a swap 

dealer those entities that engage in a de 

minimis quantity of swap dealing. Thus, 

it is expected that most small entities 

will not be required to register with the 

Commission as a swap dealer.939

Additionally, the Commission does not 

expect that the small entities identified 

by the commenter will be subject to 

registration with the Commission as a 

major swap participant, as most entities 

with total electric output not exceeding 

4 million megawatt hours are not 

expected to maintain ‘‘a substantial 

position in swaps’’ or swap positions 

that will ‘‘create substantial 

counterparty exposure that could have 

serious adverse effects on the financial 

stability of the United States banking 

system or financial markets.’’ 940

Accordingly, for the reasons stated in 

the proposing release, the Commission 

continues to believe that the Business 

Conduct Standards for Swap Dealers 

and Major Swap Participants with 

Counterparties rulemaking will not have 

a significant economic impact on a 

substantial number of small entities. 

Therefore, the Chairman, on behalf of 

the Commission, hereby certifies, 

pursuant to 5 U.S.C. 605(b), that these 

regulations being published today by 

this Federal Register release will not 

have a significant economic impact on 

a substantial number of small entities. 

B. Paperwork Reduction Act 

The Paperwork Reduction Act 

(‘‘PRA’’) 941 imposes certain 

requirements on Federal agencies in 

connection with their conducting or 

sponsoring any collection of 

information as defined by the PRA. 

Certain provisions of these regulations 

will result in new collection of 

information requirements within the 

meaning of the PRA. An agency may not 

conduct or sponsor, and a person is not 

required to respond to, a collection of 

information unless it displays a 

currently valid control number. 

In the proposing release, the 

Commission informed the public that, 

while the proposed rules did contain 

collections of information, these 

collections would overlap with 

collections proposed by the Commission 

in the Business Conduct Standards— 

Internal rulemakings 942 and with 

collections under the proposed rules 

adapting the recordkeeping, reporting 

and daily trading records requirements 

under § 1.31 to account for swap 

transactions.943 Thus, the Commission 

did not submit the proposing release to 

OMB for approval or for assignment of 

an OMB control number. 

The Commission invited comment on 

the accuracy of its estimate that no 

additional recordkeeping or information 

collection requirements or changes to 

existing collection requirements, other 

than those in the overlapping 

rulemakings, would result from the 

proposed rules. The Commission 

received no comments directly 

addressing this request, but it did 

receive one comment indirectly 

responsive to its invitation.944 In it, the 

commenter asserted that, for electric 

utilities that are governmental entities, 

the proposed rules require swap dealers 

and major swap participants to provide 

valuation and scenario analysis, as well 

as advice and disclaimers that are not 

currently requested or required by these 

electrical utilities.945 According to this 

commenter, these requirements will 

create new ‘‘paperwork’’ for the swap 

dealer or major swap participant, 

thereby creating new costs for the enduser. 

The Commission has accounted for 

the information collection costs 

attributable to the swap dealer and 

major swap participant as required by 

the PRA in the information collections 

prepared for the rulemakings noted 

above, and understands that the only 

costs that may be created for end-users 

is any costs for which the Commission 

has accounted that may be passed on to 

the end-user in the form of transaction 

fees, if at all, which would not require 

an increase in the Commission’s burden 

estimates in the information collections. 

Moreover, as the Commission noted in 

the proposing release, not only were the 

proposed disclosure rules aligned with 

current industry best practices, but 

several large swap dealers had told the 

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946See proposing release, 75 FR at 80645. 

947The Business Conduct Standards—Internal 

rulemakings referenced in the proposing release 

and their proposing release citations are: Governing 

the Duties of Swap Dealers, 75 FR 71397; CCO 

proposed rules, 75 FR 70881; and Conflict-ofInterest Standards by Swap Dealers, 75 FR 71391. 

The Commission submitted these proposing 

releases to the Office of Management and Budget 

(OMB) for review in accordance with 44 U.S.C. 

3507(d) and 5 CFR 1320.11. The Commission 

requested that OMB approve, and assign a new 

control number for, the collections of information 

covered by the proposing releases. 

948See Adaptation of Regulations to Incorporate 

Swaps, 76 FR 33066, Jun. 7, 2011. The Commission 

requested that OMB approve amendments to 

existing collections of information in connection 

with this proposal. 

949 7 U.S.C. 19(a). 

950 In exercising its broad discretionary authority 

under Section 4s(h), the Commission was guided by 

the purposes of the CEA contained in Section 3. 

Section 3 explicitly includes among the purposes of 

the CEA ‘‘to protect all market participants from 

fraudulent or other abusive sales practices * * *’’ 

and ‘‘to promote * * * fair competition * * * 

among * * * market participants.’’ The final 

business conduct standards accomplish that by 

holding swap dealers and major swap participants 

to fair dealing standards and by providing 

counterparties with tools necessary to negotiate 

effectively with swap dealers and major swap 

participants and make informed trading decisions. 

See also Sections 4s(h)(1)(D), 4s(h)(5)(B) and 

4s(h)(6) of the CEA. 

Commission staff during consultations 

that they were already providing 

counterparties with scenario analysis, at 

no extra charge.946 Therefore, 

considering what swap dealers have 

represented the current landscape to be, 

any ‘‘paperwork’’ associated with 

scenario analysis should already be 

passed along to today’s end-user. 

Moreover, to address counterparty 

concerns about costs and delay, the final 

rules will require scenario analysis only 

when requested by the counterparty for 

any swap not available for trading on a 

DCM or SEF and only from swap 

dealers, not major swap participants. In 

other circumstances, a swap dealer will 

have to notify its counterparty of the 

right to receive a scenario analysis. 

Thus, any pass-through costs for 

scenario analysis will be borne by those 

end-users that elect to receive it. 

Regardless, for purposes of this PRA 

analysis, these collections are part of the 

overall (1) supervision, compliance and 

recordkeeping requirements imposed by 

the Commission in the Business 

Conduct Standards—Internal 

rulemakings 947 and (2) recordkeeping, 

reporting and daily trading records 

requirements under §§ 1.31 and 1.35 of 

the Commission Regulations (17 CFR 

1.31 and 1.35).948 By their terms, these 

rules are part of the supervision, 

compliance and recordkeeping 

requirements that are provided for 

under the Business Conduct Standards– 

Internal rulemaking and the rulemaking 

adapting §§ 1.31 and 1.35 to swap 

transactions, and those rulemakings are 

compliant with PRA. 

C. Cost-Benefit Considerations 

Section 15(a) of the CEA requires the 

Commission to consider the costs and 

benefits of its action before 

promulgating a regulation under the 

CEA.949 In particular, the costs and 

benefits of the proposed Commission 

action shall be evaluated in light of the 

following five considerations: (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. The Commission has 

considered the costs and benefits of its 

business conduct standards rulemaking 

as part of the deliberative rulemaking 

process and discussed them below and 

throughout the preamble. 

The final rules in this adopting 

release implement Section 4s(h) of the 

CEA, which provides the Commission, 

subject to certain statutory 

requirements, with both mandatory and 

discretionary rulemaking authority to 

impose business conduct standards 

requirements on swap dealers and major 

swap participants in their dealings with 

counterparties, including Special 

Entities. Many of the final rules in this 

adopting release are mandated by 

Section 731 of the Dodd-Frank Act, 

leaving the Commission with little or no 

discretion to consider any alternatives 

where the statute prescribes particular 

requirements. Therefore, in many cases, 

the Commission’s final regulations 

adhere closely to the enabling language 

of the statute. For example, the statute 

directs the Commission to adopt rules 

requiring swap dealers and major swap 

participants to verify that counterparties 

meet eligibility criteria, disclose 

material information about 

contemplated swaps to counterparties, 

including the material risks and 

characteristics of the swap, and 

incentives and conflicts of interest that 

the swap dealer or major swap 

participant may have in connection 

with the swap. The Commission also 

must adopt rules that require swap 

dealers and major swap participants to 

provide counterparties with a daily 

mark for swaps and establish a duty for 

swap dealers and major swap 

participants to communicate in a fair 

and balanced manner based on 

principles of fair dealing and good faith. 

In formulating the final mandatory 

rules, the Commission adopted 

approaches that mitigate the potential 

costs while maintaining fidelity to the 

congressional intent behind Section 731 

the Dodd-Frank Act. 

In adopting rules using its 

discretionary authority, the Commission 

has acted consistently with the intent of 

Congress as expressed in Section 

4s(h)(3)(D) to establish business conduct 

standards that the Commission 

determines are appropriate in the public 

interest, for the protection of investors 

or otherwise in furtherance of the 

purposes of the CEA.950 The 

discretionary rules include confidential 

treatment of counterparty information, 

institutional suitability, ‘‘know your 

counterparty,’’ scenario analysis and 

pay-to-play restrictions. The 

discretionary rules reflect the 

Commission’s expertise in establishing 

and overseeing an effective regulatory 

scheme for derivatives market 

professionals and appropriate 

harmonization with existing business 

conduct standards across market 

sectors. The final rules strike an 

appropriate balance between protecting 

the public interest and providing a 

workable compliance framework for 

market participants. 

Section 731 of the Dodd-Frank Act, 

which added new Section 4s(h) to the 

CEA, gave the Commission broad new 

authority to set business conduct 

standards rules for swap dealers and 

major swap participants in response to 

abuses in the unregulated derivatives 

markets. Among the abuses were those 

that targeted Special Entities, such as 

municipalities and school districts, 

which led to the heightened protections 

for Special Entities in Sections 4s(h)(4) 

and (5). These abuses have been the 

subject of congressional hearings, 

regulatory enforcement actions and 

private litigation. Section 4s(h) is aimed 

at reversing a caveat emptor trading 

environment and providing 

transparency in dealings between swap 

dealers or major swap participants and 

their counterparties. Transparency is 

enhanced through: Mandatory pre-trade 

disclosures of material information and 

a daily mark; communications based on 

principles of fair dealing and good faith; 

and Special Entity provisions to ensure 

that swap transactions are in the ‘‘best 

interests’’ of the Special Entity. 

Congress also included a robust antifraud provision that applies to swap 

dealers and major swap participants in 

their dealings with counterparties. 

As contemplated by Congress through 

its grant of broad discretionary 

authority, the Commission 

supplemented the mandatory provisions 

in Section 4s(h) to limit the ability of 

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951For example, with respect to potential costs 

associated with restrictions on information flows 

from dealers to their counterparties and increased 

reliance by counterparties on dealers, there is no 

clear means of quantification because of the 

difficulty in designing metrics for these potential 

costs. In addition, because there is no historical 

period in which similar rules were in effect, there 

remains the formidable (and costly) challenge of 

comparing the current environment to the post-rule 

environment. This challenge is compounded by the 

likelihood that the effect of the rule will differ 

across dealers and across counterparties. 

Quantification of the potential delays in swap 

execution and higher associated fees faces similar 

challenges, including lack of available data over 

which to measure the effect (if any) of such delays. 

The combination of these factors makes it 

impractical to determine reliable estimates of these 

types of costs. Moreover, no commenters provided 

verifiable estimates. As a consequence, the 

discussion of these potential costs is undertaken in 

qualitative terms. 

The Commission recognizes that the business 

conduct standards rules impose certain compliance 

costs, most of which are the result of statutory 

mandates. Generally, the costs are anticipated to be 

incremental, because they are associated with 

existing, highly complementary compliance 

burdens imposed by the SEC or prudential 

dealers to employ abusive practices that 

could disadvantage market participants 

that are less sophisticated or have less 

market power. The final rules endeavor 

to protect market participants and the 

public without unduly restricting access 

to the important risk management tools 

and investment opportunities provided 

by swap markets. The final rules are 

informed by extensive consultations 

with relevant federal and foreign 

regulators and stakeholders. Where 

possible, the rules are harmonized with 

requirements in related market sectors, 

industry best practice recommendations 

and SRO rules. 

The Commission received comments 

regarding the potential costs and 

benefits of the proposed rules, which 

are discussed in detail above in each 

section of the preamble relating to the 

rules. The Commission considered these 

comments in adopting the final rules. 

The benefits of the final rules identified 

by commenters and the Commission 

include: (1) Enhanced transparency and 

reduced information asymmetries 

among market participants resulting 

from required disclosures and 

communications standards; (2) 

principles based duties that are 

sufficiently flexible to address emerging 

compliance issues; (3) Special Entity 

provisions to protect taxpayers, 

pensioners and charitable institutions 

from abusive practices; (4) a compliance 

framework and mechanisms, including 

safe harbors, that facilitate information 

flow and market access, mitigate costs 

and enhance legal certainty, while 

raising business conduct standards 

consistent with legislative intent; and 

(5) regulatory harmonization of existing 

business conduct standards and best 

practices in related market sectors and 

among dealers, including consideration 

of SRO guidance for comparable 

principles based rules. 

The costs identified by commenters 

include assertions that: (1) Required 

disclosures are costly both in resources 

and possible delays, and could create 

potential liability unless disclosure can 

be standardized with appropriate safe 

harbors; (2) requiring swap dealers and 

major swap participants to make 

suitability evaluations of counterparties 

for specific trades will increase 

transaction costs and may create 

execution delays (both when a 

counterparty with an established 

relationship with a given swap dealer 

elects to begin trading a product outside 

of that relationship and a counterparty 

with no such relationship looks to begin 

trading with a given dealer); (3) 

principles based rules may expose swap 

dealers and major swap participants to 

potential compliance risk in both 

enforcement and private rights of 

actions; as a result, swap dealers and 

major swap participants will pass the 

costs of added risk to their 

counterparties or there will be fewer 

possible swap dealer trading 

relationships, which could reduce 

liquidity; (4) execution delay and the 

chilling of trading activity may result as 

the rules will interfere with the flow of 

information between swap dealers or 

major swap participants and 

counterparties and impose barriers to 

efficient execution of transactions and 

possibly create moral hazard; and (5) the 

cost and risks to Special Entities may 

increase if dealers avoid such 

counterparties, and sophisticated 

Special Entities may not need the 

protections provided by the rules. 

The Commission considered the 

comments it received and, as discussed 

in detail in the various sections of the 

preamble above, and as highlighted 

below, has taken steps to mitigate the 

costs and lower the burdens to the 

extent possible while also achieving the 

regulatory objectives of the Dodd-Frank 

Act. For example, the final rules in this 

adopting release allow compliance on a 

relationship basis rather than a 

transaction basis, when appropriate, to 

meet disclosure and due diligence 

duties. In addition, whenever possible, 

the Commission provides guidance in 

complying with the principles based 

statutory disclosure duties, which 

should reduce the burdens of complying 

with such obligations. The Commission 

also confirmed that certain business 

conduct standards rules will not apply 

to swaps executed on a SEF or DCM 

where the swap dealer or major swap 

participant does not know the identity 

of the counterparty prior to execution, 

including verification of eligibility, 

disclosures and Special Entity 

requirements. Finally, the Commission 

created safe harbors where appropriate, 

including an affirmative defense for 

swap dealers and major swap 

participants to a non-scienter fraud 

claim, and, for non-scienter violations of 

the other rules, the Commission will 

consider good faith compliance with 

policies and procedures in exercising its 

prosecutorial discretion if such policies 

and procedures are reasonably designed 

to comply with the requirements of any 

particular rule. 

The Commission has considered the 

costs and benefits of the final rules in 

this adopting release pursuant to 

Section 15(a) of the CEA, including the 

comments it received relating to 

potential costs and benefits of each rule, 

where applicable. A discussion of the 

final rules in light of the Section 15(a) 

considerations is included below. In 

some cases, the Section 15(a) 

discussions apply to clusters of rules 

where the rules have a common purpose 

and shared costs and benefits. For 

example, the rules requiring disclosure 

of material information (risks, 

characteristics, incentives and conflicts 

of interest) have the common purpose of 

providing information to counterparties 

in a manner sufficient to enable 

counterparties to assess transactions 

before assuming the associated risks. 

The costs and benefits of providing such 

disclosures are similarly shared and, 

therefore, are addressed together to fully 

appreciate their cumulative effects. The 

Commission has indicated with respect 

to each rule how it has analyzed the five 

considerations in Section 15(a) of the 

CEA. 

With respect to quantification of the 

costs and benefits of the final business 

conduct standards rules, the 

Commission notes that, because the 

Dodd-Frank Act establishes a new 

regulatory regime for the swaps market, 

there is little or no reliable quantitative 

data upon which the Commission can 

evaluate, in verifiable numeric terms, 

the economic effects of the final 

business conduct standards rules. No 

commenters presented the Commission 

with verifiable data pertinent to any of 

the proposed rules, stated whether such 

verifiable data exists, or explained how 

such cost data or any empirical analysis 

of that data would inform the choice of 

implementation pursuant to a specific 

provision of the Dodd-Frank Act or 

whether such data and resultant 

empirical analysis is ascertainable with 

a degree of certainty that could inform 

Commission deliberations.951

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9807 

regulators. These existing regulations, however, are 

not uniformly applied across the entire dealer 

community. As a consequence, certain dealers are 

expected to face higher compliance costs than 

others. The lack of dealer-specific information (e.g., 

on current staffing levels and those levels 

envisioned as being necessary for compliance with 

the rule) prevents reliable estimation of these costs, 

and no such information was provided to the 

Commission during the comment period. 

952One late-filing commenter recently provided 

the Commission with a report to support its 

position 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 this final rulemaking. See NERA 

Dec. 20 letter, at 1. Based on responses to an 

anonymous survey of an unspecified number of 

firms identified only in the aggregate as 

nonfinancial energy companies that ‘‘could be 

captured’’ under the swap dealer definition, the 

report estimates that nonfinancial energy 

companies would incur certain initial and recurring 

regulatory compliance costs relevant to this 

rulemaking. As indicated in fn. 951, the 

Commission recognizes the potential for 

compliance costs associated with this rule to fall 

disproportionately across all swap dealers. The 

final rule attempts to minimize these burdens 

overall while remaining consistent with statutory 

intent. 

953Because the firm-wide supervision, 

compliance, and recordkeeping functions are all 

accounted for in the Business Conduct Standards— 

Internal Rulemakings (see Governing the Duties of 

Swap Dealers, 75 FR 71397; CCO proposed rules, 

75 FR 70881; and Conflict-of-Interest Standards by 

Swap Dealers, 75 FR 71391) and § 1.31 (see 

Adaptation of Regulations to Incorporate Swaps, 76 

FR 33066, Jun. 7, 2011), and these policies and 

procedures and record retention provisions are 

subsets of the overall supervision, compliance and 

recordkeeping functions of the swap dealer or major 

swap participant, the Commission also has 

considered the costs and benefits of these rules in 

connection with those other rulemakings. 

954This benefit is enhanced by the Commission 

requirement that recordkeeping policies and 

procedures ensure that records are sufficiently 

detailed to allow compliance officers and regulators 

to determine compliance. 

955 In particular, in connection with allegations of 

fraud under § 23.410(a)(2) and (3) (for violations of 

the fraud provisions under subpart H), final 

§ 23.410(b) provides that a swap dealer or major 

swap participant may establish an affirmative 

defense against allegations of violations of final 

§ 23.410(a)(2) and (3) by demonstrating that it did 

not act intentionally or recklessly and complied in 

good faith with written policies and procedures 

reasonably designed to meet the particular 

requirement that is the basis for the alleged 

violation. 

956As part of the materials submitted in an 

application for registration as a swap dealer or 

major swap participant, an applicant may submit its 

written policies and procedures to ‘‘demonstrate, 

concurrently with or subsequent to the filing of 

their Form 7–R with the National Futures 

Association, compliance with regulations adopted 

by the Commission pursuant to section[] * * * 

4s(h) * * * of the [CEA] * * *.’’ The Commission 

adopted final registration rules on the same day as 

these business conduct standards rules. See also 

proposed § 3.10(a)(1)(v)(A), Proposed Rules for 

Registration of Swap Dealers and Major Swap 

Participants, 75 FR 71379. 957See Section 747 of the Dodd-Frank Act. 

Commenters did not provide any 

verifiable cost estimates.952

1. Section 23.402(a)—Policies and 

Procedures To Ensure Compliance and 

Prevent Evasion and Section 23.402(g)— 

Record Retention 

a. Benefits 

Section 23.402(a) requires that swap 

dealers and major swap participants (1) 

have written policies and procedures to 

ensure compliance with subpart H of 

part 23 and to prevent evasion of any 

provision of the CEA or Commission 

Regulations, and (2) implement and 

monitor compliance with such policies 

and procedures as part of their 

supervision and risk management 

requirements as specified in subpart J of 

part 23. Section 23.402(g) requires that 

swap dealers and major swap 

participants create a record of their 

compliance with subpart H and retain 

records in accordance with subpart F 

and § 1.31. As a result, the requirements 

of § 23.402(a) and (g) are part of the 

overall supervision, compliance and 

recordkeeping regime established in 

Section 4s of the CEA and as 

implemented in the relevant internal 

business conduct standards 

rulemakings. As such, the costs and 

benefits of § 23.402(a) and (g) discussed 

herein are part of the overall costs and 

benefits of the related internal business 

conduct standards requirements as 

discussed in connection with those 

rulemakings 953 and are a function of the 

requirements in the other rules that 

comprise subpart H. In this way, 

§ 23.402(a) and (g) facilitates 

compliance with all of the subpart H 

business conduct standards rules. 

Although difficult to quantify, robust 

policies and procedures and 

documentation requirements will 

benefit all market participants.954 Swap 

dealers and major swap participants 

will benefit because, in the absence of 

fraud, the Commission will consider 

good faith compliance with policies and 

procedures reasonably designed to 

comply with the business conduct 

standards rules as a mitigating factor 

when exercising its prosecutorial 

discretion for violation of the rules.955

In addition, swap dealers and major 

swap participants will be able to rely on 

their policies and procedures to 

demonstrate compliance with subpart H 

in connection with their registration 

applications.956 The requirement to 

document compliance with the business 

conduct standards rules will reduce 

misunderstandings and complaints 

between swap dealers or major swap 

participants and counterparties. Robust 

compliance procedures will also benefit 

counterparties by encouraging a culture 

of compliance that will help to ensure 

that swap dealers and major swap 

participants deliver the protections 

intended by Section 4s(h). Section 

23.402(a) also requires swap dealers and 

major swap participants to have policies 

and procedures to prevent evasion of 

the CEA and Commission Regulations. 

Such policies and procedures will assist 

regulators in ensuring that the intent of 

Congress, particularly through the 

Dodd-Frank Act amendments, is abided 

and that the Commission’s jurisdictional 

markets are not used to circumvent 

regulatory requirements, including by 

engaging in fraud or other abuses.957

Implementing anti-evasion policies and 

procedures as part of the supervision, 

risk management and compliance 

regimes of swap dealers and major swap 

participants should benefit swap 

markets by enhancing transparency and 

encouraging participation. 

b. Costs 

While there will be costs associated 

with establishing, implementing, 

testing, reviewing and auditing 

compliance with policies and 

procedures, the Commission expects 

these costs to be incremental. Many 

swap dealers and major swap 

participants are already subject to 

comprehensive supervision, compliance 

and recordkeeping requirements 

imposed in related regulated market 

sectors, including futures, banking and 

securities. Therefore, the additional 

costs will be limited to adapting existing 

policies and procedures to 

accommodate these new requirements. 

Regardless, the costs will be an 

incremental part of a swap dealer’s or 

major swap participant’s overall risk 

management program as required under 

subpart J and may be tailored to the 

swap related business conducted by a 

particular swap dealer or major swap 

participant. 

Similarly, there will be costs 

associated with record retention, 

including the costs of creating a record 

of compliance and storing it. To mitigate 

these costs, the Commission has 

confirmed that counterparty 

relationship documentation containing 

standard form disclosures, other 

material information and counterparty 

representations may be part of the 

written record of compliance with the 

external business conduct rules that 

require certain disclosures and due 

diligence. Further, swap dealers and 

major swap participants may choose to 

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9808 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

958Swap dealers and major swap participants will 

have to retain a record of all required information 

irrespective of the method used to convey such 

information. 

959See Governing the Duties of Swap Dealers, 75 

FR 71397; CCO proposed rules, 75 FR 70881; 

Conflict-of-Interest Standards by Swap Dealers, 75 

FR 71391; and § 1.31 (see Adaptation of Regulations 

to Incorporate Swaps, 76 FR 33066). 

use internet based applications to 

provide disclosures and daily marks.958

c. Section 15(a) of the CEA 

In light of the foregoing, the 

Commission has evaluated the costs and 

benefits of final § 23.402(a) and (g) 

pursuant to the five considerations 

identified in Section 15(a) of the CEA as 

follows: 

i. Protection of Market Participants and 

the Public 

The Commission believes that the 

§ 23.402(a) policies and procedures and 

record retention requirements, which 

are part of the overall supervision, risk 

management and compliance systems of 

swap dealers and major swap 

participants included in subparts F and 

J of part 23, reinforce subpart H’s 

protections for swap market participants 

and the public by promoting 

compliance with subpart H and 

discouraging evasion of regulatory 

requirements. The costs of compliance 

are incremental and do not diminish the 

intended benefits of the business 

conduct standards rules for market 

participants. 

ii. Efficiency, Competitiveness and 

Financial Integrity 

The Commission believes that 

effective internal risk management and 

oversight protects the financial integrity 

of the critical market participants— 

individual swap dealers and major swap 

participants. Their financial integrity, in 

turn, promotes the financial integrity of 

derivatives markets as a whole by 

fostering confidence in financial system 

stability. Additionally, the Commission 

believes that § 23.402(a) will enhance 

the efficiency and competitiveness of 

markets to the extent that swap dealers 

and major swap participants have sound 

risk management programs. 

Accurate recordkeeping is 

foundational to sound risk management 

and the financial integrity of swap 

dealers and major swap participants. 

The recordkeeping rules, including 

§ 23.402(g), will enhance confidence in 

the financial integrity of the market and 

encourage participation by avoiding 

misunderstandings and reducing the 

potential for disputes between 

counterparties and evasion of regulatory 

requirements. Documentation will 

facilitate compliance reviews and 

Commission enforcement actions for 

failure to comply with disclosure, due 

diligence and fair dealing requirements. 

iii. Price Discovery 

The Commission does not believe that 

§ 23.402(a) and (g) will have a material 

impact on price discovery. 

iv. Sound Risk Management Practices 

The policies and procedures and 

record retention provisions in 

§ 23.402(a) and (g) which apply 

principally to counterparty 

relationships of swap dealers and major 

swap participants are subsets of the 

overall supervision, compliance, 

recordkeeping and risk management 

functions of the swap dealer or major 

swap participant (as accounted for in 

the Business Conduct Standards— 

Internal rulemakings).959 The 

Commission believes that proper 

recordkeeping is essential to risk 

management because it facilitates an 

entity’s awareness of its swap business. 

Such awareness supports sound internal 

risk management policies and 

procedures by ensuring that decisionmakers within swap dealers and major 

swap participants are fully informed 

about the entity’s activities, including 

its dealings with counterparties, and can 

take steps to mitigate and address 

significant risks faced by the entity. 

When individual market participants 

engage in sound risk management 

practices, the entire market benefits. On 

the other hand, compliance with these 

policies and procedures and 

recordkeeping requirements is likely to 

require investment in recordkeeping, as 

well as front office and back office 

systems. The costs associated with this 

investment might otherwise be used to 

enhance other aspects of a firm’s risk 

management program. 

v. Other Public Interest Considerations 

The Commission has not identified 

any other public interest considerations 

in connection with § 23.402(a) or (g). 

2. Section 23.402(b)—Know Your 

Counterparty; Section 23.402(c)—True 

Name and Owner; and Section 23.434— 

Recommendations to Counterparties— 

Institutional Suitability 

a. Benefits 

The Commission is promulgating 

certain due diligence rules for swap 

dealers pursuant to its discretionary 

authority under Section 4s(h) that 

further the purposes of the Dodd-Frank 

Act business conduct standards 

provisions. These final rules are 

§§ 23.402(b)—Know your counterparty, 

23.402(c)—True name and owner, and 

23.434—Institutional suitability 

(collectively, the ‘‘due diligence rules’’). 

Sections 23.402(b) and 23.402(c) 

require a swap dealer to use reasonable 

due diligence to obtain and retain a 

record of the essential facts concerning 

each counterparty whose identity is 

known to the swap dealer prior to the 

execution of the transaction and the 

authority of any person acting for such 

counterparty. Final § 23.434 requires 

swap dealers making recommendations 

to undertake reasonable diligence to 

understand the potential risks and 

rewards of the swap or trading strategy 

and to have a reasonable basis to believe 

that the swap is suitable for the 

counterparty. 

All of the due diligence rules confer 

similar benefits in that they protect the 

public and market participants by 

requiring swap dealers to have essential 

information about their counterparties 

prior to entering into transactions and, 

to the extent they are making a 

recommendation, understand the 

trading objectives and characteristics of 

the counterparty. While not readily 

amenable to quantification, the benefits 

of the rules are significant. The rules are 

designed to prevent the potentially 

considerable costs for the counterparty 

(and incidentally the swap dealer when 

a counterparty is unable or unwilling to 

cover losses) of entering into unsuitable 

transactions. Such costs include losses 

associated with the position, generally, 

and the costs (at times considerable) of 

both exiting the position and 

establishing a new position, recognizing 

that the discovery of an ‘‘unsuitable’’ 

trade is more likely to occur during a 

period of market stress, which may 

magnify these costs. In this way, the due 

diligence rules are an integral 

component of the business conduct 

standards that are, in large part, 

designed to ensure that the 

counterparties and dealers understand 

the swap or trading strategy and place 

the dealer and counterparty on equal 

footing with respect to the risks and 

rewards of a particular swap or trading 

strategy. 

The Commission believes that the due 

diligence rules will secondarily benefit 

dealers and regulators by requiring that 

a dealer be able to document essential 

information about its counterparties and 

any swaps or trading strategies that it 

recommends. While not a quantifiable 

benefit, documentation will facilitate 

effective review of a recommendation’s 

suitability and render such 

recommendations less susceptible to 

‘‘second-guessing,’’ as well as review of 

the authority of its counterparty to enter 

into transactions. The due diligence 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9809 

960See, e.g., Section III.A.3.b. at fn. 179 

discussing SRO know your customer rules; see also 

Section III.G.3. at fn. 536 discussing suitability 

requirements under the banking and federal 

securities laws. 

961See Section III.A.3.b. of this release at fn. 188 

discussing final § 23.402(b) (know your 

counterparty), Section III.F.3. of this release at fn. 

500 discussing final § 23.433 (communications-fair 

dealing), and Section III.G.3. of this release at fn. 

542 discussing final § 23.434 (recommendations to 

counterparties–institutional suitability). 

962See, e.g., CFA/AFR Feb. 22 Letter, at 1–4; 

Better Markets Feb. 22 Letter, 1–2; Sen. Levin Aug. 

29 Letter, at 2–5 and 8–10; Senate Report, at 382, 

397–98 and 619–24. 

rules relate to the risk management 

systems of the swap dealer making 

explicit the requirement that the swap 

dealer obtain facts required to 

implement the swap dealer’s credit and 

operational risk management policies in 

connection with transactions entered 

into with the counterparty. The due 

diligence rules also harmonize the 

requirements for market professionals in 

related market sectors, including 

futures, securities and banking. An 

ancillary public interest benefit of such 

rules in those related markets has been 

their deterrence of counterparty 

misconduct, including, for example, 

unauthorized trading and money 

laundering. 

b. Costs 

The primary costs of final 

§§ 23.402(b), (c) and 23.434 are 

associated with obtaining information 

necessary to identify the counterparty, 

conducting any required due diligence 

before making a recommendation and 

maintaining records of essential 

customer information and suitability 

determinations. The Commission 

believes these costs are mitigated by at 

least five factors. First, as stated above, 

many of the dealers subject to these 

rules have long been subject to similar 

obligations under either NFA rules or 

the mandates of regulatory authorities in 

other markets, including banking and 

securities.960 As such, the incremental 

costs of complying with the 

Commission’s final rules are likely to be 

insignificant. Indeed, the Commission 

confirmed that it would consider SRO 

interpretations of analogous provisions, 

as appropriate, when assessing 

compliance with the due diligence rules 

by swap dealers.961 Second, in response 

to the comments it received, the 

Commission elected to promulgate 

several cost-mitigating alternatives to 

the proposed due diligence rules. For 

example, the Commission made clear 

that a dealer could fulfill its 

counterparty-specific suitability 

obligations through certain 

representations from the counterparty. 

Third, the Commission provided 

additional guidance, including a 

detailed explanation of what is likely 

and, as importantly, unlikely to 

constitute a ‘‘recommendation’’ within 

the meaning of final § 23.434. The 

guidance is included in the preamble to 

the final rules as well as in Appendix 

A to subpart H of part 23 of the 

Commission’s Regulations. Fourth, the 

Commission made clear that a 

determination of whether a dealer acted 

in compliance with the rules is an 

objective inquiry based on a 

consideration of all the relevant facts 

and circumstances surrounding a 

particular recommendation. Fifth, the 

Commission set forth various safe 

harbors from which a dealer could 

demonstrate compliance. In these and 

other ways, the Commission believes 

that it has taken meaningful steps to 

minimize the risks and costs of 

compliance and any ancillary costs 

associated with, for example, vexatious 

litigation by a counterparty 

experiencing buyer’s remorse. 

Commenters expressed concerns 

about potential costs of the due 

diligence rules. They claimed that the 

proposed due diligence requirements 

would interfere with efficient execution 

of transactions if required on a 

transaction-by-transaction basis. The 

proposed rules also may have 

disadvantaged counterparties by 

requiring them to provide confidential 

information to swap dealers that could 

be used against them in negotiations or 

misappropriated by swap dealers. The 

Commission has made a number of 

changes in the final rules to mitigate 

those costs. For example, the 

Commission clarified that the due 

diligence requirements can be satisfied 

on a relationship basis, where 

appropriate, in accordance with final 

§ 23.402(d), through representations 

from the counterparty that can be 

contained in counterparty relationship 

documentation. The Commission also 

amended the requirements in the ‘‘know 

your counterparty’’ rule to align with 

the arm’s length nature of the 

relationship between swap dealers and 

counterparties. In addition, the 

Commission adopted a confidential 

treatment rule, § 23.410(c), that protects 

confidential counterparty information 

from disclosure and use that would be 

materially adverse to the interests of the 

counterparty. 

c. Section 15(a) of the CEA 

In light of the foregoing, the 

Commission has evaluated the costs and 

benefits of the final due diligence rules 

pursuant to the five considerations 

identified in Section 15(a) of the CEA as 

follows: 

i. Protection of Market Participants and 

the Public 

The final due diligence rules, 

although discretionary, are important 

components of the business conduct 

standards regime that Congress 

mandated to add to the integrity of the 

swaps market. By codifying and, in 

some cases, enhancing current market 

practices, the final rules provide 

protections for counterparties. More 

specifically, the rules protect market 

participants and the public from the 

risks attendant to swap dealers 

subrogating customers’ interests to 

increase the dealer’s own profit 

maximizing interests by selling 

unsuitable swaps or trading strategies. 

The requirement that dealers make 

suitable recommendations, together 

with the requirement that swap dealers 

know their counterparty, should help to 

ameliorate the risks associated with 

unfair dealing. Taken together, these 

practices should also help regulators 

perform their functions in an effective 

manner. The informational and 

diligence costs associated with this 

rulemaking are incremental and do not 

diminish these benefits. 

ii. Efficiency, Competitiveness and 

Financial Integrity 

A frequent criticism of the swaps 

market leading up to the 2008 financial 

crisis was that dealers engaged in selfdealing to the detriment of customers 

and counterparties, such as by offering 

swaps and trading strategies that the 

dealers knew were unsuitable for the 

specific counterparty.962

Recommending products that have no 

beneficial purpose other than to enrich 

the dealer erodes confidence in markets, 

which, in turn, casts doubt on the 

efficiency, competitiveness and 

financial integrity of the markets subject 

to the jurisdiction of the Commission. 

The Commission designed these rules 

to achieve the intended statutory 

benefits set forth in the Dodd-Frank Act 

and concludes that any incremental 

costs above the statutory-baseline will 

not be of such magnitude so as to 

impede swap market efficiency, 

competitiveness or financial integrity of 

the markets. 

iii. Price Discovery 

To the extent the final due diligence 

rules, which are part of a larger business 

conduct standards regulatory 

framework, prevent the aforementioned 

erosion of confidence in the markets, 

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9810 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

963See Sections III.A.3.b., III.C., III.G., IV.B. and 

IV.C. in this adopting release for a discussion of the 

following final due diligence rules, respectively: 

§ 23.402(b)—Know your counterparty; § 23.430— 

Verification of counterparty eligibility; § 23.434— 

Institutional suitability; § 23.440—Requirements for 

swap dealers acting as advisors to Special Entities; 

and § 23.450—Requirements for swap dealers and 

major swap participants acting as counterparties to 

Special Entities. 

964See SWIB Feb. 22 Letter, at 5. The costs and 

benefits associated with the ability of swap dealers 

and major swap participants to reasonably rely on 

a counterparty’s representations are discussed in 

greater detail under the cost-benefit considerations 

for the particular requirements to which it applies: 

§ 23.402(c) (True Name and Owner), § 23.430 

(Verification of Counterparty Eligibility), § 23.434 

(Recommendations to Counterparties—Institutional 

Suitability), § 23.440 (Requirements for Swap 

Dealers Acting as Advisors to Special Entities), and 

§ 23.450 (Requirements for Swap Dealers and Major 

Swap Participants Acting as Counterparties to 

Special Entities). 

they also facilitate price discovery albeit 

indirectly. 

iv. Sound Risk Management Practices 

Verification and recording of 

counterparty identities, and carefully 

considered and well-documented 

recommendations, improve the risk 

management practices of a swap dealer 

and have concomitant benefits in that 

actual compliance with the final rules 

will help to insulate the dealer from 

later accusations by a disgruntled 

counterparty seeking to exit an 

unprofitable swap position by alleging, 

for example, that the dealer engaged in 

malfeasance or recklessness in 

recommending a swap or trading 

strategy. The above-acknowledged 

informational and diligence costs do not 

directly diminish these benefits. 

v. Other Public Interest Considerations 

The due diligence rules have the 

ancillary benefit of dissuading market 

participants from using Commission 

regulated derivatives markets to engage 

in illegal conduct in violation of other 

criminal laws, including money 

laundering and tax evasion. Swap 

dealers will be required to obtain certain 

essential information from 

counterparties to know their identity, 

their authority to trade and who 

controls their trading. This type of 

information has been helpful in related 

market sectors, like futures, securities 

and banking, in detecting and deterring 

such misconduct. 

3. Section 23.402(d)—Reasonable 

Reliance on Representations 

a. Benefits 

Section 23.402(d) does not impose 

any affirmative duties on swap dealers 

or major swap dealers, but rather 

provides them with an alternative 

means of compliance with certain other 

rules under subpart H of part 23 that 

require due diligence.963 In this way, 

the rule benefits market participants by 

facilitating compliance with certain of 

the business conduct standards rules 

without undermining the protections 

intended by the rules. 

The rule allows swap dealers and 

major swap participants to rely on 

written representations from 

counterparties and their representatives 

to satisfy certain due diligence 

obligations unless the swap dealer or 

major swap participant has information 

that would cause a reasonable person to 

question the accuracy of the 

representation. Furthermore, 

representations can be made on a 

relationship basis in counterparty 

relationship documentation and need 

not be made on a transaction-bytransaction basis, provided that the 

counterparty undertakes to timely 

update such representations in 

connection with new swaps. 

Swap dealers and major swap 

participants requested clarity about the 

type of information that would satisfy 

their due diligence obligations, and 

counterparties were concerned that they 

would be required to provide 

confidential financial and position 

information that would give swap 

dealers and major swap participants an 

unfair advantage in their swap related 

negotiations. Section 23.402(d), coupled 

with the safe harbors and guidance 

provided to address compliance with 

the due diligence rules in subpart H, 

will benefit all parties by streamlining 

the means of compliance to enable 

efficient execution of transactions 

without materially diminishing the 

protections intended by the Dodd-Frank 

Act business conduct standards. 

b. Costs 

Section 23.402(d) does not, by itself, 

impose any direct costs on market 

participants. The costs of this rule, if 

any, are indirect since the rule is only 

applicable where swap dealers, major 

swap participants and counterparties 

choose to rely on counterparty 

representations to satisfy due diligence 

requirements imposed by other business 

conduct standards rules. As such, any 

costs of the rule are accounted for in the 

analysis of the related rules. One other 

cost that could arise is if the swap dealer 

or major swap participant had 

information that would cause a 

reasonable person to question the 

accuracy of a representation. In that 

situation, the swap dealer or major swap 

participant could not rely on the 

representation without undertaking 

appropriate due diligence and incurring 

any costs associated with further 

inquiry. However, swap dealers and 

major swap participants benefit from 

such inquiry if it keeps them from 

entering into a swap under false 

pretenses. Moreover, if the Commission 

determined not to adopt the rule, the 

cost to swap dealers and major swap 

participants would be significant. Under 

that alternative, as one commenter 

asserted in connection with § 23.450— 

Acting as a counterparty to a Special 

Entity, swap dealers and major swap 

participants might stop entering into 

swaps altogether or, at the very least, 

pass increased costs onto their 

counterparties.964

c. Section 15(a) of the CEA 

In light of the foregoing, the 

Commission has evaluated the costs and 

benefits of final § 23.402(d) pursuant to 

the five considerations identified in 

Section 15(a) of the CEA as follows: 

i. Protection of Market Participants and 

the Public 

The purpose of the business conduct 

standards rules is to protect market 

participants and the general public. 

Final § 23.402(d) furthers that intent by 

providing clear instruction on how 

market participants can comply with 

certain of those rules. The proviso that 

a swap dealer and major swap 

participant can only rely on a 

counterparty’s representation in the 

absence of information that would cause 

them to question the accuracy of the 

representation protects swap dealers 

and major swap participants from the 

potentially negative consequences of 

entering into a swap in reliance on false 

information. This rule also protects 

counterparties by providing 

counterparties with control over the 

amount and type of information 

provided to a swap dealer or major swap 

participant. 

ii. Efficiency, Competitiveness and 

Financial Integrity 

This rule gives swap dealers and 

major swap participants a timely and 

cost-effective way to comply with their 

duties to counterparties. This increases 

the efficiency, competitiveness and 

financial integrity of the swaps market 

relative to an alternative that retains a 

due diligence requirement without an 

explicit means of compliance. 

Moreover, the Commission believes that 

the protection of proprietary 

information, which also is achieved 

through this rule, is essential for the 

competitiveness and integrity of 

derivatives markets. 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9811 

965Consistent with Section 4s(h)(3)(B) of the CEA, 

§ 23.431—Disclosures of material information, 

requires disclosure of material risks, characteristics, 

material incentives, conflicts of interest and daily 

mark relating to a swap. Associated rules include: 

§ 23.402(e)—Manner of disclosure; § 23.402(f)— 

Disclosures in a standard format; and § 23.432— 

Clearing. 

966See Section III.F. of this adopting release for 

a discussion of § 23.433—Communications—Fair 

Dealing. 967The mid-market mark will not include 

amounts for profit, credit reserve, hedging, funding, 

liquidity or any other costs of adjustments. 

968See NFA Interpretive Notice 9041–Obligations 

to Customers and other Market Participants 

(‘‘Communications with the Public—Under NFA 

Compliance Rules 2–4 and 2–29(a)(1), all 

communications with the public regarding security 

futures products must be based on principles of fair 

dealing and good faith * * *.’’); see also NASD 

Rule 2210(d). Final § 23.433 is also harmonized 

with the SEC’s proposed Fair and Balanced 

Communications rule for SBS Entities. See 

proposed 17 CFR 240.15Fh–3(g), SEC’s proposed 

rules, 76 FR at 42455; and SEC’s proposed rules 

Correction, 76 FR 46668, Aug. 3, 2011. 

iii. Price Discovery 

The Commission does not believe that 

§ 23.402(d) will have a material impact 

on price discovery. 

iv. Sound Risk Management Practices 

The Commission does not believe that 

§ 23.402(d) will adversely impact sound 

risk management practices. While the 

principles based nature of the rules may 

introduce some uncertainty into the 

process of complying with the due 

diligence business conduct standards 

rules, the compliance roadmap in this 

particular rule decreases that risk by 

providing an efficient means for swap 

dealers and major swap participants to 

comply with several of their pretransactional duties. 

v. Other Public Interest Considerations 

The Commission has not identified 

any other public interest considerations 

in connection with § 23.402(d). 

4. Section 23.402(e)—Manner of 

Disclosure; Section 23.402(f)— 

Disclosures in a Standard Format; 

Section 23.431—Disclosure of Material 

Risks, Characteristics, Material 

Incentives and Conflicts of Interest 

Regarding a Swap; Section 23.432— 

Clearing Disclosures; and Section 

23.433—Communications—Fair Dealing 

a. Benefits 

Final § 23.431, which requires 

disclosures of material information, and 

the associated disclosure rules in 

subpart H of part 23 (the ‘‘disclosure 

rules’’) 965 contain the disclosure regime 

for swap dealers and major swap 

participants. These rules are 

fundamental to the transparency 

objectives of Section 4s(h) of the DoddFrank Act. The disclosure rules 

primarily benefit counterparties by 

requiring that swap dealers and major 

swap participants disclose material 

information regarding potential swap 

transactions, including material risks, 

characteristics, incentives, conflicts of 

interest, daily marks and rights relating 

to clearing of the swap. They also 

benefit counterparties by providing 

flexible and reliable means of 

compliance to take account of the nature 

of the swaps being offered and to avoid 

undue interference with the execution 

process. 

In addition, the communications-fair 

dealing rule in final § 23.433 adopts the 

statutory language in Section 4s(h)(3)(C) 

and requires swap dealers and major 

swap participant ‘‘to communicate in a 

fair and balanced manner based on 

principles of fair dealing and good 

faith.’’ The fair dealing rule works in 

concert with the disclosure rules and 

the anti-fraud rules in § 23.410 (the 

‘‘abusive practices rules’’) to provide 

transparency to market participants in 

dealing with swap dealers and major 

swap participants.966

While not readily amenable to 

quantification, the benefits of the 

disclosure and fair dealing rules are 

significant for counterparties. The 

disclosure rules will allow 

counterparties to better assess the risks 

and rewards of a swap and avoid swaps 

that are inconsistent with their trading 

objectives. The fair dealing rule ensures 

that swap dealers’ and major swap 

participants’ communications to 

counterparties are not exaggerated and 

discussions or presentations of profits or 

other benefits are balanced with the 

associated risks. The disclosure and fair 

dealing regime imposed by Section 4s(h) 

reverses the caveat emptor environment 

that permeated the unregulated 

derivatives marketplace prior to 

enactment of the Dodd-Frank Act and 

afforded little transparency or 

protection for either sophisticated 

counterparties or Special Entities. 

Legislative history indicates that the 

business conduct standards in Section 

4s(h) were the result of widespread 

concerns about sharp practices and 

significant information asymmetries 

between swap dealers and their 

counterparties that created significant 

imbalances in their respective 

bargaining power and the assumption of 

unanticipated risks by counterparties. 

The disclosure and fair dealing rules 

implement the statutory objective of 

transparency for all swap transactions. 

With respect to disclosures of the 

daily mark for uncleared swaps, the 

rules will provide counterparties, on a 

daily basis, the mid-market mark for the 

swap.967 This information will provide 

an objective reference mark for 

counterparties to assist them in valuing 

open positions on their books for a 

variety of purposes, including risk 

management. The standard in the rule is 

intended to achieve a degree of 

consistency in the calculation of the 

daily mark across swap dealers and 

major swap participants. Such 

consistency will provide added 

transparency in pricing transactions and 

enhance the ability of counterparties to 

consider daily marks for their own 

valuation purposes. Counterparties will 

also receive from the swap dealer or 

major swap participant a mid-market 

mark along with the price of any swap 

prior to entering into the swap. Again, 

receiving the mid-market mark prior to 

execution of a swap will assist 

counterparties in assessing the price of 

a swap and negotiating swap terms, 

generally, with swap dealers and major 

swap participants. 

The Commission believes that the 

disclosure rules will secondarily benefit 

swap dealers, major swap participants 

and regulators by requiring 

documentation of swap-related 

disclosures. While not a quantifiable 

benefit, documentation will facilitate 

effective supervision and compliance 

with required disclosures, which should 

reduce potential complaints, 

investigations and litigation. The fair 

dealing rule also benefits swap dealers 

and major swap participants by 

harmonizing the statutory requirements 

with similar protections that currently 

apply to registrants in the futures and 

securities markets.968

b. Costs 

The primary costs of the disclosure 

rules are associated with implementing 

policies and procedures to achieve 

compliance with the principles based 

disclosure requirements, preparing and 

disseminating the disclosures, and 

maintaining records of the disclosures. 

The Commission expects that expenses 

will vary depending on the regulatory 

status of the swap dealer or major swap 

participant with financial firms 

regulated by prudential or securities 

authorities having relatively less 

additional costs because of existing 

regulatory requirements. Costs will also 

vary depending on the nature of the 

business conducted by the swap dealer 

considering that the process of making 

disclosures may be more streamlined for 

standardized swaps than, for example, 

complex bespoke swaps. 

Regardless, the Commission believes 

that any costs associated with the 

disclosure rules will be incremental for 

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9812 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

969NY City Bar Feb. 22 Letter, at 3. 

970FHLBanks Feb. 22 Letter, at 6. 

971See Section III.F.3. of this adopting release for 

a discussion of final § 23.433 and NFA guidance. 

the following reasons. First, as stated 

above in Section III.D. of this adopting 

release, many swap dealers and major 

swap participants subject to this scheme 

have long been subject to similar 

disclosure obligations based on informal 

OTC derivatives industry practice and 

under the mandates of regulatory 

authorities in related market sectors, 

including banking, securities and 

insurance. As such, the incremental cost 

of complying with the Commission’s 

final rules is likely to be small relative 

to the overall costs of operating as a 

swap dealer or major swap participant. 

Second, in response to comments, the 

Commission elected to promulgate 

several cost-mitigating alternatives in 

the final disclosure rules. For example, 

the Commission made clear that a swap 

dealer or major swap participant could 

fulfill its disclosure obligations by any 

reliable means agreed to in writing by 

the counterparty. In addition, 

disclosures applicable to multiple 

swaps may be made in counterparty 

relationship documentation or other 

written agreements rather than on a 

transaction-by-transaction basis. The 

scenario analysis rule was revised from 

mandatory to elective and limited to 

swaps that are not made available for 

trading on a DCM or SEF. Further, 

anonymous transactions initiated on a 

SEF or DCM are exempt from the pretransaction disclosure requirements. 

Third, the Commission provided 

additional guidance in response to 

comments regarding many aspects of the 

disclosure scheme, including manner of 

disclosure, disclosures in a standard 

format, material risks, scenario analysis, 

material characteristics, material 

incentives, conflicts of interest, daily 

mark and clearing issues. Fourth, the 

Commission made clear that in 

exercising its prosecutorial discretion 

for disclosure violations, it would 

consider whether the swap dealer or 

major swap participant had complied in 

good faith with policies and procedures 

reasonably designed to comply with the 

particular disclosure requirement. In 

these and other ways, the Commission 

believes that it has taken meaningful 

steps to minimize the risks and costs of 

compliance and any ancillary costs 

associated with, for example, private 

rights of action by counterparties 

unhappy with a particular swap 

transaction. 

The Commission is allowing swap 

dealers and major swap participants to 

satisfy their disclosure obligations, 

where appropriate, on a relationship 

basis, as opposed to a transaction-bytransaction basis as a way of avoiding 

trading delays and the associated costs. 

However, in certain instances, 

consistent with the statutory 

requirement that swap dealers and 

major swap participants disclose 

information about the material risks and 

characteristics of the swap, the 

disclosure obligation will require 

supplements to standardized 

disclosures that are, to a degree, tailored 

to the individual transaction under 

consideration. The costs and benefits of 

these types of transaction-specific 

disclosures are considered relative to a 

case where material risk disclosure, as 

required under the statute, is 

accomplished at a level less granular 

than that which tailors such disclosure 

to a particular swap type. In addition, 

since the requirement for scenario 

analysis, through its value for 

illustrating material risk, is made at the 

discretion of the Commission, its 

associated costs and benefits are 

discussed relative to the absence of such 

a requirement. 

Commenters also identified costs 

associated with the fair dealing rule. 

One commenter asserted that the 

principles based nature of the proposed 

fair dealing rule had the potential to 

impose costs on swap dealers and major 

swap participants including costs 

resulting from compliance risk.969 As 

discussed in the introduction to this 

Section VI.C. of this adopting release, 

such costs are not readily subject to 

quantification. Another commenter 

requested that the Commission clarify 

the standards for communication by 

reference to existing SRO standards 

applicable in related market sectors.970

In response to commenters, the 

Commission clarifies in this adopting 

release that it will consider NFA 

guidance when interpreting § 23.433.971

The Commission believes harmonizing 

with existing SRO rules and precedents 

in the futures and securities markets 

diminishes the potential costs 

associated with legal uncertainty. 

Furthermore, the Commission clarifies 

in this adopting release that, in the 

absence of fraud, the Commission will 

consider good faith compliance with 

policies and procedures reasonably 

designed to comply with the fair dealing 

rule as a mitigating factor when 

exercising its prosecutorial discretion in 

connection with a violation of § 23.433. 

c. Section 15(a) of the CEA 

In light of the foregoing, the 

Commission has evaluated the costs and 

benefits of the final disclosure rules and 

the fair dealing rule pursuant to the five 

considerations identified in Section 

15(a) of the CEA as follows: 

i. Protection of Market Participants and 

the Public 

The principal purpose of the 

disclosure rules is to protect market 

participants and the public by making 

swaps more transparent to enable 

counterparties to better assess the risks 

and rewards of entering into a particular 

transaction. The disclosure rules are a 

core component of the overall business 

conduct standards regime imposed in 

Section 4s(h) of the Dodd-Frank Act. 

In determining how to implement the 

statutory disclosure requirements, the 

Commission considered certain negative 

externalities that may be created by 

requiring swap dealers and major swap 

participants to provide transaction 

specific disclosures. One risk is that 

requiring such disclosures by swap 

dealers and major swap participants 

could create disincentives to 

counterparties for performing their own 

independent assessments of a 

transaction under consideration. As a 

result, there is an increased likelihood 

that any insufficiencies in the 

information provided by swap dealers 

and major swap participants that are not 

easily discernible at the time the 

disclosure is made could impact an 

expanded class of market participants in 

a similar way. For instance, the model 

risk borne by swap dealers and major 

swap participants may be transferred 

onto a broader set of market 

participants. 

In addition, transaction-specific 

disclosures, generally, and specifically 

those based on model outputs (e.g., 

certain scenario analyses) require 

ongoing validation to ensure their 

sufficiency, accuracy and relevance. To 

the extent that the level of these 

validation efforts varies across swap 

dealers and major swap participants, the 

risk of relative insufficiencies or 

omissions in disclosure borne by the 

counterparties reliant on this 

information will vary correspondingly. 

Because the disclosure rules are 

principles based, the quality of policies 

and procedures adopted by swap 

dealers and major swap participants 

will play a significant role in 

determining the sufficiency, accuracy 

and relevance of the disclosures made to 

counterparties. Moreover, some of the 

disclosures are models-based, whether 

through disclosures of a given product’s 

sensitivity to certain market risk factors 

or the performance of the product 

during different scenario events or 

episodes. Policies and procedures, 

generally, and especially those 

governing models require ongoing 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9813 

972See Section VI.C.5.c.iii. of this adopting 

release for a discussion of price discovery 

considerations of final § 23.410—Prohibition on 

fraud, manipulation and other abusive practices. 

validation to ensure their sufficiency, 

accuracy and relevance. The 

consequences of varying levels of 

supervision, to the extent that these 

levels vary in their ability to preserve 

the sufficiency, accuracy and relevance 

of the disclosures, will be borne by 

counterparties. Any such differences in 

supervisory efforts, to the extent they 

are allowed to persist, lessen the degree 

to which counterparties can rely on the 

information being provided to them. To 

mitigate these concerns, the Dodd-Frank 

Act imposes robust supervision and 

compliance requirements on swap 

dealers and major swap participants, 

which are implemented in subpart J of 

part 23. In subpart H, and in guidance 

in this adopting release, the 

Commission has endeavored to clarify 

the relationship between swap dealers 

and major swap participants, on the one 

hand, and counterparties on the other to 

discourage undue reliance and to 

incentivize counterparties to engage in 

appropriate due diligence before 

entering into swaps. 

Transaction-specific information is 

certainly valuable to the counterparty to 

assess the relative merits of a 

prospective transaction. Through 

economies of scale, swap dealers and 

major swap participants may be better 

positioned to provide these disclosures 

(as opposed to the counterparty 

discovering the information itself). In 

other words, swap dealers and major 

swap participants may be the lowestcost provider of this information. As a 

result, efficiency gains may be realized 

by requiring swap dealers and major 

swap participants to disseminate this 

information. The fact that commenters 

point to significant information 

advantages enjoyed by swap dealers and 

major swap participants over their 

counterparties supports this lowest-cost 

solution. 

Additionally, the fair dealing rule 

protects market participants and the 

public by requiring that 

communications between swap dealers 

or major swap participants and their 

counterparties are conducted based on 

principles of fair dealing and good faith. 

The rule raises the standard for 

communications in the previously 

unregulated swaps market and 

encourages confidence in the swap 

market by market participants and the 

public. The fair dealing rule, 

particularly in conjunction with the 

disclosure rules, ensures that market 

participants have information necessary 

to assess the risks and rewards of a swap 

when dealing with swap dealers and 

major swap participants, which have 

had informational advantages over their 

counterparties by virtue of their roles in 

the marketplace. 

ii. Efficiency, Competitiveness and 

Financial Integrity 

Commenters raised concerns that 

requiring material information 

disclosure prior to execution may delay 

execution, increase market risk and 

adversely affect efficiency. Further, the 

required disclosures may result in 

proceedings or litigation, which could 

test the financial integrity of certain 

swap market participants. 

The Commission has designed the 

disclosure rules to minimize potential 

inefficiencies and anti-competitive 

results, and to bolster financial integrity. 

For example, the rules allow disclosures 

to be made by any reliable means agreed 

to by the counterparty. In addition, risk 

disclosures in a standard format may be 

included in counterparty relationship 

documentation or other written 

agreements between the parties. 

Scenario analysis is elective rather than 

mandatory. Moreover, because the 

disclosure rules are principles based, 

the Commission will take into account 

whether reasonably designed policies 

and procedures are in place prior to 

exercising its prosecutorial discretion 

when considering violations of the 

disclosure rules. 

The fair dealing rule principally 

protects counterparties; however, there 

are additional benefits for markets. The 

fair dealing rule, particularly when 

considered with the abusive practices 

rules and the disclosure rules, improves 

transparency and discourages abusive 

practices, and thereby encourages 

participation in the market, which 

contributes to liquidity, efficiency and 

competitiveness in the marketplace. 

Furthermore, the fair dealing rule assists 

market participants to assess potential 

risk in connection with a swap and 

make more informed decisions 

consistent with their trading objectives. 

iii. Price Discovery 

Transaction specific disclosures may, 

to a degree, cause delays in execution. 

These delays may occur either when a 

counterparty with an established 

relationship with a given swap dealer or 

major swap participant elects to begin 

trading a product outside of that 

relationship or a counterparty with no 

such relationship looks to begin trading 

with a given swap dealer or major swap 

participant. These delays may have 

negative consequences on liquidity, 

potentially subjecting counterparties to 

heightened transaction costs. Moreover, 

these delays may be pro-cyclical, 

meaning that they increase during times 

of heightened market volatility. In 

recognition of the potential for these 

delays, the Commission adopted several 

procedural provisions to mitigate 

adverse consequences, including (1) 

allowing, where appropriate, 

disclosures to be made at the 

relationship level as opposed to the 

transaction level, (2) allowing certain 

oral disclosures if agreed to by the 

counterparty and confirmed in writing, 

(3) making Web site-based disclosures 

(password-protected if for the daily 

mark) available, and (4) allowing swap 

dealers and major swap participants to 

partner with DCMs, SEFs, and/or thirdparty vendors to make certain 

disclosures. 

To the extent that delays in execution 

foster a more complete assessment of 

the merits of a particular transaction, 

the likelihood of after-the-fact 

realizations of ill-conceived positions 

may be reduced as well as any trading 

activity these realizations encourage. To 

the extent that this trading activity 

impacts market volatility, its reduction 

has positive implications for price 

discovery. Moreover, since these 

realizations are more likely to occur 

during periods of market stress, the 

corresponding benefit of their reduction 

may be elevated during such periods. 

As stated in the price discovery 

consideration of final § 23.410, the fair 

dealing rule benefits counterparties but 

also provides added benefits for 

markets.972 The fair dealing rule 

requires swap dealer and major swap 

participant communications to be fair 

and balanced and restricts misleading or 

other potentially abusive 

communications that could undermine 

the price discovery function of the swap 

market. 

iv. Sound Risk Management Practices 

Presumably, exercising the opt-in 

feature for scenario analysis will impart 

some cost to the counterparty. This cost 

will depend on the specificity of the 

analysis being requested and will be 

paid through some combination of 

delayed execution and/or higher fees. 

The rule attempts to mitigate these costs 

by making scenario analysis optional on 

the part of the counterparty as it is 

under current industry practice. 

Moreover, exercising this feature signals 

that the counterparty values the 

information provided by the analysis 

and, therefore, is willing to bear the 

associated costs. In contrast, a policy of 

mandatory scenario analysis forces this 

cost to be borne, to varying degrees, by 

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9814 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

973See the discussions of price discovery above 

for a description of the provisions designed to 

mitigate these delays. 

974The protections in final § 23.410 also address 

historical imbalances in negotiating power between 

swap dealers and counterparties related to 

sophistication and financial wherewithal. The 

treatment of confidential counterparty information 

by swap dealers depended on the relative ability of 

the parties to negotiate terms in their interest. 

975See Section 731 of Dodd-Frank Act. 

all market participants, even though the 

corresponding benefit to a subset of 

those participants may be at or near 

zero. As a result, the final scenario 

analysis provision furthers a primary 

objective of the Dodd-Frank Act by 

encouraging sound risk management 

practices among market participants 

without unduly imposing costs. 

Consistent with the statutory 

framework in Section 4s(h), whether 

standard form or particularized 

disclosures are sufficient in any given 

case will depend on the facts and 

circumstances of the subject transaction. 

Principles based disclosure rules take 

into account the various types of swap 

transactions that are subject to the rules 

(from highly standardized agreements to 

complex bespoke swaps), as well as the 

varied scope of swap related business 

undertaken by swap dealers and major 

swap participants. Compliance with 

principles based rules, like the 

disclosure rules, is by nature a matter of 

interpretation by swap dealers or major 

swap participants in the design of their 

policies and procedures, as well as by 

regulators and counterparties in their 

after-the-fact review of such disclosures, 

prompted, for example, by performance 

results that are claimed to be 

inconsistent with such disclosures. 

Subjective criteria introduce uncertainty 

into the compliance process and, in so 

doing, contribute to heightened risk 

costs that, at least in part, may be passed 

on to counterparties. Depending on how 

this uncertainty distributes across all 

swaps products, certain market 

participants may bear a disproportionate 

share of the resulting costs. The 

Commission attempts to dampen these 

costs, generally, by considering good 

faith compliance with policies and 

procedures reasonably designed to 

comply with the requirements of any 

particular rule. The rules also supply 

guidance for complying with these 

duties as a means for mitigating any 

uncertainty in regulatory compliance. 

To the extent that the disclosure rules 

contribute to execution delays, for the 

duration of these delays, market 

participants will either need to bear 

certain market risks or be prevented 

from taking on those risks.973

The fair dealing rule does not 

undermine sound risk management 

practices for swap dealers or major swap 

participants and has the potential to 

enhance risk management practices for 

counterparties. Counterparties will be 

able to manage their swap related risks 

based on more complete and reliable 

information from swap dealers and 

major swap participants. Swap dealers 

and major swap participants will be 

incentivized to implement policies and 

procedures reasonably designed to 

ensure that they make fair and balanced 

communications that provide their 

counterparties with a sound basis for 

evaluating the facts with respect to any 

swap. Similar to the discussion of the 

cost-benefit considerations of the antifraud rules, such practices will reduce 

counterparties’ risk that they may 

otherwise enter into a swap that is 

inconsistent with their trading 

objectives based on unbalanced or 

misleading communications. 

v. Other Public Interest Considerations 

The disclosure rules are designed to 

address historical information 

asymmetry between counterparties and 

swap dealers or major swap participants 

and should enable counterparties to 

better protect their own interests before 

assuming the risk of any particular swap 

transaction. In addition, requiring both 

the disclosure of material information 

and fair dealing will enhance 

transparency and promote counterparty 

confidence in the previously 

unregulated swap market, which better 

enables counterparties to use swaps to 

assume and manage risk. 

5. Section 23.410—Prohibition on 

Fraud, Manipulation and Other Abusive 

Practices 

a. Benefits 

Final § 23.410 prohibits fraud, 

manipulation and other abusive 

practices and is applicable to swap 

dealers and major swap participants. 

Section 23.410(a) mirrors the language 

of Section 4s(h)(4)(a) of the CEA. 

Section 23.410(b) provides an 

affirmative defense for swap dealers and 

major swap participants to alleged nonscienter violations of § 23.410(a)(2) and 

(3). Final § 23.410(c) prohibits swap 

dealers and major swap participants 

from disclosing confidential 

counterparty information or using such 

confidential information in a manner 

that would tend to be adverse to the 

counterparty. 

The rule primarily benefits 

counterparties, including Special 

Entities, in that it prohibits fraudulent, 

deceptive and manipulative practices by 

swap dealers and major swap 

participants and misuse of confidential 

information to the detriment of the 

counterparty. While not readily 

amenable to quantification, the benefits 

of the rule are significant. The rule is 

designed to mitigate the potentially 

considerable costs associated with a 

counterparty entering into a swap 

having been induced by fraudulent, 

deceptive or manipulative conduct. The 

rule also reduces the possibility that 

counterparties will be disadvantaged by 

manipulative conduct or misuse of 

confidential information by, among 

other things, improper disclosure of the 

counterparty’s trading positions, 

intentions to trade or financial status.974

In these ways, the rule is an integral 

component of the business conduct 

standards, which are, in large part, 

designed to ensure that counterparties 

and swap dealers are on equal footing 

with respect to understanding the risks 

and rewards of a particular swap or 

trading strategy. 

The rule also enhances the authority 

of the Commission to ensure fair and 

equitable markets. Market participants 

and the public will benefit substantially 

from such enhanced prevention and 

deterrence of fraud and manipulation. 

Rules protecting the confidential 

treatment of counterparty information 

and prohibiting fraud and manipulation 

encourage market participation, with 

the ensuing positive implications such 

participation has on market efficiency 

and price discovery. 

b. Costs 

The Commission does not believe that 

there will be significant costs in 

connection with final § 23.410. First, 

§ 23.410(a) merely codifies Section 

4s(h)(4)(A) of the CEA.975 To the extent 

there were any costs to be considered, 

Congress made that determination in 

promulgating Section 4s(h)(4)(A). 

Further, final § 23.410(b) has added an 

affirmative defense, which mitigates any 

costs that may have been imposed by 

the application of non-scienter fraud 

provisions in final §§ 23.410(a)(2) and 

(3) to swap dealers and major swap 

participants. The Commission believes 

that swap dealers and major swap 

participants already have in place 

policies and procedures, and provide 

training to ensure that their traders and 

staff do not engage in fraud and 

manipulation. To the extent there are 

any costs with respect to final 

§ 23.410(a), such costs will be related to 

training staff and ensuring that existing 

compliance procedures are up-to-date. 

In addition, such policies and 

procedures are already accounted for by 

virtue of the Commission’s 

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976See SIFMA/ISDA Feb. 17 Letter, at 11. 

977See Prohibition on Manipulative and 

Deceptive Devices, 76 FR at 41408–41409, for a 

discussion of the costs and benefits of final §§ 180.1 

and 180.2. 

promulgation of final §§ 180.1 and 

180.2, which similarly prohibit 

manipulative or deceptive conduct, as 

well as the other applicable anti-fraud 

and manipulation prohibitions in the 

CEA. 

To the extent there are costs with 

respect to the protection of confidential 

counterparty information, the primary 

costs of this rule are associated with 

implementing policies and procedures 

designed to protect such information. 

The design of the final rule, and the 

Commission guidance in this adopting 

release, address concerns by 

commenters that the proposed 

confidential treatment and trading 

ahead provisions would have unduly 

affected the ability of swap dealers and 

major swap participants to enter into 

transactions with other counterparties 

or manage their own risks. The 

Commission believes that the actual 

costs to swap dealers and major swap 

participants will be insubstantial and 

have been mitigated by the final rules. 

First, as stated above, swap dealers 

and major swap participants subject to 

final § 23.410(a) are already subject to 

Section 4s(h)(4)(A) of the CEA, which 

was added by the Dodd-Frank Act. In 

addition, as stated above, the 

Commission believes that swap dealers 

and major swap participants already 

have policies and procedures and a 

compliance regime in place to prevent 

fraud and manipulation by traders and 

staff. Further, swap dealers and major 

swap participants have long been 

subject to either self-imposed internal 

business conduct rules or to contractual 

requirements of confidentiality 

contained in negotiated swap 

agreements for individual swaps or in 

counterparty relationship 

documentation with counterparties.976

The Commission understands that 

there will be incremental costs 

associated with adapting existing 

policies and procedures to the new 

rules, but believes that these costs 

would be materially the same regardless 

of the rules’ substance. Final § 23.410(a) 

imposes no affirmative duties, and it is 

unlikely that it will impose any 

additional costs beyond the existing 

costs associated with ensuring that 

behavior and statements are not 

fraudulent, deceptive or 

manipulative.977 In this regard, the 

Commission believes it will not be 

necessary for firms that currently have 

adequate compliance programs to hire 

additional staff or significantly upgrade 

their systems to comply with the new 

rules, although firms may incur some 

compliance costs such as the cost 

associated with training traders and staff 

about the new rules. 

Finally, in response to comments 

regarding proposed § 23.410(a), the 

Commission elected to revise the 

proposed rule by adding a costmitigating section. Final § 23.410(b) 

provides that a swap dealer or major 

swap participant may establish an 

affirmative defense against allegations of 

violations of final § 23.410(a)(2) and (3) 

by demonstrating that it did not act 

intentionally or recklessly and complied 

in good faith with written policies and 

procedures reasonably designed to meet 

the particular requirement that is the 

basis for the alleged violation. With 

respect to the confidential treatment of 

counterparty information, the 

Commission provided that such 

confidential information may be 

disclosed or used for effective execution 

of the swap with the counterparty, to 

hedge or mitigate exposure created by 

the swap, or to comply with requests 

from regulators or as required by law, or 

as agreed by the counterparty. In these 

and other ways, the Commission 

believes that it has taken appropriate 

steps to minimize the risks and costs of 

compliance and any ancillary costs 

associated with final § 23.410 (e.g., 

vexatious litigation by a counterparty 

experiencing buyer’s remorse). 

c. Section 15(a) of the CEA 

In light of the foregoing, the 

Commission has evaluated the costs and 

benefits of final § 23.410 pursuant to the 

five considerations identified in Section 

15(a) of the CEA as follows: 

i. Protection of Market Participants and 

the Public 

The purpose of final § 23.410 is to 

protect market participants and the 

public by prohibiting fraud, 

manipulation and other abusive 

practices. Final § 23.410(a) codifies 

Section 4s(h)(4)(A) of the CEA and 

appropriately extends the protections 

intended under the Dodd-Frank Act. 

Final § 23.410(c) provides protection for 

counterparties by prohibiting disclosure 

and misuse of their confidential 

information. As such, § 23.410(c), 

although discretionary, is a central 

element in the business conduct 

standards regime that Congress 

mandated the Commission implement 

by imposing standards on swap dealers 

and major swap participants in their 

dealings with counterparties. The rule is 

also guided by Section 3(b) of the CEA, 

which explicitly includes among the 

purposes of the CEA ‘‘* * * to protect 

all market participants from fraudulent 

or other abusive sales practices * * *.’’ 

In addition, the rule implements the 

discretionary authority provided by 

Congress in Section 4s(h)(1)(A) of the 

CEA, which authorizes the Commission 

to prescribe rules that relate to ‘‘fraud, 

manipulation, and other abusive 

practices involving swaps (including 

swaps that are offered but not entered 

into * * *).’’ As provided by Sections 3 

and 4s(h)(1)(A) of the CEA, the rule 

protects market participants, generally, 

and Special Entities, particularly 

(which, when victims of fraud, 

manipulation or abuse, can have 

significant negative implications for 

taxpayers, pensioners and charitable 

institutions). 

In addition, the requirements that 

dealers disclose counterparty 

information only on a ‘‘need to know’’ 

basis and establish policies and 

procedures to protect confidential 

counterparty information, together with 

the other important requirements set 

forth in this rulemaking, ameliorate the 

risks associated with disclosure of 

confidential information to a swap 

dealer or major swap participant. The 

above-acknowledged diligence costs do 

not diminish these benefits. 

ii. Efficiency, Competitiveness and 

Financial Integrity 

While final § 23.410 is aimed at 

protecting counterparties, there are 

ancillary benefits for markets. Markets 

that are free of fraud, manipulation and 

other abusive practices encourage 

participation, which adds to liquidity, 

efficiency and competitiveness. The 

final rule enhances these benefits by 

appropriately restricting abusive 

conduct by swap dealers and major 

swap participants. In addition, 

protections against fraud, manipulation 

and misuse of counterparty information 

promote the financial integrity of 

counterparties by reducing the 

likelihood of (1) their being victims of 

fraud (and needing to bear the costs 

associated with such fraud) or 

manipulation in the value of their 

positions, and (2) their confidential 

information being used in ways that are 

adverse to their investment objectives. 

These protections look to reduce the 

level of risk to which counterparties are 

exposed when conducting business in 

the swaps markets. 

iii. Price Discovery 

As stated in the previous section, 

while final § 23.410 is aimed at 

protecting counterparties from abusive 

conduct by swap dealers and major 

swap participants, there are ancillary 

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9816 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

978Section 3(a) of the CEA (7 U.S.C. 5(a)). 

979Section 3(b) of the CEA (7 U.S.C. 5(b)). 

980See Section 4s(h)(4) and (5) of the CEA and 

§§ 23.440 and 23.450. 

981 Id. 

982See Sections 2(g) and 2(h) of the CEA prior to 

the Dodd-Frank Act amendments. 

benefits for markets. These benefits are 

key to 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.’’ 978 Indeed, it is an explicit 

purpose of the CEA ‘‘to deter and 

prevent price manipulation or any other 

disruptions to market integrity.’’ 979 The 

final rule appropriately restricts abusive 

conduct by swap dealers and major 

swap participants without unduly 

chilling legitimate trading that could 

undermine the price discovery function 

of the market. 

iv. Sound Risk Management Practices 

Final § 23.410 supports sound risk 

management practices for swap dealers 

and major swap participants by 

incentivizing them to expand their 

policies and procedures to avoid misuse 

of confidential counterparty 

information. This will reduce the risks 

faced by counterparties that their 

proprietary information will be 

misappropriated, while concomitantly 

mitigating litigation risks for swap 

dealers and major swap participants. 

The above-acknowledged diligence 

costs do not diminish these benefits. 

v. Other Public Interest Considerations 

Final § 23.410 is consistent with 

prohibitions against fraudulent and 

manipulative practices in other market 

sectors, including futures, securities and 

banking. It is also consistent with 

market abuse prohibitions that are 

generally in effect in foreign markets. 

Harmonization reduces compliance 

costs and enhances protections for 

market participants whose trading 

strategies cross market sectors and 

international borders. 

6. Section 23.430—Verification of 

Counterparty Eligibility 

a. Benefits 

Final § 23.430—Verification of 

counterparty eligibility, is a due 

diligence business conduct requirement 

for swap dealers and major swap 

participants that is mandated by Section 

4s(h) of the CEA. The final rule 

implements congressional intent that 

only ECPs have access to swaps that are 

traded bilaterally or on a SEF (where the 

swap dealer or major swap participant 

knows the identity of the counterparty). 

The final rule also ensures that swap 

dealers and major swap participants 

determine prior to offering to enter into 

or entering into a swap whether its 

counterparty is a Special Entity, which 

would trigger additional protections 

under Sections 4s(h) and subpart H of 

part 23.980 To avoid interfering with the 

efficient execution of transactions, the 

rule provides a safe harbor that allows 

swap dealers and major swap 

participants to rely on counterparty 

representations, which can be contained 

in counterparty relationship 

documentation. The rule specifies the 

content of the written representations 

on which the swap dealer or major swap 

participant can reasonably rely. 

While not readily amenable to 

quantification, the benefits of the 

verification rule are material. The 

principal benefit is the implementation 

of congressional intent that certain 

swaps be available only to ECPs and 

that retail customers be limited to swaps 

trading only on a DCM. The rule also 

fosters compliance with the Special 

Entity rules by verifying Special Entity 

status early in the relationship between 

the swap dealer or major swap 

participant and the Special Entity 

counterparty. Swap dealers and major 

swap participants benefit from the rule 

to the extent that verification of 

eligibility will assist them in avoiding 

non-ECP counterparties that would seek 

to avoid liability for unprofitable swaps 

based on ineligibility. The requirement 

to verify the Special Entity status of a 

counterparty is implicit in the 

provisions that afford heightened 

protections for Special Entities.981

b. Costs 

As discussed above, Congress 

required the Commission to implement 

a counterparty eligibility verification 

rule. The Commission is not required to 

consider the costs and benefits of 

Congress’ mandate; rather Section 15(a) 

of the CEA requires the Commission to 

consider the costs and benefits of its 

regulatory actions. In this case, the 

primary costs of final § 23.430 are 

associated with obtaining information 

necessary to verify that a counterparty is 

an ECP, and where relevant a Special 

Entity or counterparty able to elect 

Special Entity protections as provided 

in § 23.401(c)(6), and maintaining 

records regarding the verification. The 

Commission believes that its 

implementing regulation mitigates these 

costs by closely adhering to the existing 

industry best practices, which provide 

that professional intermediaries, prior to 

entering into any transaction, evaluate 

counterparty legal capacity, 

transactional authority and credit. In 

addition, the Commission’s regulation is 

similar to swap counterparty restrictions 

under the Commodity Futures 

Modernization Act amendments to the 

CEA.982 Given existing OTC derivatives 

market practice and historical 

restrictions on market access, the 

Commission expects the cost of 

complying with final § 23.430 will be 

insignificant. In addition, the final rule 

specifically allows swap dealers and 

major swap participants to rely on 

written representations by the 

counterparty to satisfy the verification 

rule for both ECP and Special Entity 

status and such representations can be 

made in counterparty relationship 

documentation. The rule also specifies 

the content of representations that 

would provide a reasonable basis for 

reliance, and the Commission confirmed 

that a change in a counterparty’s ECP 

status during the term of a swap will not 

affect the enforceability of the swap. 

Based on the foregoing, the Commission 

believes that it has taken meaningful 

and appropriate steps to minimize the 

risks and costs of compliance with 

Congress’ directive to implement a 

counterparty eligibility verification rule 

as mandated in Section 4s(h) of the 

CEA. 

c. Section 15(a) of the CEA 

In light of the foregoing, the 

Commission has evaluated the costs and 

benefits of final § 23.430 pursuant to the 

five considerations identified in Section 

15(a) of the CEA as follows: 

i. Protection of Market Participants and 

the Public 

Congress has determined that swap 

market participation, except on a DCM, 

should be limited to ECPs, and final 

§ 23.430 furthers that determination by 

establishing a procedure for restricting 

access by unqualified persons. In this 

way, the rule provides protection for 

market participants and the public by 

limiting access to qualified persons. The 

due diligence costs associated with this 

rulemaking are incremental and do not 

diminish the benefits. 

ii. Efficiency, Competitiveness and 

Financial Integrity 

The final verification rule mitigates 

negative effects on efficiency, 

competitiveness and financial integrity 

by addressing costs associated with 

execution delays. In addition, the 

financial integrity of the market may be 

enhanced by requiring due diligence by 

swap dealers and major swap 

participants to restrict participation by 

non-ECPs that generally have limited 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9817 

983Final § 23.451(a)(3) defines ‘‘governmental 

Special Entity’’ as State and municipal Special 

Entities defined in § 23.402(c)(2) and governmental 

plans as defined in § 23.402(c)(4); see also Section 

IV.D. of this adopting release at fn. 904. 

ability to evaluate and assume the risk 

of complex bilateral swaps. 

iii. Price Discovery 

By virtue of the compliance 

mechanisms built into the rule, the 

Commission believes that it will not 

unduly interfere with the price 

discovery function of the market that 

could result from execution delays. 

Section 4s(h) limits market participation 

to ECPs, which could negatively affect 

liquidity and price discovery, but the 

final rule does not exacerbate such 

potential consequences by limiting 

market access. Indeed, by ensuring that 

only ECPs (the CEA proxy for 

sophistication and financial 

wherewithal) can participate, other 

ECPs may be encouraged to participate, 

thereby enhancing liquidity and price 

discovery. 

iv. Sound Risk Management Practices 

The final rule addresses counterparty 

risk, which is one of the primary risks 

in the swaps market. As indicated 

above, the final rule codifies OTC 

derivatives industry best practice by 

requiring swap dealers and major swap 

participants to verify that the potential 

counterparty is an ECP and, where 

relevant, a Special Entity. This 

verification supplements the industry 

best practice requirement advising that, 

prior to trading, market professionals 

should check a counterparty’s legal 

capacity, transactional authority and 

credit. Therefore, the rule complements 

existing market practice and sound risk 

management practices. 

v. Other Public Interest Considerations 

The Commission has not identified 

any other public interest considerations. 

7. Section 23.440—Requirements for 

Swap Dealers Acting as Advisors to 

Special Entities; Section 23.450— 

Requirements for Swap Dealers and 

Major Swap Participants Acting as 

Counterparties to Special Entities; and 

Section 23.451—Political Contributions 

by Certain Swap Dealers 

a. Benefits 

Final §§ 23.401(c), 23.440, 23.450 and 

23.451 (the ‘‘Special Entity rules’’) 

provide heightened protections to a 

particular class of swap market 

participant when dealing with swap 

dealers and major swap participants. 

Special Entities play an important 

public interest role by virtue of their 

responsibility for managing taxpayer 

funds, the assets of public and private 

employee pension plans and 

endowments of charitable institutions. 

The Special Entity rules implement the 

congressional mandate to establish a 

higher standard of care for swap dealers 

that act as advisors to Special Entities 

and to ensure that Special Entities are 

represented by knowledgeable, 

independent advisors when dealing 

with swap dealers and major swap 

participants. 

The Special Entity rules also prohibit 

swap dealers from entering into swaps 

with a governmental Special Entity 983 if 

the swap dealer makes certain political 

contributions to officials of that 

governmental Special Entity to prevent 

what is known as ‘‘pay-to-play.’’ The 

Commission believes that the pay-toplay rule in § 23.451 is a necessary and 

appropriate prohibition to prevent swap 

dealers and others from engaging in 

fraudulent practices. Given the 

competitive nature of the swaps market, 

the incentives to engage in pay-to-play 

may be significant. The rule also 

harmonizes with existing pay-to-play 

restrictions applicable to certain swap 

dealers who are also subject to pay-toplay rules in the securities sector to 

promote regulatory consistency across 

related market sectors. 

The Special Entity rules provide 

substantial benefits to Special Entities 

and the general public. Swaps may have 

complex terms or employ leverage that 

can expose counterparties to significant 

financial risks, and unanticipated losses 

from a swap transaction can be 

financially devastating. Because 

financial losses in connection with a 

swap depend on the facts and 

circumstances regarding the particular 

swap and the particular Special Entity, 

the costs of such losses are not reliably 

quantifiable and, therefore, the benefits 

of preventing such losses are also not 

reliably quantifiable. 

Although the costs of the Special 

Entity rules are not readily quantifiable, 

the benefits to Special Entities are 

significant. Ensuring that Special 

Entities are represented by independent 

advisors that have sufficient knowledge 

to evaluate the transaction and risks of 

a swap is a vitally important protection 

for Special Entities. Independent and 

knowledgeable advice will benefit 

Special Entities, and those whose 

interests they represent, by creating a 

more level playing field when 

negotiating with swap dealers and major 

swap participants. Final § 23.450 

mitigates the likelihood that a Special 

Entity will assume risks and any 

consequent losses based on (1) 

inadequate advice due to a lack of 

understanding of the risks, or (2) biased 

advice that is not in the best interests of 

the Special Entity. 

Final § 23.440 benefits Special 

Entities by restricting swap dealers from 

providing advice that is not in the 

Special Entity’s best interests. A swap 

dealer that markets a swap to 

counterparties has an inherent conflict 

of interest, but is often in the best 

position to know the risks and 

characteristics of a complex swap, and 

the incentives for a swap dealer to 

provide conflicted advice that is not in 

the best interests of the Special Entity 

are substantial. The Commission 

believes that § 23.440 will provide 

important protections to make sure that 

a swap dealer’s communications that are 

the most susceptible to being misleading 

or abusive are subject to the statutory 

‘‘best interests’’ standard. 

Commenters were in general 

agreement that pay-to-play is a serious 

issue that should be addressed by the 

Commission. As discussed in this 

adopting release, the Commission 

expects that final § 23.451 will yield 

several important, if unquantifiable, 

benefits. Overall, the rule is intended to 

address pay-to-play relationships that 

interfere with the legitimate process by 

which a governmental Special Entity 

decides to enter into swaps with a 

particular swap dealer. Such a process 

should be determined on the merits 

rather than on contributions to political 

officials. The potential for fraud to 

invade the various, intertwined 

relationships created by pay-to-play 

arrangements has been documented in 

notorious cases of abuse. The 

Commission believes that the 

prohibition will reduce the occurrence 

of fraudulent conduct resulting from 

pay-to-play and, as a result, will achieve 

its goals of protecting market 

participants and the public from the 

resulting harms. 

By addressing pay-to-play practices, 

§ 23.451 helps to ensure that 

governmental Special Entities consider 

the merits of any particular transaction 

with a swap dealer and not the size of 

a swap dealer’s political contributions. 

These benefits, although difficult to 

quantify, could result in substantial 

savings to government institutions, 

public pension plans and their 

beneficiaries, resulting in better 

performance for taxpayers. Efficiencies 

are enhanced when government 

counterparties competitively award 

business based on price, performance 

and service and not the influence of 

pay-to-play, which in turn enables firms 

to compete on merit, rather than their 

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9818 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

984 In addition to § 23.451, which prohibits swap 

dealers from engaging in pay-to-play practices with 

governmental Special Entities, § 23.450(b)(1)(vii) 

similarly requires a swap dealer or major swap 

participant to have a reasonable basis to believe that 

a governmental Special Entity’s representative 

(other than an employee) is subject to pay-to-play 

prohibitions imposed by the Commission, SEC or 

an SRO subject to the jurisdiction of the 

Commission or the SEC. The Commission believes 

that § 23.450(b)(1)(vii) will create substantially 

similar benefits to those described regarding 

§ 23.451. Therefore, the Commission believes 

governmental Special Entities and their 

beneficiaries will benefit from advisers that are 

selected based on the quality of their advisory 

services and not the size of their political 

contributions. See Section IV.C.3.d.viii. of this 

adopting release for a discussion of final 

§ 23.450(b)(1)(vii). 

985See, e.g., Section IV.B.3.b. and d. of this 

adopting release for a discussion of commenters’ 

alternative approaches to § 23.440 and Section 

IV.C.3 of this adopting release for a discussion of 

alternative approaches to § 23.450. 

986The Commission requested comment on the 

costs and benefits of the proposed Special Entity 

rules and invited commenters to provide data or 

other information to support their views on the 

proposal’s costs and benefits. The Commission 

received general comments on costs and benefits 

but no verifiable data. See proposing release, 75 FR 

at 80657. 

987See, e.g., Section IV.C.2.g. of this adopting 

release for a summary of comments regarding 

transaction costs and risks related to the Special 

Entity rules. 

988See Section II of this adopting release for a 

discussion of regulatory intersections with the 

Commission’s business conduct standards rules. 

989ABC/CIEBA Feb. 22 Letter, at 4. 

990 Id. 

991 Id. 

992See Section IV.B.2.a. of this adopting release 

at fn. 624 and accompanying text. 

ability or willingness to make 

contributions.984

Finally, the Special Entity rules 

protect U.S. taxpayers, the retirement 

savings of U.S. private and public 

employees and pensioners, and 

beneficiaries of charitable endowments 

(‘‘Special Entity beneficiaries’’). Losses 

to a company that assumes significant 

risk through swaps are typically limited 

to its investors and creditors. However, 

Special Entities that assume risk 

through the use of swaps also expose 

Special Entity beneficiaries to such 

risks. When a Special Entity suffers 

losses in connection with a swap, the 

Special Entity beneficiaries ultimately 

bear such losses. Certain swaps can 

create significant risk exposure that may 

result in substantial losses. And in the 

wake of the 2008 financial crisis, 

significant or even catastrophic losses 

have been proven not to be merely 

theoretical. In the case of Special 

Entities, such losses could result in 

taxpayer bailouts of public institutions 

or devastating losses to vulnerable 

members of the public including 

pensioners and beneficiaries of 

charitable endowments. Additionally, 

taxpayers and public employees and 

pensioners may benefit from § 23.451 

because they might otherwise bear the 

financial burden of bailing out a public 

institution or governmental pension 

plan that has ended up with a shortfall 

due to poor performance or excessive 

fees that might result from pay-to-play. 

Therefore, the Special Entity rules 

provide significant protections for 

Special Entity beneficiaries and the 

public at large by ensuring that Special 

Entities have independent and 

knowledgeable representatives, are 

afforded a higher standard of care from 

swap dealers that act as advisors and, in 

the case of governmental Special 

Entities, are not unduly influenced by 

political contributors. The Commission 

has considered a number of regulatory 

alternatives proposed by commenters 

and has revised some of the proposed 

rules in response to commenters’ 

suggestions.985

b. Costs 

As identified by commenters,986 the 

proposed Special Entity rules had the 

potential to impose costs including: (1) 

Reduced access to swap markets for 

Special Entities if swap dealers and 

major swap participants decline to act 

as their counterparties, (2) limited flow 

of information from swap dealers to 

Special Entities, (3) litigation risk for 

swap dealers and major swap 

participants, (4) compliance obligations 

on swap dealers and major swap 

participants, (5) and delays in swap 

execution.987 As discussed in the 

introduction to this Section IV.C. of this 

adopting release, such costs are difficult 

and costly to quantify and, in some 

cases, are not subject to reliable 

quantification. Additionally, some 

commenters asserted that conflicting 

federal regulatory regimes could impose 

costs, such as penalties for violating 

ERISA’s prohibited transaction 

provisions.988 Any penalty for violation 

of another federal law in connection 

with a swap will depend on the facts 

and circumstances regarding the 

particular swap and the particular 

Special Entity; therefore, the costs of 

such penalties are not reliably 

quantifiable. 

One commenter provided an example 

to quantify potential costs to the 

sponsor of a fully-funded ERISA plan 

that could not hedge its interest rate risk 

in the swap markets.989 The commenter 

stated that an ERISA plan with $15 

billion in assets and liabilities ‘‘whose 

interest rate sensitivity is somewhat 

higher than average,’’ would be exposed 

to a 13% increase in liabilities with a 

1% decrease in interest rates.990

According to the commenter, the 1% 

decrease in interest rates would result in 

a $1.46 billion shortfall in plan assets to 

liabilities, amortized over seven years, 

and the ERISA plan sponsor would owe 

approximately $248 million in annual 

contributions to cover the shortfall.991

The commenter’s example, however, 

illustrates that the costs to a Special 

Entity that cannot access the swap 

markets will depend on the particular 

facts and circumstances of the particular 

Special Entity. Therefore, quantification 

of such costs to Special Entities as a 

class is not feasible. 

The heightened standard of care for 

swap dealers that act as advisors to 

Special Entities, which § 23.440 

implements, may, to a degree, reduce 

the level of information swap dealers 

are willing to share with Special Entities 

regarding swaps products and strategies 

out of a concern over triggering advisory 

status and the best interests duty 

attached to that status. Final § 23.440 

attempts to mitigate these costs by 

providing safe harbors that effectively 

exclude from the swap dealer’s best 

interests duty (1) communications 

between swap dealers and ERISA plans 

and (2) communications to a Special 

Entity where the swap dealer does not 

express an opinion as to whether the 

Special Entity should enter into a 

recommended swap or swap trading 

strategy that is tailored to the particular 

needs or characteristics of the Special 

Entity. 

The safe harbor for a swap dealer 

dealing with any Special Entity in 

§ 23.440(b)(2) preserves the ability of the 

swap dealer to communicate a wide 

range of information about swaps, 

including communications where a 

swap dealer provides trading ideas for 

swaps or swap trading strategies that are 

tailored to the needs or characteristics of 

a Special Entity, without being subject 

to the best interests duty. Moreover, to 

provide additional clarity on the types 

of communications that would not 

cause a swap dealer to ‘‘act as an 

advisor,’’ the Commission offers in 

Appendix A to subpart H a nonexclusive list of communications not 

subject to the best interests duty as 

guidance for swap dealers that elect to 

operate within the safe harbor. 

Additionally, the types of 

communications and information not 

subject to the best interests duty under 

the safe harbor in § 23.440(b)(2) are the 

types information that many 

commenters found to be most 

valuable.992 The types of 

communications and information 

included in the scope of the safe harbor 

also facilitates swap dealers’ ability to 

engage in normal course of business 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9819 

993See Section IV.C.3.d.iv. of this adopting 

release for a discussion of the final independence 

standard in § 23.450. 

994See Section IV.C.2.c.ii. of this adopting release 

for a summary of comments regarding the 

independence tests under proposed § 23.450 at fn. 

779. 

995See proposing release, 75 FR at 80660. 

996See, e.g., ABC/CIEBA Feb. 22 Letter, at 9–10; 

HOOPP Feb. 22 Letter, at 2; ABC Aug. 29 Letter, 

at 7. 

997See, e.g., ERIC Feb. 22 Letter, at 12; VRS Feb. 

22 Letter, at 2 and fn. 3; U. Tex. System Feb. 22 

Letter, at 4. 

998See Section II of this adopting release for a 

discussion of regulatory intersections and 

harmonization with the SEC and DOL. 

999See Section IV.A.3.e. of this adopting release 

for a discussion of the Commission’s determination 

regarding collective investment vehicles and the 

definition of Special Entity. 

1000See, e.g., AMG–SIFMA Feb. 22 Letter, at 

12–13. 

communications, including sales, 

marketing and trading ideas, with 

Special Entities without being subject to 

the best interests duty and potential 

litigation risks attendant to such a duty. 

Final § 23.450 also establishes a safe 

harbor for a swap dealer or major swap 

participant to satisfy its duty to have a 

reasonable basis to believe that a Special 

Entity has a qualified independent 

representative. The safe harbor under 

§ 23.450(d)(2) harmonizes the 

independent representative 

requirements for ERISA plans. A swap 

dealer or major swap participant will 

have a reasonable basis to believe that 

an ERISA plan has a qualified 

independent representative whenever 

the ERISA plan represents in writing 

that it has an ERISA fiduciary. This safe 

harbor alleviates concerns raised by 

some commenters that compliance with 

the proposed rule could cause a swap 

dealer or major swap participant to 

become an ERISA fiduciary that would 

impose costs, including private 

litigation liabilities, costs associated 

with violations of ERISA’s prohibited 

transaction rules or costs to ERISA plans 

that may be unable to find swap dealers 

or major swap participants willing to 

enter into swaps with them. 

With respect to all Special Entities 

other than ERISA plans, the safe harbor 

under § 23.450(d)(1) permits a swap 

dealer or major swap participant to rely 

on written representations from the 

Special Entity and its representative that 

each, respectively, has complied in good 

faith with written policies and 

procedures reasonably designed to 

ensure that the representative satisfies 

the applicable requirements in Section 

4s(h)(5) and § 23.450. Additionally, the 

Commission revised § 23.450 to address 

commenters’ concerns regarding the 

proposed ‘‘material business 

relationship’’ prong of the 

independence test.993

Many commenters expressed concern 

that the proposed independence test 

would create costly and burdensome 

compliance requirements and that the 

proposed material relationship prong 

was duplicative of or not harmonized 

with other independence standards.994

The revised independence test mitigates 

commenters’ concerns that the ‘‘material 

business relationship’’ was 

unadministrable by deleting the 

requirement to identify and disclose all 

compensation that a swap dealer or 

major swap participant paid to the 

Special Entity’s representative within 

the previous 12 months.995 The revised 

standard under which a representative 

will be deemed independent replaced 

the ‘‘material business relationship’’ 

prong with three requirements: (1) The 

representative discloses material 

conflicts of interest to the Special Entity 

and complies with policies and 

procedures designed to manage and 

mitigate such conflicts; (2) the 

representative is not controlled by, in 

control of or under common control 

with the swap dealer or major swap 

participant; and (3) the swap dealer or 

major swap participant did not refer, 

recommend or introduce the 

representative to the Special Entity. Any 

costs that arise due to a representative 

disclosing, managing and mitigating 

conflicts of interest will be incremental 

because third-party advisors, generally, 

will be regulated entities such as CTAs, 

investment advisers or municipal 

advisors, and will be subject to similar 

requirements. In addition, 

representatives that are in-house 

employees will likely be subject to 

conflict of interest restrictions by virtue 

of their employment agreement. 

The safe harbor under § 23.450(d) 

reduces litigation risk concerns raised 

by some commenters asserting that a 

swap dealer or major swap participant 

may be held liable to a Special Entity for 

‘‘approving’’ an unqualified 

representative or may be liable to a 

representative that was found to be 

unqualified.996 Under the safe harbor, a 

swap dealer or major swap participant 

may rely on written representations that 

the representative is qualified thereby 

relieving the swap dealer or major swap 

participant of engaging in extensive due 

diligence to make its own 

determination. 

Special Entities may incur additional 

costs to retain the services of a 

representative and to develop policies 

and procedures to ensure that the 

representative is qualified and 

independent. The Commission believes 

that any additional costs will be 

incremental and relatively minimal 

because, according to commenters, 

many Special Entities already employ 

in-house or third-party expert 

advisors.997 Furthermore, the 

independent representative rules 

implement the statutory requirement 

that Special Entities have qualified 

independent representatives. Therefore, 

Congress made the determination that 

the additional costs are justified by the 

benefits that such a protection provides 

to Special Entities and Special Entity 

beneficiaries. However, the final rules 

implement the statutory requirements in 

such a way as to minimize any 

additional costs associated with the 

concerns expressed by commenters. 

To mitigate and reduce any due 

diligence costs imposed under Sections 

4s(h)(4) and (5), both §§ 23.440 and 

23.450 permit reliance on 

representations to satisfy such due 

diligence obligations. Furthermore, such 

representations may be made on a 

relationship basis to reduce or eliminate 

execution delays that could otherwise 

result from transaction-by-transaction 

compliance. Commission staff has also 

extensively consulted with the SEC and 

DOL staffs to ensure that the final rules 

are appropriately harmonized and so 

that compliance with the Special Entity 

rules will not result in violation of other 

federal laws.998

The Commission has clarified, in 

response to commenters, that the 

definition of Special Entity under 

§ 23.402(c) does not include collective 

investment vehicles in which a Special 

Entity invests.999 Some commenters 

asserted that adopting a look-through 

test for the Special Entity definition 

would create unnecessary and 

duplicative compliance costs and 

execution delays for collective 

investment vehicles and their 

investors.1000 This adopting release 

clarifies that the Commission will not 

look-through a collective investment 

vehicle to its investors to determine 

whether an entity is a Special Entity and 

thereby eliminates these cost concerns. 

The pay-to-play prohibition in 

§ 23.451 is designed to prevent fraud. A 

prohibition on fraud should not, in the 

Commission’s judgment, impose 

significant costs. Nevertheless, the 

Commission is cognizant that its pay-topay prohibition will involve some 

compliance costs. At the same time, 

such costs are expected to be 

incremental and minimal because the 

Commission anticipates that many of 

the persons subject to § 23.451 will 

already be subject to similar 

prohibitions imposed by the MSRB or 

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1001The Commission also believes that 

§ 23.450(b)(1)(vii) may impose similar costs, 

including compliance costs. See supra fn. 984for a 

discussion of § 23.450(b)(1)(vii)’s benefits. However, 

the Commission also believes that the cost 

mitigating features of § 23.450 and the incremental 

nature of the requirements also limit any burdens 

or costs imposed by the rule. The costs are 

incremental because some independent 

representatives to governmental Special Entities 

may be SEC-registered investment advisers subject 

to SEC Advisers Act Rule 206(4)-5 on pay-to-play 

or registered municipal advisors subject to the 

MSRB’s pay-to-play prohibitions. See Section II.C. 

of this adopting release for a discussion of Special 

Entity representatives that are also municipal 

advisors; see also supra fn. 880 and accompanying 

text. 

1002See proposed 17 CFR 240.15Fh–6, SEC’s 

proposed rules, 76 FR at 42457–58. 

1003See Section IV.D.3. of this adopting release 

for a discussion of the pay-to-play prohibitions 

under final § 23.451. 

1004See Section IV.C.3.d. of this adopting release 

for a discussion of the factors used as guidance for 

the requirements of § 23.450(b). 

SEC.1001 In an effort to mitigate these 

costs, the Commission has adopted a 

practical, cost-effective means to 

comply with the rule without requiring 

a swap dealer to impose a blanket ban 

on all political contributions by its 

covered associates. Further, based on 

comments received, the Commission 

modified its proposed rule to achieve 

the goal of discouraging swap dealer 

participation in pay-to-play practices 

while seeking to limit the burdens 

imposed by the rule. In this regard, the 

Commission highlights its efforts to 

harmonize its rule with the prohibition 

proposed by the SEC,1002 the exceptions 

for certain de minimis contributions, 

automatic exemptions and safe 

harbors.1003

c. Section 15(a) of the CEA 

In light of the foregoing, the 

Commission has evaluated the costs and 

benefits of the final Special Entity rules 

pursuant to the five considerations 

identified in Section 15(a) of the CEA as 

follows: 

i. Protection of Market Participants and 

the Public 

At the core of the Special Entity rules 

is the protection of a specific class of 

market participants that are central to 

the public interest. Final § 23.440 

ensures that swap dealers that act as 

advisors to Special Entities are subject 

to a best interests duty. Conversely, 

where the swap dealer elects to operate 

within the safe harbor, the rule 

facilitates open communications with 

Special Entities to afford them the 

benefits of the swap dealer’s access to 

valuable swap related information. 

Final § 23.450 seeks to ensure that any 

Special Entity that enters into swaps 

with swap dealers or major swap 

participants has a sufficiently 

knowledgeable representative to 

evaluate the risks inherent in the 

transaction and to provide unbiased, 

independent advice that is in the best 

interests of the Special Entity. The payto-play prohibition protects market 

participants and the public from fraud. 

Government business allocated on the 

basis of political contributions exposes 

the public to several hazards, including 

noncompetitive pricing and 

unnecessary assumption of risk. 

The Commission believes that the 

Special Entity rules protect the public 

from, among other things, taxpayer 

bailouts and unnecessary losses to U.S. 

retirement savings and charitable 

endowments. To the extent the rules 

impose increased costs on swap dealers 

or major swap participants that may be 

passed on to Special Entities or may 

serve as an incentive for swap dealers or 

major swap participants to decline to 

transact with Special Entities, the 

Commission believes it has provided for 

reasonable and practicable means of 

compliance that mitigate any such costs. 

ii. Efficiency, Competitiveness and 

Financial Integrity of Futures Markets 

The Special Entity rules do impose 

costs that impact efficiency. However, 

the rules have been designed to mitigate 

the impact. For example, the rules allow 

for reliance on representations on a 

relationship basis to mitigate due 

diligence costs or transaction-bytransaction compliance that may delay 

execution. In addition, Congress made 

the determination that Special Entities 

need additional protections by enacting 

Section 4s(h), and the Commission has 

furthered congressional intent by 

mitigating the attendant costs of such 

protections without materially 

diminishing their benefits. Furthermore, 

the public interest is served and markets 

function more efficiently when swap 

dealers compete for governmental 

Special Entity business based on price 

and the overall utility of the swap to the 

Special Entity and not on the swap 

dealers’ willingness to make political 

contributions. 

iii. Price Discovery 

In the event that advisory status is 

triggered, compliance with the best 

interests duty by the affected swap 

dealer may lead to execution delays. 

The cumulative effect of these delays 

may, to a degree, adversely impact 

liquidity resulting in higher transaction 

costs for counterparties that trade 

swaps. In recognition of this potential 

impact, the best interests duty is limited 

to certain recommendations of swaps 

that are tailored to the particular needs 

or characteristics of the Special Entity, 

and the swap dealer may rely on 

representations from the Special Entity 

to satisfy the ‘‘reasonable efforts’’ duty 

for determining whether a 

recommended swap or swap trading 

strategy is in the best interests of that 

Special Entity. 

Final rule § 23.450 provides several 

means to mitigate the costs of satisfying 

the ‘‘reasonable basis’’ requirement. 

First, if the representative to an ERISA 

plan is an ERISA fiduciary, then the 

reasonable basis is established. Second, 

certain representations made by the 

Special Entity will be deemed to 

provide such a reasonable basis, and 

these representations, where 

appropriate, are allowable at the 

relationship level as opposed to the 

transaction level. Third, in the absence 

of such representations, the Commission 

has provided a list of factors as guidance 

for establishing this reasonable 

basis.1004

iv. Sound Risk Management Practices 

The Special Entity rules foster sound 

risk management practices by ensuring 

that Special Entities have 

representatives and advisors that are 

capable of evaluating the risks and 

rewards of swap transactions and that 

they evaluate each transaction 

considering the best interests of the 

Special Entity. The independent 

representative provisions, coupled with 

the disclosure rules, provide important 

tools for Special Entities to enhance 

their risk management practices to avoid 

unnecessary and inappropriate risk. 

Nevertheless, execution delays, to the 

extent that they may result from the 

Special Entity rules, force market 

participants to either bear certain 

market risks or be prevented from 

earning the premiums associated with 

bearing those risks over the duration of 

the delay. The design of the Special 

Entity rules permit reliance on 

representations on a relationship basis 

to mitigate these delays. 

Any uncertainty over the triggers for 

advisory status, through an increase in 

the risk exposure of the swap dealer, 

may translate into higher fees charged to 

counterparties as compensation for that 

increased exposure. Guidance provided 

by the Commission clarifying the 

instances and communications that are 

exempt from this status mitigates this 

uncertainty. 

v. Other Public Interest Considerations 

The Special Entity rules promote 

public trust in swap markets by striving 

to ensure that Special Entities are 

adequately represented and treated 

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1005See, e.g., Savage v. CFTC, 548 F.2d 192 at 

197. 1006See Section IV.B.3.c. at fn. 706 and 

accompanying text for a discussion of the legislative 

history of fiduciary duties for swap dealers; see also 

Sections II.D. and IV.B. of this adopting release for 

a discussion of Regulatory Intersections— 

Commodity Trading Advisor Status for Swap 

Dealers and § 23.440—Final Rules for Swap Dealers 

and Major Swap Participants Dealing with Special 

Entities—Requirements for Swap Dealers Acting as 

Advisors to Special Entities, respectively. 

1007See Section II.B. of this adopting release for 

a discussion of Regulatory Intersections— 

Department of Labor ERISA Fiduciary Regulations. 

1008See Section II.D. of this adopting release for 

a discussion of Regulatory Intersections— 

Commodity Trading Advisor Status for Swap 

Dealers. 

fairly. When a Special Entity incurs 

substantial losses due to inadequate 

advice, biased advice or unfair access 

such as through pay-to-play schemes, 

the public loses confidence in the 

markets. Additionally, the pay-to-play 

prohibition fosters public confidence in 

the integrity of the means and manner 

in which its elected officials handle 

government finances. 

8. Section 4.6—Exclusion for Certain 

Otherwise Regulated Persons From the 

Definition of the Term ‘‘Commodity 

Trading Advisor’’ 

a. Benefits 

Final § 4.6(a)(3) is an exclusion from 

the definition of CTA for swap dealers 

and, correspondingly, from the 

application of the CTA registration 

requirement, any relevant duties under 

part 4 of the Commission’s Regulations 

and Section 4o of the CEA, the antifraud provision for CTAs. The 

Commission believes the exclusion 

furthers the regulatory approach that 

underlies the Dodd-Frank Act by 

facilitating the flow of market-related 

information between swap dealers and 

counterparties without undermining the 

robust protections provided by the 

business conduct standards provisions. 

The exclusion benefits both swap 

dealers and counterparties that claimed 

that their communications could be 

chilled, and trading stifled, if swap 

dealers were deemed to be CTAs and 

subject to a higher standard of care 

when providing services that are ‘‘solely 

incidental’’ to their business as a swap 

dealer. The exclusion clarifies the role 

of swap dealers and reduces ambiguity 

in the trading relationship between 

swap dealers and counterparties. 

While not readily amenable to 

quantification, the benefits of the rule 

are significant. The rule is designed to 

avoid the potential costs associated with 

a swap dealer being deemed a CTA. In 

addition to CTA registration fees for a 

swap dealer and its associated persons, 

CTAs are generally held to a fiduciary 

standard under case law,1005 a standard 

that was rejected by Congress for swap 

dealers when it adopted Section 

4s(h).1006 Therefore, excluding swap 

dealers from the definition of CTA when 

engaging in certain swap dealing 

activities that overlap with CTA 

activities is consistent with 

congressional intent. 

Commenters raised concerns that if a 

swap dealer were deemed to be a CTA 

then it would increase the potential that 

they also would be deemed an ERISA 

fiduciary when dealing with ERISA 

plans. That would subject the swap 

dealer to a principal transaction 

prohibition and to substantial penalties 

under ERISA. Such risks could dissuade 

swap dealers from engaging in swaps 

with pension plans that are subject to 

ERISA.1007 Similar risks could 

potentially adversely affect other 

counterparties that are regulated under 

similar state regulatory regimes. These 

counterparties could face increased 

costs because swap dealers could charge 

more to assume the higher duties, fewer 

swap dealers would be willing to do 

business with them or swap dealers 

would offer a narrower range of 

services. 

The rule benefits counterparties by 

reducing burdens on communications 

and broadening the range of services 

available from swap dealers, as well as 

increasing the number of swap dealers 

with which a Special Entity may enter 

into swaps. While not a quantifiable 

benefit, a greater number of swap 

dealers should encourage competition 

and reduce prices for counterparties. 

Having access to a wider range of 

services will allow counterparties to 

more effectively hedge their exposure to 

market risks and to take advantage of 

investment opportunities using swaps. 

b. Costs 

As a result of final § 4.6(a)(3) relieving 

a burden rather than imposing one, the 

Commission does not believe that there 

are any costs associated with the 

exclusion from the definition of CTA for 

swap dealers whose advice is solely 

incidental to its swap dealing activities. 

This is particularly true because the 

business conduct standards viewed as a 

whole provide important protections for 

counterparties that are not diminished 

by clarifying the status of swap dealers 

that make recommendations to 

counterparties. 

c. Section 15(a) of the CEA 

In light of the foregoing, the 

Commission has evaluated the costs and 

benefits of final § 4.6(a)(3) pursuant to 

the five considerations identified in 

Section 15(a) of the CEA as follows: 

i. Protection of Market Participants and 

the Public 

The objective of § 4.6(a)(3) is to allow 

a freer flow of information and ideas 

between a swap dealer and its 

counterparties, albeit subject to the 

disclosure and due diligence 

requirements of subpart H, among other 

provisions. Allowing swap dealers to 

provide limited advice necessary to 

design bespoke instruments will benefit 

market participants by offering them a 

broader range of products to meet their 

particular hedging requirements and 

trading objectives. The exclusion will 

reduce the potential for vexatious 

litigation by providing certainty 

regarding the applicable standard of 

care to be applied to these transactions. 

The exclusion is consistent with the 

goal of protecting market participants 

and the public when considered 

together with the business conduct 

standards in Section 4s(h) and subpart 

H of part 23. The exclusion does not 

diminish protections for market 

participants and the public in those 

rules, but rather furthers the intent of 

Congress that swap dealers not be held 

to a fiduciary standard.1008 Moreover, 

the exclusion for swap dealers from the 

CTA definition does not apply to all 

advisory activities, but only the swap 

dealer’s advisory activities that are 

solely incidental to its business as a 

swap dealer. As such, the Commission 

has designed these rules to be as 

targeted as possible to achieve the 

intended statutory benefits, namely to 

enable the flow of accurate and timely 

information between swap dealers and 

their counterparties, and to continue to 

allow the marketplace to develop and 

provide opportunities for swap dealers 

and counterparties to transact. However, 

swap dealers will be CTAs if they 

provide advisory services beyond those 

that are solely incidental to their swap 

dealing activities, thereby preserving 

counterparty protections afforded by the 

rules that apply to CTAs. 

Accordingly, in the Commission’s 

judgment, this rule alleviates a burden, 

which reduces rather than imposes 

costs, in such a way that the final rule 

will achieve the intended benefits of 

protecting market participants and the 

public. 

ii. Efficiency, Competitiveness and 

Financial Integrity of Futures Markets 

Because swap dealers may not be 

willing to perform certain functions, 

like custom tailoring a swap to meet a 

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counterparty’s needs if such activities 

would cause the swap dealer to be 

deemed to be a CTA, excluding them 

from the CTA definition for certain 

activities could broaden the range of 

services that a swap dealer may offer a 

counterparty. It could also increase the 

number of swap dealers that are willing 

to perform such functions. While not a 

quantifiable benefit, a greater number of 

swap dealers and available products 

should enhance efficiency and 

competition and reduce prices for 

counterparties. Because the rule 

alleviates a burden, rather than 

imposing costs, the Commission 

concludes that § 4.6(a)(3) will not 

impede swap market efficiency, 

competitiveness or financial integrity. 

iii. Price Discovery 

Relative to not applying this 

exclusion to swap dealers, the final rule 

encourages more swap dealers to offer a 

wider range of products to 

counterparties, which promotes 

competition and facilitates price 

discovery. Accordingly, the exclusion 

does not adversely affect price discovery 

and potentially enhances it. 

iv. Sound Risk Management Practices 

While not creating material incentives 

for swap dealers to alter how they 

manage risk, the exclusion from the 

CTA definition will assist swap dealers 

in reducing the level of risk associated 

with their counterparty interactions. 

The exclusion clarifies the duties owed 

to counterparties and reduces the 

potential for litigation. Because the 

standard of care for swap dealers acting 

as CTAs is higher than the standard of 

care when they act as counterparties in 

principal to principal transactions, 

disagreements could arise based on 

misunderstandings concerning the 

respective roles of the parties. By acting 

within the scope of the exclusion in 

compliance with the final rule, swap 

dealers will reduce the risk of undue 

reliance by counterparties and any 

resulting litigation. 

v. Other Public Interest Considerations 

The Commission has not identified 

any other public interest considerations. 

List of Subjects 

17 CFR Part 4 

Advertising, Brokers, Commodity 

futures, Commodity pool operators, 

Commodity trading advisors, Customer 

protection, Reporting and recordkeeping 

requirements, Swaps. 

List of Subjects 

17 CFR Part 23 

Antitrust, Commodity futures, 

Business conduct standards, Conflict of 

interests, Counterparties, Information, 

Major swap participants, Registration, 

Reporting and recordkeeping, Special 

Entities, Swap dealers, Swaps. 

For the reasons presented above, the 

Commission hereby amends part 4 and 

part 23 (as added on January 19, 2012 

(77 FR 2613), of Title 17 of the Code of 

Federal Regulations as follows: 

PART 4—COMMODITY POOL 

OPERATORS AND COMMODITY 

TRADING ADVISORS 

■ 1. The authority citation for part 4 

shall be revised to read as follows: 

Authority: 7 U.S.C 1a, 2, 4, 6(c), 6b, 6c, 

6l, 6m, 6n, 6o, 12a and 23, as amended by 

the Dodd-Frank Wall Street Reform and 

Consumer Protection Act, Pub. L. 111–203, 

124 Stat. 1376 (2010). 

■ 2. In § 4.6, add new paragraph (a)(3) 

to read as follows: 

§ 4.6 Exclusion for certain otherwise 

regulated persons from the definition of the 

term ‘‘commodity trading advisor.’’ 

(a) * * * 

(3) A swap dealer registered with the 

Commission as such pursuant to the Act 

or excluded or exempt from registration 

under the Act or the Commission’s 

regulations; Provided, however, That the 

commodity interest and swap advisory 

activities of the swap dealer are solely 

incidental to the conduct of its business 

as a swap dealer. 

* * * * * 

PART 23—SWAP DEALERS AND 

MAJOR SWAP PARTICIPANTS 

Authority and Issuance 

■ 3. The authority citation for part 23 

shall be revised to read as follows: 

Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6c, 6p, 

6s, 9, 9a, 12a, 13b, 13c, 16a, 18, 19, 21 as 

amended by Title VII of the Dodd-Frank Wall 

Street Reform and Consumer Protection Act, 

Pub. L. No. 111–203, 124 Stat. 1376 (Jul. 21, 

2010). 

■ 4. Add subpart H to read as follows: 

Subpart H—Business Conduct Standards 

for Swap Dealers and Major Swap 

Participants Dealing With Counterparties, 

Including Special Entities 

Sec. 

23.400 Scope. 

23.401 Definitions. 

23.402 General provisions. 

23.403–23.409 [Reserved] 

23.410 Prohibition on fraud, manipulation 

and other abusive practices. 

23.411–23.429 [Reserved] 

23.430 Verification of counterparty 

eligibility. 

23.431 Disclosures of material information. 

23.432 Clearing disclosures. 

23.433 Communications—fair dealing. 

23.434 Recommendations to 

counterparties—institutional suitability. 

23.435–23.439 [Reserved] 

23.440 Requirements for swap dealers 

acting as advisors to Special Entities. 

23.441–23.449 [Reserved] 

23.450 Requirements for swap dealers and 

major swap participants acting as 

counterparties to Special Entities. 

23.451 Political contributions by certain 

swap dealers. 

Appendix A—Guidance on the application of 

§§ 23.434 and 23.440 for swap dealers 

that make recommendations to 

counterparties or Special Entities 

Subpart H—Business Conduct 

Standards for Swap Dealers and Major 

Swap Participants Dealing With 

Counterparties, Including Special 

Entities 

§ 23.400 Scope. 

The sections of this subpart shall 

apply to swap dealers and, unless 

otherwise indicated, major swap 

participants. These rules are not 

intended to limit or restrict the 

applicability of other provisions of the 

Act and rules and regulations 

thereunder, or other applicable laws, 

rules and regulations. The provisions of 

this subpart shall apply in connection 

with transactions in swaps as well as in 

connection with swaps that are offered 

but not entered into. 

§ 23.401 Definitions. 

(a) Counterparty. The term 

‘‘counterparty,’’ as appropriate in this 

subpart, includes any person who is a 

prospective counterparty to a swap. 

(b) Major swap participant. The term 

‘‘major swap participant’’ means any 

person defined in Section 1a(33) of the 

Act and § 1.3 of this chapter and, as 

appropriate in this subpart, any person 

acting for or on behalf of a major swap 

participant, including an associated 

person defined in Section 1a(4) of the 

Act. 

(c) Special Entity. The term ‘‘Special 

Entity’’ means: 

(1) A Federal agency; 

(2) A State, State agency, city, county, 

municipality, other political subdivision 

of a State, or any instrumentality, 

department, or a corporation of or 

established by a State or political 

subdivision of a State; 

(3) Any employee benefit plan subject 

to Title I of the Employee Retirement 

Income Security Act of 1974 (29 U.S.C. 

1002); 

(4) Any governmental plan, as defined 

in Section 3 of the Employee Retirement 

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Income Security Act of 1974 (29 U.S.C. 

1002); 

(5) Any endowment, including an 

endowment that is an organization 

described in Section 501(c)(3) of the 

Internal Revenue Code of 1986 (26 

U.S.C. 501(c)(3)); or 

(6) Any employee benefit plan 

defined in Section 3 of the Employee 

Retirement Income Security Act of 1974 

(29 U.S.C. 1002), not otherwise defined 

as a Special Entity, that elects to be a 

Special Entity by notifying a swap 

dealer or major swap participant of its 

election prior to entering into a swap 

with the particular swap dealer or major 

swap participant. 

(d) Swap dealer. The term ‘‘swap 

dealer’’ means any person defined in 

Section 1a(49) of the Act and § 1.3 of 

this chapter and, as appropriate in this 

subpart, any person acting for or on 

behalf of a swap dealer, including an 

associated person defined in Section 

1a(4) of the Act. 

§ 23.402 General provisions. 

(a) Policies and procedures to ensure 

compliance and prevent evasion. 

(1) Swap dealers and major swap 

participants shall have written policies 

and procedures reasonably designed to: 

(i) Ensure compliance with the 

requirements of this subpart; and 

(ii) Prevent a swap dealer or major 

swap participant from evading or 

participating in or facilitating an 

evasion of any provision of the Act or 

any regulation promulgated thereunder. 

(2) Swap dealers and major swap 

participants shall implement and 

monitor compliance with such policies 

and procedures as part of their 

supervision and risk management 

requirements specified in subpart J of 

this part. 

(b) Know your counterparty. Each 

swap dealer shall implement policies 

and procedures reasonably designed to 

obtain and retain a record of the 

essential facts concerning each 

counterparty whose identity is known to 

the swap dealer prior to the execution 

of the transaction that are necessary for 

conducting business with such 

counterparty. For purposes of this 

section, the essential facts concerning a 

counterparty are: 

(1) Facts required to comply with 

applicable laws, regulations and rules; 

(2) Facts required to implement the 

swap dealer’s credit and operational risk 

management policies in connection 

with transactions entered into with such 

counterparty; and 

(3) Information regarding the 

authority of any person acting for such 

counterparty. 

(c) True name and owner. Each swap 

dealer or major swap participant shall 

obtain and retain a record which shall 

show the true name and address of each 

counterparty whose identity is known to 

the swap dealer or major swap 

participant prior to the execution of the 

transaction, the principal occupation or 

business of such counterparty as well as 

the name and address of any other 

person guaranteeing the performance of 

such counterparty and any person 

exercising any control with respect to 

the positions of such counterparty. 

(d) Reasonable reliance on 

representations. A swap dealer or major 

swap participant may rely on the 

written representations of a 

counterparty to satisfy its due diligence 

requirements under this subpart, unless 

it has information that would cause a 

reasonable person to question the 

accuracy of the representation. If agreed 

to by the counterparties, such 

representations may be contained in 

counterparty relationship 

documentation and may satisfy the 

relevant requirements of this subpart for 

subsequent swaps offered to or entered 

into with a counterparty, provided 

however, that such counterparty 

undertakes to timely update any 

material changes to the representations. 

(e) Manner of disclosure. A swap 

dealer or major swap participant may 

provide the information required by this 

subpart by any reliable means agreed to 

in writing by the counterparty; provided 

however, for transactions initiated on a 

designated contract market or swap 

execution facility, written agreement by 

the counterparty regarding the reliable 

means of disclosure is not required. 

(f) Disclosures in a standard format. If 

agreed to by a counterparty, the 

disclosure of material information that 

is applicable to multiple swaps between 

a swap dealer or major swap participant 

and a counterparty may be made in 

counterparty relationship 

documentation or other written 

agreement between the counterparties. 

(g) Record retention. Swap dealers 

and major swap participants shall create 

a record of their compliance with the 

requirements of this subpart and shall 

retain records in accordance with 

subpart F of this part and § 1.31 of this 

chapter and make them available to 

applicable prudential regulators upon 

request. 

§§ 23.403–23.409 [Reserved] 

§ 23.410 Prohibition on fraud, 

manipulation, and other abusive practices. 

(a) It shall be unlawful for a swap 

dealer or major swap participant— 

(1) To employ any device, scheme, or 

artifice to defraud any Special Entity or 

prospective customer who is a Special 

Entity; 

(2) To engage in any transaction, 

practice, or course of business that 

operates as a fraud or deceit on any 

Special Entity or prospective customer 

who is a Special Entity; or 

(3) To engage in any act, practice, or 

course of business that is fraudulent, 

deceptive, or manipulative. 

(b) Affirmative defense. It shall be an 

affirmative defense to an alleged 

violation of paragraph (a)(2) or (3) of 

this section for failure to comply with 

any requirement in this subpart if a 

swap dealer or major swap participant 

establishes that the swap dealer or major 

swap participant: 

(1) Did not act intentionally or 

recklessly in connection with such 

alleged violation; and 

(2) Complied in good faith with 

written policies and procedures 

reasonably designed to meet the 

particular requirement that is the basis 

for the alleged violation. 

(c) Confidential treatment of 

counterparty information. (1) It shall be 

unlawful for any swap dealer or major 

swap participant to: 

(i) Disclose to any other person any 

material confidential information 

provided by or on behalf of a 

counterparty to the swap dealer or major 

swap participant; or 

(ii) Use for its own purposes in any 

way that would tend to be materially 

adverse to the interests of a 

counterparty, any material confidential 

information provided by or on behalf of 

a counterparty to the swap dealer or 

major swap participant. 

(2) Notwithstanding paragraph (c)(1) 

of this section, a swap dealer or major 

swap participant may disclose or use 

material confidential information 

provided by or on behalf of a 

counterparty to the swap dealer or major 

swap participant if such disclosure or 

use is authorized in writing by the 

counterparty, or is necessary: 

(i) For the effective execution of any 

swap for or with the counterparty; 

(ii) To hedge or mitigate any exposure 

created by such swap; or 

(iii) To comply with a request of the 

Commission, Department of Justice, any 

self-regulatory organization designated 

by the Commission, or an applicable 

prudential regulator, or is otherwise 

required by law. 

(3) Each swap dealer or major swap 

participant shall implement written 

policies and procedures reasonably 

designed to protect material confidential 

information provided by or on behalf of 

a counterparty from disclosure and use 

in violation of this section by any 

person acting for or on behalf of the 

swap dealer or major swap participant. 

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9824 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

§§ 23.411–23.429 [Reserved] 

§ 23.430 Verification of counterparty 

eligibility. 

(a) Eligibility. A swap dealer or major 

swap participant shall verify that a 

counterparty meets the eligibility 

standards for an eligible contract 

participant, as defined in Section 1a(18) 

of the Act and § 1.3 of this chapter, 

before offering to enter into or entering 

into a swap with that counterparty. 

(b) Special Entity. In verifying the 

eligibility of a counterparty pursuant to 

paragraph (a) of this section, a swap 

dealer or major swap participant shall 

also verify whether the counterparty is 

a Special Entity. 

(c) Special Entity election. In verifying 

the eligibility of a counterparty pursuant 

to paragraph (a) of this section, a swap 

dealer or major swap participant shall 

verify whether a counterparty is eligible 

to elect to be a Special Entity under 

§ 23.401(c)(6) and, if so, notify such 

counterparty of its right to make such an 

election. 

(d) Safe harbor. A swap dealer or 

major swap participant may rely on 

written representations of a 

counterparty to satisfy the requirements 

of this section as provided in 

§ 23.402(d). A swap dealer or major 

swap participant will have a reasonable 

basis to rely on such written 

representations for purposes of the 

requirements in paragraphs (a) and (b) 

of this section if the counterparty 

specifies in such representations the 

provision(s) of Section 1a(18) of the Act 

or paragraph(s) of § 1.3 of this chapter 

that describe its status as an eligible 

contract participant and, in the case of 

a Special Entity, the paragraph(s) of the 

Special Entity definition in § 23.401(c) 

that define its status as a Special Entity. 

(e) This section shall not apply with 

respect to: 

(1) A transaction that is initiated on 

a designated contract market; or 

(2) A transaction initiated on a swap 

execution facility, if the swap dealer or 

major swap participant does not know 

the identity of the counterparty to the 

transaction prior to execution. 

§ 23.431 Disclosures of material 

information. 

(a) At a reasonably sufficient time 

prior to entering into a swap, a swap 

dealer or major swap participant shall 

disclose to any counterparty to the swap 

(other than a swap dealer, major swap 

participant, security-based swap dealer, 

or major security-based swap 

participant) material information 

concerning the swap in a manner 

reasonably designed to allow the 

counterparty to assess: 

(1) The material risks of the particular 

swap, which may include market, 

credit, liquidity, foreign currency, legal, 

operational, and any other applicable 

risks; 

(2) The material characteristics of the 

particular swap, which shall include the 

material economic terms of the swap, 

the terms relating to the operation of the 

swap, and the rights and obligations of 

the parties during the term of the swap; 

and 

(3) The material incentives and 

conflicts of interest that the swap dealer 

or major swap participant may have in 

connection with a particular swap, 

which shall include: 

(i) With respect to disclosure of the 

price of the swap, the price of the swap 

and the mid-market mark of the swap as 

set forth in paragraph (d)(2) of this 

section; and 

(ii) Any compensation or other 

incentive from any source other than the 

counterparty that the swap dealer or 

major swap participant may receive in 

connection with the swap. 

(b) Scenario Analysis. Prior to 

entering into a swap with a counterparty 

(other than a swap dealer, major swap 

participant, security-based swap dealer, 

or major security-based swap 

participant) that is not made available 

for trading, as provided in Section 

2(h)(8) of the Act, on a designated 

contract market or swap execution 

facility, a swap dealer shall: 

(1) Notify the counterparty that it can 

request and consult on the design of a 

scenario analysis to allow the 

counterparty to assess its potential 

exposure in connection with the swap; 

(2) Upon request of the counterparty, 

provide a scenario analysis, which is 

designed in consultation with the 

counterparty and done over a range of 

assumptions, including severe 

downside stress scenarios that would 

result in a significant loss; 

(3) Disclose all material assumptions 

and explain the calculation 

methodologies used to perform any 

requested scenario analysis; provided 

however, that the swap dealer is not 

required to disclose confidential, 

proprietary information about any 

model it may use to prepare the scenario 

analysis; and 

(4) In designing any requested 

scenario analysis, consider any relevant 

analyses that the swap dealer 

undertakes for its own risk management 

purposes, including analyses performed 

as part of its ‘‘New Product Policy’’ 

specified in § 23.600(c)(3). 

(c) Paragraphs (a) and (b) of this 

section shall not apply with respect to 

a transaction that is: 

(1) Initiated on a designated contract 

market or a swap execution facility; and 

(2) One in which the swap dealer or 

major swap participant does not know 

the identity of the counterparty to the 

transaction prior to execution. 

(d) Daily mark. A swap dealer or 

major swap participant shall: 

(1) For cleared swaps, notify a 

counterparty (other than a swap dealer, 

major swap participant, security-based 

swap dealer, or major security-based 

swap participant) of the counterparty’s 

right to receive, upon request, the daily 

mark from the appropriate derivatives 

clearing organization. 

(2) For uncleared swaps, provide the 

counterparty (other than a swap dealer, 

major swap participant, security-based 

swap dealer, or major security-based 

swap participant) with a daily mark, 

which shall be the mid-market mark of 

the swap. The mid-market mark of the 

swap shall not include amounts for 

profit, credit reserve, hedging, funding, 

liquidity, or any other costs or 

adjustments. The daily mark shall be 

provided to the counterparty during the 

term of the swap as of the close of 

business or such other time as the 

parties agree in writing. 

(3) For uncleared swaps, disclose to 

the counterparty: 

(i) The methodology and assumptions 

used to prepare the daily mark and any 

material changes during the term of the 

swap; provided however, that the swap 

dealer or major swap participant is not 

required to disclose to the counterparty 

confidential, proprietary information 

about any model it may use to prepare 

the daily mark; and 

(ii) Additional information 

concerning the daily mark to ensure a 

fair and balanced communication, 

including, as appropriate, that: 

(A) The daily mark may not 

necessarily be a price at which either 

the counterparty or the swap dealer or 

major swap participant would agree to 

replace or terminate the swap; 

(B) Depending upon the agreement of 

the parties, calls for margin may be 

based on considerations other than the 

daily mark provided to the 

counterparty; and 

(C) The daily mark may not 

necessarily be the value of the swap that 

is marked on the books of the swap 

dealer or major swap participant. 

§ 23.432 Clearing disclosures. 

(a) For swaps required to be cleared— 

right to select derivatives clearing 

organization. A swap dealer or major 

swap participant shall notify any 

counterparty (other than a swap dealer, 

major swap participant, securities-based 

swap dealer, or major securities-based 

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swap participant) with which it entered 

into a swap that is subject to mandatory 

clearing under Section 2(h) of the Act, 

that the counterparty has the sole right 

to select the derivatives clearing 

organization at which the swap will be 

cleared. 

(b) For swaps not required to be 

cleared—right to clearing. A swap 

dealer or major swap participant shall 

notify any counterparty (other than a 

swap dealer, major swap participant, 

securities-based swap dealer, or major 

securities-based swap participant) with 

which it entered into a swap that is not 

subject to the mandatory clearing 

requirements under Section 2(h) of the 

Act that the counterparty: 

(1) May elect to require clearing of the 

swap; and 

(2) Shall have the sole right to select 

the derivatives clearing organization at 

which the swap will be cleared. 

§ 23.433 Communications—fair dealing. 

With respect to any communication 

between a swap dealer or major swap 

participant and any counterparty, the 

swap dealer or major swap participant 

shall communicate in a fair and 

balanced manner based on principles of 

fair dealing and good faith. 

§ 23.434 Recommendations to 

counterparties—institutional suitability. 

(a) A swap dealer that recommends a 

swap or trading strategy involving a 

swap to a counterparty, other than a 

swap dealer, major swap participant, 

security-based swap dealer, or major 

security-based swap participant, must: 

(1) Undertake reasonable diligence to 

understand the potential risks and 

rewards associated with the 

recommended swap or trading strategy 

involving a swap; and 

(2) Have a reasonable basis to believe 

that the recommended swap or trading 

strategy involving a swap is suitable for 

the counterparty. To establish a 

reasonable basis for a recommendation, 

a swap dealer must have or obtain 

information about the counterparty, 

including the counterparty’s investment 

profile, trading objectives, and ability to 

absorb potential losses associated with 

the recommended swap or trading 

strategy involving a swap. 

(b) Safe Harbor. A swap dealer may 

fulfill its obligations under paragraph 

(a)(2) of this section with respect to a 

particular counterparty if: 

(1) The swap dealer reasonably 

determines that the counterparty, or an 

agent to which the counterparty has 

delegated decision-making authority, is 

capable of independently evaluating 

investment risks with regard to the 

relevant swap or trading strategy 

involving a swap; 

(2) The counterparty or its agent 

represents in writing that it is exercising 

independent judgment in evaluating the 

recommendations of the swap dealer 

with regard to the relevant swap or 

trading strategy involving a swap; 

(3) The swap dealer discloses in 

writing that it is acting in its capacity as 

a counterparty and is not undertaking to 

assess the suitability of the swap or 

trading strategy involving a swap for the 

counterparty; and 

(4) In the case of a counterparty that 

is a Special Entity, the swap dealer 

complies with § 23.440 where the 

recommendation would cause the swap 

dealer to act as an advisor to a Special 

Entity within the meaning of 

§ 23.440(a). 

(c) A swap dealer will satisfy the 

requirements of paragraph (b)(1) of this 

section if it receives written 

representations, as provided in 

§ 23.402(d), that: 

(1) In the case of a counterparty that 

is not a Special Entity, the counterparty 

has complied in good faith with written 

policies and procedures that are 

reasonably designed to ensure that the 

persons responsible for evaluating the 

recommendation and making trading 

decisions on behalf of the counterparty 

are capable of doing so; or 

(2) In the case of a counterparty that 

is a Special Entity, satisfy the terms of 

the safe harbor in § 23.450(d). 

§§ 23.435–23.439 [Reserved] 

§ 23.440 Requirements for swap dealers 

acting as advisors to Special Entities. 

(a) Acts as an advisor to a Special 

Entity. For purposes of this section, a 

swap dealer ‘‘acts as an advisor to a 

Special Entity’’ when the swap dealer 

recommends a swap or trading strategy 

involving a swap that is tailored to the 

particular needs or characteristics of the 

Special Entity. 

(b) Safe harbors. A swap dealer will 

not ‘‘act as an advisor to a Special 

Entity’’ within the meaning of paragraph 

(a) of this section if: 

(1) With respect to a Special Entity 

that is an employee benefit plan as 

defined in § 23.401(c)(3): 

(i) The Special Entity represents in 

writing that it has a fiduciary as defined 

in Section 3 of the Employee Retirement 

Income Security Act of 1974 (29 U.S.C. 

1002) that is responsible for 

representing the Special Entity in 

connection with the swap transaction; 

(ii) The fiduciary represents in writing 

that it will not rely on recommendations 

provided by the swap dealer; and 

(iii) The Special Entity represents in 

writing: 

(A) That it will comply in good faith 

with written policies and procedures 

reasonably designed to ensure that any 

recommendation the Special Entity 

receives from the swap dealer materially 

affecting a swap transaction is evaluated 

by a fiduciary before the transaction 

occurs; or 

(B) That any recommendation the 

Special Entity receives from the swap 

dealer materially affecting a swap 

transaction will be evaluated by a 

fiduciary before that transaction occurs; 

or 

(2) With respect to any Special Entity: 

(i) The swap dealer does not express 

an opinion as to whether the Special 

Entity should enter into a recommended 

swap or trading strategy involving a 

swap that is tailored to the particular 

needs or characteristics of the Special 

Entity; 

(ii) The Special Entity represents in 

writing that: 

(A) The Special Entity will not rely on 

recommendations provided by the swap 

dealer; and 

(B) The Special Entity will rely on 

advice from a qualified independent 

representative within the meaning of 

§ 23.450; and 

(iii) The swap dealer discloses to the 

Special Entity that it is not undertaking 

to act in the best interests of the Special 

Entity as otherwise required by this 

section. 

(c) A swap dealer that acts as an 

advisor to a Special Entity shall comply 

with the following requirements: 

(1) Duty. Any swap dealer that acts as 

an advisor to a Special Entity shall have 

a duty to make a reasonable 

determination that any swap or trading 

strategy involving a swap recommended 

by the swap dealer is in the best 

interests of the Special Entity. 

(2) Reasonable efforts. Any swap 

dealer that acts as an advisor to a 

Special Entity shall make reasonable 

efforts to obtain such information as is 

necessary to make a reasonable 

determination that any swap or trading 

strategy involving a swap recommended 

by the swap dealer is in the best 

interests of the Special Entity, including 

information relating to: 

(i) The financial status of the Special 

Entity, as well as the Special Entity’s 

future funding needs; 

(ii) The tax status of the Special 

Entity; 

(iii) The hedging, investment, 

financing, or other objectives of the 

Special Entity; 

(iv) The experience of the Special 

Entity with respect to entering into 

swaps, generally, and swaps of the type 

and complexity being recommended; 

(v) Whether the Special Entity has the 

financial capability to withstand 

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9826 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

changes in market conditions during the 

term of the swap; and 

(vi) Such other information as is 

relevant to the particular facts and 

circumstances of the Special Entity, 

market conditions, and the type of swap 

or trading strategy involving a swap 

being recommended. 

(d) Reasonable reliance on 

representations of the Special Entity. As 

provided in § 23.402(d), the swap dealer 

may rely on written representations of 

the Special Entity to satisfy its 

requirement in paragraph (c)(2) of this 

section to make ‘‘reasonable efforts’’ to 

obtain necessary information. 

§§ 23.441–23.449 [Reserved] 

§ 23.450 Requirements for swap dealers 

and major swap participants acting as 

counterparties to Special Entities. 

(a) Definitions. For purposes of this 

section: 

(1) The term ‘‘principal relationship’’ 

means where a swap dealer or major 

swap participant is a principal of the 

representative of a Special Entity or the 

representative of a Special Entity is a 

principal of the swap dealer or major 

swap participant. The term ‘‘principal’’ 

means any person listed in § 3.1(a)(1) 

through(3) of this chapter. 

(2) The term ‘‘statutory 

disqualification’’ means grounds for 

refusal to register or to revoke, 

condition, or restrict the registration of 

any registrant or applicant for 

registration as set forth in Sections 8a(2) 

and 8a(3) of the Act. 

(b)(1) Any swap dealer or major swap 

participant that offers to enter or enters 

into a swap with a Special Entity, other 

than a Special Entity defined in 

§ 23.401(c)(3), shall have a reasonable 

basis to believe that the Special Entity 

has a representative that: 

(i) Has sufficient knowledge to 

evaluate the transaction and risks; 

(ii) Is not subject to a statutory 

disqualification; 

(iii) Is independent of the swap dealer 

or major swap participant; 

(iv) Undertakes a duty to act in the 

best interests of the Special Entity it 

represents; 

(v) Makes appropriate and timely 

disclosures to the Special Entity; 

(vi) Evaluates, consistent with any 

guidelines provided by the Special 

Entity, fair pricing and the 

appropriateness of the swap; and 

(vii) In the case of a Special Entity as 

defined in § 23.401(c)(2) or (4), is 

subject to restrictions on certain 

political contributions imposed by the 

Commission, the Securities and 

Exchange Commission, or a selfregulatory organization subject to the 

jurisdiction of the Commission or the 

Securities and Exchange Commission; 

provided however, that this paragraph 

(b)(1)(vii) of this section shall not apply 

if the representative is an employee of 

the Special Entity. 

(2) Any swap dealer or major swap 

participant that offers to enter or enters 

into a swap with a Special Entity as 

defined in § 23.401(c)(3) shall have a 

reasonable basis to believe that the 

Special Entity has a representative that 

is a fiduciary as defined in Section 3 of 

the Employee Retirement Income 

Security Act of 1974 (29 U.S.C. 1002). 

(c) Independent. For purposes of 

paragraph (b)(1)(iii) of this section, a 

representative of a Special Entity will be 

deemed to be independent of the swap 

dealer or major swap participant if: 

(1) The representative is not and, 

within one year of representing the 

Special Entity in connection with the 

swap, was not an associated person of 

the swap dealer or major swap 

participant within the meaning of 

Section 1a(4) of the Act; 

(2) There is no principal relationship 

between the representative of the 

Special Entity and the swap dealer or 

major swap participant; 

(3) The representative: 

(i) Provides timely and effective 

disclosures to the Special Entity of all 

material conflicts of interest that could 

reasonably affect the judgment or 

decision making of the representative 

with respect to its obligations to the 

Special Entity; and 

(ii) Complies with policies and 

procedures reasonably designed to 

manage and mitigate such material 

conflicts of interest; 

(4) The representative is not directly 

or indirectly, through one or more 

persons, controlled by, in control of, or 

under common control with the swap 

dealer or major swap participant; and 

(5) The swap dealer or major swap 

participant did not refer, recommend, or 

introduce the representative to the 

Special Entity within one year of the 

representative’s representation of the 

Special Entity in connection with the 

swap. 

(d) Safe Harbor. (1) A swap dealer or 

major swap participant shall be deemed 

to have a reasonable basis to believe that 

the Special Entity, other than a Special 

Entity defined in § 23.401(c)(3), has a 

representative that satisfies the 

applicable requirements of paragraph 

(b)(1) of this section, provided that: 

(i) The Special Entity represents in 

writing to the swap dealer or major 

swap participant that it has complied in 

good faith with written policies and 

procedures reasonably designed to 

ensure that it has selected a 

representative that satisfies the 

applicable requirements of paragraph (b) 

of this section, and that such policies 

and procedures provide for ongoing 

monitoring of the performance of such 

representative consistent with the 

requirements of paragraph (b) of this 

section; and 

(ii) The representative represents in 

writing to the Special Entity and swap 

dealer or major swap participant that 

the representative: 

(A) Has policies and procedures 

reasonably designed to ensure that it 

satisfies the applicable requirements of 

paragraph (b) of this section; 

(B) Meets the independence test in 

paragraph (c) of this section; and 

(C) Is legally obligated to comply with 

the applicable requirements of 

paragraph (b) of this section by 

agreement, condition of employment, 

law, rule, regulation, or other 

enforceable duty. 

(2) A swap dealer or major swap 

participant shall be deemed to have a 

reasonable basis to believe that a Special 

Entity defined in § 23.401(c)(3) has a 

representative that satisfies the 

applicable requirements in paragraph 

(b)(2) of this section, provided that the 

Special Entity provides in writing to the 

swap dealer or major swap participant 

the representative’s name and contact 

information, and represents in writing 

that the representative is a fiduciary as 

defined in Section 3 of the Employee 

Retirement Income Security Act of 1974 

(29 U.S.C. 1002). 

(e) Reasonable reliance on 

representations of the Special Entity. A 

swap dealer or major swap participant 

may rely on written representations of a 

Special Entity and, as applicable under 

this section, the Special Entity’s 

representative to satisfy any 

requirement of this section as provided 

in § 23.402(d). 

(f) Chief compliance officer review. If 

a swap dealer or major swap participant 

initially determines that it does not have 

a reasonable basis to believe that the 

representative of a Special Entity meets 

the criteria established in this section, 

the swap dealer or major swap 

participant shall make a written record 

of the basis for such determination and 

submit such determination to its chief 

compliance officer for review to ensure 

that the swap dealer or major swap 

participant has a substantial, unbiased 

basis for the determination. 

(g) Before the initiation of a swap, a 

swap dealer or major swap participant 

shall disclose to the Special Entity in 

writing: 

(1) The capacity in which it is acting 

in connection with the swap; and 

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Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 9827 

(2) If the swap dealer or major swap 

participant engages in business with the 

Special Entity in more than one 

capacity, the swap dealer or major swap 

participant shall disclose the material 

differences between such capacities. 

(h) This section shall not apply with 

respect to a transaction that is: 

(1) Initiated on a designated contract 

market or swap execution facility; and 

(2) One in which the swap dealer or 

major swap participant does not know 

the identity of the counterparty to the 

transaction prior to execution. 

§ 23.451 Political contributions by certain 

swap dealers. 

(a) Definitions. For the purposes of 

this section: 

(1) The term ‘‘contribution’’ means 

any gift, subscription, loan, advance, or 

deposit of money or anything of value 

made: 

(i) For the purpose of influencing any 

election for federal, state, or local office; 

(ii) For payment of debt incurred in 

connection with any such election; or 

(iii) For transition or inaugural 

expenses incurred by the successful 

candidate for federal, state, or local 

office. 

(2) The term ‘‘covered associate’’ 

means: 

(i) Any general partner, managing 

member, or executive officer, or other 

person with a similar status or function; 

(ii) Any employee who solicits a 

governmental Special Entity for the 

swap dealer and any person who 

supervises, directly or indirectly, such 

employee; and 

(iii) Any political action committee 

controlled by the swap dealer or by any 

person described in paragraphs (a)(2)(i) 

and (a)(2)(ii) of this section. 

(3) The term ‘‘governmental Special 

Entity’’ means any Special Entity 

defined in § 23.401(c)(2) or (4). 

(4) The term ‘‘official’’ of a 

governmental Special Entity means any 

person (including any election 

committee for such person) who was, at 

the time of the contribution, an 

incumbent, candidate, or successful 

candidate for elective office of a 

governmental Special Entity, if the 

office: 

(i) Is directly or indirectly responsible 

for, or can influence the outcome of, the 

selection of a swap dealer by a 

governmental Special Entity; or 

(ii) Has authority to appoint any 

person who is directly or indirectly 

responsible for, or can influence the 

outcome of, the selection of a swap 

dealer by a governmental Special Entity. 

(5) The term ‘‘payment’’ means any 

gift, subscription, loan, advance, or 

deposit of money or anything of value. 

(6) The term ‘‘regulated person’’ 

means: 

(i) A person that is subject to 

restrictions on certain political 

contributions imposed by the 

Commission, the Securities and 

Exchange Commission, or a selfregulatory agency subject to the 

jurisdiction of the Commission or the 

Securities and Exchange Commission; 

(ii) A general partner, managing 

member, or executive officer of such 

person, or other individual with a 

similar status or function; or 

(iii) An employee of such person who 

solicits a governmental Special Entity 

for the swap dealer and any person who 

supervises, directly or indirectly, such 

employee. 

(7) The term ‘‘solicit’’ means a direct 

or indirect communication by any 

person with a governmental Special 

Entity for the purpose of obtaining or 

retaining an engagement related to a 

swap. 

(b) Prohibitions and exceptions. (1) As 

a means reasonably designed to prevent 

fraud, no swap dealer shall offer to enter 

into or enter into a swap or a trading 

strategy involving a swap with a 

governmental Special Entity within two 

years after any contribution to an 

official of such governmental Special 

Entity was made by the swap dealer or 

by any covered associate of the swap 

dealer; provided however, that: 

(2) This prohibition does not apply: 

(i) If the only contributions made by 

the swap dealer to an official of such 

governmental Special Entity were made 

by a covered associate: 

(A) To officials for whom the covered 

associate was entitled to vote at the time 

of the contributions, provided that the 

contributions in the aggregate do not 

exceed $350 to any one official per 

election; or 

(B) To officials for whom the covered 

associate was not entitled to vote at the 

time of the contributions, provided that 

the contributions in the aggregate do not 

exceed $150 to any one official per 

election; 

(ii) To a swap dealer as a result of a 

contribution made by a natural person 

more than six months prior to becoming 

a covered associate of the swap dealer, 

provided that this exclusion shall not 

apply if the natural person, after 

becoming a covered associate, solicits 

the governmental Special Entity on 

behalf of the swap dealer to offer to 

enter into or to enter into a swap or 

trading strategy involving a swap; or 

(iii) To a swap that is: 

(A) Initiated on a designated contract 

market or swap execution facility; and 

(B) One in which the swap dealer 

does not know the identity of the 

counterparty to the transaction prior to 

execution. 

(3) No swap dealer or any covered 

associate of the swap dealer shall: 

(i) Provide or agree to provide, 

directly or indirectly, payment to any 

person to solicit a governmental Special 

Entity to offer to enter into, or to enter 

into, a swap with that swap dealer 

unless such person is a regulated 

person; or 

(ii) Coordinate, or solicit any person 

or political action committee to make, 

any: 

(A) Contribution to an official of a 

governmental Special Entity with which 

the swap dealer is offering to enter into, 

or has entered into, a swap; or 

(B) Payment to a political party of a 

state or locality with which the swap 

dealer is offering to enter into or has 

entered into a swap or a trading strategy 

involving a swap. 

(c) Circumvention of rule. No swap 

dealer shall, directly or indirectly, 

through or by any other person or 

means, do any act that would result in 

a violation of paragraph (b) of this 

section. 

(d) Requests for exemption. The 

Commission, upon application, may 

conditionally or unconditionally 

exempt a swap dealer from the 

prohibition under paragraph (b) of this 

section. In determining whether to grant 

an exemption, the Commission will 

consider, among other factors: 

(1) Whether the exemption is 

necessary or appropriate in the public 

interest and consistent with the 

protection of investors and the purposes 

of the Act; 

(2) Whether the swap dealer: 

(i) Before the contribution resulting in 

the prohibition was made, implemented 

policies and procedures reasonably 

designed to prevent violations of this 

section; 

(ii) Prior to or at the time the 

contribution which resulted in such 

prohibition was made, had no actual 

knowledge of the contribution; and 

(iii) After learning of the contribution: 

(A) Has taken all available steps to 

cause the contributor involved in 

making the contribution which resulted 

in such prohibition to obtain a return of 

the contribution; and 

(B) Has taken such other remedial or 

preventive measures as may be 

appropriate under the circumstances; 

(3) Whether, at the time of the 

contribution, the contributor was a 

covered associate or otherwise an 

employee of the swap dealer, or was 

seeking such employment; 

(4) The timing and amount of the 

contribution which resulted in the 

prohibition; 

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9828 Federal Register / Vol. 77, No. 33 / Friday, February 17, 2012 / Rules and Regulations 

(5) The nature of the election (e.g., 

federal, state or local); and 

(6) The contributor’s apparent intent 

or motive in making the contribution 

that resulted in the prohibition, as 

evidenced by the facts and 

circumstances surrounding the 

contribution. 

(e) Prohibitions inapplicable. (1) The 

prohibitions under paragraph (b) of this 

section shall not apply to a contribution 

made by a covered associate of the swap 

dealer if: 

(i) The swap dealer discovered the 

contribution within 120 calendar days 

of the date of such contribution; 

(ii) The contribution did not exceed 

the amounts permitted by paragraphs 

(b)(2)(i)(A) or (B) of this section; and 

(iii) The covered associate obtained a 

return of the contribution within 60 

calendar days of the date of discovery of 

the contribution by the swap dealer. 

(2) A swap dealer may not rely on 

paragraph (e)(1) of this section more 

than twice in any 12-month period. 

(3) A swap dealer may not rely on 

paragraph (e)(1) of this section more 

than once for any covered associate, 

regardless of the time between 

contributions. 

Appendix A—Guidance on the 

Application of §§ 23.434 and 23.440 for 

Swap Dealers That Make 

Recommendations to Counterparties or 

Special Entities 

The following provides guidance on the 

application of §§ 23.434 and 23.440 to swap 

dealers that make recommendations to 

counterparties or Special Entities. 

Section 23.434—Recommendations to 

Counterparties—Institutional Suitability 

A swap dealer that recommends a swap or 

trading strategy involving a swap to a 

counterparty, other than a swap dealer, major 

swap participant, security-based swap dealer 

or major security-based swap participant, 

must undertake reasonable diligence to 

understand the potential risks and rewards 

associated with the recommended swap or 

trading strategy involving a swap—general 

suitability (§ 23.434(a)(1))—and have a 

reasonable basis to believe that the 

recommended swap or trading strategy 

involving a swap is suitable for the 

counterparty—specific suitability 

(§ 23.434(a)(2)). To satisfy the general 

suitability obligation, a swap dealer must 

undertake reasonable diligence that will vary 

depending on, among other things, the 

complexity of and risks associated with the 

swap or swap trading strategy and the swap 

dealer’s familiarity with the swap or swap 

trading strategy. At a minimum, a swap 

dealer’s reasonable diligence must provide it 

with an understanding of the potential risks 

and rewards associated with the 

recommended swap or swap trading strategy. 

Recommendation. Whether a 

communication between a swap dealer and a 

counterparty is a recommendation will turn 

on the facts and circumstances of the 

particular situation. There are, however, 

certain factors the Commission will consider 

in reaching such a determination. The facts 

and circumstances determination of whether 

a communication is a ‘‘recommendation’’ 

requires an analysis of the content, context, 

and presentation of the particular 

communication or set of communications. 

The determination of whether a 

‘‘recommendation’’ has been made, 

moreover, is an objective rather than a 

subjective inquiry. An important factor in 

this regard is whether, given its content, 

context, and manner of presentation, a 

particular communication from a swap dealer 

to a counterparty reasonably would be 

viewed as a ‘‘call to action,’’ or suggestion 

that the counterparty enter into a swap. An 

analysis of the content, context, and manner 

of presentation of a communication requires 

examination of the underlying substantive 

information transmitted to the counterparty 

and consideration of any other facts and 

circumstances, such as any accompanying 

explanatory message from the swap dealer. 

Additionally, the more individually tailored 

the communication to a specific counterparty 

or a targeted group of counterparties about a 

swap, group of swaps or trading strategy 

involving the use of a swap, the greater the 

likelihood that the communication may be 

viewed as a ‘‘recommendation.’’ 

Safe harbor. A swap dealer may satisfy the 

safe harbor requirements of § 23.434(b) to 

fulfill its counterparty-specific suitability 

duty under § 23.434(a)(2) if: (1) The swap 

dealer reasonably determines that the 

counterparty, or an agent to which the 

counterparty has delegated decision-making 

authority, is capable of independently 

evaluating investment risks with regard to 

the relevant swap or trading strategy 

involving a swap; (2) the counterparty or its 

agent represents in writing that it is 

exercising independent judgment in 

evaluating the recommendations of the swap 

dealer; (3) the swap dealer discloses in 

writing that it is acting in its capacity as a 

counterparty and is not undertaking to assess 

the suitability of the recommendation; and 

(4) in the case of a counterparty that is a 

Special Entity, the swap dealer complies 

with § 23.440 where the recommendation 

would cause the swap dealer to act as an 

advisor to a Special Entity within the 

meaning of § 23.440(a). 

To reasonably determine that the 

counterparty, or an agent to which the 

counterparty has delegated decision-making 

authority, is capable of independently 

evaluating investment risks of a 

recommendation, the swap dealer can rely on 

the written representations of the 

counterparty, as provided in § 23.434(c). 

Section 23.434(c)(1) provides that a swap 

dealer will satisfy § 23.434(b)(1)’s 

requirement with respect to a counterparty 

other than a Special Entity if it receives 

representations that the counterparty has 

complied in good faith with the 

counterparty’s policies and procedures that 

are reasonably designed to ensure that the 

persons responsible for evaluating the 

recommendation and making trading 

decisions on behalf of the counterparty are 

capable of doing so. Section § 23.434(c)(2) 

provides that a swap dealer will satisfy 

§ 23.434(b)(1)’s requirement with respect to a 

Special Entity if it receives representations 

that satisfy the terms of § 23.450(d) regarding 

a Special Entity’s qualified independent 

representative. 

Prong (4) of the safe harbor clarifies that 

§ 23.434’s application is broader than 

§ 23.440—Requirements for Swap Dealers 

Acting as Advisors to Special Entities. 

Section 23.434 is triggered when a swap 

dealer recommends any swap or trading 

strategy that involves a swap to any 

counterparty. However, § 23.440 is limited to 

a swap dealer’s recommendations (1) to a 

Special Entity (2) of swaps that are tailored 

to the particular needs or characteristics of 

the Special Entity. Thus, a swap dealer that 

recommends a swap to a Special Entity that 

is tailored to the particular needs or 

characteristics of the Special Entity may 

comply with its suitability obligation by 

satisfying the safe harbor in § 23.434(b); 

however, the swap dealer must also comply 

with § 23.440 in such circumstances. 

Section 23.440—Requirements for Swap 

Dealers Acting as Advisors to Special Entities 

A swap dealer ‘‘acts as an advisor to a 

Special Entity’’ under § 23.440 when the 

swap dealer recommends a swap or trading 

strategy involving a swap that is tailored to 

the particular needs or characteristics of the 

Special Entity. A swap dealer that ‘‘acts as an 

advisor to a Special Entity’’ has a duty to 

make a reasonable determination that a 

recommendation is in the ‘‘best interests’’ of 

the Special Entities and must undertake 

‘‘reasonable efforts’’ to obtain information 

necessary to make such a determination. 

Whether a swap dealer ‘‘acts as an advisor 

to a Special Entity’’ will depend on: (1) 

Whether the swap dealer has made a 

recommendation to a Special Entity; and (2) 

whether the recommendation concerns a 

swap or trading strategy involving a swap 

that is tailored to the particular needs or 

characteristics of the Special Entity. To 

determine whether a communication 

between a swap dealer and counterparty is a 

recommendation, the Commission will apply 

the same factors as under § 23.434, the 

suitability rule. However, unlike the 

suitability rule, which covers 

recommendations regarding any type of swap 

or trading strategy involving a swap, the 

‘‘acts as an advisor rule’’ and ‘‘best interests’’ 

duty will be triggered only if the 

recommendation is of a swap or trading 

strategy involving a swap that is ‘‘tailored to 

the particular needs or characteristics of the 

Special Entity.’’ 

Whether a swap is tailored to the particular 

needs or characteristics of the Special Entity 

will depend on the facts and circumstances. 

Swaps with terms that are tailored or 

customized to a specific Special Entity’s 

needs or objectives, or swaps with terms that 

are designed for a targeted group of Special 

Entities that share common characteristics, 

e.g., school districts, are likely to be viewed 

as tailored to the particular needs or 

characteristics of the Special Entity. 

Generally, however, the Commission would 

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1The guidance in this appendix regarding the 

safe harbor to § 23.440 is limited to the safe harbor 

for any Special Entity under § 23.440(b)(2). A swap 

dealer may separately comply with the safe harbor 

under § 23.440(b)(1) for its communications to a 

Special Entity that is an employee benefit plan as 

defined in § 23.401(c)(3). 

2Communications on the list that are not within 

the meaning of the term ‘‘acts as an advisor to a 

Special Entity’’ are outside the requirements of 

§ 23.440. By including such communications on the 

list, the Commission does not intend to suggest that 

they are ‘‘recommendations.’’ Thus, a swap dealer 

that does not ‘‘act as an advisor to a Special Entity’’ 

within the meaning of § 23.440(a) is not required to 

comply with the safe harbor to avoid the ‘‘best 

interests’’ duty with respect to its communications. 

not view a swap that is ‘‘made available for 

trading’’ on a designated contract market or 

swap execution facility, as provided in 

Section 2(h)(8) of the Act, as tailored to the 

particular needs or characteristics of the 

Special Entity. 

Safe harbor. Under § 23.440(b)(2), when 

dealing with a Special Entity (including a 

Special Entity that is an employee benefit 

plan as defined in § 23.401(c)(3)),1 a swap 

dealer will not ‘‘act as an advisor to a Special 

Entity’’ if: (1) The swap dealer does not 

express an opinion as to whether the Special 

Entity should enter into a recommended 

swap or swap trading strategy that is tailored 

to the particular needs or characteristics of 

the Special Entity; (2) the Special Entity 

represents in writing, in accordance with 

§ 23.402(d), that it will not rely on the swap 

dealer’s recommendations and will rely on 

advice from a qualified independent 

representative within the meaning of 

§ 23.450; and (3) the swap dealer discloses 

that it is not undertaking to act in the best 

interests of the Special Entity. 

A swap dealer that elects to communicate 

within the safe harbor to avoid triggering the 

‘‘best interests’’ duty must appropriately 

manage its communications. To clarify the 

type of communications that they will make 

under the safe harbor, the Commission 

expects that swap dealers may specifically 

represent that they will not express an 

opinion as to whether the Special Entity 

should enter into a recommended swap or 

trading strategy, and that for such advice the 

Special Entity should consult its own 

advisor. Nothing in the final rule would 

preclude such a representation from being 

included in counterparty relationship 

documentation. However, such a 

representation would not act as a safe harbor 

under the rule where, contrary to the 

representation, the swap dealer does express 

an opinion to the Special Entity as to 

whether it should enter into a recommended 

swap or trading strategy. 

If a swap dealer complies with the terms 

of the safe harbor, the following types of 

communications would not be subject to the 

‘‘best interests’’ duty: 2 (1) Providing 

information that is general transaction, 

financial, educational, or market information; 

(2) offering a swap or trading strategy 

involving a swap, including swaps that are 

tailored to the needs or characteristics of a 

Special Entity; (3) providing a term sheet, 

including terms for swaps that are tailored to 

the needs or characteristics of a Special 

Entity; (4) responding to a request for a quote 

from a Special Entity; (5) providing trading 

ideas for swaps or swap trading strategies, 

including swaps that are tailored to the needs 

or characteristics of a Special Entity; and (6) 

providing marketing materials upon request 

or on an unsolicited basis about swaps or 

swap trading strategies, including swaps that 

are tailored to the needs or characteristics of 

a Special Entity. This list of communications 

is not exclusive and should not create a 

negative implication that other types of 

communications are subject to a ‘‘best 

interests’’ duty. 

The safe harbor in § 23.440(b)(2) allows a 

wide range of communications and 

interactions between swap dealers and 

Special Entities without invoking the ‘‘best 

interests’’ duty, including discussions of the 

advantages or disadvantages of different 

swaps or trading strategies. The Commission 

notes, however, that depending on the facts 

and circumstances, some of the examples on 

the list could be ‘‘recommendations’’ that 

would trigger a suitability obligation under 

§ 23.434. However, the Commission has 

determined that such activities would not, by 

themselves, prompt the ‘‘best interests’’ duty 

in § 23.440, provided that the parties comply 

with the other requirements of § 23.440(b)(2). 

All of the swap dealer’s communications, 

however, must be made in a fair and 

balanced manner based on principles of fair 

dealing and good faith in compliance with 

§ 23.433. 

Swap dealers engage in a wide variety of 

communications with counterparties in the 

normal course of business, including but not 

limited to the six types of communications 

listed above. Whether any particular 

communication will be deemed to be a 

‘‘recommendation’’ within the meaning of 

§§ 23.434 or 23.440 will depend on the facts 

and circumstances of the particular 

communication considered in light of the 

guidance in this appendix with respect to the 

meaning of the term ‘‘recommendation.’’ 

Swap dealers that choose to manage their 

communications to comply with the safe 

harbors provided in §§ 23.434 and 23.440 

will be able to limit the duty they owe to 

counterparties, including Special Entities, 

provided that the parties exchange the 

appropriate representations. 

By the Commission, this 11th day of 

January 2012. 

David A. Stawick, 

Secretary. 

Appendices to the Final Rules for 

Implementing the Business Conduct 

Standards for Swap Dealers and Major 

Swap Participants With 

Counterparties—Table of Comment 

Letters, Statement of the Department of 

Labor, Commission Voting Summary, 

and Statements of Commissioners 

Note: The following appendices will not 

appear in the Code of Federal Regulations. 

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BILLING CODE 6351–01–C 

Appendix 2—Statement of the 

Department of Labor 

U.S. Department of Labor 

Assistant Secretary for Employee Benefits 

Security Administration, Washington, 

DC 20210 

JAN 17 2012 

Honorable Gary Gensler 

The Honorable Jill Sommers 

The Honorable Bart Chilton 

The Honorable Scott D. O’Malia 

The Honorable Mark Wetjen 

U.S. Commodity Futures Trading 

Commission 

Three Lafayette Centre 

1155 21st Street, NW 

Washington, DC 20581 

Re: Final Business Conduct Standards Rules 

Adopted January 11, 2012 

Dear Chairman Gensler and Commissioners 

Sommers, Chilton, O’Malia and Wetjen: 

The Department of Labor has reviewed the 

final draft of the Commodity Futures Trading 

Commission’s (‘‘CFTC’s’’) rules to implement 

Section 4s(h) of the Commodity Exchange 

Act pursuant to Section 731 of Title VII of 

the Dodd-Frank Wall Street Reform and The 

Consumer Protection Act of 2010. These 

rules prescribe external business conduct 

standards for swap dealers and major swap 

participants and will have a direct impact on 

ERISA-covered plans and plan fiduciaries. I 

very much appreciate the care that the CFTC 

has taken to coordinate its work on this 

project with the Department of Labor in light 

of the Department’s regulatory and 

enforcement responsibilities with respect to 

ERISA fiduciaries. As we have worked with 

your staff, we have paid particular attention 

to the interaction between the original 

business conduct proposal and the 

Department’s own fiduciary regulations and 

proposals. 

The Department of Labor has reviewed 

these final business conduct standards and 

concluded that they do not require swap 

dealers or major swap participants to engage 

in activities that would make them 

fiduciaries under the Department of Labor’s 

current five-part test defining fiduciary 

advice 29 CFR § 2510.3–21(c). In the 

Department’s view, the CFTC’s final business 

conduct standards neither conflict with the 

Department’s existing regulations, nor 

compel swap dealers or major swap 

participants to engage in fiduciary conduct. 

Moreover, the Department states that it is 

fully committed to ensuring that any changes 

to the current ERISA fiduciary advice 

regulation are carefully harmonized with the 

final business conduct standards, as adopted 

by the CFTC and the SEC, so that there are 

no unintended consequences for swap 

dealers and major swap participants who 

comply with these business conduct 

standards. 

We look forward to continuing to work 

with you on these important projects and are 

grateful for your staff’s thoughtful efforts to 

harmonize our work. 

Sincerely, 

Phyllis C. Borzi 

Assistant Secretary, Employee Benefits 

Security Administration 

Appendix 3—Commission Voting 

Summary 

On this matter, Chairman Gensler and 

Commissioners Chilton, O’Malia and Wetjen 

voted in the affirmative; Commissioner 

Sommers voted in the negative. 

Appendix 4—Statement of Chairman 

Gensler 

I support the final rules to establish 

business conduct standards for swap dealers 

and major swap participants in their dealings 

with counterparties, or external business 

conduct. Today’s final rules implement 

important new authorities in the Dodd-Frank 

Wall Street Reform and Consumer Protection 

Act (Dodd-Frank Act) for the Commodity 

Futures Trading Commission to establish and 

enforce robust sales practices in the swaps 

markets. Dealers will have to tell their 

counterparties the mid-market mark of their 

outstanding bilateral swaps every day, 

bringing transparency to the markets and 

helping to level the playing field for market 

participants. 

The rules prohibit fraud and certain other 

abusive practices. They also implement 

requirements for swap dealers and major 

swap participants to deal fairly with 

customers, provide balanced 

communications, and disclose material risks, 

conflicts of interest and material incentives 

before entering into a swap. 

The rules include restrictions on certain 

political contributions from swap dealers to 

municipal officials, known as ‘‘pay to play’’ 

prohibitions. 

The rules also implement the Dodd-Frank 

heightened duties on swap dealers and major 

swap participants when they deal with 

certain entities, such as pension plans, 

governmental entities and endowments. 

The rules were carefully tailored to include 

safe harbors to ensure that special entities, 

such as pension plans subject to the 

Employee Retirement Income Security Act, 

will continue to be able to access these 

markets and hedge their risks. 

The final rules benefitted substantially 

from the input of members of the public who 

met with staff and Commissioners and those 

who submitted thoughtful, detailed letters. 

The Securities and Exchange Commission, 

prudential regulators and the Department of 

Labor also provided helpful feedback. 

[FR Doc. 2012–1244 Filed 2–16–12; 8:45 am] 

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