65882 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

1The Dodd-Frank Wall Street Reform and 

Consumer Protection Act (Pub. L. 111–203, H.R. 

4173). 

2See Public Law 111–203, Preamble. 

3Section 712(d) of the Dodd-Frank Act provides 

that the Commission and the CFTC, in consultation 

with the Board of Governors of the Federal Reserve 

System (‘‘Federal Reserve’’), shall jointly further 

define the terms ‘‘swap,’’ ‘‘security-based swap,’’ 

‘‘swap dealer,’’ ‘‘security-based swap dealer,’’ ‘‘major 

swap participant,’’ ‘‘major security-based swap 

participant,’’ ‘‘eligible contract participant,’’ and 

‘‘security-based swap agreement.’’ These terms are 

defined in Sections 721 and 761 of the Dodd-Frank 

Act and, with respect to the term ‘‘eligible contract 

participant,’’ in Section 1a(18) of the Commodity 

Exchange Act (‘‘CEA’’), 7 U.S.C. 1a(18), as redesignated and amended by Section 721 of the 

Dodd-Frank Act. Further, Section 721(c) of the 

Dodd-Frank Act requires the CFTC to adopt a rule 

to further define the terms ‘‘swap,’’ ‘‘swap dealer,’’ 

‘‘major swap participant,’’ and ‘‘eligible contract 

participant,’’ and Section 761(b) of the Dodd-Frank 

Act permits the Commission to adopt a rule to 

further define the terms ‘‘security-based swap,’’ 

‘‘security-based swap dealer,’’ ‘‘major security-based 

swap participant,’’ and ‘‘eligible contract 

participant,’’ with regard to security-based swaps, 

for the purpose of including transactions and 

entities that have been structured to evade Title VII 

of the Dodd-Frank Act. Finally, Section 712(a) of 

the Dodd-Frank Act provides that the Commission 

and CFTC, after consultation with the Federal 

Reserve, shall jointly prescribe regulations 

regarding ‘‘mixed swaps’’ as may be necessary to 

carry out the purposes of Title VII. To assist the 

Commission and CFTC in further defining the terms 

specified above, and to prescribe regulations 

regarding ‘‘mixed swaps’’ as may be necessary to 

carry out the purposes of Title VII, the Commission 

and the CFTC have requested comment from 

interested parties. See Securities Exchange Act 

Release No. 62717 (August 13, 2010), 75 FR 51429 

(August 20, 2010) (File No. S7–16–10) (advance 

joint notice of proposed rulemaking regarding 

definitions contained in Title VII of the Dodd-Frank 

Act) (‘‘Definitions Release’’). 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Part 242 

[Release No. 34–63107; File No. S7–27–10] 

RIN 3235–AK74 

Ownership Limitations and 

Governance Requirements for 

Security-Based Swap Clearing 

Agencies, Security-Based Swap 

Execution Facilities, and National 

Securities Exchanges With Respect to 

Security-Based Swaps Under 

Regulation MC 

AGENCY: Securities and Exchange 

Commission. 

ACTION: Proposed rule. 

SUMMARY: In accordance with Section 

765 (‘‘Section 765’’) of Title VII (‘‘Title 

VII’’) of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act of 

2010 (‘‘Dodd-Frank Act’’), the Securities 

and Exchange Commission (‘‘SEC’’ or 

‘‘Commission’’) is proposing Regulation 

MC under the Securities Exchange Act 

of 1934 (‘‘Exchange Act’’) for clearing 

agencies that clear security-based swaps 

(‘‘security-based swap clearing 

agencies’’) and for security-based swap 

execution facilities (‘‘SB SEFs’’) and 

national securities exchanges that post 

or make available for trading securitybased swaps (‘‘SBS exchanges’’). 

Regulation MC is designed to mitigate 

potential conflicts of interest that could 

exist at these entities. Specifically, the 

Commission seeks to mitigate the 

potential conflicts of interest through 

conditions and structures relating to 

ownership, voting, and governance of 

security-based swap clearing agencies, 

SB SEFs, and SBS exchanges. 

DATES: Comments should be submitted 

on or before November 26, 2010. 

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/ 

rules/proposed.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number S7–27–10 on the subject line; 

or 

• Use the Federal eRulemaking Portal 

(http://www.regulations.gov). Follow the 

instructions for submitting comments. 

Paper Comments 

• Send paper comments in triplicate 

to Elizabeth M. Murphy, Secretary, 

Securities and Exchange Commission, 

100 F St., NE., Washington, DC 20549– 

1090. 

All submissions should refer to File 

Number S7–27–10. This file number 

should be included on the subject line 

if e-mail is used. To help us process and 

review your comments more efficiently, 

please use only one method. The 

Commission will post all comments on 

the Commission’s Internet Web site 

(http://www.sec.gov/rules/ 

proposed.shtml). Comments are also 

available for Web site viewing and 

printing in the Commission’s Public 

Reference Room, 100 F St., NE., 

Washington, DC 20549 on official 

business days between the hours of 

10 a.m. and 3 p.m. All comments 

received will be posted without change; 

the Commission does not edit personal 

identifying information from 

submissions. You should submit only 

information that you wish to make 

available publicly. 

FOR FURTHER INFORMATION CONTACT: 

Proposals relating to security-based 

swap clearing agencies: Catherine 

Moore, Senior Special Counsel, at (202) 

551–5710; and Joseph P. Kamnik, 

Special Counsel, at (202) 551–5710; 

Office of Clearance and Settlement, 

Division of Trading and Markets, 

Securities and Exchange Commission, 

100 F Street, NE., Washington, DC 

20549–7010; proposals relating to 

security-based swap execution facilities 

and national securities exchanges that 

post or make available for trading 

security-based swaps: Nancy BurkeSanow, Assistant Director, at (202) 551– 

5621; Molly Kim, Special Counsel, at 

(202) 551–5644; Steven Varholik, 

Special Counsel, at (202) 551–5615; 

Sarah Schandler, Attorney, at (202) 551– 

7145; and Iliana Lundblad, Attorney, at 

(202) 551–5871; Office of Market 

Supervision, Division of Trading and 

Markets, Securities and Exchange 

Commission, 100 F Street, NE., 

Washington, DC 20549–7010. 

SUPPLEMENTARY INFORMATION: The 

Commission is proposing new 

Regulation MC under the Exchange Act 

relating to conflicts of interest with 

respect to security-based swap clearing 

agencies, SB SEFs, and SBS exchanges. 

I. Introduction 

On July 21, 2010, the President signed 

the Dodd-Frank Act into law.1 The 

Dodd-Frank Act was enacted to, among 

other purposes, promote the financial 

stability of the United States by 

improving accountability and 

transparency in the financial system.2

Title VII of the Dodd-Frank Act provides 

the Commission and the Commodity 

Futures Trading Commission (‘‘CFTC’’) 

with the authority to regulate over-thecounter (‘‘OTC’’) derivatives in light of 

the recent financial crisis, which 

demonstrated the need for enhanced 

regulation in the OTC derivatives 

market. The Dodd-Frank Act is intended 

to close loopholes in the existing 

regulatory structure and to provide the 

Commission and the CFTC with 

effective regulatory tools to oversee the 

OTC swaps market, which has grown 

exponentially in recent years and is 

capable of affecting significant sectors of 

the U.S. economy. 

The Dodd-Frank Act provides that the 

CFTC will regulate ‘‘swaps,’’ the 

Commission will regulate ‘‘securitybased swaps,’’ and the CFTC and the 

Commission will jointly regulate ‘‘mixed 

swaps.’’ 3 The Dodd-Frank Act amends 

the Exchange Act to require, among 

other things, the following: 

(1) Transactions in security-based swaps 

must be cleared through a clearing 

agency if they are of a type that the 

Commission determines must be 

cleared, unless an exemption from 

mandatory clearing applies; (2) 

transactions in security-based swaps 

must be reported to a registered 

security-based swap data repository or 


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4See Section 761 of the Dodd-Frank Act, added 

as Section 3(a)(77) of the Exchange Act, 15 U.S.C. 

78(c)(a), which defines the term ‘‘security-based 

swap execution facility’’ to mean ‘‘a trading system 

or platform in which multiple participants have the 

ability to execute or trade security-based swaps by 

accepting bids and offers made by multiple 

participants in the facility or system, through any 

means of interstate commerce, including any 

trading facility that (A) facilitates the execution of 

security-based swaps between persons; and (B) is 

not a national securities exchange.’’ See Public Law 

111–203, Section 761. The Dodd-Frank Act amends 

the CEA to provide for a similar regulatory 

framework with respect to transactions in swaps 

regulated by the CFTC. 

5See Public Law 111–203, Section 765. 

6The term ‘‘bank holding company’’ has the 

meaning set forth in Section 2 of the Bank Holding 

Company Act of 1956 (12 U.S.C. 1841) (‘‘Bank 

Holding Company Act’’), and generally means any 

company that has control over any bank or over any 

company that is or becomes a bank holding 

company by virtue of the Bank Holding Company 

Act. 

7Under Section 765(a) of the Dodd-Frank Act, the 

term ‘‘nonbank financial company’’ has the meaning 

set forth in Section 102 of the Dodd-Frank Act, and 

generally means a company, other than a bank 

holding company, national securities exchange, 

clearing agency, SB SEF, registered security-based 

swap data repository, board of trade designated as 

a contract market (‘‘DCM’’), derivatives clearing 

organization, swap execution facility (‘‘SEF’’) or 

registered swap data repository, that is 

predominantly engaged in financial activities 

(including through a branch in the U.S., if such 

company is incorporated or organized in a country 

other than the U.S.). See Public Law 111–203, 

Section 102 for the complete definition. 

8Pursuant to Section 761 of the Dodd-Frank Act, 

the term ‘‘security-based swap dealer’’ is added as 

Section 3(a)(71) of the Exchange Act, 15 U.S.C 

78c(a), and generally means any person who (A) 

holds themselves out as a dealer in security-based 

swaps; (B) makes a market in security-based swaps; 

(C) regularly enters into security-based swaps with 

counterparties as an ordinary course of business for 

its own account; or (D) engages in any activity 

causing it to be commonly known in the trade as 

a dealer or market maker in security-based swaps. 

See Public Law 111–203, Section 761 for the 

complete definition. See also Definitions Release, 

75 FR 51429, supra note 3. 

9Pursuant to Section 761 of the Dodd-Frank Act, 

the term ‘‘major security-based swap participant’’ is 

added as Section 3(a)(67) of the Exchange Act, 15 

U.S.C 78c(a), and generally means any person 

(A) who is not a security-based swap dealer; and 

(B)(I) who maintains a substantial position in 

security-based swaps for any of the major securitybased swap categories, as such categories are 

determined by the Commission, excluding positions 

held for hedging or mitigating commercial risk; (II) 

whose outstanding security-based swaps create 

substantial counterparty exposure that could have 

serious adverse effects on the financial stability of 

the U.S. banking system or financial markets; or (III) 

that is a financial entity that (a) is highly leveraged 

relative to the amount of capital such entity holds 

and that is not subject to capital requirements 

established by an appropriate Federal banking 

regulator; and (b) maintains a substantial position 

in outstanding security-based swaps in any major 

security-based swap category, as such categories are 

determined by the Commission. See Public Law 

111–203, Section 761 for the complete definition. 

See also Definitions Release, 75 FR 51429, supra 

note 3. 

10See Public Law 111–203, Section 765(b). 

11See Public Law 111–203, Section 765(c). 

Although this provision refers to swaps and to 

entities regulated by the CFTC, the Commission 

believes that the Congress intended it to refer to 

security-based swaps and to security-based swap 

clearing agencies, SB SEFs, and SBS exchanges, 

because Section 765 pertains to transactions in 

security-based swaps and persons and entities 

related thereto. 

the Commission; and (3) if a securitybased swap is subject to a clearing 

requirement, it must be traded on a 

registered trading platform, i.e., a SB 

SEF or SBS exchange, unless no facility 

makes such security-based swap 

available for trading.4

II. Mandated Rulemaking on Mitigating 

Conflicts of Interest 

Section 765 of the Dodd-Frank Act 

requires the Commission to adopt rules 

to mitigate specified conflicts of 

interest.5 Section 765(a) requires the 

Commission to adopt rules, which rules 

may include numerical limits on the 

control of, or the voting rights with 

respect to, any security-based swap 

clearing agency, or on the control of any 

SB SEF or SBS exchange, by specified 

entities, such as a bank holding 

company with total consolidated assets 

of $50 billion or more,6 a nonbank 

financial company,7 an affiliate of such 

bank holding company or nonbank 

financial company, a security-based 

swap dealer,8 or a major security-based 

swap participant (collectively, 

‘‘Specified Entities’’).9

Section 765(b)—captioned 

‘‘Purposes’’—provides that the 

Commission shall adopt such rules if it 

determines they are necessary or 

appropriate to improve the governance 

of, or to mitigate systemic risk, promote 

competition or mitigate conflicts of 

interest in connection with a securitybased swap dealer’s or major securitybased swap participant’s conduct of 

business with, a security-based swap 

clearing agency, SB SEF, or SBS 

exchange and in which such securitybased swap dealer or major securitybased swap participant has a material 

debt or equity investment.10 Section 

765(b) sets forth a number of underlying 

policy objectives for the Commission’s 

rulemaking—improving governance, 

mitigating systemic risk, promoting 

competition, and mitigating conflicts of 

interest with respect to security-based 

swap clearing agencies, SB SEFs, and 

SBS exchanges. In considering proposed 

rules to mitigate conflicts of interest, the 

Commission is mindful that, in some 

instances, certain of these diverse policy 

objectives may be in tension with 

others. For example, as described in 

Section III.A.2.a below, with respect to 

security-based swap clearing agencies, 

the statutory objective of promoting 

competition, which may be furthered 

through enhanced access to cleared 

products and clearing venues, may to 

some extent be in tension with the 

objective of minimizing systemic risk 

through effective risk management of 

the clearing agency. 

Section 765(c) of the Dodd-Frank Act 

also provides that in adopting rules 

under Section 765, the Commission 

shall consider any conflicts of interest 

arising from the amount of equity 

ownership and voting by a single 

investor; the ability of owners to vote, 

cause the vote of, or withhold votes 

entitled to be cast on any matters by the 

holders of the ownership interest; and 

the governance arrangements of any 

derivatives clearing organization that 

clears swaps, or swap execution facility 

or board of trade designated as a 

contract market that posts swaps or 

makes swaps available for trading.11

The Commission is cognizant that the 

proposed rules discussed herein, as well 

as other proposals that the Commission 

may consider in the coming months to 

implement the Dodd-Frank Act, if 

adopted, could significantly affect—and 

be significantly affected by—the nature 

and scope of the security-based swaps 

market in a number of ways. For 

example, the Commission recognizes 

that if the measures proposed in this 

release are adopted and are too onerous 

for new entrants, they could hinder the 

further development of a market for 

security-based swaps by unduly 

discouraging competition and the 

formation of new security-based swap 

clearing agencies and of new SB SEFs or 

SBS exchanges. On the other hand, if 

the Commission adopts rules that are 

too permissive, conflicts of interest may 

be inadequately mitigated and such 

conflicts may incentivize restricting 

access to centralized clearing and lack 

of transparency in the trading of 

security-based swaps as described in 

detail in Section III below. The 

Commission is also mindful that the 

further development of the securitybased swaps market may alter the 

calculus for future regulation of 

conflicts of interest. As commenters 

review the instant proposals, they are 

urged to consider generally the role that 

regulation may play in fostering or 

limiting the development of the market 

for security-based swaps (or, vice versa, 

the role that market developments may 

play in changing the nature and 

implications of regulation) and 

specifically to focus on this issue with 

respect to the proposals to mitigate 

conflicts of interest for security-based 

swap clearing agencies, SB SEFs, and 

SBS exchanges. 


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65884 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

12Section 726 of the Dodd-Frank Act similarly 

requires the CFTC to adopt rules designed to 

mitigate conflicts of interest with respect to entities 

under its jurisdiction that clear or trade swaps. See 

Public Law 111–203, Section 726. The Commission 

preliminarily believes that an entity that registers 

with the Commission as either a security-based 

swap clearing agency or a SB SEF is likely to 

register also with the CFTC as a derivatives clearing 

organization or swap execution facility, 

respectively. As a result, the Commission staff and 

the CFTC staff have consulted and coordinated with 

one another regarding their respective agencies’ 

proposed rules to mitigate conflicts of interest. 

13See, generally, Policy Objectives for the OTC 

Derivatives Market, The President’s Working Group 

on Financial Markets (November 14, 2008) 

(available at http://www.ustreas.gov/press/releases/ 

reports/policyobjectives.pdf). 14See The Role of Credit Derivatives in the U.S. 

Economy before the H. Agric. Comm., 110th Cong. 

(2008) (Statement of Erik Sirri, Director of the 

Division of Trading and Markets, Commission) 

(available at http://agriculture.house.gov/testimony/ 

110/110-49.pdf). 

15See supra note 13. See also Policy Statement 

on Financial Market Developments, The President’s 

Working Group on Financial Markets (March 13, 

2008) (available at http://www.treas.gov/press/ 

releases/reports/ 

pwgpolicystatemktturmoil_03122008.pdf) and 

Progress Update on March Policy Statement on 

Financial Market Developments, The President’s 

Working Group on Financial Markets (October 

2008) (available at http://www.treas.gov/press/

releases/reports/q4progress%20update.pdf). 

16See Memorandum of Understanding Between 

the Board of Governors of the Federal Reserve 

System, the U.S. Commodity Futures Trading 

Commission, and the U.S. Securities and Exchange 

Commission Regarding Central Counterparties for 

Credit Default Swaps (November 14, 2008) 

(available at http://www.treas.gov/press/releases/ 

reports/finalmou.pdf). 

17The Commission authorized five entities to 

clear credit default swaps. See Securities Exchange 

Act Release Nos. 60372 (July 23, 2009), 74 FR 37748 

(July 29, 2009) and 61973 (April 23, 2010), 75 FR 

22656 (April 29, 2010) (CDS clearing by ICE Clear 

Europe Limited); 60373 (July 23, 2009), 74 FR 

37740 (July 29, 2009) and 61975 (April 23, 2010), 

75 FR 22641 (April 29, 2010) (CDS clearing by 

Eurex Clearing AG); 59578 (March 13, 2009), 74 FR 

11781 (March 19, 2009), 61164 (December 14, 

2009), 74 FR 67258 (December 18, 2009) and 61803 

(March 30, 2010), 75 FR 17181 (April 5, 2010) (CDS 

clearing by Chicago Mercantile Exchange Inc.); 

59527 (March 6, 2009), 74 FR 10791 (March 12, 

2009), 61119 (December 4, 2009), 74 FR 65554 

(December 10, 2009) and 61662 (March 5, 2010), 75 

FR 11589 (March 11, 2010) (CDS clearing by ICE 

Trust US LLC); 59164 (December 24, 2008), 74 FR 

139 (January 2, 2009) (temporary CDS clearing by 

LIFFE A&M and LCH.Clearnet Ltd.) (collectively, 

‘‘CDS Clearing Exemption Orders’’). LIFFE A&M and 

LCH.Clearnet Ltd. allowed their order to lapse 

without seeking renewal. 

18To date most cleared CDS transactions have 

cleared at ICE Trust US LLC (‘‘ICE Trust’’) or ICE 

Clear Europe Limited (‘‘ICE Clear Europe’’). As of 

October 8, 2010, ICE Trust had cleared 

approximately $7.1 trillion notional amount of CDS 

contracts based on indices of securities and 

approximately $490 billion notional amount of CDS 

contracts based on individual reference entities or 

securities. As of October 8, 2010, ICE Clear Europe 

had cleared approximately Ö3.09 trillion notional 

amount of CDS contracts based on indices of 

securities and approximately Ö560 billion notional 

amount of CDS contracts based on individual 

reference entities or securities. See https:// 

www.theice.com/marketdata/reports/ 

ReportCenter.shtml. 

19See 78q–1(b)(3)(A). 

20The Depository Trust and Clearing Corporation 

(‘‘DTCC’’) is participant-owned and has three 

separate subsidiaries that are registered clearing 

agencies which function as quasi-utilities. The 

Options Clearing Corporation is owned by five 

unaffiliated options exchanges. 

21These clearing agencies include ICE Trust US 

LLC, ICE Clear Europe Limited, Eurex Clearing AG, 

and Chicago Mercantile Exchange Inc. 

22Section 763(b) of the Dodd-Frank Act adds new 

Section 17A(k) to the Exchange Act, which 

authorizes the Commission to exempt, 

conditionally or unconditionally, a security-based 

swap clearing agency from registration if the 

Commission determines it is subject to comparable, 

comprehensive supervision and regulation by the 

CFTC or appropriate government authorities in the 

The Commission must adopt the rules 

required by Section 765 of the DoddFrank Act by January 17, 2011, which is 

180 days after enactment of the DoddFrank Act.12 The Commission therefore 

is proposing Regulation MC under the 

Exchange Act to mitigate conflicts of 

interest with respect to security-based 

swap clearing agencies, SB SEFs, and 

SBS exchanges. 

This proposed rulemaking is among 

the first that the Commission has 

considered in connection with its 

mandates under the Dodd-Frank Act, 

and the Commission is mindful of the 

considerations raised by this timing. In 

particular, under the prescribed 

timeframes of the Dodd-Frank Act, the 

Commission must propose rules 

required by Section 765 before it has the 

opportunity to consider proposed rules 

that also are likely to affect the 

development of security-based swap 

clearing agencies, SB SEFs, and SBS 

exchanges, as well as the security-based 

swaps market overall. The Commission 

also notes that the market for securitybased swaps is in a nascent stage of 

development compared to the markets 

for equity securities and listed options 

and that the market for security-based 

swaps could develop further as the 

Dodd-Frank Act is fully implemented 

and these transactions continue to move 

to central clearing and trading on 

organized markets. 

III. Discussion of Potential Conflicts of 

Interest 

A. Security-Based Swap Clearing 

Agencies 

1. Current Regulatory Structure 

Credit market events from the last few 

years have demonstrated that a securitybased swaps market operating without 

meaningful regulation 13 and central 

counterparties 14 can pose systemic 

risks. In November 2008, under the 

auspices of the President’s Working 

Group on Financial Markets, the 

Secretary of the Department of the 

Treasury, the Chairs of the Board of 

Governors of the Federal Reserve, the 

Office of the Comptroller of the 

Currency, the CFTC, and the 

Commission established as a policy 

objective for the OTC derivatives market 

that regulators and prudential 

supervisors require participants in a 

central counterparty (‘‘CCP’’) 

arrangement to clear all eligible 

contracts through that CCP.15 In 

furtherance of this policy objective, the 

Commission, the Federal Reserve, and 

the CFTC signed a Memorandum of 

Understanding that established a 

framework for consultation and 

information sharing on issues related to 

central counterparties for the OTC 

derivatives market.16

The Commission has taken steps to 

help foster the prompt development of 

CCPs. In particular, the Commission 

acted to authorize the clearing of OTC 

security-based swaps by permitting 

certain clearing agencies to clear credit 

default swaps (‘‘CDS’’) on a temporary 

conditional basis.17 Today, a significant 

volume of CDS transactions is cleared 

centrally and the Commission monitors 

the activities of these clearing 

agencies.18

The Exchange Act does not impose 

specific requirements regarding the 

ownership structure of a clearing 

agency. As a result, clearing agencies 

may operate under a variety of 

appropriate organizational structures 

provided that they have the capacity to 

meet the standards in Section 17A of the 

Exchange Act.19 Certain clearing 

agencies registered with the 

Commission are owned either by 

participants or by securities 

exchanges.20 Other clearing agencies, 

such as the security-based swap clearing 

agencies that, once registered, would be 

required to comply with proposed 

Regulation MC, are subsidiaries of or 

partly-owned by publicly traded 

companies.21 These entities are not 

wholly-owned by participants or 

exchanges and may have different 

governance related issues than the 

securities clearing agencies currently 

registered with the Commission. 

Upon the effective date of Title VII of 

the Dodd-Frank Act, clearing agencies 

that clear and settle security-based swap 

transactions will be subject to a number 

of regulatory obligations that are 

intended to promote the policy 

objectives of the Dodd-Frank Act, 

including increased clearing of securitybased swaps and effective risk 

management. Accordingly, securitybased swap clearing agencies will be 

required to be registered with, and 

regulated by, the Commission under 

Section 17A.22 In addition, all registered 


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home country of the security-based swap clearing 

agency. See Public Law 111–203, Section 763(b). 

23See 15 U.S.C. 78q–1(b)(3)(F). Section 17A of 

the Exchange Act also includes standards that help 

to mitigate conflicts of interest. See infra Section 

IV.C. for a discussion of these standards. 

24 15 U.S.C. 78q–1(b)(3)(A), (B), and (F). 

25See Securities Exchange Act Release No. 62725, 

75 FR 51305 (August 19, 2010). The Commission 

solicited comments on the Conflicts Roundtable 

(comments received by the Commission are 

available at http://sec.gov/cgi-bin/rulingcomments?ruling=4-609&rule_path=/comments/4- 

609&file_num=4- 

609&action=Show_Form&title=SEC%2DCFTC 

Roundtable on Swaps and Security%2DBased 

Swaps%3A Notice of roundtable discussion and 

request for comment). 

26The transcript of the Conflicts Roundtable is 

available on the CFTC’s Web site at http://cftc.gov/ 

ucm/groups/public/@newsroom/documents/file/ 

derivative9sub082010.pdf. 

27The term ‘‘participant’’ when used with respect 

to a clearing agency has the meaning set forth in 

Section 3(a)(24) of the Exchange Act, 15 U.S.C 

78c(a), and shall include Specified Entities. See 

proposed Rule 700(o) under Regulation MC. 

28See infra Section IV.A.3. for a discussion of 

‘‘related person’’ in the context of a security-based 

swap clearing agency. 

29See, generally, Matthew Leising and Shannon 

D. Harrington, ‘‘Wall Street Dominance of Swaps 

Must End, Brokers Say (Update 1),’’ Bloomberg 

(March 16, 2010). 

30See Public Law 111–203, Section 763(a). 

Section 763(a) of the Dodd-Frank Act adds new 

Section 3C to the Exchange Act, which requires 

clearing for certain security-based swaps. 

Specifically, Section 3C(a)(1) provides that ‘‘It shall 

be unlawful for any person to engage in a securitybased swap unless that person submits such 

security-based swap for clearing to a clearing 

agency that is registered under the Exchange Act or 

a clearing agency that is exempt from registration 

under the Exchange Act if the security-based swap 

is required to be cleared.’’ 

31See CDS Clearing Exemption Orders, supra 

note 17. 

clearing agencies must comply with the 

standards in Section 17A, which 

include, but are not limited to, 

maintaining rules for promoting the 

prompt and accurate clearance and 

settlement of securities transactions, 

assuring the safeguarding of securities 

and funds which are in the custody or 

control of the clearing agency or for 

which it is responsible, fostering 

cooperation and coordination with 

persons engaged in the clearance and 

settlement of securities transactions, 

removing impediments to and 

perfecting the mechanism of a national 

system for the prompt and accurate 

clearance and settlement of securities 

transactions, and, in general, protecting 

investors and the public interest.23 A 

registered clearing agency is also 

required to provide fair access to 

clearing and to have the capacity to 

facilitate the prompt and accurate 

clearance and settlement of securities 

transactions and derivative agreements, 

contracts, and transactions for which it 

is responsible, as well as to safeguard 

securities and funds in its custody or 

control or for which it is responsible.24

Pursuant to Section 765 of the DoddFrank Act, the Commission must 

identify the nature and sources of any 

conflicts of interest relating to the voting 

interests in and governance of a 

security-based swap clearing agency 

that may interfere with achieving the 

policy objectives described above or 

with the clearing agency complying 

with the regulatory mandates of Section 

17A of the Exchange Act described 

above, including the obligation to adopt 

rules consistent with the protection of 

investors and the public interest. 

2. Sources of Conflicts of Interest 

The Commission’s experience in 

monitoring the activities of the clearing 

agencies engaged in clearing CDS has 

provided it with insight into the 

potential sources of conflicts of interest 

that may exist at security-based swap 

clearing agencies. Since shortly after the 

enactment of the Dodd-Frank Act, the 

Commission staff and staff from the 

CFTC have met with interested persons 

to learn more about potential conflicts. 

Moreover, on August 20, 2010, the staff 

of the Commission and CFTC held a 

joint public roundtable in part to gain 

further insight into the sources of 

conflicts of interest at security-based 

swap clearing agencies, SB SEFs, and 

SBS exchanges, as well as methods for 

mitigating conflicts of interest 

(‘‘Conflicts Roundtable’’).25 Panelists 

from this roundtable included industry 

and non-industry participants.26

Drawing on these experiences, the 

Commission has reviewed the potential 

for conflicts of interest at security-based 

swap clearing agencies in accordance 

with Section 765 of the Dodd-Frank Act 

and has identified those conflicts that 

could affect access to clearing agency 

services, products eligible for clearing, 

and risk management practices of the 

clearing agencies. Preliminarily, the 

Commission believes that the most 

significant conflicts of interest that may 

have an adverse effect on statutory goals 

in Section 765 of the Dodd-Frank Act 

are those that arise when a small 

number of participants,27 including 

participants that are Specified Entities 

and including related persons of the 

participants,28 exercise undue control or 

influence over a security-based swap 

clearing agency. 

The Commission has identified three 

key areas where it believes a conflict of 

interest of participants who exercise 

undue control or influence over a 

security-based swap clearing agency 

could adversely affect the central 

clearing of security-based swaps. First, 

participants could limit access to the 

security-based swap clearing agency, 

either by restricting direct participation 

in the security-based swap clearing 

agency or restricting indirect access by 

controlling the ability of nonparticipants to enter into correspondent 

clearing arrangements.29 Second, 

participants could limit the scope of 

products eligible for clearing at the 

security-based swap clearing agency, 

particularly if there is a strong economic 

incentive to keep a product traded in 

the OTC market for security-based 

swaps. Third, participants could use 

their influence to lower the risk 

management controls of a security-based 

swap clearing agency in order to reduce 

the amount of collateral they would be 

required to contribute and liquidity 

resources they would have to expend as 

margin or guaranty fund to the securitybased swap clearing agency. 

Each of these potential conflicts of 

interest could limit the benefits of a 

security-based swap clearing agency in 

the security-based swaps market, and 

even potentially cause substantial harm 

to that market and the broader financial 

markets, as described below. Conflicts 

of interest in these areas could also 

potentially undermine the mandatory 

clearing requirement in Section 763 of 

the Dodd-Frank Act, thereby affecting 

transparency, investor protection, risk 

management, efficiency, and 

competition in the security-based swaps 

market.30

a. Limitations on Open Access to 

Security-Based Swap Clearing Agencies 

The Commission believes that the 

increased use of central clearing for 

security-based swaps should help to 

promote robust risk management, foster 

greater efficiencies, improve investor 

protection, and promote transparency in 

the market for security-based swaps. For 

these reasons, the Commission has 

encouraged the use of central clearing 

for security-based swaps.31 A 

consequence of increased use of central 

clearing services, however, is that 

participants that control or influence a 

security-based swap clearing agency 

may gain a competitive advantage in the 

security-based swaps market by 

restricting access to the clearing agency. 

If that occurred, financial institutions 

and marketplaces that do not have 

access to central clearing would have 

limited ability to trade in or list 

security-based swaps. This problem 

would continue to exist after the 

mandatory clearing requirement under 

Section 763 of the Dodd-Frank Act 

becomes effective, because financial 

institutions may be required either to 

submit security-based swaps for central 


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32Correspondent clearing is an arrangement 

between a current participant of a clearing agency 

and a non-participant that desires to use the 

clearing agency for clearance and settlement 

services. 

33An example of such restrictive policies and 

procedures would be a clearing agency establishing 

prohibitively high participation standards so that 

only the largest financial institutions qualify as 

participants. 

34See, generally, Swaps and Derivatives Market 

Association, ‘‘Lessening Systemic Risk: Removing 

Final Hurdles to Clearing OTC Derivatives’’ 

(available at http://media.ft.com/cms/fe51a538- 

78d7-11df-a312-00144feabdc0.pdf) (‘‘SDMA 

Letter’’). See also Public Roundtable on Governance 

and Conflicts of Interest in the Clearing and Listing 

of Swaps, comments of Darrell Duffie (‘‘[W]e want 

to be very careful that the members of a central 

clearing counterparty that determine what gets 

cleared * * * are the members that have * * * the 

right social incentives to create competition.’’) 

(available at http://cftc.gov/ucm/groups/public/

@newsroom/documents/file/derivative9

sub082010.pdf at 62). 

35See supra note 25. 

36See, e.g., CDS Clearing Exemption Orders, 

supra note 17. 

37As part of their internal processes, securitybased swap clearing agencies generally calculate 

end-of-day settlement prices for each product in 

which they hold a cleared interest each business 

day. See, e.g., Letter from Kevin McClear, ICE Trust, 

to Elizabeth Murphy, Secretary, Commission, 

December 4, 2009, and letter from Ann K. Shuman, 

Managing Director and Deputy General Counsel, 

CME, to Elizabeth Murphy, Secretary, Commission, 

December 14, 2009. One method for calculating an 

end-of-day settlement price for open positions is 

based on prices submitted by participants. As part 

of this mark-to-market process, the security-based 

swap clearing agency may periodically require 

participants to execute certain security-based swap 

trades at the applicable end-of-day settlement price. 

This is designed to ensure that participants’ 

submitted prices reflect their best assessment of the 

value of their open positions on a daily basis. Id. 

38See SDMA Letter, supra note 34. 

clearing or face heightened capital or 

margin requirements associated with 

bilateral agreements. 

Market participants generally obtain 

access to a clearing agency in one of two 

ways: (1) Directly, by becoming a 

participant in a clearing agency or (2) 

indirectly, by entering into a 

correspondent clearing arrangement 

with a participant in a clearing 

agency.32 There are several ways that 

both direct and indirect access to a 

security-based swap clearing agency 

could be restricted if persons who make 

decisions for or act on behalf of the 

clearing agency have a conflict of 

interest because of their incentives to 

further their own business interests 

outside of the security-based swap 

clearing agency. Participants may seek 

to limit the number of other direct 

participants in a security-based swap 

clearing agency in order to limit 

competition and increase their ability to 

maintain higher profit margins. A 

security-based swap clearing agency 

that is controlled by a limited number 

of participants might also adopt policies 

and procedures that are designed to 

unduly restrict access, or have the effect 

of unduly restricting access, to the 

clearing agency by other participants in 

ways that are unrelated to sound risk 

management practices.33 At the same 

time, affording greater access to the 

clearing agency at some point may come 

at the expense of sound risk 

management practices. 

The Commission recognizes that 

security-based swap clearing agencies 

must establish reasonable participation 

standards in order to ensure the 

participants in the clearing agency do 

not expose it to unacceptable risk or 

otherwise adversely affect the 

performance of the clearing agency, 

particularly during periods of market 

stress. However, participant standards 

may have the effect of restricting access 

to the clearing agency. On the one hand, 

panelists at the Conflicts Roundtable 

and others have raised the concern that 

participation requirements could be 

unnecessarily restrictive and primarily 

designed to limit the number of entities 

that are permitted to become direct 

participants in the clearing agency.34

While appropriate participation 

standards are necessary for the sound 

operation of the security-based swap 

clearing agency, unduly high standards 

may needlessly exclude persons who 

are otherwise qualified to clear securitybased swaps. On the other hand, some 

panelists at the Conflicts Roundtable 

also suggested that increasing access can 

come at the expense of sound risk 

management practices.35

Access could also be restricted by the 

way that clearing members determine 

executable end-of-day settlement prices. 

Since there is currently no exchange or 

other venue that publishes securitybased swap prices, the Commission has 

required security-based swap clearing 

agencies to publish end-of-day 

settlement prices and any other prices 

with respect to cleared security-based 

swaps that the security-based swap 

clearing agency may use to calculate 

mark-to-market requirements.36 To 

ensure that end-of-day settlement prices 

are reliable and consistent, a securitybased swap clearing agency may require 

that the price submission be 

executable.37 The security-based swap 

clearing agency, however, might not 

permit an entity to rely on a third party 

to provide an executable end-of-day 

settlement price. This could potentially 

prevent all but the largest dealer firms 

from having direct access to the clearing 

agency as they may be the only firms 

that have the processes to determine 

executable end-of-day settlement 

prices.38

In situations where direct access is 

limited by reasonable participation 

standards, non-participant firms may be 

able to access the security-based swap 

clearing agency through correspondent 

clearing arrangements with direct 

participants. Correspondent clearing is 

common in securities markets as well as 

in futures markets. However, the nonparticipant firms ultimately would be 

required to enter into a correspondent 

clearing arrangement with a participant 

in order to have the transactions 

submitted to the security-based swap 

clearing agency. Thus, the success of 

correspondent clearing arrangements 

depends on the willingness of securitybased swap participants to enter into 

such arrangements with non-participant 

firms that may act as direct competitors 

to the participants. Given that current 

participants may have an incentive to 

restrict access to potential competitors, 

correspondent clearing arrangements 

may not be readily established while 

only the large dealer firms are direct 

participants in the security-based swap 

clearing agency. 

In addition, procedural barriers may 

prohibit a firm from having indirect 

access to a security-based swap clearing 

agency. For example, although there are 

no overt restrictions on indirect access 

at the currently exempted securitybased swap clearing agencies, many of 

the processing platforms by which 

participants submit transactions to the 

security-based swap clearing agency do 

not have the functionality to allow a 

non-participant firm to submit a trade 

with a customer to the security-based 

swap clearing agency through a 

correspondent arrangement with a 

direct member. 

Prohibitively burdensome or 

restrictive direct participation standards 

and lack of availability of correspondent 

clearing arrangements effectively deny 

non-participant firms access to the 

security-based swap clearing agency’s 

services and, accordingly, create a 

substantial competitive advantage for 

those firms that are direct participants 

in the security-based swap clearing 

agency. As previously noted, this 

competitive advantage would become 

even more significant after the 

mandatory clearing requirement for 

security-based swaps in the Dodd-Frank 

Act becomes effective. 

b. Limitations on the Scope of Products 

Eligible for Clearing 

As discussed above, Congress found 

and the Commission believes that 

increased use of central clearing would 

provide significant benefits to the 

security-based swaps market and 

mitigate systemic risk, particularly 


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Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 65887 

39Representative Barney Frank, who chaired the 

conference committee that reconciled the House 

Bill and the Senate Bill, referred to this specific 

concern when discussing the amendment adding 

Section 765 to the Dodd-Frank Act. Chairman Frank 

stated, ‘‘The purpose of this in part is to get many 

more derivatives cleared. But the clearing houses 

have the right to refuse them if they say the 

transactions aren’t suitable for clearing. We believe 

that some banks have an interest in not having them 

cleared. So we don’t want entities that have an 

interest and [sic] there being no clearing, owning 

the clearing houses. That’s why this is an important 

amendment to us, and it was passed after 

considerable debate on the House floor.’’ HouseSenate Conf. Comm. Holds Markup on HR 4173, 

Financial Regulatory Overhaul Bill, June 24, 2010, 

reprinted in CQ Congressional Transcripts, 111th 

Cong. 182 (2010) (statement of Barney Frank, 

Chairman, House Comm. on Fin. Serv.). 

40See Office of the Comptroller of the Currency, 

Quarterly Report on Bank Trading and Derivatives 

Activities, First Quarter 2010. (‘‘Derivatives activity 

in the U.S. banking system continues to be 

dominated by a small group of large financial 

institutions. Five large commercial banks represent 

97% of the total banking industry notional amounts 

* * *.’’) 

41See Darrell Duffie, Ada Li, and Theo Lubke, 

‘‘Policy Perspectives on OTC Derivatives Market 

Infrastructure,’’ Federal Reserve Bank of New York 

Staff Report No. 424, dated January 2010, as revised 

March 2010 (‘‘Even after an OTC derivatives 

product has achieved relatively active trading 

* * * dealers have an incentive to maintain the 

wide bid-ask spreads that they can obtain in the 

OTC market * * *. Thus, from the viewpoint of 

profits, dealers may prefer to reduce the migration 

of derivatives trading from the OTC market to 

central exchanges.’’). 

42Section 763(a) adds new Section 3C(d)(3)(A) to 

the Exchange Act, which prohibits the Commission 

from requiring any clearing agency to accept a 

security-based swap for central clearing. See Public 

Law 111–203, Section 763(a). 

43Such a scenario would arise, for example, 

where a defaulting participant has contributed 

insufficient margin to meet its obligations to the 

security-based swap clearing agency. 

during times of financial crisis. Central 

clearing of security-based swaps likely 

would result in lower spreads and lower 

transaction costs for end-users. A 

participant in a security-based swap 

clearing agency might, however, derive 

greater revenues from its activities in 

the OTC market for security-based 

swaps than it would from sharing in the 

profits of a security-based swap clearing 

agency in which it holds a financial 

interest. As a result, the increased use 

of central clearing may be contrary to 

the economic interests of some 

participants to a security-based swap 

clearing agency. Such participants or 

their related persons could therefore 

seek to have the security-based swap 

clearing agency limit the types of 

security-based swaps that are eligible for 

clearing at a security-based swap 

clearing agency over which they 

exercise influence or control.39

A further incentive for a clearing 

agency controlled by participants to 

restrict the products that are eligible for 

clearing at the security-based swap 

clearing agency may be to control a 

security-based swap’s price 

transparency. Trading in the OTC 

derivatives market is currently 

dominated by a small number of firms.40

Prior to the use of clearing agencies to 

clear security-based swaps, end-users 

had to transact directly with a small 

number of firms to trade in securitybased swaps without the benefit of 

publicly available pricing data. 

Security-based swap clearing agencies 

provide greater price transparency by 

making certain price data available to 

the public and thereby helping to 

reduce the information asymmetry that 

benefits firms in the OTC market.41

Publicly available pricing data may 

result in reducing the spreads and 

reduce the profit per trade for firms that 

have dominated the OTC market. 

While certain security-based swaps 

may be suitable for central clearing, the 

Commission recognizes the possibility 

that some security-based swaps may not 

be suitable for clearing if their risks 

cannot be adequately managed by the 

security-based swap clearing agency. 

Clearing products whose risks cannot be 

adequately managed may increase the 

potential of a default of a participant or 

even the failure of the security-based 

swap clearing agency.42 This in turn 

could adversely affect systemic risk, as 

participants and their customers would 

likely have significant funds and 

securities tied to the clearing agency 

and would be dependent on the 

continued operations of a security-based 

swap clearing agency in order to enter 

into new transactions in security-based 

swaps. This again highlights the 

potential tensions between sound risk 

management and the increased use of 

central clearing services. Expanding the 

number and scope of products cleared 

would in some cases be in the best 

interests of the security-based swap 

clearing agency and the security-based 

swaps market generally, because it 

provides processing efficiencies and 

replaces bilateral counterparty risk. 

However, allowing a greater number and 

scope of products to be centrally cleared 

would in some cases be harmful to the 

security-based swap clearing agency and 

the security-based swaps market, if 

sound risk management standards are 

compromised in order to clear those 

products. 

The Commission is mindful of the 

need to balance goals associated with 

promoting the central clearing of 

security-based swaps and assuring that 

proposed rules are designed to increase 

the number of products eligible for 

central clearing with the goals 

associated with effective risk 

management. The Commission is also 

aware that any rules that it may 

ultimately adopt relating to conflicts of 

interest may affect this balance. The 

Commission believes, however, that 

decisions regarding the products that 

are eligible for clearing by a securitybased swap clearing agency should not 

be subject to undue influence by parties 

that have a financial interest in keeping 

such products from being centrally 

cleared, while also noting that nonparticipants may have an interest in 

increasing access, which potentially 

could serve to compromise effective risk 

management. 

c. Reduced Risk Management Controls 

Security-based swap clearing agencies 

will perform a critical function in 

mitigating financial risk for market 

participants. The Commission believes 

that through uniform margining and 

other risk controls, including controls 

over market-wide concentrations that 

cannot be implemented effectively 

when counterparty risk management is 

decentralized, security-based swap 

clearing agencies would help to prevent 

a single market participant’s failure 

from destabilizing other market 

participants and, ultimately, the broader 

financial system. 

Although participants may seek to 

raise risk management controls in order 

to restrict access to the clearing agency 

or protect their financial stake in the 

clearing agency, they might also seek to 

lower certain risk management controls 

such as margin requirements in order to 

release collateral that they may wish to 

use for other purposes. Furthermore, as 

security-based swap clearing agencies 

become more established and the 

mandatory clearing requirement under 

Section 763 is implemented, more 

security-based swaps will likely be 

centrally cleared and clearing 

participants will be required to provide 

a substantially larger amount of liquid 

collateral to security-based swap 

clearing agencies in the form of margin. 

As a result, participants may be willing 

to accept greater risk than is prudent for 

the security-based swap clearing agency 

in order to reduce the amount of their 

margin contributions. A reduction in 

risk management controls ultimately 

could function to increase systemic risk 

by increasing the potential for a 

financial loss that must be borne by the 

participants of the security-based swap 

clearing agency.43

The Commission recognizes that 

participants generally have a financial 

incentive to ensure that the securitybased swap clearing agency collects 

sufficient margin from each participant. 


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65888 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

44Section 765 of the Dodd-Frank Act authorizes 

the Commission to adopt rules regarding conflicts 

of interest of Specified Entities at security-based 

swap clearing agencies in general. However, the 

Commission preliminarily believes that those 

entities that are participants in a security-based 

swap clearing agency will have a conflict of interest 

that could be acted upon to adversely affect the 

development of the market for security-based swaps 

consistent with the policy objectives of Section 765 

of the Dodd-Frank Act. 

45The Commission’s discussion in this Release of 

the motivations or incentives of directors of a 

clearing agency, SB SEF, or SBS exchange comes in 

the context of requiring modes of governance that 

permit consideration of a variety of perspectives. As 

noted throughout this Release, a company’s 

directors have a duty to all the company’s 

shareholders, and the Commission does not regard 

any directors as simply surrogates for a particular 

group of shareholders. The Commission’s 

discussion is intended to forestall possible conflicts 

and does not reflect findings that particular 

conflicts are present. 

46This distinction between participant-related 

and non-participant-related directors may be most 

significant where the clearing agency is (i) a 

publicly owned corporation, or part of a publicly 

owned corporation, or (ii) otherwise owned by 

persons other than participants. The Commission 

recognizes that ownership structures for clearing 

agencies may take other forms, including ownership 

solely by participants, in which case the incentives 

and perspectives of the directors may be somewhat 

different. 

A clearing agency’s rules and 

procedures typically provide that in the 

event of a participant default, losses 

exceeding a participant’s individual 

margin contribution may be satisfied 

from a guaranty fund composed of 

contributions from all participants. As a 

result, participants have a unique 

financial incentive to ensure that the 

security-based swap clearing agency has 

sufficient collateral from each 

participant to withstand a participant 

default in almost all market conditions. 

However, participant defaults occur 

infrequently and the incentive for 

participants to protect their guaranty 

fund contributions may have less weight 

than the incentive to reduce margin 

requirements in order to release margin 

collateral for immediate use. 

A non-participant does not contribute 

to a guaranty fund and may not have the 

same incentives as a participant with 

respect to establishing and maintaining 

sufficiently robust participant margin 

requirements. Non-participants’ 

incentives may be to focus less on risk 

management and focus more on 

allowing more participants to be 

admitted to the clearing agency and 

more products to be made eligible for 

central clearing. 

d. Implications for Ownership and 

Governance 

As described above, conflicts of 

interest may arise if participants 

exercise undue control or influence over 

a security-based swap clearing agency. 

This influence, typically acquired 

through an ownership stake in the 

clearing agency, generally may be 

exercised by participants through either 

(i) voting interests in the security-based 

swap clearing agency or (ii) 

participation in the governance of the 

security-based swap clearing agency, 

such as by selecting (or influencing the 

selection of) the directors of the 

security-based swap clearing agency.44

In either case, undue control or 

influence may be particularly acute if (i) 

the participants are part of the process 

for nominating the directors, even if 

such participants are not themselves 

directors, or (ii) the election of directors 

is subject to concentrated voting power 

in a small number of participants, 

especially if such participants also 

dominate much of the trading in 

security-based swaps and could use 

their controlling position to maintain or 

extend their dominant market position. 

In addition, it is important to consider 

the likely incentives of individual 

directors, once they are on the Board, 

when they are governing the securitybased swap clearing agency.45 Directors 

of a security-based swap clearing agency 

owe a fiduciary duty to the securitybased swap clearing agency and all of its 

shareholders. In addition, among other 

obligations, the Board as a whole is 

ultimately responsible for overseeing 

the clearing agency’s compliance with 

the regulatory obligations of securitybased swap clearing agencies under the 

Dodd-Frank Act and the Exchange Act, 

including the open and fair access 

requirements. At the same time, 

however, directors may be subject to 

different perspectives when fulfilling 

these duties and roles. Although the 

Commission recognizes that incentives 

and motivations may vary among 

directors and over time for a range of 

reasons—and therefore it is not possible 

to predict precisely how any individual 

director will address a particular 

matter—directors who are appointed by 

or related to participants (‘‘participantrelated directors’’) may on balance be 

more likely to reflect the views of 

participants than would directors who 

are not appointed by or related to 

participants (‘‘non-participant-related 

directors’’).46

In light of these dynamics, as between 

the two categories of directors, 

participant-related directors, like 

participants themselves, may on balance 

be more likely to favor reducing or 

minimizing the risk exposure of the 

clearing agency, potentially at the 

expense of more open access. In 

addition, participant-related directors 

may also be more likely to favor 

restricting access to the clearing agency, 

which as discussed above would serve 

to preserve profits that participants earn 

through trading security-based swaps in 

the OTC markets. 

In contrast, non-participant-related 

directors may, on balance, be more 

likely to seek to maximize the value of 

the enterprise, which, in addition to 

sound risk management, may involve 

increasing the revenues of the securitybased swap clearing agency, such as by 

expanding the number and scope of 

products being cleared. Moreover, at a 

minimum it would seem less likely that 

non-participant-related directors would 

favor unduly restricting access to the 

clearing agency and its services. Thus, 

non-participant-related directors may be 

inclined to favor expanded access to 

products and services, which may 

increase the amount of risk that the 

clearing agency must successfully 

manage. The interest in expanded 

access to products and services may be 

especially relevant in the early stages of 

a clearing agency’s development, when 

establishing a new entity as a viable 

clearing agency is especially important. 

The Commission recognizes that other 

factors may also affect director 

incentives and behavior. For example, it 

may be argued that participant-related 

directors may in general have greater 

risk management expertise and 

experience than non-participant-related 

directors, and that non-participantrelated directors may tend to defer to 

the views or judgment of participants or 

participant-related directors on risk 

matters, with the effect that open access 

may be unduly compromised in favor of 

risk management. On the other hand, it 

may be argued that qualified nonparticipant-related directors with 

sufficient risk management expertise 

can be readily found, and in any event 

these directors’ independence of 

participants would justify their 

heightened involvement on the Board. 

In addition, directors may face other 

conflicts of interest. For example, there 

may be conflicts between the competing 

interests of different shareholders— 

whether or not participants—which 

could have implications for director 

behavior, as discussed more fully below. 

There also may be a tension between the 

directors’ incentives to maximize profits 

and their duties to oversee the securitybased swap clearing agency’s 

compliance with applicable legal 

restrictions which, although not 

necessarily unique to clearing agencies, 

may nevertheless affect how they decide 

any particular matter. 

As described more fully below, the 

proposed rules are intended to strike a 

balance among these various 


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47See, e.g., Craig Pirrong, ‘‘The Inefficiency of 

Clearing Mandates,’’ Cato Institute Policy Analysis 

No. 665, July 21, 2010. 

considerations by allowing participants 

to maintain a significant voice within a 

security-based swap clearing agency 

while also imposing ownership 

limitations and independent director 

requirements to mitigate the potential 

influences of participant owners and 

participant-related directors. 

e. Request for Comments Regarding 

Identified Conflicts of Interest 

The Commission requests comment 

on the conflicts of interest it has 

identified with respect to security-based 

swap clearing agencies, including the 

conflicts related to participant 

standards, product eligibility, and risk 

management. Do commenters agree with 

the potential conflict concerns that the 

Commission has identified? Some 

parties have questioned the benefits of 

central clearing generally in terms of 

reducing systemic risk,47 potentially 

suggesting a different analysis with 

respect to the identified conflicts of 

interest. What are commenters views on 

the potential benefits and costs of 

central clearing and the resulting effect 

on the conflicts of interest analysis? 

What effect would the identified 

conflicts of interest likely have? Should 

the Commission focus on any of these 

conflicts more than others? Are there 

other existing conflicts concerns that 

commenters believe warrant scrutiny? If 

so, what are they and how are they 

likely to affect security-based swap 

clearing agencies? 

The conflicts of interest discussed in 

part stem from the current concentrated 

market structure for security-based 

swaps. How is the current market 

structure likely to evolve over time? 

What effect will that evolution have on 

the consideration of conflicts of 

interest? Are there any other conflicts of 

interest that may result due to expected 

changes in the security-based swaps 

market or the clearing of security-based 

swaps that the Commission should 

consider? If so, what are they and how 

are they likely to affect security-based 

swap clearing agencies? 

The central clearing of security-based 

swaps is still developing and may 

change significantly as the market for 

security-based swaps develops. In 

particular, the new provisions in the 

Dodd-Frank Act relating to the central 

clearing of security-based swaps are not 

yet effective. Once they become 

effective, security-based swap clearing 

agencies will be subject to substantially 

more regulation, which may have an 

effect on conflicts of interest. How are 

conflicts of interest likely to change as 

the central clearing of security-based 

swaps, and security-based swap clearing 

agencies, become more established? 

What potential new conflicts of interest 

could arise that the Commission should 

consider? How will potential changes in 

the trading of security-based swaps 

affect conflicts of interest at securitybased swap clearing agencies? In 

addition, competitive forces within the 

security-based swaps market may help 

to mitigate conflicts of interest, for 

example, by increasing the number of 

institutions that trade in security-based 

swaps and creating a broader market in 

security-based swaps. How might 

competition issues affect or change 

current conflicts of interest? Will 

competition potentially create different 

or additional conflicts of interest that 

the Commission should consider? Will 

competition potentially mitigate 

conflicts of interest? 

What other parties may have conflicts 

of interest that would affect whether 

they should control or participate in the 

governance of a security-based swap 

clearing agency? In what circumstances 

do these conflicts of interest arise? 

Under certain circumstances, there is 

the potential that incentives of 

shareholders to maximize profits could 

compromise prudent risk management 

by a security-based swap clearing 

agency. For example, shareholders 

could seek to increase revenue from 

clearing fees by increasing the number 

of products cleared by the clearing 

agency beyond those that can be 

appropriately risk managed or by having 

the clearing agency expand its services 

or engage in new lines of business that 

would expose the security-based swap 

clearing agency to increased risk. 

Shareholders that are not users of a 

security-based swap clearing agency 

may also not have the same incentives 

to keep the costs of clearing low. The 

Commission requests comment on the 

conflicts of interest that non-participant 

shareholders may have and the effect 

such conflicts could have on a securitybased swap clearing agency. What are 

the differences in conflicts of interest 

between participants and nonparticipants? What are the different 

effects these conflicts could have on a 

security-based swap clearing agency? 

Which conflicts of interest could 

potentially cause the greatest harm to 

the security-based swap clearing 

agency? 

Do persons who are selected to be 

directors of a security-based swap 

clearing agency by participants have a 

conflict of interest based on their status 

as directors that would affect their 

ability to act in the best interest of the 

clearing agency, to act in conformity 

with the Exchange Act, or to act to meet 

the policy objectives in Section 765 of 

the Dodd-Frank Act? Would directors be 

less likely to act to meet the policy 

objectives in Section 765 of the DoddFrank Act if they are selected by 

shareholders seeking to maximize the 

profits of the security-based swap 

clearing agency? What effect would they 

likely have on security-based swap 

clearing agencies? How do participants’ 

conflicts of interest that affect risk 

management and open access issues 

compare with non-participants’ interests 

regarding these issues? How do 

participants’ incentives with respect to 

risk management compare with the 

incentives of non-participant 

shareholders or directors? How do the 

incentives of independent directors 

differ from the non-independent 

directors in terms of considering the 

potential for conflicts of interest? 

The Commission also requests 

comment on the interplay of the 

identified conflicts of interest, and any 

additional conflicts of interest identified 

by commenters, and how that may affect 

a security-based swap clearing agency. 

For example, there may at times be a 

trade-off between risk management 

standards and open access to the 

clearing agency. What is the best way to 

balance these and other potential 

conflicts of interest in order to assure 

that the clearing agency has both robust 

risk management and fair and open 

access to clearing services? Are there 

any other conflicts of interest that pose 

similar trade-offs? What conflicts are 

these and how should the Commission 

balance the related concerns? 

The Commission recognizes that other 

conflicts of interest may arise in the 

governance of security-based swap 

clearing agencies—for example, there 

may be a conflict between the interests 

of certain shareholders. The rules the 

Commission is proposing today focus on 

the conflicts of interest presented by the 

potential influence of participants in the 

security-based swaps market because, as 

described above, the Commission 

believes those conflicts may be most 

relevant to the development of securitybased swap clearing agencies. The 

Commission recognizes that conflicts of 

interest may also arise with respect to 

independent directors and has 

attempted to achieve a balance between 

the different incentives of participantrelated and non-participant-related 

directors and the potential benefits each 

might bring to the Board of a securitybased swap clearing agency. 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
65890 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

48The term ‘‘security-based swap execution 

facility participant’’ means a person permitted to 

directly effect transactions on the security-based 

swap execution facility. See proposed Rule 700(z) 

under Regulation MC. 

49A ‘‘member’’ when used with respect to a 

national securities exchange means (i) any natural 

person permitted to effect transactions on the floor 

of the exchange without the services of another 

person acting as broker, (ii) any registered broker or 

dealer with which such a natural person is 

associated, (iii) any registered broker or dealer 

permitted to designate as a representative such a 

natural person, and (iv) any other registered broker 

or dealer which agrees to be regulated by such 

exchange and with respect to which the exchange 

undertakes to enforce compliance with the 

provisions of the Exchange Act, the rules and 

regulations thereunder, and its own rules. See 

Section 3(a)(3)(A) of the Exchange Act, 15 U.S.C. 

78c(a)(3)(A). 

50See infra Section V.A. for a discussion of 

‘‘related person’’ in the context of a SB SEF and SBS 

exchange or facility thereof. 

51See infra Section V.A. for a discussion of the 

ownership and voting limits of proposed Rule 702 

under Regulation MC. 

52See supra note 40. 

53The Commission will address the issue of 

transparency of security-based swap pricing and 

transaction data in a separate rulemaking. 

54An entity that registers as a SB SEF will have 

oversight responsibility over its market pursuant to 

the Exchange Act (as amended by the Dodd-Frank 

Act) and rules adopted thereunder. See Section 

763(c) of the Dodd-Frank Act, Public Law 111–203, 

Section 763(c). Similarly, all national securities 

exchanges, including those that may post or make 

available for trading security-based swaps, have 

oversight responsibilities over their markets and 

their members pursuant to the Exchange Act. See 

Section 6 of the Exchange Act, 15 U.S.C. 78(f). 

55See Sections 6(b)(1) of the Exchange Act, 15 

U.S.C. 78f(b)(1). 

56Historically, national securities exchanges were 

structured as not-for-profit or similar organizations 

owned by their members. Exchanges, however, have 

more recently evolved to become shareholderowned. See supra note 49 for the definition of 

‘‘member’’ as applicable to national securities 

exchanges. 

B. Security-Based Swap Execution 

Facilities and National Securities 

Exchanges 

The Commission has also reviewed 

the potential for conflicts of interest at 

SB SEFs and SBS exchanges in 

accordance with Section 765 of the 

Dodd-Frank Act and has identified 

those conflicts that it believes may be 

mitigated by rules designed to improve 

the governance of a SB SEF or SBS 

exchange, promote competition, or 

mitigate conflicts of interest in 

connection with the operation of a SB 

SEF or SBS exchange by a securitybased swap execution facility 

participant (‘‘SB SEF participant’’) 48 or a 

member of an SBS exchange (‘‘SBS 

exchange member’’) 49 that has an 

ownership interest in the SB SEF or SBS 

exchange. As with security-based swap 

clearing agencies, the Commission 

preliminarily believes that conflicts of 

interest that may have an adverse affect 

on the statutory goals of Section 765 are 

those that arise when a small number of 

market participants, including 

participants that are Specified Entities 

and including related persons of 

participants,50 exercise control or undue 

influence over a SB SEF or SBS 

exchange. This influence may be 

exercised either through ownership of 

voting interests 51 or participation in the 

governance of the SB SEF or SBS 

exchange. 

The Commission believes that 

through ownership of voting interests or 

ability to influence governance, market 

participants could exercise influence 

with respect to the services provided by 

SB SEFs or SBS exchanges, the rules 

and policies applicable to participants 

or members of such entities, and, more 

generally, the security-based swaps 

market. When a small group of those 

same market participants also dominate 

much of the trading in security-based 

swaps, control of a SB SEF or SBS 

exchange by these participants raises a 

heightened concern. If a SB SEF or a 

SBS exchange is controlled by a small 

group of dealers who also dominate 

trading in the market for security-based 

swaps, the dealers may have 

competitive incentives to exert undue 

influence to control the level of access 

to the SB SEF or SBS exchange and thus 

impede competition by other market 

participants. In other words, 

participants or members in a SB SEF or 

SBS exchange, as applicable, might seek 

to limit the number of direct 

participants in the trading venue in 

order to limit competition and increase 

their ability to maintain higher profit 

margins. Given such incentives, a SB 

SEF or SBS exchange that is controlled 

by a limited number of participants or 

members might adopt policies and 

procedures that are designed to restrict 

access. 

Participants or members also might be 

motivated to restrict the scope of 

security-based swaps that are eligible for 

trading at SB SEFs or SBS exchanges if 

there is a strong economic incentive to 

keep such swaps in the OTC market. On 

the other hand, this concern may be 

mitigated by competitive forces if a 

greater number and variety of facilities 

where security-based swaps can be 

traded are available. A small number of 

firms currently dominate trading in the 

OTC derivatives market.52 Centralized 

trading of security-based swaps likely 

would result in lower spreads and lower 

transaction costs for end-users, 

particularly as a result of increased pretrade and post-trade transparency of 

prices, assuming sufficient trading 

volume and liquidity.53 As noted above, 

increased price transparency might help 

to eliminate much of the basis for 

asymmetrical information, reduce 

spreads, and reduce the profit per trade 

for firms that dominated the OTC 

security-based swaps market. As a 

result, this might create an incentive for 

participants or members in a SB SEF or 

SBS exchange, as applicable, to seek to 

limit the number of security-based 

swaps that are made available for 

trading by such venues. The 

Commission recognizes, however, that 

there could in certain circumstances be 

legitimate concerns regarding liquidity 

or other trading characteristics of a 

security-based swap that reasonably 

might justify the decision of participants 

in a SB SEF or members of a SBS 

exchange not to make a particular 

product available for trading on a SB 

SEF or a SBS exchange. However, 

decisions regarding the eligibility of 

security-based swaps for trading on a SB 

SEF or SBS exchange should not be 

subject to undue influence by parties 

that have a financial interest in keeping 

such products from being centrally 

traded on a facility or exchange. 

Finally, the Commission also believes 

that a SB SEF or SBS exchange could 

have potential conflicts of interest 

between the commercial interests of the 

SB SEF or SBS exchange or the SB SEF’s 

or SBS exchange’s owners and the SB 

SEF’s or SBS exchange’s market 

oversight responsibilities.54 With 

respect to these kinds of conflicts of 

interest, the Commission’s proposal is 

informed, in part, by its experience 

overseeing national securities 

exchanges. The Commission notes, 

however, that a SB SEF’s regulatory 

obligations under Section 763(c) of the 

Dodd-Frank Act are not identical to 

those of a national securities exchange’s 

obligations under Section 6 of the 

Exchange Act. 

National securities exchanges are selfregulatory organizations (‘‘SROs’’) and 

are statutorily required to comply, and 

enforce compliance by their members 

and their associated persons, with the 

Federal securities laws, the rules and 

regulations thereunder, and their own 

rules.55 Exchanges also generally 

operate for-profit markets and, as a 

result, are concerned with preserving 

and enhancing their competitive 

positions vis-a`-vis other exchanges.56

Consequently, exchanges have potential 

conflicts of interest between carrying 

out their regulatory obligations to 

vigorously oversee their members and 

marketplace and promoting their and 

their shareholders’ economic interests. 

For example, an exchange could put its 

interest and that of its members or 


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57See SRO Governance Proposing Release, 69 FR 

71126, infra note 59. 

58See Section 6(b) of the Exchange Act, 15 U.S.C. 

78f(b). 

59See, e.g., Securities Exchange Act Release Nos. 

61698 (March 12, 2010), 75 FR 13151 (March 18, 

2010) (In the Matter of the Applications of EDGX 

Exchange, Inc., and EGDA Exchange, Inc. for 

Registration as National Securities Exchanges; 

Findings, Opinion, and Order of the Commission) 

(‘‘Exchange Act Release No. 61698’’); 58375 (August 

18, 2008), 73 FR 49498 (August 21, 2008) (In the 

Matter of the Application of BATS Exchange, Inc. 

for Registration as a National Securities Exchange; 

Findings, Opinion, and Order of the Commission) 

(‘‘Exchange Act Release No. 58375’’). In 2004, the 

Commission proposed rules relating to: the fair 

administration and governance of SROs; disclosure 

and regulatory reporting by SROs; recordkeeping 

requirements by SROs; ownership and voting 

limitations for SROs; and listing and trading of 

affiliated securities by SROs. The Commission has 

not taken action on these proposed rule changes. 

See Securities Exchange Act Release No. 50699 

(November 18, 2004), 69 FR 71126 (December 8, 

2004) (‘‘SRO Governance Proposing Release’’). 

60 15 U.S.C. 78s. 

61 15 U.S.C. 78f. 

62See, e.g., Securities Exchange Act Release Nos. 

62158 (May 24, 2010), 75 FR 30082 (May 28, 2010) 

(order approving the demutualization of the 

Chicago Board Options Exchange, Incorporated 

(‘‘CBOE’’)) and 53382 (February 27, 2006), 71 FR 

11251 (March 6, 2006) (order approving the merger 

of New York Stock Exchange, Inc. (‘‘NYSE’’) and 

Archipelago and NYSE’s demutualization). 

63 Generally, a ‘‘related person’’ means, with 

respect to any person, any other person, directly or 

indirectly, controlling, controlled by, or under 

common control with such person or any person 

acting in concert with such person. 

64See, e.g., Exchange Act Release No. 61698, 75 

FR at 13156, supra note 59. The exchange’s Board 

may waive the voting and ownership limits if it 

makes certain findings, including a finding that 

such a waiver would be consistent with the 

exchange’s self-regulatory obligations. The board, 

however, may not waive these limits for any 

exchange members. Moreover, the exchange must 

file such waiver with the Commission as a proposed 

rule change for approval before it could be 

implemented. 

The ownership limits currently in place for 

exchanges generally apply to any ownership 

interest. See, e.g., Exchange Act Release No. 61698, 

75 FR 13151, supra note 59; Amended and Restated 

Certificate of Incorporation of BATS Global 

Markets, Inc., Article FIFTH. In contrast, proposed 

Rule 702 would apply ownership limits only with 

respect to those shares or other interests entitled to 

vote. See infra Section V.A. for a discussion of the 

differences between the ownership and voting 

limits in proposed Rule 702 and those limits 

currently in place for exchanges. 

65 15 U.S.C. 78f(b)(3). Pursuant to Section 6(b)(3), 

the Commission generally requires, at a minimum, 

that at least 20% of the directors on the board be 

selected by exchange members. The Commission 

also requires that exchange members be permitted 

to participate in the nomination process of such 

representative directors and that they have the right 

to petition for alternative candidates. See, e.g., 

Securities Exchange Act Release No. 58375, 73 FR 

at 49500, supra note 59. 

66 15 U.S.C. 78f(b)(1). Pursuant to Section 6(b)(1), 

the Commission generally requires, at a minimum, 

that the number of non-industry directors on the 

exchange’s board equal or exceed the number of 

industry directors. Generally, a ‘‘non-industry 

director’’ is someone who is not subject to 

regulation by the exchange, is not a broker or dealer 

or an officer, director, or employee of a broker or 

dealer, is not associated with an entity that is 

affiliated with a broker or dealer, and has neither 

a material ownership interest nor investment in a 

broker or dealer. See, e.g., CBOE By-Laws, Article 

III, Section 3.1. Some exchanges also have 

‘‘independent directors.’’ Typically, an independent 

director has no material relationship with the 

exchange or an exchange member. See, e.g., 

Amended and Restated By-Laws of BATS Exchange, 

Inc., Article I(m). For example, an officer or director 

of a listed issuer generally is considered a nonindustry director rather than an independent 

director. The definitions of ‘‘non-industry’’ and 

‘‘independent’’ do, however, differ across 

exchanges. 

67 15 U.S.C. 78f(b)(6) and (7). To find an 

exchange’s disciplinary rules to be consistent with 

the Exchange Act, the Commission generally 

requires that disciplinary processes be balanced and 

include industry member participation. See, e.g., 

Exchange Act Release No. 61698, 75 FR at 13160, 

n. 124, supra note 59. 

68See SRO Governance Proposing Release, 69 FR 

71126, supra note 59. 

69 Id. 

shareholders ahead of its regulatory 

responsibilities by failing to take 

regulatory or enforcement actions or to 

adequately fund self-regulation. Further, 

the commercial interests of the 

shareholders of an exchange may 

conflict with the regulatory obligations 

of an exchange. A shareholder may be 

incentivized to maximize profits 

through the economic stake it has in the 

exchange or, if the shareholder is also a 

member of the exchange, to more 

directly further its own commercial 

interests.57 For example, a shareholder 

could promote the distribution of the 

exchange’s revenues in a manner that 

could result in inadequate funding of 

the exchange’s regulatory operations or, 

if also an exchange member, could use 

the exchange’s disciplinary process 

potentially to harass or penalize a 

competitor. 

The Commission has considered the 

conflicts between an exchange’s 

regulatory responsibilities and its 

commercial interests in operating a 

marketplace for the trading of securities. 

To address these types of concerns, the 

Commission has developed, consistent 

with the requirements of Section 6 of 

the Exchange Act,58 an approach to 

mitigate conflicts of interest for national 

securities exchanges.59 Specifically, 

through its review of proposals filed by 

exchanges with respect to changes to 

their ownership and governance 

structures (generally from memberowned to shareholder-owned 

organizations) pursuant to Section 19 of 

the Exchange Act 60 or of applications 

filed by entities to register as national 

securities exchanges pursuant to Section 

6 of the Exchange Act,61 the 

Commission examines the way in which 

an exchange applies ownership and 

voting limits and addresses certain 

governance principles.62 Namely, the 

Commission looks to ensure that there 

are limits on the ability of persons to 

own and control exchanges by, for 

example, requiring at a minimum that 

no person, alone or together with its 

related persons,63 be permitted to own 

more than 40%, and no member, alone 

or together with its related persons, be 

permitted to own more than 20%, of the 

ownership interests of the exchange or 

be entitled to vote shares in excess of 

20%.64 Further, the Commission also 

looks to ensure that an exchange 

provide fair representation of members 

in the selection of directors and the 

administration of its affairs, consistent 

with the requirement in Section 6(b)(3) 

of the Exchange Act,65 that an exchange 

is organized in a manner that allows it 

to carry out the purposes of the 

Exchange Act pursuant to Section 

6(b)(1) of the Exchange Act,66 and that 

it provides fair procedures for 

disciplining members, consistent with 

the requirements in Sections 6(b)(6) and 

6(b)(7) of the Exchange Act.67

The Commission’s recognition of 

potential conflicts of interest at 

exchanges and its approach to date in 

reviewing and approving measures 

designed to mitigate those conflicts of 

interest are a useful point of reference 

as the Commission identifies, and 

develops proposals to mitigate, the 

conflicts of interest potentially faced by 

SB SEFs and SBS exchanges as the 

trading of security-based swaps moves 

to regulated markets. However, as noted 

above, the Commission recognizes that 

a SB SEF’s regulatory obligations are not 

the same as a national securities 

exchange’s regulatory obligations. 

The Commission in 2004 proposed 

rules to promote the fair administration 

and governance of, and to impose 

ownership and voting limitations on, 

national securities exchanges and 

registered national securities 

associations.68 Among other things, the 

proposal would have required an 

exchange to: Have a Board composed of 

a majority of independent directors; 

maintain fully independent nominating, 

compensation, and audit committees; 

separate its regulatory obligations and 

business functions by establishing a 

fully independent regulatory oversight 

committee (‘‘ROC’’) or equivalent 

structure; and limit ownership and 

voting control by members.69 This 

proposal was intended to improve the 

governance of certain SROs by 

establishing independence standards for 

the board of directors (‘‘Board’’) and key 

committees and by minimizing conflicts 

of interest by instituting ownership and 

voting limitations and the separation of 

the exchange’s regulatory obligations 

and commercial interests. Although the 


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65892 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

70See, e.g., CBOE By-Laws, Article III, Board of 

Directors (‘‘Board of Directors’’ must have a majority 

of ‘‘Non-Industry Directors’’) and Article IV, 

Committees (‘‘Regulatory Oversight Committee’’ 

must consist of at least three directors, all of whom 

shall be ‘‘Non-Industry Directors’’); By-Laws of the 

NASDAQ Stock Market LLC (‘‘Nasdaq’’), Article III, 

Board of Directors, Section 2, Qualifications (‘‘Board 

of Directors’’ must have a majority of ‘‘Non-Industry 

Directors’’) and Section 5, Committees Composed 

Solely of Directors (Regulatory Oversight 

Committee must consist of at least three members, 

each of whom shall be a ‘‘Public Director’’ and an 

‘‘independent director’’ as defined in Nasdaq Rule 

4200). 

71See, e.g., Amended and Restated Certificate of 

Incorporation of BATS Global Markets, Inc., Article 

FIFTH. 

72See Public Law 111–203, Section 763(a). 

Section 3C(h) of the Exchange Act imposes a 

mandatory trading requirement, which provides 

that counterparties shall execute a transaction in a 

security-based swap subject to the clearing 

requirement of Section 3C(a)(1) on an exchange or 

a registered SB SEF or a SB SEF that is exempt from 

registration pursuant to Section 3D(e) of the 

Exchange Act. 

73Within the past several years, the Commission 

has reviewed and assessed comprehensively the 

governance structure of each national securities 

exchange, either in connection with a significant 

transaction by the exchange or as part of its 

application for registration as a national securities 

exchange. See, e.g., Securities Exchange Act Release 

Nos. 58324 (August 7, 2008), 73 FR 46936 (August 

12, 2008) (order approving The NASDAQ OMX 

Group, Inc.’s (‘‘Nasdaq OMX’’) acquisition of the 

Boston Stock Exchange, Inc. (‘‘BSE’’)); 58179 (July 

17, 2008), 73 FR 42874 (July 23, 2008) (order 

approving Nasdaq OMX’s acquisition of the 

Philadelphia Stock Exchange, Inc. (‘‘Phlx’’)); 55293 

(February 14, 2007), 72 FR 8033 (February 22, 2007) 

(order approving the business combination between 

NYSE and Euronext N.V.); 56955 (December 13, 

2007), 72 FR 71979 (December 19, 2007) (order 

approving acquisition of International Securities 

Exchange, Inc. (‘‘ISE’’) by Eurex Frankfurt AG); 

Exchange Act Release No. 58375, 73 FR at 49500, 

supra note 59; 61152 (December 10, 2009), 74 FR 

66699 (December 16, 2009) (order approving 

application of C2 Options Exchange, Incorporated 

to register as a national securities exchange); 

Exchange Act Release No. 61698, 75 FR at 13156, 

supra note 59; 53128 (January 13, 2006), 71 FR 3550 

(January 23, 2006) (order approving Nasdaq’s 

application to register as a national securities 

exchange). 

74See supra note 40. 

75As of the date of this release, the Commission 

has not proposed rules regarding the scope, 

registration requirements, and operation of a SB 

SEF, including the types of entities that would 

qualify for registration as a SB SEF. 

76See Section 763(c) of the Dodd-Frank Act, 

Public Law 111–203, Section 763(c). 

Commission has not acted further on 

this proposal, a number of exchanges 

have adopted some of the governance 

concepts on their own initiative 70 and 

all of the exchanges registered under 

Section 6 of the Exchange Act have 

adopted ownership and/or voting 

limitations, with the Commission’s 

approval.71

Each potential conflict of interest 

identified in this Section III.B. could 

limit the benefits of centralized trading 

in the security-based swaps market and 

potentially undermine the mandatory 

trading requirement in new Section 

3C(h) of the Exchange Act, thereby 

negatively affecting efficiency and 

competition in the security-based swaps 

market.72 Further, while the 

Commission believes that its past 

application of statutory requirements 

has been appropriate to improve the 

governance of, and mitigate the conflicts 

of interest for, exchanges, given the 

difference in the structure of the OTC 

derivatives market and the markets for 

exchange-listed securities, it also 

believes that potential conflicts of 

interest in SBS exchanges can and 

should be further examined.73 Namely, 

unlike exchange-listed securities, 

trading in the OTC derivatives market is 

currently dominated by a small group of 

dealers.74 Although mechanisms in 

place to address conflicts of interest 

among members, shareholders, and 

exchanges would help mitigate some 

concerns about conflicts of interest that 

could result from dealer control of the 

current security-based swaps market, 

the Commission believes that additional 

measures may be necessary to 

effectively mitigate conflict of interest 

concerns. For example, applying 

standards approved for exchanges to SB 

SEFs and SBS exchanges, as described 

above, may not alone adequately 

address the potential concern that a 

small group of dealers could gain 

control over such entities and limit 

security-based swaps from trading on, 

and participant or member access to, a 

centralized market. Accordingly, the 

Commission is proposing rules for SB 

SEFs and SBS exchanges that are 

designed to mitigate the potential 

conflicts of interest that it has identified 

in the context of the security-based 

swaps market, including ownership 

limitations and governance 

requirements, as more fully described 

below.75

The Commission has considered the 

mechanisms in place to mitigate 

conflicts of interest at national securities 

exchanges in developing its proposals to 

mitigate conflicts of interest for SB SEFs 

and SBS exchanges. The Commission 

notes that there are similarities and 

differences between the exchange-listed 

markets and the market for securitybased swaps that merit consideration in 

crafting appropriate proposals to 

mitigate conflicts of interest for SB SEFs 

and SBS exchanges. National securities 

exchanges list and trade cash equity 

securities and options pursuant to a 

well-developed body of their own rules, 

as well as Commission rules, and 

compete actively with each other and 

with other non-exchange trading venues 

for market share and revenues 

associated with trading volume. The 

markets for cash equity securities and 

listed options are generally liquid, 

trading is widely dispersed, and there 

are numerous trading venues and 

market participants. Unlike the wellestablished cash equity and options 

markets, the security-based swaps 

market is at an earlier stage of 

development and, as noted above, is 

currently dominated by a small number 

of dealers. Further, the regulatory 

structure governing the security-based 

swaps market will not be completely 

realized until all provisions of the 

Dodd-Frank Act and any rules 

promulgated thereunder are fully 

implemented. However, like exchanges, 

SB SEFs may have shareholder-owners 

who also may be SB SEF participants 

and may compete with any other SB 

SEF to the extent that they trade the 

same security-based swaps. In addition, 

although SB SEFs would not be SROs 

and therefore would not be subject to 

the same obligations under the 

Exchange Act as SROs, they nonetheless 

will be subject to regulatory 

responsibilities under Section 763(c) of 

the Dodd-Frank Act and, as a result, will 

have to establish rules and enforce 

compliance with those rules by their 

participants.76 Thus, the conflicts of 

interest that the Commission has 

experienced with exchanges may be 

similar, although not necessarily 

identical, to the conflicts of interest that 

SB SEFs and SBS exchanges may face. 

The Commission nevertheless is 

mindful of the need to mitigate conflicts 

of interest for SB SEFs and SBS 

exchanges without unduly restricting 

the ability of trading facilities to be 

formed or the emergence of a 

competitive market for the trading of 

security-based swaps. 

The Commission requests comment 

on the types of conflicts of interest it has 

identified with respect to SB SEFs and 

SBS exchanges, including the listing 

and trading of security-based swaps on 

SB SEFs and SBS exchanges. Has the 

Commission identified all of the 

significant potential conflicts concerns? 

Do commenters disagree with any 

potential conflicts concerns that the 

Commission has identified? What other 

conflicts concerns may exist, if any? 

As discussed above, the Commission 

seeks to minimize the conflicts of 

interest for national securities 

exchanges through ownership 

limitations and governance 

requirements. Are the conflicts of 

interest relating to exchanges, which 

could elect to trade swaps and thus 

become SBS exchanges, different than 

the conflicts of interest relating to SB 


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77See proposed Rule 701(a) and (b) of Regulation 

MC. 

78See proposed Rule 701(a) under Regulation 

MC. 

SEFs, and, if so, how? To what extent, 

if any, should the Commission draw on 

its experience with conflicts of interest 

that may arise in the exchange context 

and with efforts to mitigate those 

conflicts and apply that experience in 

assessing conflicts of interest that may 

arise in the context of SB SEFs and SBS 

exchanges? What are the differences and 

similarities between the conflicts of 

interest that the Commission has 

encountered with respect to national 

securities exchanges and the conflicts of 

interest that it has identified with 

respect to SB SEFs and SBS exchanges? 

Further, are the conflicts of interest 

relating to SBS exchanges different than 

the conflicts of interest relating to 

exchanges that do not post or make 

available for trading security-based 

swaps? If there are no differences, 

should the Commission propose to 

adopt rules to mitigate conflicts of 

interest with respect to national 

securities exchanges that are not SBS 

exchanges or are the existing 

approaches to mitigating conflicts of 

interest for such exchanges sufficient? 

The Commission also requests 

comment on potential changes in these 

conflicts of interest. The Commission 

recognizes that the conflicts of interest 

that may exist today with respect to the 

trading of security-based swaps by SB 

SEFs and SBS exchanges may evolve 

over time and that, as this market 

evolves, the conflicts of interest that the 

Commission has identified for SB SEFs 

and SBS exchanges may change. The 

centralized trading of security-based 

swaps is still developing and may 

change significantly as the market for 

security-based swaps develops. In 

particular, the provisions in the DoddFrank Act relating to the centralized 

trading of security-based swaps are not 

yet effective. Once they become 

effective, market participants that trade 

security-based swaps will be subject to 

substantially more regulation, which 

may have an effect on the conflicts of 

interest at SB SEFs and SBS exchanges. 

What are commenters’ views on 

whether and how conflicts of interest 

for SB SEFs and SBS exchanges may 

evolve over time and how the 

Commission should respond to such 

changes? How are conflicts of interest 

likely to change as the centralized 

trading of security-based swaps and SB 

SEFs and SBS exchanges become more 

established? Are the conflicts of interest 

identified by the Commission likely to 

change as the trading of security-based 

swaps moves to regulated markets that 

must provide for impartial access and, 

if so, how? What potential new conflicts 

of interest could arise that the 

Commission should consider? How will 

potential changes in the clearing of 

security-based swaps affect conflicts of 

interest at SB SEFs and SBS exchanges? 

In addition, competitive forces within 

the security-based swaps market may 

help to mitigate conflicts of interest, for 

example, by increasing the number of 

institutions that trade security-based 

swaps and creating a broader market for 

security-based swaps. How will 

competition issues affect or change 

current or identified conflicts of 

interest? Will competition potentially 

create different or additional conflicts of 

interest that the Commission should 

consider? Would the Commission’s 

proposal to apply to SB SEFs and SBS 

exchanges standards to mitigate 

conflicts of interest that are similar to 

those approved for national securities 

exchanges influence whether those 

conflicts of interest will increase, 

diminish, or remain unchanged over 

time? 

Are there any other conflicts of 

interest that warrant examination? What 

other parties may have conflicts of 

interest that would affect whether they 

should control or participate in the 

governance of a SB SEF or SBS 

exchange? In what circumstances would 

these conflicts of interest arise? For 

example, might non-participant or nonmember shareholders have a conflict of 

interest? What would be the differences 

in conflicts of interest between 

participants and non-participants or 

members and non-members that would 

affect the SB SEF or SBS exchange? 

Would persons who are selected to be 

directors of a SB SEF or SBS exchange 

by participants or members have 

conflicts of interest based on their status 

as directors that would affect their 

ability to act in the best interest of the 

entity or in conformity with the 

Exchange Act, or to act to meet the 

policy objectives in Section 765 of the 

Dodd-Frank Act? Would directors be 

less likely to act to meet the policy 

objectives in Section 765 of the DoddFrank Act if they are selected by 

shareholders seeking to maximize the 

profits of the SB SEF or SBS exchange? 

How would participants’ or members’ 

potential conflicts of interest concerning 

open access and products traded 

compare to non-participants’ or nonmembers’ conflicts on such issues? How 

do the incentives of independent 

directors differ from those of nonindependent directors with respect to 

increasing access or promoting 

competition? 

IV. Discussion of Proposed Regulation 

MC: Mitigation of Conflicts of Interest 

of Security-Based Swap Clearing 

Agencies 

Section 765 directs the Commission to 

adopt rules to mitigate conflicts of 

interest, which rules may include 

numerical limits on control of, or voting 

rights with respect to, any securitybased swap clearing agency. The 

Commission preliminarily believes that 

requirements applicable to both 

governance and voting interests can 

play an essential role in mitigating 

conflicts of interests. However, the 

Commission recognizes that the nature 

of the governance, ownership and 

voting requirements to mitigate conflicts 

may differ depending on the conflicts of 

interest of the persons making decisions 

on behalf of the security-based swap 

clearing agency. In particular, the nature 

of the ownership and voting power of 

stockholders of the security-based swap 

clearing agency plays a role in 

determining the nature of the conflicts 

of interest that directors of the securitybased swap clearing agency will face. 

As previously noted, the Commission 

preliminarily believes that conflicts of 

interest may arise when a small number 

of participants exercise control or undue 

influence over a security-based swap 

clearing agency. Conflicts of interest 

may also arise, however, simply because 

directors and other decision-makers at a 

security-based swap clearing agency 

have multiple interests and goals, 

including maximizing profit for the 

benefit of shareholders and imposing 

risk restraints that may limit short-term 

profits, among others. 

In seeking to address conflicts of 

interests, the imposition of governance 

restrictions may lessen the need to 

impose certain voting limitations, while 

the imposition of certain voting 

limitations may alleviate the need to 

impose certain governance restrictions. 

Accordingly, the Commission is 

proposing two alternative approaches 

with respect to voting limitations and 

governance that would place differing 

levels of emphasis on each of these 

factors.77

The proposed rule would allow the 

security-based swap clearing agency to 

elect between the two alternatives. The 

first alternative places an emphasis on 

voting limitations while also imposing 

certain governance restrictions (‘‘Voting 

Interest Focus Alternative’’).78 The 

second alternative places an emphasis 

on governance restrictions while also 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
65894 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

79See proposed Rule 701(b) under Regulation 

MC. 

80See infra Section VIII requesting comment on 

whether alternatives with or without modifications 

should be allowed and whether certain 

requirements in each alternative should be 

combined to form a single approach. 

81See discussion infra Section IV.C. Securitybased swap clearing agencies will be required to be 

registered with the Commission under Section 17A 

of the Exchange Act upon the effective date of Title 

VII and, as a result, must comply with the standards 

in Section 17A that are applicable to all registered 

clearing agencies. 

82See proposed Rule 701(a)(1)(i) and (ii) under 

Regulation MC. 

83See proposed Rule 700(b) under Regulation 

MC, which provides that the terms ‘‘beneficial 

ownership,’’ ‘‘beneficially owns,’’ or any derivative 

thereof would be defined as having the same 

meaning, with respect to any security or other 

ownership interest, as set forth in § 240.13d–3, as 

if (and whether or not) such security or other 

ownership interest were a voting equity security 

registered under Section 12 of the Exchange Act (15 

U.S.C. 78l); provided that to the extent any person 

beneficially owns any security or other ownership 

interest solely because such person is a member of 

a group within the meaning of Section 13(d)(3) of 

the Exchange Act (15 U.S.C. 78m(d)(3)), such 

person shall not be deemed to beneficially own 

such security or other ownership interest, unless 

such person has the power to direct the vote of such 

security or other ownership interest. 

84The four clearing agencies registered with the 

Commission that have active business operations 

include: The Depository Trust Company, The 

National Securities Clearing Corporation, The Fixed 

Income Clearing Corporation, and The Options 

Clearing Corporation. 

85See supra note 40. 

86 Id. (stating that U.S. commercial banks reported 

trading revenues of $8.3 billion in the first quarter 

of 2010). 

87See supra notes 26 and 34. 

imposing certain voting limitations 

(‘‘Governance Focus Alternative’’).79

Although the Commission is proposing 

two separate alternatives, the 

Commission may also consider adopting 

only one alternative as the final rule or 

may combine aspects of each proposed 

alternative and adopt it as a single 

rule.80

In addition, the existing standards in 

Section 17A of the Exchange Act also 

help to mitigate conflicts of interest at 

registered clearing agencies and will be 

applied in addition to any standards 

adopted by the Commission under the 

Dodd-Frank Act.81

A. Alternative I: Voting Interest Focus 

Alternative 

As more fully described below, under 

the Voting Interest Focus Alternative, 

the Commission is proposing limitations 

on the voting interests held by 

individual participants of a securitybased swap clearing agency and by 

participants acting collectively as a 

group. In addition, the Commission is 

proposing certain requirements related 

to governance that would give 

independent directors a strong role in 

overseeing the security based-swap 

clearing agency. 

1. Voting Interest Focus Alternative: 

Individual Voting Limitation 

The Voting Interest Focus Alternative 

would provide that a security-based 

swap clearing agency may not permit a 

participant, either alone or together with 

its related persons, to (1) beneficially 

own, directly or indirectly, any interest 

in the security-based swap clearing 

agency that exceeds 20% of any class of 

securities, or other ownership interest, 

entitled to vote of such security-based 

swap clearing agency or (2) directly or 

indirectly vote, cause the voting of, or 

give any consent or proxy with respect 

to the voting of, any interest in the 

security-based swap clearing agency 

that exceeds 20% of the voting power of 

any class of securities or other 

ownership interest of such securitybased swap clearing agency.82 This 

proposed limitation on individual 

participant voting interest is designed to 

prevent any individual participant from 

owning, on a direct or indirect basis, a 

voting interest that would allow it to act 

on conflicts of interest in the securitybased swap clearing agency to the 

detriment of such security-based swap 

clearing agency and the security-based 

swaps market. 

The terms ‘‘beneficial ownership,’’ 

‘‘beneficially owns’’ or any derivatives 

thereof would be defined in reference to 

Rule 13d–3 under the Exchange Act, 

Determination of Beneficial 

Ownership.83 The concept of beneficial 

ownership in Rule 13d–3 is designed to 

encompass any person or group of 

persons that may be able to act to 

influence or control an issuer. The 

Commission proposes to use the same 

definition of beneficial ownership in 

this rule because it also would describe 

those persons or groups of persons that 

may be able to act to influence or 

control a security-based swap clearing 

agency. However, to the extent any 

participant beneficially owns any 

security or other ownership interest 

solely because such participant is a 

member of a group within the meaning 

of Section 13(d)(3) of the Exchange Act, 

such participant would not be deemed 

to beneficially own such security or 

other ownership interest for purposes of 

this section, unless such person had the 

power to direct the vote of such security 

or other ownership interest. The 

Commission proposes to exclude 

beneficial ownership that results solely 

from being a member of a group to 

provide more certainty to those that 

would be required to comply with the 

limitations, in light of the effect of 

exceeding the ownership limit—i.e., 

that the participant will be divested of 

the excess interest. 

While the Commission has not 

previously adopted voting interest 

limitations for registered clearing 

agencies in the other securities markets, 

the security-based swaps market 

presents a different potential concern 

with respect to conflicts of interests. In 

the securities markets for which clearing 

agencies currently registered with the 

Commission provide clearance and 

settlement services,84 there are 

significantly more dealers and 

participants. The incentives of 

participant-owners of these registered 

clearing agencies are generally aligned 

with those of the clearing agency: To 

accept for clearing as many participants 

that can meet reasonable participation 

standards and as many transactions that 

fit into the clearing agencies’ risk 

management structure. Furthermore, the 

OTC derivatives market has a relatively 

high concentration of market activity 

among a limited number of dealers 85

that earn significant revenues from the 

currently opaque OTC market.86 The 

existing cash equities and listed options 

markets, on the other hand, are 

transparent and widely disbursed over a 

range of market participants. As 

previously discussed, participants in a 

security-based swap clearing agency 

may have incentives to limit 

participation in the clearing agency and 

to limit the scope of products cleared. 

Moreover, the Commission’s experience 

regulating security-based swap clearing 

agencies along with the views expressed 

by market participants suggest that 

security-based swap clearing agencies 

may be particularly susceptible to 

conflicts of interest.87 The Commission 

preliminarily believes that prohibiting a 

participant and its affiliates and related 

persons from having more than a 20% 

voting interest in a security-based swap 

clearing agency, taking into account the 

other requirements under the Voting 

Interest Focus Alternative as described 

below, would establish a sufficiently 

high threshold to preclude any one 

participant from exerting undue 

influence over the security-based swap 

clearing agency. The 20% threshold 

proposed for participant voting interests 

in a security-based swap clearing agency 

is similar to the threshold that the 

Commission previously proposed for 

national securities exchanges and 

national securities associations, is the 

same as the threshold now being 

proposed for SBS exchanges and SB 

SEFs, and is consistent with the limits 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 65895 

88As previously noted, national securities 

exchanges generally prohibit exchange members, 

alone or together with their related persons, from 

owning more than 20% of the exchange or being 

entitled to vote shares in excess of 20%. See, e.g., 

Securities Exchange Act Release No. 61698, 75 FR 

at 13156, supra note 59. 

89See proposed Rule 701(a)(1)(iii) and (iv) under 

Regulation MC. 

90See supra note 40. 

91As previously noted, the Commission has 

generally prohibited any person, alone or together 

with its related persons, from owning more than 

40% of a national securities exchange. See, e.g., 

Securities Exchange Act Release No. 61698, 75 FR 

at 13156, supra note 59. 

92See proposed Rule 700(u) of Regulation MC. 

93The term ‘‘affiliate’’ would be defined as any 

person that, directly or indirectly, controls, is 

controlled by, or is under common control with, the 

person. See proposed Rule 700(a) under Regulation 

MC. ‘‘Control’’ would be defined as the possession, 

direct or indirect, of the power to direct or cause 

the direction of the management and policies of a 

person, whether through the ownership of voting 

securities, by contract, or otherwise. Any person 

that (i) is a director, general partner, or officer 

exercising executive responsibility (or having 

similar status or function); (ii) directly or indirectly 

has the right to vote 25% or more of a class of 

voting securities or has the power to sell or direct 

the sale of 25% or more of a class of voting 

securities; or (iii) in the case of a partnership, has 

the right to receive, upon dissolution, or has 

contributed, 25% or more of the capital, is 

presumed to control that person. See proposed Rule 

700(e) under Regulation MC. 

94There is currently not a definition for a ‘‘person 

associated with a participant in a clearing agency’’ 

in the Exchange Act or in Commission rules. 

However, the Commission believes that the 

definition for the term ‘‘person associated with a 

member’’ in Section 3(a)(21) of the Exchange Act 

should be used as the basis for the definition of the 

term ‘‘person associated with a participant in a 

security-based swap clearing agency,’’ as the 

purposes of the two defined terms are similar. 

Accordingly, the Commission proposes to define 

the term ‘‘person associated with a participant in a 

security-based swap clearing agency’’ as (1) any 

partner, officer, director, or branch manager of such 

security-based swap dealer or major security-based 

swap participant (or any person occupying a similar 

status or performing similar functions); (2) any 

person directly or indirectly controlling, controlled 

by, or under common control with such securitybased swap dealer or major security-based swap 

participant; or (3) any employee of such securitybased swap dealer or major security-based swap 

participant. This term does not include any person 

associated with a participant in a security-based 

swap clearing agency whose functions are solely 

clerical or ministerial. See proposed Rule 700(r) of 

Regulation MC. 

95The term ‘‘immediate family member’’ would be 

defined in the proposed rules as a person’s spouse, 

parents, children, and siblings, whether by blood, 

marriage, or adoption, or anyone residing in such 

person’s house. See proposed Rule 700(i) under 

Regulation MC. 

96See proposed Rule 701(a)(2) under Regulation 

MC. 

currently in place with respect to 

national securities exchanges.88

2. Voting Interest Focus Alternative: 

Aggregate Voting Limitation 

The Voting Interest Focus Alternative 

would provide that a security-based 

swap clearing agency may not permit a 

participant, either alone or together with 

its related persons, to in the aggregate 

with any other security-based swap 

clearing agency participants and their 

related persons (1) beneficially own, 

directly or indirectly, any interest in the 

security-based swap clearing agency 

that exceeds 40% of any class of 

securities, or other ownership interest, 

entitled to vote of such security-based 

swap clearing agency or (2) directly or 

indirectly vote, cause the voting of, or 

give any consent or proxy with respect 

to the voting of, any interest in the 

security-based swap clearing agency 

that exceeds 40% of the voting power of 

any class of securities or other 

ownership interest of such securitybased swap clearing agency.89 Under the 

individual participant voting limitation 

and without this aggregate limitation on 

voting interest, five entities that have 

voting interests of 20% could control 

the security-based swap clearing agency. 

Since a small number of dealers 

currently control the OTC derivatives 

market,90 the Commission preliminarily 

believes that this aggregate limitation on 

voting interest is a necessary corollary 

to the individual participant voting 

limitation. The 40% aggregate limitation 

on voting interest, which is consistent 

with limits used in similar contexts,91

would restrict participants’ ability to 

collectively acquire a majority voting 

interest, while maintaining the integrity 

of the 20% individual participant 

limitation. 

3. Voting Interest Focus Alternative: 

Indirect or Affiliate Ownership and 

Ownership Through Related Persons 

The Voting Interest Focus Alternative 

would also address conflicts of interest 

created by indirect voting interests of 

the security-based swap clearing agency 

because a rule that limits only direct 

voting interests could be circumvented 

by holding the interest through an 

affiliated party or by holding an interest 

in a controlling entity. For purposes of 

determining a security-based swap 

clearing agency participant’s voting 

interest, the proposed rule would, as 

indicated in the description of the rules 

above, combine such person’s interest 

with those of its ‘‘related persons.’’ 92

The Commission proposes to define 

the term ‘‘related person’’ to include 

persons whose relationship with respect 

to a participant would likely cause them 

to have the same conflicts of interest 

with respect to the security-based swap 

clearing agency (e.g., ‘‘affiliate,’’ 

‘‘immediate family member,’’ and 

‘‘person associated with a participant in 

a security-based swap clearing agency’’). 

Specifically, proposed Rule 700(u) 

would define ‘‘related person’’ as that 

term relates to security-based swap 

clearing agencies as: (i) Any affiliate 93

of a participant in a security-based swap 

clearing agency; (ii) any person 

associated with a participant in a 

security-based swap clearing agency; 94

(iii) any immediate family member 95 of 

a participant in the security-based swap 

clearing agency that is a natural person, 

or any immediate family member of the 

spouse of such person, who, in each 

case, has the same home as the 

participant in the security-based swap 

clearing agency, or who is a director or 

officer of the security-based swap 

clearing agency or any of its parents or 

subsidiaries; and (iv) any immediate 

family member of a person associated 

with a participant in the security-based 

swap clearing agency that is a natural 

person, or any immediate family 

member of the spouse of such person, 

who, in each case, has the same home 

as the person associated with the 

participant in the security-based swap 

clearing agency, or who is a director or 

officer of the security-based swap 

clearing agency, or any of its parents or 

subsidiaries. 

A voting interest limitation of 20% for 

an individual participant of a securitybased swap clearing agency and an 

aggregate voting interest limitation of 

40% for all participants of a securitybased swap clearing agency is intended 

to restrict the ability of security-based 

swap clearing agency participants to 

exercise undue influence over the 

governance of a security-based swap 

clearing agency for their own selfinterest. At the same time, these voting 

limitations would still permit 

participants to hold significant 

economic interests in a security-based 

swap clearing agency. 

4. Voting Interest Focus Alternative: 

Divestiture and Voting Restriction 

Requirement 

In order to assure that a securitybased swap clearing agency maintains 

the proposed voting interest limitations, 

the Commission is proposing to require 

security-based swap clearing agencies to 

have rules in place for the divestiture of 

voting interests that exceed the 

prescribed limitations.96 The 

Commission preliminarily believes that 

in order for the voting limitations to be 

effective, the rule must require securitybased swap clearing agencies to take 

action to reduce participants’ and 

participants’ related persons’ voting 

interests. 

The Commission is proposing to 

provide security-based swap clearing 

agencies flexibility in determining how 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
65896 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

97 Id. 98The term ‘‘Board’’ would be defined as the 

Board of Directors or Board of Governors of the SB 

SEF, SBS exchange or facility thereof that posts or 

makes available for trading security-based swaps, or 

security-based swap clearing agency, as applicable, 

or any equivalent body. See proposed Rule 700(c) 

under Regulation MC. 

99The term ‘‘director’’ would be defined as any 

member of the Board. See Proposed Rule 700(f) 

under Regulation MC. 

100Other regulators have previously chosen 35% 

as an appropriate level for independent 

representation on the Board of self-regulatory 

organizations. See 72 FR 6936 (February 14, 2007), 

which adopts final rules to address conflicts of 

interest at self-regulatory organizations regulated by 

the CFTC. Specifically, the final rules establish 

acceptable practices under Core Principle 15 

applicable to DCMs and that provide that the Board 

is composed of at least 35% public directors. 

101Proposed Rule 700(c) under Regulation MC 

does not prescribe the number of participant 

directors that are required to be on the Board. A 

security-based swap clearing agency may choose to 

have the majority of the Board be composed of 

independent directors. 

102See proposed Rule 700(j) under Regulation 

MC. 

to implement this divesture 

requirement. Any rules adopted by a 

security-based swap clearing agency 

must assure that the security-based 

swap clearing agency has a viable, 

enforceable mechanism to divest a 

participant and its related persons of 

any voting interest owned in excess of 

the 20% limitation, and not to give 

effect to the portion of any voting 

interest in excess of the 20% individual 

limitation or the 40% aggregate 

limitation. The Commission is also 

proposing to require a security-based 

swap clearing agency’s procedures to 

provide a mechanism for the securitybased swap clearing agency to obtain 

information relating to the voting 

interests in the security-based swap 

clearing agency held by its participants 

and their related persons.97 The 

Commission believes that this 

requirement is essential to a securitybased swap clearing agency’s ability to 

monitor the voting interest held by its 

participants and their related persons in 

relation to the proposed voting 

limitations. 

5. Voting Interest Focus Alternative: 

Independent Directors on Board 

The Commission’s Voting Interest 

Focus Alternative would impose 

substantive requirements on the 

governance of security-based swap 

clearing agencies that are designed to 

address the concern that participants’ 

conflicts of interest may lead them to 

take actions that would potentially limit 

fair and open access and product 

eligibility for central clearing, as well as 

potentially weaken the risk management 

of security-based swap clearing 

agencies. The proposed governance 

provisions, as discussed below, are 

intended to help mitigate potential 

conflicts of interest and assure the fair 

administration and governance of a 

security-based swap clearing agency by 

limiting the control that any one 

participant or group of participants may 

exercise over the security-based swap 

clearing agency. 

The Commission proposes under the 

Voting Interest Focus Alternative to 

require the Board 98 of a security-based 

swap clearing agency to be composed of 

at least 35% independent directors.99

The presence of a significant number of 

independent directors on the Board of a 

security-based swap clearing agency 

should provide the addition of strong 

and independent oversight within the 

security-based swap clearing agency to 

serve as a potential check against 

conflicts of interest that could pose a 

detriment to the security-based swap 

clearing agency, other firms, or the 

security-based swaps market generally. 

The Commission preliminarily believes 

that a level below 35% independent 

directors may not be sufficient to assure 

that independent directors have a 

significant voice.100 A requirement 

lower than 35% would potentially place 

independent directors in a small enough 

minority that, relative to the remaining 

director slots that could potentially be 

filled by participant or management 

directors, the views of the independent 

directors would not be given enough 

consideration. While independent 

directors would have less than a 

majority representation on the Board 

under the Voting Interest Focus 

Alternative, they would have a 

meaningful opportunity to contribute to 

determinations made by the Board and 

the various Board committees. The 

Commission is proposing to require at 

least 35% independent directors 

combined with the proposal to limit 

participant voting interests in a securitybased swap clearing agency, both on an 

individual and aggregate basis, as a 

means of effectively mitigating conflict 

of interest concerns while also 

permitting a greater proportion of 

participants to serve on the Board of a 

security-based swap clearing agency.101

This aspect of the proposal may address 

potential concerns that requiring a 

majority independent Board would 

affect the Board’s ability to effectively 

perform risk management functions. 

The Commission also proposes that 

no director may qualify as an 

independent director unless the Board 

affirmatively determines that the 

director does not have a material 

relationship with the security-based 

swap clearing agency or any affiliate of 

the security-based swap clearing agency, 

or a participant in the security-based 

swap clearing agency, or any affiliate of 

a participant in the security-based swap 

clearing agency. The purpose of this 

proposal is to provide assurance that an 

independent director candidate does not 

have any relationships or affiliations 

that would prevent the candidate from 

being independent of the security-based 

swap clearing agency. Accordingly, the 

Commission proposes to define the term 

‘‘independent director,’’ as it is used 

with respect to a security-based swap 

clearing agency, as a director who has 

no material relationship with: 

(1) The security-based swap clearing 

agency; 

(2) Any affiliate of the security-based 

swap clearing agency; 

(3) A participant in the security-based 

swap clearing agency; or 

(4) Any affiliate of a participant in the 

security-based swap clearing agency.102

Some relationships or affiliations 

would clearly exclude a director from 

qualifying as independent of a securitybased swap clearing agency. For 

example, a director would not be 

considered independent if any of the 

following circumstances exists: 

• The director, or an immediate 

family member, is employed by or 

otherwise has a material relationship 

with the security-based swap clearing 

agency or any affiliate thereof; or within 

the past three years was employed by or 

otherwise had a material relationship 

with the security-based swap clearing 

agency or any affiliate thereof; 

• The director is a participant in the 

security-based swap clearing agency or 

within the past three years was 

employed by or affiliated with a 

participant or any affiliate thereof, or 

the director has an immediate family 

member that is, or within the past three 

years was, an executive officer of a 

participant in the security-based swap 

clearing agency or any affiliate thereof; 

• The director, or an immediate 

family member, has received during any 

twelve-month period within the past 

three years payments that reasonably 

could affect the independent judgment 

or decision-making of the director from 

the security-based swap clearing agency 

or any affiliate thereof or from a 

participant in the security-based swap 

clearing agency or any affiliate thereof, 

other than the following: 

Æ Compensation for Board or Board 

committee services; 

Æ Compensation to an immediate 

family member who is not an executive 

officer of the security-based swap 

clearing agency or any affiliate thereof 

or of a participant in the security-based 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 65897 

103See proposed Rule 700(j)(2) under Regulation 

MC. 

104See proposed Rule 700(l) under Regulation 

MC. 

105See Securities Exchange Act Release No. 

48745 (November 4, 2003), 68 FR 64154 (November 

12, 2003) (order approving SRO rules that would 

find a director independent only where that 

director does not have a relationship with the 

company that would impair her independence). 

106See proposed Rule 701(a)(3)(iii) under 

Regulation MC. 

107See proposed Rule 701(a)(4)(i) under 

Regulation MC. 

108See proposed Rule 701(a)(4)(ii) under 

Regulation MC. 

109Section 17A(a)(3)(C) of the Exchange Act 

requires fair representation among participants of a 

clearing agency by providing them with a 

meaningful opportunity to participate in the 

selection of directors. 15 U.S.C. 78q–1(a)(3)(C). 

110See proposed Rule 701(a)(5) under Regulation 

MC. 

swap clearing agency or any affiliate 

thereof; or 

Æ Pension and other forms of deferred 

compensation for prior services, not 

contingent on continued service. 

• The director, or an immediate 

family member, is a partner in, or 

controlling shareholder or executive 

officer of, any organization to or from 

which the security-based swap clearing 

agency or any affiliate thereof made or 

received payments for property or 

services in the current or any of the past 

three full fiscal years that exceed 2% of 

the recipient’s consolidated gross 

revenues for that year, other than the 

following: 

Æ Payments arising solely from 

investments in the securities of the 

security-based swap clearing agency or 

affiliate thereof; or 

Æ Payments under non-discretionary 

charitable contribution matching 

programs. 

• The director, or an immediate 

family member, is, or within the past 

three years was, employed as an 

executive officer of another entity where 

any executive officers of the securitybased swap clearing agency serve on 

that entity’s compensation committee; 

• The director, or an immediate 

family member, is a current partner of 

the outside auditor of the security-based 

swap clearing agency or any affiliate 

thereof, or was a partner or employee of 

the outside auditor of the security-based 

swap clearing agency or any affiliate 

thereof who worked on the audit of the 

security-based swap clearing agency or 

any affiliate thereof, at any time within 

the past three years; or 

• In the case of a director that is a 

member of the audit committee, such 

director (other than in his or her 

capacity as a member of the audit 

committee, the Board, or any other 

Board committee), accepts, directly or 

indirectly, any consulting, advisory, or 

other compensatory fee from the 

security-based swap clearing agency or 

any affiliate thereof or a participant in 

the security-based swap clearing agency 

or any affiliate thereof, other than fixed 

amounts of pension and other forms of 

deferred compensation for prior service, 

provided such compensation is not 

contingent in any way on continued 

service.103

Under the proposed rule, the term 

‘‘material relationship’’ would be 

defined as a relationship, whether 

compensatory or otherwise, that 

reasonably could affect the independent 

judgment or decision-making of the 

director.104 This definition is intended 

to encompass all significant instances in 

which a director’s independence is 

compromised.105 In determining 

whether a ‘‘material relationship’’ exists, 

security-based swap clearing agencies 

should consider the known 

relationships between a director and the 

security-based swap clearing agency to 

determine whether the relationship is 

likely to impair the independence of the 

director in making decisions that affect 

the security-based swap clearing agency. 

The proposed definitions of 

‘‘independent director’’ and ‘‘material 

relationship’’ should help to reduce the 

potential that the independent directors 

on the Board of the security-based swap 

clearing agency are subject to conflicts 

of interest. 

Under the Voting Interest Focus 

Alternative, the security-based swap 

clearing agency would be required to 

establish policies and procedures to 

require each director, on his or her own 

initiative or upon request of the 

security-based swap clearing agency, to 

inform the security-based swap clearing 

agency of the existence of any 

relationship or interest that may 

reasonably be considered to bear on 

whether such director is an independent 

director.106 The security-based swap 

clearing agency would be expected to 

take reasonable measures to confirm the 

accuracy of the information provided. 

This requirement should help the 

security-based swap clearing agency to 

assure that it is informed of the 

existence of any relationship or interest 

that may reasonably be considered to 

bear on whether a director is 

independent as soon as possible and 

without requiring the security-based 

swap clearing agency to investigate for 

such information. 

6. Voting Interest Focus Alternative: 

Board Committees 

a. Nominating Committee 

The Voting Interest Focus Alternative 

would require security-based swap 

clearing agencies to create and maintain 

a nominating committee for the 

selection of Board members, and would 

require that such nominating committee 

be composed of a majority of 

independent directors.107 Directors 

serving on the nominating committee 

that are not independent may be more 

likely to select Board candidates whose 

views align with such directors’ 

interests instead of the interests of the 

security-based swap clearing agency or 

the markets generally. Having a 

nominating committee that is composed 

of majority independent directors 

should help to address and facilitate the 

selection of independent directors. 

The Voting Interest Focus Proposal 

would also require that the nominating 

committee identify candidates for Board 

membership through a consultative 

process with the participants of the 

security-based swap clearing agency 

consistent with criteria approved by the 

Board.108 This should help assure that 

the selection of directors of the Board is 

conducted in a prudent manner while at 

the same time allowing for the 

participants of the security-based swap 

clearing agency to have fair 

representation in the selection of the 

directors of the Board.109

b. Other Board Committees 

The Voting Interest Focus Alternative 

would require that other Board 

committees of a security-based swap 

clearing agency that are delegated 

authority to act on the Board’s behalf, 

including but not limited to the risk 

committee, consist of at least 35% 

independent directors similar to the 

requirement that would be imposed on 

the Board itself.110 This requirement 

should give independent directors a 

meaningful voice, similar to the one 

they would have in the Board itself, 

within Board committees that 

essentially perform the functions of a 

Board. The proposed requirement 

would also apply to an ‘‘advisory 

committee’’ to the extent that the 

committee is authorized to act on behalf 

of the Board, including instances where 

the Board is required to seek approval 

from the committee before making a 

determination. However, the 

Commission preliminarily believes that 

the independence requirement should 

not extend to a committee that functions 

in a purely advisory role, because 

members of those committees are not in 

a position to exercise powers of the 


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111See proposed Rule 701(a)(6) under Regulation 

MC. If the security-based swap clearing agency does 

not have a disciplinary panel, these requirements 

should be interpreted as applying to the equivalent 

of a disciplinary panel in the security-based swap 

clearing agency’s internal processes, unless the 

disciplinary panel (or its equivalent) has been 

delegated authority to act on the Board’s behalf, in 

which case it would be subject to the 35% 

independent director requirement. 

Board or exert influence over the Board 

by dictating how the Board will act. 

c. Disciplinary Panels 

The Commission’s Voting Interest 

Focus Alternative would impose special 

requirements on the composition of 

disciplinary panels (or their 

equivalents) of security-based swap 

clearing agencies that have not been 

delegated authority to act on the Board’s 

behalf.111 The Commission believes that 

participants of a security-based swap 

clearing agency should be appropriately 

disciplined for failure to comply with 

the rules of a security-based swap 

clearing agency, particularly as they 

relate to the ongoing risk management 

related requirements applicable to 

participants. Accordingly, the 

Commission is proposing that the 

disciplinary processes of a securitybased swap clearing agency preclude 

any group or class of persons that are 

participants in the security-based swap 

clearing agency from exercising 

disproportionate influence on any 

disciplinary panels. In other words, to 

the extent that there is more than one 

type of group or class of persons that are 

participants in a security-based swap 

clearing agency, the composition of the 

disciplinary panel shall include 

representation of each group or class 

and shall not allow one group or class 

to have representation on the 

disciplinary panel that is out of 

proportion as compared to other groups 

or classes of persons that are 

participants in the security-based swap 

clearing agency. Furthermore, the 

disciplinary panel of the security-based 

swap clearing agency would include at 

least one person who would qualify as 

an independent director. 

7. Voting Interest Focus Alternative: 

Request for Comment 

The Commission requests comment 

on all aspects of the voting limitations 

under the Voting Interest Focus 

Alternative, including whether the 20% 

limitations on individual participant 

voting interest and the 40% aggregate 

limitation on participant voting interest 

are sufficient to limit the ability of a 

participant or a group of participants to 

exercise undue influence or control over 

the governance of a security-based swap 

clearing agency. Should the 20% and 

40% limitations be lower given the 

existing concentration of the industry in 

a small number of large dealers? If so, 

what limitations would be appropriate 

and why? Are there other conflicts of 

interest not discussed in this release 

that the Commission should consider 

generally and specifically with respect 

to voting limitations? Would the 

proposed restrictions have an effect on 

the ability to form new security-based 

swap clearing agencies or to effectively 

operate existing security-based swap 

clearing agencies? 

The Commission also requests 

comment on whether there may be other 

ways to structure the interests in a 

security-based swap clearing agency to 

mitigate potential conflicts of interest. 

Are there other thresholds for voting 

limitations or approaches that the 

Commission should consider? Are there 

other methods for mitigating conflicts of 

interest the Commission should 

consider, such as limitations on holding 

non-voting interests in a security-based 

swap clearing agency? How would nonvoting interests affect the potential for 

conflicts of interests? 

Section 765 enumerates Specified 

Entities for the Commission to consider 

in its rulemaking. The proposed rule 

would apply only to Specified Entities 

that are participants of the securitybased swap clearing agency and not to 

other Specified Entities, because the 

Commission preliminarily believes that 

those entities that are participants of a 

clearing agency are most likely to have 

a conflict of interest that would affect 

the access, product eligibility, and risk 

management issues discussed in this 

release. However, the Commission 

requests comment on whether all 

Specified Entities, regardless of 

participant status, should be subject to 

the proposed restrictions on voting 

interests. What are the potential 

conflicts of interest associated with 

Specified Entities that are not 

participants? Might Specified Entities 

that are not participants in a securitybased swap clearing agency have an 

interest in limiting the number or type 

of security-based swaps that are 

accepted for clearing to the extent that 

they may profit from trading securitybased swaps that are not centrally 

cleared? Are there any other classes of 

persons, such as participants or 

members of SB SEFs or SBS exchanges, 

that should also be subject to the 

proposed restrictions even though they 

are not participants of a security-based 

swap clearing agency? What effect 

would such restrictions have on 

mitigating conflicts of interest at 

security-based swap clearing agencies? 

What effect would such restrictions 

have on the ability to form new securitybased swap clearing agencies? 

The Voting Interest Focus Alternative 

would require that voting limitations be 

determined by including interests held 

directly by a participant in the securitybased swap clearing agency, by 

including indirect interests of a 

participant in the security-based swap 

clearing agency, and by including 

interests held by related persons of a 

participant in the security-based swap 

clearing agency. The Commission 

requests comment on whether its 

formulation for calculating the aggregate 

and individual limits is appropriate. 

Specifically, the Commission requests 

comment on whether the scope of the 

definitions of ‘‘affiliate,’’ ‘‘immediate 

family member,’’ and ‘‘related person’’ 

are over-inclusive or under-inclusive 

and, if either, why? Is there a different 

methodology to reach the interest of any 

person with whom a security-based 

swap clearing agency participant may be 

able to act in concert with to unduly 

influence or control a security-based 

swap clearing agency that the 

Commission should consider? 

The Commission seeks comment on 

whether requiring the Board of a 

security-based swap clearing agency to 

be composed of at least 35% 

independent directors would improve 

governance of the security-based swap 

clearing agency and mitigate potential 

conflicts of interest. Is 35% sufficient to 

give independent directors a meaningful 

voice within the Board, or would a 

higher or lower level be appropriate? 

Should the Commission require that a 

majority of the Board be composed of 

independent directors? How are these 

independent directors likely to affect 

the activities of the security-based swap 

clearing agency? What are their 

incentives to assure open and fair 

access, increased product eligibility, 

and sound risk management at a 

security-based swap clearing agency? Do 

independent directors have any 

conflicts of interest that would affect 

their ability to facilitate these 

objectives? 

The Commission also requests 

comment on whether other measures 

concerning governance should be used 

to mitigate conflicts of interest at 

security-based swap clearing agencies, 

either in addition to or instead of the 

proposals outlined in this release. In 

particular, what other approaches 

would improve governance and mitigate 

conflicts of interest for security-based 

swap clearing agencies? For example, 

would State laws governing the 

fiduciary duty owed by the Board to a 

corporation help to mitigate conflicts of 

interest? Should the Commission 


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consider any additional requirements 

related to fiduciary duties? The policies 

and charter documents of individual 

corporations also often impose 

additional responsibilities and 

obligations on directors. Should 

security-based swap clearing agencies 

be required to put in place specific 

policies or charters to address conflicts 

of interest by the Board? What policies 

or charters would be necessary to 

provide assurance that participant 

directors will act in the best interests of 

the security-based swap clearing 

agency? What other requirements, if 

any, should be in place with respect to 

the duties owed by the Board in order 

to mitigate conflicts of interest at 

security-based swap clearing agencies? 

In addition, the Commission requests 

comment on its proposed definitions, 

including the definitions of 

‘‘independent director’’ and ‘‘material 

relationship.’’ Are there other ways to 

define ‘‘independent director’’ or 

‘‘material relationship?’’ If so, what are 

they? Should the Commission adopt 

other provisions that contain particular 

circumstances that would preclude a 

finding that a director is independent or 

that would deem a relationship 

material? Should the Commission take 

into account a director’s salary or 

benefits he or she receives for being a 

director in order to consider whether an 

interest in keeping the directorship 

could make a director more likely to act 

favorably toward those that control the 

Board? Should the Commission adopt a 

specific look-back period within which 

to determine whether a ‘‘material 

relationship’’ exists? Should additional 

terms used in the proposed rule be 

defined? 

The Commission requests comment 

on the proposed compositional 

requirements of committees of the Board 

under the Voting Interest Focus 

Alternative. Is the requirement that 

Board committees that are delegated 

authority to act on behalf of the Board 

be composed of at least 35% 

independent directors appropriate? The 

Commission also requests comment on 

whether there may be other ways to 

structure governance restrictions for 

security-based swap clearing agencies to 

mitigate potential conflicts of interest. 

In particular, the Commission requests 

comment on the proposed 

compositional requirements of the 

nominating committee. What is the 

potential effect of requiring a securitybased swap clearing agency to have a 

majority independent nominating 

committee? Are there other processes 

for the selection of independent 

directors and the fair representation of 

the participants and shareholders of a 

security-based swap clearing agency 

that the Commission should consider 

with respect to the nominating 

committee? Should end-users or any 

other group be given guaranteed rights 

of participation in the governance of the 

security-based swap clearing agency? 

Should the Commission participate in 

the Board selection process, such as by 

requiring consultation on 

appointments? Should the Commission 

consider an alternative to a 

compositional requirement for a 

nominating committee, such as allowing 

a security-based swap clearing agency to 

have a board of trustees responsible for 

nominating candidates for the Board? If 

this were a viable alternative, should 

there be compositional requirements or 

other limits imposed on the board of 

trustees? How should such a board of 

trustees be appointed? Would the 

alternative of a board of trustees to 

nominate directors provide greater 

assurance that independent directors are 

truly independent not only at the time 

of their nomination but during their 

service on the Board as well? 

With respect to governance as it 

relates to the risk committee, should 

there be special requirements relating to 

the risk committee, or its equivalent, of 

the Board? For instance, one possible 

alternative approach could be to provide 

separate requirements applicable only to 

the risk committee that reflect the 

highly specialized risk management 

expertise required of directors serving 

on that committee. For example, instead 

of requiring that the risk committee be 

composed of at least 35% independent 

directors (where such committee is 

delegated authority to act on the Board’s 

behalf), the requirement could apply to 

a smaller number of independent 

directors, and also explicitly require 

that other interested persons, such as 

customers of participants, be 

represented on the risk committee. The 

Commission requests comment on 

whether a more prescriptive approach 

such as the one described above would 

be appropriate for the risk committee 

and what levels of participation by 

participants, customers of participants, 

or others would be appropriate. Are 

there factors that warrant treating the 

risk committee differently from other 

Board committees? Should the 

Commission require the Board to report 

to the Commission if the Board 

disagrees with a recommendation of the 

risk committee? Is the risk committee 

more or less prone to conflict of interest 

issues? Are there factors other than 

conflicts of interest that should be taken 

into consideration? Is it desirable to 

have an explicit requirement with 

respect to customers of participants? If 

so, how many customers should serve 

on the risk subcommittee relative to 

independent directors and participant 

directors? What definition of customer 

should be used for these purposes? Are 

there distinctions that should be made 

between the different types of customer 

firms for this purpose? 

Another possible alternative approach 

could be to limit the applicable 

restrictions on the risk committee to 

circumstances where a specific range of 

topics is being addressed. For example, 

restrictions on participation in a risk 

committee could be limited to only 

those circumstances in which a 

determination about issues such as 

participant standards and product 

eligibility were being made. What are 

the potential advantages or 

disadvantages of such an approach? 

Would it be possible to separate 

activities of a committee based on 

topics? Are there certain issues that 

pose more or less of a concern with 

respect to conflicts of interests? 

The Commission also requests 

comment regarding whether any 

requirements should be imposed on 

advisory committees. Would an 

independence requirement on a purely 

advisory committee mitigate potential 

conflicts of interest? Are there 

circumstances in which a purely 

advisory committee exercises 

substantial power over the Board? 

The Commission requests comment 

on the composition of the disciplinary 

panel of the security-based swap 

clearing agency. Would the proposed 

rule be sufficient to address potential 

conflicts of interest that may interfere 

with the fair and effective disciplinary 

processes of a security-based swap 

clearing agency? Should different 

restrictions be imposed? 

Although independent directors may 

address some of the conflicts of interest 

concerns that underlie Section 765 of 

the Dodd-Frank Act, they may not 

effectively eliminate all conflicts. The 

Commission, however, believes that 

effective governance via a partially 

independent Board is compatible with 

the characteristics of security-based 

swap clearing agencies, and the types of 

conflicts that may be inherent with 

respect to such entities. 

B. Alternative II: Governance Focus 

Alternative 

As more fully described below, under 

the Governance Focus Alternative, the 

Commission is proposing governance 

restrictions including requiring a 

majority of independent directors on the 

Board and voting restrictions that would 

be applicable only to individual 


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65900 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

112See proposed Rule 701(b)(1) under Regulation 

MC. 

113The 5% threshold level for ownership has 

previously been found by the Commission in other 

contexts to trigger reporting requirements to the 

Commission related to the ability to control an 

organization. See Rule 13d–1(a) under the Exchange 

Act, 17 CFR 240.13d–1(a) (‘‘Any person who, after 

acquiring directly or indirectly the beneficial 

ownership of any equity security of a class which 

is specified in paragraph (i) of this section, is 

directly or indirectly the beneficial owner of more 

than 5% of the class shall, within 10 days after the 

acquisition, file with the Commission, a statement 

containing the information required by Schedule 

13D’’). In addition, investors acquiring more than a 

5% interest in a company must file a form certifying 

that they acquired that interest without ‘‘the effect 

of changing or influencing the control of the issuer 

***’’ Rule 13d–1(c)(1) under the Exchange Act, 17 

CFR 240.13d–1(c)(1). See, also, Gaf Corp. v. 

Milstein, 453 F.2d 709 (2d Cir. N.Y. 1971), stating 

that ‘‘[T]he purpose of section 13(d) is to alert the 

marketplace to every large, rapid aggregation or 

accumulation of securities, regardless of technique 

employed, which might represent a potential shift 

in corporate control. * * *’’ Id. at 717. 

114See, e.g., ‘‘The US Model for Clearing and 

Settlement: An Overview of DTCC,’’ available at: 

http://www.dtcc.com/downloads/about/

US%20Model%20for%20Clearing%

20and%20Settlement.pdf. (‘‘[O]wnership and 

governance of [The National Securities Clearing 

Corporation] and [The Depository Trust Company] 

were from the outset those typical of market 

utilities.’’). 

115See supra Section I.A.3. 

116See supra note 92 and accompanying text. 

117See proposed Rule 701(b)(1) under Regulation 

MC. 

118See supra Section I.A.4. 

119See proposed Rule 701(b)(2) under Regulation 

MC. 

participants of a security-based swap 

clearing agency. The Governance Focus 

Alternative differs from the Voting 

Interest Focus Alternative in that it 

provides greater emphasis on 

requirements regarding the governance 

arrangements of a security-based swap 

clearing agency as the primary means to 

mitigate conflicts of interest. As with 

the Voting Interest Focus Alternative, 

the Commission is proposing rules 

related to the governance of a securitybased swap clearing agency and the 

voting interests held by participants 

because the Commission believes each 

contributes to conflict of interest 

concerns. However, the Voting Interest 

Focus Alternative places greater 

emphasis on the ability of participants 

to hold voting interests in the securitybased swap clearing agency than it does 

on participants’ ability to participate in 

the governance of the security-based 

swap clearing agency, while the 

Governance Focus Alternative, as 

described in more detail below, places 

greater emphasis on the ability of 

participants to participate in the 

governance of the security-based swap 

clearing agency than it does on the 

ability of participants on a collective 

basis to hold a voting interest in the 

security-based swap clearing agency. 

1. Governance Focus Alternative: Voting 

Limitation 

The Governance Focus Alternative 

would require that a security-based 

swap clearing agency may not permit a 

participant, either alone or together with 

its related persons, to (1) beneficially 

own, directly or indirectly, any interest 

in the security-based swap clearing 

agency that exceeds 5% of any class of 

securities, or other ownership interest, 

entitled to vote of such security-based 

swap clearing agency or (2) directly or 

indirectly vote, cause the voting of, or 

give any consent or proxy with respect 

to the voting of, any interest in the 

security-based swap clearing agency 

that exceeds 5% of the voting power of 

any class of securities or other 

ownership interest of such securitybased swap clearing agency.112 The 5% 

limitation on participant voting interest 

is intended to help mitigate conflicts of 

interest because each individual 

participant’s voting interest would be 

substantially limited and, therefore, its 

ability to control the security-based 

swap clearing agency would also be 

limited.113 As discussed previously, the 

Voting Interest Focus Alternative would 

permit a higher individual participant 

voting interest of 20%, but would limit 

the aggregate voting interests held by all 

participants to 40%. However, the 

Voting Interest Focus Alternative would 

allow a security-based swap clearing 

agency to have a Board with a majority 

of directors selected by participants. 

The Commission believes that the 5% 

limit per participant, in combination 

with the requirements related to 

governance arrangements described 

below, is sufficiently low that there is 

no need for the 40% aggregate cap on 

the voting interests held by all 

participants. 

Furthermore, the Commission notes 

that the 40% aggregate cap on 

participant voting interests proposed in 

the Voting Interest Focus Alternative 

may restrict the potential formation of 

participant-owned security-based swap 

clearing agencies. Some clearing 

agencies currently registered with the 

Commission are user-owned or usercontrolled institutions that function as 

quasi-utilities. This structure may 

provide certain benefits to the 

participants and the securities markets 

generally because such clearing agencies 

generally seek to match the fees charged 

to participants to the clearing agency’s 

costs and not to maximize profits.114

In addition, potential users may have 

a strong incentive to form a new 

clearing agency if they believe an 

existing clearing agency is not 

effectively serving the security-based 

swaps market. Not imposing an 

aggregate cap on participant voting 

interests in a security-based swap 

clearing agency could help encourage 

the formation of new security-based 

swap clearing agencies and thereby 

increase the potential for competition 

among security-based swap clearing 

agencies. In addition, the 5% voting 

interest limitation may encourage open 

access by creating incentives for a larger 

number of participants to acquire a 

voting interest in the security-based 

swap clearing agency. While the 

Commission has not previously adopted 

voting limitations or governance rules 

for registered clearing agencies in the 

other securities markets, as previously 

discussed under the Voting Interest 

Focus Alternative, the security-based 

swaps market presents different 

concerns with respect to potential 

conflicts of interests that warrant 

additional scrutiny and efforts to 

mitigate such conflicts. 

2. Governance Focus Alternative: 

Indirect or Affiliate Ownership and 

Ownership Through Related Persons 

The Commission believes that a rule 

that limits only direct voting interests 

could be circumvented by holding the 

interest through an affiliated party or by 

holding an interest in a controlling 

entity. Accordingly, similar to the 

Voting Interest Focus Alternative,115 the 

Governance Focus Alternative would 

address conflicts of interest created by 

indirect voting interests of the securitybased swap clearing agency and would 

require aggregation of a security-based 

swap clearing agency participant’s 

voting interest with its related 

persons’ 116 voting interests.117

3. Governance Focus Alternative: 

Divestiture and Voting Restriction 

Requirement 

Similar to the Voting Interest Focus 

Alternative,118 the Governance Focus 

Alternative would require securitybased swap clearing agencies to have 

rules in place for the divestiture of 

voting interests that exceed the 5% 

limitation and a mechanism to not give 

effect to the portion of any voting 

interest held by a participant in excess 

of the 5% voting limitation.119 The 

Commission believes that this 

requirement is essential to a securitybased swap clearing agency’s ability to 

monitor voting interests by its 

participants in relation to the proposed 

voting limitations. 


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120See supra note 98. 

121See proposed Rule 701(b)(3)(i) under 

Regulation MC. See supra note 99 for the definition 

of ‘‘director.’’ 

122See, e.g., James H. Cheek III, et al., Report of 

the American Bar Association Task Force on 

Corporate Responsibility (2003); and The Business 

Roundtable, Principles of Corporate Governance 

(May 2010). 

123Section 17A(b)(3)(C) of the Exchange Act 

requires that the rules of a registered clearing 

agency assure a fair representation of its 

shareholders (or members) and participants in the 

selection of its directors and administration of its 

affairs. 15 U.S.C. 78q–1(b)(3)(C). 

124See supra note 102 and accompanying text. 

125See proposed Rule 701(b)(3)(ii) under 

Regulation MC. 

126See proposed Rule 701(b)(3)(iii) under 

Regulation MC. 

127See proposed Rule 701(b)(4)(i) under 

Regulation MC. 

4. Governance Focus Alternative: 

Majority Independent Board 

As discussed previously, the 

Governance Focus Alternative differs 

from the Voting Interest Focus 

Alternative by placing greater emphasis 

on the governance arrangements of the 

security-based swap clearing agency. 

Each alternative approach seeks to strike 

a balance between the appropriate 

restrictions imposed on a security-based 

swap clearing agency relating to 

governance and voting rights held by 

participants. Under the Governance 

Focus Alternative, participants on a 

collective basis could potentially own 

all voting interests in a security-based 

swap clearing agency. While this option 

allows for potential benefits in terms of 

participants’ ability to form new 

clearing agencies, it also allows 

participants’ to control 100% of the 

voting interest in a security-based swap 

clearing agency, in contrast to the 

Voting Interest Focus Alternative, which 

would limit participants to holding no 

more than 40% of the voting interest. 

Accordingly, in order to balance the 

increased voting interest that may be 

held by participants collectively, the 

Commission proposes that a greater 

proportion of the Board be composed of 

independent directors under the 

Governance Focus Alternative. 

The Governance Focus Alternative is 

intended to mitigate conflicts of interest 

by limiting the influence participants 

may have in the determinations of the 

Board or in the administration of a 

security-based swap clearing agency. 

Specifically, the Governance Focus 

Alternative would require the Board 120

of a security-based swap clearing agency 

to be composed of a majority of 

independent directors.121 The presence 

of a majority of independent directors 

on the Board of a security-based swap 

clearing agency is intended to reduce 

the ability of non-independent directors 

to influence the operation of the 

security-based swap clearing agency in 

favor of their own self-interests and to 

promote open and fair access, product 

eligibility, and sufficient risk 

management standards. This should in 

turn benefit non-participant firms that 

enter into correspondent clearing 

arrangements with participants, and 

SBS exchanges and SB SEFs who will 

rely on the availability of a securitybased swap clearing agency. A majority 

independent Board requirement is 

consistent with accepted corporate 

governance ‘‘best practices.’’ 122

Furthermore, requiring a majority of the 

Board of a security-based swap clearing 

agency to be independent would still 

permit the security-based swap clearing 

agency to provide participants with fair 

representation in the selection of 

directors and the administration of the 

affairs of the security-based swap 

clearing agency as required under the 

Exchange Act.123

The Commission also proposes that 

no director may qualify as an 

independent director unless the Board 

affirmatively determines that the 

director does not have a material 

relationship with the security-based 

swap clearing agency or any affiliate of 

the security-based swap clearing 

agency,124 or a participant in the 

security-based swap clearing agency, or 

any affiliate of a participant in the 

security-based swap clearing agency.125

The proposed definitions of 

‘‘independent director’’ and ‘‘material 

relationship’’ are designed to reduce the 

potential that the Board of the securitybased swap clearing agency is 

controlled by persons who are subject to 

conflicts of interest. 

While the proposal that a majority of 

the Board be composed of independent 

directors should help to mitigate certain 

conflicts of interest, and particularly 

those conflicts that are most likely to 

result in an adverse effect on the 

security-based swap clearing agency, the 

Commission recognizes that it would 

not completely eliminate conflicts of 

interest. Participant directors would still 

be permitted to serve on the Board. The 

Commission believes that participants 

may have operational, risk management, 

and market expertise that may be useful 

for effective oversight of a securitybased swap clearing agency. 

In addition, independent directors 

themselves may not be free of conflicts 

of interest. Although the independent 

directors would not have a material 

relationship with the clearing agency or 

any of its participants, they could still 

be influenced by other sources such as 

non-participant shareholders of the 

security-based swap clearing agency. 

The presence of independent directors 

may be an effective mechanism to 

address certain types of conflicts in 

certain types of institutions but not 

necessarily in all instances nor for all 

institutions. The Commission, however, 

believes that effective governance via a 

majority independent Board is 

compatible with the characteristics of 

security-based swap clearing agencies, 

and the types of conflicts that may be 

inherent with respect to such entities. 

To help address these concerns, the 

proposed rules would require each 

security-based swap clearing agency to 

establish policies and procedures to 

require each director, on his or her own 

initiative or upon request of the 

security-based swap clearing agency, to 

inform the security-based swap clearing 

agency of the existence of any 

relationship or interest that may 

reasonably be considered to bear on 

whether such director is an independent 

director.126 This requirement should 

keep the security-based swap clearing 

agency informed of the existence of any 

relationship or interest that may 

reasonably be considered to bear on 

whether a director is independent as 

soon as possible without requiring the 

security-based swap clearing agency to 

investigate for such relationships or 

interest. 

5. Governance Focus Alternative: Board 

Committees 

a. Nominating Committee 

The Governance Focus Alternative 

would require security-based swap 

clearing agencies to create and maintain 

a nominating committee composed 

entirely of independent directors.127

This is consistent with the purpose of 

the Governance Focus Alternative to 

place enhanced requirements on the 

governance arrangements of a securitybased swap clearing agency, including 

the composition of the Board and Board 

committees, with less emphasis on the 

requirements with respect to the voting 

interests held by participants. Nonindependent directors on the 

nominating committee could 

circumvent the majority independence 

requirement by nominating a candidate 

that is subject to their influence. 

Specifically, directors serving on the 

nominating committee that are not 

independent may be more likely to 

select Board candidates whose views 

align with such directors’ interests 

instead of the interests of the securitybased swap clearing agency or the 

markets generally. A requirement that 


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65902 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

128See proposed Rule 701(b)(4)(ii) under 

Regulation MC. 

129See supra note 123. 

130See proposed Rule 701(b)(5) under Regulation 

MC. 

131See supra Section I.A.8.d. and accompanying 

text. 

132See proposed Rule 701(b)(6) under Regulation 

MC. 

all directors serving on the nominating 

committee be independent of 

participants would address these 

concerns by limiting participants’ 

control over the nomination process. A 

fully independent nominating 

committee may be warranted under the 

Governance Focus Alternative because 

the lack of an aggregate cap in this 

proposal means that participants may 

collectively hold greater voting interests 

in selecting the independent directors. 

The Governance Focus Alternative 

would also require that the nominating 

committee identify candidates for Board 

membership through a consultative 

process with the participants of the 

security-based swap clearing agency 

consistent with criteria approved by the 

Board.128 This should assure that the 

selection of the independent directors of 

the Board is conducted in a prudent 

manner while at the same time allowing 

participants of the security-based swap 

clearing agency to have a fair voice in 

the selection of the directors of the 

Board.129

b. Other Board Committees 

The Governance Focus Alternative 

would require that other Board 

committees of a security-based swap 

clearing agency that are delegated 

authority to act on the Board’s behalf, 

including but not limited to the risk 

committee, consist of a majority of 

independent directors similar to the 

requirement that would be imposed on 

the Board itself.130 This requirement 

should prevent the dilution of the 

majority Board independence 

requirement that may result if Board 

committees that essentially perform the 

functions of a Board are not themselves 

subject to a similar requirement. The 

proposed requirement would also apply 

to an ‘‘advisory committee’’ to the extent 

that such a committee is authorized to 

act on behalf of the Board, including 

instances where the Board is required to 

seek approval from the committee 

before making a determination. 

However, the Commission preliminarily 

believes that this majority independence 

requirement should not extend to a 

committee that functions in a purely 

advisory role, because members of those 

committees are not in a position to 

exercise powers of the Board or exert 

influence over the Board by dictating 

the actions of the Board. 

c. Disciplinary Panels 

Similar to the Voting Interest Focus 

Alternative,131 the Governance Focus 

Alternative would impose special 

requirements on the composition of 

disciplinary panels (or their 

equivalents) of security-based swap 

clearing agencies that have not been 

delegated authority to act on the Board’s 

behalf.132

6. Governance Focus Alternative: 

Request for Comment 

The Commission requests comment 

on all aspects of the 5% participant 

voting interest limitation. Is the 5% 

voting limitation appropriate, or should 

the Commission consider a higher or 

lower limitation? How does the relative 

concentration of the security-based 

swaps market among a small number of 

large dealers affect whether a 5% 

limitation is appropriate? Would 5% 

still allow a relatively small number of 

participants to effectively dominate the 

Board of a clearing agency? Should the 

Commission consider any form of an 

aggregate cap under this alternative? 

How likely is it that a security-based 

swap clearing agency would adopt a 

utility model, given the status of the 

security-based swaps market? Would 

the 5% limit impede the ability of a 

clearing agency to adopt a utility model? 

What advantages or disadvantages 

would such a model have? Are there 

other conflicts of interest, not discussed 

in this release, that the Commission 

should consider generally and 

specifically with respect to voting 

interest limitations? Would the 

proposed restrictions have an effect on 

the ability to form new security-based 

swap clearing agencies? 

Are there other ways to more 

narrowly target voting limitations? 

Should the Commission impose voting 

restrictions on only the largest 

participants because those participants 

control the majority of the securitybased swaps market (based on either the 

volume of transactions cleared at the 

security-based swap clearing agency or 

the notional value of the participant’s 

outstanding security-based swap 

positions)? If such an approach is 

preferable, what should the threshold be 

for determining whether a participant is 

‘‘large’’? Should the Commission require 

the security-based swap clearing agency 

to consider the participant’s volume of 

cleared transactions at the securitybased swap clearing agency, the 

notional value of the participant’s 

outstanding security-based swap 

positions at the security-based swap 

clearing agency, or both? Should the 

Commission require the security-based 

swap clearing agency to consider either 

volume or outstanding notional value of 

a participant’s positions held outside of 

a security-based swap clearing agency? 

How often should the Commission 

require the security-based swap clearing 

agency to reevaluate its standard? How 

effectively would such an approach 

address conflict of interest concerns? 

What would be the advantages and 

disadvantages of this approach 

compared to the approach proposed 

above? Are there administrative 

complexities associated with 

determining and monitoring the point at 

which a firm reaches large participant 

status? Are the conflicts of interest 

concerns regarding all large participants 

similar or should there be differences in 

the voting limitations among large 

participants? 

Should the restrictions on voting 

interests apply to other large entities, 

such as the Specified Entities listed in 

Section 765, even if they are not 

participants in a security-based swap 

clearing agency? What potential 

conflicts of interest could result if 

Specified Entities that are not large 

participants controlled the voting 

interest in a security-based swap 

clearing agency? How should such 

potential conflicts of interest be 

addressed? 

Should the Commission consider a 

limitation on the non-voting interests 

owned by participants? Should the 

Commission consider a limitation on 

the voting and non-voting interests held 

by Specified Entities? 

The Commission seeks comment on 

whether requiring the Board of a 

security-based swap clearing agency to 

be composed of a majority of 

independent directors would improve 

governance of the security-based swap 

clearing agency and mitigate potential 

conflicts of interest. Would a majority 

independent Board be helpful in 

mitigating conflicts of interest if the 

voting interest of a security-based swap 

clearing agency is owned by 

participants? If a majority independent 

Board is not appropriate to mitigate 

conflicts, what percentage of the Board 

should be independent? What are the 

costs and benefits of requiring the 

Boards of security-based swap clearing 

agencies to be composed of a majority 

of independent directors? How do these 

costs and benefits differ from the 

proposal that 35% of the Board be 

composed of independent directors? 

Would independent directors be likely 

to have the necessary experience and 


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Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 65903 

133 Depository institutions or derivatives clearing 

organizations that have previously cleared swaps 

pursuant to an exemption from registration as a 

clearing agency will be deemed to be registered 

with the Commission under Section 17A of the 

Exchange Act. See Public Law 111–203, Section 

763(l). 

134See Section 17A(b)(3) of the Exchange Act, 

which sets forth the standards for registered 

clearing agencies. 15 U.S.C. 78q–1(b)(3). See also 

Securities Exchange Act Release No. 16900 

(‘‘Standards Release’’) (June 17, 1980), 20 FR 416 

(July 1, 1980). The Standards Release provides 

guidance on the standards to be used by the 

Commission’s Division of Trading and Markets in 

connection with the registration of clearing 

agencies. The standards also serve as staff 

guidelines to assist clearing agencies in modifying 

their organizations, capacities, and rules to comply 

with the clearing agency registration provisions of 

the Exchange Act. 

The Commission is also considering matters 

related to conflicts of interests as part of broader 

standards that would be applicable to clearing 

agencies in association with requirements under 

Sections 763(b) and 805(a) of the Dodd-Frank Act. 

expertise to serve on the Board? Could 

less experience or expertise negatively 

affect risk management practices or the 

efficiency of the clearing agency and, if 

so, how? If any such experience or 

efficiency issues exist, how could they 

be overcome? What are the independent 

directors’ incentives regarding fair and 

open access, product eligibility, and 

sound risk management? How are these 

incentives different from those of 

participants? Do they result in conflicts 

of interest? If so, how are the conflicts 

of interest different from those of 

participants? How should they be 

addressed by the Commission? 

Should the Commission consider 

alternative limits, or alternative 

combinations of limits, on voting 

interests or independent directors? For 

example, should the voting interest 

restrictions of 20% on individual 

interests and 40% in the aggregate be 

combined with the requirements for a 

majority independent Board and a 100% 

independent nominating committee? 

Would an alternative combination of 

requirements related to voting interests 

and independent directors be more 

effective? For example, would a higher 

requirement in each case (e.g., a 10% 

limit on individual voting interests and 

a requirement for 60% independent 

directors) be more effective? Or would 

other combinations be more effective? 

Should the Commission reduce the 

restrictions over time if conflict of 

interest concerns are lessened as the 

security-based swaps market develops? 

For example, if participation in the 

security-based swaps market becomes 

more open and includes a broader range 

of participants, the interests of the 

participants may become more aligned 

with those of the clearing agency and 

the markets generally. Would 

restrictions on voting interests and 

governance still be needed in this 

circumstance? Are there other 

circumstances where the voting interest 

and governance restrictions may be 

reduced or eliminated altogether? If, 

over time, the security-based swaps 

market does not become more 

competitive, should the Commission 

consider additional governance and 

voting measures to promote open access 

and competition? What measures would 

be appropriate? What standards should 

the Commission use to determine 

whether additional restrictions should 

or should not be imposed? 

Could restrictions regarding the 

governance structure of a security-based 

swap clearing agency alone be sufficient 

to address conflict of interest concerns 

or are both restrictions on governance 

and voting interests needed? Would 

participants of a security-based swap 

clearing agency be able to exercise 

undue influence over a security-based 

swap clearing agency through a voting 

interest even if a majority of the Board 

is independent? Are requirements 

related to the governance structure of a 

security-based swap clearing agency 

more or less effective than voting 

limitations at addressing conflicts of 

interest? 

The Commission requests comment 

on the proposed compositional 

requirements of the nominating 

committee. What is the potential effect 

of requiring a security-based swap 

clearing agency to have an entirely 

independent nominating committee? 

Would requiring an entirely 

independent nominating committee, 

which is required to consult with 

participants of the security-based swap 

clearing agency, be consistent with the 

fair representation requirement under 

the Exchange Act? Should end-users or 

any other group be given guaranteed 

rights of participation in the governance 

of the security-based swap clearing 

agency? Should the Commission have 

some oversight of the Board selection 

process? Should the Commission 

consider an alternative to a 

compositional requirement for a 

nominating committee, such as allowing 

a security-based swap clearing agency to 

have a board of trustees responsible for 

nominating candidates for the Board? If 

this were a viable alternative, should 

there be compositional requirements or 

other limits imposed on the board of 

trustees? How should such a board of 

trustees be appointed? Would the 

alternative of a board of trustees to 

nominate directors provide greater 

assurance that independent directors are 

truly independent not only at the time 

of their nomination but during their 

service on the Board as well? 

The Commission requests comment 

on the proposed compositional 

requirements of committees of the Board 

under the Governance Focus 

Alternative. Is the requirement that 

Board committees that are delegated 

authority by the Board be composed of 

a majority of independent directors 

appropriate? Should there be special 

requirements relating to the risk 

committee, or its equivalent, of the 

Board? The Commission requests 

comment on the possible alternatives for 

risk committee governance as discussed 

in Section IV.A.7. Would the possible 

alternatives for the risk committee be 

more or less desirable with respect to 

the Governance Focus Alternative? 

Under the Governance Focus 

Alternative, should the percentage of 

directors on the risk committee be 

higher or lower than what is proposed? 

The Commission also requests comment 

on whether there are other ways to 

structure governance arrangements for 

security-based swap clearing agencies to 

mitigate potential conflicts of interest. 

The Commission requests comment 

on the composition of the disciplinary 

panel of the security-based swap 

clearing agency. Would the proposed 

rule be sufficient to address potential 

conflicts of interest that may interfere 

with the fair and effective disciplinary 

processes of a security-based swap 

clearing agency? Should different 

restrictions be imposed? 

C. Existing Standards for Registered 

Clearing Agencies 

In addition to any new rules adopted 

by the Commission with respect to 

conflicts of interest at security-based 

swap clearing agencies, the standards in 

the Exchange Act that apply to all 

securities clearing agencies registered 

with the Commission will apply to 

security-based swap clearing agencies. 

The Dodd-Frank Act requires securitybased swap clearing agencies to be 

registered as clearing agencies with the 

Commission under Section 17A of the 

Exchange Act.133 Thus, security-based 

swap clearing agencies will be required 

to comply with the standards in Section 

17A of the Exchange Act. Some of these 

standards may be used to address 

concerns related to conflicts of interest, 

regardless of whether a security-based 

swap clearing agency elects the Voting 

Interest Focus Alternative or the 

Governance Focus Alternative. As a 

result, the standards in Section 17A 

would be used in addition to specific 

conflict of interest rules adopted under 

Section 765 of the Dodd-Frank Act.134

The Section 17A standards may be 

used to mitigate conflicts of interest or 

the effects of conflicts of interest in a 


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65904 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

135Section 17A(b)(3)(A) provides in full a 

clearing agency shall not be registered unless the 

Commission determines that the ‘‘clearing agency is 

so organized and has the capacity to facilitate the 

prompt and accurate clearance and settlement of 

securities transactions and derivative agreements, 

contracts, and transactions for which it is 

responsible, to safeguard securities and funds in its 

custody or control or for which it is responsible, to 

comply with the provisions of [the Exchange Act] 

and the rules and regulations thereunder, to enforce 

(subject to any rule or order of the Commission 

pursuant to section 17(d) or 19(g)(2) of [the 

Exchange Act]) compliance by its participants with 

the rules of the clearing agency, and to carry out 

the purposes of [Section 17A of the Exchange Act].’’ 

15 U.S.C. 78q–1(a)(3)(C). 

136See Securities Exchange Act Release Nos. 

612194 (December 22, 2009), 74 FR 68883 

(December 22, 2009) (File No. SR–FICC–2009–10); 

61215 (December 22, 2009), 74 FR 68888 (December 

29, 2009) (File No. SR–NSCC–2009–10); and 61216 

(December 22, 2009), 74 FR 68877 (December 29, 

2009) (File No. SR–DTC–2009–16), notice and order 

granting accelerated approval of proposed rule 

changes filed by the clearing agency subsidiaries of 

the Depository Trust and Clearing Corporation 

(DTC, NSCC, and FICC) to permit DTCC to 

nominate non-participant candidates for election to 

its Board. 

137 15 U.S.C. 78q–1(b)(3)(B). 

138 Id. See also Section 17A(b)(4)(B), which 

provides that a registered clearing agency may deny 

participation to, or condition the participation of, 

any person if such person does not meet such 

standards of financial responsibility, operational 

capability, experience, and competence as are 

prescribed by the rules of the clearing agency. A 

registered clearing agency may examine and verify 

the qualifications of an applicant to be a participant 

in accordance with procedures established by the 

rules of the clearing agency. 15 U.S.C. 78q– 

1(b)(4)(B). 

139 15 U.S.C. 78q–1(b)(3)(F). 

140See Standards Release, supra note 134, at 419. 

All participants utilizing similar clearing agency 

services, with the exception of participants that are 

registered clearing agencies for which specialized 

requirements apply, should be required to comply 

fully with the clearing agency’s internal financial 

and operational rules such as clearing fund 

deposits, mark-to-market payments, and margin 

deposits related to the services used. 

141 Id at 418. The provisions in Section 17A 

recognize that a clearing agency may discriminate 

among persons in the admission to, or the use of, 

the clearing agency, by requiring that participants 

meet certain financial, operational, and other fitness 

standards. However, Section 17A also requires that 

sanctioned discriminations must not be unfair. In 

addition, the Commission must find that clearing 

agency rules embodying any discriminations are in 

the public interest and are consistent with the 

requirements of the Exchange Act. 

142The standard does not prohibit all burdens on 

competition. However, if a proposed rule of a 

clearing agency would impose a burden on 

competition, the burden must be weighed against 

the benefits of the rule in achieving the purposes 

of the Exchange Act. For example, a clearing agency 

may impose participation standards that have an 

anticompetitive effect as long as any such 

anticompetitive effect is justified. 

143See Standards Release, supra note 134, at 419. 

number of ways. As part of the initial 

registration process, the Commission 

approves the organizational structure of 

a clearing agency.135 The Commission 

also reviews and approves significant 

changes to a clearing agency’s 

governance structure after it is 

registered.136 In addition, a clearing 

agency must admit persons such as 

banks and broker-dealers, and other 

entities that the Commission may 

designate by rule, as participants,137

subject to the participation standards of 

the clearing agency.138

Clearing agencies also may not permit 

unfair discrimination in the admission 

of participants or among participants in 

the use of the clearing agency.139 These 

standards in Section 17A help to 

mitigate concerns related to conflicts of 

interest by promoting access to and use 

of a clearing agency by all qualified 

persons on an equivalent basis.140 The 

Section 17A standards also help to 

prevent a participant from using its 

influence to amend the rules of the 

clearing agency in a manner that favors 

its own institution to the disadvantage 

of other participants because the rules of 

a clearing agency may not be applied on 

a discriminatory basis.141

Finally, the Section 17A standards 

help to mitigate conflict of interest 

concerns by providing that the rules of 

a registered clearing agency may not 

impose a burden on competition that is 

not necessary or appropriate in 

furtherance of the purposes of the 

Exchange Act. This helps assure that the 

clearing agency operates in a manner 

that is consistent with the public 

interest and is not used by participants 

or other interested parties to gain an 

unfair competitive advantage.142 The 

Commission staff has previously 

interpreted these standards as requiring 

that a clearing agency must justify any 

anticompetitive effect of membership 

criteria and that it will evaluate an 

anticompetitive effect in light of the 

following factors: (1) The essential 

nature of the service; (2) the number and 

type of potential participants denied 

access to clearance and settlement 

services; (3) the number of entities 

providing comparable clearance and 

settlement services; and (4) the 

availability of correspondent clearing 

arrangements to provide indirect access 

to a clearing agency’s services.143 The 

Commission believes these factors 

should also be used to evaluate the 

anticompetitive effect of the 

membership standards of security-based 

swap clearing agencies once they are 

registered clearing agencies under 

Section 17A of the Exchange Act. 

The Commission requests comment 

on the application of the standards 

under Section 17A to security-based 

swap clearing agencies in conjunction 

with the proposed rules to address 

conflicts of interest. Will the proposed 

rules effectively build on the Section 

17A standards? Should the Commission 

take a more targeted approach by 

focusing new requirements under 

Section 765 of the Dodd-Frank Act on 

Section 17A standards alone, such as by 

having requirements addressing only 

membership standards and 

determinations whether to clear 

products? Would such an approach 

sufficiently address conflicts of 

interests? If not, are the proposed rules 

sufficient to address potential gaps in 

the way Section 17A alone would 

address conflicts of interest with respect 

to security-based swap clearing 

agencies? Should additional rules be 

proposed under Section 17A to further 

address conflict of interest concerns? 

Should the Commission extend the 

application of the proposed rules for 

security-based swap clearing agencies to 

all registered clearing agencies? To what 

extent would competitive pressures in 

the security-based swaps market, 

particularly as it continues to develop, 

help to mitigate conflicts of interest? 

Would the standards under Section 17A 

help to promote competition in a way 

that would help to mitigate conflicts of 

interest? To what extent does the 

Commission’s oversight of clearing 

agencies pursuant to the standards 

under Section 17A alleviate the need for 

ownership limitations and governance 

requirements? 

V. Discussion of Proposed Rule 702 

Under Regulation MC for SecurityBased Swap Execution Facilities and 

National Securities Exchanges That 

Post or Make Available for Trading 

Security-Based Swaps 

A. Ownership and Voting Limitations 

Section 765 requires the Commission 

to adopt rules to mitigate conflicts of 

interest, which may include numerical 

limits on control of, or the voting rights 

with respect to, any clearing agency that 

clears security-based swaps, or on the 

control of any SB SEFs or SBS 

exchanges. Pursuant to this directive, 

the Commission is proposing ownership 

and voting limits for a SB SEF that 

would apply to any SB SEF participant 

and for a SBS exchange or facility of a 

national securities exchange that posts 

or makes available for trading securitybased swaps (‘‘SBS exchange facility’’) 

that would apply to any SBS exchange 

member. Specifically, the Commission 

proposes that a SB SEF, SBS exchange, 

or SBS exchange facility shall not 

permit any SB SEF participant or SBS 

exchange member, as applicable, either 

alone or together with its related 

persons, to: (1) Beneficially own, 

directly or indirectly, any interest in the 

SB SEF, SBS exchange, or SBS exchange 

facility, as applicable, that exceeds 20% 

of any class of securities, or other 


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144See proposed Rule 702(b) under Regulation 

MC. 

145See supra note 98 for the proposed definition 

of ‘‘Board.’’ 

146The Commission also believes that such limits 

would further the ability of the SB SEF and SBS 

exchange to effectively carry out its obligations. 

Section 763(c) of the Dodd-Frank Act and Section 

6 of the Exchange Act, respectively, and, in 

particular, provide market participants with 

impartial access to SB SEFs. See Section 763(c) of 

the Dodd-Frank Act, Public Law 111–203, Section 

763(c), and 15 U.S.C. 78f. 

147The Commission has not made any 

determinations about whether security-based swap 

clearing agencies will also tend to converge to a 

single clearing agency or even a small number of 

clearing agencies, as the central clearing of securitybased swaps is still a developing area. 

ownership interest, entitled to vote of 

such SB SEF, SBS exchange, or SBS 

exchange facility; or (2) directly or 

indirectly vote, cause the voting of, or 

give any consent or proxy with respect 

to the voting of, any interest in the SB 

SEF, SBS exchange, or SBS exchange 

facility, as applicable, that exceeds 20% 

of the voting power of any class of 

securities or other ownership interest of 

such SB SEF, SBS exchange, or SBS 

exchange facility.144

The Commission is concerned that if 

a SB SEF participant or SBS exchange 

member, either alone or together with 

its related persons, were to own a 

significant stake in the SB SEF, SBS 

exchange, or SBS exchange facility, 

respectively, the SB SEF participant or 

SBS exchange member could use its 

significant ownership interest to 

influence the operations of the SB SEF, 

SBS exchange, or SBS exchange facility 

to unduly derive benefits at the expense 

of other owners and market participants. 

The Commission is particularly 

concerned that a SB SEF participant or 

SBS exchange member may have 

financial incentives to limit the level of 

access to, and the scope of products 

traded on, these trading venues as a 

means to impede competition from 

other market participants. For example, 

the Commission understands that many 

of the electronic multi-dealer trading 

platforms that exist today for OTC 

derivatives or fixed income products 

limit the number of dealers from which 

a customer can request a quote. The 

Commission believes that a fewer 

number of dealers participating on a 

platform or exchange could result in 

less competition on pricing. The 

Commission believes that imposing 

ownership and voting limits, as 

described above, could mitigate 

potential conflicts of interest with 

respect to the level of access to the 

market and determinations as to which 

products are traded by limiting the 

ability of a small group of persons (such 

as dealers) to control the Board 145 and 

thus the governance of the SB SEF, SBS 

exchange, or SBS exchange facility.146

Unlike the Voting Interest Focus 

Alternative or the Governance Focus 

Alternative for security-based swap 

clearing agencies, the Commission is not 

proposing an aggregate 40% voting 

interest limit collectively on all SB SEF 

participants (with respect to SB SEFs) 

and SBS exchange members (with 

respect to SBS exchanges) or a 5% 

individual voting interest limit, 

respectively. The Commission 

recognizes that, as with security-based 

swap clearing agencies, the proposed 

rule would limit, but not eliminate, the 

ability of a small group of SB SEF 

participants or SBS exchange members, 

as applicable, to own a SB SEF, SBS 

exchange, or SBS exchange facility. 

Specifically, as few as five entities could 

own SB SEFs, SBS exchanges, and SBS 

exchange facilities under this proposal. 

However, the Commission’s concerns 

with respect to concentration of 

ownership in security-based swap 

clearing agencies and SB SEFs, SBS 

exchanges, and SBS exchange facilities 

are informed by the differences in the 

structure for clearing and trading of 

security-based swaps. The 

Commission’s experience has been that 

the central clearing model in the 

securities markets historically has 

tended toward convergence to a single 

clearing agency for each type of cleared 

product, while the market structure for 

securities trading historically has not 

necessarily tended toward a similar 

model.147 The Commission also notes 

that security-based swap clearing 

agencies perform a critical function in 

mitigating financial risk for securitybased swaps market participants. 

Although SB SEFs, SBS exchanges, and 

SBS exchange facilities are critical to 

promoting price transparency and 

therefore market efficiency, the 

Commission does not believe that the 

operation of SB SEFs, SBS exchanges, 

and SBS exchange facilities would pose 

the same level of systemic risk as 

security-based swap clearing agencies. 

There generally will be a lower barrier 

to entry with respect to trading 

platforms because participants of a SB 

SEF or members of an SBS exchange 

would not incur the margin, guaranty 

fund, or other obligations that members 

of a clearing agency would incur, and 

thus multiple venues for the trading of 

security-based swaps are more likely to 

emerge. Thus, the Commission is not 

proposing identical ownership 

requirements for security-based swap 

clearing agencies and SB SEFs, SBS 

exchanges, and SBS exchange facilities. 

For purposes of calculating a SB SEF 

participant’s or SBS exchange member’s 

ownership and voting interests, the 

proposed rule would aggregate such 

person’s ownership and voting interests 

with those of its related persons. When 

used with respect to a SB SEF, proposed 

Rule 700(u) under Regulation MC would 

define the term ‘‘related person’’ to 

mean: (1) Any affiliate of a securitybased swap execution facility 

participant; (2) any person associated 

with a security-based swap execution 

facility participant; (3) any immediate 

family member of a security-based swap 

execution facility participant or any 

immediate family member of the spouse 

of such person, who, in each case, has 

the same home as the security-based 

swap execution facility participant or 

who is a director or officer of the 

security-based swap execution facility 

or any of its parents or subsidiaries; or 

(4) any immediate family member of a 

person associated with a security-based 

swap execution facility participant or 

any immediate family member of the 

spouse of such person, who, in each 

case, has the same home as the person 

associated with the security-based swap 

execution facility participant or who is 

a director or officer of the security-based 

swap execution facility or any of its 

parents or subsidiaries. 

Further, when used with respect to a 

SBS exchange or SBS exchange facility, 

proposed Rule 700(u) under Regulation 

MC would define the term ‘‘related 

person’’ to mean: (1) Any affiliate of a 

member of the national securities 

exchange that posts or makes available 

for trading security-based swaps; (2) any 

person associated with a member of the 

national securities exchange that posts 

or makes available for trading securitybased swaps; (3) any immediate family 

member of a member of the national 

securities exchange that posts or makes 

available for trading security-based 

swaps or any immediate family member 

of the spouse of such person, who, in 

each case, has the same home as the 

member of the national securities 

exchange that posts or makes available 

for trading security-based swaps or who 

is a director or officer of the national 

securities exchange or facility thereof 

that posts or makes available for trading 

security-based swaps, or any of its 

parents or subsidiaries; or (4) any 

immediate family member of a person 

associated with a member of the 

national securities exchange that posts 

or makes available for trading securitybased swaps or any immediate family 

member of the spouse of such person, 

who, in each case, has the same home 

as the person associated with the 


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148See supra note 93 for the proposed definition 

of ‘‘control.’’ 

149See proposed Rules 702(c)(1) and (2) under 

Regulation MC. 150See proposed Rule 702(c)(3) under Regulation 

MC. 151See supra Section IV.A.4. 152National securities exchanges that may trade 

security-based swaps currently prohibit a member 

from owning or voting more than 20% of the 

exchange, although an exchange’s method of 

calculating the 20% interest, aggregated with any 

person with whom such person may be able to act 

together to influence or control an exchange, may 

vary from the Commission’s proposal. See, e.g., 

Amended and Restated Certificate of Incorporation 

of BATS Global Markets, Inc., Article FIFTH; 

Amended and Restated Certificate of Incorporation 

of NYSE Euronext, Article V. 

153The counterparties to a transaction in a 

security-based swap that is required to be cleared 

under Section 763(a)(2) of the Dodd-Frank Act will 

be required to execute the transaction on a SBS 

exchange or on a SB SEF. There is an exception 

from the execution requirement if no SBS exchange 

or SB SEF makes the security-based swap available 

to trade. See Public Law 111–203, Section 763(h). 

The exception from trade execution is also available 

if the exception from mandatory clearing under 

Section 763(g) applies. See Public Law 111–203, 

Section 763(g). 

national securities exchange that posts 

or makes available for trading securitybased swaps or who is a director or 

officer of the national securities 

exchange or facility thereof that posts or 

makes available for trading securitybased swaps or any of its parents or 

subsidiaries. To further the purpose of 

the proposed limits, the Commission 

preliminarily believes that it would be 

important to aggregate the SB SEF 

participant’s or SBS exchange member’s 

ownership and voting interests with the 

interest of any person with whom such 

person may be able to act together to 

influence or control the SB SEF, SBS 

exchange, or SBS exchange facility. 

The proposed rule would restrict 

indirect as well as direct ownership and 

voting of a SB SEF, SBS exchange, or 

SBS exchange facility. Because the 

proposed rule could be easily 

circumvented if the Commission were to 

limit solely direct ownership and 

voting, the Commission preliminarily 

believes it would be important to further 

the purpose of imposing ownership and 

voting limits to also restrict the indirect 

ownership and voting interests of SB 

SEF participants and SBS exchange 

members. For example, if the 

Commission simply proposed to 

prohibit a SB SEF participant from 

directly owning or voting shares, the 

participant could hold its ownership 

interests in the SB SEF through a 

holding company, thus easily 

circumventing the intent of the 

proposed rule. Accordingly, the 

ownership and voting limits would 

apply to ownership and voting of 

interests in a parent company of the SB 

SEF, SBS exchange, or SBS exchange 

facility. For example, if the SB SEF were 

wholly-owned by a holding company, a 

SB SEF participant would be prohibited 

from owning or voting more than 20% 

of the voting interest in the parent 

company. Finally, the proposed limits 

also would apply to a SB SEF 

participant or SBS exchange member 

that beneficially owns more than 25% of 

an entity that itself owns more than 

20% of a SB SEF, SBS exchange, or SBS 

exchange facility.148

To assure that SB SEFs, SBS 

exchanges, and SBS exchange facilities 

maintain an ownership structure 

consistent with the proposed ownership 

and voting limits, the Commission 

proposes that these entities have rules 

that (1) provide an effective mechanism 

to divest a SB SEF participant’s or SBS 

exchange member’s ownership that, 

alone or together with its related 

persons, exceeds 20% and (2) are 

reasonably designed not to give effect to 

a SB SEF participant’s or SBS exchange 

member’s voting interest that, alone or 

together with its related persons, 

exceeds 20%.149 The Commission 

believes that in order for the ownership 

and voting limits to be effective, each 

SB SEF, SBS exchange, and SBS 

exchange facility must take measures to 

reduce a SB SEF participant’s or 

member’s ownership interest or not give 

effect to any voting interest that exceeds 

the proposed limits. The Commission 

intends to provide SB SEFs, SBS 

exchanges, and SBS exchange facilities 

flexibility in determining how to 

implement these requirements. Any 

rules adopted by these trading venues, 

however, must assure that they have a 

viable, enforceable mechanism to divest 

a SB SEF participant or SBS exchange 

member of any interest held in excess of 

the 20% limit and to not give effect to 

the portion of voting interest held in 

excess of the 20% limit. The 

Commission also proposes to require 

each SB SEF, SBS exchange, or SBS 

exchange facility to have rules to 

provide a mechanism to obtain 

information relating to its ownership 

and voting interests.150 The Commission 

believes that a requirement to collect 

information regarding ownership and 

voting interests of SB SEF participants 

and SBS exchange members is essential 

for registered trading venues to monitor 

and comply with the proposed 

ownership and voting limits.151

The Commission believes that an 

ownership and voting limit of 20% is an 

appropriate threshold. On the one hand, 

the restriction would limit the ability of 

a SB SEF participant or SBS exchange 

member to exert undue influence over 

the governance of a SB SEF, SBS 

exchange, or SBS exchange facility, 

respectively. On the other hand, such an 

ownership and voting limit should not 

overly interfere in such an entity’s 

organizational structure or the ability of 

a SB SEF participant or SBS exchange 

member to acquire a substantial equity 

interest in a SB SEF, SBS exchange, or 

SBS exchange facility, as applicable.152

Thus, the proposed ownership and 

voting limits should strike an 

appropriate balance between the 

objectives of mitigating conflicts of 

interest and refraining from 

unnecessarily hindering the ability of 

entities to form new trading venues. In 

addition, there may be incentives to 

create a new SBS exchange or SB SEF 

because a SBS exchange or SB SEF may 

draw significant new business by 

making available to trade a securitybased swap that is required to be cleared 

under Section 763(a).153 Furthermore, 

the risk management and economies of 

scale issues that may create a barrier to 

entry with respect to new security-based 

swap clearing agencies generally would 

not affect the creation of SBS exchanges 

or SB SEFs. 

While the Commission believes that 

the proposed 20% ownership and 

voting limits are appropriate, it also 

understands that the movement of 

trading of security-based swaps onto SB 

SEFs, SBS exchanges, or SBS exchange 

facilities will foster enhanced 

transparency and market efficiency. The 

Commission does not intend to 

unnecessarily impede the emergence of 

what could be vital sources of, among 

other things, liquidity and pricing 

transparency for security-based swaps. 

However, imposing on SB SEFs and SBS 

exchanges ownership and voting limits 

similar to those that shareholder-owned 

cash equities and options exchanges 

have in place could have the 

unintended consequence of deterring 

new, competitive trading venues at a 

time when organized markets for 

security-based swaps are just beginning 

to develop. A trading platform that 

currently trades security-based swaps in 

the OTC market but would not meet the 

proposed ownership and voting limits 

would need to revise its ownership 

structure if it chooses to become a SB 

SEF. There could be costs and delays as 

the potential SB SEF seeks to find one 

or more additional owners to satisfy the 

proposed limits, with a possible 

diminution in the value of the original 

owner(s)’ investment. Moreover, it is 

possible that imposing these limits may 

affect the security-based swaps market 

differently than the cash equities and 

listed options markets. Ownership and 


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154 In the equities market a small group of brokerdealers or single-dealer proprietary firms can and 

do own alternative trading systems (‘‘ATSs’’) and 

thus it can be argued that SB SEFs and SBS 

exchanges should be permitted to operate similarly. 

See Securities Exchange Act Release No. 60997 

(November 13, 2009), 74 FR 61208 (November 23, 

2009) (as of November 2009, there were 

approximately 73 ATSs that are subject to 

Regulation ATS). However, ATSs exist in the 

context of a marketplace with robust competition 

among numerous trading venues. Therefore, ATSs 

that are owned by one broker-dealer or a small 

group of broker-dealers, by virtue of their 

ownership structure alone, generally do not present 

a concern that they could lessen price competition 

or market efficiency. 

155See supra note 64. 

156 In the SRO Governance Proposing Release, the 

Commission proposed a similar 20% ownership 

and voting limit for members of a national 

securities exchange. A number of commenters 

favored this proposal, including several 

commenters that were national securities exchanges 

or a facility of a registered securities association. 

See, e.g., letter from Michael J. Simon, Secretary, 

ISE, to Jonathan G. Katz, Secretary, Commission, 

dated March 8, 2005 (‘‘ISE Comment Letter’’) (‘‘[The 

ownership limitation] provides SROs with 

flexibility, yet recognizes the unique conflicts that 

could arise if a member were to own a controlling 

interest in an SRO with regulatory responsibility for 

the member.’’); letter from Meyer S. Frucher, 

Chairman and Chief Executive Officer, Phlx, to 

Jonathan G. Katz, Secretary, Commission, dated 

March 8, 2005 (‘‘Phlx Comment Letter’’) (‘‘The 

Exchange unequivocally agrees with the 

Commission that a significant shareholder could 

use its voting power to influence the operations of 

an exchange in a way that adversely affects the 

mission, integrity or regulatory capacity of the 

exchange, or otherwise is detrimental to the public 

interest.’’); letter from Philip D. DeFeo, Chairman 

and Chief Executive Officer, Pacific Exchange, Inc. 

(‘‘PSX’’), to Jonathan G. Katz, Secretary, 

Commission, dated March 8, 2005 (‘‘PSX Comment 

Letter’’); letter from Edward S. Knight, Executive 

Vice President and General Counsel, Nasdaq Stock 

Market, Inc., to Jonathan G. Katz, Secretary, 

Commission, dated March 8, 2005 (‘‘Nasdaq 

Comment Letter’’). The Commission notes, however, 

that the SRO Governance Proposing Release related 

to national securities exchanges that trade equity 

securities and listed options and registered 

securities associations, and the comments received 

did not address potential conflicts in other contexts. 

157The CFTC has proposed similar ownership 

and voting limits for DCMs and registered SEFs, 

and applies the ownership limit only to any class 

of equity securities entitled to vote. See http:// 

www.cftc.gov/ucm/groups/public/@newsroom/ 

documents/file/federalregister_governance.pdf. 

voting limits were implemented at 

national securities exchanges at a time 

when the trading of exchange-listed 

securities was fairly well established 

and competitive. Consequently, a 20% 

ownership and voting limit may not 

negatively affect the ability of cash 

equity and options exchanges to 

promote competing trading venues but, 

if applied to the security based-swaps 

market that is in its infancy, could 

retard market development. 

The Commission is sensitive to 

arguments against imposing ownership 

and voting limits for SB SEFs, SBS 

exchanges, and SBS exchange facilities, 

some of which were articulated at the 

Conflicts Roundtable. However, it also 

understands that the OTC derivatives 

market is highly concentrated and 

dealer dominated. Although ownership 

and voting limits arguably may have a 

less negative effect on new entrants to 

the cash equities and options markets 

and their ability to compete, there may 

also be less need for such limitations in 

those markets. In contrast, although 

ownership and voting limits may more 

directly affect the ability of SB SEFs and 

SBS exchanges to start up, the lack of 

market characteristics to promote 

competing trading venues for securitybased swaps may emphasize the greater 

need for ownership and voting limits. If 

the market characteristics for securitybased swaps naturally promote dealer 

domination without robust competing 

trading venues, there is more need to 

mitigate the types of concerns that 

underlie Section 765, such as by 

imposing ownership and voting 

limits.154

The Commission must weigh the 

potential implications of imposing 

ownership and voting limits against 

imposing other requirements that would 

allow a dealer-dominated security-based 

swaps market to continue. As part of the 

balance between mitigating conflicts of 

interest without unduly restricting the 

ability of a competitive market for 

trading of security-based swaps to 

emerge, the Commission proposes to 

limit ownership in SB SEFs, SBS 

exchanges, and SBS exchange facilities 

specifically to those interests entitled to 

vote.155 Consequently, a SB SEF 

participant or SBS exchange member 

would not be prohibited from owning 

any percentage of a nonvoting interest 

in a SB SEF, SBS exchange, or SBS 

exchange facility. In contrast, national 

securities exchanges generally limit 

their members from owning more than 

20% of any interest, voting or otherwise. 

However, as discussed above, trading 

venues for exchange-listed securities are 

well established and highly competitive. 

In this regard, the Commission does not 

believe that it is necessary to propose 

the same ownership limits as those 

currently in place at national securities 

exchanges. Further, the proposed 20% 

limit on ownership and voting would 

still allow as few as five entities to own 

a SB SEF, SBS exchange, or SBS 

exchange facility. Thus, the proposed 

limit by itself would not completely 

prohibit a small number of entities from 

potentially exerting undue influence 

over SB SEFs, SBS exchanges, or SBS 

exchange facilities in a way that could 

benefit the few to the detriment of 

others. 

The Commission requests comment 

on all aspects of the proposed 

ownership and voting limits, including 

whether it is necessary and appropriate 

to have ownership and voting limits at 

all. If commenters believe that it is 

necessary and appropriate to impose 

ownership and voting limits to mitigate 

conflicts of interest, the Commission 

requests comment on whether the 

proposed limits are appropriate, or 

whether they would unduly hinder the 

development of SB SEFs without 

serving to mitigate any conflicts.156

Should the Commission require a voting 

limit, but not an ownership limit or a 

different limit for ownership versus 

voting? Even with the prohibition 

against owning more than 20% of any 

interest entitled to vote, a SB SEF 

participant or SBS exchange member 

could have sufficient ownership of 

nonvoting interest, either alone or in 

addition to voting interest, to exert 

influence on these trading venues. 

Should the Commission require the 

ownership limit to apply to any class of 

equity securities or other ownership 

interest rather than any class of 

securities, or ownership interest, 

entitled to vote? 157 Would the proposed 

limits impede the number or types of SB 

SEFs from being established? Should 

the proposed ownership and voting 

limits be phased in for SB SEFs to 

provide a grace period for those entities 

that would not meet the requirements 

under Regulation MC? 

The Commission also seeks comment 

on whether the proposed ownership and 

voting limits would continue to be 

important as the market for securitybased swaps evolves. If multiple SB 

SEFs emerge as this market develops, 

would competitive pressures alleviate 

any of the conflicts of interest that are 

the basis for the Commission’s 

proposals? In that case, would it be 

appropriate for the Commission to 

impose different limits? Should the 

Commission reduce the restrictions over 

time, if conflict of interest concerns are 

lessened as the security-based swaps 

market develops? For example, if 

participation in the trading of securitybased swaps becomes more open and 

includes a broader range of participants, 

and multiple SB SEFs or SBS exchanges 

evolve to trade the same security-based 

swaps, would there still be a need to 

retain ownership and voting limits or 

are there factors that would allow such 

limits to be revised? What factors 

should the Commission consider in 

assessing whether any ownership and 

voting limits it may impose on SB SEFs 

should be revisited? 

As mentioned above, each national 

securities exchange currently prohibits 


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65908 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

158A member has in the past been permitted on 

a pilot basis to own more than 20% of a facility of 

an exchange subject to certain terms and 

conditions. See Securities Exchange Act Release 

Nos. 59281 (January 22, 2009), 74 FR 5014 (January 

28, 2009) (order approving on a pilot basis 50% 

ownership of the New York Block Exchange, a 

trading facility of NYSE, by BIDS ATS, a member 

of NYSE). This pilot has since been extended for an 

additional year and will expire on January 22, 2011 

unless further extended or permanently approved. 

See Securities Exchange Act Release No. 61409 

(January 22, 2010), 75 FR 4889 (January 29, 2010). 159See supra Section III.B. 

160See proposed Rule 702(d)(1) under Regulation 

MC. See also supra note 102 and accompanying text 

for the proposed definition ‘‘independent director.’’ 

its members from owning an interest, 

voting or otherwise, or voting more than 

20% (or less) of the exchange or a 

facility of the exchange.158 Therefore, 

the Commission preliminarily does not 

believe that the proposed rules would 

have a material effect on an exchange’s 

ability to post or make available for 

trading security-based swaps. 

Nevertheless, the Commission requests 

comment on whether the proposed 

limits in this rulemaking could affect a 

national securities exchange’s ability or 

decision to post or make available for 

trading security-based swaps. Also, 

given that national securities exchanges 

currently have limits on ownership and 

voting by members, would codifying the 

proposed limits help to further mitigate 

the types of conflicts of interest that 

underlie the Dodd-Frank Act for SBS 

exchanges? Would there be any effect on 

the willingness of entities to register to 

become a national securities exchange 

and trade security-based swaps? What 

would be the implication, if any, on an 

exchange that chose to trade securitybased swaps through a facility that is a 

separate legal entity? More generally, for 

SB SEFs and SBS exchanges or SBS 

exchange facilities, should ownership 

and voting be limited to the same 

threshold or should they be different? If 

the Commission should take a different 

approach for ownership and voting, 

what should that approach be? 

As described above, Section 765 

enumerates Specified Entities that the 

Commission should consider in its 

rulemaking. The Commission 

understands that, depending on who 

may be permitted to directly effect 

transactions on a SB SEF (or is a SBS 

exchange member), limits on ownership 

and voting that apply only to SB SEF 

participants or SBS exchange members 

could be either over-inclusive or underinclusive or both, with respect to the 

Specified Entities. For example, 

restricting control of a SB SEF based on 

an entity’s direct participation on the SB 

SEF could capture a person who is not 

one of the Specified Entities or, 

conversely, fail to take into 

consideration a Specified Entity. 

Accordingly, the Commission requests 

comment on whether the scope of the 

proposed ownership and voting limits is 

appropriate. Should the limits on 

ownership and voting extend to all or 

some of the Specified Entities, 

regardless of their direct participation 

on the SB SEF or SBS exchange? If so, 

why? What are the potential conflicts 

concerns that such Specified Entities 

may pose? How are conflicts concerns 

posed by such Specified Entities 

different from those posed by SB SEF 

participants or SBS exchange members 

who are not also Specified Entities? In 

this regard, the Commission notes that 

the definition of ‘‘related person’’ would 

encompass any such entity that is 

affiliated with such a SB SEF 

participant or SBS exchange member, 

although it may not itself be a SB SEF 

participant or SBS exchange member. 

In addition, national securities 

exchanges generally limit ownership 

and voting by non-members, as well as 

members.159 Specifically, exchanges 

generally limit each non-member to no 

more than 40% ownership of the 

exchange. The limit on ownership by 

non-members of an exchange is 

designed in part to provide the 

Commission and the exchange with the 

proper tools (such as access to books 

and records) necessary to carry out the 

Commission’s and the exchange’s 

respective regulatory oversight 

responsibilities, as well as to mitigate 

more general conflict concerns between 

owners’ commercial interests and the 

exchange’s regulatory obligations. The 

Commission requests comment on 

whether it should impose, as part of this 

rulemaking, similar limits on ownership 

and voting. Such an ownership limit 

would apply to the Specified Entities, to 

the extent they are not subject to the 

proposed ownership limit described 

above. In addition to the requirements 

of Section 765, the Dodd-Frank Act 

more generally requires a SB SEF to 

establish and enforce rules to minimize 

conflicts of interest in its decisionmaking process and establish a process 

for resolving the conflicts of interest. 

What are the types of conflicts that a 

person who is not a SB SEF participant 

or SBS exchange member may pose? 

The Commission also requests 

comment on whether its formulation for 

calculating the 20% threshold is 

appropriate. Specifically, the 

Commission requests comment on all 

prongs of the definition of ‘‘related 

person,’’ including whether the 

definition is over-inclusive or underinclusive. What other method could the 

Commission use to reach the interest of 

any person with whom a SB SEF 

participant or SBS exchange member 

may be able to act together to influence 

or control a SB SEF or SBS exchange? 

Finally, the Commission expects a SB 

SEF, SBS exchange, and SBS exchange 

facility to have in place an effective 

mechanism for enforcing the ownership 

and voting limits. The Commission 

requests comment on whether the 

proposed rules related to divesture of 

ownership and voting limits are 

appropriate. Should the Commission 

explicitly require in the proposed rules 

specific ways to divest ownership and 

voting interest of SB SEF participants 

and SBS exchange members who violate 

the ownership and voting limits? Is the 

proposed rule pertaining to obtaining 

information on ownership and voting 

interest of SB SEFs, SBS exchanges, and 

SBS exchange facilities appropriate? 

Should the Commission require that 

trading venues collect information 

pertaining to certain ownership or 

voting thresholds? 

B. Governance Requirements 

The Commission is proposing 

substantive requirements with respect to 

the governance of SB SEFs, SBS 

exchanges, and SBS exchange facilities 

that are designed to address the conflict 

of interest concerns identified above, 

including the concern that dealerowners could unduly influence the 

governance and operation of a SB SEF 

or SBS exchange. These governance 

provisions, as discussed below, should 

help mitigate conflicts of interest as 

directed by Section 765 of the DoddFrank Act. 

1. Board 

The Commission proposes that the 

Board of a SB SEF, SBS exchange, or 

SBS exchange facility be composed of a 

majority of independent directors.160

The presence of a majority of 

independent directors on the Board 

should reduce the ability of ownerdirectors of a SB SEF, SBS exchange, or 

SBS exchange facility to improperly 

influence the operation of such entity to 

their own advantage and to the 

detriment of other users or potential 

users of the facility or exchange. A 

majority independent director 

requirement should help foster a greater 

degree of independent decision-making 

consistent with the objectives of the 

Dodd-Frank Act and the Exchange Act 

and should reduce the ability of owners 

that are participants or members to 

control key decisions regarding the 

operation of the SB SEF or SBS 

exchange and thereby potentially limit 


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161For SB SEFs, these responsibilities include 

establishing and enforcing rules with respect to the 

terms and conditions of the security-based swaps 

traded or processed on or through the facility and 

any limitation on access to the facility; trading 

procedures to be used in entering and executing 

orders traded on SB SEFs; and monitoring trading 

in SB SEFs to prevent manipulation, price 

distortion, and disruptions of the settlement process 

through surveillance, compliance and disciplinary 

practices and procedures. See Section 763(c) of the 

Dodd-Frank Act, Public Law 111–203, Section 

763(c). 

162See supra Section III.B. Currently, the 

governance structure of a facility of an exchange 

that is a separate legal entity from the exchange and 

that is not a wholly-owned subsidiary of the 

exchange is not subject to any specific board or 

committee compositional requirements. Given the 

nature of the conflict concerns for the trading of 

security-based swaps and the structure of the 

security-based swaps market—namely, the 

dominance by a small group of dealers and the 

concern with respect to undue influence in the 

operation of the SB SEF or SBS exchange—the 

Commission believes that it is necessary and 

appropriate to impose the same board and 

committee compositional requirements on a facility 

of an exchange if that facility posts or makes 

available for trading security-based swaps. 

163See Securities Exchange Act Release No. 

48745 (November 4, 2003), 68 FR 64154 (November 

12, 2003) (order approving File Nos. SR–NYSE– 

2002–33, SR–NASD–2002–77, SR–NASD–2002–80, 

SR–NASD–2002–138, SR–NASD–2002–139, and 

SR–NASD–2002–141). 164 15 U.S.C. 78s. 

access to, or limit the products made 

available for trading on, the SB SEF or 

SBS exchange, which could adversely 

affect the trading of security-based 

swaps in regulated markets. Further, the 

definition of independent director is 

designed to assure that the independent 

director would not have a direct 

economic stake in the SB SEF or SBS 

exchange, or other relationship that 

would call into question the impartiality 

of the director, and thus would not be 

subject to the conflicts of interest 

identified above. 

SB SEFs and SBS exchanges are 

intended to serve important roles in 

providing centralized, transparent 

trading of security-based swaps and, 

under Section 763(c) of the Dodd-Frank 

Act or existing Section 6 of the 

Exchange Act, as applicable, will have 

a number of responsibilities.161

Requiring a majority independent Board 

should help assure that SB SEFs and 

SBS exchanges would operate in an 

impartial manner with respect to these 

(and other) mandated duties. Moreover, 

requiring a majority independent Board 

for SB SEFs and SBS exchanges would 

be commensurate with the manner in 

which national securities exchanges 

generally are governed today 162 and 

comports with the listing rules of 

exchanges, which are approved by the 

Commission.163

One of the alternatives the 

Commission proposes for security-based 

swap clearing agencies is to require the 

Board of any security-based swap 

clearing agency be composed of 35% 

independent directors. The Commission 

proposes this 35% independence 

alternative to address potential concerns 

that requiring a majority independent 

Board for security-based swap clearing 

agencies would affect the Board’s ability 

to effectively perform risk management 

functions. Security-based swap clearing 

agencies perform a critical function in 

mitigating financial risk for securitybased swaps market participants. 

Although critical to promoting price 

transparency and therefore market 

efficiency, as noted above, the 

Commission does not believe that the 

operation of SB SEFs, SBS exchanges, 

and SBS exchange facilities would pose 

the same level of systemic risk as 

security-based swap clearing agencies 

because they do not assume the risk of 

managing open positions or of 

guaranteeing the settlement of 

transactions. Thus, the Commission is 

not making the same proposal with 

respect to SB SEFs, SBS exchanges, and 

SBS exchange facilities. 

Although a majority independent 

Board may address conflicts of interest 

concerns that underlie Section 765 of 

the Dodd-Frank Act, it may not 

effectively eliminate all conflicts. The 

presence of independent directors may 

be an effective mechanism to address 

certain types of conflicts in certain types 

of institutions but not necessarily in all 

instances nor for all institutions. The 

Commission, however, does not believe 

that the characteristics of SB SEFs and 

SBS exchanges, and the types of 

conflicts that may be inherent with 

respect to such entities, pose a set of 

circumstances that are incompatible 

with an effective governance via a 

majority independent Board. 

Taking into account these and other 

concerns, the Commission has 

considered a less prescriptive 

governance rule to address conflicts of 

interest for venues that trade securitybased swaps. However, especially 

because SB SEFs are not SROs and thus 

their rules are not subject to 

Commission approval pursuant to 

Section 19 of the Exchange Act,164 a 

principles-based approach to 

governance may not give the 

Commission sufficient ability to address 

potential conflicts in the operation of SB 

SEFs. Although the Commission, 

through its authority to approve 

applications to register as a SB SEF, may 

be able to ascertain that a SB SEF at the 

time of its registration has a governance 

structure that sufficiently would 

mitigate conflicts of interest, a less 

prescriptive approach could make it 

more difficult for the Commission to 

assure that the SB SEF’s governance 

structure continues to meet the 

proposed requirements over time. 

The Commission welcomes 

commenters’ insights to inform its 

understanding of the governance of 

trading venues for security-based swaps. 

As discussed above, a majority 

independent Board may not effectively 

address all conflicts. The Commission 

therefore seeks comment on all aspects 

of its proposal for a majority 

independent Board. Should the 

Commission adopt a less prescriptive 

approach to mitigating conflicts of 

interest in the governance of SB SEFs 

and SBS exchanges? Are there other 

approaches that would improve 

governance and mitigate conflicts of 

interest? For example, would State laws 

governing the fiduciary duty owed by 

corporate board members help to 

mitigate conflicts of interest or, as noted 

above, would such laws potentially 

aggravate the types of conflicts of 

interest that the Commission is trying to 

address? Should the Commission 

consider any additional requirements 

related to fiduciary duties to either 

enhance mitigation of conflicts or 

address deficiencies? 

Further, the Commission requests 

comment on whether requiring the 

Board of a SB SEF, SBS exchange, or 

SBS exchange facility to be composed of 

a majority of independent directors 

would improve the governance of the 

SB SEF, SBS exchange, or SBS exchange 

facility, as applicable, and mitigate 

conflicts of interest that could arise. The 

Commission specifically requests 

comment on whether there are other 

Board structures that could help 

mitigate conflicts of interest. If having a 

majority independent Board is not 

necessary to mitigate conflicts, but some 

lesser percentage of independent 

directors would help address such 

concerns, what percentage of Board 

members should be required to be 

independent? What are the benefits and 

costs of requiring Boards of SB SEFs, 

SBS exchanges, and SBS exchange 

facilities to be composed of a majority 

of independent directors? Would a 

majority independent Board help to 

mitigate conflicts of interest if the 

ownership of a SB SEF, SBS exchange, 

or SBS exchange facility is concentrated 

in a small group of owners (e.g., five 

owners) rather than a larger group (e.g., 

greater than ten owners)? Would a 

majority independent Board help to 

mitigate conflicts of interest that could 

arise between the commercial interests 

of a SB SEF, SBS exchange, or SBS 

exchange facility or the owners of the 

SB SEF, SBS exchange or SBS exchange 


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65910 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

165The SRO Governance Proposing Release 

proposed that the board of a national securities 

exchange or national securities association be 

composed of a majority of independent directors. 

See SRO Governance Proposing Release, supra note 

59. A number of commenters, particularly national 

securities exchanges, favored this proposal. See, 

e.g., PSX Comment Letter, supra note 156; Letter 

from Anthony K. Stankiewicz, Esq., Vice President, 

Legal and Governance, BSE, to Jonathan G. Katz, 

Secretary, Commission, dated March 8, 2005 

(supporting the majority independent board 

requirement but objecting to the definition of 

independence) (‘‘BSE Comment Letter’’); Letter from 

Mary Yeager, Assistant Secretary, NYSE, to 

Jonathan G. Katz, Secretary, Commission, dated 

March 8, 2005 (‘‘NYSE Comment Letter’’). A few 

commenters objected to it as being an unnecessary 

requirement to mandate for all exchanges. See, e.g., 

ISE Comment Letter, supra note 156; Letter from 

William J. Brodsky, Chairman and Chief Executive 

Officer, Chicago Board Options Exchange, 

Incorporated, to Jonathan G. Katz, Secretary, 

Commission, dated March 8, 2005 (‘‘CBOE 

Comment Letter’’). The Commission notes, however, 

that the SRO Governance Proposing Release related 

to national securities exchanges that trade equity 

securities and listed options and registered 

securities associations, and the comments received 

did not address potential conflicts in other contexts. 

166See supra Section III.B. 

167See proposed Rules 700(j) and (l) under 

Regulation MC. 

168See Section 303A.02 of the NYSE Listed 

Company Manual and Nasdaq Rule 5605(a)(2), both 

of which contain specific circumstances that, if 

satisfied, would preclude a determination that the 

director is independent. 

169See supra note 66. 

170 If the parent company of a SB SEF, SBS 

exchange or SBS exchange facility was itself a 

regulated entity that is subject to the Exchange Act 

and rules and regulations thereunder, then it would 

comply with any requirements that it is subject to 

in that capacity. 

171The CFTC has proposed to apply a ‘‘public 

director’’ requirement to parent companies that 

operate DCMs and SEFs. See http://www.cftc.gov/ 

ucm/groups/public/@newsroom/documents/file/ 

federalregister_governance.pdf. 

172See Section 763(c) of the Dodd-Frank Act, 

Public Law 111–203, Section 763(c), and 15 U.S.C. 

78(f). See also proposed Rule 702(e)(1) under 

Regulation MC. 

173Proposed Rule 702(e) under Regulation MC 

does not explicitly include a SBS exchange facility. 

A facility that posts or makes available for trading 

a security-based swap would do so under the 

registration of an exchange of which it is a facility. 

Therefore, the exchange is deemed the statutory 

entity posting or making available for trading the 

security based swap and is responsible for the 

regulatory oversight of the facility. Accordingly, the 

exchange whose facility posts or makes available for 

trading a security-based swap must itself establish 

the requisite ROC. 

174See proposed Rule 702(e)(2) under Regulation 

MC. 

facility and the regulatory 

responsibilities of the SB SEF or SBS 

exchange? Are there experience or 

efficiency issues if a majority of the 

Board must be composed of 

independent directors? Are there 

remedies for overcoming any such 

experience or efficiency issues? 165

The Commission also notes that 

currently, for national securities 

exchanges, at a minimum, the number 

of non-industry directors should equal 

or exceed the number of industry 

directors.166 The Commission requests 

comment on whether requiring a 

majority independent Board could 

further mitigate conflicts for SBS 

exchanges or whether the current 

standards exchanges have in place 

would sufficiently address the conflict 

concerns with respect to exchanges that 

would post or make available for trading 

security-based swaps. Further, the 

Commission requests comment as to 

whether the requirement for Board 

composition should be different for SB 

SEFs and SBS exchanges and, if so, why 

and how? 

The Commission also requests 

comment on the proposed definitions of 

‘‘independent director’’ and ‘‘material 

relationship.’’ 167 Are the definitions of 

‘‘independent director’’ and ‘‘material 

relationship’’ appropriate? If not, how 

should they be defined? The proposed 

rule provides circumstances that would 

preclude a finding that a director is 

independent.168 The Commission 

requests comment on whether this 

approach is appropriate or whether the 

Commission should take a less 

prescriptive approach. The Commission 

also notes that the proposed rule 

precludes a director from being deemed 

independent if he or she has received 

from the SB SEF, SBS exchange, or SBS 

exchange facility within the past three 

years payments that reasonably could 

affect his or her independent judgment 

or decision-making, excluding 

remunerations for Board or Board 

committee services. The Commission 

requests comment on whether it is 

appropriate to exclude compensation for 

Board or Board committee service from 

disqualifying a director as an 

independent director. Are there 

circumstances or levels of compensation 

that should disqualify a candidate from 

being deemed independent? The 

Commission also requests comment on 

whether, instead of independence 

requirements, it should require that the 

number of ‘‘non-industry’’ directors 

equal or exceed the number of 

‘‘industry’’ directors, as such terms are 

generally defined by the exchanges.169

Are there other types of affiliations that 

the Commission should be concerned 

about that are not addressed by the 

proposed definitions of ‘‘independent 

director’’ or ‘‘material relationship’’? 

The Commission is not proposing that 

the Board composition requirement 

apply to parent companies of a SB SEF, 

SBS exchange, or SBS exchange 

facility.170 In other words, the 

Commission is not proposing to require 

a holding company that wholly owns, or 

entities that control, a SB SEF, SBS 

exchange, or SBS exchange facility to 

have a majority independent Board.171

The Commission preliminarily believes 

that the composition of the Board of a 

parent that wholly owns or controls a 

SB SEF, SBS exchange, or SBS exchange 

facility does not raise conflicts concerns 

that require Commission rulemaking. 

The Commission, however, requests 

comment on whether the majority 

independent Board requirement should 

apply to an entity that owns and 

controls a SB SEF, SBS exchange, or 

SBS exchange facility. 

2. Regulatory Oversight Committee 

In addition to a majority independent 

Board, the Commission proposes that a 

SB SEF or SBS exchange establish a 

ROC that is composed solely of 

independent directors to oversee the SB 

SEF’s obligations under Section 763(c) 

of the Dodd-Frank Act or the SBS 

exchange’s regulatory oversight 

responsibilities under Section 6 of the 

Exchange Act, respectively.172 This 

requirement also would apply to a 

national securities exchange that posts 

or makes available for trading securitybased swaps through a facility of the 

exchange.173 The ROC would oversee 

the regulatory program on behalf of the 

Board. Specifically, the Commission 

expects that a ROC, among other things, 

would monitor a SB SEF’s or SBS 

exchange’s regulatory program for 

sufficiency, effectiveness, and 

independence; oversee all facets of the 

regulatory program; review the size and 

allocation of the regulatory budget and 

resources; and review regulatory 

proposals and advise the Board as to 

whether and how such changes may 

affect regulation. The proposed rule also 

would require that any recommendation 

of the ROC that is not adopted or 

implemented by the Board be reported 

promptly to the Commission.174

The proposed provisions relating to 

the ROC should help limit the ability of 

owners of the SB SEF and SBS exchange 

to unduly influence the operation of 

these entities, and thus would further 

the objectives of good governance and 

mitigation of conflicts of interest that 

underlie Section 765 of the Dodd-Frank 

Act. A ROC is intended to have an 

important role in assuring that a SB SEF 

or SBS exchange carries out its 

obligations in an even-handed and 

effective manner and that its oversight 

functions are adequately funded. 

Although the Commission encourages 

national securities exchanges to have a 

wholly independent ROC, it has not in 


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175 In the SRO Governance Proposing Release, the 

Commission proposed to require SROs to have a 

ROC and to require that all members of such 

committee be independent. See SRO Governance 

Proposing Release, supra note 59. Some 

commenters generally favored the requirement of a 

ROC. See, e.g., PSX Comment Letter, supra note 

156; CBOE Comment Letter, supra note 165. 

However, a number of commenters objected to the 

requirement that certain board committees, 

including the ROC, be composed solely of 

independent directors. See, e.g., Phlx Comment 

Letter, supra note 156 (‘‘To impose this requirement 

on all Standing Committees would potentially 

exclude persons with the most experience and 

knowledge from serving on these committees.’’); 

CBOE Comment Letter, supra note 165; letter from 

Neal Wolkoff, Acting Chief Executive Officer, the 

American Stock Exchange LLC, to Jonathan G. Katz, 

Secretary, Commission, dated March 8, 2005 (‘‘[A] 

number of the exchanges may find it difficult to 

find enough qualified independent directors with 

sufficient expertise to satisfy all of these 

committees.’’); letter from the Archipelago 

Exchange, BSE, the Chicago Stock Exchange, ISE, 

the Nasdaq Stock Market, and Phlx, to Jonathan G. 

Katz, Secretary, Commission, dated March 8, 2005 

(‘‘[As] a result of the potential loss of flexibility, we 

disagree with the mandated requirement for specific 

committees composed exclusively of directors that 

meet the [Commission’s] proposed definition of 

independence.’’). The Commission notes, however, 

that the SRO Governance Proposing Release related 

to national securities exchanges that trade equity 

securities and listed options and registered 

securities associations, and the comments received 

did not address potential conflicts in other contexts. 

176See supra note 54. 

177Some exchanges have voluntarily created 

ROCs. See, e.g., Securities Exchange Act Release 

Nos. 51149 (February 8, 2005), 70 FR 7531 

(February 14, 2005) (order approving 

demutualization of the Chicago Stock Exchange 

(‘‘CHX’’)) (at the time of the demutualization, CHX 

proposed to have, and currently has, majority 

public directors on its ROC) and 62158 (May 24, 

2010), 75 FR 30082 (May 28, 2010) (order approving 

the demutualization of CBOE) (CBOE’s ROC is 

composed solely of non-industry directors). 

178See proposed Rule 702(f) under Regulation 

MC. This proposed provision would not apply to 

the ROC or the nominating committee since the 

proposals would require the ROC and the 

nominating committee to be composed solely of 

independent directors. 

the past required them to do so.175 As 

mentioned above, however, the conflict 

concerns that Section 765 is intended to 

address are not entirely analogous to 

those posed by national securities 

exchanges. Rather, there is a heightened 

concern regarding conflicts of interest 

for trading venues of security-based 

swaps because a small group of dealers 

may exert undue influence to control 

the level of access to, and the scope of 

products traded on such venues. 

Further, while SB SEFs do not possess 

the full range of self-regulatory 

obligations that exchanges have, they 

nonetheless have a number of regulatory 

duties that are set forth in the core 

principles for SB SEFs contained in 

Section 763(c) of the Dodd-Frank Act.176

Thus, it appears that a need for a wholly 

independent ROC may be greater for SB 

SEFs and SBS exchanges than for other 

registered national securities 

exchanges.177

The Commission also recognizes that, 

as mentioned above, an independent 

director, who by definition would be 

outside the management of a SB SEF or 

SBS exchange and not a SB SEF 

participant or SBS exchange member 

may not have access to the same amount 

or types of information as nonindependent directors. Therefore, a ROC 

composed solely of independent 

directors may need to rely on 

management or non-independent 

directors for information, with attendant 

biases of information from such sources. 

If directors on a ROC, moreover, lack 

necessary information or are otherwise 

not sufficiently knowledgeable, the 

committee’s effectiveness as a whole 

may be compromised. Such ROC may 

defer to management’s expertise or the 

expertise of non-independent directors 

on the Board. Further, as mentioned 

above, independent directors may have 

their own biases that could compromise 

the structural protections intended by a 

wholly independent ROC. Therefore, 

the Commission seeks comment on the 

proposal relating to the composition and 

duties of the ROC. Would the 

establishment of a fully independent 

ROC help mitigate the identified 

conflicts of interest? Are there particular 

circumstances under which a ROC 

should be permitted to have nonindependent directors? If so, please 

identify them. 

Separately, the Commission requests 

comment on whether it should specify 

in the proposed rule the duties of the 

ROC. If so, what should be the scope of 

the ROC’s duties? For example, should 

a ROC be required to oversee decisions 

as to which entities have access to the 

trading facility and under what 

circumstances, or which products are 

made available for trading? Is it 

appropriate to require that the Board 

submit to the Commission any 

recommendation of the ROC that it does 

not adopt or implement? Would this 

requirement help assure good 

governance that may mitigate conflicts? 

Should such reports be required to be 

submitted promptly to the Commission? 

Would a different time period be more 

appropriate? For instance, should such 

reports instead be required to be 

submitted semi-annually or, for SB 

SEFs, should they be incorporated as 

part of the annual report of the Chief 

Compliance Officer, which is required 

pursuant to core principle 14 under 

Section 763(c) of the Dodd-Frank Act? 

Are there reasons, consistent with 

mitigation of conflicts, why SB SEFs 

and SBS exchanges should be treated 

differently with respect to the proposal 

to require a fully independent ROC? Are 

there other ways in which material 

information pertaining to the ROC’s 

ability to carry out its duties effectively 

can be brought to the Commission’s 

attention? 

3. Other Board Committees 

The Commission is proposing 

compositional and other requirements 

with respect to various other Board 

committees. In this regard, proposed 

Rule 702(f)(1) under Regulation MC 

would require that the nominating 

committee of a SB SEF, SBS exchange, 

or SBS exchange facility be composed 

solely of independent directors. The 

proposed requirement for the Board of 

the SB SEF, SBS exchange, or SBS 

exchange facility to be composed of a 

majority of independent directors could 

be undercut if the nominating 

committee were dominated by persons 

that had an ownership interest in these 

entities, were affiliated with such 

owners, or were selected by the ownerdirectors or their affiliates. Further, the 

proposed rule would require that any 

committee of the Board that is delegated 

the authority to act on the Board’s 

behalf, such as any executive 

committee, also must be composed of a 

majority of independent directors.178

This proposed provision extends to 

Board committees that are authorized to 

act on behalf of the Board the 

compositional requirement proposed for 

the full Board and is designed to assure 

that the SB SEF, SBS exchange or SBS 

exchange facility would not subvert the 

proposed majority Board independence 

standard by delegating the Board’s 

duties to a committee that does not have 

the same majority independence 

standard. 

With respect to a wholly independent 

nominating committee, the Commission 

recognizes that the proposal may not 

sufficiently mitigate concerns that 

certain shareholders may be able to 

influence or control the director 

nominating process and thus undermine 

the intent of a majority independent 

Board. As discussed above, an 

independent director may not truly be 

independent from the influence of, or 

bias toward, a large shareholder or 

group of shareholders, other nonindependent directors, or even from 

management. Consequently, if the 

nominating committee is composed of 

enough directors who are subject to 

such influence or bias, the palliative 

purpose of requiring a wholly 

independent nominating committee 

could be compromised. Accordingly, 

the Commission requests comment on 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
65912 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

179The SRO Governance Proposing Release 

proposed that certain committees, including the 

nominating committee, be composed solely of 

independent directors. See SRO Governance 

Proposing Release, supra note 59. Some 

commenters favored this requirement. See, e.g., PSX 

Comment Letter, supra note 156. A number of 

commenters, particularly national securities 

exchanges, objected to the requirement that certain 

board committees be composed solely of 

independent directors. See supra note 175. 

180See Section 6(b)(3) of the Exchange Act, 15 

U.S.C. 78f(b)(3). 

181As discussed above, Section 763(c) of the 

Dodd-Frank Act sets forth 14 core principles that 

SB SEFs must satisfy, including one relating to 

conflicts of interest, and provides the Commission 

with rulemaking authority with respect to 

implementation of these core principles. As the 

Commission has not yet proposed rules regarding 

the requirements and operation of a SB SEF, 

including the scope of trading on and which 

entities would be allowed to directly access a SB 

SEF, the Commission may determine that it is more 

appropriate to propose participant representation 

requirements, if any, in its broader rulemaking 

relating to SB SEFs. 

182See supra Section III.B. 

183See proposed Rule 702(h) under Regulation 

MC. 

184See supra note 173. Similar to the requirement 

pertaining to the ROC, the exchange, not the 

facility, bears the responsibility of disciplining its 

members. See Section 6 of the Exchange Act. 

Consequently, proposed Rule 702(h) does not 

explicitly mention SBS exchange facility. However, 

a national securities exchange that posts or makes 

available for trading a security-based swap through 

its facility must also comply with the requirements 

of proposed Rule 702(h) under Regulation MC. 

185See supra note 181. 

whether it should prescribe or limit the 

manner in which a SB SEF, SBS 

exchange, or SBS exchange facility 

could appoint the nominating 

committee. Should the Commission 

consider an alternative to a 

compositional requirement for a 

nominating committee, such as allowing 

a SB SEF, SBS exchange, or SBS 

exchange facility to have a board of 

trustees responsible for nominating 

candidates for the Board? If this were a 

viable alternative, should there be 

compositional requirements or other 

limits imposed on the board of trustees? 

How should such a board of trustees be 

appointed? Would the alternative of a 

board of trustees to nominate directors 

provide greater assurance that 

independent directors are truly 

independent not only at the time of 

their nomination but during their 

service on the Board as well? 

Conversely, the Commission also 

notes that dealer-owners that are Board 

members would not be able to serve on 

a wholly independent nominating 

committee and thus would not have a 

voice in the process of nominating 

candidates for Board seats. This would 

mean that the nominating committee 

would not have access to the dealerowners’ potentially valuable insights 

with respect to qualified candidates for 

either independent or non-independent 

director positions. Accordingly, the 

Commission invites commenters to 

suggest the appropriate compositional 

requirements for the nominating 

committee and explain their views. 

Should the Commission instead require 

a majority independent nominating 

committee? Would a majority 

independent nominating committee be 

consistent with the proposal’s goal to 

mitigate conflicts for SB SEFs and SBS 

exchanges? 179

SB SEFs are not subject to ‘‘fair 

representation’’ requirements, like 

national securities exchanges, which 

must assure their members ‘‘fair 

representation’’ in the selection of 

directors and the administration of the 

exchange’s affairs.180 Should the 

Commission adopt additional 

compositional requirements to provide 

SB SEF participants a guaranteed voice 

in the selection of the SB SEF’s directors 

and the administration of its affairs? 181

For example, should the Commission 

require that the nominating committee 

consult with participants in the SB SEFs 

or SBS exchanges, as applicable? Or, 

should the Commission require that the 

participants in the SB SEFs or SBS 

exchanges select a certain percentage of 

directors? If so, should the Commission 

also limit the ability of owner 

participants (such as dealers) to 

participate in this process? If that is the 

case, should any such limitation depend 

on whether ownership is concentrated 

in a small number of dealers? Should 

end users also be given guaranteed 

rights of participation in the governance 

of the SB SEF? 

The Commission also seeks comment 

on whether the proposed compositional 

requirements relating to any committee 

that is delegated the authority to act on 

behalf of the Board are appropriate and 

whether there are any other areas in 

which the Commission should propose 

compositional requirements for SB SEF 

and SBS exchange committees. For 

example, the Commission requests 

comment on whether it should require 

any SB SEF, SBS exchange, or SBS 

exchange facility committee that 

determines which security-based swaps 

will trade on the SB SEF or SBS 

exchange, respectively, be composed of 

majority independent directors, or 

require participation by other groups on 

such committee. Should the ROC be 

required to oversee decisions regarding 

access to the SB SEF and regarding 

which security-based swaps are made 

available to trade on the SB SEF? 

4. Disciplinary Process 

As noted above, the Commission 

historically has required that national 

securities exchanges’ disciplinary 

panels be balanced and include industry 

member representation.182 Proposed 

Rule 702(g) under Regulation MC would 

require that any disciplinary process of 

a SB SEF and SBS exchange shall 

preclude any group or class of persons 

that is a SB SEF participant or SBS 

exchange member from dominating or 

exercising disproportionate influence. 

In other words, to the extent that there 

is more than one type of group or class 

of persons that are participants or 

members in a SB SEF or SBS exchange, 

as applicable, the composition of any 

disciplinary panel should not allow one 

group or class to have representation on 

the disciplinary panel that is out of 

proportion as compared to other groups 

or classes of persons that are 

participants in the SB SEF or SBS 

exchange. In addition, any panel that is 

responsible for disciplinary decisions, 

and any appeals body, must include at 

least one independent director.183 These 

proposed provisions should help 

mitigate conflicts of interest in the SB 

SEF’s and SBS exchange’s disciplinary 

process. This requirement also would 

apply to a national securities exchange 

that posts or makes available for trading 

a security-based swap through its 

facility.184

The Commission seeks comment on 

the proposal relating to requirements of 

the disciplinary process, including the 

compositional requirements. Should 

any disciplinary panel also be required 

to include representatives selected by 

SB SEF participants or SBS exchange 

members, as applicable? Would the 

proposed provisions help to mitigate the 

identified conflicts of interest? Should 

any other persons be precluded from 

dominating the disciplinary process? 

Are there any additional provisions that 

should be proposed to mitigate conflicts 

of interest in the disciplinary 

process? 185 The Commission also 

requests comment on whether the 

Commission’s proposal would 

meaningfully supplement or enhance 

the requirements that SBS exchanges, as 

national securities exchange, already 

have in place with respect to the 

disciplinary process. 

VI. Discussion of Exemptive Authority 

Pursuant to Section 36 of the Exchange 

Act 

The Commission pursuant to Section 

36 of the Exchange Act may grant an 

exemption from any rule or any 

provision of any rule under Regulation 

MC. Any such exemption could be 

subject to conditions and could be 

revoked by the Commission at any time. 


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Generally, the Commission would 

consider granting an exemption where 

the exemption is necessary or 

appropriate in the public interest and 

consistent with the protection of 

investors. For example, the SBS 

exchange, SB SEF, or security-based 

swap clearing agency might be unable, 

on a temporary basis and for reasons 

beyond its control, to comply with one 

of the rules under Regulation MC. The 

Commission could also grant an 

exemption where the SBS exchange, SB 

SEF, or security-based swap clearing 

agency demonstrated that it established 

alternative means to effectively mitigate 

conflicts of interest as contemplated 

under Regulation MC and that it would 

otherwise be unable to comply with the 

requirements under Regulation MC, 

including as a start-up SB SEF, SBS 

exchange, or security-based swap 

clearing agency. The Commission in its 

sole discretion would determine 

whether to grant or deny a request for 

an exemption. In addition, the 

Commission could revoke an exemption 

at any time, including if the SBS 

exchange, SB SEF, or security-based 

swap clearing agency could no longer 

demonstrate that such exemption is 

necessary or appropriate in the public 

interest, or is consistent with the 

protection of investors. 

The Commission requests comment 

on all aspects of the exemptive 

authority. Would such exemptive 

authority be useful to facilitate the 

purposes of Section 765? If so, in what 

circumstances should the Commission 

grant exemptions? Should exemptions 

only be granted in limited 

circumstances? Should the Commission 

potentially consider granting 

exemptions from all rules under 

Regulation MC or are exemptions only 

warranted for specific rules or specific 

entities? For example, should 

exemptions only be available with 

respect to the voting interest restrictions 

applicable to security-based swap 

clearing agencies? What specific factors 

should the Commission consider in 

determining whether to grant an 

exemption? Are there cases where 

exemptions may not be appropriate and 

should not be considered? 

VII. Effective and Compliance Date 

The Commission is required to adopt 

rules under Section 765 within 180 days 

of enactment of Title VII. However, 

certain of the rules the Commission is 

proposing today would apply to SB 

SEFs, which will be the subject of new 

definitional rules that are required 

under the Dodd-Frank Act to be 

completed by July 15, 2011. 

Accordingly, the Commission is 

proposing that provisions of Regulation 

MC as applicable to SB SEFs would 

become effective sixty (60) days after 

July 15, 2011. All other provisions of the 

rules under Regulation MC would 

become effective sixty (60) days after the 

final rules are published in the Federal 

Register. 

The Commission recognizes that 

existing entities may need a transitional 

period to implement any final rules. 

Accordingly, the Commission is 

proposing to permit the phase-in 

implementation of the rules under 

Regulation MC over two (2) years or two 

regularly-scheduled Board elections. 

The phase-in implementation would 

apply to existing exchanges, clearing 

agencies, or other institutions that apply 

to register as a SBS exchange, SB SEF, 

or security-based swap clearing agency. 

However, the Commission expects that 

entities that are newly created in order 

to establish a SBS exchange, SB SEF, or 

security-based swap clearing agency 

would fully comply with the final rules. 

The Commission requests comment 

on (i) the timing of effectiveness for the 

final rules, and (ii) the length and 

applicability of the implementation 

period. 

VIII. General Request for Comments 

The Commission seeks comment on 

the proposed rules that are intended to 

mitigate conflicts of interest with 

respect to security-based swap clearing 

agencies, SB SEFs, SBS exchanges, and 

SBS exchange facilities, on any 

additional or different provisions that 

would mitigate conflicts of interest for 

these entities, and on any other matters 

that might have an implication on the 

proposals. The Commission particularly 

requests comment from the point of 

view of entities that plan to register as 

security-based swap clearing agencies or 

SB SEFs and from national securities 

exchanges that plan to become SBS 

exchanges or create SBS exchange 

facilities; entities operating platforms 

that currently trade or clear securitybased swaps; broker-dealers, financial 

institutions, major security-based swap 

participants, and other persons that 

trade security-based swaps; and endusers generally. 

The Commission invites commenters 

to address whether the proposed rules 

are appropriately tailored to achieve the 

goal of mitigating conflicts of interest in 

the ownership and governance of 

security-based swap clearing agencies, 

SB SEFs, SBS exchanges, and SBS 

exchange facilities, including with 

respect to the administration of these 

entities’ regulatory activities. The 

Commission also requests comment on 

the necessity and appropriateness of 

mandating ownership and voting 

limitations for security-based swap 

clearing agencies, SB SEFs, SBS 

exchanges, and SBS exchange facilities 

and on whether there are other means 

to achieve the statutory mandate of 

Section 765 of the Dodd-Frank Act. 

The Commission is proposing 

governance requirements for securitybased swap clearing agencies, SB SEFs, 

SBS exchanges, and SBS exchange 

facilities that are designed to mitigate 

conflicts of interest. The Commission 

requests comment on whether the 

governance requirements, by 

themselves, would be enough to 

mitigate conflicts. 

The Commission requests comment 

on the two alternative proposals for 

security-based swap clearing agencies. 

Are there other alternatives that would 

more effectively mitigate conflicts of 

interest? Should security-based swap 

clearing agencies be permitted to choose 

between alternatives at all? The 

Commission may determine to adopt 

only one of the proposed alternatives as 

a final rule. If only one alternative were 

to be adopted as a final rule, which one 

should it be? Should any of the 

provisions of the proposed alternatives 

be revised? The Commission may 

combine aspects of each proposed 

alternative rule (with or without 

modifications) and adopt them as a 

single final rule. If that approach is 

taken, which aspects of each alternative 

should be combined? For example, 

should the voting interest restrictions in 

Rule 701(a) be combined with the 

governance restrictions in Rule 701(b) to 

create a stronger rule to mitigate 

conflicts of interest at security-based 

swap clearing agencies? As compared to 

each other, how is each alternative 

likely to affect access and risk 

management at security-based swap 

clearing agencies? How will each 

alternative affect and be affected by 

developments in the market, including 

the prospect of future competition? 

The Commission also requests 

comment on the impact on competition 

the two alternative proposals might 

have. The Voting Interest Focus 

Alternative and the Governance Focus 

Alternative are designed to address the 

unique conflict of interest issues at 

security-based swap clearing agencies. 

The Commission requests comment on 

whether imposing voting interest and 

governance limitations could have the 

unintended consequence of deterring 

new, competitive security-based swap 

clearing agencies at a time when central 

clearing for security-based swaps is still 

developing. A security-based swap 

clearing agency that currently clears 

security-based swaps but would not 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
65914 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

186 In the equities market a small group of brokerdealers or single-dealer proprietary firms can and 

do own alternative trading systems (‘‘ATSs’’) and 

thus it can be argued that SB SEFs and SBS 

exchanges should be permitted to operate similarly. 

See Securities Exchange Act Release No. 60997 

(November 13, 2009), 74 FR 61208 (November 23, 

2009) (as of November 2009, there were 

approximately 73 ATSs that are subject to 

Regulation ATS). However, ATSs exist in the 

context of a marketplace with robust competition 

among numerous trading venues. Therefore, ATSs 

that are owned by one broker-dealer or a small 

group of broker-dealers, by virtue of their 

ownership structure alone, generally do not present 

a concern that they could lessen price competition 

or market efficiency. 187 44 U.S.C. 3501 et seq. 

meet the proposed voting interest limits 

would need to revise its ownership 

structure. There could be costs and 

delays as the security-based swap 

clearing agency seeks to find one or 

more additional owners to satisfy the 

proposed limits, with a possible 

diminution in the value of the original 

owner(s)’ investment. 

The Commission is sensitive to 

arguments against imposing ownership 

and voting limits for security-based 

swap clearing agencies, some of which 

were articulated at the Conflicts 

Roundtable. However, it also 

understands that the OTC derivatives 

market is highly concentrated and 

dealer dominated. As a result, voting 

interest and governance restrictions may 

be necessary at security-based swap 

clearing agencies where they have not 

been necessary at other securities 

clearing agencies. Access to central 

clearing services will be crucial for most 

firms that will actively trade in securitybased swaps that are required to be 

cleared. Although the proposed 

restrictions may have the effect of 

creating barriers to potential securitybased swap clearing agencies (and thus 

market participants could have fewer 

clearing agencies to choose from) the 

incentives of independent directors will 

likely promote increased access to 

central clearing for market participants. 

In contrast, although ownership and 

voting limits may more directly affect 

the ability of SB SEFs and SBS 

exchanges to start up, the lack of market 

characteristics to promote competing 

trading venues for security-based swaps 

may emphasize the greater need for 

ownership and voting limits. If the 

market characteristics for security-based 

swaps naturally promote dealer 

domination without robust competing 

trading venues, there is more need to 

mitigate the types of concerns that 

underlie Section 765, such as by 

imposing ownership and voting 

limits.186

The CFTC is adopting rules to 

mitigate conflicts of interest for 

derivatives clearing organizations that 

clear swaps, swap execution facilities 

and boards of trade designated as a 

contract markets that post swaps or 

make swaps available for trading as 

required under Section 726 of the DoddFrank Act. Understanding that the 

Commission and the CFTC regulate 

different products and markets and, as 

such, appropriately may be proposing 

alternative regulatory requirements, the 

Commission requests comments on the 

impact of any differences between the 

Commission and CFTC approaches to 

the mitigation of conflicts of interest. 

Specifically, would the regulatory 

approaches under the Commission’s 

proposed rulemaking pursuant to 

Section 765 of the Dodd-Frank Act and 

the CFTC’s proposed rulemaking 

pursuant to Section 726 of the DoddFrank Act result in duplicative or 

inconsistent efforts on the part of market 

participants subject to both regulatory 

regimes or result in gaps between those 

regimes? If so, in what ways do 

commenters believe that such 

duplication, inconsistencies, or gaps 

should be minimized? Do commenters 

believe the approaches proposed by the 

Commission and the CFTC to mitigate 

conflicts of interest are comparable? If 

not, why? Do commenters believe there 

are approaches that would make the 

mitigation of conflicts of interest more 

comparable? If so, what? Do 

commenters believe that it would be 

appropriate for the Commission to adopt 

an approach proposed by the CFTC that 

differs from the Commission’s proposal? 

Is so, which one? The Commission 

requests commenters to provide data, to 

the extent possible, supporting any such 

suggested approaches. 

In addition, the Commission seeks 

comment regarding any potential 

implication of the proposals on users of 

any security-based swap clearing 

agencies, SB SEFs, and SBS exchanges, 

other market participants, and the 

public generally. The Commission seeks 

comment on the proposals as a whole, 

including their interaction with the 

other provisions of the Dodd-Frank Act. 

The Commission seeks comment on 

whether the proposals would help 

achieve the broader goals of increasing 

transparency and accountability in the 

OTC derivatives market. 

Commenters should, when possible, 

provide the Commission with empirical 

data to support their views. Commenters 

suggesting alternative approaches 

should provide comprehensive 

proposals, including any conditions or 

limitations that they believe should 

apply, the reasons for their suggested 

approaches, and their analysis regarding 

why their suggested approaches would 

satisfy the statutory mandate contained 

in Section 765 of the Dodd-Frank Act 

regarding mitigation of conflicts of 

interest. 

IX. Paperwork Reduction Act 

The proposed rules contain 

‘‘collection of information’’ requirements 

within the meaning of the Paperwork 

Reduction Act of 1995 (‘‘PRA’’).187 The 

titles for these collections are Rule 701 

of Regulation MC, both in the Voting 

Interest Focus Alternative and the 

Governance Focus Alternative, and Rule 

702 of Regulation MC. 

The Commission has submitted the 

information to the Office of 

Management and Budget (‘‘OMB’’) for 

review in accordance with 44 U.S.C. 

3507 and 5 CFR 1320.11. 

A. Summary of Collection of 

Information 

1. Security-Based Swap Clearing 

Agencies 

Proposed alternative Rule 701(a)(2) 

under Regulation MC would require 

security-based swap clearing agencies to 

have rules that would: (1) Provide for an 

effective mechanism to divest any 

participant of any interest owned in 

excess of the proposed 20% ownership 

limit; (2) not give effect to the portion 

of any voting interest held by one 

participant in excess of the proposed 

20% voting limit; (3) not give effect to 

the portion of any voting interest among 

all security-based swap clearing agency 

participants owned in the aggregate in 

excess of the proposed 40% ownership 

limit; and (4) provide an effective 

mechanism for the security-based swap 

clearing agency to obtain information 

relating to the voting interests in such 

entity. Alternative Rule 701(b)(2) under 

Regulation MC would require securitybased swap clearing agencies to have 

rules that would: (1) Provide for an 

effective mechanism to divest any 

participant of any interest owned in 

excess of the proposed 5% ownership 

limit; (2) not give effect to the portion 

of any voting interest held by one 

participant in excess of the proposed 

5% voting limit; and (3) provide an 

effective mechanism for the securitybased swap clearing agency to obtain 

information relating to the voting 

interests in such entity. Each securitybased swap clearing agency must 

comply with one of the alternatives. 

Establishing such rules would result in 

a paperwork burden for a security-based 

swap clearing agency. In addition, if the 

security-based swap clearing agency 

was to request to receive ownership and 

voting information from participants 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 65915 

188Proposed Rule 702(e) under Regulation MC 

does not explicitly include SBS exchange facilities 

because the exchange whose facility posts or makes 

available for trading a security-based swap must 

itself establish the requisite ROC. See supra note 

173. 

189See Section 763(c) of the Dodd-Frank Act, 

Public Law 111–203, Section 763(c). Specifically, 

the ROC would oversee the SBS exchange’s and SB 

SEF’s regulatory program on behalf of the Board 

and the Board would be required to delegate 

sufficient authority, dedicate sufficient resources, 

and allow sufficient time for the ROC to fulfill its 

mandate. 

190Of the four clearing agencies granted 

temporary exemptions from registration, only three 

have cleared products that are classified as securitybased swaps under Title VII of the Dodd-Frank Act. 

191 15 U.S.C. 78mm. 

192The Commission does not expect there to be 

a large number of clearing agencies that clear 

security-based swaps, based on the significant level 

of capital and other financial resources necessary 

for the formation of a clearing agency. 

193See Sections 763(a) and 763(c) of the DoddFrank Act, Public Law 111–203, Section 763(a) and 

(c). 

194The 15 national securities exchanges are: 

BATS Exchange, Inc.; BATS Y–Exchange, Inc.; 

Chicago Board Options Exchange, Incorporated; 

Chicago Stock Exchange, Inc.; C2 Options 

Exchange, Incorporated, EDGA Exchange, Inc., 

EDGX Exchange, Inc., International Securities 

Exchange, LLC; The NASDAQ Stock Market LLC; 

NASDAQ OMX BX, Inc.; NASDAQ OMX PHLX, 

Inc.; National Stock Exchange Inc.; New York Stock 

Exchange LLC; NYSE Amex LLC; and NYSE Arca, 

Inc. 

pursuant to Rule 701(a) or (b), the 

request would be a collection of 

information. 

2. SB SEFs, SBS Exchanges, and SBS 

Exchange Facilities 

Proposed Rule 702(c) under 

Regulation MC would require SB SEFs, 

SBS exchanges, and SBS exchange 

facilities to have rules that would: (1) 

Provide for an effective mechanism to 

divest any participant or member, as 

applicable, of any interest owned in 

excess of the proposed 20% ownership 

limit; (2) not to give effect to the portion 

of any voting interest help by one or 

more participants or members, as 

applicable, in excess of the proposed 

20% voting limit; and (3) provide an 

effective mechanism for the SB SEF, 

SBS exchange or SBS exchange facility 

to obtain information relating to 

ownership and voting interests in such 

entity. Establishing such rules would 

result in a paperwork burden for a SB 

SEF, SBS exchange, or SBS exchange 

facility, as applicable. In addition, if a 

SB SEF, SBS exchange, or SBS exchange 

facility were to request to receive 

ownership and voting information from 

participants or members pursuant to 

Rule 702(c) that would be a collection 

of information. 

Proposed Rule 702(e) under 

Regulation MC would require SB SEFs 

and SBS exchanges to establish a ROC 

that is composed solely of independent 

directors,188 to oversee the SB SEF’s and 

SBS exchange’s obligations under 

Section 763(c) of the Dodd-Frank Act 

and Section 6 of the Exchange Act, 

respectively.189 The proposed rule 

would require that any recommendation 

of the ROC that is not adopted or 

implemented by the SB SEF’s or SBS 

exchange’s Board be reported promptly 

to the Commission. 

B. Proposed Use of Information 

1. Security-Based Swap Clearing 

Agencies 

The purpose of the collection of 

information in proposed Rule 701(a) or 

(b) under Regulation MC is to enable a 

security-based swap clearing agency to 

monitor voting interests with respect to 

the security-based swap clearing agency, 

and enable the security-based swap 

clearing agency to take necessary action 

if the voting interests by a participant or 

group of participants in the securitybased swap clearing agency exceed 

those allowed under proposed Rule 

701(a) or (b). 

2. SB SEFs, SBS Exchanges, and SBS 

Exchange Facilities 

The purpose of the collection of 

information in proposed Rule 702(c) 

under Regulation MC is to enable a SB 

SEF, SBS exchange, or SBS exchange 

facility to monitor voting interests with 

respect to such entity, and enable the SB 

SEF, SBS exchange, or SBS exchange 

facility, as applicable, to take necessary 

action if the ownership or voting rights 

by a participant or member or group of 

participants or members, as applicable, 

exceed those allowed under proposed 

Rule 702(b). 

The purpose of the collection of 

information in proposed Rule 702(e) 

under Regulation MC is to provide the 

Commission with information regarding 

the instances in which the SB SEF or 

SBS exchange does not adopt or 

implement a recommendation of the 

ROC, which would help the 

Commission in its oversight of SB SEFs 

and SBS exchanges. The information 

collection also should promote sound 

regulatory policies and foster the 

effectiveness of the ROC by putting the 

SB SEF or SBS exchange on notice that 

the Commission must be apprised 

promptly of any recommendation that is 

made by the ROC that is not adopted or 

implemented. 

C. Respondents 

1. Security-Based Swap Clearing 

Agencies 

The collection of information 

associated with the proposed Rule 

701(a) and (b) under Regulation MC 

would apply to security-based swap 

clearing agencies. Currently, four 

clearing agencies are authorized to clear 

credit default swaps, including securitybased swaps,190 pursuant to temporary 

conditional exemptions under Section 

36 of the Exchange Act.191 The 

obligation to centrally clear securitybased swap transactions is a new 

requirement under Title VII of the 

Dodd-Frank Act. Based on the fact that 

there are currently four clearing 

agencies authorized to clear securitybased swaps and that there could 

conceivably be one or two more in the 

future,192 the Commission preliminarily 

estimates that four to six clearing 

agencies may seek to clear securitybased swaps and be subject to the 

information collection requirements in 

proposed Rule 701(a) or (b). The 

Commission is using the higher estimate 

of six for the PRA analysis. 

2. SB SEFs, SBS Exchanges, and SBS 

Exchange Facilities 

The collection of information 

associated with the proposed Rule 

702(c) under Regulation MC would 

apply to SB SEFs, SBS exchanges, and 

SBS exchange facilities. In the DoddFrank Act, Congress defined for the first 

time a SB SEF and mandated the 

registration of these new facilities.193

Based on conversations with the CFTC 

and industry sources, the Commission 

preliminarily believes that 

approximately 10–20 entities could seek 

to become SB SEFs and thus be subject 

to the collection of information 

requirement of proposed Rule 702(c). 

The Commission is using the higher 

estimate of 20 SB SEFs for this PRA 

analysis. In addition, there are currently 

15 national securities exchanges that 

could be subject to the collection of 

information requirement of Rule 

702(c).194 To provide an estimate that is 

not under-inclusive, the Commission 

preliminarily estimates that all 15 of the 

currently registered national securities 

exchanges could become SBS exchanges 

or could create a separate legal entity 

that would be a facility of the exchange 

to trade security-based swaps. 

The collection of information 

associated with the proposed Rule 

702(e) under Regulation MC would 

apply to SB SEFs and SBS exchanges. 

Based on the estimates noted above, to 

provide an estimate that is not underinclusive, the Commission preliminarily 

believes that 20 SB SEFs and 15 SBS 

exchanges or SBS exchange facilities 

would be subject to the collection of 

information requirement of Rule 702(e). 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
65916 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

195The aggregate initial paperwork burden is 

calculated as follows: 90 hours (one time paperwork 

burden for security-based swap clearing agencies to 

establish rules to divest any ownership interest in 

excess of the limit and not to give effect to any 

portion of the voting interests in excess of the limit) 

+ 336 hours (annual burden for security-based swap 

clearing agencies to prepare and send requests for 

voting information) + 336 hours (annual burden for 

participants of security-based swap clearing 

agencies to prepare and send responses to requests 

for voting information) = 762 hours. After the initial 

year, the paperwork burden is calculated as follows: 

762 hours (total paperwork burden resulting from 

the proposals relating to security-based swap 

clearing agencies) ¥ 90 hours (one-time paperwork 

burden for security-based swap clearing agencies) = 

672 hours. 

D. Total Annual Reporting and 

Recordkeeping Burdens 

1. Security-Based Swap Clearing 

Agencies 

Proposed Rule 701(a) would require 

security-based swap clearing agencies to 

have rules that would: (1) Provide for an 

effective mechanism to divest any 

participant of any interest owned in 

excess of the proposed 20% ownership 

limit; (2) not give effect to the portion 

of any voting interest held by one 

participant in excess of the proposed 

20% voting limit; (3) not give effect to 

the portion of any voting interest among 

all security-based swap clearing agency 

participants owned in the aggregate in 

excess of the proposed 40% ownership 

limit; and (4) provide an effective 

mechanism for the security-based swap 

clearing agency to obtain information 

relating to the voting interests in such 

entity. Proposed Rule 701(b) would 

require security-based swap clearing 

agencies to have rules that would: (1) 

Provide for an effective mechanism to 

divest any participant of any interest 

owned in excess of the proposed 5% 

ownership limit; (2) not give effect to 

the portion of any voting interest held 

by one participant in excess of the 

proposed 5% voting limit; and (3) 

provide an effective mechanism for the 

security-based swap clearing agency to 

obtain information relating to the voting 

interests in such entity. Each securitybased swap clearing agency must 

comply with one of the alternatives. 

Establishing such rules would result 

in a paperwork burden for a securitybased swap clearing agency. The 

Commission preliminarily believes that 

there would be a one-time paperwork 

burden of 15 hours per entity associated 

with the drafting and implementation of 

any such rules by the security-based 

swap clearing agency for a total of 90 

hours (15 hours × 6 respondents). 

Any collection of information by a 

security-based swap clearing agency 

from a participant that has a voting 

interest in the security-based swap 

clearing agency would differ depending 

upon the number of shareholders or 

other owners of voting interests that are 

participants in the security-based swap 

clearing agency. Accordingly, the 

number of responses per year that 

would be generated by proposed Rule 

701(a) or (b) under Regulation MC 

would vary by security-based swap 

clearing agency. At this point, however, 

currently only the largest fourteen 

dealer firms are participants that clear 

security-based swaps at such clearing 

agencies. The Commission believes that 

it would be reasonable for securitybased swap clearing agencies to collect 

information related to the voting 

interests held by participants on a 

quarterly basis. This would provide the 

security-based swap clearing agency 

with sufficiently current information 

regarding participants’ voting interests 

in the security-based swap clearing 

agency and allows the security-based 

swap clearing agency to review the 

information at a single point in time. 

Accordingly, the Commission 

preliminarily estimates that each 

security-based swap clearing agency 

would request information 

approximately 4 times per year from 

approximately 14 participants. 

The Commission also estimates that 

the preparation and sending of each of 

the 4 requests for information would 

require approximately 4 hours and 

reviewing the responses to each of the 

4 requests for information would require 

10 hours. This would result in a total 

annual reporting and recordkeeping 

burden of 56 hours ((4 requests × 4 

hours) + (4 requests × 10 hours)) for 

each security-based swap clearing 

agency, and a total annual burden for all 

security-based swap clearing agencies of 

336 hours (56 hours × 6 clearing 

agencies). The Commission 

preliminarily estimates that each 

participant would require 1 hour to 

prepare and send the security-based 

swap clearing agency its response to the 

request, for a total annual reporting and 

recordkeeping burden for each 

participant of each security-based swap 

clearing agency of 4 hours (4 requests × 

1 hour) and a total annual burden for all 

participants in all 6 security-based swap 

clearing agencies of 336 hours (14 

participants × 4 hours × 6 security-based 

swap clearing agencies) thereby 

resulting in a total estimated annual 

burden for all security-based swap 

clearing agencies and participants of 

672 hours (336 hours for all participants 

+ 336 hours for all security-based swap 

clearing agencies). The Commission 

requests comment on these estimates. 

The Commission estimates that the 

total paperwork burden resulting from 

the proposals relating to security-based 

swap clearing agencies is 762 hours for 

an initial paperwork burden and 672 

hours thereafter.195

2. SB SEFs, SBS Exchanges, and SBS 

Exchange Facilities 

Proposed Rule 702(c) would require 

SB SEFs, SBS exchanges, and SBS 

exchange facilities to have rules that 

would provide for an effective 

mechanism to divest any participant or 

member, as applicable, of any interest 

owned in excess of the proposed 20% 

ownership limit; that would not give 

effect to the portion of any voting 

interest held by one or more 

participants or members, as applicable, 

in excess of the proposed 20% voting 

limit; and that would provide an 

effective mechanism for the SB SEF, 

SBS exchange, or SBS exchange facility 

to obtain information relating to 

ownership and voting interests in such 

entity. Establishing such rules or 

policies and procedures, as applicable, 

would result in a paperwork burden for 

a SB SEF, SBS exchange, or SBS 

exchange facility, as applicable. The 

Commission preliminarily believes that 

there would be a one-time paperwork 

burden of 15 hours per entity associated 

with the drafting and implementation of 

any such rules by the SB SEF, SBS 

exchange, or SBS exchange facility, as 

applicable, for a total of 525 hours (15 

hours × 35 respondents). 

The number of responses per year that 

would be generated by requests by a SB 

SEF, SBS exchange, or SBS exchange 

facility, as applicable, for ownership or 

voting information from participants or 

members that are owners of securities 

entitled to vote or otherwise have a 

voting interest in the SB SEF, SBS 

exchange, or SBS exchange facility 

would depend upon the number of 

owners of voting securities that are 

participants or members. Assuming that 

all classes of securities entitled to vote 

are owned or otherwise controlled by 

participants or members, the minimum 

number per SB SEF, SBS exchange, or 

SBS exchange facility would be 5. Based 

on the Commission’s understanding of 

the ownership structures and voting 

rights of existing entities that may 

register as SB SEFs, and its 

understanding of the ownership 

structures and voting rights of existing 

national securities exchanges, the 

Commission preliminarily estimates 

that each SB SEF, SBS exchange, or SBS 

exchange facility on average would 

request information from approximately 

20 participants or members, as 

applicable. The Commission believes 

that it would be reasonable for a SB 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 65917 

196 (20 (estimated number of SB SEFs subject to 

the collection of information under the proposed 

Rule 702(e)) + 15 (estimated number of SBS 

exchanges subject to the collection of information 

under the proposed Rule 702(e))) × 12 (estimated 

number of notices prepared annually by each SB 

SEF pursuant to the proposed Rule 702(e)) × 1 hour 

(estimate of total time to complete, review, and 

prepare required notice) = 420 hours. 

197The aggregate initial paperwork burden is 

calculated as follows: 525 hours (one-time 

paperwork burden for SB SEFs, SBS exchanges and 

SBS exchange facilities to establish rules to divest 

any ownership interest in excess of, and to not give 

effect to any portion of voting interests in excess of, 

the proposed 20% limit) + 1,960 hours (annual 

burden for SB SEFs, SBS exchanges and SBS 

exchange facilities to prepare and send requests for 

ownership and voting information) + 2,800 hours 

(annual burden for participants to prepare and send 

responses to requests for ownership and voting 

information) + 420 hours (annual burden for SB 

SEFs and SBS exchanges to prepare and submit 

notices pursuant to proposed Rule 702(e)(2)) = 

5,705 hours. After the initial year, the paperwork 

burden is calculated as follows: 5,705 hours (total 

paperwork burden resulting from the proposals 

relating to SB SEFs, SBS exchanges and SBS 

exchange facilities)—525 hours (one-time 

paperwork burdens for SB SEFs, SBS exchanges 

and SBS exchange facilities) = 5,180 hours. 

198New Exchange Act Section 17A(g) provides 

that it shall be unlawful for a clearing agency, 

unless registered with the Commission, directly or 

indirectly to make use of the mails or any means 

or instrumentality of interstate commerce to 

perform the functions of a clearing agency with 

respect to a security-based swap. 15 U.S.C. 78q– 

1(g). 

199 17 CFR 240.17a–1. 

200As discussed above, Section 763(c) of the 

Dodd-Frank Act sets forth 14 core principles that 

SB SEFs must satisfy, including one relating to 

recordkeeping and reporting, and provides the 

Commission with rulemaking authority with 

respect to implementation of these core principles. 

See Section 763(c) of the Dodd-Frank Act, Public 

Law 111–203, Section 763(c). 

201See Section 763(c) of the Dodd-Frank Act, 

Public Law 111–203, Section 763(c). 

202 17 CFR 240.17a–1. 

SEF, SBS exchange, or SBS exchange 

facility to collect information on 

ownership and voting rights on a 

quarterly basis. Accordingly, the 

Commission preliminarily estimates 

that each SB SEF, SBS exchange, or SBS 

exchange facility would request 

information approximately 4 times per 

year from approximately 20 participants 

or members. 

The Commission estimates that the 

preparation and sending of each of the 

4 requests for information would require 

approximately 4 hours, and reviewing 

the responses to each of the 4 requests 

for information would require 10 hours. 

This would result in a total annual 

reporting and recordkeeping burden of 

56 hours ((4 requests × 4 hours) + (4 

requests × 10 hours)) for each SB SEF, 

SBS exchange, or SBS exchange facility, 

as applicable, and a total annual burden 

for all SB SEFs, SBS exchanges, and 

SBS exchange facilities of 1,960 hours 

(56 hours × 35 respondents). The 

Commission preliminarily estimates 

that each participant or member would 

require 1 hour to prepare and send the 

response to the request, for a total 

annual reporting and recordkeeping 

burden for each participant or member 

of 4 hours (4 requests × 1 hour) and a 

total annual burden for all participants 

or members of 2,800 hours (700 

participants or members × 4 hours). The 

Commission requests comment on these 

estimates. 

The Commission preliminarily 

believes that the collection of 

information burden imposed by 

proposed Rule 702(e) under Regulation 

MC would be minimal. The Commission 

estimates that a representative of the 

Board of a SB SEF or SBS exchange 

would spend no more than one hour to 

complete the required notice to the 

Commission. This figure includes the 

time to prepare, review, and 

electronically submit such notice to the 

Commission. The Commission expects 

to establish an electronic mailbox for 

these notices and would identify the 

address if the Commission were to 

adopt this specific proposal. Although 

the Commission preliminarily believes 

that the Board of a SB SEF or SBS 

exchange often would adopt or 

implement the recommendations of its 

ROC, the Commission preliminarily 

believes that the Board of a SB SEF or 

SBS exchange could occasionally decide 

not to adopt such recommendations. 

Although the Commission expects that 

this would be an infrequent occurrence, 

the Commission preliminarily estimates 

that a Board could decide not to adopt 

a ROC recommendation up to 12 times 

per year. This estimate assumes that the 

Board of a SB SEF or SBS exchange 

would meet at least once per month and 

would decide each time that it meets 

not to adopt a ROC recommendation. 

Therefore, the Commission estimates 

that the total reporting burden under the 

proposed Rule 702(e) for all SB SEFs 

and SBS exchanges combined would be 

420 hours.196

The Commission estimates that the 

total paperwork burden resulting from 

the proposals relating to SB SEFs, SBS 

exchanges or SBS exchange facilities is 

5,705 for an initial paperwork burden 

and 5,180 thereafter.197

E. Retention Period of Recordkeeping 

Requirements 

1. Security-Based Swap Clearing 

Agencies 

Security-based swap clearing agencies 

will be required to be registered with 

the Commission following the effective 

date of Title VII of the Dodd-Frank 

Act.198 Accordingly, once registered 

with the Commission, security-based 

swap clearing agencies would be 

required to retain any collection of 

information pursuant to proposed Rules 

701(a) or (b) under Regulation MC as 

applicable, in accordance with, and for 

the periods specified in Rule 17a–1 

under the Exchange Act.199 Retention 

and recordkeeping requirements have 

not been established for security-based 

swap clearing agencies before the 

effective date of Title VII; however, 

security-based swap clearing agencies 

may be required to retain records and 

information collected pursuant to 

proposed Rules 701(a) or (b) similar to 

the current recordkeeping requirements 

in Rule 17a–1. 

2. SB SEFs, SBS Exchanges, and SBS 

Exchange Facilities 

Although recordkeeping and retention 

requirements have not yet been 

established for SB SEFs under new 

Exchange Act provisions added by the 

Dodd-Frank Act, the Commission is 

authorized to adopt such rules.200 In 

addition, the recordkeeping and 

reporting core principle applicable to 

SB SEFs, as set forth in Section 763(c) 

of the Dodd-Frank Act, requires a SB 

SEF to maintain records of all activities 

relating to the business of the facility, 

including a complete audit trail, in a 

form and manner acceptable to the 

Commission for a period of five 

years.201 Therefore, for purposes of this 

PRA, the Commission assumes that a SB 

SEF would be required to retain any 

collection of information pursuant to 

proposed Rules 702(c) and 702(e) under 

Regulation MC, as applicable, for a 

period of not less than five years. 

Should the Commission propose rules 

to implement the recordkeeping and 

reporting core principle for SB SEFs, it 

would include any collection of 

information burden with respect to any 

proposed recordkeeping and retention 

rules for SB SEFs in such rulemaking. 

All registered national securities 

exchanges must currently comply with 

the recordkeeping and reporting 

requirements in Rule 17a–1 under the 

Exchange Act.202 Therefore, SBS 

exchanges would be required to retain 

any collection of information pursuant 

to proposed Rules 702(c) and 702(e), as 

applicable, in accordance with, and for 

the periods specified in, Rule 17a–1 

under the Exchange Act. 

F. Collection of Information Is 

Mandatory 

1. Security-Based Swap Clearing 

Agencies 

The collection of information under 

proposed alternative Rules 701(a) and 

(b) under Regulation MC would be 


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65918 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

203The Commission pursuant to Section 36 of the 

Exchange Act may grant an exemption from any 

rule or any provision of any rule under Regulation 

MC. Any such exemption could be subject to 

conditions and could be revoked by the 

Commission at any time. See supra Section VI for 

a discussion of the Commission’s exemptive 

authority under Section 36 of the Exchange Act. 

204See CDS Clearing Exemption Orders, supra 

note 17. 

205See, e.g., Darrell Duffie and Haoxiang Zhu, 

‘‘Does a Central Clearing Counterparty Reduce 

Counterparty Risk?’’ Stanford University Working 

Paper, March 2010; Craig Pirrong, 2009, ‘‘The 

mandatory. The collection of 

information under proposed Rules 

701(a) and (b) would be required from 

participants in a security-based swap 

clearing agency upon request from the 

security-based swap clearing agency. 

The collection of information would 

allow the security-based swap clearing 

agency and the Commission to 

determine whether the requirements in 

proposed Rules 701(a) and (b) regarding 

limitations on voting interests are met. 

2. SB SEFs, SBS Exchanges, and SBS 

Exchange Facilities 

The collection of information under 

proposed Rule 702(c) under Regulation 

MC would be mandatory. The collection 

of information would allow the SB SEF, 

SBS exchange, or SBS exchange facility 

as applicable, and the Commission to 

determine whether the requirements in 

proposed Rule 702(c) regarding 

limitations on ownership and voting 

rights are met and enable the SB SEF, 

SBS exchange, or SBS exchange facility, 

as applicable, to take necessary action if 

the ownership or voting rights by a 

participant or group of participants 

exceed those allowed under proposed 

Rule 702(b). 

The collection of information under 

proposed Rule 702(e) under Regulation 

MC would be mandatory and permit the 

Commission to collect accurate 

information about the regulatory 

program of SB SEFs and SBS exchanges. 

Specifically, the collection of 

information would allow the 

Commission to stay informed about the 

recommendations of the ROC that are 

not followed by the SB SEF or SBS 

exchange and the SB SEF’s or SBS 

exchange’s reasons for not adopting 

such recommendations. 

G. Responses to Collection of 

Information Will Not Be Kept 

Confidential 

1. Security-Based Swap Clearing 

Agencies 

Other than information for which a 

security-based swap clearing agency 

requests confidential treatment and 

which may be withheld from the public 

in accordance with the provisions of 5 

U.S.C. 522, the collection of information 

pursuant to the proposed Rules 701(a) 

and (b) would not be confidential and 

would be publicly available. 

2. SB SEFs, SBS Exchanges, and SBS 

Exchange Facilities 

Other than information for which a 

SB SEF, SBS exchange or SBS exchange 

facility requests confidential treatment 

and which may be withheld from the 

public in accordance with the 

provisions of 5 U.S.C. 522, the 

collection of information pursuant to 

the proposed Rules 702(c) and (e) would 

not be confidential and would be 

publicly available. 

H. Request for Comment 

Pursuant to 44 U.S.C. 3505(c)(2)(B), 

the Commission solicits comment to: 

1. Evaluate whether the proposed 

collection of information is necessary 

for the performance of the functions of 

the agency, including whether the 

information shall have practical utility; 

2. Evaluate the accuracy of the 

agency’s estimate of the burden of the 

proposed collection of information; 

3. Enhance the quality, utility, and 

clarity of the information to be 

collected; and 

4. Minimize the burden of collection 

of information on those who are to 

respond, including through the use of 

automated collection techniques or 

other forms of information technology. 

Persons wishing to submit comments 

on the collection of information 

requirements should direct them to the 

following persons: (1) Desk Officer for 

the Securities and Exchange 

Commission, Office of Information and 

Regulatory Affairs, OMB, Room 3208, 

New Executive Office Building, 

Washington, DC 20503; and (2) 

Secretary, Securities and Exchange 

Commission, Station Place, 100 F Street, 

NE., Washington, DC 20549–1090 with 

reference to File No. S7–27–10. OMB is 

required to make a decision concerning 

the collection of information between 30 

and 60 days after publication, so a 

comment to OMB is best assured of 

having its full effect if OMB receives it 

within 30 days of publication. The 

Commission has submitted the 

proposed collection of information to 

OMB for approval. Requests for the 

materials submitted to OMB by the 

Commission with regard to this 

collection of information should be in 

writing, refer to File No. S7–27–10, and 

be submitted to the Securities and 

Exchange Commission, Office of 

Investor Education and Advocacy, 

Station Place, 100 F Street, NE., 

Washington, DC 20549–0213. 

X. Cost-Benefit Analysis 

Congress has required the 

Commission to implement rules under 

Section 765 of the Dodd-Frank Act to 

mitigate conflicts of interest in the 

security-based swaps market. The 

proposed rules under Regulation MC are 

designed to enhance, through mitigation 

of conflicts of interest, the benefits of 

having security-based swaps cleared 

through a security-based swap clearing 

agency and traded on a SB SEF or SBS 

exchange. The proposed rules, however, 

are also likely to impose costs on 

security-based swap clearing agencies, 

SB SEFs, and SBS exchanges. The 

Commission is sensitive to the costs and 

benefits that would result from the 

proposed rules and has identified 

certain costs and benefits of these 

proposals, as described below. 

A. Background 

The proposed governance and 

ownership and voting rules are intended 

to reduce conflicts of interest in 

security-based swap clearing agencies, 

SB SEFs, and SBS exchanges. 

Ownership and voting limitations and 

other governance rules are designed to 

limit the influence of any single market 

participant or a group of participants in 

the operation of security-based swap 

clearing agencies, SB SEFs, and SBS 

exchanges and thus reduce the risk that 

conflicts of interest would negatively 

affect the operation of these entities and 

the security-based swaps market.203

However, since the OTC swaps 

marketplace regulated under Title VII 

likely would change significantly after 

the effective date of the Dodd-Frank Act 

and the Commission’s rules 

promulgated thereunder, it is difficult to 

quantify the costs and benefits that the 

proposed rules may create. These issues 

are discussed more fully below. 

B. Security-Based Swap Clearing 

Agencies 

The Commission has granted 

exemptions from Section 17A of the 

Exchange Act to five entities to act as 

clearing agencies for security-based 

swaps.204 The first cleared CDS 

transaction pursuant to the exemptive 

orders was cleared on March 9, 2009. 

Security-based swap clearing is, 

therefore, in an emergent stage and 

empirical evidence on how the securitybased swaps market will develop 

following the effective date of the DoddFrank Act and rules thereunder is 

scarce. However, the number of 

security-based swap clearing agencies 

may converge in the long run to a very 

small number or even a single securitybased swap clearing agency.205 This is 


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Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 65919 

Economics of Clearing in Derivatives Markets: 

Netting, Asymmetric Information, and the Sharing 

of Default Risks Through a Central Counterparty,’’ 

Working paper, University of Houston. 

206The central clearing of security-based swaps is 

still developing and the Commission has not made 

any determinations about the number of securitybased swap clearing agencies that may be used by 

market participants. However, it is important that 

emerging security-based swap clearing agencies 

have the opportunity to compete with existing 

security-based swap clearing agencies. 

207See, e.g., Ice Trust Overview, p. 7 (available 

at https://www.theice.com/publicdocs/clear_us/ 

ICE_Trust_Overview.pdf). 

208See supra Section II.A.2.a. 

because of the potential for efficiency 

gains through convergence given that 

central clearing of securities is 

characterized by large fixed costs and 

benefits to participants associated with 

consolidating portfolios. Alternatively, 

competitive forces may result in use of 

a larger number of security-based swap 

clearing agencies, particularly if the 

security-based swap clearing agencies 

specialize in clearing particular types of 

security-based swaps or if they clear 

security-based swaps only in certain 

jurisdictions.206

1. Costs and Benefits Related to 

Ownership Restrictions in SecurityBased Swap Clearing Agencies 

Restrictions on the voting interests 

held by clearing participants may affect 

the number of potential clearing 

participants and may also affect the 

level of their participation in clearing 

security-based swaps. The 20% 

individual voting limitation on securitybased swap clearing agencies and the 

40% aggregate voting limitation on 

security-based swap clearing agencies, 

under the proposed Voting Interest 

Focus Alternative, and the 5% 

individual voting limitation under the 

Governance Focus Alternative, are 

intended to keep participants from 

exercising undue influence over the 

security-based swap clearing agency and 

to lessen the likelihood of anticompetitive behavior. One particular 

concern is that without a limitation on 

voting interests, large dealers may 

control a security-based swap clearing 

agency and set standards—such as a 

heightened capital threshold for 

participation or a requirement that 

participants have execution 

capabilities—to limit participation by 

non-owner dealers or brokers and 

increase or protect their market share 

and potentially influence market prices. 

Hence, a potential benefit of voting 

limitations may be the preservation of 

non-owner dealers’ access to central 

clearing and promotion of competition 

that results in lower costs to market 

participants. The proposed limitations 

in both the Voting Interest Focus 

Alternative and the Governance Focus 

Alternative are designed to achieve this 

result. 

Another potential benefit of the 

imposition of a limitation on voting 

interests is the chance that a broader 

group of participants would have the 

ability to reduce their risk exposure as 

greater levels of central clearing is 

encouraged if the risks at the clearing 

agency are managed appropriately. 

Clearing agencies decrease systemic risk 

by mutualizing losses 207 and netting 

otherwise bilateral obligations. There 

may, however, at times be a trade-off 

between a clearing agency’s risk 

management and its participation 

standards. It likely would be beneficial 

if the voting restrictions proposed by 

Rules 701(a) and (b) under Regulation 

MC in each of the Voting Interest Focus 

Alternative and the Governance Focus 

Alternative lead to increased market 

participation. Conversely though, to the 

extent that such market participation 

goes beyond prudent levels, it may 

create more systemic risk at the 

security-based swap clearing agency. 

For example, lessening capital 

requirements to increase participation 

beyond a prudent level may increase the 

overall risk of clearing operations, while 

increasing capital requirements for 

clearing members without an adequate 

basis may needlessly exclude some 

smaller dealers or other firms from 

participation and thereby create market 

inefficiencies.208

Non-participant shareholders may 

also have an incentive to permit more 

clearing agency participation than 

clearing agency participant shareholders 

would. Non-participant shareholders 

benefit from increased membership to 

the extent that additional revenues are 

generated and therefore have an 

incentive to promote increased use of 

central clearing both in terms of number 

of participants and the scope of 

products cleared. This could potentially 

reduce systemic risk by making more 

OTC products eligible for central 

clearing. In addition, non-shareholder 

participants have an incentive to 

promote appropriate risk management 

because a financial loss to the clearing 

agency would devalue their investment. 

For example, security-based swap 

clearing agencies may put their own 

capital or surplus funds at risk in the 

event of a default. In addition, clearing 

agencies face reputational risk 

associated with a member default that 

would likely negatively affect the value 

of shareholders’ shares. This aligns the 

interests of shareholders with 

appropriate risk management of a 

clearing agency. However, nonparticipant shareholders may not face 

the same potential of downside risk as 

clearing agency participants. For 

example, non-participant shareholders 

do not bear certain costs associated with 

increased risk since the clearing agency 

losses are shared by the clearing agency 

participants. To the extent that nonparticipant shareholders use their 

control to maximize revenues of the 

clearing agency without full 

consideration of the total clearing 

agency risks, the potential cost is that 

suboptimal clearing agency 

participation standards will be 

developed. All directors have a 

fiduciary duty to the security-based 

swap clearing agency and its 

shareholders, however, they also have a 

duty to oversee the security-based swap 

clearing agency’s compliance with the 

requirements in the Exchange Act and 

the rules and regulations thereunder. In 

certain circumstances, independent 

directors could give greater emphasis to 

profit-maximizing initiatives and fail to 

give sufficient consideration to the 

related risk management issues. 

Another potential cost of ownership 

and voting limitations, notwithstanding 

the fact that the market structure may 

converge in the long-run to a single 

security-based swap clearing agency, is 

the potential effect on competition 

among alternative security-based swap 

clearing agency venues. Under the 

Voting Interest Focus Alternative, a 20% 

individual participant voting limit and 

a 40% aggregate participant voting limit 

restricts the ability of any single dealer 

or small group of dealers to own a 

security-based swap clearing agency, 

but it may also reduce the potential 

number of investors that would be 

willing to devote resources to form a 

security-based swap clearing agency. 

This potentially diminishes the 

likelihood for a long-term market 

structure with multiple clearing 

agencies. Conversely, the Governance 

Focus Alternative would not impose an 

aggregate cap and would allow the 

voting interests in a security-based swap 

clearing agency to be owned entirely by 

participants. This would facilitate the 

formation of security-based swap 

clearing agencies by potential users and 

promote greater competition among 

security-based swap clearing agencies. 

In addition, if a participant is subject 

to restrictions regarding the amount of 

voting interest it may own in a securitybased swap clearing agency, then it may 

forgo a potential investment 

opportunity, unless it is willing to 

invest in non-voting shares of the 

security-based swap clearing agency. 

The effect of these restrictions is 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
65920 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

209 ICE Trust’s profits for the first six months of 

2010 were $1,325,000, which would represent an 

annual profit of $2,650,000. FFIEC Central Data 

Repository’s Public Data Distribution, https:// 

cdr.ffiec.gov/public/Default.aspx. 210The hourly rate for the compliance attorney is 

from SIFMA’s Management & Professional Earnings 

in the Securities Industry 2009, modified by the 

Commission’s staff to account for an 1,800-hour 

work-year and multiplied by 5.35 to account for 

bonuses, firm size, employee benefits and overhead. 

211Overall initial annual cost for participants and 

clearing agencies information requirements = (336 

hours + 336 hours + 90 hours) × $291 = $221,742. 

Overall subsequent annual cost for participants and 

clearing agencies information requirements = (336 

hours + 336 hours) × $291 = $195,552. 

212See, generally, Darrell Duffie, ‘‘How Should 

We Regulate Derivatives Markets?’’ Pew Financial 

Reform Project, Briefing Paper #5, 2009. 213However, the Commission recognizes that the 

industry widely accepts a majority of independent 

directors as ‘‘best practices.’’ See supra note 122. 

different with respect to individual 

participants under the Governance 

Focus Alternative, which limits any one 

participant’s voting interest in a 

security-based swap clearing agency to 

5%, than it is under the Voting Interest 

Focus Alternative, which limits any one 

participant’s voting interests to 20% and 

has an aggregate voting interest limit of 

40%. In the case of an ownership 

position in excess of regulator’s 

restrictions, the owner would have to 

divest a portion of its voting shares in 

order to meet the regulatory 

requirement. The potential foregone 

benefits include profits generated from 

clearing activities that are distributed to 

owners as well as any private ownership 

benefits from directing the clearing 

operations, which include activities 

discussed above with respect to 

conflicts of interest. While it is difficult 

to assess the value of these investment 

opportunities, the 2010 six-month data 

from consolidated reports of condition 

and income from the Federal Financial 

Institutions Examinations Council of the 

largest security-based swap clearing 

agency provides a snapshot of the 

magnitude of current profits being 

generated.209

Moreover, as previously discussed in 

the PRA section, proposed Rules 701(a) 

and (b) under Regulation MC would 

require a security-based swap clearing 

agency to have an effective mechanism 

to obtain information relating to voting 

interests in the security-based swap 

clearing agency by any participant in 

the security-based swap clearing agency. 

It was estimated that these obligations 

would result in a total annual burden 

for all security-based swap clearing 

agencies of 336 hours plus a total 

annual reporting and recordkeeping 

burden for all participants of 336 hours. 

It was also estimated that there would 

be a 90 hour one-time paperwork 

burden for security-based swap clearing 

agencies to establish rules to divest any 

ownership interest in excess of the limit 

and not to give effect to any portion of 

the voting interests in excess of the 

limit. Assuming an hourly cost of $291 

for a compliance attorney 210 to meet 

these requirements, this would result in 

an overall estimated initial annual cost 

of $221,742 and an annual cost 

thereafter of $195,552 for participants 

and security-based swap clearing 

agencies collectively.211

Under the Voting Interest Focus 

Alternative, proposed Rule 701(a) in 

Regulation MC would require the 

security-based swap clearing agency to 

have rules requiring a participant to 

divest voting interest greater than the 

20% threshold and rules reasonably 

designed not to give effect to a voting 

interest of a participant greater than the 

20% threshold or voting interests of 

participants considered in the aggregate 

with any other participants greater than 

the 40% threshold. This proposed rule 

would impose a cost on the securitybased swap clearing agency to initiate 

the divestiture or not give effect to the 

voting rights that surpass the stated 

threshold. Particularly in the case of the 

aggregate participant voting limitation, 

the security-based swap clearing agency 

would have to develop standards 

regarding how to allocate the voting 

interest for which it will give effect if 

the aggregate voting interest is above the 

40 percent threshold. 

Similarly, under the Governance 

Focus Alternative, proposed Rule 701(b) 

in Regulation MC would impose a cost 

on the security-based swap clearing 

agency to require the divestiture or not 

give effect to the voting rights that 

surpass the stated threshold of 5 

percent. However, because there is not 

a proposed limit on participants’ 

aggregate voting interests under the 

Governance Focus Alternative, the 

security-based swap clearing agency 

would not have to adopt rules for 

allocating voting interests in the case of 

a divestiture. 

2. Costs and Benefits Related to 

Independence Requirements for 

Security-Based Swap Clearing Agencies 

Potential conflicts of interest also 

exist between participants of a securitybased swap clearing agency and the 

public interest. Even when the influence 

of any single dealer is limited through 

voting restrictions, economic incentives 

could align several dealer participants 

in a way that may be costly to investors. 

For instance, in order for a product to 

be required to trade through an SB SEF 

or SBS exchange, it must be deemed 

eligible for clearing at a clearing agency. 

A dealer-controlled security-based swap 

clearing agency may have an incentive 

to limit the products deemed eligible for 

clearing because then such a product 

would remain viable in the OTC 

markets, in which the dealers have a 

significant financial stake.212 Products 

that are eligible for clearing that are not 

cleared do not have the price 

transparency or investor accessibility 

that they would otherwise have, 

increasing market participant costs paid 

by investors. As a result, there are 

potential incentives for security-based 

swap clearing agency participants to 

coordinate in ways that voting 

restrictions cannot address. 

Representation by independent 

directors would provide views and 

influence that by design are not subject 

to these conflicts. 

Proposed Rule 701(b)(3) in Regulation 

MC of the Governance Focus Alternative 

would require that a majority of 

directors must be independent. As a 

result, participants could not directly 

control the Board regardless of their 

voting interests. To further the goal of 

majority independence on the Board, 

proposed Rule 701(b)(4) under 

Regulation MC in the Governance Focus 

Alternative would require a securitybased swap clearing agency to establish 

a nominating committee composed 

solely of independent directors. Since 

many of the Board decisions come from 

committees and conflicts may be 

prevalent or even more pronounced in 

these situations, proposed Rule 

701(b)(5) under Regulation MC in the 

Governance Focus Alternative would 

require that if any committee, including 

but not limited to a risk committee, has 

authority to act on behalf of the Board, 

that committee must also be composed 

of a majority of independent directors. 

This would help prevent important 

decisions from escaping the view of a 

majority of independent directors. To 

the extent that independent directors 

reduce the likelihood that one group of 

participants coordinate decision-making 

in such a way that is detrimental to the 

security-based swap clearing agency as 

a whole, it would serve to benefit the 

security-based swap clearing agency and 

the market generally. 

The Voting Interest Focus Alternative 

would require 35%, rather than a 

majority, of the Board be composed of 

independent directors. While director 

independence is widely believed to be 

a catalyst for improved governance, 

there is no conclusive empirical 

evidence to support the view that a 

majority of independent directors 

benefits shareholder profits.213 It also is 

often argued that the presence of inside 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 65921 

214See M. Harris and A. Raviv, 2007, ‘‘A Theory 

of Board Control and Size,’’ The Journal of Finance; 

R. Adams and D. Fererria, 2008, ‘‘A Theory of 

Friendly Boards,’’ The Journal of Finance, vol. 62(1) 

pp. 217–250. 

215The Commission is basing this estimate on a 

recent study noting that the retainer fee for outside 

directors is on average $67,624. See http:// 

www.hewittassociates.com/ 

_MetaBasicCMAssetCache_/Assets/Articles/2010/ 

2010_Outside_Director_Compensation.pdf. The 

Commission believes that this amount could serve 

as a proxy for the amount of any fee to be charged 

by a recruitment firm that would conduct a national 

search for an independent director. 

216Section 763(c) of the Dodd-Frank Act sets 

forth 14 core principles that SB SEFs must satisfy 

and provides the Commission with rulemaking 

authority with respect to implementation of these 

core principles. The Commission expects to address 

the issue of what is a SB SEF in a separate 

rulemaking under Section 763(c) of the Dodd-Frank 

Continued 

affiliated board members is important in 

facilitating the flow of material 

information to independent directors so 

that they may come to informed 

decisions.214 This may be especially 

important for a security-based swap 

clearing agency because it provides 

highly specialized and technical 

services. The imposition of a Board 

structure that precludes the likely 

owners of a security-based swap 

clearing agency—dealers—from gaining 

a majority may have a negative effect on 

the operations of the security-based 

swap clearing agency if independent 

directors do not have commensurate 

qualifications or skills as participant 

directors. There could be significant 

costs associated with educating 

independent directors about the 

clearance and settlement process and 

the complex risk management issues 

that must be considered by the Board. 

This could slow the Board or committee 

processes, at least initially. Clearing and 

settlement is a highly specialized area 

and it may be difficult to find 

independent directors with relevant 

experience. As a result, independent 

directors may defer to industry directors 

or to the officials of the clearing agency, 

who have more knowledge and 

experience, thereby undermining the 

benefits of requiring independence. 

In the context of wholly independent 

committees, such as a nominating 

committee, the independent directors 

may become reliant on executive 

directors and other employees of the 

security-based swap clearing agency to 

inform their decision-making due to 

their lack of expertise in clearing and 

settlement. If management fails to keep 

the directors on wholly independent 

committees fully informed, the 

independent directors on such 

committees fail to seek sufficient 

information from management to make 

informed decisions, or management fails 

to give independent directors adequate 

resources to make effective decisions, 

there could be costs to the securitybased swap clearing agency. On the 

other hand, if management fully 

apprises the directors on wholly 

independent committees of necessary 

information and the independent 

directors have sufficient resources and 

are fully engaged with respect to their 

duties, there would be benefits to the 

security-based swap clearing agency. 

In addition, the effectiveness of the 

Board can depend on the personalities 

and personal traits, as well as the 

qualifications, of the persons serving on 

the Board. Independent directors that 

take the time to understand the 

operations and programs of a securitybased swap clearing agency and to ask 

probing questions of management are 

more likely to be effective independent 

directors. However, independent 

directors would unlikely be able to 

acquire the specific risk management 

expertise related to clearance and 

settlement if they do not have relevant 

experience prior to serving on the 

Board. In addition, because independent 

directors would not be employed by or 

participants in the security-based swap 

clearing agency, they may often need to 

rely on management or other directors 

to keep fully informed. There could be 

costs to the security-based swap clearing 

agency if one or more independent 

directors is ineffectual because he or she 

did not fully understand the operations 

or risk management procedures of the 

security-based swap clearing agency. 

Thus, imperfect decisions by 

independent directors could result in 

costs to the security-based swap clearing 

agency. This may potentially be more 

likely where the majority of the Board 

is required to be independent. On the 

other hand, independent directors who 

have relevant expertise, are engaged in 

carrying out their director duties, and 

who grasp the issues confronting the 

security-based swap clearing agency 

could be very beneficial to the securitybased swap clearing agency because 

they could bring an outside perspective 

and fresh insights and ideas to the 

security-based swap clearing agency. 

The proposed governance 

requirements under both the Voting 

Interest Focus Alternative and the 

Governance Focus Alternative could 

impose other costs on security-based 

swap clearing agencies. An entity that 

plans to register as a security-based 

swap clearing agency may need to revise 

the composition of its Board if the Board 

currently is not composed of 35% or a 

majority of independent directors. 

Moreover, security-based swap clearing 

agencies may have to restructure their 

nominating committees as well as other 

committees that are authorized to act for 

the Board. In this regard, security-based 

swap clearing agencies could face 

difficulties locating qualified 

individuals to serve as independent 

directors, particularly because securitybased swaps trading is complex and the 

pool of qualified candidates may be 

limited. There also may be costs in 

educating independent directors to 

become familiar with the manner in 

which these security-based swaps are 

traded and the new regulatory structure 

governing security-based swaps, which 

could slow Board processes at least 

initially. These costs would be greater 

under the Governance Focus 

Alternative, which requires a higher 

percentage of independent directors on 

the Board and on the committees. 

The proposed governance 

requirements could impose other costs 

on security-based swap clearing 

agencies. A security-based swap 

clearing agency may incur costs as a 

result of the requirement to include 

35% or a majority of independent 

directors on its Board and a similar or 

heightened requirement with respect to 

committees authorized to act on behalf 

of the Board. Any such costs are likely 

to be incurred in connection with 

conducting a search for independent 

directors with the necessary 

qualifications and expertise to serve on 

the Board of a security-based swap 

clearing agency. The actual cost for each 

security-based swap clearing agency 

may vary based on the current 

governance arrangements and practices 

of the security-based swap clearing 

agencies. In addition, if a security-based 

swap clearing agency is required to 

conduct a search for independent 

directors, the costs incurred by the 

security-based swap clearing agency 

may vary based on whether it has the 

resources to conduct its own search or 

has to retain an outside consultant. The 

Commission preliminarily estimates 

that those security-based swap clearing 

agencies that must rely on a recruitment 

specialist to secure an independent 

director could incur a cost of 

approximately $68,000 per director.215

C. SB SEFs and SBS Exchanges 

Currently, there are no trading venues 

that are registered with the Commission 

as SB SEFs, and no national securities 

exchanges that currently post or make 

available for trading security-based 

swaps. Based on the Dodd-Frank Act’s 

definition, a SB SEF could include a 

trading platform with participating 

dealers.216 SB SEFs are conceptually 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
65922 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

Act. See Section 763(c) of the Dodd-Frank Act, 

Public Law 111–203, Section 763(c). 

217For example, there are currently 15 registered 

national securities exchanges with varying 

platforms and business models that compete for 

clients and order flow in the equities and/or options 

markets. 

218As noted above, Section 763(c) of the DoddFrank Act sets forth 14 core principles that SB SEFs 

must satisfy, including one relating to conflicts of 

interest, and provides the Commission with 

rulemaking authority with respect to 

implementation of these core principles. The 

Commission may determine that it is appropriate to 

propose additional rules to mitigate conflicts of 

interest with respect to SB SEFs, including 

incorporating ownership and/or voting limits and 

other requirements with respect to ownership of a 

SB SEF by persons other than SB SEF participants. 

The Commission also may consider proposals such 

as providing for the fair representation of SB SEF 

participants in the selection of the SB SEF’s 

directors and the administration of its affairs as part 

of its broader rulemaking relating to SB SEFs. 

219See supra note 210. 220Overall annual cost per SB SEF, SBS 

exchange, or SBS exchange facility = 15 hours × 

$291 = $4,365; aggregate annual cost for all SB 

SEFs, SBS exchanges, and SBS exchange facilities 

= $4,365 × 35 = $152,775. 

221See supra Section IX. 

222See supra note 210. 

223Overall annual cost for participants or 

members and SB SEFs, SBS exchanges and SBS 

exchange facilities = (1,960 hours + 2,800 hours) × 

$291 = $1,385,160. 

224See supra note 210. 

similar to alternative trading systems 

and national securities exchanges in the 

equity and options markets and 

designated contract markets in the 

futures markets in that they will provide 

a centralized trading facility for the 

trading of security-based swaps. To the 

extent that SB SEFs would organize and 

form in a similar manner to these 

structures, the Commission 

preliminarily anticipates that SB SEFs 

and SBS exchanges would be 

significantly more competitive than 

security-based swap clearing agencies. 

In particular, barriers to entry in terms 

of capital are likely to be lower, and 

many existing dealers, national 

securities exchanges and other entities 

of various sizes currently have 

electronic trading capabilities that could 

allow them to enter this market readily. 

1. Costs and Benefits Related to 

Ownership Requirements of SB SEFs 

and SBS Exchanges 

The 20% ownership and voting limits 

contained in proposed Rule 702(b) 

under Regulation MC would prohibit 

any SB SEF participant or SBS exchange 

member or small group thereof from 

owning or otherwise controlling any 

class of voting securities or other 

interests of a SB SEF, SBS exchange or 

SBS exchange facility, as applicable. 

The intent of this requirement, as with 

security-based swap clearing agencies, 

is to limit the influence of any single 

dealer or a small group of dealers in a 

single SB SEF, SBS exchange or SBS 

exchange facility and thus reduce the 

likelihood that smaller non-owner 

dealers would be unfavorably treated 

and the ability of dealer-owners to 

influence market prices of securitybased swaps. It is hard to predict, 

however, what entities will be SB SEFs 

or SBS exchanges or whether there will 

be any market power from owning or 

controlling a SB SEF or SBS exchange 

as discussed above. If the concern, as 

with central clearing, is that a single SB 

SEF or SBS exchange emerges as the 

dominant trading platform, then 

ownership and voting restrictions may 

be an important consideration. For 

example, the NYSE was the dominant 

exchange for trading equity securities 

for a long period, and even today U.S. 

futures markets are characterized by a 

dominant exchange connected to a 

single clearing agency. 

However, evidence from the current 

cash equity and options markets shows 

that several trading platforms with 

different business models and clienteles 

often emerge.217 Hence, SB SEFs, SBS 

exchanges, and SBS exchange facilities 

that are controlled by a single dealer 

may not necessarily result in unfair 

trading practices if market participants 

have alternative comparable venues to 

execute the same security-based swaps 

and those venues are able to compete 

effectively with single dealer platforms. 

Allowing SB SEFs, SBS exchanges and 

SBS exchange facilities that are 

controlled by a single dealer may in fact 

increase the level of competition, which 

would benefit investors. A 20% 

restriction on ownership of voting 

securities could require a dealer to 

partner with either other dealers or a 

non-dealer majority owner, or to hold a 

non-voting ownership interest, which 

could reduce incentives to start up a 

new venue, potentially limiting 

innovative alternatives to security-based 

swap execution and security-based 

swap products.218

The Commission anticipates that the 

proposed ownership and voting 

limitations may impose costs on SB 

SEFs, SBS exchanges and SBS exchange 

facilities. Entities planning to register as 

SB SEFs and SBS exchanges would have 

to ensure that they are in compliance 

with the proposed ownership and 

voting limitations and thus would need 

to spend time and incur costs to design 

or modify their ownership structure and 

internal processes, as well as take the 

necessary steps to draft or amend their 

governing documents and rules to 

comply with such ownership and voting 

limitations. Designing or modifying 

internal processes and drafting or 

revising governing documents and rules 

would impose costs on SB SEFs, SBS 

exchanges and SBS exchange facilities. 

The Commission estimates that it would 

take a compliance attorney 

approximately 15 hours to revise the 

relevant governing documents and to 

file them with the appropriate 

authorities. Assuming an hourly cost of 

$291 for a compliance attorney,219 these 

requirements would result in an overall 

annual cost per SB SEF, SBS exchange 

or SBS exchange facility of $4,365, or 

$152,775 in the aggregate for all SB 

SEFs, SBS exchanges, and SBS 

exchange facilities.220

As previously discussed in the PRA 

section, proposed Rule 702(c) would 

require SB SEFs, SBS exchanges, or SBS 

exchange facilities, as applicable, to 

have an effective mechanism to obtain 

information relating to ownership and 

voting interest in the SB SEF, SBS 

exchange, or SBS exchange facility, by 

any participant or member of the SB 

SEF, SBS exchange or SBS exchange 

facility.221 It was estimated that these 

obligations would result in a total 

annual burden for all SB SEFs, SBS 

exchanges, and SBS exchange facilities 

of 1,960 hours. It was also estimated 

that there would be a total annual 

reporting and recordkeeping burden for 

all participants or members of 2,800 

hours. Assuming an hourly cost of $291 

for a compliance attorney 222 to meet 

these requirements, this would result in 

an overall annual cost of $1,385,160 for 

participants or members and SB SEFs, 

SBS exchanges, and SBS exchange 

facilities collectively.223 To the extent 

that certain participants or members 

may be required to file ownership or 

voting information with a domestic or 

international government authority 

pursuant to securities laws, and such 

information is made available to the SB 

SEF, SBS exchange, or SBS exchange 

facility, this cost would be reduced. 

Proposed Rule 702(c) under 

Regulation MC also would require a SB 

SEF, SBS exchange or SBS exchange 

facility to have rules to divest a 

participant or member of an ownership 

interest that violates the proposed 

ownership limits, and to not give effect 

to a voting interest of a participant or 

member that violates the proposed 

voting limits. As previously discussed 

in the PRA section, this requirement is 

estimated to result in an initial 

paperwork burden for all SB SEFs, SBS 

exchanges, or SBS exchange facilities of 

525 hours. Assuming an hourly cost of 

$291 for a compliance attorney 224 to 

meet these requirements, this would 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 65923 

225This initial cost is estimated as follows: 15 

hours × 35 respondents × $291 per hour = $152,775. 

226Proposed Rule 702(e) under Regulation MC 

does not explicitly include SBS exchange facilities 

because the exchange whose facility posts or makes 

available for trading a security-based swap must 

itself establish the requisite ROC. See supra note 

173. 

227See CBOE Comment Letter, supra note 165 

(‘‘CBOE also implemented other changes that are 

similar to the proposals contained in the Release, 

for example establishing a Regulatory Oversight 

Committee, composed solely of public directors 

* * *. As a result, CBOE believes that its existing 

governance structure and practices serve not only 

to protect investors and the public interest and 

Continued 

result in an initial cost of $152,775 for 

all SB SEFs, SBS exchanges, and SBS 

exchange facilities.225

This proposed rule also would impose 

costs on SB SEFs, SBS exchanges, or 

SBS exchange facilities to initiate the 

divestiture or not give effect to the 

voting rights that surpass the stated 

threshold. For example, a SB SEF, SBS 

exchange, or SBS exchange facility 

could incur costs involved with 

redeeming shares held in excess of the 

proposed limits if such entity chooses to 

provide in its rules that any such excess 

shares would be purchased by the 

entity. A SB SEF, SBS exchange, or SBS 

exchange facility also could adopt rules 

to limit voting by any participant or 

member that owns more than 20% of 

outstanding interests. Thus, a SB SEF, 

SBS exchange, or SBS exchange facility 

also could incur costs associated with 

monitoring votes cast at any shareholder 

meeting to determine that no SB SEF 

participant or SBS exchange member 

and its related persons subject to the 

voting limits exceeds those limits. 

The Commission recognizes that 

entities that are currently in existence 

and plan to become SB SEFs, SBS 

exchanges or SBS exchange facilities 

could incur costs if they do not meet the 

proposed ownership and voting 

limitations. For example, if a single or 

small group of market participants that 

would be direct participant(s) in a SB 

SEF plans to register a platform as a SB 

SEF, it or they potentially would need 

to secure additional owners to meet the 

20% limitation on ownership of voting 

securities of a SB SEF. This could 

impose costs on an entity that has a 

single owner-participant or a small 

number of owner-participants and that 

plans to register a platform as a SB SEF, 

from the costs of finding other owners 

or the sharing of potential profits with 

a larger group of owners. As noted 

above, currently there are no trading 

venues that are registered with the 

Commission as SB SEFs. Based on 

initial discussions with market 

participants that have indicated an 

interest in registering as a SB SEF, the 

Commission preliminarily believes that 

few entities that may register as a SB 

SEF currently have ownership 

structures that would conflict with the 

proposed ownership and voting 

limitations for SB SEFs. In addition, as 

discussed above, national securities 

exchanges that may potentially register 

as SBS exchanges or create a facility that 

will be a SBS exchange facility should 

already be in compliance with the 

proposed ownership and voting 

limitations. Based on these factors, the 

Commission preliminarily believes that 

the aggregate costs imposed by the 

ownership and voting limitations on 

entities initially seeking to register as SB 

SEFs, SBS exchanges or SBS exchange 

facilities would not be significant. 

2. Costs and Benefits Related to 

Independence Requirements in SB SEFs 

and SBS Exchanges 

Proposed Rule 702(d) under 

Regulation MC would require the 

Boards of SB SEFs and SBS exchanges 

or SBS exchange facilities to be 

composed of at least a majority of 

independent directors to mitigate 

conflicts of interest and help ensure that 

the entity does not advance the interests 

of its owners, some of which may be 

dealer-participants or their affiliates. By 

mandating a structure that would 

require a majority of Board members to 

be independent, the governance of SB 

SEFs, SBS exchanges and SBS exchange 

facilities should be less susceptible to 

promoting the self-interests of such 

participants. The majority independent 

directors should help foster a greater 

degree of independent decision-making 

consistent with the objectives of the 

Dodd-Frank Act and the Exchange Act. 

Further, a Board whose independent 

directors constitute at least a majority of 

the Board should help ensure that the 

views of independent directors are 

taken into account and should help 

strengthen the hand of independent 

directors when dealing with 

management. In the Commission’s 

preliminary view, requiring the Boards 

of SB SEFs, SBS exchanges and SBS 

exchange facilities to have a majority of 

independent directors should help 

reduce the possibility of damaging 

conflicts of interest that otherwise might 

arise when persons who do not meet the 

definition of independent director at the 

SB SEF, SBS exchange or SBS exchange 

facility are involved in key decisions, 

such as which products will be made 

available for trading and the access 

levels of potential market participants. 

To the extent that independent directors 

would reduce the likelihood that one 

group of participants could coordinate 

decision-making in such a way that 

would be detrimental to the SB SEF, 

SBS exchange or SBS exchange facility 

as a whole, this would be a benefit. 

In addition, proposed Rule 702(f) 

under Regulation MC would require that 

the nominating committee of a SB SEF, 

SBS exchange or SBS exchange facility 

be composed solely of independent 

directors. This proposed requirement 

should foster a process for nominating 

independent directors that would help 

to assure that such directors are 

independent and not likely to be unduly 

influenced by an owner of the SB SEF, 

SBS exchange or SBS exchange facility 

who is possibly a SB SEF participantdealer or SBS exchange member or 

affiliate thereof. In addition, the 

requirement in proposed Rule 702(g) 

under Regulation MC that any 

committee that would have the 

authority to act on behalf of the Board 

be composed of a majority of 

independent directors is designed to 

prevent important decisions from 

escaping the view of a majority of 

independent directors. Many Board 

decisions come from committees and 

conflicts may be similarly prevalent or 

even more pronounced in these 

situations. 

Proposed Rule 702(e) under 

Regulation MC also would require the 

Board of any SB SEF and SBS exchange 

to establish a ROC consisting solely of 

independent directors to oversee the 

entity’s regulatory obligations.226 The 

Commission preliminarily believes that 

this requirement should be effective in 

managing the conflicts of interest 

inherent in the Board’s oversight of 

whether a SB SEF or SBS exchange 

satisfies its regulatory obligations. The 

proposed provision relating to the 

establishment of an independent ROC 

should help promote greater 

accountability on the part of SB SEFs 

and SBS exchanges with respect to the 

obligations placed on them by the 

Exchange Act, including as amended by 

the Dodd-Frank Act, and strengthen 

their ability to meet those obligations. A 

ROC composed solely of independent 

directors should result in a greater 

degree of objective decision-making 

with respect to the SB SEF’s or SBS 

exchange’s regulatory obligations. 

Vigilant and informed oversight by a 

strong, effective and independent ROC 

may increase investor confidence in the 

operation of SB SEFs and SBS 

exchanges, and the security-based 

swaps market generally. National 

securities exchanges that currently have 

a ROC composed of independent 

directors have noted the benefits of such 

a governance mechanism.227 In 


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assure the integrity of CBOE’s regulatory activities, 

but also to enhance the ability of CBOE to develop 

and implement sound business strategies’’); NYSE 

Comment Letter, supra note 165 (‘‘As an important 

part of the reform process of 2003, the NYSE 

formalized the effective functional separation of 

regulatory programs from the competitive business 

functions, under a Chief Regulatory Officer (‘‘CRO’’) 

reporting to a Regulatory Oversight Committee 

(‘‘ROC’’) of the Board of Directors consisting of all 

independent directors * * *. We agree with the 

Commission that this structure, with a separate 

regulatory executive reporting to an empowered, 

qualified and independent board, amply funded 

and professionally staffed, assures the integrity of 

the regulatory process.’’) 

228See supra note 122. 

229MODEL BUS. CORP. ACT § 8.01(c) (4th ed. 

2008). 

230Assuming an hourly cost of $291 for a 

compliance attorney, the overall annual cost per SB 

SEF, SBS exchange or SBS exchange facility and 

aggregate cost for all SB SEFs, SBS exchanges, and 

SBS exchange facilities was calculated as follows: 

per entity annual cost = 15 hours × $291 = $4,365; 

aggregate annual cost = $4,365 × 35 = $152,775. See 

supra note 210. 

231The Commission is basing this estimate on a 

recent study noting that the retainer fee for outside 

directors is on average $67,624. See http:// 

www.hewittassociates.com/ 

_MetaBasicCMAssetCache_/Assets/Articles/2010/ 

2010_Outside_Director_Compensation.pdf. The 

Commission believes that this amount could serve 

as a proxy for the amount of any fee to be charged 

by a recruitment firm that would conduct a national 

search for an independent director. 

232As discussed above, since 2004 when the 

Commission proposed rules to promote the fair 

administration and governance of, and to impose 

ownership and voting limitations on, national 

securities exchanges, a number of exchanges have 

adopted governance structures which meet many of 

the requirements of proposed Rule 702. Thus, the 

costs for complying with the proposed governance 

rules would be decreased for some SBS exchanges. 

addition, requiring the Board to report 

promptly to the Commission any 

recommendation of the ROC that the 

Board does not implement should 

provide the Commission with 

information on a timely basis regarding 

the Board’s decision not to take certain 

actions. 

The governance proposals for SB 

SEFs, SBS exchanges and SBS exchange 

facilities would complement the 

proposed ownership and voting limits 

for these entities. Five or more dealerparticipants or members could still own 

100% of the voting securities of a SB 

SEF, SBS exchange or SBS exchange 

facility, as applicable, under the 

proposed voting and ownership limits. 

In addition, even when the influence of 

any single dealer is limited through 

ownership and voting restrictions, 

economic incentives can align several 

dealer participants in a way that may be 

costly to investors. As a result, there are 

potential incentives for SB SEF 

participant-dealers and SBS exchange 

member-dealers to coordinate in ways 

that ownership and voting restrictions 

could not address. Requiring 

independence on the Board and certain 

key Board committees should further 

reduce the ability of the participantowners of the SB SEF or memberowners of the SBS exchange or SBS 

exchange facility to unduly influence 

decision-making at the Board level in a 

way that advances their interests. 

Representation by independent 

directors would provide views and 

influence that by design are not subject 

to these conflicts. 

As noted in the discussion relating to 

security-based swap clearing agencies, 

while director independence is widely 

believed to be a catalyst for improved 

governance and the Commission 

recognizes that the industry widely 

accepts a majority of independent 

directors as ‘‘best practices,’’ 228 there is 

no conclusive empirical evidence to 

support the view that a majority of 

independent directors benefits 

shareholder profits. However, the Model 

Business Corporation Act recognizes the 

important role of independent 

directors.229

The proposed governance 

requirements could impose costs on SB 

SEFs, SBS exchanges and SBS exchange 

facilities. Entities planning to register as 

SB SEFs and SBS exchanges may need 

to draft or amend their governing 

documents and design or modify their 

governance processes to comply with 

the proposed governance requirements, 

which would impose costs on SB SEFs, 

SBS exchanges and SBS exchange 

facilities. The Commission estimates 

that it would take a compliance attorney 

approximately 15 hours to revise the 

relevant governing documents and to 

file them with the appropriate 

authorities, for a total estimated cost per 

SB SEF, SBS exchange or SBS exchange 

facility of $4,365, or $152,775 in the 

aggregate for all SB SEFs or SBS 

exchanges, and SBS exchange 

facilities.230

An entity that plans to register as a SB 

SEF or a SBS exchange may need to 

revise the composition of its Board (or 

that of its SBS exchange facility, in the 

case of an exchange that posts or makes 

available for trading security-based 

swaps through a facility with a separate 

governance structure), if the Board 

currently is not composed of a majority 

of independent directors. SB SEFs and 

SBS exchanges or SBS exchange 

facilities also would need to establish 

wholly independent nominating 

committees, and SB SEFs and SBS 

exchanges would need to establish 

wholly independent ROCs. In this 

regard, SB SEFs, SBS exchanges and 

SBS exchange facilities could face 

difficulties in locating qualified 

individuals to serve as independent 

directors, particularly because securitybased swaps trading is complex and 

some potential candidates may decline 

to serve as a director if they believe that 

they lack sufficient expertise. 

The Commission preliminarily 

believes that the cost of securing 

independent directors to serve on the 

Board of the SB SEF, SBS exchange or 

SBS exchange facility could range from 

a relatively low cost for those entities 

that have the contacts and resources to 

be able to search for one or more 

independent directors on their own; to 

a moderate cost for those entities that 

can undertake the search on their own 

but would incur some expenditures, 

such as placing advertisements in 

national media; to a higher cost for 

those entities that must secure the 

services of a recruitment firm that 

specializes in the placement of 

independent directors. The Commission 

preliminarily estimates that those SB 

SEFs, SBS exchanges or SBS exchange 

facilities that must rely on a recruitment 

specialist to secure an independent 

director could incur a cost of 

approximately $68,000 per director.231

The Commission preliminarily 

estimates that 10–20 entities could seek 

to register as SB SEFs and notes that 

there are 15 national securities 

exchanges; however, the number of 

Board members could vary widely 

among SB SEFs, SBS exchanges and 

SBS exchange facilities. Therefore, the 

Commission provides an estimate of a 

maximum recruitment cost of $68,000 

per independent director.232

The imposition of a Board structure 

that precludes the likely participants in 

SB SEFs, SBS exchanges or SBS 

exchange facilities—dealers—from 

gaining a majority or having 

representation on certain Board 

committees may have a negative effect 

on the operations of the SB SEF, SBS 

exchange or SBS exchange facility if 

independent directors do not have 

commensurate qualifications or skills as 

affiliated directors or do not engage 

actively in their Board or committee 

duties. There could be costs in 

educating independent directors to 

become familiar with the manner in 

which security-based swaps are traded 

and in the new regulatory structure that 

would govern them, which could slow 

Board or committee processes at least 

initially. In addition, independent 

directors may yield to industry directors 

who have more knowledge and 

experience, thereby undermining the 

benefits of requiring independence. In 

the context of wholly independent 

committees, such as a nominating 


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233See supra Section IX.D. 

234 12 hours (estimated annual information 

collection burden for each SB SEF and SBS 

exchange) × $291 (hourly cost for a compliance 

attorney) = $3,492. The hourly rate for the 

compliance attorney is from SIFMA’s Management 

& Professional Earnings in the Securities Industry 

2009, modified by the Commission’s staff to 

account for an 1,800-hour work-year and multiplied 

by 5.35 to account for bonuses, firm size, employee 

benefits and overhead. 

235 15 U.S.C. 78c(f). 

236 15 U.S.C. 78w(a)(2). 

237See Office of the Comptroller of the Currency, 

Quarterly Report on Bank Trading and Derivatives 

Activities, First Quarter 2010. 

238 Data available at http://www.isda.org/ 

statistics/pdf/ISDA-Market-Survey-results1987- 

present.xls. 

239See CDS Clearing Exemption Orders, supra 

note 17. 

committee or ROC, the independent 

directors may become reliant on 

executive officers and other employees 

of the SB SEF or SBS exchange to 

inform their decision-making due to 

their lack of expertise in the industry. If 

management fails to keep the directors 

on wholly independent committees 

fully-informed, if the independent 

directors on such committees fail to 

seek sufficient information from 

management to make informed 

decisions or if management fails to give 

independent directors adequate 

resources to make effective decisions, 

there could be costs to the SB SEF, SBS 

exchange or SBS exchange facility. On 

the other hand, if management fully 

apprises the directors on wholly 

independent committees of necessary 

information and the independent 

directors have sufficient resources and 

are fully engaged with respect to their 

duties, there would be benefits to the SB 

SEF, SBS exchange or SBS exchange 

facility. 

In addition, the effectiveness of 

majority independent Boards can 

depend on the personalities and 

personal traits, as well as the 

qualifications, of the persons serving on 

the Board. Independent directors that 

take the time to understand the 

operations and programs of a SB SEF, 

SBS exchange or SBS exchange facility 

and to ask probing questions of 

management are more likely to be 

effective independent directors. 

However, because independent 

directors would not be employed by the 

SB SEF, SBS exchange, or SBS exchange 

facility or be participants or members of 

such entity, they often may need to rely 

on management or other directors to 

keep them fully informed. There could 

be costs to the SB SEF, SBS exchange, 

or SBS exchange facility if one or more 

independent directors is ineffectual 

because he or she did not fully 

understand the operations of the SB SEF 

or SBS exchange, either because the 

independent directors did not take the 

necessary initiative or management 

failed to keep the independent directors 

fully apprised of information that would 

lead to their effective decision-making. 

Thus, imperfect decisions by 

independent directors could result in 

costs to the SB SEF, SBS exchange, or 

SBS exchange facility. On the other 

hand, independent directors who have 

expertise in areas that could be helpful 

to the SB SEF, SBS exchange or SBS 

exchange facility, who are engaged in 

carrying out their director duties, and 

who grasp the issues confronting the SB 

SEF, SBS exchange or SBS exchange 

facility could be very beneficial to the 

SB SEF, SBS exchange or SBS exchange 

facility because they could bring fresh 

insights and ideas to these entities. 

Finally, under the proposed Rule 

702(e)(2) under Regulation MC, SB SEFs 

and SBS exchanges would need to 

report promptly to the Commission any 

recommendation of the ROC that the 

Board does not adopt or implement, 

which would result in costs to SB SEFs 

and SBS exchanges. As discussed above, 

the Commission preliminarily estimates 

that the annual information collection 

burden for each SB SEF or SBS 

exchange under this provision of the 

proposed rules would be 12 hours.233

Accordingly, the Commission’s staff 

estimates that it would cost each SB SEF 

or SBS exchange $3,492 annually to 

comply with this provision of the 

proposed rules.234

D. Request for Comments 

The Commission requests that 

commenters provide views and 

supporting information regarding the 

costs and benefits associated with the 

proposals. The Commission seeks 

estimates of these costs and benefits, as 

well as any costs and benefits not 

already identified. The Commission also 

requests comment regarding the relative 

costs and benefits of pursuing 

alternative regulatory approaches that 

are consistent with Section 765 of the 

Dodd-Frank Act. In addition, the 

Commission requests comment on 

whether other provisions of the DoddFrank Act for which Commission 

rulemaking is required are likely to have 

an effect on the costs and benefits of the 

proposed rules. 

XI. Consideration of Burden on 

Competition, and Promotion of 

Efficiency, Competition, and Capital 

Formation 

Section 3(f) of the Exchange Act 235

requires the Commission, whenever it 

engages in rulemaking and is required to 

consider or determine whether an action 

is necessary or appropriate in the public 

interest, to consider, in addition to the 

protection of investors, whether the 

action would promote efficiency, 

competition, and capital formation. In 

addition, Section 23(a)(2) of the 

Exchange Act 236 requires the 

Commission, when adopting rules 

under the Exchange Act, to consider the 

effect such rules would have on 

competition. Section 23(a)(2) of the 

Exchange Act also prohibits the 

Commission from adopting any rule that 

would impose a burden on competition 

not necessary or appropriate in 

furtherance of the purposes of the 

Exchange Act. 

Security-based swaps are currently 

executed and traded in the OTC market, 

with five large commercial banks 

representing 97% of the total U.S. 

banking industry national amounts 

outstanding of derivatives.237 The gross 

notional amount of CDS as of the end 

of 2009 was approximately $30 

trillion.238

As discussed above, the Commission 

has granted exemptions to five entities 

to act as security-based swap clearing 

agencies for CDS.239 Four of the 

exemptions are currently active. SB 

SEFs and SBS exchanges are expected to 

register to trade security-based swaps in 

connection with the implementation of 

rules under Title VII of the Dodd-Frank 

Act. 

As discussed above, the intent of the 

ownership and voting limitations and 

governance proposed rules is to mitigate 

potential conflicts of interests of market 

participants in the clearing and trading 

of security-based swaps. These 

proposed rules may have a significant 

effect on the level of competition within 

the marketplace. 

The voting restrictions on securitybased swap clearing agencies that limit 

the influence of any single participant 

or group of participants could increase 

the level of competition at the 

participant level if they preserve access 

to central clearing and trading by other 

participants. Without these voting 

restrictions, it may be possible for a 

dominant participant owner to use its 

voting interest to set rules, fees, or 

capital requirements that engender an 

uncompetitive environment. For 

instance, a heightened capital threshold 

for participation might prevent some 

firms from qualifying as participants 

and thus deny them access to clearing. 

However, the proposed voting 

limitations among participants may also 

impede competition at the securitybased swap clearing agency level, since 


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240The Commission pursuant to Section 36 of the 

Exchange Act may grant an exemption from any 

rule or any provision of any rule under Regulation 

MC. See supra Section VI. 

241The central clearing of security-based swaps is 

still developing and the Commission has not made 

any determinations about the number of securitybased swap clearing agencies that may be used by 

market participants. 242See supra note 240. 

243Public Law 104–121, Title II, 110 Stat. 857 

(1996) (codified in various sections of 5 U.S.C., 15 

U.S.C. and as a note to 5 U.S.C. 601). 

244 5 U.S.C. 603(a). 

245 5 U.S.C. 605(b). 

there are likely a limited number of 

firms with the expertise, resources and 

desire to have an ownership interest in 

a security-based swap clearing 

agency.240

As previously noted, evidence from 

the securities markets suggests that 

clearing agencies over the long-run tend 

to converge to a small number of entities 

or even a single entity. Clearing 

activities are characterized by high startup costs and low marginal costs such 

that there are large economies of scale. 

For example, all trades executed on the 

eight U.S. based options exchanges are 

cleared at the Options Clearing 

Corporation, and trades executed on the 

U.S. equity markets, composed of 

exchanges, alternative trading platforms, 

and OTC trading, are cleared at the 

National Securities Clearing 

Corporation, a wholly-owned subsidiary 

of the Depository Trust and Clearing 

Corporation.241 A single security-based 

swap clearing agency may also be more 

efficient in that it would facilitate the 

fungibility of contracts across multiple 

execution facilities and exchanges. 

Whether the differences in the Voting 

Interest Focus Alternative and the 

Governance Focus Alternative would 

result in substantially different effects 

on efficiency, capital formation, and 

competition remains uncertain. 

Preliminarily, the Commission believes 

that the aggregate cap on participant 

voting interests may limit the formation 

of new clearing agencies and, 

consequently, limit the opportunity for 

competition among security-based swap 

clearing agencies. However, the 

aggregate cap under the Voting Interest 

Focus Alternative may also be more 

effective at mitigating conflicts of 

interest than the rules proposed under 

the Governance Focus Alternative, and 

could result in greater access to central 

clearing and a higher volume of 

security-based swap products made 

eligible for clearing. As discussed 

previously, central clearing would 

facilitate improved transparency, risk 

management, and competition in the 

security-based swaps market. This in 

turn should have a positive effect on 

efficiency, capital formation, and 

competition. 

The Commission preliminarily 

believes that the start-up costs for a SB 

SEF, SBS exchange or SBS exchange 

facility, or for an existing national 

securities exchange to post or make 

available for trading security-based 

swaps, will be low. If a SB SEF, SBS 

exchange or SBS exchange facility 

would not provide the desired level of 

access to a market participant, and the 

start-up costs of setting up a competing 

SB SEF, SBS exchange or SBS exchange 

facility are low, then this would 

encourage the entrance of alternate 

trading venues for market participants 

and allow competition to discipline 

harmful practices by any single SB SEF, 

SBS exchange, or SBS exchange facility. 

However, if ownership restrictions are 

such that dealers must coordinate 

ownership among a group, then there 

may be fewer potential owners 

available, and thus there could be less 

incentive to form competing SB SEFs, 

SBS exchanges, or SBS exchange 

facilities. In this case, ownership 

limitations would impede 

competition.242

The proposed rules under Regulation 

MC relating to Board and committee 

independence may also increase the 

level of participant competition by 

making it more difficult for a small 

group of dealer-owners to influence a 

security-based swap clearing agency, SB 

SEF or SBS exchange even in light of 

the proposed ownership and voting 

restrictions. This is necessary because 

economic incentives could align the 

interests of participants against the 

interest of the security-based swap 

clearing agency, SB SEF or SBS 

exchange as a whole irrespective of 

whether those participants are owners. 

For example, if the Board of a dealercontrolled security-based swap clearing 

agency determines to refuse to clear a 

proposed security-based swap product, 

then such a product would not be 

required to be traded on a SB SEF or 

SBS exchange and would likely trade 

OTC, reducing price transparency and 

likely resulting in higher revenue for the 

dealers in the OTC market than if the 

product was available through a SB SEF, 

SBS exchange or SBS exchange facility. 

Majority independence requirements for 

the Board and committees that have the 

authority to act on behalf of the Board 

are an additional tool to address this 

potential conflict of interest. Given the 

size of the security-based swaps market 

and its non-competitive tendencies, the 

benefits with respect to efficiency and 

competition that ownership, voting, and 

director representation requirements 

would provide are likely to be 

substantial. 

The Commission requests comment 

on the possible effects of the proposed 

rules under Regulation MC on 

efficiency, competition, and capital 

formation. The Commission requests 

that commenters provide views and 

supporting information regarding any 

such effects. The Commission notes that 

such effects are difficult to quantify. The 

Commission seeks comment on possible 

anti-competitive effects of the proposed 

rules under Regulation MC not already 

identified. The Commission also 

requests comment regarding the 

competitive effects of pursuing 

alternative regulatory approaches that 

are consistent with Section 765 of the 

Dodd-Frank Act. In addition, the 

Commission requests comment on how 

the other provisions of the Dodd-Frank 

Act for which Commission rulemaking 

is required will interact with and 

influence the competitive effects of the 

proposed rules under Regulation MC. 

XII. Consideration of Impact on the 

Economy 

For purposes of the Small Business 

Regulatory Enforcement Fairness Act of 

1996, or ‘‘SBREFA,’’ 243 the Commission 

must advise the OMB as to whether 

proposed Regulation MC and the rules 

proposed thereunder constitute a 

‘‘major’’ rule. Under SBREFA, a rule is 

considered ‘‘major’’ where, if adopted, it 

results or is likely to result in: (1) An 

annual effect on the economy of $100 

million or more (either in the form of an 

increase or a decrease); (2) a major 

increase in costs or prices for consumers 

or individual industries; or (3) 

significant adverse effect on 

competition, investment or innovation. 

The Commission requests comment 

on the potential impact of proposed 

Regulation MC and the rules proposed 

thereunder on the economy on an 

annual basis. Commenters are requested 

to provide empirical data and other 

factual support for their view to the 

extent possible. 

XIII. Regulatory Flexibility Act 

Certification 

Section 603(a) of the Regulatory 

Flexibility Act 244 (‘‘RFA’’) requires the 

Commission to undertake an initial 

regulatory flexibility analysis of the 

proposed rules under Regulation MC on 

small entities, unless the Commission 

certifies that the proposed rules, if 

adopted, would not have a significant 

economic impact on a substantial 

number of small entities.245


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246See CDS Clearing Exemptions, supra note 17. 

247 17 CFR 230.157. See also 17 CFR 240.0–10(a). 

248Commission staff based this determination on 

its review of various public sources of financial 

information about the current registered clearing 

agencies and entities currently exempt from 

clearing agency registration under Section 17A of 

the Exchange Act. 

249 17 CFR 230.157. See also 17 CFR 240.0–10(a). 

250Commission staff based this determination on 

its review of various public sources of financial 

information about the entities likely to register as 

SB SEFs. 

251See supra note 194. 

252 17 CFR 242.601. 

253 17 CFR 240.0–10(e). 

A. Security-Based Swap Clearing 

Agencies 

Proposed Rule 701 under Regulation 

MC would apply to all security-based 

swap clearing agencies. Four entities are 

currently exempt from registration as a 

clearing agency under section 17A of 

the Exchange Act to provide central 

clearing services for CDS, a class of 

security-based swaps.246 The 

Commission believes, based on its 

understanding of the market, that likely 

no more than six security-based swap 

clearing agencies could be subject to the 

requirements of proposed Rule 701. 

For purposes of Commission 

rulemaking in connection with the RFA, 

an issuer or person, other than an 

investment company, is a small 

business if its total assets on the last day 

of its most recent fiscal year were $5 

million or less.247 The Commission 

believes that the entities likely to 

register as security-based swap clearing 

agencies will not be small entities, but 

rather part of large business entities that 

have assets in excess of $5 million and 

total capital in excess of $500,000.248

B. SB SEFs 

Proposed Rule 702 under Regulation 

MC would apply to all SB SEFs. In the 

Dodd-Frank Act, Congress defined for 

the first time what activity would 

constitute a SB SEF and mandated the 

registration of these new facilities. The 

Commission preliminarily believes that 

approximately 10 to 20 SB SEFs could 

be subject to the requirements of 

proposed Rule 702. 

For purposes of Commission 

rulemaking in connection with the RFA, 

an issuer or person, other than an 

investment company, is a small 

business if its total assets on the last day 

of its most recent fiscal year were $5 

million or less.249 The Commission 

preliminarily believes that the entities 

likely to register as SB SEFs will not be 

considered small entities because most, 

if not all, of the SB SEFs will be part of 

large business entities, and that all SB 

SEFs will have assets in excess of $5 

million.250

C. SBS Exchanges 

Proposed Rule 702 under Regulation 

MC would apply to all SBS exchanges. 

All of the 15 currently registered 

national securities exchanges could 

become SBS exchanges, and therefore, 

subject to the requirements of Rule 

702.251

For purposes of Commission 

rulemaking in connection with the RFA, 

a national securities exchange is a small 

business if it has been exempted from 

the reporting requirements of Rule 601 

of Regulation NMS 252 (Dissemination of 

Transaction Reports and Last Sale Data 

with Respect to Transactions in NMS 

Stocks) and is not affiliated with any 

person (other than a natural person) that 

is not a ‘‘small business.’’ 253 None of the 

currently registered national securities 

exchanges is a small entity. Therefore, 

the Commission preliminarily believes 

that none of the SBS exchanges will be 

considered small entities. 

D. Certification 

For the reasons stated above, the 

Commission certifies that the proposed 

rules under Regulation MC would not 

have a significant economic impact on 

a substantial number of small entities. 

The Commission requests comments 

regarding this certification. The 

Commission requests that commenters 

describe the nature of any impact on 

small entities, including national 

securities exchanges, clearing agencies 

or other small businesses or small 

organizations that may register as SB 

SEFs, SBS exchanges or security-based 

swap clearing agencies, and provide 

empirical data to support the extent of 

the impact. 

XIV. Statutory Basis and Rule Text 

Pursuant to the Exchange Act, 15 

U.S.C. 78a et seq., and particularly, 

Sections 3, 3D, 6, 11A, 17A, 19, and 

23(a) thereof, and Section 765 of the 

Dodd-Frank Act, the Commission is 

proposing to adopt Regulation MC 

under the Exchange Act. 

List of Subjects in 17 CFR Part 242 

Reporting and recordkeeping 

requirements, Securities. 

Text of Proposed Rule Amendments 

For the reasons stated in the 

preamble, the Commission is proposing 

to amend Title 17, Chapter II of the 

Code of the Federal Regulations as 

follows: 

PART 242—REGULATIONS M, SHO, 

ATS, AC, NMS, AND MC AND 

CUSTOMER MARGIN REQUIREMENTS 

FOR SECURITY FUTURES 

1. The authority citation for part 242 

is amended by adding authorities for 

Sections 242.700, 242.701 and 242.702 

to read as follows: 

Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 

78b, 78c, 78f, 78g(c)(2), 78i(a), 78j, 78k–1(c), 

78l, 78m, 78n, 78o(b), 78o(c), 78o(g), 78q–1, 

78q(a), 78q(h), 78w(a), 78dd–1, 78mm, 80a– 

23, 80a–29, and 80a–37. 

* * * * * 

Section 242.700 is also issued under sec. 

943, Public Law 111–203, Section 765. 

Section 242.701 is also issued under sec. 

943, Public Law 111–203, Section 765. 

Section 242.702 is also issued under sec. 

943, Public Law 111–203, Sections 763 and 

765. 

2. The part heading for part 242 is 

revised to read as set forth above. 

3. Sections 242.700, 242.701 and 

242.702 are added to read as follows: 

§ 242.700 Definitions. 

(a) The term affiliate means any 

person that, directly or indirectly, 

controls, is controlled by, or is under 

common control with, the person. 

(b) The terms beneficial ownership, 

beneficially owns or any derivative 

thereof shall have the same meaning, 

with respect to any security or other 

ownership interest, as set forth in 

§ 240.13d–3, as if (and whether or not) 

such security or other ownership 

interest were a voting equity security 

registered under section 12 of the 

Exchange Act (15 U.S.C. 78l); provided 

that to the extent any person 

beneficially owns any security or other 

ownership interest solely because such 

person is a member of a group within 

the meaning of section 13(d)(3) of the 

Exchange Act (15 U.S.C. 78m(d)(3)), 

such person shall not be deemed to 

beneficially own such security or other 

ownership interest for purposes of this 

section, unless such person has the 

power to direct the vote of such security 

or other ownership interest. 

(c) The term Board means the Board 

of Directors or Board of Governors of the 

security-based swap execution facility 

or national securities exchange or 

facility thereof that posts or makes 

available for trading security-based 

swaps, or security-based swap clearing 

agency, as applicable, or any equivalent 

body. 

(d) The term clearing agency has the 

same meaning as set forth in section 

3(a)(23) of the Exchange Act (15 U.S.C. 

78c(a)(23)). 

(e) The term control means the 

possession, direct or indirect, of the 


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power to direct or cause the direction of 

the management and policies of a 

person, whether through the ownership 

of voting securities, by contract, or 

otherwise. A person is presumed to 

control another person if the person: 

(1) Is a director, general partner or 

officer exercising executive 

responsibility (or having similar status 

or functions); 

(2) Directly or indirectly has the right 

to vote 25 percent or more of a class of 

voting securities or has the power to sell 

or direct the sale of 25 percent or more 

of a class of voting securities; or 

(3) In the case of a partnership, has 

the right to receive, upon dissolution, or 

has contributed, 25 percent or more of 

the capital. 

(f) The term director means any 

member of the Board. 

(g) The term Exchange Act means the 

Securities Exchange Act of 1934 (15 

U.S.C. 78a et seq.). 

(h) The term facility has the same 

meaning as set forth in section 3(a)(2) of 

the Exchange Act (15 U.S.C. 78c(a)(2)). 

(i) The term immediate family 

member means a person’s spouse, 

parents, children and siblings, whether 

by blood, marriage or adoption, or 

anyone residing in such person’s home. 

(j) The term independent director 

means: 

(1) A director who has no material 

relationship with: 

(i) The security-based swap execution 

facility or national securities exchange 

or facility thereof that posts or makes 

available for trading security-based 

swaps, or security-based swap clearing 

agency, as applicable; 

(ii) Any affiliate of the security-based 

swap execution facility or national 

securities exchange or facility thereof 

that posts or makes available for trading 

security-based swaps, or security-based 

swap clearing agency, as applicable; 

(iii) A security-based swap execution 

facility participant, a member of a 

national securities exchange that posts 

or makes available for trading securitybased swaps, or a participant in the 

security-based swap clearing agency, as 

applicable; or 

(iv) Any affiliate of a security-based 

swap execution facility participant, a 

member of a national securities 

exchange that posts or makes available 

for trading security-based swaps, or a 

participant in the security-based swap 

clearing agency, as applicable. 

(2) A director is not an independent 

director if any of the following 

circumstances exists: 

(i) The director, or an immediate 

family member, is employed by or 

otherwise has a material relationship 

with the security-based swap execution 

facility or national securities exchange 

or facility thereof that posts or makes 

available for trading security-based 

swaps, or security-based swap clearing 

agency, as applicable, or any affiliate 

thereof, or within the past three years 

was employed by or otherwise had a 

material relationship with the securitybased swap execution facility or 

national securities exchange or facility 

thereof that posts or makes available for 

trading security-based swaps, or 

security-based swap clearing agency, as 

applicable, or any affiliate thereof; 

(ii) (A) The director is a securitybased swap execution facility 

participant, a member of a national 

securities exchange that posts or makes 

available for trading security-based 

swaps, or a participant in the securitybased swap clearing agency, as 

applicable, or within the past three 

years was employed by or affiliated with 

such participant or member or any 

affiliate thereof; or 

(B) The director has an immediate 

family member that is, or within the 

past three years was, an executive 

officer of a security-based swap 

execution facility participant, a member 

of a national securities exchange that 

posts or makes available for trading 

security-based swaps, or a participant in 

the security-based swap clearing agency, 

as applicable, or any affiliate thereof; 

(iii) The director, or an immediate 

family member, has received during any 

twelve month period within the past 

three years payments that reasonably 

could affect the independent judgment 

or decision-making of the director from 

the security-based swap execution 

facility or national securities exchange 

or facility thereof that posts or makes 

available for trading security-based 

swaps, or security-based swap clearing 

agency, as applicable, or any affiliate 

thereof or from a security-based swap 

execution facility participant, a member 

of a national securities exchange that 

posts or makes available for trading 

security-based swaps, or a participant in 

the security-based swap clearing agency, 

as applicable, or any affiliate thereof, 

other than the following: 

(A) Compensation for Board or Board 

committee services; 

(B) Compensation to an immediate 

family member who is not an executive 

officer of the security-based swap 

execution facility or national securities 

exchange or facility thereof that posts or 

makes available for trading securitybased swaps, or security-based swap 

clearing agency, as applicable, or any 

affiliate thereof or of a security-based 

swap execution facility participant, a 

member of a national securities 

exchange that posts or makes available 

for trading security-based swaps, or a 

participant in the security-based swap 

clearing agency, as applicable, or any 

affiliate thereof; or 

(C) Pension and other forms of 

deferred compensation for prior 

services, not contingent on continued 

service. 

(iv) The director, or an immediate 

family member, is a partner in, or 

controlling shareholder or executive 

officer of, any organization to or from 

which the security-based swap 

execution facility or national securities 

exchange or facility thereof that posts or 

makes available for trading securitybased swaps, or security-based swap 

clearing agency, as applicable, or any 

affiliate thereof made or received 

payments for property or services in the 

current or any of the past three full 

fiscal years that exceed two percent of 

the recipient’s consolidated gross 

revenues for that year, other than the 

following: 

(A) Payments arising solely from 

investments in the securities of the 

security-based swap execution facility 

or national securities exchange or 

facility thereof that posts or makes 

available for trading security-based 

swaps, or security-based swap clearing 

agency, as applicable, or affiliate 

thereof; or 

(B) Payments under non-discretionary 

charitable contribution matching 

programs. 

(v) The director, or an immediate 

family member, is, or within the past 

three years was, employed as an 

executive officer of another entity where 

any executive officers of the securitybased swap execution facility or 

national securities exchange or facility 

thereof that posts or makes available for 

trading security-based swaps, or 

security-based swap clearing agency, as 

applicable, serve on that entity’s 

compensation committee; 

(vi) The director, or an immediate 

family member, is a current partner of 

the outside auditor of the security-based 

swap execution facility or national 

securities exchange or facility thereof 

that posts or makes available for trading 

security-based swaps, or security-based 

swap clearing agency, as applicable, or 

any affiliate thereof, or was a partner or 

employee of the outside auditor of 

security-based swap execution facility 

or national securities exchange or 

facility thereof that posts or makes 

available for trading security-based 

swaps, or security-based swap clearing 

agency, as applicable, or any affiliate 

thereof who worked on the audit of the 

security-based swap execution facility 

or national securities exchange or 

facility thereof that posts or makes 


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available for trading security-based 

swaps, or security-based swap clearing 

agency, as applicable, or any affiliate 

thereof, at any time within the past 

three years; or 

(vii) In the case of a director that is 

a member of the audit committee, such 

director (other than in his or her 

capacity as a member of the audit 

committee, the Board, or any other 

Board committee), accepts, directly or 

indirectly, any consulting, advisory, or 

other compensatory fee from the 

security-based swap execution facility 

or national securities exchange or 

facility thereof that posts or makes 

available for trading security-based 

swaps, or security-based swap clearing 

agency, as applicable, or any affiliate 

thereof or a security-based swap 

execution facility participant, a member 

of a national securities exchange that 

posts or makes available for trading 

security-based swaps, or a participant in 

the security-based swap clearing agency, 

as applicable, or any affiliate thereof, 

other than fixed amounts of pension and 

other forms of deferred compensation 

for prior service, provided such 

compensation is not contingent in any 

way on continued service. 

(k) The term major security-based 

swap participant has the same meaning 

as set forth in section 3(a)(65) of the 

Exchange Act (15 U.S.C. 78c(a)(65)) or 

any rules or regulations thereunder. 

(l) The term material relationship 

means a relationship, whether 

compensatory or otherwise, that 

reasonably could affect the independent 

judgment or decision-making of the 

director. 

(m) The term member has the same 

meaning as set forth in section 3(a)(3) of 

the Exchange Act (15 U.S.C. 78c(a)(30)). 

(n) The term national securities 

exchange means any exchange 

registered pursuant to section 6 of the 

Exchange Act (15 U.S.C. 78f). 

(o) The term participant when used 

with respect to a clearing agency has the 

same meaning set forth in section 

3(a)(24) of the Exchange Act (15 U.S.C 

78c(a)). 

(p) The term person has the same 

meaning as set forth in section 3(a)(9) of 

the Exchange Act (15 U.S.C. 78c(a)(9)). 

(q) The term person associated with a 

member has the same meaning as set 

forth in section 3(a)(21) of the Exchange 

Act (15 U.S.C. 78c(a)(21)). 

(r) The term person associated with a 

participant in a security-based swap 

clearing agency means: 

(1) Any partner, officer, director, or 

branch manager of such security-based 

swap dealer or major security-based 

swap participant (or any person 

occupying a similar status or performing 

similar functions); 

(2) Any person directly or indirectly 

controlling, controlled by, or under 

common control with such securitybased swap dealer or major securitybased swap participant; or 

(3) Any employee of such securitybased swap dealer or major securitybased swap participant. This term does 

not include any person associated with 

a participant in a security-based swap 

clearing agency whose functions are 

solely clerical or ministerial. 

(s) The term person associated with a 

security-based swap dealer or major 

security-based swap participant has the 

same meaning as set forth in section 

3(a)(70) of the Exchange Act (15 U.S.C. 

78c(a)(70)) or any rules or regulations 

thereunder. 

(t) The term person associated with a 

security-based swap execution facility 

participant means any partner, officer, 

director, or branch manager of such 

security-based swap execution facility 

participant (or any person occupying a 

similar status or performing similar 

functions), any person directly or 

indirectly controlling, controlled by, or 

under common control with such 

security-based swap execution facility 

participant, or any employee of such 

security-based swap execution facility 

participant. 

(u) The term related person means: 

(1) When used with respect to a 

security-based swap clearing agency: 

(i) Any affiliate of a security-based 

swap clearing agency participant; 

(ii) Any person associated with a 

security-based swap clearing 

participant; 

(iii) Any immediate family member of 

a security-based swap clearing agency 

participant that is a natural person or 

any immediate family member of the 

spouse of such person, who, in each 

case, has the same home as the securitybased swap clearing agency participant 

or who is a director or officer of the 

security-based swap clearing agency or 

any of its parents or subsidiaries; or 

(iv) Any immediate family member of 

a person associated with a securitybased swap clearing agency participant 

that is a natural person or any 

immediate family member of the spouse 

of such person, who, in each case, has 

the same home as the person associated 

with the security-based swap clearing 

agency participant or who is a director 

or officer of the security-based swap 

clearing agency or any of its parents or 

subsidiaries; 

(2) When used with respect to a 

security-based swap execution facility: 

(i) Any affiliate of a security-based 

swap execution facility participant; 

(ii) Any person associated with a 

security-based swap execution facility 

participant; 

(iii) Any immediate family member of 

a security-based swap execution facility 

participant or any immediate family 

member of the spouse of such person, 

who, in each case, has the same home 

as the security-based swap execution 

facility participant or who is a director 

or officer of the security-based swap 

execution facility or any of its parents 

or subsidiaries; or 

(iv) Any immediate family member of 

a person associated with a securitybased swap execution facility 

participant or any immediate family 

member of the spouse of such person, 

who, in each case, has the same home 

as the person associated with the 

security-based swap execution facility 

participant or who is a director or 

officer of the security-based swap 

execution facility or any of its parents 

or subsidiaries; and 

(3) When used with respect to a 

national securities exchange or facility 

thereof that posts or makes available for 

trading security-based swaps: 

(i) Any affiliate of a member of the 

national securities exchange that posts 

or makes available for trading securitybased swaps; 

(ii) Any person associated with a 

member of the national securities 

exchange that posts or makes available 

for trading security-based swaps; 

(iii) Any immediate family member of 

a member of the national securities 

exchange that posts or makes available 

for trading security-based swaps or any 

immediate family member of the spouse 

of such person, who, in each case, has 

the same home as the member of the 

national securities exchange that posts 

or makes available for trading securitybased swaps or who is a director or 

officer of the national securities 

exchange or facility thereof that posts or 

makes available for trading securitybased swaps, or any of its parents or 

subsidiaries; or 

(iv) Any immediate family member of 

a person associated a member of the 

national securities exchange that posts 

or makes available for trading securitybased swaps or any immediate family 

member of the spouse of such person, 

who, in each case, has the same home 

as the person associated with the 

national securities exchange that posts 

or makes available for trading securitybased swaps or who is a director or 

officer of the national securities 

exchange or facility thereof that posts or 

makes available for trading securitybased swaps or any of its parents or 

subsidiaries. 


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(v) The term security-based swap has 

the same meaning as set forth in section 

3(a)(68) of the Exchange Act (15 U.S.C. 

78c(a)(68)) or any rules or regulations 

thereunder. 

(w) The term security-based swap 

dealer has the same meaning as set forth 

in section 3(a)(71) of the Exchange Act 

(15 U.S.C. 78c(a)(71)) or any rules or 

regulations thereunder. 

(x) The term security-based swap 

clearing agency means a clearing agency 

that clears security-based swaps. 

(y) The term security-based swap 

execution facility has the same meaning 

as set forth in section 3(a)(77) of the 

Exchange Act (15 U.S.C. 78c(a)(77)) or 

any rules or regulations thereunder. 

(z) The term security-based swap 

execution facility participant means a 

person permitted to directly effect 

transactions on the security-based swap 

execution facility. 

§ 242.701 Mitigation of conflicts of interest 

of security-based swap clearing agencies. 

Each security-based swap clearing 

agency must comply with the provisions 

of either paragraphs (a) or (b) this 

section, and must have the capacity to 

carry out the purposes of paragraphs (a) 

or (b) of this section, respectively. 

(a)(1) Limits on voting interest. A 

security-based swap clearing agency 

shall not permit any security-based 

swap clearing agency participant, either 

alone or together with its related 

persons, to: 

(i) Beneficially own, directly or 

indirectly, any interest in the securitybased swap clearing agency that exceeds 

20 percent of any class of securities, or 

other ownership interest, entitled to 

vote of such security-based swap 

clearing agency; 

(ii) Directly or indirectly vote, cause 

the voting of, or give any consent or 

proxy with respect to the voting of, any 

interest in the security-based swap 

clearing agency that exceeds 20 percent 

of the voting power of any class of 

securities or other ownership interest of 

such security-based swap clearing 

agency; 

(iii) In the aggregate with any other 

security-based swap clearing agency 

participants and their related persons, 

beneficially own, directly or indirectly, 

any interest in the security-based swap 

clearing agency that exceeds 40 percent 

of any class of securities, or other 

ownership interest, entitled to vote of 

such security-based swap clearing 

agency; or 

(iv) In the aggregate with any other 

security-based swap clearing agency 

participants and their related persons, 

directly or indirectly vote, cause the 

voting of, or give any consent or proxy 

with respect to the voting of, any 

interest in the security-based swap 

clearing agency that exceeds 40 percent 

of the voting power of any class of 

securities or other ownership interest of 

such security-based swap clearing 

agency. 

(2) Divestiture. (i) The rules of the 

security-based swap clearing agency 

must provide an effective mechanism to 

divest any participant of any voting 

interest owned in excess of the 

limitation in paragraph (a)(1) of this 

section. 

(ii) The rules of the security-based 

swap clearing agency must be 

reasonably designed not to give effect to 

the portion of any voting interest held 

by one or more participants in excess of 

the limitations in paragraph (a)(1) of this 

section. 

(iii) The rules of the security-based 

swap clearing agency must provide an 

effective mechanism for it to obtain 

information relating to voting interests 

in the security-based swap clearing 

agency by any participant in the 

security-based swap clearing agency and 

its related persons. 

(3) Board. (i) The Board of each 

security-based swap clearing agency 

must be composed of at least 35 percent 

independent directors. 

(ii) No director may qualify as an 

independent director unless the Board 

affirmatively determines that the 

director does not have a material 

relationship with the security-based 

swap clearing agency or any affiliate of 

the security-based swap clearing agency, 

or a participant in the security-based 

swap clearing agency, or any affiliate of 

a participant in the security-based swap 

clearing agency. 

(iii) The security-based swap clearing 

agency must establish policies and 

procedures to require each director, on 

his or her own initiative or upon request 

of the security-based swap clearing 

agency, to inform the security-based 

swap clearing agency of the existence of 

any relationship or interest that may 

reasonably be considered to bear on 

whether such director is an independent 

director. 

(4) Nominating committee. (i) A Board 

of any security-based swap clearing 

agency shall establish a nominating 

committee composed of a majority of 

independent directors. 

(ii) The nominating committee of any 

security-based swap clearing agency 

must identify individuals qualified to 

become Board members through a 

consultative process with the 

participants of the security-based swap 

clearing agency consistent with criteria 

approved by the Board and consistent 

with the provisions of this section, and 

administer a process for the nomination 

of individuals to the Board. 

(5) Other committees of the Board. A 

security-based swap clearing agency 

may establish such other committees of 

the Board, including a risk committee, 

as it deems appropriate. However, if 

such committee has the authority to act 

on behalf of the Board, the committee 

must be composed of at least 35 percent 

independent directors. 

(6) Disciplinary panels. The 

disciplinary processes of a securitybased swap clearing agency shall 

preclude any group or class of persons 

that is a participant from dominating or 

exercising disproportionate influence on 

the disciplinary process. Any 

disciplinary panel of a security-based 

swap clearing agency shall also include 

at least one person who would qualify 

as an independent director. If the 

security-based swap clearing agency 

provides for a process of an appeal to 

the Board, or to a committee of the 

Board, then that appellate body also 

shall include at least one person who 

would qualify as an independent 

director. 

(b)(1) Limits on voting interests. A 

security-based swap clearing agency 

shall not permit any security-based 

swap clearing agency participant, either 

alone or together with its related 

persons, to: 

(i) Beneficially own, directly or 

indirectly, any interest in the securitybased swap execution facility that 

exceeds 5 percent of any class of 

securities, or other ownership interest, 

entitled to vote of such security-based 

swap clearing agency; or 

(ii) Directly or indirectly vote, cause 

the voting of, or give any consent or 

proxy with respect to the voting of, any 

interest in the security-based swap 

clearing agency that exceeds 5 percent 

of the voting power of any class of 

securities or other ownership interest of 

such security-based swap clearing 

agency. 

(2) Divestiture. (i) The rules of the 

security-based swap clearing agency 

must provide an effective mechanism to 

divest any participant of any voting 

interest owned in excess of the 

limitation in paragraph (b)(1) of this 

section. 

(ii) The rules of the security-based 

swap clearing agency must be 

reasonably designed not to give effect to 

the portion of any voting interest held 

by one or more participants in excess of 

the limitations in paragraph (b)(1) of 

this section. 

(iii) The rules of the security-based 

swap clearing agency must provide an 

effective mechanism for it to obtain 

information relating to voting interests 


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Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 65931 

in the security-based swap clearing 

agency or its holding company by any 

participant in the security-based swap 

clearing agency. 

(3) Board. (i) The Board of each 

security-based swap clearing agency 

must be composed of a majority of 

independent directors. 

(ii) No director may qualify as an 

independent director unless the Board 

affirmatively determines that the 

director does not have a material 

relationship with the security-based 

swap clearing agency or any affiliate of 

the security-based swap clearing agency, 

or a participant in the security-based 

swap clearing agency, or any affiliate of 

a participant in the security-based swap 

clearing agency. 

(iii) The security-based swap clearing 

agency must establish policies and 

procedures to require each director, on 

his or her own initiative or upon request 

of the security-based swap clearing 

agency, to inform the security-based 

swap clearing agency of the existence of 

any relationship or interest that may 

reasonably be considered to bear on 

whether such director is an independent 

director. 

(4) Nominating committee. (i) A Board 

of any security-based swap clearing 

agency shall establish a nominating 

committee composed solely of 

independent directors. 

(ii) The nominating committee of any 

security-based swap clearing agency 

must identify individuals qualified to 

become Board members through a 

consultative process with the 

participants of the security-based swap 

clearing agency consistent with criteria 

approved by the Board and consistent 

with the provisions of this section, and 

administer a process for the nomination 

of individuals to the Board. 

(5) Other committees of the Board. A 

security-based swap clearing agency 

may establish such other committees of 

the Board, including a risk committee, 

as it deems appropriate. However, if 

such committee has the authority to act 

on behalf of the Board, the committee 

must be composed of a majority of 

independent directors. 

(6) Disciplinary panels. The 

disciplinary processes of a securitybased swap clearing agency shall 

preclude any group or class of persons 

that is a participant from dominating or 

exercising disproportionate influence on 

the disciplinary process. Any 

disciplinary panel of a security-based 

swap clearing agency shall also include 

at least one person who would qualify 

as an independent director. If the 

security-based swap clearing agency 

provides for a process of an appeal to 

the Board, or to a committee of the 

Board, then that appellate body also 

shall include at least one person who 

would qualify as an independent 

director. 

§ 242.702 Mitigation of conflicts of interest 

of security-based swap execution facilities 

and national securities exchanges that post 

or make available for trading security-based 

swaps. 

(a) General. Each security-based swap 

execution facility and national 

securities exchange or facility thereof 

that posts or makes available for trading 

security-based swaps must comply with 

the provisions of this section and must 

have the capacity to carry out the 

purposes of this section. 

(b) Limits on ownership and voting. 

(1) A security-based swap execution 

facility shall not permit any securitybased swap execution facility 

participant, either alone or together with 

its related persons, to: 

(i) Beneficially own, directly or 

indirectly, any interest in the securitybased swap execution facility that 

exceeds 20 percent of any class of 

securities, or other ownership interest, 

entitled to vote of such security-based 

swap execution facility; or 

(ii) Directly or indirectly vote, cause 

the voting of, or give any consent or 

proxy with respect to the voting of, any 

interest in the security-based swap 

execution facility that exceeds 20 

percent of the voting power of any class 

of securities or other ownership interest 

of such security-based swap execution 

facility. 

(2) A national securities exchange or 

facility thereof that posts or makes 

available for trading security-based 

swaps shall not permit any member, 

either alone or together with its related 

persons, to: 

(i) Beneficially own, directly or 

indirectly, any interest in the national 

securities exchange or facility thereof 

that posts or makes available for trading 

security-based swaps that exceeds 20 

percent of any class of securities, or 

other ownership interest, entitled to 

vote of such national securities 

exchange or facility thereof that posts or 

makes available for trading securitybased swaps; or 

(ii) Directly or indirectly vote, cause 

the voting of, or give any consent or 

proxy with respect to the voting of, any 

interest in the national securities 

exchange or facility thereof that posts or 

makes available for trading securitybased swaps that exceeds 20 percent of 

the voting power of any class of 

securities or other ownership interest of 

such national securities exchange or 

facility thereof that posts or makes 

available for trading security-based 

swaps. 

(c) Divestiture. (1) The rules of a 

security-based swap execution facility 

or national securities exchange or 

facility thereof that posts or makes 

available for trading security-based 

swaps must provide an effective 

mechanism to divest any security-based 

swap execution facility participant or 

member, as applicable, of any interest 

owned in excess of the ownership 

limitations in paragraphs (b)(1)(i) and 

(2)(i) of this section. 

(2) The rules of a security-based swap 

execution facility or national securities 

exchange or facility thereof that posts or 

makes available for trading securitybased swaps must be reasonably 

designed not to give effect to the portion 

of any voting interest held by one or 

more security-based swap execution 

facility participant or member, as 

applicable, in excess of the limitations 

in paragraphs (b)(1)(ii) and (b)(2)(ii) of 

this section. 

(3) The rules of a security-based swap 

execution facility or national securities 

exchange or facility thereof that posts or 

makes available for trading securitybased swaps must provide an effective 

mechanism for it to obtain information 

relating to ownership and voting 

interests in the security-based swap 

execution facility or national securities 

exchange or facility thereof that posts or 

makes available for trading securitybased swaps by any security-based swap 

execution facility participant or 

member, as applicable. 

(d) Board. (1) The Board of any 

security-based swap execution facility 

or national securities exchange or 

facility thereof that posts or makes 

available for trading security-based 

swaps must be composed of a majority 

of independent directors. 

(2) No director may qualify as an 

independent director of a security-based 

swap execution facility unless the Board 

affirmatively determines that the 

director does not have a material 

relationship with the security-based 

swap execution facility, any affiliate of 

the security-based swap execution 

facility, a security-based swap execution 

facility participant, or any affiliate of a 

security-based swap execution facility 

participant. 

(3) No director may qualify as an 

independent director of a national 

securities exchange or facility thereof 

that posts or makes available for trading 

security-based swaps unless the Board 

affirmatively determines that the 

director does not have a material 

relationship with the national securities 

exchange or facility thereof, any affiliate 

of the national securities exchange or 


srobinson on DSK8KYBLC1PROD with PROPOSALS2
65932 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 

facility thereof, a member of the 

national securities exchange, or any 

affiliate of such member. 

(e) Regulatory oversight committee. 

(1) A Board of any security-based swap 

execution facility or national securities 

exchange that posts or makes available 

for trading security-based swaps shall 

establish a regulatory oversight 

committee, composed solely of 

independent directors, to assist it in 

minimizing actual and potential 

conflicts of interest. The regulatory 

oversight committee shall oversee the 

security-based swap execution facility’s 

obligations under section 3D of the 

Exchange Act or the national securities 

exchange’s obligation under section 6 of 

the Exchange Act (15 U.S.C. 78f), as 

applicable, on behalf of the Board. The 

Board shall delegate sufficient authority, 

dedicate sufficient resources, and allow 

sufficient time for the regulatory 

oversight committee to fulfill its 

mandate. 

(2) The Board shall promptly report to 

the Commission any recommendations 

of the Regulatory Oversight Committee 

that the Board does not adopt or 

implement. 

(f) Nominating committee. (1) The 

nominating committee of a securitybased swap execution facility or 

national securities exchange or facility 

thereof that posts or makes available for 

trading security-based swaps must be 

composed solely of independent 

directors. 

(2) The nominating committee of a 

security-based swap execution facility 

or national securities exchange or 

facility thereof that posts or makes 

available for trading security-based 

swaps must identify individuals 

qualified to become directors, consistent 

with criteria approved by the Board and 

consistent with the provisions of this 

section, and administer a process for the 

nomination of individuals to the Board. 

(g) Other committees of the Board. A 

security-based swap execution facility 

or national securities exchange or 

facility thereof that posts or makes 

available for trading security-based 

swaps may establish such other 

committees of the Board, including an 

executive committee, as it deems 

appropriate. However, if such 

committee has the authority to act on 

behalf of the Board, the committee must 

be composed of a majority of 

independent directors. 

(h) Disciplinary panels. The 

disciplinary processes of a securitybased swap execution facility or 

national securities exchange that posts 

or makes available for trading securitybased swaps shall preclude any group or 

class of security-based swap execution 

facility participants or group or class of 

members of the national securities 

exchange that posts or makes available 

for trading security-based swaps, as 

applicable, from dominating or 

exercising disproportionate influence on 

the disciplinary process. Any 

disciplinary panel of a security-based 

swap execution facility or national 

securities exchange that posts or makes 

available for trading security-based 

swaps shall also include at least one 

person who would qualify as an 

independent director. If the securitybased swap execution facility or 

national securities exchange that posts 

or makes available for trading securitybased swaps provides for a process of an 

appeal to the Board, or to a committee 

of the Board, then that appellate body 

also shall include at least one person 

who would qualify as an independent 

director. 

Dated: October 14, 2010. 

By the Commission. 

Elizabeth M. Murphy, 

Secretary. 

[FR Doc. 2010–26315 Filed 10–25–10; 8:45 am] 

BILLING CODE 8011–01–P 


srobinson on DSK8KYBLC1PROD with PROPOSALS2