Wednesday, 

December 22, 2010 

Part III 

Commodity Futures 

Trading Commission 

17 CFR Parts 23 and 155 

Business Conduct Standards for Swap 

Dealers and Major Swap Participants With 

Counterparties; Proposed Rule 


srobinson on DSKHWCL6B1PROD with PROPOSALS3
80638 Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 

1 17 CFR 145.9. 

2The proposed swap execution standards § 155.7 

would apply to any Commission registrant, 

including a swap dealer or major swap participant, 

handling an order for a swap that is available for 

trading on a designated contract market or a swap 

execution facility. 

3See Dodd-Frank Wall Street Reform and 

Consumer Protection Act, Public Law 111–203, 124 

Stat. 1376 (2010) (‘‘Dodd-Frank Act’’). The text of 

the Dodd-Frank Act may be accessed at http:// 

www.cftc.gov/LawRegulation/OTCDERIVATIVES/

index.htm. 

4 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. 

COMMODITY FUTURES TRADING 

COMMISSION 

17 CFR Parts 23 and 155 

RIN 3038–AD25 

Business Conduct Standards for Swap 

Dealers and Major Swap Participants 

With Counterparties 

AGENCY: Commodity Futures Trading 

Commission. 

ACTION: Proposed rules. 

SUMMARY: The Commodity Futures 

Trading Commission (‘‘Commission’’ or 

‘‘CFTC’’) is proposing for comment new 

rules under Section 4s(h) of the 

Commodity Exchange Act (‘‘CEA’’) to 

implement provisions of Title VII of the 

Dodd-Frank Wall Street Reform and 

Consumer Protection Act of 2010 

(‘‘Dodd-Frank Act’’) relating generally to 

external business conduct standards for 

swap dealers and major swap 

participants. 

DATES: Written comments must be 

received on or before February 22, 2011. 

ADDRESSES: You may submit comments, 

identified by RIN number 3038–AD25, 

by any of the following methods: 

• Agency Web site, via its Comments 

Online process: http:// 

comments.cftc.gov/. Follow the 

instructions for submitting comments 

through the Web site. 

• Mail: David A. Stawick, Secretary of 

the Commission, Commodity Futures 

Trading Commission, Three Lafayette 

Centre, 1155 21st Street, NW., 

Washington, DC 20581. 

• Hand Delivery/Courier: Same as 

mail above. 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

Please submit your comments using 

only one method. 

All comments must be submitted in 

English, or if not, accompanied by an 

English translation. Comments will be 

posted as received to http:// 

www.cftc.gov. You should submit only 

information that you wish to make 

available publicly. If you wish the 

Commission to consider information 

that you believe is exempt from 

disclosure under the Freedom of 

Information Act, a petition for 

confidential treatment of the exempt 

information may be submitted according 

to the procedures established in § 145.9 

of the Commission’s Regulations.1

The Commission reserves the right, 

but shall have no obligation, to review, 

pre-screen, filter, redact, refuse or 

remove any or all of your submission 

from http://www.cftc.gov that it may 

deem to be inappropriate for 

publication, such as obscene language. 

All submissions that have been redacted 

or removed that contain comments on 

the merits of the rulemaking will be 

retained in the public comment file and 

will be considered as required under the 

Administrative Procedure Act and other 

applicable laws, and may be accessible 

under the Freedom of Information Act. 

FOR FURTHER INFORMATION CONTACT: 

Phyllis J. Cela, Deputy Director and 

Chief Counsel, Division of Enforcement, 

or Peter Sanchez, Special Counsel, 

Division of Clearing and Intermediary 

Oversight, Commodity Futures Trading 

Commission, 1155 21st Street, NW., 

Washington, DC 20581. Telephone 

number: (202) 418–7642. 

SUPPLEMENTARY INFORMATION: The 

Commission is proposing §§ 23.400– 

402, 23.410, 23.430–434, 23.440, 

23.450–451, and 155.7 under Section 

4s(h) of the CEA. The Commission is 

soliciting comments on all aspects of the 

proposed rules and will carefully 

consider any comments received. 

Table of Contents 

I. Introduction 

A. Business Conduct Standards—Dealing 

With Counterparties Generally 

B. Business Conduct Standards—Dealing 

With Counterparties That Are Special 

Entities 

C. Consultations With Stakeholders 

D. Consultation and Coordination With the 

SEC, Prudential Regulators and Other 

Domestic and Foreign Regulatory 

Authorities 

II. Proposed Rules for Swap Dealers and 

Major Swap Participants Dealing With 

Counterparties Generally 

A. Proposed §§ 23.400, 23.401 and 

23.402—Scope, Definitions and General 

Provisions 

B. Proposed § 23.410—Prohibition on 

Fraud, Manipulation and Other Abusive 

Practices 

C. Proposed § 23.430—Verification of 

Counterparty Eligibility 

D. Proposed § 23.431—Disclosures of 

Material Risks, Characteristics, Material 

Incentives and Conflicts of Interest 

Regarding a Swap 

1. Timing and Manner of Disclosures 

2. Disclosure of Material Risks 

3. Scenario Analysis for High-Risk 

Complex Bilateral Swaps and 

Counterparty ‘‘Opt-In’’ for Bilateral 

Swaps Not Available for Trading on a 

Designated Contract Market or Swap 

Execution Facility 

4. Material Characteristics 

5. Material Incentives and Conflicts of 

Interest 

6. Daily Mark 

E. Proposed § 23.432—Clearing 

F. Proposed § 23.433—Communications— 

Fair Dealing 

G. Proposed § 23.434—Recommendations 

to Counterparties—Institutional 

Suitability 

H. Proposed § 155.7—Execution 

Standards 2

III. Proposed Rules for Swap Dealers and 

Major Swap Participants With Special 

Entities 

A. Definition of ‘‘Special Entity’’ Under 

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

B. Proposed § 23.440—Requirements for 

Swap Dealers Acting as Advisors to 

Special Entities 

1. Act as an Advisor to a Special Entity 

2. Best Interests 

3. Reasonable Efforts 

4. Reasonable Reliance To Satisfy the 

‘‘Reasonable Efforts’’ Obligation 

C. Proposed § 23.450—Requirements for 

Swap Dealers and Major Swap 

Participants Acting as Counterparties to 

Special Entities 

1. Qualifications of the Independent 

Representative 

2. Statutory Disqualification 

3. Independent 

4. Best Interests 

5. Makes Appropriate and Timely 

Disclosures 

6. Evaluates Fair Pricing and the 

Appropriateness of the Swap 

7. ERISA Fiduciary 

8. Restrictions on Political Contributions 

by Independent Representative of a 

Municipal Entity 

9. Unqualified Independent Representative 

10. Disclosure of Capacity 

11. Inapplicability 

D. Proposed § 23.451—Political 

Contributions by Certain Swap Dealers 

and Major Swap Participants 

1. Prohibitions 

2. Exceptions 

3. Exemptions 

IV. Request for Comment 

A. Generally 

B. Consistency With SEC Approach 

V. Related Matters 

A. Regulatory Flexibility Act 

B. Paperwork Reduction Act 

C. Cost-Benefit Analysis 

I. Introduction 

On July 21, 2010, President Obama 

signed the Dodd-Frank Act.3 Title VII of 

the Dodd-Frank Act amended the CEA 4

to establish a comprehensive new 

regulatory framework for swaps and 

certain security-based swaps. The 

legislation was enacted to reduce risk, 

increase transparency, and promote 


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Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 80639 

5Congress enacted a virtually identical provision 

in Dodd-Frank Act Section 764 which adds Section 

15F(h) to the Securities Exchange Act of 1934 

(‘‘Exchange Act’’) (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. Section 

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

Commission consult with the Securities and 

Exchange Commission and prudential regulators in 

promulgating rules pursuant to Section 4s(h). 

6See 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 this 

Act’’); see also Sections 4s(h)(1)(D), 4s(h)(5)(B) and 

4s(h)(6). 

7See also Regulations Establishing and Governing 

the Duties of Swap Dealers and Major Swap 

Participants, 75 FR 71397, Nov. 23, 2010 (proposed 

§ 23.602 imposing additional diligent supervision 

requirements on swap dealers and major swap 

participants). 

8 Id. (proposed § 23.601 imposing requirements 

for swap dealers and major swap participants 

related to monitoring position limits). 

9 Dodd-Frank Act Sections 722(d) (amending CEA 

Section 2(i)), 723(a)(3) (amending CEA Sections 

2(h)(4)(A) and 2(h)(7)(F)) and 741(b)(11) (amending 

CEA Section 6(e)) amend the CEA by prohibiting a 

swap dealer or major swap participant from 

‘‘knowingly or recklessly’’ evading certain 

provisions of the CEA. 

10See Sections 2(h)(7)(A) and (B) of the CEA. 

11 In this regard, the Commission has looked to 

the requirements imposed by the National Futures 

Association (‘‘NFA’’), CME Group, Inc. (‘‘CME’’), 

IntercontinentalExchange, Inc. (‘‘ICE’’), Financial 

Industry Regulatory Authority, Inc. (‘‘FINRA’’) and 

the Municipal Securities Rulemaking Board 

(‘‘MSRB’’). SRO rules, in particular, provide a useful 

model because historically the Commission has 

relied on SROs to regulate conduct that is unethical 

or otherwise undesirable, but may not be 

fraudulent. See, e.g., NFA Compliance Rule 2–4, 

Just and Equitable Principles of Trade. 

12See, e.g., International Organization of 

Securities Commissions, ‘‘Operational and Financial 

Risk Management Control Mechanisms for Overthe-Counter Derivatives Activities of Regulated 

Securities Firms’’ (Jul. 1994); Derivatives Policy 

Group, ‘‘Framework for Voluntary Oversight’’ (Mar. 

1995) (‘‘DPG Framework’’), available at http:// 

www.riskinstitute.ch/137790.htm; The Counterparty 

Risk Management Policy Group, ‘‘Improving 

Counterparty Risk Management Practices’’ (June 

1999) (CRMPG is composed of OTC derivatives 

dealers including Bank of America, BNP Paribas, 

Citigroup, Goldman Sachs, HSBC, JP Morgan and 

Morgan Stanley); The Counterparty Risk 

Management Policy Group, ‘‘Toward Greater 

Financial Stability: A Private Sector Perspective— 

The Report of the Counterparty Risk Management 

Policy Group II’’ (Jul. 27, 2005); The Counterparty 

Risk Management Policy Group, ‘‘Containing 

Systemic Risk: The Road to Reform, The Report of 

the CRMPG III (Aug. 6, 2008) (‘‘CRMPG III Report’’), 

available at http://www.crmpolicygroup.org/. 

13The CRMPG III Report identifies the 

characteristics of high-risk complex bilateral swaps 

to be: The degree and nature of leverage, the 

potential for periods of significantly reduced 

liquidity, and the lack of price transparency. The 

CRMPG III Report, at 54–57. 

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. 

Section 731 of the Dodd-Frank Act 

amends the CEA by adding Section 

4s(h). This section provides the 

Commission with both mandatory and 

discretionary rulemaking authority to 

impose business conduct requirements 

on swap dealers and major swap 

participants in their dealings with 

counterparties, including ‘‘Special 

Entities.’’ 5 Such entities are generally 

defined to include Federal agencies, 

States and political subdivisions, 

employee benefit plans as defined under 

the Employee Retirement Income 

Security Act of 1974 (‘‘ERISA’’), 

governmental plans as defined under 

ERISA, and endowments. 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.6

A. Business Conduct Standards— 

Dealing With Counterparties Generally 

Section 4s(h)(1) grants the 

Commission authority to promulgate 

rules applicable to swap dealers and 

major swap participants related to, 

among other things: Fraud, 

manipulation and abusive practices 

involving swaps; diligent supervision; 7

and adherence to position limits.8 The 

proposed rules incorporate the antifraud provision for swap dealers and 

major swap participants contained in 

Section 4s(h)(4), and also would 

prohibit swap dealers and major swap 

participants from disclosing 

confidential counterparty information, 

or front running or trading ahead of 

counterparty transactions. The 

Commission also proposes to adopt 

certain counterparty-specific 

supervisory and compliance duties 

including a ‘‘know your counterparty’’ 

requirement and policies and 

procedures to enforce these business 

conduct rules and to prevent evasion of 

the requirements of the CEA and 

Commission Regulations.9

Section 4s(h)(3) directs the 

Commission to promulgate rules that 

would require swap dealers and major 

swap participants to: Verify the 

eligibility of their counterparties; 

disclose to their counterparties material 

information about swaps, including 

material risks, characteristics, incentives 

and conflicts of interest; and provide 

counterparties with information 

concerning the daily mark for swaps. 

The Commission also is directed to 

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 addition, using its discretionary 

authority under 4s(h)(3)(D), the 

Commission is proposing to require that 

swap dealers and major swap 

participants comply with certain 

disclosure requirements based on 

certain clearing provisions of the DoddFrank Act and the CEA.10

The Commission proposes to use its 

rulemaking authority under Section 

4s(h) to promulgate several 

requirements adapted from analogous 

standards and practices applicable to 

certain financial market professionals. 

In drafting the proposed rules, the 

Commission considered existing 

requirements for market intermediaries 

under the CEA, Commission 

Regulations and the Federal securities 

laws, as well as self-regulatory 

organization (‘‘SRO’’) rules.11 The 

Commission also considered standards 

adopted by prudential regulators, 

industry recommendations concerning 

‘‘best practices’’ and requirements 

applicable under foreign regulatory 

regimes.12 To the extent practicable, the 

Commission has modeled the proposed 

rules on these existing rules and 

standards. Among the proposed 

requirements that are based on these 

analogous rules and standards are: An 

institutional suitability requirement for 

swap dealers and major swap 

participants when making 

recommendations to counterparties; 

swap execution standards that would 

apply to all Commission registrants, 

including swap dealers, for swaps 

available for trading on a designated 

contract market (‘‘DCM’’) or swap 

execution facility (‘‘SEF’’); and, as part of 

a swap dealer’s or major swap 

participant’s duty to disclose the 

material risks and characteristics of the 

swap, a duty to provide a scenario 

analysis of potential exposure for highrisk complex bilateral swaps, and on an 

‘‘opt-in’’ basis scenario analysis for 

bilateral swaps not available for trading 

on a DCM or SEF.13 The Commission 

also is proposing that both swap dealers 

and independent representatives of 

Special Entities, including those that are 

registered with the Commission as 


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80640 Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 

14See Dodd-Frank Act Sections 712 and 754. 

15A list of Commission staff consultations in 

connection with this proposed rulemaking is posted 

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

www.cftc.gov/LawRegulation/DoddFrankAct/

ExternalMeetings/index.htm. 

16The Commission received several written 

submissions from the public including: National 

Futures Association, Aug. 25, 2010 (‘‘NFA Letter’’); 

Swap Financial Group, Aug. 9, 2010 (‘‘SFG Letter’’); 

Swap Financial Group, ‘‘Briefing for SEC/CFTC 

Joint Working Group’’ Aug. 9, 2010 (‘‘SFG 

Presentation’’); Christopher Klem, Ropes & Gray 

LLP, Sept. 2, 2010 (‘‘Ropes & Gray Letter’’); 

American Benefits Council, Sept. 8, 2010 (‘‘ABC 

Letter’’); American Benefits Council and the 

Committee on Investment of Employee Benefit 

Assets, Oct. 19, 2010 (‘‘ABC/CIEBA Letter’’); and 

Securities Industry and Financial Markets 

Association and International Swaps and 

Derivatives Association, Oct. 22, 2010 (‘‘SIFMA/ 

ISDA Letter’’), available at http://www.cftc.gov/

LawRegulation/DoddFrankAct/Rulemakings/OTC_

3_BusConductStandardsCP.html. 

17 Dodd-Frank Act Section 752(a) states in part, 

‘‘the Commodity Futures Trading Commission, the 

Securities and Exchange Commission, and the 

prudential regulators (as that term is defined in 

section 1a(39) of the [CEA]), as appropriate, shall 

consult and coordinate with foreign regulatory 

authorities on the establishment of consistent 

international standards with respect to the 

regulation (including fees) of swaps * * *.’’ 

18See 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, available at http://eur-lex.europa.eu/

LexUriServ/LexUriServ.do?uri

=CONSLEG:2004L0039:20070921:EN:PDF; 

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, available at http:// 

eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri

=OJ:L:2003:096:0016:0016:EN:PDF. 

19The proposed swap execution § 155.7 would be 

promulgated in part 155. All the other proposed 

rules would appear in subpart H of new part 23. 

20 In addition to its obligations under the 

proposed rules, to the extent a swap dealer or major 

swap participant is required to be a member of a 

registered futures association it would be required 

to comply as well with the business conduct and 

other requirements of NFA and any other applicable 

SROs. 

commodity trading advisors (‘‘CTAs’’), 

be subject to certain restrictions with 

respect to political contributions to 

certain governmental Special Entities 

(‘‘pay-to-play’’). 

B. Business Conduct Standards— 

Dealing With Counterparties That Are 

Special Entities 

Section 4s(h)(4) requires that a swap 

dealer who ‘‘acts as an advisor to a 

Special Entity’’ must act in the ‘‘best 

interests’’ of the Special Entity and 

undertake ‘‘reasonable efforts’’ to obtain 

information necessary to determine that 

a recommended swap is in the best 

interests of the Special Entity. The 

Commission proposes to incorporate the 

statutory text in a proposed rule and to 

specify that certain swaps-related 

conduct would be included within the 

meaning of the term ‘‘act as an advisor 

to a Special Entity.’’ 

Section 4s(h)(5) authorizes the 

Commission to establish duties for swap 

dealers and major swap participants that 

offer swaps or enter into swaps with 

Special Entities, including requiring a 

swap dealer or major swap participant 

to have a reasonable basis to believe that 

the Special Entity has a representative, 

independent of the swap dealer or major 

swap participant, that meets certain 

criteria, including having sufficient 

knowledge to evaluate the transaction 

and risks, undertaking a duty to act in 

the ‘‘best interests’’ of the Special Entity, 

and being subject to pay-to-play 

restrictions. The statute requires swap 

dealers and major swap participants to 

disclose in writing the capacity in 

which they are acting before initiating a 

transaction with a Special Entity. The 

Commission is proposing to establish 

the duties described in Section 4s(h)(5) 

for swap dealers and major swap 

participants dealing with all categories 

of Special Entities. 

The Dodd-Frank Act requires the 

Commission to promulgate the 

mandatory rules by July 15, 2011.14 The 

Commission requests comment on all 

aspects of the proposed rules, as well as 

comment on the specific provisions and 

issues highlighted in the discussion 

below. 

C. Consultations With Stakeholders 

Commission staff held more than two 

dozen external consultations 15 with 

stakeholders representing a broad 

spectrum of views on business conduct 

standards.16 Commission staff 

conducted many of these consultations 

jointly with Securities and Exchange 

Commission (‘‘SEC’’) staff. The 

consultations included discussions of 

the general nature of counterparty 

relationships today, counterparty 

practices unique to different types of 

swaps and asset classes, and 

interpretive recommendations 

concerning certain provisions of Section 

4s(h). 

D. Consultation and Coordination With 

the SEC, Prudential Regulators and 

Other Domestic and Foreign Regulatory 

Authorities 

In compliance with Sections 712(a)(1) 

and 752(a) 17 of the Dodd-Frank Act, 

Commission staff has consulted and 

coordinated with the SEC, prudential 

regulators and foreign authorities. 

Commission staff has worked closely 

with SEC staff in the development of the 

proposed rules. 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. 

With respect to the prudential 

regulators, Commission staff consulted 

and considered certain existing business 

conduct standards that apply to banks. 

Commission staff also consulted 

informally with staff from the 

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

Internal Revenue Service with respect to 

certain Special Entity definitions and 

the intersection of their regulatory 

requirements with the Dodd-Frank Act 

business conduct provisions. 

In addition, Commission staff 

consulted with foreign authorities, 

specifically, European Commission and 

United Kingdom Financial Services 

Authority staff. Staff also considered the 

existing and ongoing work of the 

International Organization of Securities 

Commissions (‘‘IOSCO’’). Staff 

consultations with foreign authorities 

revealed many similarities in the 

proposed rules and foreign regulatory 

requirements.18

II. Proposed Rules for Swap Dealers 

and Major Swap Participants Dealing 

With Counterparties 

The proposed business conduct rules 

dealing with counterparty relationships 

are contained in subpart H of new part 

23 of the Commission’s regulations.19

While the CEA and other provisions of 

the Commission’s rules will govern 

swap transactions and the business of 

swap dealers and major swap 

participants, subpart H will contain the 

principal regulations governing sales 

practices and counterparty 

relationships. A section-by-section 

description of the proposed rules 

follows. 

A. Proposed §§ 23.400, 23.401 and 

23.402—Scope, Definitions and General 

Provisions 

These proposed rules set out the 

scope, definitions and general 

provisions that apply, as appropriate, to 

subpart H of new part 23 of the 

Commission’s regulations. The ‘‘scope’’ 

provision, under proposed § 23.400, 

states that the rules in subpart H apply 

to swap dealers and major swap 

participants and that the rules do not 

limit the applicability of other 

provisions of the CEA, Commission 

Regulations or other laws.20 So, for 

example, in addition to the anti-fraud 

provision that would apply only to 

swap dealers and major swap 

participants in proposed § 23.410, swap 

dealers and major swap participants 

will be subject to all other applicable 

anti-fraud provisions in the CEA and 


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Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 80641 

21See, e.g., Section 4b of the CEA. 

22Separately, the Commission is proposing rules 

detailing when a counterparty may elect to use the 

exception to mandatory clearing under section 

2(h)(7)(A)(iii) of the CEA. 

23Separately, the Commission is proposing rules 

detailing the supervision, compliance and risk 

management obligations for swap dealers and major 

swap participants. See 75 FR 71397, Nov. 23, 2010. 

24See proposed §§ 23.600 and 23.602, 75 FR 

71397, Nov. 23, 2010. 

25This rule is based in part on 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. 

See NFA Interpretive Notice 9013. 

26 17 CFR 1.37(a)(1). 

27The Commission understands that swaps are 

generally governed by a master agreement and 

confirmation setting forth the relationship of the 

counterparties and the particulars of the 

transaction. Master agreements, which have 

typically been standard form agreements prepared 

by industry associations like the International 

Swaps and Derivatives Association (‘‘ISDA’’), 

include basic representations and covenants that 

are subject to negotiation by the parties and are 

supplemented with modifications to account for 

their specific interests. Master agreements contain 

terms that govern all succeeding swaps between the 

counterparties, and generally include provisions 

applicable to all swaps including: Payment netting, 

events of default, cross-default provisions, early 

termination events and closeout netting. 

Commission Regulations, as 

appropriate.21 The scope section also 

provides that, where appropriate, the 

rules also apply to swaps offered but not 

entered into. For example, the fair and 

balanced communications and fair 

dealing requirements in proposed 

§ 23.433 apply to swap dealers and 

major swap participants with respect to 

both counterparties and prospective 

counterparties. 

The proposed rules under subpart H 

will have most applicability when swap 

dealers and major swap participants 

have a pre-trade relationship with their 

counterparty, where that relationship 

includes discussions and negotiations 

that would allow a swap dealer or major 

swap participant to make appropriate 

disclosures and conduct due diligence. 

Indeed, when a swap is initiated on a 

DCM or SEF and the swap dealer or 

major swap participant does not know 

the counterparty’s identity prior to 

execution, disclosure and due diligence 

obligations, such as the duties to verify 

counterparty eligibility under proposed 

§ 23.430, to disclose material 

information under proposed § 23.431, 

and the duty to verify that a Special 

Entity has a qualified representative 

under proposed § 23.450, would not 

apply because there would be no basis 

on which to make those disclosures or 

opportunity to engage in discussions. 

However, when a swap dealer or major 

swap participant does not know the 

counterparty’s identity pre-execution, 

but does become aware of the 

counterparty’s identity post-execution 

of a bilateral swap, the swap dealer or 

major swap participant would still have 

certain specific duties such as the one 

to provide a daily mark in proposed 

§ 23.431(c)(2), (3). 

The Commission also proposes to 

define several terms for purposes of 

subpart H in proposed § 23.401. The 

term ‘‘counterparty’’ would include 

‘‘prospective counterparty’’ as 

appropriate in the rules. The terms swap 

dealer and major swap participant 

would include anyone acting for or on 

behalf of such persons, including 

associated persons as defined in Section 

1a(4) of the CEA. Proposed § 23.401 

adopts the definition of Special Entity 

in Section 4s(h)(2). Additional terms are 

defined in the proposed rules relating to 

Special Entities. 

The ‘‘general provisions’’ for subpart H 

that are specified in proposed § 23.402 

include a requirement that swap dealers 

and major swap participants have 

policies and procedures reasonably 

designed to ensure compliance with the 

business conduct rules in subpart H 

and, in particular, to prevent a swap 

dealer or major swap participant from 

evading any provision of the CEA or 

Commission Regulations. For example, 

for a swap that is subject to mandatory 

clearing, a swap dealer or major swap 

participant should only be offering to 

enter into such a swap on an uncleared 

basis with a counterparty who has 

qualified for a valid end-user exception 

to the mandatory clearing of swaps.22

The Commission expects that these 

policies and procedures would be part 

of a swap dealer’s or major swap 

participant’s overall system of 

supervision, compliance and risk 

management.23

Section 4s(h)(1)(B) gives the 

Commission the authority to prescribe 

rules relating to diligent supervision by 

swap dealers and major swap 

participants. In a separate release 

containing internal business conduct 

rules, the Commission has proposed 

comprehensive supervision and risk 

management program duties on swap 

dealers and major swap participants 

contained in new subpart J of part 23 of 

the Commission’s Regulations.24

Proposed § 23.402(b) would require 

swap dealers and major swap 

participants to diligently supervise their 

dealings with counterparties as required 

under subpart H in accordance with the 

diligent supervision requirements of 

subpart J. 

Proposed § 23.402(c) would establish 

a ‘‘know your counterparty’’ requirement 

on swap dealers and major swap 

participants.25 The proposed 

requirement would include the use of 

reasonable due diligence to know and 

retain a record of the essential facts 

concerning the counterparty, including 

information necessary to comply with 

the law, to service the counterparty, to 

implement a counterparty’s special 

instructions, and to evaluate the 

counterparty’s swaps experience and 

objectives. The proposed rule also 

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.’’ 

Proposed § 23.402(d) would require 

swap dealers and major swap 

participants to keep a record showing 

the true name and address of each 

counterparty, as well as a counterparty’s 

address and the same information for 

any other person guaranteeing the 

counterparty’s performance or 

controlling the counterparty’s positions. 

This proposed rule is based on existing 

§ 1.37(a)(1) 26 of the Commission’s 

Regulations which applies to futures 

commission merchants, introducing 

brokers and members of a designated 

contract market. 

Another general provision, under 

proposed § 23.402(e), states that swap 

dealers and major swap participants that 

seek to rely on the representations of 

their counterparties to satisfy any 

requirements in the proposed rules must 

have a reasonable basis to believe that 

the representations are reliable under 

the circumstances. In addition, the 

representations must be sufficiently 

detailed to enable the swap dealer or 

major swap participant to reasonably 

conclude that the particular requirement 

is satisfied. Proposed § 23.402(e) would 

allow the parties to a swap to agree that 

such representations can be included in 

a master agreement 27 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. For example, particular 

counterparty representations about its 

sophistication or financial wherewithal 

relevant to the institutional suitability 

obligation imposed on swap dealers and 

major swap participants in proposed 

§ 23.434 may be contained in a master 

agreement, if agreed by the parties, and 

may be applied to subsequent swaps 

between the parties if the 

representations continue to be accurate 


srobinson on DSKHWCL6B1PROD with PROPOSALS3
80642 Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 

28 17 CFR 1.31. 

29On October 26, 2010, the Commission 

proposed rules to implement new antimanipulation authority in Section 753 of the DoddFrank Act. The proposed rules expand and codify 

the Commission’s authority to prohibit 

manipulation. 75 FR 67657, Nov. 3, 2010. The same 

day, the Commission issued an advance notice of 

proposed rulemaking seeking comment on Section 

747 of the Dodd-Frank Act, which amends Section 

4c(a) of the CEA to expressly prohibit certain 

trading practices deemed disruptive of fair and 

equitable trading. 75 FR 67301, Nov. 2, 2010. 

30 In addition to the proposed anti-fraud rule, 

swap dealers and major swap participants will be 

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), (3) and 9(a)(2) of the CEA). 

31This language mirrors 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 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 

* * *.’’) (citations omitted). 

32Senator 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. Jul. 15, 2010) (statement of Sen. Lincoln). In 

consultations with stakeholders, Commission staff 

has learned that these concerns apply more 

generally to all counterparties, rather than 

exclusively to Special Entities. Thus, the 

Commission proposes 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. 

33See, e.g., 17 CFR 155.3–4; cf. Market Abuse 

Directive, at Para. 19, Art. 1(1) (prohibiting the 

misuse of confidential customer information and 

front running). The proposed rule would make clear 

that the confidentiality requirements do not apply 

when disclosure is made upon request of the 

Commission, Department of Justice or an applicable 

prudential regulator. 

34See, e.g., United States v. Dial, 757 F.2d 163, 

168 (7th Cir. 1985). 

and relevant with respect to the 

subsequent swaps. 

Proposed § 23.402(f) would provide 

flexibility to swap dealers, major swap 

participants and their counterparties to 

agree to a reliable means for making 

disclosures of material information. 

Furthermore, proposed § 23.402(g) 

would also allow 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 

other written agreement between the 

parties, if agreed to by the parties. While 

standardized disclosures may be 

appropriate to meet certain disclosure 

obligations relating to the risks, 

characteristics, incentives and conflicts 

of interest related to a particular swap, 

it is unlikely that they would be 

adequate to meet all such disclosure 

duties. Swap dealers and major swap 

participants are cautioned to consider 

their disclosure obligations under the 

CEA and proposed rules with respect to 

each swap that they offer or enter into 

with a counterparty. 

Finally, proposed § 23.402(h) would 

require swap dealers and major swap 

participants to create and retain a 

written record of their compliance with 

the requirements in subpart H. Such 

requirements would be part of the 

overall recordkeeping obligations 

imposed on swap dealers and major 

swap participants in the CEA and part 

23 supbart F of the Commission’s 

Regulations, would be maintained in 

accordance with § 1.31 28 of the 

Commission’s Regulations, and would 

be accessible to applicable prudential 

regulators. 

Request for Comment: The 

Commission requests comment 

generally on all of the proposed rules 

regarding scope, general provisions and 

definitions, and specifically on the 

following specific issues: 

• Should the Commission adopt any 

of the guidance from SRO rules relating 

to know your customer requirements? Is 

other guidance necessary in this area? 

• Are there additional terms that 

should be defined by the Commission? 

If so, how should such terms be defined 

and why? 

• Do any proposed requirements 

conflict with any requirement imposed 

by an SRO such that it would be 

impracticable or impossible for a swap 

dealer or major swap participant that is 

a member of an SRO to meet both 

obligations? If so, which ones and why? 

• Should the Commission specify any 

particular restrictions or prohibitions to 

further protect against evasion? 

B. Proposed § 23.410—Prohibition on 

Fraud, Manipulation and Other Abusive 

Practices 

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.29

To implement this provision the 

Commission proposes to adopt the antifraud provision in Section 4s(h)(4)(A) as 

§ 23.410, which prohibits fraudulent, 

deceptive and manipulative practices by 

swap dealers and major swap 

participants.30 While the heading of 

Section 4s(h)(4) states ‘‘Special 

Requirements for Swap Dealers Acting 

as Advisors,’’ the anti-fraud provision 

that follows in Section 4s(h)(4)(A) is not 

so limited. The proposed rule follows 

the statutory text and applies to swap 

dealers and major swap participants 

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

advisor, counterparty or other market 

participant in relation to counterparties 

generally. The first two paragraphs of 

the rule focus on Special Entities and 

prohibit 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 is not limited to Special 

Entities and prohibits swap dealers and 

major swap participants from engaging 

in any act, practice, or course of 

business that is fraudulent, deceptive or 

manipulative.31

The Commission also proposes 

§§ 23.410(b) and 23.410(c), which 

would prohibit swap dealers and major 

swap participants from disclosing 

confidential counterparty information 

and front running or trading ahead of 

counterparty swap transactions.32 These 

rules are based on trading standards 

applicable to futures commission 

merchants and introducing brokers that 

prohibit trading ahead of a customer 

and protect the confidentiality of 

customer orders.33 Such abuses are 

considered fraudulent practices.34

Viewed together, proposed §§ 23. 410(b) 

and 23.410(c) build on the code of 

ethics requirements and informational 

barriers in proposed subpart J which 

add substantial protections for 

counterparties from abuse of their 

confidential information and business 

opportunities. 

Request for Comment: The 

Commission requests comment 

generally on all of the proposed rules 

regarding fraud, manipulation, and 

abusive practices, and on the following 

specific issues: 

• Should a swap dealer or major swap 

participant be required to disclose to a 

counterparty its pre-existing positions 

in a type of swap prior to entering into 

the same type of swap with the 

counterparty? 

• Should the prohibitions on trading 

ahead of a counterparty transaction and 

disclosure of confidential counterparty 

information be limited in any way not 

already provided in the proposed rule? 

For example, if a counterparty discusses 

a potential swap but does not 

immediately enter into it with the swap 


srobinson on DSKHWCL6B1PROD with PROPOSALS3
Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 80643 

35 ‘‘Eligible contract participant’’ is a defined term 

in Section 1a(18) of the CEA. 

36See Section 2(e) of the CEA. 

37This position is consistent with industry 

comment. See, e.g., NFA Letter, at 2 (recommending 

the Commission adopt a rule modeled after NFA 

Compliance Rule 2–23, which permits NFA 

members to rely on information provided by the 

customer to satisfy the member’s know-yourcustomer obligations). 

38Certain industry comments support this 

approach. See, e.g., NFA Letter, at 2; SIFMA/ISDA 

Letter, at 12. 

39This rule tracks the statutory language in 

Section 4s(h)(7). 

40Cf. 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)). 

41Additionally, under proposed § 23.402(h), 

swap dealers and major swap participants would be 

required to maintain a record of their compliance 

with the proposed rules. 

42Cf. SIFMA/ISDA Letter, at 12 (recommending 

the use of standard disclosure templates that could 

be adopted on an industry-wide basis, with 

disclosure requirements satisfied by a registrant on 

a relationship (rather than a transaction-bytransaction) basis in cases where prior disclosures 

apply to and adequately address the relevant 

transaction). 

43Market risk refers to the risk to a counterparty’s 

financial condition resulting from adverse 

movements in the level or volatility of market 

prices. 

44Credit risk refers to the risk that a party to a 

swap will fail to perform on an obligation under the 

swap. 

45Operational risk refers to the risk that 

deficiencies in information systems or internal 

controls, including human error, will result in 

unexpected loss. 

46Liquidity 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. 

dealer or major swap participant, should 

there be a limit on the time during 

which the swap dealer or major swap 

participant must refrain from trading on 

or otherwise disclosing the 

counterparty’s information? 

• Are there other specific fraudulent, 

manipulative or abusive practices by 

swap dealers and major swap 

participants that should be prohibited in 

these proposed rules? If so, how would 

they assist in protecting swap markets 

and counterparties? Are there gaps in 

the existing requirements that should be 

filled here? 

C. Proposed § 23.430—Verification of 

Counterparty Eligibility 

The Dodd-Frank Act makes it 

unlawful for any person, other than an 

eligible contract participant (‘‘ECP’’),35 to 

enter into a swap unless it is executed 

on or subject to the rules of a designated 

contract market.36 Section 4s(h)(3)(A) 

also requires the Commission to 

establish a duty for a swap dealer or 

major swap participant to verify that 

any counterparty meets the eligibility 

standards for an ECP. Proposed § 23.430 

would require swap dealers and major 

swap participants to verify that a 

counterparty meets the definition of an 

ECP prior to offering or entering into a 

swap. The proposed rule also would 

require a swap dealer or major swap 

participant to determine whether the 

counterparty is a Special Entity as 

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

proposed § 23.401. 

The Commission contemplates 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.37 In addition, 

under proposed § 23.402(g), such 

written representations could be 

expressed in a master agreement or 

other written agreement and, if agreed 

by the parties, could be deemed to be 

renewed with each subsequent swap 

transaction, absent any facts or 

circumstances to the contrary.38

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.39

Request for Comment: The 

Commission requests comment 

generally on all of the proposed rules 

regarding verification of counterparties 

as ECPs and Special Entities, and on the 

following specific issues: 

• Should there be an ongoing, 

affirmative duty to verify eligibility? If 

so, how would it be met? Would the 

swap dealer or major swap participant’s 

duty change in any way if the ECP 

status of the counterparty changes after 

the swap has been entered into? 

• Are there particular ‘‘red flags’’ that 

should indicate a need for a swap dealer 

or major swap participant to obtain 

additional information about the status 

of the counterparty as an ECP or Special 

Entity? 

D. Proposed § 23.431—Disclosure of 

Material Risks, Characteristics, Material 

Incentives and Conflicts of Interest 

Regarding a Swap 

Section 4(s)(h)(3)(B) requires swap 

dealers and major swap participants to 

disclose to their counterparties material 

information about the risks, 

characteristics, incentives and conflicts 

of interest regarding a swap. The 

requirements do not apply if both 

counterparties are any of the following: 

Swap dealer, major swap participant, 

security-based swap dealer or major 

security-based swap participant. 

Proposed § 23.431 would implement the 

statutory disclosure requirements and 

provide specificity with respect to 

certain material information that must 

be disclosed under the rule. Information 

is material if there is a substantial 

likelihood that a reasonable 

counterparty would consider it 

important in making a swap related 

decision.40

1. Timing and Manner of Disclosures 

The Dodd-Frank Act does not address 

the timing and form of the required 

disclosures. Proposed § 23.431(a) would 

require that the disclosures be made 

before entering into a swap and in a 

manner reasonably designed to allow 

the counterparty to assess the 

disclosures. To satisfy its obligation, the 

swap dealer or major swap participant 

would also be required to make such 

disclosures at a time prior to entering 

into the swap that was reasonably 

sufficient to allow the counterparty to 

assess the disclosures. Swap dealers and 

major swap participants would have 

flexibility to make these disclosures 

using reliable means agreed to by the 

parties, as provided in proposed 

§ 23.402(f).41

Standardized disclosure of some 

required information may be 

appropriate if the information is 

applicable to multiple swaps of a 

particular type and class.42 As discussed 

below, the Commission believes that 

most bespoke transactions, however, 

will require some combination of 

standardized and particularized 

disclosures. 

2. Disclosure of Material Risks 

The proposed rule tracks the statutory 

obligations under Section 4s(h)(3)(B)(i) 

and would require 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 anticipates that 

swap dealers and major swap 

participants typically will rely on a 

combination of general and more 

particularized disclosures to satisfy this 

requirement. The Commission 

understands that there are certain types 

of risks that are associated with swaps 

generally, including market,43 credit,44

operational,45 and liquidity risks.46

Required risk disclosure would include 

sufficient information to enable a 


srobinson on DSKHWCL6B1PROD with PROPOSALS3
80644 Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 

47See CRMPG III Report, at 60. 

48See NFA Letter, at 2; SIFMA/ISDA Letter, at 12. 

49Scenario analysis is in addition to required 

disclosures for swaps which do not qualify as highrisk complex. Such required disclosures include a 

clear explanation of the economics of the 

instrument. 

50CRMPG III Report, at 60–61. 

51The leverage characteristic is particularly 

relevant when the swap includes an embedded 

option, including one in which the counterparty is 

‘‘short’’ or selling volatility. Such features can 

significantly increase counterparty risk exposure in 

ways that are not transparent. 

52CRMPG III Report states that: 

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. CRMPG III Report, at 56. 

53These 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. 

54Material assumptions include: (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. 

55The Commission has proposed that swap 

dealers and major swap participants adopt policies 

and procedures regarding a new product policy as 

part of the risk management system. See proposed 

§ 23.600(c)(3), 75 FR 71397, Nov. 23, 2010. 

counterparty to assess its potential 

exposure during the term of the swap 

and at expiration or upon early 

termination. Consistent with industry 

‘‘best practices,’’ information regarding 

specific material risks must identify the 

material factors that influence the dayto-day changes in valuation, as well as 

the factors or events that might lead to 

significant losses.47 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. 

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. 

Request for Comment: The 

Commission requests comment 

generally on all of the proposed rules 

regarding material risk disclosures for 

swaps and on the following specific 

issues: 

• Are there specific material risks that 

the Commission should require a swap 

dealer or major swap participant to 

disclose to a counterparty? Are there 

specific risks that should be disclosed 

with respect to particular types of 

swaps, asset classes and trading venues? 

• NFA and SIFMA/ISDA submitted 

letters that have suggested that the 

Commission develop a standard form 

risk disclosure statement for certain 

generic-type disclosures, similar to 

those used today for futures, options 

and retail foreign currency 

transactions.48 Should the Commission 

undertake such an effort? Should the 

Commission encourage the industry or 

SROs to develop such disclosures, in 

addition, or instead? If it would be 

beneficial to have such forms, why has 

the industry not developed such a 

standard form to date? Would standard 

form disclosure be inconsistent with the 

requirement that disclosures be based 

on the facts and circumstances 

presented by each swap and 

counterparty? 

• Are there other ways for the 

Commission to describe the risk 

disclosure duty required by the CEA 

that would provide additional guidance 

or clarify the obligation? 

• Should the rule distinguish 

explicitly risk disclosure requirements 

for SEF or DCM traded swaps versus 

bilateral swaps? 

3. Scenario Analysis for High-Risk 

Complex Bilateral Swaps and 

Counterparty ‘‘Opt-In’’ for Bilateral 

Swaps Not Available for Trading on a 

Designated Contract Market or Swap 

Execution Facility 

The Commission is proposing that 

swap dealers and major swap 

participants be required to provide 

scenario analyses when they offer to 

enter into high-risk complex bilateral 

swaps to allow the counterparty to 

assess its potential exposure in 

connection with the swap.49 In addition, 

the rule would allow counterparties to 

elect to receive scenario analysis when 

offered bilateral swaps that are not 

available for trading on a DCM or SEF. 

The elective aspect of the rule reflects 

the expectation that there may be 

circumstances where scenario analysis 

may be helpful for certain 

counterparties, even for swaps that are 

not high-risk complex. Proposed 

§ 23.431(a)(1) is modeled on the CRMPG 

III industry best practices 

recommendation for high-risk complex 

financial instruments.50

a. High-Risk Complex Bilateral Swap: 

Characteristics 

The rule’s mandatory scenario 

analysis delivery requirement would 

apply only when ‘‘high-risk complex 

bilateral swaps’’ are offered or 

recommended. Like the industry ‘‘best 

practice’’ recommendation, the term 

‘‘high-risk complex bilateral swap’’ is 

not defined in the proposed rule; rather, 

certain flexible characteristics are 

identified to avoid over inclusive and 

under inclusive concerns. The 

characteristics are: The degree and 

nature of leverage,51 the potential for 

periods of significantly reduced 

liquidity, and the lack of price 

transparency.52 The proposed rule 

would require 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). 

b. Market Risk Disclosures: Scenario 

Analysis 

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.53

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 would 

require 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 would require that all 

material assumptions underlying a 

given scenario and its impact on swap 

valuation be disclosed.54 In requiring 

such disclosures, however, the 

Commission does not propose to require 

swap dealers or major swap participants 

to disclose proprietary information 

about any pricing models. 

The Commission does not propose to 

define the parameters of the scenario 

analysis in order to provide flexibility to 

the parties to design the analyses in 

accordance with the characteristics of 

the bespoke swap at issue, as well as 

any criteria developed in consultations 

with the counterparty. Further, the 

proposed rule would require swap 

dealers and major swap participants to 

consider relevant internal risk analyses 

including any new product reviews 

when designing the analyses.55 As for 

the format, the proposed rule would 

require 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 would 


srobinson on DSKHWCL6B1PROD with PROPOSALS3
Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 80645 

56See DPG Framework, at Part V(II)(G); but see 

SIFMA/ISDA Letter, at 13–14. 

57This may exist, for example, when the swap 

dealer or major swap participant acts both as an 

underwriter in a bond offering and as a 

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. 

58Cf. SIFMA and ISDA assert that ‘‘[b]y market 

convention and often by contract, parties generally 

agree to utilize a mid-market level for margin 

Continued 

be 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’s proposed rule is aligned 

with longstanding industry best practice 

recommendations,56 and indeed, several 

large swap dealers told Commission 

staff that they provide scenario analysis 

upon request and without separate 

charge to counterparties today. 

Request for Comment: The 

Commission requests comment 

generally on all of the proposed rules 

regarding required scenario analysis for 

high-risk complex bilateral swaps and 

opt-in scenario analysis for swaps not 

available for trading on a DCM or SEF 

and on the following specific issues: 

• Regarding high-risk complex 

bilateral swaps, should other 

characteristics be added to the rule? 

Should any of the proposed high-risk 

complex bilateral swap characteristics 

be deleted or modified? 

• Instead of high-risk complex 

bilateral swaps, should the Commission 

require scenario analysis for all swaps 

that are: (1) Not accepted or listed for 

clearing on a derivatives clearing 

organization (‘‘DCO’’), or alternatively, 

(2) uncleared? What are the costs/ 

benefits of changing the requirement to 

option one or option two? 

• Regarding scenario analysis, should 

a swap dealer/major swap participant be 

required to provide such analysis for 

any swap upon reasonable request by 

any counterparty? Would there be a 

charge to counterparties that elect to 

‘‘opt-in’’? How much on average would 

it cost? If the cost varies by swap type 

or asset class, provide an average cost by 

category. What are the costs and benefits 

to swap dealers and major swap 

participants and counterparties 

associated with scenario analysis? 

• Are there certain types of 

counterparties for which a scenario 

analysis should always be provided? If 

so, which ones and why? 

• Should swap dealers and major 

swap participants be able to avoid their 

duty to provide scenario analysis if a 

counterparty opts out of receiving it? 

• Should a Value at Risk (‘‘VaR’’) type 

analysis be part of the mandatory 

scenario analysis? 

• In the event that a swap dealer or 

major swap participant elects to disclose 

a VaR type analysis, should any 

minimum parameters apply? For 

instance, should there be any required 

confidence levels such as 95 percent or 

99 percent? Should there be any 

minimum standards regarding the type 

of VaR model chosen? Should there be 

a required time horizon such as the time 

between payments, the expected time to 

liquidate the position, or something 

else? 

4. Material Characteristics 

The proposed rule would require 

swap dealers and major swap 

participants to include in their 

disclosures of material characteristics, 

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 Commission intends 

that the material characteristics would 

include the material terms of the swap 

that would be included in any 

‘‘confirmation’’ of any swap sent by the 

swap dealer or major swap participant 

to the counterparty upon execution. 

5. Material Incentives and Conflicts of 

Interest 

The proposed rule tracks the statutory 

language under Section 4s(h)(3)(B)(ii) 

and would require 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 the particular 

swap. Several stakeholders 

recommended that the Commission 

require added transparency concerning 

the components that make up the price 

of a transaction. In response, the 

Commission proposes that swap dealers 

and major swap participants be required 

to include with the price of a swap the 

mid-market value of the swap as defined 

in proposed § 23.431(c)(2). In addition, 

swap dealers and major swap 

participants would be required to 

disclose any compensation or benefit 

that they receive from any third party in 

connection with the swap. In 

connection with any recommended 

swap, swap dealers and major swap 

participants would be 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. With respect to 

conflicts of interest, the Commission 

expects such disclosure to include the 

inherent conflicts in a counterparty 

relationship, particularly when the 

swap dealer or major swap participant 

recommends the transaction. The 

Commission also expects 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 conflict of interests that 

require disclosure.57

Request for Comment: The 

Commission requests comment 

generally on all of the proposed rules 

regarding material incentives and 

conflicts of interest and on the following 

specific issues: 

• Should the Commission impose 

more specific requirements concerning 

the content of the required disclosures 

generally? 

• Should the Commission require 

swap dealers and major swap 

participants to disclose their profit? If 

so, how should a swap dealer or major 

swap participant be required to compute 

profitability for purposes of the rule? 

6. Daily Mark 

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

Commission to adopt rules that require: 

(1) For cleared swaps, upon request of 

the counterparty, receipt of the daily 

mark from the appropriate DCO; and (2) 

for uncleared swaps, receipt of the daily 

mark of the swap from the swap dealer 

or major swap participant. The term 

‘‘daily mark’’ is not defined in the 

statute, and the Commission 

understands that the term ‘‘mark’’ is 

used colloquially to refer to various 

types of valuation information. 

a. Cleared Swaps 

For a cleared swap, proposed 

§ 23.431(c)(1) would require the swap 

dealer or major swap participant to 

notify a counterparty of their right to 

receive, upon request, the daily mark 

from the appropriate DCO. 

b. Uncleared Swaps 

For uncleared swaps, proposed 

§ 23.431(c)(2) and (3) would require a 

swap dealer or major swap participant 

to provide a daily mark to its 

counterparty 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 is proposing to define daily 

mark for uncleared swaps as the midmarket value of the swap,58 which shall 


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80646 Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 

purposes. Counterparties understand that this level 

does not represent a valuation at which a 

transaction may be entered into or terminated and 

accordingly may differ from actual market prices. 

We recommend that the Commissions endorse this 

use of mid-market levels for margin purposes as a 

uniform market practice.’’ SIFMA/ISDA Letter, at 

17. 

59For 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. 

60But see SIFMA/ISDA Letter at 17 (asserting that 

mid-market level is market convention for margin 

purposes and not a quote for entering into a 

transaction or terminating the swap). 

61See also Trading & Capital-Markets Activities 

Manual, section 2150.1 (Bd. of Gov. Fed. Reserve 

Sys. Jan. 2009) (‘‘Trading & Capital-Markets 

Activities Manual’’) (‘‘When providing a quote to a 

counterparty, institutions should be careful that the 

counterparty does not confuse indicative quotes 

with firm prices. Firms receiving dealer quotes 

should be aware that these values may not be the 

same as those used by the dealer for its internal 

purposes and may not represent other ‘market’ or 

model-based valuations.’’), available at http:// 

www.federalreserve.gov/boarddocs/supmanual/ 

trading/200901/0901trading.pdf. 

62SIFMA/ISDA Letter, at 17; NFA Letter, at 3. 

63See Section 2(h) of the CEA. 

64With respect to these proposed disclosure 

requirements, the Commission notes that, as 

between the parties, the counterparty is entitled to 

choose whether and where to clear, but that no 

DCM or SEF must make clearing available through 

any DCO. In other words, it would be up to the 

parties to take the swap to a DCM or SEF that 

provides for clearing through the counterparty’s 

preferred DCO. 

65See, 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. 

66See, e.g., NFA Compliance Rule 2–29(b)(2), (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). 

67See, 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 * * *’’). 

68See, e.g., NFA Compliance Rule 2–29(b)(4)–(5). 

not include amounts for profit, credit 

reserve, hedging, funding, liquidity or 

any other costs or adjustments.59 Based 

on staff consultations, the consensus 

was that mid-market value is a 

transparent measure that would assist 

counterparties in calculating valuations 

for their own internal risk management 

purposes. Further, the Commission is 

proposing 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 understands 

that the daily mark for certain bespoke 

swaps may be generated using 

proprietary models. The proposed rule 

does not require the swap dealer or 

major swap participant to disclose 

proprietary information relating to its 

model. 

Lastly, the Commission proposes that 

swap dealers and major swap 

participants provide appropriate 

clarifying statements relating to the 

daily mark. Such disclosures may 

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; 60 nor (3) the value 

of the swap that is marked on the books 

of the swap dealer or major swap 

participant.61

Industry representatives have asked 

whether swap dealers and major swap 

participants may satisfy their 

obligations to provide daily marks for 

uncleared swaps by making the relevant 

information available to counterparties 

through password protected access to a 

webpage containing the relevant 

information.62 Proposed § 23.402(f) 

would permit swap dealers and major 

swap participants to provide daily 

marks by any reliable means agreed to 

in writing by the counterparty. 

Request for Comment: The 

Commission requests comments 

generally on the daily mark and on the 

following specific issues: 

• Should the Commission define the 

daily mark for uncleared swaps as 

proposed, on a different basis, or should 

it be subject to negotiation by the 

parties? If so, why? 

• In addition to the daily mark as 

defined in the proposed rule, should the 

Commission require that swap dealers 

or major swap participants provide 

executable quotes to counterparties 

upon request? Should this be left to 

negotiations between the parties? 

E. Proposed § 23.432—Clearing 

For swaps where clearing is 

mandatory,63 proposed § 23.432(a) 

would require that a swap dealer or 

major swap participant notify the 

counterparty that the counterparty has 

the sole right to select the DCO that will 

clear the swap. For swaps that are not 

required to be cleared, under proposed 

§ 23.432(b), a swap dealer or major swap 

participant must 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.64 Neither of these 

notification provisions would apply 

where the counterparty is a registered 

swap dealer, major swap participant, 

security-based swap dealer, or major 

security-based swap participant. 

Request for Comment: The 

Commission requests comment 

generally on all of the proposed rules 

regarding clearing, and on the following 

specific issues: 

• Are there additional disclosures 

that a swap dealer or major swap 

participant should be required to make 

with respect to clearing of swaps? 

F. Proposed § 23.433— 

Communications—Fair Dealing 

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 would establish such a duty 

and, consistent with statutory language, 

would apply broadly to all swap dealer 

and major swap participant 

communications with counterparties. 

These principles are well established in 

the futures and securities markets, 

particularly through SRO rules.65 For 

example, the duty to communicate in a 

fair and balanced manner is one of the 

primary requirements of the NFA 

customer communication rule 66 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 expects that a swap 

dealer or major swap participant would 

consider factors such as whether the 

communication: (1) Provides a sound 

basis for evaluating the facts with 

respect to any swap; 67 (2) avoids 

making exaggerated or unwarranted 

claims, opinions or forecasts; 68 and (3) 

balances any statement that refers to the 

potential opportunities or advantages 

presented by a swap with statements of 

corresponding risks. The Commission 

also would expect that to deal fairly 

would require the swap dealer or major 

swap participant to treat counterparties 

in such a way so as not to advantage one 

counterparty or group of counterparties 

over another. Additionally, 

communications would be subject to the 

specific anti-fraud provisions of the 

CEA and Commission Regulations, as 

well as applicable SRO rules, if swap 

dealers and major swap participants are 

required to be SRO members. 

Request for Comment: The 

Commission requests comment 

generally on all of the proposed rules 

regarding fair and balanced 

communications, and on the following 

specific issues: 

• Should the Commission specify in 

its final rule any additional 


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Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 80647 

69See, e.g., 12 CFR 13.4; Trading & CapitalMarkets Activities Manual, Section 2150. 

70See NASD Rule 2310, Recommendations to 

Customers (Suitability); see also proposed FINRA 

Rule 2111 (Suitability), 75 FR 53562, Aug. 26, 2010. 

71See Municipal Securities Rulemaking Board 

Rule G–19, Suitability of Recommendations and 

Transactions; Discretionary Accounts. 

72MiFID Art. 19(3). ‘‘Professional clients’’ under 

MiFID include certain financial institutions, 

insurance companies, pension funds, and other 

entities. See MiFID Art. 19(4), Annex II. 

73The proposed institutional suitability 

obligation would apply only to swap dealers and 

major swap participants, and only when they make 

swap recommendations, not futures. 

74NFA Compliance Rule 2–30, Customer 

Information and Risk Disclosure; NFA Interpretive 

Notice 901—NFA Compliance Rule 2–30: Customer 

Information and Risk Disclosure. 

75 17 CFR 1.55. 

76NFA Compliance Rules 2–29, 2–36, 

Requirements for Forex Transactions. 

77See, e.g., Section 4b of the CEA and §§ 32.9, 

33.10 of the Commission’s Regulations (17 CFR 

32.9, 33.10). 

78See, e.g., 12 CFR 13.4; Trading & CapitalMarkets Activities Manual, section 2150. 

79The rule would not apply to recommendations 

made to counterparties that are swap dealers, major 

swap participants, security-based swap dealers or 

major security-based swap participants. 

80A counterparty may indicate that it is 

exercising independent judgment on one or more 

particular swaps or types of swaps, or in terms of 

all swaps. 

81NASD Notice to Members 01–23 (April 2001); 

FINRA Proposed Suitability Rule, 75 FR 52562, 

52564–69, Aug. 26, 2010. 

82See, e.g., 12 CFR 13.4, 208.25(d), 368.4. In 

1997, the Federal banking agencies offered the 

following guidance regarding recommendations in 

the context of government securities sales practices: 

‘‘While the agencies do not believe it is appropriate 

to define the term ‘recommendation,’ they note that 

they would not view the provision of general 

market information, including market observations, 

forecasts about interest rates, and price quotations, 

as making a recommendation under the rule, absent 

other conduct.’’ 62 FR 13276, 13280, Mar. 19, 1997. 

83Section 1a(12) of the CEA defines a commodity 

trading advisor, in relevant part, as any person who, 

for compensation or profit, trades, or advises (either 

directly or through publications, writings, or 

Continued 

requirements necessary to satisfy the 

duty? If so, what? 

• Should the Commission specify 

additional considerations in the rule to 

guide compliance with the rule? Should 

the Commission adopt interpretive 

guidance, instead or in addition? 

G. Proposed § 23.434— 

Recommendations to Counterparties— 

Institutional Suitability 

To determine whether the 

Commission should use its 

discretionary authority under new 

Section 4s(h), the Commission 

considered requirements for 

professionals in other markets and in 

other jurisdictions. One common 

requirement is a suitability obligation 

which is imposed when a market 

professional recommends a product to a 

customer, including institutional or 

sophisticated customers. For example, 

federally regulated banks acting as 

broker-dealers for government securities 

have an institutional suitability 

obligation when making 

recommendations to institutional 

customers.69 Securities broker-dealers 

are also subject to a suitability 

obligation when recommending any 

securities to an institutional customer.70

Municipal securities dealers have a 

suitability obligation for any municipal 

security offered to a ‘‘sophisticated 

municipal market professional.’’ 71 And, 

in the European Union, investment 

services firms have a suitability 

obligation with respect to financial 

instruments recommended to 

‘‘professional clients’’ under MiFID.72

In light of its broad application in 

other markets and jurisdictions, the 

Commission proposes 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. The 

Commission recognizes that futures 

market professionals have not been 

subject to an explicit ‘‘suitability’’ 

obligation.73 Instead, such professionals 

have been required to meet a variety of 

related requirements, including NFA 

‘‘know your customer’’ duties,74

mandatory standard form risk 

disclosure,75 NFA’s fair and balanced 

communication rules and just and 

equitable principles,76 and general antifraud provisions.77 These requirements 

developed to address the risks and 

characteristics of standardized 

exchange-traded futures and options 

contracts. Because the definition of 

swap includes a variety of different 

types of financial instruments and those 

instruments can be customized to have 

a wide range of risk/reward profiles, the 

Commission believes that standard risk 

disclosure, alone, may not be sufficient 

to ensure that counterparties understand 

their potential exposure. The 

Commission also has considered that 

many swap dealers and major swap 

participants already are, or will be, 

subject to institutional suitability 

obligations by virtue of their status as 

banks, broker-dealers or security-based 

swap dealers. Thus, to promote 

regulatory consistency 78 and to take 

account of the nature of swaps, the 

Commission proposes to adopt an 

institutional suitability obligation for 

swap dealers and major swap 

participants, modeled, in part, on 

existing obligations for banks and 

broker-dealers dealing with institutional 

clients. 

Proposed § 23.434 would require a 

swap dealer or major swap participant 

to have reasonable grounds to believe 

that any recommendation for a swap or 

trading strategy involving swaps is 

suitable for its counterparty.79 A 

suitability determination would be 

based upon information the swap dealer 

or major swap participant obtains 

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. 

A swap dealer or major swap 

participant could rely on counterparty 

representations to satisfy its suitability 

obligations if: (1) It had a reasonable 

basis to believe that the counterparty 

was capable of independently 

evaluating relevant risks with regard to 

the particular swap or trading strategy; 

(2) the counterparty had affirmatively 

indicated that it was exercising 

independent judgment in evaluating any 

recommendations; 80 and (3) the swap 

dealer or major swap participant had a 

reasonable basis to believe that the 

counterparty had the capacity to absorb 

potential losses related to the 

recommended swap or swap trading 

strategy. To the extent that a swap 

dealer or major swap participant cannot 

rely on a counterparty’s representations 

as contemplated by proposed § 23.434, 

it would need to undertake a suitability 

analysis as set forth in the rule. 

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, 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.81 In implementing the 

proposed institutional suitability rule, 

the Commission intends to consult 

relevant precedents and interpretive 

guidance under Federal securities and 

banking requirements in the United 

States.82

The Commission notes that swap 

dealers and major swap participants are 

likely to be acting as CTAs 83 when they 


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80648 Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 

electronic media) as to the value of, or the 

advisability of trading in, a commodity for future 

delivery, or swap. Section 1a(12)(B) of the CEA 

excludes from the definition of commodity trading 

advisor a variety of persons, but only if a person’s 

commodity advice is solely incidental to the 

conduct of its principal business or profession. The 

excluded persons include (i) banks and trust 

companies and their employees, (ii) news reporters, 

news columnists, and news editors of print or 

electronic media, (iii) lawyers, accountants, and 

teachers, (iv) floor brokers and futures commission 

merchants, (v) publishers and producers of any 

print or electronic data of general and regular 

dissemination, including their employees, (vi) 

fiduciaries of defined benefit plans subject to 

ERISA, (vii) contract markets, and (viii) other 

persons that the CFTC, by rule, regulation, or order, 

may exclude as ‘‘not within the intent of’’ the 

definition. The revised definition does not exclude 

swap dealers whose advice is solely incidental to 

their swap dealer activities. Therefore, any 

‘‘advisory’’ activities by a swap dealer could bring 

it within the statutory definition of a commodity 

trading advisor. 

84 Depending on the nature of the relationship, 

swap dealers might also have common law 

fiduciary duties to their counterparties. Cf. 

Commodity Trend Serv., Inc. v. CFTC, 233 F.3d 981, 

990 (7th Cir. 2000). 

85The term ‘‘reasonable relationship’’ has been 

used in evaluating execution standards over several 

decades in the securities industry. In an early 

securities law case, the Second Circuit stated that 

‘‘[i]n its interpretation of Sec. 17(a) of the Securities 

Act, the Commission has consistently held that a 

dealer cannot charge prices not reasonably related 

to the prevailing market price without disclosing 

that fact.’’ Charles Hughes & Co. v. SEC, 139 F.2d 

434, 437 (2d Cir. 1943). The SEC issued a release 

in 1987, ‘‘Notice to broker-dealers concerning 

disclosure requirements for mark-ups on zerocoupon securities,’’ which stated that the ‘‘duty of 

fair dealing includes the implied representation that 

the price a firm charges bears a reasonable 

relationship to the prevailing market price.’’ 52 FR 

15575, 15576, Apr. 21, 1987 (citing Charles Hughes, 

139 F.2d at 437). In IM–2440–1 the former NASD 

stated that ‘‘It shall be deemed a violation of Rule 

2110 [recommendations] and Rule 2440 [fair prices 

and commissions] for a member to enter into any 

transaction with a customer in any security at any 

price not reasonably related to the current market 

price of the security or to charge a commission 

which is not reasonable.’’ Although Rule 2440 and 

IM–2440–1 related to OTC transactions, FINRA 

expanded the principle to include fees charged in 

exchange-traded transactions. See FINRA 

Regulatory Notice 08–36. 

86The duty under the proposed rule would apply 

whether the Commission registrant was acting as 

agent or principal in the transaction. This is 

consistent with existing duties for broker-dealers 

under the Federal securities laws. See Newton v. 

Merrill, Lynch, Pierce, Fenner & Smith, Inc., 135 

F.3d 266, 270 n. 1 (3d Cir. 1988) (‘‘[T]he best 

execution duty ‘does not dissolve when the broker/ 

dealer acts in its capacity as a principal.’’’) (citations 

omitted). Accord E.F. Hutton & Co., Release No. 34– 

25887, 49 S.E.C. 829, 832 (1988); NASD Rule 

2320(e). 

87Supra at footnote 85. The ‘‘duty of fair dealing 

includes the implied representation that the price 

a firm charges bears a reasonable relationship to the 

prevailing market price.’’ 52 FR 15575, 15576, Apr. 

21, 1987. 

88See Newton, 135 F.3d at 270 (‘‘The duty of best 

execution * * * has its roots in the common law 

agency obligations of undivided loyalty and 

reasonable care that an agent owes to his 

principal.’’) 

make recommendations, particularly 

recommendations tailored to the needs 

of their counterparty. As such, they 

would be subject to any additional 

duties that might be applicable to CTAs 

under the CEA and Commission 

Regulations, including registration 

requirements and Section 4o of the CEA, 

the anti-fraud provision that applies to 

CTAs and commodity pool operators.84

Request for Comment: The 

Commission requests comments 

generally on the proposed rules 

regarding recommendations and the 

following specific issues: 

• Should the Commission adopt a 

suitability obligation for swaps in the 

absence of such an explicit requirement 

for exchange traded futures and 

options? Have securities-style suitability 

obligations for institutional customers 

had demonstrable benefits for such 

customers? If so, provide examples. 

• Are there additional factors that 

swap dealers or major swap participants 

should consider in determining whether 

a particular swap is suitable for a 

particular counterparty? 

• Should the Commission specify 

additional considerations in the rule to 

guide compliance with the rule? Should 

the Commission adopt interpretive 

guidance, similar to that provided by 

the prudential regulators in connection 

with sales of government securities 

instead or in addition? 

• Should swap dealers be subject to 

an explicit fiduciary duty when making 

a recommendation to a counterparty? 

H. Proposed § 155.7—Execution 

Standards 

The Commission is proposing a swap 

execution standard rule that would 

apply to swaps available for trading on 

a DCM or SEF to ensure fair dealing and 

protect against fraud and other abusive 

practices. The proposed execution 

standard rule would require 

Commission registrants, with respect to 

any swap that is available for trading on 

a DCM or SEF, to execute the swap on 

terms that have a ‘‘reasonable 

relationship’’ to the best terms 

available.85 In addition, the registrant 

would be required, prior to execution of 

the order, to disclose the DCMs and 

SEFs on which the swap is available for 

trading, and on which markets the 

registrant has trading privileges. The 

swap execution standards would apply 

to all Commission registrants executing 

customer orders for swaps made 

available for trading on a DCM or SEF, 

whether execution occurs on or through 

a DCM, SEF or bilaterally.86 The 

Commission notes that bilateral 

execution of swaps available for trading 

on a DCM or a SEF would only occur 

pursuant to the ‘‘end user’’ exemption 

provided under Section 2(h)(7)(A) of the 

CEA. 

In determining what constitutes a 

‘‘reasonable relationship,’’ the 

Commission registrant should consider 

whether the terms offered to the 

customer are fair and consistent with 

principles of fair dealing,87 good faith, 

and, when acting as an agent for the 

customer, the duty of loyalty.88 To have 

a reasonable relationship to the best 

terms available, the terms must be fair 

and not excessive in light of all other 

relevant circumstances. Additionally, 

whether the terms of any swap executed 

on behalf of a customer satisfy the 

‘‘reasonable relationship’’ duty would be 

analyzed in connection with the specific 

anti-fraud provisions of the CEA and 

Commission Regulations and would be 

considered in connection with the 

course of dealing between the registrant 

and the customer. 

To satisfy its reasonable relationship 

obligation, a Commission registrant 

would be expected to exercise 

reasonable diligence to ascertain which 

DCM or SEF offers the best terms 

available for the transaction. To meet 

their reasonable diligence duty, 

Commission registrants would have to 

survey a sufficient number of DCMs or 

SEFs to be able to make a reasonable 

determination as to whether the terms 

they offer their clients bear a reasonable 

relationship to the best terms available. 

Such a survey would not necessarily be 

confined to markets on which the 

registrant has trading privileges and 

would include reviewing available bids 

and offers, requests for quotes, and real 

time reporting of trades executed within 

a reasonable period of time prior to 

execution of the order. In proposing this 

execution standard, the Commission 

notes that in separate rulemakings the 

Commission is proposing rules 

requiring DCMs and SEFs to provide 

market participants with open access to 

their trading platforms and that current 

pre-trade price and quote information 

will be available to all persons with 

access to DCMs and SEFs. Post-trade 

data also will be available to registrants 

on a real-time reporting basis. The 

Commission’s proposed rule lists a 

number of factors that the Commission 

would consider in determining 

compliance with the rule which include 

an evaluation of the characteristics 

unique to the customer’s swap order as 

well as the prevailing market 

conditions. 

As swaps trading transitions to and 

develops on DCMs and SEFs, 

technology and other innovations are 


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Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 80649 

89 29 U.S.C. 1002. The term ‘‘Special Entities’’ 

includes employee benefit plans defined in section 

3 of ERISA. This class of employee benefit plans is 

broader than the category of plans that are ‘‘subject 

to’’ ERISA for purposes of Section 4s(h)(5)(A)(i)(VII). 

Employee benefit plans not ‘‘subject to’’ regulation 

under ERISA include: (1) Governmental plans; (2) 

church plans; (3) plans maintained solely for the 

purpose of complying with applicable workmen’s 

compensation laws or unemployment 

compensation or disability insurance laws; (4) plans 

maintained outside the U.S. primarily for the 

benefit of persons substantially all of whom are 

nonresident aliens; or (5) unfunded excess benefit 

plans. See 29 U.S.C. 1003(b). 

90Section 3(32) of ERISA defines ‘‘governmental 

plan’’ as a ‘‘plan established or maintained for its 

employees by the Government of the United States, 

by the government of any State or political 

subdivision thereof, or by any agency or 

instrumentality of any of the foregoing.’’ 29 U.S.C. 

1002(32). 

91The term ‘‘endowment’’ is not defined in the 

Dodd-Frank Act or in the CEA. 

92 29 U.S.C. 1002. 

93See, e.g., SIFMA/ISDA Letter, at 5 (investment 

vehicle which 25 percent or more of its equity 

interest is owned by benefit plan investors and is 

subject to DOL plan assets rules (29 CFR 2510.3– 

101) for purposes of ERISA). 

94See, e.g., SIFMA/ISDA Letter, at 2. 

95SIFMA/ISDA Letter, at 5 (‘‘This would exclude 

such plans as (i) unfunded plans for highly 

compensated employees; (ii) foreign pension plans 

(including foreign-based governmental plans); (iii) 

church plans that have elected not to subject 

themselves to ERISA; (iv) Section 403(b) plans that 

accept only employee contributions; and (v) Section 

401(a), 403(b) and 457 plans sponsored by 

governmental entities.’’) (citations omitted). 

96 26 U.S.C. 501(c)(3). Section 501(c)(3) lists tax 

exempt organizations including: ‘‘Corporations, and 

any community chest, fund, or foundation, 

organized and operated exclusively for religious, 

charitable, scientific, testing for public safety, 

literary, or educational purposes * * *.’’ 

97SIFMA/ISDA Letter, at 6; SFG Presentation, at 

8. 

likely to affect how Commission 

registrants determine whether the terms 

they offer their customers are reasonably 

related to the ‘‘best terms available’’ for 

purposes of satisfying the proposed 

execution standards. For example, 

registrants’ survey obligations may be 

satisfied by consulting, where available, 

information aggregators that facilitate 

the collection of information about 

current trading activity across markets. 

The proposed rule is intended to be 

sufficiently flexible to take account of 

such innovations and developments 

which should further the quality of 

executions. 

Request for Comment: The 

Commission requests comments 

generally on the proposed rules 

regarding the swap execution standard 

and the following specific issues: 

• For the purpose of meeting the duty 

to use reasonable diligence to determine 

whether the terms it offers are 

reasonably related to the best terms 

available for execution of a swap that is 

available for trading on a DCM or SEF, 

should the Commission prescribe a 

certain percentage of DCMs or SEFs that 

must be reviewed/considered by the 

Commission registrant? If so, what 

percentage is appropriate? 

• Should the Commission define 

what it means for the terms of execution 

to have a ‘‘reasonable relationship to the 

best terms available’’? If so, how should 

the Commission define the phrase? 

• Should the Commission require any 

additional disclosures to the customer, 

including for example, the best terms 

available for execution of the swap 

order and the difference between the 

best terms and the terms on which the 

swap was executed? 

III. Proposed Rules for Swap Dealers 

and Major Swap Participants Dealing 

With Special Entities 

In Section 4s(h), Congress created a 

separate category of swap counterparty 

called Special Entities, and imposed 

heightened duties and requirements for 

swap dealers that act as advisors to 

them, and for swap dealers and major 

swap participants that are their 

counterparties. 

A. Definition of ‘‘Special Entity’’ Under 

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

Section 4s(h)(2)(C) defines a ‘‘Special 

Entity’’ as: (i) A Federal agency; (ii) a 

State, State agency, city, county, 

municipality, or other political 

subdivision of a State; (iii) any 

employee benefit plan, as defined in 

Section 3 of ERISA; 89 (iv) any 

governmental plan, as defined in 

Section 3 of ERISA; 90 or (v) any 

endowment, including an endowment 

that is an organization described in 

Section 501(c)(3) of the Internal 

Revenue Code of 1986.91

The Commission has received a 

number of letters from stakeholders 

identifying a variety of ambiguities in 

the definition of Special Entity in 

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

clarifications. For example, under 

Section 4s(h)(2)(C)(iii), the term Special 

Entity includes employee benefit plans 

as defined in Section 3 of ERISA.92

Industry representatives have raised 

issues concerning whether the 

definition requires ‘‘looking through’’ 

investment vehicles to determine 

whether the vehicle is a Special Entity, 

including master trusts holding the 

assets of one or more pension plans of 

a single employer, and collective 

investment vehicles in which Special 

Entities invest.93

Stakeholders similarly have raised 

issues with respect to whether plans 

defined in but not subject to ERISA 

(unless they are covered by another 

applicable prong of the Special Entity 

definition) are Special Entities,94 and 

whether only those plans subject to the 

fiduciary responsibility provisions of 

ERISA should be included within the 

Special Entity definition.95

Under Section 4s(h)(2)(C)(v), the term 

Special Entity includes any endowment, 

including an endowment that is an 

organization described in Section 

501(c)(3) of the Internal Revenue Code 

of 1986.96 Non-profit organizations that 

enter into swaps have asked whether 

they will be treated as Special Entities 

if their endowment is pledged as 

collateral or is used to make payments 

on those swaps or whether the 

definition of endowment is limited to 

those endowments that are the named 

counterparty to the swap.97 Others have 

suggested that the phrase ‘‘any 

endowment’’ be limited to endowments 

that are non-profit organizations 

described in Section 501(c) of the 

Internal Revenue Code or are 

established for the benefit of such an 

organization. 

Given the range of issues surrounding 

the definition of Special Entity, the 

Commission is not proposing to clarify 

the definition at this time but, instead, 

is seeking comment on whether 

clarification is necessary. 

Request for Comment: The 

Commission requests comments on the 

definition of Special Entity in general 

and on the following specific issues: 

• Should the definition of State, State 

agency, city, county, municipality, or 

other political subdivision of a State be 

clarified in any way? 

• Should the definition ‘‘employee 

benefit plans, as defined in Section 3 of 

ERISA’’ be clarified in any way? 

• Should the definition ‘‘employee 

benefit plans, as defined in Section 3 of 

ERISA’’ be limited to plans subject to 

regulation under ERISA? 

• Should the Commission ‘‘look 

through’’ an entity to determine whether 

it is a Special Entity for the purposes of 

these rules? If so, why? If not, why not? 

If so, should the Commission clarify that 

master trusts, or similar entities, that 

hold assets of more than one pension 

plan from the same plan sponsor are 

within the definition of Special Entity? 

• Should the Commission clarify in 

any way the definition of governmental 

plan under Section 4s(h)(C)(iv)? 

• Should the Commission clarify the 

definition of endowment to include or 

exclude charitable organizations that 

enter into swaps but whose 

endowments have contractual 

obligations regarding that swap? 

• Should the Commission clarify the 

definition of endowment to include or 

exclude foreign endowments? If so, 

why? If not, why not? 


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80650 Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 

98There is similar language in SEC v. Capital 

Gains Research Bureau, Inc., 375 U.S. 180, 191–94 

(1963) in which the Supreme Court construed 

Advisers Act Section 206 (15 U.S.C. 80b–6) as 

creating an enforcement mechanism for violations 

of fiduciary duties under the common law. The 

fiduciary duty imposes upon investment advisers 

the ‘‘affirmative duty of ‘utmost good faith, and full 

and fair disclosure of all material facts,’ as well as 

an affirmative obligation to ‘employ reasonable care 

to avoid misleading’ ’’ their clients. 

99Senator Blanche Lincoln stated in a floor 

colloquy that: 

[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). However, swap dealers 

have an obligation to ensure that any Special Entity 

counterparty is represented by a sophisticated 

representative, independent of the swap dealer, 

when the swap dealer is acting both as an advisor 

and as counterparty to the Special Entity. (Section 

4s(h)(5)). 

100The Commission anticipates that swap dealers 

and Special Entities will continue to rely on 

representations to inform the nature of their 

relationships, including, for example, 

representations that the Special Entity: (1) Is not 

relying on the swap dealer; (2) has an independent 

representative that, by virtue of their relationship, 

is legally obligated to act in the best interests of the 

Special Entity; and (3) is relying on the 

independent representative’s advice in evaluating 

any recommendation from a swap dealer. The 

parties’ agreement, however, does not bind the 

Commission or override the protections granted to 

market participants under the CEA. Cf. Complaint 

at ¶ 18, SEC v. Barclays Bank, 07–CV–04427 

(S.D.N.Y. May 30, 2007) (so-called ‘‘Big Boy’’ letters 

may not insulate parties from enforcement actions 

brought by the SEC for insider trading); SEC v. 

Barclays Bank, SEC Litig. Release No. 20132 (May 

30, 2007) (Barclays Bank settles insider trading 

charges). 

101The Commission staff has consulted with DOL 

staff, who has advised that any determination of 

status under the Dodd-Frank Act is separate and 

distinct from the determination of whether an entity 

is a fiduciary under ERISA. 

102Certain Special Entity trade associations 

supported this approach. See ABC Letter, at 6–7; 

ABC/CIEBA Letter, at 3. 103 In the absence of sufficient representations 

from the Special Entity, and if a swap dealer’s 

reasonable efforts produce incomplete information, 

the swap dealer would be required to assess 

whether it is able to make a swap recommendation 

that is in the best interests of the Special Entity as 

required by proposed § 23.440. 

B. Proposed § 23.440—Requirements for 

Swap Dealers Acting as Advisors to 

Special Entities 

Section 4s(h)(4) provides that a swap 

dealer that ‘‘acts as an advisor to a 

Special Entity’’ must act in the ‘‘best 

interests’’ of the Special Entity and 

undertake ‘‘reasonable efforts’’ to obtain 

information necessary to determine that 

a recommended swap is in the best 

interests of the Special Entity. These 

terms are not defined in the statute. The 

Commission’s proposed rules 

incorporate the statutory language and 

clarify that ‘‘acts as an advisor to a 

Special Entity’’ includes to make a swap 

recommendation to a Special Entity. 

1. Act as an Advisor to a Special Entity 

With respect to what it means to ‘‘act 

as an advisor to a Special Entity,’’ the 

Commission proposes to clarify that a 

swap dealer that makes a 

recommendation to a Special Entity falls 

within the definition. The Commission 

also proposes to clarify that a swap 

dealer that merely provides to a Special 

Entity general transaction, financial, or 

market information or that provides 

swap terms as part of a response to a 

competitive bid request from the Special 

Entity does not fall within the 

definition. 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. 

2. Best Interests 

The proposed rule would not define 

the term ‘‘best interests.’’ There are 

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 

Commission believes that those best 

interest 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, and to employ 

reasonable care that any 

recommendation given to a Special 

Entity is designed to further the 

purposes of the Special Entity.98 The 

Commission’s proposal is guided by the 

statutory language in Sections 4s(h)(4) 

and (5) and Congressional intent that 

swap dealers could act both as an 

advisor to a Special Entity when 

recommending a swap and then as a 

counterparty by entering into the same 

swap with the Special Entity, where the 

Special Entity has a representative 

independent of the swap dealer on 

which it can rely.99 The proposed rules 

are intended to allow existing business 

relationships to continue, albeit subject 

to the new, higher statutory standards of 

care.100 Thus, the proposed rule is not 

intended to preclude, per se, a swap 

dealer from both recommending a swap 

to a Special Entity and entering into that 

swap with the same Special Entity 

where the parties abide by the 

requirements of Sections 4s(h)(4) and (5) 

and the Commission’s proposed 

regulations.101

3. Reasonable Efforts 

Section 4s(h)(4)(C) requires swap 

dealers to undertake ‘‘reasonable efforts’’ 

to obtain information necessary to 

determine that a recommended swap is 

in the best interests of the Special 

Entity. Such information includes the 

financial and tax status of the Special 

Entity and the financing objectives of 

the Special Entity. The statute grants the 

Commission discretionary authority to 

prescribe additional types of 

information. The Commission proposes 

to add: (1) The authority of the Special 

Entity to enter into a swap; (2) future 

funding needs of the Special Entity; (3) 

the experience of the Special Entity 

with respect to entering into swaps, 

generally, and swaps of the type and 

complexity being recommended; (4) 

whether the Special Entity has a 

representative as provided in proposed 

§ 23.450 and Section 4s(h)(5) that is 

capable of evaluating the recommended 

swap in light of the needs and 

circumstances of the Special Entity; and 

(5) whether the Special Entity has the 

financial capability to withstand 

changes in market conditions during the 

term of the swap. The Commission 

believes that this non-exclusive list 

would assist a swap dealer in meeting 

its duty to act in the ‘‘best interests’’ of 

a Special Entity in recommending a 

swap or swap trading strategy. 

4. Reasonable Reliance To Satisfy the 

‘‘Reasonable Efforts’’ Obligation 

Proposed § 23.440(c) would allow a 

swap dealer to rely on the Special 

Entity’s representations to satisfy its 

‘‘reasonable efforts’’ obligations. The 

Commission understands from 

stakeholders, including a number of 

Special Entities, that Special Entities are 

sometimes 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. To address this 

circumstance, the Commission proposes 

to allow a swap dealer to meet its 

‘‘reasonable efforts’’ duty by relying on 

representations of the Special Entity 102

and any other information known by the 

swap dealer. In such circumstances, the 

swap dealer would be expected to 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 as provided in 

Section 4s(h)(4)(C) and proposed 

§ 23.440(b)(2).103

To rely, the swap dealer must have a 

reasonable basis to believe that the 

representations of the Special Entity are 

reliable based on the facts and 


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Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 80651 

104Although 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 proposes to apply the 

counterparty requirements to major swap 

participants as well as to swap dealers. 

105Pursuant to Section 4s(h)(7), the duty would 

not apply to transactions initiated on a DCM or SEF 

where the swap dealer or major swap participant 

does not know the counterparty to the transaction. 

106The 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). 

107See, e.g., Ropes & Gray Letter, at 1; ABC/ 

CIEBA Statement letter, at 2; SIFMA/ISDA Letter, 

at 11. 

108See 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.’’). 

109See, e.g., ABC Letter, at 4; ABC/CIEBA Letter, 

at 2; SIFMA/ISDA Letter, at 11. Stakeholders have 

asserted that, even if Congress did intend for 

Section 4s(h)(5)(A) to apply to non-governmental 

Special Entities, it did not intend for it to apply to 

ERISA plans. Stakeholders further assert that, even 

if Section 4s(h)(5)(A) applies to ERISA plans, swap 

dealers and major swap participants should only be 

expected to verify that the independent 

representative satisfies the criteria of Section 

4s(h)(5)(A)(i)(VII)—that the independent 

representative is a fiduciary as defined in Section 

3 of ERISA (29 U.S.C. 1002)—and not the criteria 

of Section 4s(h)(5)(A)(i)(I)–(VI). They contend that 

verification of the duty under Section 

4s(h)(5)(A)(i)(VII) is the equivalent of verification of 

Section 4s(h)(5)(A)(i)(I)–(VI) and that to require 

verification of all the criteria would lead to 

regulatory conflicts under ERISA and the CEA. 

110The criteria for an independent representative 

based generally on the statute and under proposed 

§ 23.450 would be: (1) Sufficient knowledge to 

evaluate the transaction and risks; (2) not subject to 

a statutory disqualification; (3) independent of the 

swap dealer or major swap participant; (4) 

undertakes a duty to act in the best interests of the 

Special Entity it represents; (5) makes appropriate 

and timely disclosures to the Special Entity; (6) 

evaluates, consistent with any guidelines provided 

by the Special Entity, fair pricing and the 

appropriateness of the swap; (7) in the case of 

employee benefit plans subject to the ERISA, is a 

fiduciary as defined in Section 3 of ERISA (29 

U.S.C. 1002); and 8) in the case of a municipal 

entity as defined in proposed § 23.451, whether the 

representative is subject to restrictions on certain 

political contributions imposed by the Commission, 

the SEC or a self-regulatory organization subject to 

the jurisdiction of the Commission or the SEC. 

Criterion 8 is not in the statutory text under Section 

4s(h)(5)(A)(i)(I)–(VII). The Commission is proposing 

this criterion using its discretionary authority under 

Section 4s(h)(5)(B). 

111See DOL Prohibited Transaction Exemption 

(‘‘PTE’’) 84–14, 70 FR 49305, Aug. 23, 2005. 

112See DOL PTE 96–23, 61 FR 15975, Apr. 10, 

1996; Proposed Amendment to PTE 96–23, 75 FR 

33642, June 14, 2010. 

circumstances of the particular swap 

and the Special Entity. The 

representations themselves must be 

detailed and include information 

regarding the Special Entity’s ability to: 

evaluate the recommended transaction; 

exercise independent judgment; and 

absorb potential losses associated with 

the swap. The Special Entity also would 

have to have a representative that meets 

the criteria in Section 4s(h)(5) and 

proposed § 23.450. This mechanism 

would not relieve a swap dealer of its 

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

Special Entity. 

Request for Comment: The 

Commission requests comment 

generally on all of the proposed rules 

regarding swap dealers that act as 

advisors to Special Entities, and on the 

following specific issues: 

• Is the proposed clarification of the 

term ‘‘acts as an advisor to a Special 

Entity’’ appropriate? Should the 

Commission further define the term? 

• Should the Commission define 

‘‘best interests’’ in this context, and if so, 

what should the definition be? 

• Because a swap dealer has an 

inherent conflict of interest when it acts 

as both an advisor and a counterparty to 

Special Entity, are there additional 

disclosures that a swap dealer should 

have to make that could mitigate the 

conflicts of interest? 

• When acting as both an advisor and 

a counterparty to a Special Entity, 

should a swap dealer have to disclose 

any positions it holds from which it 

may profit should the swap in question 

move against the Special Entity? 

• Should swap dealers have to 

disclose to a Special Entity the profit it 

expects to make on swaps it enters into 

with the Special Entity. 

• Should swap dealers be subject to 

an explicit fiduciary duty when acting 

as an advisor to a Special Entity? 

• Would the proposed rule preclude 

swap dealers from continuing their 

current practice of both recommending 

and entering into swaps with Special 

Entities? If so, why? 

• Should the Commission prescribe 

additional information that would be 

relevant to a swap dealer’s ‘‘reasonable 

efforts’’ and ‘‘best interests’’ duties under 

the proposed rule? 

C. Proposed § 23.450—Requirements for 

Swap Dealers and Major Swap 

Participants Acting as Counterparties to 

Special Entities 

Section 4s(h)(5) requires that swap 

dealers and major swap participants 104

that offer swaps to or enter into swaps 

with Special Entities comply with any 

duty established by the Commission 

that requires them to have a reasonable 

basis to believe that the Special Entity 

has an independent representative that 

meets certain criteria.105 The 

Commission interprets the statute as 

imposing this duty on swap dealers and 

major swap participants when they are 

counterparties to any Special Entity.106

In making this determination the 

Commission considered staff’s 

consultations with staff at other Federal 

regulators, stakeholders, letters from the 

public,107 as well as legislative 

history.108 To meet their duties under 

the proposed rule, swap dealers and 

major swap participants would be able 

to rely on reasonable, detailed 

representations of the Special Entity 

concerning the qualifications of the 

independent representative.109

1. Qualifications of the Independent 

Representative 

The proposed rule would require 

swap dealers and major swap 

participants to have a reasonable basis 

to believe that a Special Entity has a 

representative that satisfies the 

enumerated criteria.110 The proposed 

rule provides that relevant 

considerations would include: (1) The 

nature of the Special Entityrepresentative relationship; (2) the 

representative’s capability of making 

hedging or trading decisions; (3) use of 

consultants or, with respect to employee 

benefit plans subject to ERISA, use of a 

Qualified Professional Asset Manager 111

or In-House Asset Manager; 112 (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. 

2. Statutory Disqualification 

To guide swap dealers and major 

swap participants, the proposed rule 

defines ‘‘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. 

3. Independent 

Proposed § 23.450(b) would require 

that a swap dealer or major swap 

participant ‘‘have a reasonable basis to 

believe a Special Entity has a 


srobinson on DSKHWCL6B1PROD with PROPOSALS3
80652 Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 

113Section 4s(h)(5)(A)(i) provides in relevant part: 

‘‘reasonable basis to believe that the counterparty 

that is a Special Entity has an independent 

representative that * * * (III) is independent of the 

swap dealer or major swap participant * * *’’ By 

including the word ‘‘independent’’ twice, an 

ambiguity was created as to whether the 

representative had to be independent of both the 

swap dealer or major swap participant and the 

Special Entity. The legislative history indicates that 

was not the intent of Congress. Thus, the proposed 

rule drops the first ‘‘independent’’ to clarify that the 

representative of a Special Entity only needs to be 

independent of the swap dealer or major swap 

participant. 

114See, e.g., ABC Letter, at 6; ABC/CIEBA Letter, 

at 3; Ropes & Gray Letter, at 2; SIFMA/ISDA Letter, 

at 12; NFA Letter, at 6. 

115See 156 Cong. Rec. S5903 (daily ed. Jul. 15, 

2010) (statements of Sens. Lincoln and Harkin): 

Mrs. LINCOLN Our intention in imposing the 

independent representative requirement was to 

ensure that there was always someone independent 

of the swap dealer or the security-based swap dealer 

reviewing and approving swap or security-based 

swap transactions. However, we did not intend to 

require that the special entity hire an investment 

manager independent of the special entity. Is that 

your understanding, Senator Harkin? 

Mr. HARKIN. Yes, that is correct. We certainly 

understand that many special entities have internal 

managers that may meet the independent 

representative requirement. For example, many 

public electric and gas systems have employees 

whose job is to handle the day-to-day hedging 

operations of the system, and we intended to allow 

them to continue to rely on those in-house 

managers to evaluate and approve swap and 

security-based swap transactions, provided that the 

manager remained independent of the swap dealer 

or the security-based swap dealer and meet the 

other conditions of the provision. Similarly, the 

named fiduciary or in-house asset manager-INHAMfor a pension plan may continue to approve swap 

and security-based swap transactions. 

116 17 CFR 3.1(a). 

117Under the CEA, a commodity trading advisor 

will have a fiduciary duty towards its customer 

when it offers personalized advice. See Savage v. 

CFTC, 548 F.2d 192, 194 (7th Cir. 1977); 

Commodity Trend Serv., 233 F.3d at 990 (‘‘the party 

in [Savage] offered personalized advice and so 

would be considered a fiduciary under the common 

law’’) (citing Capital Gains, 375 U.S. at 194). Under 

the Advisers Act, an adviser is a fiduciary whose 

duty is to serve the best interests of its clients, 

which includes an obligation not to subrogate 

clients’ interests to its own. An adviser must deal 

fairly with clients and prospective clients, seek to 

avoid conflicts with its clients and, at a minimum, 

make full disclosure of any material conflict or 

potential conflict. ‘‘Amendments to Form ADV,’’ 

Release No. IA–3060 (Aug. 12, 2010) (citing Capital 

Gains, 375 U.S. at 191–94). Under ERISA, ‘‘a 

fiduciary shall discharge his duties with respect to 

a plan solely in the interest of the participants and 

beneficiaries and * * * for the exclusive purpose 

of: (i) providing benefits to participants and their 

beneficiaries; and (ii) defraying reasonable expenses 

of administering the plan’’ (29 U.S.C. 1104(a)(1)(A)) 

and act ‘‘with the care, skill, prudence, and 

diligence under the circumstances then prevailing 

that a prudent man acting in a like capacity and 

familiar with such matters would use in the 

conduct of an enterprise of a like character and with 

like aims * * *’’ (29 U.S.C. 1104(a)(1)(B)). 

118The description of the duties under Section 

4s(h)(5)(A)(i)(IV) is drawn from a description of 

ERISA fiduciary obligations in connection with the 

use of derivatives in the management of a portfolio 

of assets of a pension plan that is subject to ERISA. 

See Letter of Olena Berg, DOL, to Honorable Eugene 

A. Ludwig, Comptroller of the Currency (March 21, 

1996), available at, http://www.dol.gov/ebsa/ 

programs/ori/advisory96/driv4ltr.htm. 

119See, e.g., ABC Letter, at 8; SFG Letter, at 1. 

representative that * * * is 

independent of the swap dealer or major 

swap participant * * * ’’ 113 This 

formulation of the duty is intended to 

clarify that ‘‘independent’’ as it relates to 

a representative of a Special Entity 

means independent of the swap dealer 

or major swap participant,114 not 

independent of the Special Entity.115

As to what it means for the 

representative to be independent of the 

swap dealer or major swap participant, 

the Commission’s proposed rule 

provides that a representative would be 

deemed to be independent if: (1) It is 

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 is no ‘‘principal’’ relationship 

between the representative and the 

swap dealer or major swap participant 

within the meaning of § 3.1(a)116 of the 

Commission’s Regulations; and (3) the 

representative does not have a material 

business relationship with the swap 

dealer or major swap participant. 

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. The proposed rule defines 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. 

4. Best Interests 

The Commission is not proposing to 

define what ‘‘best interests’’ means in 

this context. As the Commission 

explained regarding proposed § 23.440, 

the scope of the duty will be related to 

the nature of the relationship between 

the independent representative and the 

Special Entity. There are established 

principles in case law which will 

inform the meaning of the term on a 

case-by-case basis.117

We would expect that, 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’s entering into the 

transaction.118

5. Makes Appropriate and Timely 

Disclosures 

The proposed rule refines the 

criterion under Section 4s(h)(5)(A)(i)(V), 

‘‘appropriate disclosures,’’ to mean 

‘‘appropriate and timely disclosures.’’ A 

swap dealer or major swap participant 

would have to have a reasonable basis 

to believe that a representative makes 

appropriate and timely disclosures to 

the Special Entity for the representative 

to meet the requirements of the 

proposed rule. 

6. Evaluates Fair Pricing and the 

Appropriateness of the Swap 

The Commission has received a 

number of questions regarding the 

statutory criterion in Section 

4s(h)(5)(A)(i)(VI) which states that the 

representative will provide ‘‘written 

representations to the Special Entity 

regarding fair pricing and the 

appropriateness of the transaction.’’ 119

The Commission’s proposed rule refines 

the statutory language to say that the 

representative ‘‘evaluates, consistent 

with any guidelines provided by the 

Special Entity, fair pricing and the 

appropriateness of the swap.’’ The 

Commission proposes to allow swap 

dealers and major swap participants to 

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 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 should also have a 

reasonable basis to believe that the 


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Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 80653 

120For example, CTAs are required to maintain 

books and records for 5 years pursuant to § 1.31 of 

the Commission’s regulations. (17 CFR 1.31). 121 29 U.S.C. 1002. 122 See, e.g., ABC Letter, at 4–5; ABC/CIEBA 

Letter, at 2–5. 123Proposed § 23.451. 124The Commission proposes this requirement 

pursuant to its discretionary authority in Section 

4s(h) of the CEA, including in particular Section 

4s(h)(5)(B). 

125See, e.g., SEC Rule 206(4)–5 under the 

Advisers Act (17 CFR 275.206(4)–5); MSRB Rule 

G–37: Political Contributions and Prohibitions on 

Municipal Securities Business. The Commission 

proposes to impose comparable requirements on 

swap dealers and major swap participants that act 

as advisors or counterparties to Special Entities. See 

proposed § 23.432. In a separate release, the 

Commission will also propose comparable 

requirements on registered commodity trading 

advisors when they advise municipal entities. 

126The definition of ‘‘municipal advisor’’ in 

Section 15B of the Exchange Act (15 U.S.C. 78o– 

4) excludes employees of a municipal entity. 

127E.g., ABC Letter, at 8. 

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.120 This 

approach would apply to in-house 

independent representatives as well. 

7. ERISA Fiduciary 

The proposed rule tracks the statutory 

language that in the case of employee 

benefit plans subject to ERISA, the 

independent representative is a 

fiduciary as defined in Section 3 of that 

Act.121 Certain ERISA plans, fiduciaries 

and their trade associations, have urged 

the Commission to interpret the statute 

to mean that the independent 

representative of a plan subject to 

ERISA would not have to satisfy the 

additional criteria in Section 

4s(h)(5)(A)(i)(I)–(VI), because such 

criteria would be duplicative of or 

inconsistent with ERISA 

requirements.122 After consultations 

with DOL staff, the Commission is 

inclined, at this time, to treat ERISA 

fiduciaries like other independent 

representatives of Special Entities with 

respect to the criteria in Section 

4s(h)(5)(A)(i)(I)–(VI). The Commission 

would expect that such ERISA 

fiduciaries and plans would be able to 

provide adequate representations to 

swap dealers and major swap 

participants to meet the additional 

criteria without incurring significant 

costs. The Commission seeks further 

comment from interested parties as to 

this approach, particularly with respect 

to whether the additional criteria, as 

proposed in the rule, are inconsistent in 

any way with the requirements under 

ERISA. 

8. Restrictions on Political 

Contributions by Independent 

Representative of a Municipal Entity 

As part of the process of determining 

the qualifications of an independent 

representative of a Special Entity that is 

a municipal entity,123 the Commission 

proposes 124 to require swap dealers and 

major swap participants to ensure that 

the independent representative is 

subject to restrictions on certain 

political contributions, known as ‘‘payto-play’’ rules.125 The requirement 

would not apply to in-house 

independent representatives of a 

municipal entity.126

9. Unqualified Independent 

Representative 

Some stakeholders have expressed 

concern that the independent 

representative requirement places 

undue influence in the hands of the 

swap dealer or major swap participant 

by allowing it to use Section 

4s(h)(5)(A)(i) to control who qualifies as 

an independent representative.127 Thus, 

the proposed rule also provides that, if 

a swap dealer or major swap participant 

were to determine that the independent 

representative of a Special Entity did 

not meet the criteria established in this 

provision, 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 to ensure that the 

swap dealer or major swap participant 

had a substantial, unbiased basis for the 

determination. 

10. Disclosure of Capacity 

Section 4s(h)(5)(A)(ii) requires swap 

dealers and major swap participants to 

disclose in writing to Special Entities 

the capacity in which they are acting 

before initiation of a swap transaction. 

The Commission proposes to adopt the 

statutory standard in a rule, and to 

require that, 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. This would 

apply, for example, when the swap 

dealer acts both as an advisor and as a 

counterparty to the Special Entity, or 

when firms act both as underwriters in 

a bond offering and as counterparties in 

swaps used to hedge such financing. In 

these circumstances, the swap dealers’ 

or major swap participants’ duties to the 

Special Entities would vary depending 

on the capacities in which they are 

operating. 

11. Inapplicability 

Proposed § 23.450 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. 

Request for Comment: The 

Commission requests comment 

generally on all of the proposed rules 

regarding swap dealers and major swap 

participants that act as counterparties to 

Special Entities, and on the following 

specific issues: 

• Should the rule clarify the statutory 

language to give more guidance to the 

criteria in Section 4s(h)(5)(A)(i)(I)–(VI)? 

If, yes, how? 

• Are there any specific qualifications 

that should be considered in forming a 

reasonable basis regarding whether the 

independent representative has 

sufficient knowledge to evaluate the 

transaction and risks? 

• Should the criterion in Section 

4s(h)(5)(A)(i)(VII) be the only criterion 

that applies to employee benefit plans 

subject to ERISA? Why or why not? Are 

the criteria in Section 4s(h)(5)(A)(i)(I)– 

(VI) inconsistent with a fiduciary’s 

duties under ERISA? Do the criteria in 

Section 4s(h)(5)(A)(i)(I)–(VI) add any 

protections for plans subject to ERISA 

that are not otherwise provided under 

ERISA? 

• To resolve the ambiguity in the 

statutory text referenced in footnote 106, 

should the rule be limited to certain 

types of Special Entities? Why or why 

not? Which types should be included or 

excluded from coverage under the 

proposed rule? 

• Should the rule define what it 

means for the independent 

representative to be independent of the 

swap dealer or major swap participant? 

If yes, should independence be 

measured in relation to ownership and 

control, material business relationships, 

or another measure? Should any 

‘‘independence’’ test apply to employees 

of the independent representative, as 

well as to the representative, itself? 

• Should the Commission specify a 

de minimis threshold below wh ich an 

independent representative will not be 

deemed to have a material business 

relationship with the swap dealer or 

major swap participant? If so, what 

would be an appropriate threshold? 

D. Proposed § 23.451—Political 

Contributions by Certain Swap Dealers 

and Major Swap Participants 

Using its discretionary rulemaking 

authority under Section 4s(h) to impose 

business conduct requirements in the 


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80654 Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 

128Section 4s(h)(5)(B). 

129See proposed § 23.451(a)(3). The proposed 

definition of ‘‘municipal entity’’ is based on 

Exchange Act Section 15B(e)(8) (15 U.S.C. 78o– 

4(e)(8)) and means any State, political subdivision 

of a State, or municipal corporate instrumentality 

of a State, including— 

(A) Any agency, authority, or instrumentality of 

the State, political subdivision, 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. 

130 17 CFR 275.206(4)–5 (‘‘SEC Advisers Act Rule 

206(4)–5’’). 

131See ‘‘Political Contributions by Certain 

Investment Advisers,’’ Release No. IA–3043 (Jul. 1, 

2010), 75 FR 41018, Jul. 14, 2010 (adopting a rule 

that prohibits certain political contributions by 

investment advisers providing or seeking to provide 

investment advisory services to public pension 

plans and other government investors). 

132See MSRB Rule G–37, Political Contributions 

and Prohibitions on Municipal Securities Business; 

MSRB Rule G–38, Solicitation of Municipal 

Securities Business. 

133The Commission is proposing to define 

‘‘regulated person,’’ for purposes of the rule, to mean 

generally a person that is subject to rules of the SEC, 

the MSRB, a self-regulatory organization, or the 

Commission prohibiting it from engaging in 

specified activities if certain political contributions 

have been made, or its officers or employees. 

public interest,128 the Commission is 

proposing to prohibit swap dealers and 

major swap participants from entering 

into swaps with ‘‘municipal entities’’ if 

they make certain political 

contributions to officials of such 

entities.129 The proposed rule is 

intended to complement existing pay-toplay prohibitions imposed by Federal 

securities regulators to deter undue 

influence and other fraudulent practices 

that harm the public. The Commission’s 

proposed rule would promote 

consistency in the business conduct 

standards that apply to financial market 

professionals dealing with municipal 

entities. 

The existing restrictions on pay-toplay practices are contained in SEC Rule 

206(4)–5 under the Investment Advisers 

Act of 1940,130 which prohibits certain 

political contributions by investment 

advisers providing or seeking to provide 

investment advisory services to public 

pension plans and other government 

investors,131 and under the Municipal 

Securities Rule Making Board (‘‘MSRB’’) 

Rules G–37 and G–38,132 which impose 

pay-to-play restrictions on municipal 

securities dealers and broker-dealers 

engaging or seeking to engage in the 

municipal securities business. The 

proposed rule is intended to deter swap 

dealers and major swap participants 

from engaging in pay-to-play practices. 

1. Prohibitions 

Proposed § 23.451, generally, would 

make 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 would prohibit a swap dealer or 

major swap participant from paying a 

third-party to solicit municipal entities 

to enter into a swap, unless the thirdparty is a ‘‘regulated person’’ that is itself 

subject to a pay-to-play restriction under 

applicable law.133 The proposed rule 

also would ban 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. These proposed 

prohibitions are similar to those 

contained in SEC Advisers Act Rule 

206(4)–5 and MSRB Rules G–37 and G– 

38. 

The proposed rule also includes 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. 

a. Two-Year ‘‘Time Out’’ 

The proposed rule would prohibit 

swap dealers and major swap 

participants from offering to enter into 

or entering into a swap with a 

municipal entity within two years after 

a contribution to an official of such 

municipal entity was made by the swap 

dealer or major swap participant or any 

of its covered associates. The two-year 

time out is consistent with the time out 

provisions contained in SEC Advisers 

Act Rule 206(4)–5 and MSRB Rule 

G–37. 

b. Covered Associates 

Political contributions made to 

influence the firm selection process are 

typically made not by the firm itself, but 

by officers and employees of the firm 

who have a stake in the business 

relationship with the municipal client. 

For this reason, contributions by such 

persons, which the rule defines as 

‘‘covered associates,’’ would trigger the 

two-year time out. A ‘‘covered associate’’ 

of a swap dealer or major swap 

participant is defined 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. This definition 

mirrors a similar provision in SEC 

Advisers Act Rule 206(4)–5. 

Because the proposed rule attributes 

to a firm contributions made by a person 

even prior to becoming a covered 

associate of the firm, swap dealers and 

major swap participants must ‘‘look 

back’’ in time to determine whether the 

time out applies when an employee 

becomes a covered associate. For 

example, if the contribution was made 

less than two years (or six months, as 

applicable) before an individual 

becomes a covered associate, the 

proposed rule would prohibit the firm 

from entering into a swap with the 

relevant municipal entity until the twoyear time out period has expired. 

2. Exceptions 

a. De Minimis Contributions 

The proposed rule would permit 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 for any one 

official for whom the individual is 

entitled to vote, and up to $150, per 

election, to an official for whom the 

individual is not entitled to vote. The 

Commission believes this two-tiered de 

minimis approach is reasonable because 

of the more remote interest an 

individual is likely to have in 

contributing to a person for whom such 

individual is not entitled to vote. This 

provision is similar to the one contained 

in SEC Advisers Act Rule 206(4)–5. 

b. New Covered Associates 

The prohibitions of the proposed rule 

would 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. 

c. Exchange and SEF Transactions 

The prohibitions of the proposed rule 

would 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. 


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Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 80655 

134Proposed § 23.451(d). 

135As used in SEC Advisers Act Rule 206(4)– 

5(f)(5) (17 CFR 275.206(4)–5(f)(5)), the term 

‘‘government entity’’ means any State or political 

subdivision of a State, including: 

(i) Any agency, authority, or instrumentality of 

the State or political subdivision; 

(ii) A pool of assets sponsored or established by 

the State or political subdivision or any agency, 

authority or instrumentality thereof, including, but 

not limited to a ‘‘defined benefit plan’’ as defined 

in section 414(j) of the Internal Revenue Code (26 

U.S.C. 414(j)), or a State general fund; 

(iii) A plan or program of a government entity; 

and 

(iv) Officers, agents, or employees of the State or 

political subdivision or any agency, authority or 

instrumentality thereof, acting in their official 

capacity. 

136MSRB Rule G–37(g)(ii) references ‘‘the 

governmental issuer specified in section 3(a)(29) of 

the [Exchange] Act’’ which includes ‘‘a State or any 

political subdivision thereof, or any agency or 

instrumentality of a State or any political 

subdivision thereof, or any municipal corporate 

instrumentality of one more States * * *’’ (15 

U.S.C. 78c(29)). 

137 5 U.S.C. 601 et seq. 

138 Id. 

139 47 FR 18618, Apr. 30, 1982. 

3. Exemptions 

A swap dealer or major swap 

participant would be exempt from the 

prohibitions of the proposed rule where 

the contribution that was made by a 

covered associate did not exceed $150 

or $350, as applicable, was discovered 

by the swap dealer or major swap 

participant within four months of the 

date of contribution, and was returned 

to the contributor within 60 calendar 

days of the date of discovery. This 

automatic exemption mirrors similar 

provisions contained in SEC Advisers 

Act Rule 206(4)–5 and MSRB Rule 

G–37. 

In addition, the Commission proposes 

a provision under which a swap dealer 

or major swap participant may apply to 

the Commission for an exemption from 

the two-year ban. In determining 

whether to grant the exemption, the 

Commission would consider, among 

other factors: (i) Whether the exemption 

is necessary or appropriate in the public 

interest and consistent with the 

protection of investors and the purposes 

of the CEA; (ii) whether the swap dealer 

or major swap participant, before the 

contribution resulting in a prohibition 

was made, had adopted and 

implemented policies and procedures 

reasonably designed to prevent 

violations of the proposed rule, prior to 

or at the time of the contribution, had 

any actual knowledge of the 

contribution, and, after learning of the 

contribution, has taken all available 

steps to cause the contributor to obtain 

return of the contribution and such 

other remedial or preventative measures 

as may be appropriate under the 

circumstances; (iii) whether, at the time 

of the contribution, the contributor was 

a covered associate or otherwise an 

employee of the swap dealer or major 

swap participant, or was seeking such 

employment; (iv) the timing and amount 

of the contribution; (v) the nature of the 

election (e.g., Federal, State or local); 

and (vi) the contributor’s intent or 

motive in making the contribution, as 

evidenced by the facts and 

circumstances surrounding the 

contribution.134 This exemption is 

similar to automatic exemption 

provisions contained in SEC Rule 

206(4)–5 and MSRB Rule G–37. 

Request for Comment: The 

Commission requests comments 

generally on the proposed rules 

regarding restrictions on certain 

political contributions by swap dealers 

and major swap participants and the 

following specific issues: 

• Is the term ‘‘municipal entity’’ 

appropriately defined? If not, should the 

Commission refer to ‘‘a State, State 

agency, city, county, municipality, or 

other political subdivision of a State, or 

any governmental plan, as defined in 

Section 3 of [ERISA] (29 U.S.C. 1002)’’ 

within the meaning of Section 

4s(h)(2)(C)? Should the Commission use 

the definition of ‘‘government entity’’ 

from SEC Advisers Act Rule 206(4)– 

5? 135 Should the Commission instead 

follow the approach of MSRB Rule 

G–37? 136

• Should the proposed rule apply not 

to all swap dealers and major swap 

participants, but instead to only swap 

dealers? If so, why? 

IV. Request for Comment 

A. Generally 

The Commission requests comment 

on all aspects of the proposed rules. In 

addition, the Commission seeks 

comment on the following specific 

issues: 

• Should any proposed requirements 

be modified or deemed satisfied with 

respect to swaps that are traded and/or 

cleared on a registered entity? If so, 

which requirements should be modified 

or deemed satisfied, and why? 

• Should the Commission use its 

discretionary authority, where 

applicable, to distinguish among swap 

dealers depending on their size and the 

nature of their business? If so, under 

what circumstances and how? 

• Should any additional business 

conduct requirements be imposed on 

swap dealers and/or major swap 

participants? If so, which requirements 

should be imposed, and why? 

• Should the Commission delay the 

effective date of any of the proposed 

requirements to allow additional time to 

comply with the requirements? If so, 

which requirements, and what is the 

compliance burden that should merit a 

delay? 

B. Consistency With SEC Approach 

The SEC is proposing rules related to 

business conduct standards for swap 

dealers and major swap participants as 

required under Section 764 of the DoddFrank Act. Understanding that the 

Commission and the SEC regulate 

different products and markets and 

thus, appropriately may be proposing 

alternative regulatory requirements, we 

request comments generally on the 

impact of any differences between the 

Commission and SEC approaches to 

business conduct regulation in this area. 

• Do the regulatory approaches 

proposed by the Commission and the 

SEC result in duplicative or inconsistent 

business conduct standards for market 

participants subject to both regulatory 

regimes? Do the approaches result in 

gaps or different levels of regulation 

between those regimes? If so, in what 

ways do commenters believe that such 

duplication, inconsistencies, or gaps 

should be minimized? 

• Do commenters believe there are 

ways that would make the approaches 

more consistent? 

V. Related Matters 

A. Regulatory Flexibility Act 

The Regulatory Flexibility Act 

(RFA)137 requires that agencies consider 

whether the rules they propose will 

have a significant economic impact on 

a substantial number of small entities 

and, if so, provide a regulatory 

flexibility analysis respecting the 

impact.138 The business conduct rules 

proposed by the Commission generally 

will affect swap dealers and major swap 

participants. Prior to Dodd-Frank, the 

Commission did not have jurisdiction 

over swaps, swap dealers and major 

swap participants. Thus, the 

Commission has not previously 

addressed the question of whether swap 

dealers and major swap participants are, 

in fact, ‘‘small entities’’ for purposes of 

the RFA. 

However, the Commission has 

previously established certain 

definitions for small entities to be used 

by the Commission in evaluating the 

impact of its regulations on small 

entities in accordance with the RFA.139

For example, the Commission has 

previously determined that futures 

commission merchants (‘‘FCMs’’) are not 

small entities for the purpose of the 


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80656 Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 

140 Id. at 18619. 

141 Id. at 18620. 

142 Id. 

143 44 U.S.C. 3501 et seq. 

144The Business Conduct Standard-Internal 

Rulemakings are: Regulations Establishing and 

Governing the Duties of Swap Dealers and Major 

Swap Participants, 75 FR 71397, Nov. 23, 2010; 

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; and Implementation of Conflict-of-Interest 

Standards by Swap Dealers and Major Swap 

Participants, 75 FR 71391, Nov. 23, 2010. In 

addition, the Commission will be issuing proposed 

rules regarding recordkeeping, reporting and daily 

trading records for swap transactions consistent 

with § 1.31 of the Commission’s Regulations. (17 

CFR § 1.31). 

145See, e.g., Trading & Capital-Markets Activities 

Manual, Section 2150; CRMPG III Report. 

RFA140 based upon, among other things, 

the requirements that FCMs meet 

certain minimum financial requirements 

that enhance the protection of 

customers’ segregated funds and protect 

the financial condition of FCMs 

generally. The analogy to FCMs is 

appropriate in that we anticipate that 

swap dealers and major swap 

participants may have to register as 

FCMs depending on the nature of their 

business. Moreover, swap dealers and 

major swap participants will be subject 

to minimum capital and margin 

requirements, and are expected to 

comprise the largest global financial 

firms. Entities that engage in a de 

minimis quantity of swap dealing in 

connection with transactions with or on 

behalf of customers are exempt from the 

definition of swap dealers and major 

swap participants. Accordingly, the 

Commission is hereby determining that 

swap dealers and major swap 

participants not be considered to be 

‘‘small entities’’ for essentially the same 

reasons that FCMs have previously been 

determined not to be small entities. 

Similarly, the Commission has also 

previously determined that large traders 

are not ‘‘small entities’’ for RFA 

purposes.141 The Commission 

considered the size of a trader’s position 

to be the only appropriate test for 

purposes of large trader reporting.142

Major swap participants maintain 

substantial positions in swaps, creating 

substantial counterparty exposure that 

could have serious adverse effects on 

the financial stability of the United 

States banking system or financial 

markets. Accordingly, the Commission 

is hereby determining that major swap 

participants not be considered ‘‘small 

entities’’ for essentially the same reasons 

that large traders have previously been 

determined not to be small entities. 

Therefore, the Chairman, on behalf of 

the Commission, hereby certifies 

pursuant to 5 U.S.C. 605(b) that the 

proposed rules will not have a 

significant economic impact on a 

substantial number of small entities. 

B. Paperwork Reduction Act 

The Paperwork Reduction Act 

(‘‘PRA’’) provides that 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 from the 

Office of Management and Budget 

(‘‘OMB’’). 143

This rulemaking contains collections 

of information, notably the proposed 

rules that will require swap dealers and 

major swap participants to make 

records, document processes, and make 

disclosures to counterparties with 

whom they propose to enter into swaps. 

OMB has not yet assigned a control 

number to the new collections. OMB 

has not yet assigned a control number 

to the new collection. 

The collections of information 

contained herein overlap the 

requirements that are being proposed by 

the Commission in other rulemakings 

implementing the Dodd-Frank Act. The 

Commission is seeking or will seek 

control numbers from OMB for these 

collections in association with the other 

rulemakings. The other proposed 

rulemakings are being issued 

contemporaneously within the CFTC’s 

Business Conduct Standard–Internal 

related rulemakings144 implementing 

the Dodd-Frank Act. The Commission 

invites public comment on the accuracy 

of its estimate that no additional 

recordkeeping or information collection 

requirements or changes to existing 

collection requirements would result 

from the rules proposed herein. 

C. Cost-Benefit Analysis 

Section 15(a) of the CEA requires the 

Commission to consider the costs and 

benefits of its actions before issuing a 

rulemaking under the CEA. By its terms, 

Section 15(a) does not require the 

Commission to quantify the costs and 

benefits of an order or to determine 

whether the benefits of the order 

outweigh its costs; rather, it requires 

that the Commission ‘‘consider’’ the 

costs and benefits of its actions. Section 

15(a) further specifies that the costs and 

benefits shall be evaluated in light of 

five broad areas of market and public 

concern: (1) Protection of market 

participants and the public; (2) 

efficiency, competitiveness and 

financial integrity of futures markets; (3) 

price discovery; (4) sound risk 

management practices; and (5) other 

public interest considerations. The 

Commission may in its discretion give 

greater weight to any one of the five 

enumerated areas and could in its 

discretion determine that, 

notwithstanding its costs, a particular 

order is necessary or appropriate to 

protect the public interest or to 

effectuate any of the provisions or 

accomplish any of the purposes of the 

CEA. 

Summary of proposed requirements. 

The proposed regulations would 

implement Section 4s(h) which requires 

the Commission to promulgate rules to 

establish business conduct standards for 

swap dealers and major swap 

participants governing their 

relationships with counterparties 

including special requirements with 

respect to Special Entities. Among other 

things, the statute mandates that the 

Commission adopt rules requiring swap 

dealers and major swap participants to 

verify that counterparties meet 

eligibility criteria, disclose material 

information about the contemplated 

swaps to counterparties, including 

material risks, characteristics, incentives 

and conflicts of interest; and an ongoing 

duty to provide counterparties a daily 

mark for swaps. The Commission also is 

directed to 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. 

Costs. The Commission’s proposed 

rules implement new Section 4s(h) and 

enhance transparency, protect 

counterparties from fraud and abuse, 

bolster confidence in markets, reduce 

risk, and allow regulators to better 

monitor and manage our financial 

system. With respect to efficiency, the 

Commission has determined that 

adhering to the new requirements under 

the proposed rules will not be unduly 

burdensome for swap dealers and major 

swap participants. Indeed, the proposed 

rules, in part, reflect existing regulatory 

requirements in other markets as well as 

current industry practices in the swaps 

market.145 In addition, the Commission 

has determined that the cost to market 

participants and the public if these rules 

are not adopted could be substantial. 

Significantly, without these rules to 

promote transparency and fair dealing, 

the financial integrity and stability of 

the swaps markets could be 

undermined. 

Benefits. With respect to benefits, the 

Commission has determined that the 

proposed regulations would require a 

swap dealer or major swap participant 

to transact with market participants 

according to the principles of fair 


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Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 80657 

dealing and good faith in a manner 

intended to heighten the protection of 

market participants and the public. The 

additional protections for Special 

Entities reduces the overall risk to 

institutions critical to the public interest 

and the stability of the financial system 

by providing tools and safeguards to 

market participants in order to 

accurately assess risk, make informed 

decisions, and avoid crises. The 

proposed rules, if adopted, will result in 

greater certainty, reduced risk, increased 

transparency and market integrity in the 

swap market. Therefore, the 

Commission believes it is prudent to 

issue these business conduct 

requirements for swap dealers and 

major swap participants. 

The Commission invites public 

comment on its cost-benefit 

considerations. Commenters are also are 

invited to submit any data or other 

information that they may have 

quantifying or qualifying the costs and 

benefits of the proposed regulations 

with their comment letters. 

List of Subjects in 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. 

List of Subjects in 17 CFR Part 155 

Brokers, Commodity futures, 

Consumer protection, Reporting and 

recordkeeping requirements, Swaps. 

For the reasons presented above, the 

Commodity Futures Trading 

Commission proposes to amend part 23 

(as proposed to be added by FR Doc 

2010–29024, published on November 

23, 2010, 75 FR 71379) and part 155 of 

Title 17 of the Code of Federal 

Regulations as follows: 

PART 23—SWAP DEALERS AND 

MAJOR SWAP PARTICIPANTS 

Authority and Issuance 

1. 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). 

2. 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. 

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 and major swap 

participants. 

§ 23.400 Scope. 

(a) Scope. The sections of this subpart 

shall apply to swap dealers and 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. 

Counterparty. The term 

‘‘counterparty,’’ as appropriate in this 

subpart, includes any person who is a 

prospective counterparty to a swap. 

Major swap participant. The term 

‘‘major swap participant’’ means any 

person defined in Section 1a(33) of the 

Act and § 1.33(bbb) 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. 

Special Entity. The term Special 

Entity means: 

(1) A Federal agency; 

(2) A State, State agency, city, county, 

municipality, or other political 

subdivision of a State or; 

(3) Any employee benefit plan, as 

defined in Section 3 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 

Income Security Act of 1974 (29 U.S.C. 

1002); or 

(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)). 

Swap dealer. The term ‘‘swap dealer’’ 

means any person defined in Section 

1a(49) of the Act and § 1.3(aaa) 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 of the 

Requirements of this Subpart. 

(1) Swap dealers and major swap 

participants shall have 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) Diligent Supervision. Swap dealers 

and major swap participants shall 

diligently supervise their compliance 

with the requirements of this subpart in 

accordance with the diligent 

supervision requirements of subpart J of 

this part. 

(c) Know your counterparty. Each 

swap dealer or major swap participant 

shall 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. 

(d) True name and owner. Each swap 

dealer or major swap participant shall 

keep a record which shall show the true 

name and address of each counterparty, 

the principal occupation or business of 

such counterparty as well as the name 

and address of any other person 


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guaranteeing the performance of such 

counterparty and any person exercising 

any control with respect to the positions 

of such counterparty. 

(e) Reasonable Reliance on 

Representations. A swap dealer or major 

swap participant that seeks to rely on 

the written representations of a 

counterparty with respect to any 

requirements under this subpart must 

have a reasonable basis to believe that 

the representations are reliable taking 

into consideration the facts and 

circumstances of the particular 

relationship, assessed in the context of 

the particular transaction. The 

representations shall include 

information sufficiently detailed for the 

swap dealer or major swap participant 

reasonably to conclude that the relevant 

requirement is satisfied. If agreed to by 

the counterparties, such representations 

may be contained in a master or other 

written agreement between the 

counterparties and may satisfy the 

relevant requirements of this subpart for 

subsequent swaps offered to or entered 

into with a counterparty, unless the 

representations are inadequate to meet 

the requirements of this subpart with 

respect to any subsequent swap. 

(f) 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. 

(g) 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 a 

standard format, including in a master 

or other written agreement between the 

counterparties. 

(h) Record Retention. Swap dealers 

and major swap participants shall create 

a record of their compliance with the 

requirements in this subpart and shall 

retain such 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) Confidential treatment of 

counterparty information. It shall be 

unlawful for any swap dealer or major 

swap participant to disclose to any other 

person any material confidential 

information obtained from a 

counterparty, unless such disclosure is 

necessary for the effective execution of 

any swap for or with the counterparty 

or to hedge any exposure created by 

such swap, and the counterparty 

specifically consents to such disclosure, 

or such disclosure is made upon request 

of the Commission, Department of 

Justice or an applicable prudential 

regulator. 

(c) Trading ahead and front running 

prohibited. It shall be unlawful for any 

swap dealer or major swap participant 

knowingly to enter into a transaction for 

its own benefit ahead of: 

(1) Any executable order for a swap 

received from a counterparty, or 

(2) Any swap that is the subject of 

negotiation with a counterparty, unless 

the counterparty specifically consents to 

the prior execution of such swap 

transaction. 

§§ 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(m) 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) This section shall not apply with 

respect to a transaction that is: 

(1) Initiated on 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. 

§ 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. In addition to the disclosures of 

material risks required in paragraph (a) 

of this section: 

(i) Prior to entering into a bilateral 

swap that is not available for trading on 

a designated contract market or swap 

execution facility, swap dealers and 

major swap participants shall notify the 

counterparty that it can request a 

scenario analysis as provided in 

paragraph (a)(1) of this section. Swap 

dealers and major swap participants 

shall, upon request of such 

counterparty, provide such scenario 

analysis. 

(ii) For a high-risk complex bilateral 

swap with a counterparty, a swap dealer 

or major swap participant shall provide 

a scenario analysis designed in 

consultation with the counterparty to 

allow the counterparty to assess its 

potential exposure in connection with 

the swap. The scenario analysis shall be 

done over a range of assumptions, 

including severe downside stress 

scenarios that would result in a 

significant loss. 

(iii) For the purposes of paragraph 

(a)(1)(ii) of this section, a swap dealer or 

major swap participant shall use 

reasonable policies and procedures to 

determine whether a bilateral swap is a 

high-risk complex swap based on the 

material characteristics of the swap 

including, but not limited to, one or 

more of the following criteria: 

(A) The degree and nature of leverage; 

(B) The potential for periods of 

significantly reduced liquidity; and 

(C) The lack of price transparency. 

(iv) The scenario analysis required by 

paragraphs (a)(1)(i) and (a)(1)(ii) of this 

section shall be provided by the swap 

dealer or major swap participant in both 

tabular and narrative formats. The swap 

dealer or major swap participant shall 

disclose all material assumptions and 

explain the calculation methodologies 

used to perform the required analysis; 

provided that, the swap dealer or major 

swap participant is not required to 

disclose confidential, proprietary 

information about any model it may use 

to value the swap. 

(v) In designing the scenario analysis 

required by paragraphs (a)(1)(i) and 

(a)(1)(ii) of this section, a swap dealer or 

major swap participant shall consider 

any relevant analyses that it undertakes 

for its own risk management purposes, 

including analyses performed as part of 

its ‘‘New Product Policy’’ specified in 

§ 23.600(c)(3); 


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(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 the particular swap, 

which shall include: 

(i) With respect to disclosure of the 

price of a swap, the price of the swap 

and the mid-market value of the swap 

as defined in paragraph (c)(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) Paragraph (a) 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. 

(c) Daily mark. A swap dealer or 

major swap participant shall: 

(1) For cleared swaps, notify a 

counterparty of the counterparty’s right 

to receive, upon request, the daily mark 

from the appropriate derivatives 

clearing organization; and 

(2) For uncleared swaps, provide the 

counterparty with a daily mark which 

shall be the mid-market value of the 

swap. The mid-market value 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 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. 

(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 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. 

(ii) Additional information 

concerning the daily mark to ensure a 

fair and balanced communication, 

including, as appropriate: 

(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. 

(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 registered 

swap dealer, securities-based swap 

dealer, major swap participant or major 

securities-based swap participant) that 

enters into a swap or is offered to enter 

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 

registered swap dealer, securities-based 

swap dealer, major swap participant or 

major securities-based swap participant) 

that enters 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 or major swap 

participant shall have a reasonable basis 

to believe that any swap or trading 

strategy involving swaps recommended 

to a counterparty is suitable for the 

counterparty based on information 

obtained through reasonable due 

diligence concerning 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. 

(b)(1) A swap dealer or major swap 

participant will fulfill its obligations 

under paragraph (a) of this section if: 

(i) The swap dealer has a reasonable 

basis to believe that the counterparty is 

capable of evaluating, independently, 

the risks related to a particular swap or 

trading strategy involving swaps 

recommended to the counterparty; 

(ii) The counterparty affirmatively 

indicates that it is exercising 

independent judgment in evaluating the 

recommendations; and 

(iii) The swap dealer has a reasonable 

basis to believe that the counterparty 

has the capacity to absorb potential 

losses related to the recommended swap 

or trading strategy involving swaps. 

(2) Provided that, where a 

counterparty has delegated 

discretionary authority to another 

person, such as a registered commodity 

trading advisor, the factors contained in 

paragraphs (b)(1)(i) and (b)(1)(ii) of this 

section shall be applied to such person. 

(c) This section shall not apply: 

(1) To any recommendations made to 

another swap dealer, major swap 

participant, security-based swap dealer, 

or major security-based swap 

participant; or 

(2) Where a swap dealer or major 

swap participant provides: 

(i) Information that is general 

transaction, financial, or market 

information; or 

(ii) Swap terms in response to a 

competitive bid request from the 

counterparty. 

§§ 23.435–23.439 [Reserved] 

§ 23.440 Requirements for swap dealers 

acting as advisors to special entities. 

(a) For purposes of this section the 

term ‘‘acts as an advisor to a Special 

Entity’’ shall include where a swap 

dealer recommends a swap or trading 

strategy that involves the use of swaps 

to a Special Entity. The term shall 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 the Special 

Entity. 

(b) A swap dealer that acts as an 

advisor to a Special Entity regarding a 

swap 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 act in the best interests of the 

Special Entity. 

(2) Reasonable Efforts. Any swap 

dealer that acts as an advisor to a 


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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. This 

information shall include information 

relating to: 

(i) The authority of the Special Entity 

to enter into a swap; 

(ii) The financial status of the Special 

Entity, as well as future funding needs; 

(iii) The tax status of the Special 

Entity; 

(iv) The investment or financing 

objectives of the Special Entity 

(including review of any written 

derivatives, financing and investment 

policies, plans or similar documents); 

(v) The experience of the Special 

Entity with respect to entering into 

swaps, generally, and swaps of the type 

and complexity being recommended; 

(vi) Whether the Special Entity has an 

independent representative that meets 

the criteria enumerated in § 23.450(b); 

(vii) Whether the Special Entity has 

the financial capability to withstand 

potential market-related changes in the 

value of the swap during the term of the 

swap; and 

(viii) Such other information as is 

relevant to the particular facts and 

circumstances of the Special Entity, 

market conditions and the type of swap 

recommended. 

(c) Reasonable reliance on 

representations of the Special Entity. 

The swap dealer may rely on written 

representations of the Special Entity to 

satisfy its requirement in paragraph (b) 

of this section to make ‘‘reasonable 

efforts’’ to obtain necessary information, 

provided that: 

(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). 

§§ 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 ‘‘material business 

relationship’’ means 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, provided 

however, that material business 

relationship does not include payment 

of fees by the swap dealer or major swap 

participant to the representative at the 

written direction of the Special Entity 

for services provided by the 

representative in connection with the 

swap executed between the Special 

Entity and the swap dealer or major 

swap participant. The term ‘‘material 

business relationship’’ shall be subject to 

a one-year look back; and 

(2) 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, as the term ‘‘principal’’ 

is defined in § 3.1(a) of this chapter; 

(3) 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) Any swap dealer or major swap 

participant that offers to or enters into 

a swap with a Special Entity shall have 

a reasonable basis to believe that the 

Special Entity has a representative that: 

(1) Has sufficient knowledge to 

evaluate the transaction and risks; 

(2) Is not subject to a statutory 

disqualification; 

(3) Is independent of the swap dealer 

or major swap participant; 

(4) Undertakes a duty to act in the 

best interests of the Special Entity it 

represents; 

(5) Makes appropriate and timely 

disclosures to the Special Entity; 

(6) Evaluates, consistent with any 

guidelines provided by the Special 

Entity, fair pricing and the 

appropriateness of the swap; 

(7) In the case of employee benefit 

plans subject to the Employee 

Retirement Income Security Act of 1974, 

is a fiduciary as defined in Section 3 of 

that Act (29 U.S.C. 1002); and 

(8) In the case of a municipal entity 

as defined in § 23.451, 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 that, this paragraph shall not 

apply if the representative is an 

employee of the Special Entity. 

(c) For purposes of paragraph (b)(3) 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, was not an associated 

person of the swap dealer or major swap 

participant, within the meaning of 

Section 1a(4) of the Act; 

(2) There is no principal relationship 

between the representative of the 

Special Entity and the swap dealer or 

major swap participant; and 

(3) The representative does not have 

a material business relationship with 

the swap dealer or major swap 

participant, provided however, that if 

the representative received any 

compensation from the swap dealer or 

major swap participant, the swap dealer 

or major swap participant must ensure 

that the Special Entity is informed of the 

compensation and the Special Entity 

agrees in writing, in consultation with 

the representative, that the 

compensation does not constitute a 

material business relationship. 

(d) Reasonable reliance on 

representations of the Special Entity. A 

swap dealer may rely on written 

representations of a Special Entity to 

satisfy its obligation to have a 

reasonable basis to believe that the 

Special Entity has a representative that 

satisfies the criteria in paragraph (b) of 

this section provided that: 

(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 

Special Entity-representative 

relationship, assessed in the context of 

a particular transaction; 

(2) The representations include 

information sufficiently detailed for the 

swap dealer reasonably to conclude that 

the representative satisfies the criteria in 

paragraph (b) of this section. Relevant 

considerations would include: 

(i) The nature of the relationship 

between the Special Entity and the 

representative and the duties of the 

representative, including the obligation 

of the representative to act in the best 

interests of the Special Entity; 

(ii) The representative’s capability to 

make hedging or trading decisions, and 

the resources available to the 


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representative to make informed 

decisions; 

(iii) The use by the representative of 

one or more consultants; 

(iv) 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; 

(v) The representative’s ability to 

understand the economic features of the 

swap involved; 

(vi) The representative’s ability to 

evaluate how market developments 

would affect the swap; and 

(vii) The complexity of the swap or 

swaps involved. 

(e) Unqualified representative. If a 

swap dealer or major swap participant 

determines that the representative of a 

Special Entity does not meet 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. 

(f) 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 

(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 in 

connection with the swap and any other 

financial transaction or service 

involving the Special Entity. 

(g) 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. 

§ 23.451 Political contributions by certain 

swap dealers and major swap participants. 

(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 state or local office; 

(ii) For payment of debt incurred in 

connection with any such election; or 

(iii) For transition or inaugural 

expenses incurred by the successful 

candidate for state or local office. 

(2) The term ‘‘covered associate’’ 

means: 

(i) Any general partner, managing 

member or executive officer, or other 

person with a similar status or function; 

(ii) Any employee who solicits a 

municipal entity 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 by any person 

described in paragraphs (a)(2)(i) and 

(a)(2)(ii) of this section. 

(3) The term ‘‘municipal entity’’ means 

any State, political subdivision of a 

State, or municipal corporate 

instrumentality of a State, including— 

(i) Any agency, authority, or 

instrumentality of the State, political 

subdivision, or municipal corporate 

instrumentality; 

(ii) 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 any other 

issuer of municipal securities. 

(4) The term ‘‘official’’ of a municipal 

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 

municipal entity, if the office: 

(i) Is directly or indirectly responsible 

for, or can influence the outcome of, the 

selection of a swap dealer or major swap 

participant by a municipal entity; or 

(ii) Has authority to appoint any 

person who is directly or indirectly 

responsible for, or can influence the 

outcome of, the selection of a swap 

dealer or major swap participant by a 

municipal 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 municipal entity for the swap 

dealer or major swap participant 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 municipal 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 or major 

swap participant shall offer to enter into 

or enter into a swap or a trading strategy 

involving a swap with a municipal 

entity within two years after any 

contribution to an official of such 

municipal entity was made by the swap 

dealer or major swap participant, or by 

any covered associate of the swap dealer 

or major swap participant, provided 

however, that: 

(2) This prohibition does not apply: 

(i) If the only contributions made by 

the swap dealer or major swap 

participant to an official of such 

municipal 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 or major swap 

participant 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 or major 

swap participant, provided that this 

exclusion shall not apply if the natural 

person, after becoming a covered 

associate, solicits the municipal entity 

on behalf of the swap dealer or major 

swap participant to offer to enter into or 

to enter into a swap or trading strategy 

involving; or 

(iii) With respect to a swap that is 

initiated on a designated contract 

market or swap execution facility if the 

swap dealer or major swap participant 

does not know the identity of the 

counterparty to the transaction at the 

time of the transaction. 

(3) No swap dealer or major swap 

participant or any covered associate of 

the swap dealer or major swap 

participant shall: 

(i) Provide or agree to provide, 

directly or indirectly, payment to any 

person to solicit a municipal entity to 

offer to enter into, or to enter into, a 

swap with that swap dealer or major 

swap participant unless such person is 

a regulated person; or 


srobinson on DSKHWCL6B1PROD with PROPOSALS3
80662 Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 

(ii) Coordinate, or solicit any person 

or political action committee to make, 

any: 

(A) Contribution to an official of a 

municipal entity with which the swap 

dealer or major swap participant 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 or major swap participant 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 or major swap participant 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 or major swap 

participant 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 or major 

swap participant: 

(i) Before the contribution resulting in 

the prohibition was made, adopted and 

implemented policies and procedures 

reasonably designed to prevent 

violations of this section; 

(ii) Prior to or at the time the 

contribution which resulted in such 

prohibition was made, had no actual 

knowledge of the contribution; and 

(iii) After learning of the contribution: 

(A) Has taken all available steps to 

cause the contributor involved in 

making the contribution which resulted 

in such prohibition to obtain a return of 

the contribution; and 

(B) Has taken such other remedial or 

preventive measures as may be 

appropriate under the circumstances; 

(3) Whether, at the time of the 

contribution, the contributor was a 

covered associate or otherwise an 

employee of the swap dealer or major 

swap participant, or was seeking such 

employment; 

(4) The timing and amount of the 

contribution which resulted in the 

prohibition; 

(5) The nature of the election (e.g., 

Federal, State or local); and 

(6) The contributor’s apparent intent 

or motive in making the contribution 

that resulted in the prohibition, as 

evidenced by the facts and 

circumstances surrounding the 

contribution. 

(e) Prohibitions Inapplicable. (1) The 

prohibitions under paragraph (b) of this 

section shall not apply to a contribution 

made by a covered associate of the swap 

dealer or major swap participant if: 

(i) The swap dealer or major swap 

participant 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 or 

major swap participant. 

(2) A swap dealer or major swap 

participant may not rely on paragraph 

(e)(1) of this section more than twice in 

any 12-month period. 

(3) A swap dealer or major swap 

participant may not rely on paragraph 

(e)(1) of this section more than once for 

any covered associate, regardless of the 

time between contributions. 

PART 155—TRADING STANDARDS 

Authority and Issuance 

3. The authority citation for part 155 

shall be revised to read as follows: 

Authority: 7 U.S.C. 6b, 6c, 6g, 6j, 6s, and 

12a as amended by Title VII of the DoddFrank Wall Street Reform and Consumer 

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

1376 (Jul. 21, 2010). 

4. Add § 155.7 to read as follows: 

§ 155.7 Execution standards. 

(a) In connection with any customer 

order to enter into a swap where such 

swap is available for trading on one or 

more designated contract markets or 

swap execution facilities, a Commission 

registrant shall: 

(1) Prior to execution of the swap, 

disclose to the customer: 

(i) The designated contract markets 

and swap execution facilities on which 

the swap is available for trading; and 

(ii) The designated contract markets 

and swap execution facilities on which 

the registrant has trading privileges. 

(2) Execute the order on terms that 

have a reasonable relationship to the 

best terms available for such swap on 

designated contract markets or swap 

execution facilities trading such swap. 

(b) As part of the execution 

requirements in paragraph (a) of this 

section, the registrant shall use 

reasonable diligence to ascertain the 

best terms available. Among the factors 

that will be considered in determining 

whether a Commission registrant has 

used ‘‘reasonable diligence’’ are: 

(1) The character of the market for the 

swap, including price, volatility, speed, 

certainty of execution, and liquidity; 

(2) The size and type of transaction; 

(3) The number of markets checked; 

(4) Accessibility of quotations; and 

(5) The terms and conditions of the 

order which results in the transaction, 

as communicated to the Commission 

registrant. 

By the Commission, this 9th day of 

December 2010. 

David A. Stawick, 

Secretary. 

Appendices to Business Conduct 

Standards for Swap Dealers and Major 

Swap Participants With 

Counterparties—Commission Voting 

Summary and Statements of 

Commissioners 

Note: The following appendices will not 

appear in the Code of Federal Regulations. 

Appendix 1—Commission Voting 

Summary 

On this matter, Chairman Gensler and 

Commissioners Dunn, Sommers, Chilton and 

O’Malia voted in the affirmative; no 

Commissioner voted in the negative. 

Appendix 2—Statement of Chairman 

Gary Gensler 

I support the proposed rulemaking to 

establish business conduct standards for 

swap dealers and major swap participants in 

their dealings with counterparties. Today’s 

proposal implements important new 

authorities that Congress granted the 

Commission to establish and enforce robust 

sales practices in the swap markets. The 

proposed rule will level the playing field and 

bring needed transparency. It will strengthen 

confidence in the market to benefit hedgers 

and other market participants. 

The proposed rule would prohibit fraud 

and certain abusive practices. It also would 

implement requirements for swap dealers 

and major swap participants to deal fairly 

with customers, provide balanced 

communications and disclose conflicts of 

interest and material incentives before 

entering into a swap. The rule also would 

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 proposed rule is intended to ensure 

that swaps customers get fair treatment in the 

execution of their transactions. It would 

require swap dealers to disclose what access 

they have to swap execution facilities and 

designated contract markets. These rules also 

prohibit a swap dealer from defrauding a 

customer by executing a transaction on terms 

that have no ‘‘reasonable relationship’’ to the 

market. The proposed rule provides 

flexibility to accommodate developments in 


srobinson on DSKHWCL6B1PROD with PROPOSALS3
Federal Register / Vol. 75, No. 245 / Wednesday, December 22, 2010 / Proposed Rules 80663 

the swaps markets while also protecting 

customers. 

[FR Doc. 2010–31588 Filed 12–21–10; 8:45 am] 

BILLING CODE 6351–01–P 


srobinson on DSKHWCL6B1PROD with PROPOSALS3