[Federal Register Volume 76, Number 137 (Monday, July 18, 2011)]
[Proposed Rules]
[Pages 42396-42459]
[FR Doc No: 2011-16758]

Vol. 76

Monday,

No. 137

July 18, 2011

Part III

Securities and Exchange Commission

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17 CFR Part 240

Business Conduct Standards for Security-Based Swap Dealers and Major
Security-Based Swap Participants; Proposed Rule

Federal Register / Vol. 76 , No. 137 / Monday, July 18, 2011 /
Proposed Rules

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-64766; File No. S7-25-11]
RIN 3235-AL10

Business Conduct Standards for Security-Based Swap Dealers and
Major Security-Based Swap Participants

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is
proposing for comment new rules under the Securities Exchange Act of
1934 (``Exchange Act'') that are intended to implement provisions of
Title VII (``Title VII'') of the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (``Dodd-Frank Act'') relating to
external business conduct standards for security-based swap dealers
(``SBS Dealers'') and major security-based swap participants (``Major
SBS Participants'').

DATES: Comments should be received on or before August 29, 2011.

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<EMAIL_ADDRESS>Please include
File Number S7-25-11 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 Street, NE.,
Washington, DC 20549-1090.

All submissions should refer to File Number S7-25-11. 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 Street, 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: Lourdes Gonzalez, Acting Co-Chief
Counsel, Joanne Rutkowski, Branch Chief, Cindy Oh, Special Counsel,
Office of Chief Counsel, Division of Trading and Markets, at (202) 551-
5550, at the Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission is proposing Rules 15Fh-1 to
15Fh-6 and 15Fk-1 under the Exchange Act governing certain business
conduct requirements for SBS Dealers and Major SBS Participants. The
Commission is soliciting comments on all aspects of the proposed rules
and will carefully consider any comments received.

Table of Contents

I. Introduction
    A. Statutory Framework
    B. Consultations
    C. Approach to Drafting the Proposed Rules
    1. General Objectives
    2. SRO Rules as a Potential Point of Reference
    3. Business Conduct Rules Not Expressly Addressed by the Dodd-
Frank Act
    4. Differences Between SBS Dealers and Major SBS Participants
    5. Treatment of Special Entities
II. Discussion of Proposed Rules Governing Business Conduct
    A. Scope: Proposed Rule 15Fh-1
    B. Definitions: Proposed Rule 15Fh-2
    C. Business Conduct Requirements: Proposed Rule 15Fh-3
    1. Counterparty Status
    2. Disclosure
    a. Disclosure Not Required When the Counterparty Is an SBS
Entity or a Swap Dealer or Major Swap Participant
    b. Timing and Manner of Certain Disclosures
    c. Material Risks and Characteristics of the Security-Based Swap
    d. Material Incentives or Conflicts of Interest
    e. Daily Mark
    f. Clearing Rights
    3. Know Your Counterparty
    4. Recommendation by SBS Dealers
    5. Fair and Balanced Communications
    6. Obligation Regarding Diligent Supervision
    D. Proposed Rules Applicable to Dealings With Special Entities
    1. Scope of Definition of ``Special Entity''
    2. Best Interests
    3. Anti-Fraud Provisions: Proposed Rule 15Fh-4(a)
    4. Advisor to Special Entities: Proposed Rules 15Fh-2(a) and
15Fh-4(b)
    5. Counterparty to Special Entities: Proposed Rule 15Fh-5
    a. Scope of Qualified Independent Representative Requirement
    b. Independent Representative--Proposed Rule 15Fh-2(c)
    c. Reasonable Basis to Believe the Qualifications of the
Independent Representative
    i. Qualified Independent Representative--Sufficient Knowledge to
Evaluate Transaction and Risks
    ii. Qualified Independent Representative--No Statutory
Disqualification
    iii. Qualified Independent Representative--Acting in the Best
Interests of the Special Entity
    iv. Qualified Independent Representative--Appropriate
Disclosures to Special Entity
    v. Qualified Independent Representative--Written Representations
    vi. Qualified Independent Representative--ERISA Fiduciary
    vii. Qualified Independent Representative--Subject to ``Pay to
Play'' Prohibitions
    d. Disclosure of Capacity
    6. Prohibition on Certain Political Contributions by SBS
Dealers: Proposed Rule 15Fh-6
    a. Prohibitions
    b. Two-Year ``Time Out''
    c. Covered Associates
    d. Officials
    e. Exceptions
    i. De Minimis Contributions
    ii. New Covered Associates
    iii. Exchange and SEF Transactions
    f. Exception and Exemptions
    E. Chief Compliance Officer: Rule Proposed 15Fk-1
III. Request for Comments
    A. Generally
    B. Consistency With CFTC Approach
IV. Paperwork Reduction Act
    A. Summary of Collections of Information
    1. Verification of Status
    2. Disclosures by SBS Entities
    3. ``Know Your Counterparty'' and Recommendations
    4. Fair and Balanced Communications
    5. Supervision
    6. SBS Dealers Acting as Advisors to Special Entities
    7. SBS Entities Acting as Counterparties to Special Entities
    8. Political Contributions
    9. Chief Compliance Officers
    B. Proposed Use of Information
    1. Verification of Status
    2. Disclosures by SBS Entities
    3. ``Know Your Counterparty'' and Recommendations
    4. Fair and Balanced Communications
    5. Supervision
    6. SBS Dealers Acting as Advisors to Special Entities
    7. SBS Entities Acting as Counterparties to Special Entities
    8. Political Contributions
    9. Chief Compliance Officers
    C. Respondents
    D. Total Annual Reporting and Recordkeeping Burdens

    1. Verification of Status
    2. Disclosures by SBS Entities
    3. ``Know Your Counterparty'' and Recommendations
    4. Fair and Balanced Communications
    5. Supervision
    6. SBS Dealers Acting as Advisors to Special Entities
    7. SBS Entities Acting as Counterparties to Special Entities
    8. Political Contributions
    9. Chief Compliance Officers
    E. Collection of Information Is Mandatory
    F. Responses to Collection of Information Will Be Kept
Confidential
    G. Request for Comment
V. Cost-Benefit Analysis
    A. Costs and Benefits of Rules Relating to Daily Mark
    B. Costs and Benefits of Rules Concerning Verification of
Counterparty Status, Knowing your Counterparty and Recommendations
of Security-Based Swaps or Trading Strategies
    C. Costs and Benefits of Rules Relating to Political
Contributions by Certain SBS Entities and Independent
Representatives of Special Entities
    D. Costs and Benefits Relating to the Specification of Minimum
Requirements of the Annual Compliance Report and the Requirement of
Board Approval of Compensation or Removal of a Chief Compliance
Officer
VI. Consideration of Burden on Competition and Promotion of
Efficiency, Competition and Capital Formation
VII. Consideration of Impact on the Economy
VIII. Regulatory Flexibility Act Certification
    A. Market Participants in Security-Based Swaps
    B. Certification

I. Introduction

A. Statutory Framework

    On July 21, 2010, the President signed the Dodd-Frank Act into
law.\1\ Title VII of the Dodd-Frank Act generally provides the
Commission with authority to regulate ``security-based swaps,'' the
Commodity Futures Trading Commission (``CFTC'') with authority to
regulate ``swaps,'' and both the CFTC and the Commission with authority
to regulate ``mixed swaps.'' \2\
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    \1\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010).
    \2\ Section 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.''
Public Law 111-203, 124 Stat. 1376, 1644-1646 (2010). 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, 7 U.S.C. 1a(18), as re-
designated and amended by Section 721 of the Dodd-Frank Act. Section
721(c) of the Dodd-Frank Act also 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. Public Law 111-203, 124
Stat. 1376, 1658-1672, 1754, 1759 (2010). 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. Public Law 111-203, 124 Stat. 1376,
1642 (2010).
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    Section 764 of the Dodd-Frank Act amends the Exchange Act by adding
new Section 15F.\3\ Paragraph (h) of the new section authorizes and
requires the Commission to adopt rules specifying business conduct
standards for SBS Dealers \4\ and Major SBS Participants \5\ in their
dealings with counterparties, including counterparties that are
``special entities.'' ``Special entities'' are generally defined to
include federal agencies, states and their political subdivisions,
employee benefit plans as defined under the Employee Retirement Income
Security Act of 1974 (``ERISA''), governmental plans as defined under
ERISA, and endowments.\6\ Congress granted the Commission broad
authority to promulgate business conduct requirements, as appropriate
in the public interest, for the protection of investors or otherwise in
furtherance of the purposes of the Exchange Act.\7\
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    \3\ See Public Law 111-203, 124 Stat. 1376, 1789-1792, Sec.
764(a) (adding Exchange Act Section 15F). All references to the
Exchange Act are to the Exchange Act, as amended by the Dodd-Frank
Act.
    \4\ Section 761 of the Dodd-Frank Act amends Section 3(a) of the
Exchange Act to add new Exchange Act Section 3(a)(71)(A), which
generally defines ``security-based swap dealer'' as ``any person
who: (i) holds themself [sic] out as a dealer in security-based
swaps; (ii) makes a market in security-based swaps; (iii) regularly
enters into security-based swaps with counterparties as an ordinary
course of business for its own account; or (iv) engages in any
activity causing it to be commonly known in the trade as a dealer or
market maker in security-based swaps.'' Public Law 111-203, 124
Stat. 1376, 1758, Sec.  761.
    The Commission and the CFTC are jointly proposing rules and
interpretive guidance under the Exchange Act and the Commodity
Exchange Act to further define the terms ``swap dealer,''
``security-based swap dealer,'' ``major swap participant,'' ``major
security-based swap participant,'' and ``eligible contract
participant.'' See Further Definition of ``Swap Dealer,''
``Security-Based Swap Dealer,'' ``Major Swap Participant,'' ``Major
Security-Based Swap Participant'' and ``Eligible Contract
Participant,'' Exchange Act Release No. 63452 (Dec. 7, 2010), 75 FR
80174 (Dec. 21, 2010) (``Definitions Release'').
    \5\ Section 761 of the Dodd-Frank Act amends Section 3(a) of the
Exchange Act to add new Exchange Act Section 3(a)(67)(A), which
defines ``major security-based swap participant'' as ``any person:
(i) Who is not a security-based swap dealer; and (ii)(I) who
maintains a substantial position in security-based swaps for any of
the major security-based swap categories, as such categories are
determined by the Commission, excluding both positions held for
hedging or mitigating commercial risk and positions maintained by
any employee benefit plan (or any contract held by such a plan) as
defined in paragraphs (3) and (32) of Section 3 of the Employee
Retirement Income Security Act of 1974 (29 U.S.C. 1002) for the
primary purpose of hedging or mitigating any risk directly
associated with the operation of the plan; (II) whose outstanding
security-based swaps create substantial counterparty exposure that
could have serious adverse effects on the financial stability of the
United States banking system or financial markets; or (III) that is
a financial entity that (aa) 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 (bb) maintains a substantial position in outstanding
security-based swaps in any major security-based swap category, as
such categories are determined by the Commission.'' Public Law 111-
203, 124 Stat. 1376, 1755-1756, Sec.  761(a) (to be codified at 15
U.S.C. 78c(a)(67)(A)).
    See also Definitions Release, supra note 4.
    \6\ Public Law 111-203, 124 Stat. 1376, 1789-1790, Sec.  764(a)
(to be codified at 15 U.S.C. 78o-10(h)(2)(C)).
    \7\ See Public Law 111-203, 124 Stat. 1376, 1790 (to be codified
at 15 U.S.C. 78o-10(h)(3)(D)) (``[b]usiness conduct requirements
adopted by the Commission shall establish such other standards and
requirements as the Commission may determine are appropriate in the
public interest, for the protection of investors, or otherwise in
furtherance of the purposes of this Act''). See also Public Law 111-
203, 124 Stat. 1376, 1789 (to be codified at 15 U.S.C. 78o-
10(h)(1)(D)) (requiring that SBS Entities comply as well with ``such
business conduct standards * * * as may be prescribed by the
Commission by rule or regulation that relate to such other matters
as the Commission determines to be appropriate'').
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    Section 15F(h)(6) of the Exchange Act directs the Commission to
prescribe rules governing business conduct standards for SBS Dealers
and Major SBS Participants (collectively, ``SBS Entities''). These
standards, as described in Exchange Act Section 15F(h)(3), must require
an SBS Entity to: verify that a counterparty meets the eligibility
standards for an ``eligible contract participant'' (``ECP''); disclose
to the counterparty material information about the security-based swap,
including material risks and characteristics of the security-based
swap, and material incentives and conflicts of interest of the SBS
Entity in connection with the security-based swap; and provide the
counterparty with information concerning the daily mark for the
security-based swap. Section 15F(h)(3) also directs the Commission to
establish a duty for SBS Entities to communicate in a fair and balanced
manner based on principles of fair dealing and good faith. Section
15F(h)(1) of the Exchange Act grants the Commission authority to
promulgate rules applicable to SBS Entities that relate to, among other
things, fraud, manipulation and abusive practices involving security-
based swaps (including security-based swaps that are offered but not
entered into),

diligent supervision of SBS Entities and adherence to all applicable
position limits.\8\
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    \8\ The Commission has proposed for comment a new Rule 9j-1
under the Exchange Act, which is intended to prevent fraud,
manipulation, and deception in connection with the offer, purchase
or sale of any security-based swap, the exercise of any right or
performance of any obligation under a security-based swap, or the
avoidance of such exercise or performance. Prohibition against
Fraud, Manipulation, and Deception in Connection with Security-Based
Swaps, Exchange Act Release No. 63236 (Nov. 3, 2010), 75 FR 68560
(Nov. 8, 2010). The Commission is separately considering the matter
of position limits, and would propose any position limits in a
separate rulemaking, as necessary.
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    Section 15F(h)(4) of the Exchange Act requires that an SBS Dealer
that ``acts as an advisor to a special entity'' must act in the ``best
interests'' of the special entity and undertake ``reasonable efforts to
obtain such information as is necessary to make a reasonable
determination'' that a recommended security-based swap is in the best
interests of the special entity. Section 15F(h)(5) requires that SBS
Entities that offer to or enter into a security-based swap with a
special entity comply with any duty established by the Commission that
requires an SBS Entity to have a ``reasonable basis'' for believing
that the special entity has an ``independent representative'' that
meets certain criteria and undertakes a duty to act in the ``best
interests'' of the special entity.\9\ This provision also requires that
an SBS Entity disclose in writing the capacity in which it is acting
(e.g., as principal) before initiating a transaction with a special
entity.\10\
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    \9\ Pub. L. 111-203, 124 Stat. 1376, 1791 (to be codified at 15
U.S.C. 78o-10(h)(5)).
    \10\ Id.
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    Section 15F(k) of the Exchange Act requires each SBS Entity to
designate a chief compliance officer and imposes certain duties on that
person.

B. Consultations

    In developing the rules proposed herein, the Commission staff has,
in compliance with Sections 712(a)(2) \11\ and 752(a) \12\ of the Dodd-
Frank Act, consulted and coordinated with the CFTC and the prudential
regulators.\13\ Commission staff also met with persons representing a
broad spectrum of views on the proposed rules.\14\ These meetings were
conducted jointly with CFTC staff. Among the persons who participated
in the meetings were other regulators, broker-dealers, consumer and
investor advocates, endowments, end-users, financial institutions,
futures commission merchants, industry trade groups, investment fund
managers, labor unions, pension fund managers, self-regulatory
organizations (``SROs''), state and local governments, and swap
dealers. We have considered standards or guidance issued by prudential
regulators and international organizations, requirements applicable
under foreign regulatory regimes, and recommendations for industry
``best practices.'' \15\ We have also taken into account the more than
70 comments received by the CFTC on its proposed business conduct rules
for swap dealers and major swap entities.\16\
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    \11\ Section 712(a)(2) of the Dodd-Frank Act states in part,
``the Securities and Exchange Commission shall consult and
coordinate to the extent possible with the Commodity Futures Trading
Commission and the prudential regulators for the purposes of
assuring regulatory consistency and comparability, to the extent
possible.'' Public Law 111-203, 124 Stat. 1376, 1641-1642 (to be
codified at 15 U.S.C. 8302(a)(2)).
    \12\ Section 752(a) of the Dodd-Frank Act states in part that,
``[i]n order to promote effective and consistent global regulation
of swaps and security-based swaps, the Commodity Futures Trading
Commission, the Securities and Exchange Commission, and the
prudential regulators (as that term is defined in Section 1a(39) of
the Commodity Exchange Act), as appropriate, shall consult and
coordinate with foreign regulatory authorities on the establishment
of consistent international standards with respect to the regulation
(including fees) of swaps.'' Public Law 111-203, 124 Stat. 1376,
1749-1750 (to be codified at 15 U.S.C. 8325(a)).
    \13\ ``Prudential regulator,'' as explained in Section 711 of
the Dodd-Frank Act, has the meaning given to it in section 1a of the
Commodity Exchange Act (7 U.S.C. 1a), including any modification
thereof under section 721(b) of the Dodd-Frank Act. Public Law 111-
203, 124 Stat. 1376, 1641 (to be codified at 15 U.S.C. 8301).
    \14\ A list of Commission staff meetings in connection with this
rulemaking is available on the Commission's website under ``Meetings
with SEC Officials'' at http://www.sec.gov/comments/df-title-vii/swap/swap.shtml. In addition, the Commission received several
letters from the public, available at http://www.sec.gov/comments/df-title-vii/swap/swap.shtml.
    \15\ See, e.g., Int'l Org. of Securities Commissions,
Operational and Financial Risk Management Control Mechanisms for
Over-the-Counter Derivatives Activities of Regulated Securities
Firms, (July 1994) (``IOSCO Report''); Bank for Int'l Settlements,
Basel Committee on Banking Supervision, Risk Management Guidelines
for Derivatives (July 1994) (``BIS Report''); Derivatives Policy
Group, Framework for Voluntary Oversight (Mar. 1995), http://www.riskinstitute.ch/137790.htm; The Counterparty Risk Management
Group, Improving Counterparty Risk Management Practices (June 1999)
(``CRMPG I Report''); The Counterparty Risk Management Group, Toward
Greater Financial Stability: A Private Sector Perspective. The
Report of the Counterparty Risk Management Policy Group II (July 27,
2005) (``CRMPG II Report''); The Counterparty Risk Management Group,
Containing Systemic Risk: The Road to Reform, The Report of the
CRMPG III (Aug. 6, 2008) (``CRMPG III Report''). In considering
industry voluntary best practices, the Commission acknowledges that
such best practices were not necessarily intended to establish or
guide regulatory standards for which market participants would have
legal liability if violated.
    \16\ See Business Conduct Standards for Swap Dealers and Major
Swap Participants with Counterparties, 75 FR 80638 (Dec. 22, 2010)
(``CFTC External Business Conduct Release''). Comments received by
the CFTC are available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=935.
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    The staffs of the Commission and the CFTC have been consulting with
the staff of the Department of Labor, and will continue to do so,
concerning the potential interface between ERISA and the business
conduct requirements of the Dodd-Frank Act. We recognize the importance
of the ability of SBS Dealers to offer security-based swaps to special
entities that are subject to ERISA, both for dealers and for the
pension plans that may rely on security-based swaps to manage risk and
reduce volatility.

C. Approach to Drafting the Proposed Rules

1. General Objectives
    Section 15F(h) of the Exchange Act provides the Commission with
both mandatory and discretionary rulemaking authority. Our intent, in
exercising this authority, is to establish a regulatory framework that
both protects investors and promotes efficiency, competition, and
capital formation.\17\ The Commission staff has worked closely with
CFTC staff in consulting with the public and in developing the proposed
rules, with a view to establishing consistent and comparable
requirements for our respective registrants, to the extent
possible.\18\
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    \17\ See Section 3(f) of the Exchange Act, 15 U.S.C. 78c(f).
    \18\ See Section I.B, supra.
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    The Commission understands that the proposed rules discussed
herein, as well as other proposals that the Commission is considering
to implement the Dodd-Frank Act, if adopted, could significantly
affect--and be significantly affected by--the development of the
security-based swaps market in a number of ways. If the Commission
adopts rules that are too permissive, for example, they may not
adequately protect investor interests or promote the purposes of the
Dodd-Frank Act. If, however, the Commission adopts measures that are
too onerous, they could unduly limit hedging and other legitimate
activities by discouraging participation in security-based swap
markets. We are aware that the further development of the security-
based swaps market, including in response to rules adopted by the
Commission under the Dodd-Frank Act, may alter the calculus for
regulation of business conduct of SBS Entities. We urge commenters, as
they review the proposed rules, to consider generally the role that
regulation may play in the development of the market for security-

based swaps, as well as the role that market developments may play in
changing the nature and implications of regulation, and to focus in
particular on this issue with respect to the proposed business conduct
standards for SBS Entities.
2. SRO Rules as a Potential Point of Reference
    Under the framework established in the Dodd-Frank Act, SBS Entities
are not required to be members of SROs, and no SRO has authority to
regulate the activities of an SBS Entity, unless the SBS Entity is
otherwise a member of that SRO. Nevertheless, we preliminarily believe
that SRO business conduct rules provide a potential point of reference
to inform our development of business conduct rules for SBS Entities,
for several reasons.\19\
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    \19\ We have looked, in particular, to the requirements imposed
by the Financial Industry Regulatory Authority, Inc., the Municipal
Securities Rulemaking Board, and the National Futures Association.
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    First, a number of the business conduct standards in Section 15F(h)
of the Exchange Act, including those regarding fair and balanced
communications,\20\ supervision,\21\ and designation of a chief
compliance officer,\22\ appear to be patterned on and are consistent
with standards that have been established by SROs for their members,
with Commission approval.\23\
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    \20\ Section 15F(h)(3)C) of the Exchange Act, Public Law 111-
203, 124 Stat. 1376, 1790 (to be codified at 15 U.S.C. 78o-
10(h)(3)(C)). Cf. NASD Rule 2210(d)(1)(A).
    \21\ Section 15F(h)(1)(B) of the Exchange Act, Pub. L. 111-203,
124 Stat. 1376, 1789 (to be codified at 15 U.S.C. 78o-10(h)(1)(B)).
Cf. NASD Rules 3010 and 3012.
    \22\ Section 15F(k) of the Exchange Act, Public Law 111-203, 124
Stat. 1376, 1793--1794 (to be codified at 15 U.S.C. 78o-10(k)). Cf.
FINRA Rule 3130.
    \23\ The Commission exercises oversight over SROs with respect
to their interpretive, rulemaking and enforcement activities. See
Section 19 of the Exchange Act, 15 U.S.C. 78s.
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    Second, business conduct standards under SRO rules have been
developed over the course of many decades with input from market
participants. Many market participants are familiar with these
standards and are experienced with implementing them through existing
compliance and supervisory controls and procedures. Indeed, if the
Commission were to promulgate completely new business conduct standards
that deviate in approach from established SRO rules in the same areas,
our actions could increase uncertainty and impose burdens on the many
market participants already familiar with SRO business conduct
standards by requiring them to adapt to and implement a new and
different business conduct regime for security based swap transactions.
    Third, to the extent that certain SBS Entities may also be
registered as broker-dealers, they would be subject to the full panoply
of SRO rules, including SRO business conduct rules, with respect to
their activities related to security-based swaps.\24\ If the Commission
were to adopt business conduct standards that differ materially from
those imposed by SRO rules, these firms could be required to comply
with two different, and potentially inconsistent, business conduct
regimes--the Commission's and the SRO's--for the same transaction.
Conversely, consistency between the business conduct requirements could
reduce potential competitive disparities between SBS Entities that are
SRO members and those that are not. Consistent regulatory requirements
could also potentially benefit counterparties to SBS Entities, by
providing a more uniform level of protection and limiting the confusion
or uncertainty that might otherwise arise if substantially different
rules were to apply to the same type of transaction based solely on
whether the SBS Entity is an SRO member.
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    \24\ Because security-based swap transactions are ``securities''
within the meaning of Section 3(a)(10) of the Exchange Act, broker-
dealers would be subject to SRO business conduct and other rules
applicable to such transactions. Public Law 111-203, 124 Stat. 1376,
1755, Sec.  761(a)(2) (to be codified at 15 U.S.C. 78c(a)(10)).
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    At the same time, in considering the business conduct standards
that have been developed by SROs, we are mindful that the security-
based swap market historically has been primarily an institutional
market in which transactions are typically negotiated on a principal-
to-principal basis. While there is a wide range of counterparty
sophistication within this market, the greater participation of
institutional investors in the security-based swap market suggests a
potentially different dynamic in the nature of the interactions between
SBS Entities and their counterparties. Accordingly, it may be
appropriate, for example, for the business conduct requirements
applicable to SBS Entities to diverge to some extent from the
requirements generally applicable to broker-dealers, whose activities
may range from principal trading with institutional counterparties to
retail brokerage on behalf of individual investors.
    In light of these considerations, the Commission is seeking to
strike a balance in its use of SRO business conduct standards as a
point of reference for the proposed rules. As noted above, one
potential benefit of this approach would be to provide greater legal
certainty and promote consistent requirements across different types of
SBS Entities. That potential benefit would not be achieved if the
Commission were to implement, interpret and enforce its business
conduct standards in a manner that differs substantially from that of
the SROs without grounding such actions in functional differences
between the security-based swap market and other securities markets.
Thus, absent such functional differences, when a business conduct
standard in these proposed rules is based on a similar SRO standard, we
would expect--at least as an initial matter--to take into account the
SRO's interpretation and enforcement of its standard when we interpret
and enforce our rule. At the same time, as noted above, we are not
bound by an SRO's interpretation and enforcement of an SRO rule, and
our policy objectives and judgments may diverge from those of a
particular SRO. Accordingly, we would also expect to take into account
such differences in interpreting and enforcing our rules.
    We request comment on all aspects of our approach to using business
conduct requirements applicable to market professionals (such as
broker-dealers and futures commission merchants) under existing SRO
rules as a point of reference in developing the business conduct
requirements applicable to SBS Entities.
3. Business Conduct Rules Not Expressly Addressed by the Dodd-Frank Act
    In addition to business conduct requirements expressly addressed by
Title VII of the Dodd-Frank Act, we are proposing for comment certain
other business conduct requirements for SBS Dealers that we
preliminarily believe would further the principles that underlie the
Dodd-Frank Act. These rules would, among other things, impose certain
``know your counterparty'' and suitability obligations on SBS Dealers,
and restrict SBS Dealers from engaging in certain ``pay to play''
activities.\25\
---------------------------------------------------------------------------

    \25\ The CFTC has recently proposed rules that would impose
similar requirements for swap dealers and major swap participants.
See CFTC External Business Conduct Release, supra, note 16.
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    Know Your Counterparty--Broker-dealers are subject to ``know your
customer'' standards that help to ensure investor protection and fair
dealing in securities transactions, both for retail

and institutional investors.\26\ We preliminarily believe that a ``know
your counterparty'' standard would be consistent with the principles
underlying the Dodd-Frank Act. Accordingly, we are proposing, in
addition to the rules expressly addressed by Section 15F(h) of the
Exchange Act, certain ``know your counterparty'' requirements for SBS
Dealers.\27\
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    \26\ See Notice of Filing of Amendment No. 1 to a Proposed Rule
Change and Order Granting Accelerated Approval of a Proposed Rule
Change, as Modified by Amendment No. 1, to Adopt FINRA Rules 2090
(Know Your Customer) and 2111 (Suitability) in the Consolidated
FINRA Rulebook, Exchange Act Release No. 63325 (Nov. 17, 2010), 75
FR 71479 (Nov 23, 2010) (effective July 9, 2012) (``Suitability
Order'').
    \27\ Proposed Rule 15Fh-3(e), discussed in Section II.C.3,
infra.
---------------------------------------------------------------------------

    Suitability--Broker-dealers are subject to suitability standards
that help to ensure investor protection and fair dealing in securities
transactions, both for retail and institutional investors.\28\ In
addition, the Dodd-Frank Act effectively imposes a suitability
requirement on SBS Dealers that, when acting as advisors, make
recommendations to special entities.\29\ We preliminarily believe that
it would be appropriate to extend these protections to certain
situations in which an SBS Dealer is entering into a security-based
swap with a counterparty that is not a special entity. Accordingly, we
are proposing certain suitability requirements for SBS Dealers when
making recommendations to counterparties.\30\
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    \28\ See Suitability Order, supra.
    \29\ Section 15F(h)(4)(C) of the Exchange Act (``Any security-
based swap dealer that acts as an advisor to a special entity shall
make reasonable efforts to obtain such information as is necessary
to make a reasonable determination that any security-based swap
recommended by the security-based swap dealer is in the best
interests of the special entity''). Pub. L. 111-203, 124 Stat. 1376,
1790-1791 (to be codified at 15 U.S.C. 78o-10(h)(4)(C)).
    \30\ Proposed Rule 15Fh-3(f), discussed in Section II.C.4,
infra. The suitability obligation would not apply if the
counterparty is an SBS Entity or a swap dealer or major swap
participant. In addition, the proposed rule would include an
alternative similar to the FINRA ``institutional suitability''
exemption, as described more fully below.
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    Pay to Play--We are also proposing pay to play restrictions for SBS
Dealers that are intended to complement the restrictions applicable to
other market intermediaries seeking to engage in securities
transactions with municipal entities. As explained more fully in
Section II.D.5, pay to play practices, in which elected officials may
allow political contributions to play a role in the selection of
financial services providers, distort the process by which public
contracts are awarded. Concerns about pay to play practices in the
municipal securities and investment adviser contexts have prompted the
promulgation of pay to play restrictions for those market
professionals.\31\ We are concerned that similar pay to play practices
could distort the market for securities-based swap transactions.\32\
These abuses encourage corrupt market practices, and can harm municipal
entities that subsequently enter into inappropriate security-based
swaps.\33\ Because certain SBS Dealers may not be covered by other pay
to play rules already in effect, we are proposing for comment here pay
to play rules intended to create a comparable regulatory framework with
respect to those SBS Dealers. Given the similarity of pay to play
practices across various contexts, and to facilitate compliance, we are
proposing pay to play rules that are intended to be consistent with
existing pay to play rules, to the extent practicable.
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    \31\ See Rule 205(4)-5 under the Investment Advisers Act of 1940
(applying pay to play restrictions to investment advisers), and MSRB
Rule G-37 (which seeks to eliminate pay to play practices in the
municipal securities market through restrictions on political
contributions and prohibitions on municipal securities business).
    \32\ For example, the Commission has brought a number of actions
in connection with payments by J.P. Morgan Securities Inc. to local
firms whose principals or employees were friends of Jefferson
County, Alabama public officials in connection with $5 billion in
County bond underwriting and interest rate swap agreement business
awarded to the broker-dealer. The Commission has alleged that J.P.
Morgan Securities engaged in pay to play practices in connection
with obtaining municipal security underwriting and interest swap
agreement business from municipalities. The Commission has alleged
that J.P. Morgan Securities incorporated certain of the costs of
these payments into higher swap interest rates it charged the
County, directly increasing the swap transaction costs to the County
and its taxpayers. See SEC v. Larry P. Langford, Litigation Release
No. 20545 (Apr. 30, 2008) and SEC v. Charles E. LeCroy, Litigation
Release No. 21280 (Nov. 4, 2009) (charging Alabama local government
officials and J.P. Morgan employees with undisclosed payments made
to obtain municipal bond offering and swap agreement business from
Jefferson County, Alabama). See also J.P. Morgan Securities Inc.,
File No. 3-13673 (Nov. 4, 2009) (instituting administrative and
cease-and-desist proceedings against a broker-dealer that allegedly
was awarded bond underwriting and interest rate swap agreement
business by Jefferson County in connection with undisclosed payments
by employees of the firm).
    \33\ See also Political Contributions by Certain Investment
Advisers, Investment Advisers Act Release No. 3043 (July 1, 2010),
75 FR 41018 (July 14, 2010) (describing concerns that led to
adoption of Advisers Act Rule 206(4)-5); Alexander W. Butler, Larry
Fauver, and Sandra Mortal, Corruption, Political Connections, and
Municipal Finance, 22 The Review of Financial Studies 2873 (2009)
(describing effect of pay to play practices on greater credit risk,
higher bond yields and underwriting premium fees in municipal bond
sales and underwriting).
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    We request comment on all aspects of our proposal to impose certain
limited business conduct requirements not expressly addressed by the
Dodd-Frank Act.
4. Differences Between SBS Dealers and Major SBS Participants
    We have also considered how the differences between the definitions
of SBS Dealer and Major SBS Participant may be relevant in formulating
the business conduct standards applicable to these entities. The Dodd-
Frank Act defines ``security-based swap dealer'' in a functional
manner, by reference to the way a person holds itself out in the market
and the nature of the conduct engaged in by that person, and how the
market perceives the person's activities.\34\ As described in our joint
proposal with the CFTC regarding this definition:
---------------------------------------------------------------------------

    \34\ See note 4, supra (definition of ``security-based swap
dealer'').

    [S]wap dealers can often be identified by their relationships
with counterparties. Swap dealers tend to enter into swaps with more
counterparties than do non-dealers, and in some markets, non-dealers
tend to constitute a large portion of swap dealers' counterparties.
In contrast, non-dealers tend to enter into swaps with swap dealers
more often than with other non-dealers. The Commissions can most
efficiently achieve the purposes underlying Title VII of the Dodd-
Frank Act--to reduce risk and to enhance operational standards and
fair dealing in the swap markets--by focusing their attention on
those persons whose function is to serve as the points of connection
in those markets. The definition of swap dealer, construed
functionally in the manner set forth above, will help to identify
those persons.\35\
---------------------------------------------------------------------------

    \35\ Definitions Release (using ``swap dealer'' to refer both to
security-based swap dealer and to swap dealer).

The definition of ``major security-based swap participant,'' in
contrast, focuses on the market impacts and risks associated with an
entity's security-based swap positions.\36\ Despite the differences in
focus, the Dodd-Frank Act applies substantially the same statutory
standards to SBS Dealers and Major SBS Participants.\37\ We have
attempted to

take into account these differing definitions and regulatory concerns
in considering whether the business conduct requirements that we are
proposing for SBS Dealers that are not expressly addressed by the
statute should or should not apply to Major SBS Participants as
well.\38\ In general, where the Dodd-Frank Act imposes a business
conduct requirement on both SBS Dealers and Major SBS Participants, we
have proposed rules that would apply equally to SBS Dealers and Major
SBS Participants. Where, however, a business conduct requirement is not
expressly addressed by the Dodd-Frank Act, the proposed rules generally
would not apply to Major SBS Participants.\39\
---------------------------------------------------------------------------

    \36\ As explained in the Definitions Release, the ``major
security-based swap participant'' definition uses terms--
particularly ``systemically important,'' ``significantly impact the
financial system,'' and ``create substantial counterparty
exposure''--that denote a focus on entities that pose a high degree
of risk through their security-based swap activities. In addition,
the link between the ``major participant'' definition and risk was
highlighted during the Congressional debate on the statute. See 156
Cong. Rec. S5907 (daily ed. July 15, 2010) (dialogue between
Senators Hagen and Lincoln, discussing how the goal of the major
participant definition was to ``focus on risk factors that
contributed to the recent financial crisis, such as excessive
leverage, under-collateralization of swap positions, and a lack of
information about the aggregate size of positions'').
    \37\ In particular, under Section 15F of the Exchange Act, SBS
Dealers and Major SBS Participants generally are subject to the same
types of margin, capital, business conduct and certain other
requirements, unless an exclusion applies. In this way, the statute
applies comprehensive regulation to entities (i.e., Major SBS
Participants) whose security-based swap activities do not cause them
to be dealers, but nonetheless could pose a high degree of risk to
the U.S. financial system generally. See Public Law 111-203, 124
Stat. 1376, 1785-1796 (to be codified at 15 U.S.C. 78o-10).
    \38\ See Section I.C.4, infra.
    \39\ There are exceptions to this principle. We are proposing
that all SBS Entities be required to determine if a counterparty is
a special entity. In addition, Section 3C(g)(5) of the Exchange Act
creates certain rights with respect to clearing for counterparties
entering into security-based swaps with SBS Entities but does not
require disclosure. We are proposing a rule that would require an
SBS Entity to disclose to a counterparty certain information
relating to these rights. See Public Law 111-203, 124 Stat. 1376,
1766-1767 (to be codified at 15 U.S.C. 78c-3(g)(5)). The proposed
rule is intended to further the purposes of the Dodd-Frank Act to
ensure that, wherever possible and appropriate, derivatives
contracts formerly traded exclusively in the OTC market are cleared
through a regulated clearing agency.
---------------------------------------------------------------------------

    We request comment on whether this approach is appropriate. Where
the Dodd-Frank Act requires that a business conduct rule apply to all
SBS Entities, should the rule impose the same requirements on Major SBS
Participants as on SBS Dealers? Where we are proposing rules for SBS
Dealers that are not expressly addressed by the Dodd-Frank Act, should
any of these rules apply as well to Major SBS Participants? If so,
which rules and why?
5. Treatment of Special Entities
    Congress has provided certain additional protections in the Dodd-
Frank Act for ``special entities''--including certain municipalities,
pension plans, and endowments--in connection with security-based swaps.
In particular, as described in Section II.D below, Sections 15F(h)(4)
and (5) of the Exchange Act, as amended by the Dodd Frank Act,
establish a set of additional provisions addressed solely to the
interactions between SBS Entities and special entities in connection
with security-based swaps.
    Some commenters have noted that special entities, like other market
participants, may use swaps and security-based swaps for a variety of
beneficial purposes, including risk management and portfolio
adjustment.\40\ For example, we understand that pension plans can be
authorized to use such instruments in order to meet the investment
objectives of their members.\41\ At the same time, some commenters have
also noted that the financial sophistication of these entities can vary
greatly.\42\ Such variation in sophistication, among other factors, has
raised concerns about potential abuses in connection with security-
based swap transactions with special entities.\43\
---------------------------------------------------------------------------

    \40\ As explained by one commenter:
    ``Swaps permit [pension] plans to hedge against market
fluctuations, interest rate changes, and other factors that create
volatility and uncertainty with respect to plan funding. Swaps also
help plans rebalance their investment portfolios, diversify their
investments, and gain exposure to particular asset classes without
direct investments. By helping to protect plan assets as part of a
prudent long-term investment strategy, swaps benefit the millions of
participants who rely on these plans for retirement income, health
care, and other important benefits.''
    Letter from Mark J. Ugoretz, President and CEO, The ERISA
Industry Committee to David A. Stawick, Secretary, CFTC (Feb. 22,
2011).
    \41\ See, e.g., Letter from Joseph A. Dear, Chief Investment
Officer, California Public Employees' Retirement System et al. to
David A. Stawick, Secretary, CFTC (Feb. 18, 2011) (the ``Public
Pension Funds Letter''):
    To fulfill obligations to our members, we invest in a wide
variety of assets classes, including alternative investment
management, global equity, global fixed income, inflation-linked
assets, and real estate. As part of our investment and risk
management policies, we have authorized the use of certain
derivates. The authorized derivatives include futures, forward,
swaps, structured notes and options.
    \42\ See, e.g., Letter from Barbara Roper, Director of Investor
Protection, Consumer Federation of America, Lisa Donner, Executive
Director, Americans for Financial Reform, Michael Greenberger, J.D.,
Founder and Director of University of Maryland Center for Health and
Homeland Security, and Damon Silvers, Director of Policy and Special
Counsel, AFL-CIO to David A. Stawick, Secretary, CFTC (Feb. 22,
2011).
    \43\ See, e.g., 156 Cong. Rec. S5903 (daily ed. Jul. 15, 2010)
(statement of Sen. Lincoln) (discussing how ``pension plans,
governmental investors, and charitable endowments were falling
victim to swap dealers marketing swaps and security-based swaps that
they knew or should have known to be inappropriate or unsuitable for
their clients. Jefferson County, AL, is probably the most infamous
example, but there are many others in Pennsylvania and across the
country.'').
---------------------------------------------------------------------------

    In implementing the special entity provisions of the Dodd-Frank
Act, we have sought to give full effect to the additional protections
for these entities contemplated by the statute, while not imposing
restrictions on SBS Entities that would unduly limit their willingness
or ability to provide special entities with the access to security-
based swaps that special entities may need for risk management and
other beneficial purposes. We request comment on all aspects of the
approach to special entities described in this release.

II. Discussion of Proposed Rules Governing Business Conduct

    The proposed rules would implement the requirements of the Dodd-
Frank Act relating to business conduct standards for SBS Entities.

A. Scope: Proposed Rule 15Fh-1

    Proposed Rule 15Fh-1 provides that proposed Rules 15Fh-1 through
15Fh-6 and Rule 15Fk-1 are not intended to limit, or restrict, the
applicability of other provisions of the federal securities laws,
including but not limited to Section 17(a) of the Securities Act of
1933 (``Securities Act''), Sections 9 and 10(b) of the Exchange Act,
and the rules and regulations thereunder.\44\ It also provides that
proposed Rules 15Fh-1 through 15Fh-6 and Rule 15Fk-1 would not only
apply in connection with entering into security-based swaps but also
would continue to apply, as relevant, over the term of executed
security-based swaps. Specifically, as discussed more fully herein, an
SBS Entity's obligations under proposed Rules 15Fh-3(c) (daily mark)
and 15Fh-3(g) (fair and balanced communications) would continue to
apply over the life of a security-based swap. In addition, SBS Entities
would be subject to ongoing obligations under proposed Rules 15Fh-3(h)
(supervision) and 15Fk-1 (chief compliance officer). The proposed rules
would not, however, apply to security-based swaps executed prior to the
compliance date of these rules.
---------------------------------------------------------------------------

    \44\ Section 15F(h) of the Exchange Act does not, by its terms,
create a new private right of action or right of rescission, nor do
we anticipate that the proposed rules would create any new private
right of action or right of rescission.
---------------------------------------------------------------------------

Request for Comments
    The Commission requests comments generally on all aspects of
proposed Rule 15Fh-1 and the scope of the proposed business conduct
rules. In addition, we request comment on the following specific
issues:
     Should any rule proposed by this release specify in
greater detail the manner in which its disclosure or other requirements
apply to associated persons? \45\ If so, for which rules would such
clarification be helpful? How should the Commission apply the
requirements of such rules to the associated person?
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    \45\ As described below, proposed Rule 15Fh-2(d) would provide
that the term ``security-based swap dealer or major security-based
swap participant'' would include, ``where relevant,'' an associated
person of the SBS Entity in question.
---------------------------------------------------------------------------

     Should the proposed rules apply to transactions between an
SBS Entity and

its affiliates? If so, which rules? Why or why not?
     Should any rules proposed by this release, such as those
relating to the daily mark or fair and balanced communications, apply
to security-based swaps that were entered into prior to the effective
date of these rules? If so, which rules and why?
     Should any of the proposed rules apply to amendments, made
after the effective date of these rules, to security-based swaps that
were entered into prior to the effective date of the rules? If so,
which rules and why?
     Are there any specific interactions or relationships
between the proposed rules and existing federal securities laws that
should be addressed? Are there any specific interactions or
relationships between the proposed rules and other regulatory
requirements, such as SRO rules, that should be addressed? Are there
any specific interactions or relationships between the proposed rules
and other existing non-securities statutes and regulations (e.g.,
ERISA) that should be addressed? If so, how should those interactions
or relationships be clarified?
     To the extent any of the rules proposed herein are
intended to provide additional protections for a particular
counterparty, should the counterparty be able to opt out of those
protections? Should the ability to opt out be limited to certain types
of counterparties? Why or why not? What criteria should determine or
inform the decision to permit a counterparty to opt out? For example,
should opt out be permitted when a counterparty is a regulated entity
such as a registered broker-dealer? A registered futures commission
merchant? A bank? Should opt out be permitted when a counterparty meets
certain objective standards, such as being a ``qualified institutional
buyer'' within the meaning of Rule 144A under the Securities Act? \46\
Why or why not? What other standards, if any, should the Commission
consider? What would be the advantages and disadvantages of permitting
a counterparty to opt out? What are the reasons that a counterparty
might want to opt out of protections provided by the proposed business
conduct standards? For example, would permitting counterparties to opt
out lower costs? Would these reasons vary among different types of
counterparties? Would counterparties have a meaningful opportunity to
elect whether or not to opt out of these protections, or would they
face commercial or other pressure from SBS Entities that could curtail
their choice? How would permitting counterparties to opt out affect the
protections otherwise afforded by the proposed rules to the
counterparties of SBS Entities? How would the overall effectiveness of
a proposed rule be affected if a substantial population of
counterparties opts out of that rule?
---------------------------------------------------------------------------

    \46\ See Rule 144A(a), 17 CFR 230.144A(a) (defining ``qualified
institutional buyer''). See Letter from Kenneth E. Bensten, Jr.,
Executive Vice President, Public Policy and Advocacy, SIFMA, and
Robert C. Pickel, Executive Vice Chairman, ISDA to David A. Stawick,
Secretary, CFTC (Feb. 17, 2011) (on file with Commission) (``SIFMA/
ISDA 2011 Letter'') (recommending that Commission permit opt out by
``sophisticated counterparties,'' including `` `qualified
institutional buyers' as defined in Rule 144A * * * and corporations
having total assets of $100 million or more'').
---------------------------------------------------------------------------

     As discussed below in Section II.E, proposed Rule 15Fk-1
would require an SBS Entity to have policies and procedures reasonably
designed to achieve compliance with Section 15F and the rules and
regulations thereunder. Should an SBS Entity be deemed to have complied
with a requirement under the proposed rules if: (i) The SBS Entity has
established and maintained written policies and procedures, and a
documented system for applying those policies and procedures, that are
reasonably designed to achieve compliance with the requirement; and
(ii) the SBS Entity has reasonably discharged the duties and
obligations required by the written policies and procedures and
documented system and did not have a reasonable basis to believe that
the written policies and procedures and documented system were not
being followed? Why or why not? Please explain the advantages or
disadvantages of this approach to the extent it results in rules that
effectively require SBS Entities to maintain and enforce specified
policies and procedures regarding certain conduct, rather than rules
that directly require, or prohibit, that conduct. Would this approach
be appropriate for certain specific requirements of the rules but not
for others? Why or why not? Would such an approach encourage or
discourage compliance with the requirements under the proposed rules?
Would the behavior of SBS Entities or the way in which they design
their compliance programs be different under this approach than it
would be under the rules as proposed? How would the effectiveness of
such an approach compare to the effectiveness of the rules as proposed
in implementing the requirements of the Dodd-Frank Act regarding the
business conduct of SBS Entities, especially with respect to special
entities? Would such an approach affect the ability of the Commission
to inspect for compliance with the rules or to bring enforcement
actions regarding violations? If so, how?
     As discussed herein, we preliminarily believe that, absent
special circumstances, it would be appropriate for SBS Entities to rely
on counterparty representations in connection with certain specific
requirements under the proposed rules. To solicit input on when it
would no longer be appropriate for an SBS Entity to rely on such
representations without further inquiry, the Commission is proposing
for comment two alternative approaches. One approach would permit an
SBS Entity to rely on a representation from a counterparty unless it
knows that the representation is not accurate. The second would permit
an SBS Entity to rely on a representation unless the SBS Entity has
information that would cause a reasonable person to question the
accuracy of the representation. Should the rules that the Commission
ultimately adopts include a standard addressing the circumstances in
which an SBS Entity may rely on representations to establish compliance
with the proposed rules? Why or why not?

B. Definitions: Proposed Rule 15Fh-2

    Proposed Rule 15Fh-2(a), as discussed in Section II.D.3 below,
would define ``act as an advisor'' for purposes of Section 15F(h)(4) of
the Exchange Act and proposed Rule 15Fh-4(b).
    Proposed Rule 15Fh-2(b) would define ``eligible contract
participant'' to mean any person defined in Section 3(a)(66) of the
Exchange Act.
    Proposed Rule 15Fh-2(c), as discussed in Section II.D.4.b. below,
would define ``independent representative of a special entity'' for
purposes of Section 15F(h)(5) of the Exchange Act and proposed Rule
15Fh-5.
    Proposed Rule 15Fh-2(d) would provide that ``security-based swap
dealer or major security-based swap participant'' would include, where
relevant, an associated person of the SBS Dealer or Major SBS
Participant.\47\ To the extent that an SBS Entity acts through, or by
means of, an associated person of that SBS Entity, the associated
person must comply as well with the

applicable business conduct standards.\48\
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    \47\ See Section 3(a)(70) of the Exchange Act, Pub. L. 111-203,
124 Stat. 1376, 1757-1758 (to be codified at 15 U.S.C. 78c(a)(70))
(defining ``Person Associated with a Security-Based Swap Dealer or
Major Security-Based Swap Participant'').
    \48\ See Section 20(b) of the Exchange Act, 15 U.S.C. 78t(b)
(``It shall be unlawful for any person, directly or indirectly, to
do any act or thing which it would be unlawful for such person to do
under the provisions of this title or any rule or regulation
thereunder through or by means of any other person.'').
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    Proposed Rule 15Fh-2(e), as discussed in Section II.D.1 below,
would define ``special entity.''
    Proposed Rule 15Fh-2(f), as discussed in Section II.D.4.e below,
would define a person that is ``subject to a statutory
disqualification'' to mean a person that would be subject to a
statutory disqualification under the provisions of Section 3(a)(39) of
the Exchange Act.
Request for Comments
    The Commission requests comments generally on all aspects of
proposed Rule 15Fh-2. In addition, we request comments on the following
specific issues:
     Are there additional terms that should be defined by the
Commission; if so, how should such terms be defined and why? \49\
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    \49\ The Commission is proposing to define certain additional
terms solely for purposes of proposed Rules 15Fh-6 and 15Fk-1. See
proposed Rules 15Fh-6(a) and 15Fk-1(e).
---------------------------------------------------------------------------

     Should the proposed rules expressly identify the
requirements that apply to associated persons of an SBS Entity? If so,
which rules and why?
     Is it possible that an associated person that is an entity
(i.e., not a natural person) that effects or is involved in effecting
security-based swaps on behalf of an SBS Entity would be subject to a
statutory disqualification? If so, should the Commission consider
excepting any such persons from the prohibition in Section 15F(b)(6)?
Under what circumstances and why? Should the Commission except such
persons globally or on an individual basis?
     Are there certain statutorily disqualified persons who
should not be permitted to remain associated with an SBS Entity based
upon the nature of the disqualification?
     Should there be any differentiation in relief based upon
the nature of the person, e.g., a natural person or an entity? If so,
when and why?

C. Business Conduct Requirements: Proposed Rule 15Fh-3

1. Counterparty Status
    Proposed Rule 15Fh-3(a)(1) would require an SBS Entity, as provided
by Section 15F(h)(3)(A) of the Exchange Act, to verify that a
counterparty whose identity is known to an SBS Entity prior to the
execution of the transaction meets the eligibility standards for an ECP
before entering into a security-based swap with that counterparty other
than on a registered national securities exchange.\50\ Although the
statute is silent concerning the timing of the verification, we believe
it is important for an SBS Entity to verify ECP status before entering
into a security-based swap because, among other things, Section 6(l) of
the Exchange Act makes it unlawful to effect a transaction in a
security-based swap with or for a person that is not an ECP, unless the
transaction is effected on a registered national securities
exchange.\51\ In addition, proposed Rule 15Fh-3(a)(1) would not require
an SBS Entity to verify the ECP status of a counterparty in a
transaction executed on a registered national securities exchange or a
registered security-based swap execution facility (``SEF''). Such
verification would not be necessary because, under proposed Rule 809,
SEFs may not provide access to entities that are not ECPs, and thus an
SBS Entity could effectively rely on the verification of ECP status by
a SEF or any broker or SBS Dealer indirectly providing access.\52\
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    \50\ See Section 15F(h)(3)(A) of the Exchange Act (requiring the
Commission to establish a duty for an SBS Entity to verify that its
counterparty meets the eligibility requirements of an ECP). Public
Law 111-203, 124 Stat. 1376, 1790 (to be codified at 15 U.S.C. 78o-
10(h)(3)(A). Under Exchange Act Section 3(a)(65), the term
``eligible contract participant'' has the same meaning as in Section
1a of the Commodity Exchange Act (7 U.S.C. 1a). Public Law 111-203,
124 Stat. 1376, 1755 (to be codified at 15 U.S.C. 78c(a)(65)). See
also Definitions Release (proposing to further define ``eligible
contract participant'' to include, among others, swap dealers, major
swap participants, security-based swap dealers and major security-
based swap participants).
    \51\ Public Law 111-203, 124 Stat. 1376, 1777, Sec.  764(e) (to
be codified at 15 U.S.C. 78f(l)) (``[i]t shall be unlawful for any
person to effect a transaction in a security-based swap with or for
a person that is not an eligible contract participant, unless such
transaction is effected on a [registered] national securities
exchange''). See also Public Law 111-203, 124 Stat. 1376, 1801,
Sec.  768(b) (to be codified at 15 U.S.C. 77e(d)) (``unless a
registration statement meeting the requirements of section 10(a) [of
the Securities Act] is in effect as to a security-based swap, it
shall be unlawful for any person * * * to offer to sell, offer to
buy or purchase or sell a security-based swap to any person who is
not an eligible contract participant'').
    \52\ Registration and Regulation of Security-Based Swap
Execution Facilities, Exchange Act Release No. 63825 (Feb. 2, 2011),
76 FR 10948 (Feb. 28, 2011) (proposed Rule 809 would permit, but not
require SEF participation ``only if such person is registered with
the Commission as a security-based swap dealer, major security-based
swap participant, or broker (as defined in section 3(a)(4) of the
Act, 15 U.S.C. 78c(a)(4)), or if such person is an eligible contract
participant (as defined in section 3(a)(65) of the Act, 15 U.S.C.
78c(a)(65)).'').
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    Proposed Rule 15Fh-3(a)(2) would require an SBS Entity to verify
whether a counterparty whose identity is known to an SBS Entity prior
to the execution of the transaction is a special entity before entering
into a security-based swap with that counterparty.\53\ Although the
Dodd-Frank Act does not specifically require an SBS Entity to verify
whether a counterparty is a special entity, we preliminarily believe
that such verification would facilitate the implementation of the
special business conduct rules under the Dodd-Frank Act that apply to
SBS Entities dealing with special entities.\54\
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    \53\ See generally Section 15F(h)(1)(D) of the Exchange Act,
Public Law 111-203, 124 Stat. 1376, 1789 (to be codified at 15
U.S.C. 78o-10(h)(1)(D)) (authorizing the Commission to prescribe
business conduct standards that relate to ``such other matters as
the Commission determines to be appropriate'').
    \54\ See Section II.D, infra. Because proposed Rule 15Fh-3(a)(2)
would only apply when an SBS Entity knows the identity of its
counterparty prior to the execution of a transaction, it is
consistent with Section 15F(h)(7) of the Exchange Act, which
contemplates an exception to all of the various business conduct
requirements of Section 15F(h) for any transaction that is initiated
by a special entity on an exchange or SEF, where the SBS Entity does
not know the identity of the counterparty to the transaction.
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    We believe that SBS Entities may satisfy these proposed
verification requirements through any reasonable means.\55\ For
example, an SBS Entity could verify that a counterparty is an ECP by
obtaining a written representation from the counterparty. We
preliminarily believe that it would not be reasonable for an SBS Entity
to rely on a representation that merely states that the counterparty is
an ECP because the counterparty may not be familiar with the
definitions of the term under the federal securities laws. However, it
would be reasonable for an SBS Entity to rely on a written
representation as to specific facts about the counterparty (e.g., that
it has $10 million in assets) in order to conclude that the
counterparty is an ECP.
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    \55\ The SBS Entity must keep records of its verification. See
proposed Rule 15Fk-1, discussed infra at Section II.E, which would
require an SBS Entity to have written policies and procedures and
maintain records sufficient to enable its chief compliance office to
verify compliance with the requirements of the proposed rules. In
addition, the Commission is required to propose a rule regarding
reporting and recordkeeping requirements for SBS Entities. See
Section 15F(f)(2) of the Exchange Act, Public Law 111-203, 124 Stat.
1376, 1788 (to be codified at 15 U.S.C. 78o-10(f)(2)) (``The
Commission shall adopt rules governing reporting and recordkeeping
for security-based swap dealers and major security-based swap
participants'').
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    Similarly, we preliminarily believe that it would not be reasonable
for an SBS Entity to rely on a representation that merely states that
the counterparty is not a ``special entity'' because the counterparty
may not be familiar with the definition of the term under the federal
securities laws. However, an

SBS Entity could verify that a counterparty is not a special entity by
obtaining a written representation from the counterparty that it does
not fall within any of the enumerated categories of persons that are
``special entities'' for purposes of Section 15F of the Exchange Act
(e.g., that the counterparty is not a municipality, pension plan,
etc.). In the context of either the ECP or the special entity
verification, an SBS Entity would be entitled to rely on a
counterparty's written representation for purposes of compliance with
Rule 15Fh-3(a) without further inquiry, absent special circumstances
described below.\56\
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    \56\ An SBS Entity would not be required to obtain a
representation from the counterparty and so could elect to verify
the counterparty's status through any other reasonable means.
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    To solicit input on when it would no longer be appropriate for an
SBS Entity to rely on such representations without further inquiry, the
Commission is proposing for comment two alternative approaches. One
approach would permit an SBS Entity to rely on a representation from a
special entity for purposes of Rule 15Fh-3(a) unless it knows that the
representation is not accurate. The second would permit an SBS Entity
to rely on a representation unless the SBS Entity has information that
would cause a reasonable person to question the accuracy of the
representation.
    Under either approach, an SBS Entity could not ignore information
in its possession as a result of which the SBS Entity would know that a
representation is inaccurate.\57\ In addition, under the second
approach, an SBS Entity also could not ignore information that would
cause a reasonable person to question the accuracy of a representation
and, if the SBS Entity had such information, it would need to make
further reasonable inquiry to verify the accuracy of the
representation.\58\
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    \57\ As described infra, proposed Rule 15Fh-3(e) would require
an SBS Dealer to have policies and procedures reasonably designed to
obtain and retain certain essential facts regarding a counterparty.
As a result, information in the SBS Entity's possession would
include information gathered by an SBS Dealer through compliance
with the ``know your counterparty'' provisions of proposed Rule
15Fh-3(e), as well as any other information the SBS Entity has
acquired through its interactions with the counterparty including
other representations obtained from the counterparty by the SBS
Entity.
    \58\ Cf. Rule 144A(d)(1)(iv) under the Securities Act, 17 CFR
230.144A(d)(1)(iv) (providing that in determining whether a
prospective purchaser is a qualified institutional buyer, a seller
of securities is entitled to rely on a certification by an executive
officer of the purchaser with respect to the amount of securities
owned and invested on a discretionary basis). The Commission, in its
release adopting Rule 144A, explained that ``[u]nless circumstances
exist giving a seller reason to question the veracity of the
certification, the seller would not have a duty of inquiry to verify
the certification.'' Private Resales of Securities to Institutions,
Securities Act Release No. 6862 (April 27, 1990), 55 FR 17933 (Apr.
30, 1990). Cf. also Short Sales, Exchange Act Release No. 50103
(July 28, 2004), 69 FR 48008 (Aug. 6, 2004) at n. 58 (explaining
that a broker-dealer can rely on a customer's assurance to establish
the ``reasonable grounds'' required by Rule 203(b)(1)(ii) unless the
broker-dealer ``knows or has reason to know'' that a customer's
prior assurances resulted in failures to deliver).
    Under Regulation R, a bank or a broker-dealer satisfies its
customer eligibility requirements if the bank or broker-dealer ``has
a reasonable basis to believe that the customer'' is an
institutional customer or high net worth customer before the time
specified in the rule. When adopting Regulation R, the Commission
stated that a bank or broker-dealer would have a ``reasonable basis
to believe'' if it obtains a signed acknowledgment that the customer
met the applicable standards, unless it had information that would
cause it to believe that the information provided by the customer
was or was likely to be false. Definitions of Terms and Exemptions
Relating to the ``Broker'' Exceptions for Banks, Exchange Act
Release No. 56501 (Sep. 28, 2007), 72 FR 56514 (Oct. 3, 2007).
    Commenters have suggested a similar approach. See SIFMA/ISDA
2011 Letter (suggesting that an SBS Entity should be able to rely on
written representations by the counterparty ``absent actual notice
of countervailing facts (or facts that reasonably should have put
the [SBS Entity] on notice)'').
    We note that Congress used similar language in the statutory
provisions governing registration of SBS Entities. See Section
15F(b)(6) of the Exchange Act, Public Law 111-203, 124 Stat. 1376,
1785 (to be codified at 15 U.S.C. 78o-10(b)(6)) (generally making it
unlawful for an SBS Entity to permit an associated person that is
subject to a statutory disqualification to effect or participate in
effecting security-based swaps on behalf of the SBS Entity if the
SBS Entity ``knew, or in the exercise of reasonable care should have
known,'' of the statutory disqualification).
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    An SBS Entity that has complied with the requirements of proposed
Rule 15Fh-3(a)(1) concerning a counterparty's eligibility for a
particular security-based swap would fulfill its obligations under the
proposed rule for that security-based swap, even if the counterparty
subsequently ceases to meet the eligibility standards for an ECP during
the term of that security-based swap. However, verification of a
counterparty's status as an ECP (and, as applicable, as a special
entity) for one security-based swap would not necessarily satisfy the
SBS Entity's obligation with respect to other security-based swaps
executed with that counterparty in the future. An SBS Entity would need
to verify the counterparty's status for each subsequent security-based
swap (which it could do by relying on written representations from the
counterparty, as described above). An SBS Entity could satisfy this
obligation by relying on a representation in a master or other
agreement that is deemed to be repeated and incorporated into each
security-based swap under that agreement as of the date on which each
security-based swap is executed.\59\
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    \59\ See, e.g., SIFMA/ISDA 2011 Letter (suggesting that an SBS
Entity should be able to rely on a master agreement that contains
(1) a counterparty eligibility representation that is deemed to be
made at the inception of each transaction and (2) a covenant that
the counterparty will notify the SBS Entity if it ceases to be an
ECP).
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Request for Comments
    The Commission requests comments generally on all aspects of this
provision. In addition, we request comments on the following specific
issues:
     Although we are proposing to require that an SBS Entity
verify that a counterparty is an ECP, we are not proposing at this time
to require that the SBS Entity otherwise determine that a potential
counterparty is ``qualified'' to engage in security-based swaps before
entering into a security-based swap with that person.\60\ Given that
the Dodd-Frank Act permits any ECP to engage in security-based swaps,
would it be appropriate for the Commission to limit which ECPs may
engage in security-based swaps? Should the Commission impose an
additional requirement that an SBS Entity determine that an ECP is
otherwise ``qualified'' before the SBS Entity can enter into security-
based swaps with such ECP? If so, what qualifications should be
applied, and to which types of ECPs? For example, the definition of ECP
includes persons with $5 million or more invested on a discretionary
basis that enter into the security-based swap ``to manage risks.'' \61\
In contrast, under FINRA rules, ``retail customers'' would include
persons (whether a natural person, corporation, partnership, trust, or
otherwise) with total assets of up to $50 million.\62\ To what extent
do natural persons and institutions with assets of less than $50
million engage in security-based swap transactions? Would the ``know
your counterparty'' and suitability obligations of an SBS Dealer under
proposed Rule15Fh-3(e) and (f), as described more fully below, help to

mitigate concerns regarding these persons?
---------------------------------------------------------------------------

    \60\ Cf. FINRA Rule 2360(16)(A) (providing that no member or
person associated with a member shall accept an order from a
customer to purchase or write an option contract unless, among other
things, the customer's account has been approved for options
trading).
    \61\ A natural person with $5 million or more invested on a
discretionary basis would qualify as an ECP if he or she entered
into a security-based swap ``to manage risks.'' See Section
1a(18)(A)(xi) of the Commodity Exchange Act.
    \62\ Under FINRA rules, unless a person had total assets of at
least $50 million, a broker-dealer engaging in transactions with
that person would be subject to retail suitability obligations. See
FINRA Rule 2111(b) (referring to NASD Rule 3110(c)(4)).
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     Are there alternative approaches that would be feasible in
terms of market practice for determining ECP and special entity status?
If so, what would be the advantages and disadvantages of these
approaches for SBS Entities and counterparties? Should the Commission,
for example, establish specific documentation requirements or
procedures that could be used to verify ECP or special entity status?
Should specific types of documentation be required? If so, what types
of documentation (e.g., bank or brokerage statements, legal entity
filings)?
     Should the Commission otherwise specify the means by which
SBS Entities should verify the status of a counterparty? If so, what
means should it require?
     What are the advantages and disadvantages of the two
alternative proposed approaches for determining when an SBS Entity may
no longer rely on counterparty representations? Which alternative would
strike the better balance among the regulatory interest in the
verification of ECP and special entity status, the sound functioning of
the security-based swap market, and the potential compliance costs for
market participants? What, if any, other alternatives should the
Commission consider (e.g., a recklessness standard) and why?
     In light of the additional protections that are afforded
special entities under the Dodd-Frank Act described in Section I.C.5
above, should an SBS Entity be required to undertake diligence or
further inquiry in ascertaining the special entity status of a
potential counterparty before it can rely on any representation as to
such status from the counterparty? Why or why not? If such diligence or
inquiry is not required, should an SBS Entity be permitted to rely on
representations as to special entity status from a counterparty only
where the SBS Entity does not have information that would cause a
reasonable person to question the accuracy of the representation? Why
or why not? Would requiring such diligence or further inquiry--or
allowing reliance on representations only in such a manner--unduly
limit the willingness or ability of SBS Entities to provide special
entities with the access to security-based swaps for the purposes
described in Section I.C.5 above? Why or why not? What, if any, other
measures should be required in connection with an SBS Entity's
verification of a counterparty's special entity status?
     Are there particular classes of ECPs or special entities
for which an SBS Entity should be required to undertake further review
or inquiry, rather than rely on written representations to verify
status? Should further review or inquiry be required when, for example,
a potential counterparty is a natural person or a special entity? If
so, what review or inquiry should be required and, in what
circumstances?
     Are there other potentially reasonable means or procedures
that an SBS Entity might use to verify ECP or special entity status,
other than through written representations, as to which the Commission
should consider providing guidance? If so, what means or procedures
should such guidance address, and how?
2. Disclosure
    Section 15F(h)(3)(B) of the Exchange Act broadly requires the
Commission to adopt rules requiring disclosures by SBS Entities to
counterparties of information related to ``material risks and
characteristics'' of the security-based swap, ``material incentives or
conflicts of interest'' that an SBS Entity may have in connection with
the security-based swap, and the ``daily mark'' of a security-based
swap.
a. Disclosure Not Required When the Counterparty Is an SBS Entity or a
Swap Dealer or a Major Swap Participant
    Section 15F(h)(3)(B) further provides that disclosures under that
section are not required when the counterparty is ``a security-based
swap dealer, major security-based swap participant, security-based swap
dealer, or major security-based swap participant.'' \63\ We believe
that the repetition of the terms ``security-based swap dealer and major
security-based swap participant'' in this Exchange Act provision is a
drafting error, and that Congress instead intended an exclusion
identical to that found in the Commodity Exchange Act, which provides
that these general disclosures are not required when the counterparty
is ``a swap dealer, major swap participant, security-based swap dealer,
or major security-based swap participant.'' \64\ Accordingly, we are
proposing that the disclosure requirements under Rule 15Fh-3(b)
(information about material risks and characteristics, and material
incentives or conflicts of interests), Rule 15Fh-3(c) (the daily mark),
and Rule 15Fh-3(d) (clearing rights) not apply whenever the
counterparty is an SBS Dealer, a Major SBS Participant, a swap dealer
or a major swap participant.\65\
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    \63\ Public Law 111-203, 124 Stat. 1376, 1790 (to be codified at
15 U.S.C. 78o-10(h)(3)(B)).
    \64\ Public Law 111-203, 124 Stat. 1376, 1708 (to be codified at
7 U.S.C. 6s(h)(3)(B)).
    \65\ But see proposed Rule 15Fh-1 (the proposed rules ``are not
intended to limit, or restrict, the applicability of other
provisions of the federal securities laws, including but not limited
to, Section 17(a) of the Securities Act of 1933 and Sections 9 and
10(b) of the Securities Exchange Act of 1934.'').
---------------------------------------------------------------------------

Request for Comments

    The Commission requests comments generally on all aspects of this
exception. In addition, we request comments on the following specific
issues:
     Should some or all of the disclosure requirements under
proposed Rule 15Fh-3(b) (information about material risks and
characteristics, material incentives or conflicts of interests), Rule
15Fh-3(c) (the daily mark), and Rule 15Fh-3(d) (clearing rights) apply
when the counterparty is an SBS Entity, swap dealer or major swap
participant? Why or why not? For example, we are not proposing to
require that an SBS Entity provide a daily mark to a counterparty that
is an SBS Entity, swap dealer or major swap participant, because we
preliminarily believe that a counterparty that falls into one of these
categories would be able to perform the function on its own.
Nevertheless, would there be some advantage in requiring such
counterparties to exchange their respective marks, on a daily basis, so
that any discrepancies are more transparent and can be identified and
addressed promptly? Why or why not? Would there be disadvantages to
this approach? Why or why not? Similarly, would there be any advantage
in requiring any of the other disclosures to be made to a counterparty
that is an SBS Entity, swap dealer or major swap participant? Why or
why not? Would there be disadvantages? Why or why not?
     Should the Commission instead require that disclosures be
made upon request by a counterparty that is an SBS Entity, swap dealer
or major swap participant? Why or why not?
     Should the Commission require a different type or amount
of disclosure for categories of counterparties that are market
professionals such as broker-dealers, futures commission merchants and
banks? What criteria should determine or inform the type or amount of
disclosure? For example, should an SBS Entity be permitted to provide
different or less detailed disclosure to a counterparty that is a
registered broker-dealer? A registered futures commission merchant? A
bank?

b. Timing and Manner of Certain Disclosures
    Proposed Rule 15Fh-3(b) would require that disclosures regarding
material risks and characteristics and material incentives or conflicts
of interest be made to potential counterparties before entering into a
security-based swap, but would not mandate the manner in which those
disclosures are made.\66\ Proposed Rule 15Fh-3(d) similarly would
require that disclosures regarding certain clearing rights be made
before entering into a security-based swap, but also would not mandate
the manner of disclosure. To the extent such disclosures were not
otherwise provided to the counterparty in writing prior to entering
into a security-based swap, proposed Rules 15Fh-3(b)(3) and 15Fh-
3(d)(3) would require an SBS Entity to make a contemporaneous record of
the non-written disclosures made pursuant to proposed Rules15Fh-3(b)
and 15Fh-3(d), respectively, and provide a written version of these
disclosures to the counterparty in a timely manner, but in any case no
later than the delivery of the trade acknowledgement \67\ of the
particular transaction.\68\
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    \66\ Section 15F(h)(3)(B) of the Exchange Act is silent
regarding both form and timing of disclosure. See Public Law 111-
203, 124 Stat. 1376, 1790 (to be codified at 15 U.S.C. 78o-
10(h)(3)(B)).
    \67\ See Trade Acknowledgement and Verification of Security-
Based Swap Transactions, Exchange Act Release No. 63727 (Jan. 14,
2011), 76 FR 3859 (Jan. 21, 2011) (proposing Rule 15Fi-1(c)(1),
which would require a trade acknowledgement to be provided within 15
minutes of execution for a transaction that has been executed and
processed electronically; within 30 minutes of execution for a
transaction that is not electronically executed, but that will be
processed electronically; and within 24 hours of execution for a
transaction that the SBS Entity cannot process electronically).
    \68\ See also Section 15F(g) of the Exchange Act (requiring the
Commission to adopt rules governing daily trading records, including
recordings of telephone calls):
    (g) DAILY TRADING RECORDS.--
    (1) IN GENERAL.--Each registered security-based swap dealer and
major security-based swap participant shall maintain daily trading
records of the security-based swaps of the registered security-based
swap dealer and major security-based swap participant and all
related records (including related cash or forward transactions) and
recorded communications, including electronic mail, instant
messages, and recordings of telephone calls, for such period as may
be required by the Commission by rule or regulation.
    (2) INFORMATION REQUIREMENTS.--The daily trading records shall
include such information as the Commission shall require by rule or
regulation.
    (3) COUNTERPARTY RECORDS.--Each registered security-based swap
dealer and major security-based swap participant shall maintain
daily trading records for each counterparty in a manner and form
that is identifiable with each security-based swap transaction.
    Public Law 111-203, 124 Stat. 1376, 1788-1789 (to be codified at
15 U.S.C. 78o-10(g)).
---------------------------------------------------------------------------

    Because disclosures of material risks and characteristics, material
incentives or conflicts of interests, and clearing rights include
information that the counterparty should consider in deciding whether
to enter into the security-based swap, we are proposing to require that
these disclosures be provided before entry into a security-based swap.
    Concerning the manner of disclosure, however, we preliminarily
believe that parties should have flexibility to make disclosures by
various means, provided that the SBS Entity (1) makes an appropriate
record of such disclosures and (2) supplies its counterparty with a
written version of any disclosure required under these rules that was
not made in writing prior to the transaction. Means of disclosure may
include master agreements and related documentation, telephone calls,
emails, instant messages, and electronic platforms.\69\ Proposed Rule
15Fh-3(b) would require that the required disclosures regarding
material risks and characteristics and material incentives or conflicts
of interest be made ``in a manner reasonably designed to allow the
counterparty to assess'' the information being provided. This provision
is intended to require that disclosures be reasonably clear and
informative as to the relevant material risks or conflicts that are the
subject of the disclosure. This provision is not intended to impose a
requirement that disclosures be tailored to a particular counterparty
or to the financial, commercial or other status of that
counterparty.\70\
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    \69\ For SBS Entities to rely on electronic media, however,
their counterparties must have the capability to effectively access
all of the information required by Rule 15Fh-3(b)(3) in a format
that is understandable but not unduly burdensome for the
counterparty. See Use of Electronic Media by Broker-Dealers,
Transfer Agents and Investment Advisers for Delivery of Electronic
Information, Securities Act Release No. 7288 (May 9, 1996), 61 FR
24644 (May 15, 1996). See also Use of Electronic Media, Exchange Act
Release No. 42728 (Apr. 28, 2000), 65 FR 25843 (May 4, 2000).
    \70\ SBS Entities would, of course, have an on-going obligation
to communicate with counterparties in a fair and balanced manner
based on principles of fair dealing and good faith. See proposed
Rule 15Fh-3(g) (discussed infra at Section II.C.5).
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    We understand that security-based swaps generally are executed
under master agreements, with much of the transaction-specific
disclosure provided over the telephone, in instant messages or in
confirmations. We anticipate that SBS Entities may elect to make
certain required disclosures of material information to their
counterparties in a master agreement or other written document
accompanying such agreement.\71\
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    \71\ While certain forms of disclosure may be highly
standardized, the Commission anticipates that even such forms of
disclosures will require certain provisions to be tailored to the
particular transaction, most notably pricing and other transaction-
specific commercial terms. We believe the proposed approach is
generally consistent with the use of standardized disclosures
suggested by industry groups and commenters. See CRMPG III Report
(suggesting that standardized risk disclosures should be viewed as a
supplement to, rather than a substitute for, more detailed
disclosures); and Letter from Kenneth E. Bentsen, Jr., Executive
Vice President, Public Policy and Advocacy, SIFMA and Robert G.
Pickel, Executive Vice Chairman, ISDA to Elizabeth M. Murphy,
Secretary, Commission and David A. Stawick, Secretary, Commodity
Futures Trading Commission (Oct. 22, 2010) (on file with Commission)
(``SIFMA/ISDA 2010 Letter'') (recommending the use of standard
disclosure templates that could be adopted on an industry-wide
basis, and noting that ``the process of developing standardized
disclosure materials would * * * provide a means for identifying
circumstances in which more tailored disclosure might be
appropriate'').
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    Commenters have asked that we clarify the applicability of these
disclosure requirements to SEF- and exchange-traded security-based
swaps in which the SBS Entity may not know the identity of the
counterparty until immediately prior to (or after) execution of a
transaction. The Dodd-Frank Act only addresses this issue in the
context of special entities. Specifically, Section 15F(h)(7) provides
an exception to the requirements of Section 15F(h) for a transaction
that is ``initiated'' by a special entity on a SEF or an exchange and
for which the SBS Entity does not know the identity of the counterparty
to the transaction.\72\
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    \72\ Public Law. 111-203, 124 Stat. 1376, 1792 (to be codified
at 15 U.S.C. 78o-10(h)(7). See Section II.D, infra.
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    We are seeking comment, therefore, on whether and how the proposed
disclosure requirements should be satisfied for security-based swap
transactions that are executed on a SEF or exchange and for which the
SBS Entity does not know the identity of the counterparty until
immediately prior to (or after) the execution of the transaction. In
particular, we seek comment on how the disclosure obligations discussed
below under proposed Rule 15Fh-3(b) (concerning material risks and
characteristics, and material incentives or conflicts of interest) and
proposed Rule 15Fh-3(d) (regarding clearing rights) could be met.
    The statute requires rules adopted by the Commission to require the
SBS Entity to make these disclosures. We believe that SBS Entities
generally should be able to rely on means reasonably designed to
achieve timely delivery of the required disclosures. In particular, an
SBS Entity could cause

the required disclosures to be delivered through a third party or other
indirect means (such as by contracting with a SEF to deliver the
disclosure electronically) in circumstances in which it may not be
practicable for an SBS Entity to directly provide the disclosures in a
timely manner.
    Commenters have suggested that SBS Entities should be able to rely
on trade acknowledgements to satisfy certain disclosure
requirements.\73\ Because proposed Rule 15Fh-3(b) would require that
disclosures be made before ``entering into'' a security-based swap, SBS
Entities generally would not be able to rely on trade acknowledgements
and other documents that are provided after the transaction is executed
to satisfy the rule's disclosure obligations. SBS Entities could,
however, rely on trade acknowledgements to memorialize disclosures they
made, whether orally or by other means, prior to entering into the
proposed transaction.\74\
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    \73\ See SIFMA/ISDA 2010 Letter (``We recommend that the
Commissions clarify that, to the extent that a counterparty is in
possession of the master documentation and confirmation specifying
the economic and other material terms of a specific transaction,
registrant counterparties will have satisfied this requirement.'').
    \74\ Proposed Rule 15Fk-1, discussed infra at Section II. E,
would require an SBS Entity to have reasonable written policies and
procedures concerning the timing and form of disclosure, and
maintain records sufficient to enable its chief compliance officer
to verify compliance with the disclosure requirements under the
proposed rules.
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    Finally, although we are proposing to permit disclosure by a range
of means, both oral and written, we may revisit whether Congress's
objectives under Section 15F(h) and the focus here on supervision and
compliance require some further specific obligations concerning the
manner in which disclosures are made.
Request for Comments
    The Commission requests comments generally on all aspects of this
approach to the timing and manner of disclosure. In addition, we
request comments on the following specific issues:
     Should the Commission impose more specific requirements
concerning the timing and manner of disclosures? If so, what additional
requirements should the Commission impose, and why?
     Commenters have urged the Commission to encourage the use
of standardized disclosure templates.\75\ Who would develop those
templates? What would the content be? What disclosures do or do not
lend themselves to a standardized template? How would the templates be
updated or supplemented to respond to market developments or account
for the characteristics of a specific transaction?
---------------------------------------------------------------------------

    \75\ See, e.g., SIFMA/ISDA 2010 Letter at 3.
---------------------------------------------------------------------------

     Should the Commission require that all material
disclosures be provided in writing prior to the execution of the
transaction? If not, does the option to memorialize the disclosure and
provide a written version of the disclosure to the counterparty provide
adequate safeguards to ensure that parties are complying with the
disclosure, supervision and compliance requirements discussed more
fully below, as well as the provisions intended to increase the
protection of special entities? Are there any other safeguards the
Commission should consider? How do such safeguards provide the same or
better protection or information for counterparties than written
disclosures in advance of a transaction?
     Should the Commission require disclosures to be made a
certain period of time before execution of a transaction? If so, what
would be the advantages and disadvantages of various periods?
     Should the Commission impose specific requirements
concerning the timing and manner in which disclosures are made to
certain counterparties, such as special entities or categories of
special entities? If so, which counterparties, and why? What
requirements would be appropriate for which counterparties?
     Should the Commission require that disclosures be made in
writing prior to the execution of the transaction when the counterparty
is a special entity? Why or why not? If so, should this requirement
apply with respect to all special entities? If not, how should the
Commission distinguish among special entities?
     Should the Commission permit SBS Entities to rely on
information in trade acknowledgements to satisfy certain disclosure
requirements? Why or why not? Are there other approaches that would be
more effective or efficient than the Commission's proposed approach to
disclosure?
     In which situations (or under what circumstances) would
the SBS Entity not know the identity of the counterparty prior to
execution of the transaction on a SEF or exchange? If the SBS Entity
subsequently learns the identity of the counterparty, when would such
identity typically be ascertained (e.g., before, at the time of, or
after the execution of the transaction)? In such situations, how should
material information be disclosed?
     The Dodd-Frank Act and the Commission's proposal with
respect to SEFs contemplate that SEFs and exchanges will promulgate
detailed standards for the listing and trading of security-based swaps
that may be transacted on their markets. Should SEFs and exchanges also
be required to provide a means to deliver the disclosures to
counterparties required under proposed Rules 15Fh-3(b) and (d)? Would
SEF and exchange listing and trading rules provide an adequate
alternative means for providing the required disclosures? Why or why
not? How would differences in rules across markets for similar products
be addressed? What other issues may arise in connection with this
approach and how could they be addressed?
     Should disclosures by means of a SEF or exchange require a
standardized format? Are there specific transactions, classes of
transactions, or types of counterparties for which this approach would
or would not be appropriate? Are there other means by which SBS
entities could satisfy their disclosure obligations in this context?
     Should an SBS Entity be permitted to reference publicly
available information to comply with its disclosure requirements to its
counterparty without having the information deemed to be adopted or
affirmed by the SBS Entity? For example, should an SBS Entity be
permitted to direct its counterparty to reports filed under the
Exchange Act and publicly available on EDGAR without being considered
to affirm or adopt the disclosure? Should an SBS Entity be permitted to
satisfy the disclosure requirements by directing its counterparty to
the Web site of a company underlying a credit default swap regarding
disclosures of material risks without being considered to affirm or
adopt the disclosure?
c. Material Risks and Characteristics of the Security-Based Swap
    Section 15F(h)(3)(B) of the Exchange Act provides that business
conduct requirements adopted by the Commission shall require disclosure
by the SBS Entity of information about the material risks and
characteristics of the security-based swap.\76\ A fact is material if
there is a substantial likelihood that a reasonable investor would
consider the information to be important in making an investment
decision.\77\ Disclosures should include a clear explanation of the
material economic

characteristics of the security-based swap, including a discussion of
the key assumptions that give rise to the expected pay-offs.\78\ The
SBS Entity should consider, among other things, the complexity of each
of the characteristics of the security-based swap in determining the
materiality of the characteristic, as well as the related material
risks to be disclosed.\79\
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    \76\ We read this provision to require disclosure about the
material risks and characteristics of the security-based swap itself
and not of the underlying reference security or index.
    \77\ Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988).
    \78\ See CRMPG III Report at 61. See also SIFMA/ISDA 2010 Letter
(stating that ``[t]here is no better description of the
characteristics of a transaction than the contract provisions
expressly defining its economic terms.'').
    \79\ The adequacy of such disclosures will be determined by
reference to the ``reasonable investor'' standard above.
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    We understand that there are certain general types of risks,
including credit risk,\80\ settlement risk,\81\ market risk,\82\
liquidity risk,\83\ operational risk,\84\ and legal risk \85\ that are
commonly associated with securities-based swaps.\86\ Proposed Rule
15Fh-3(b)(1) would require an SBS Entity to disclose the material
factors that influence the day-to-day changes in valuation, the factors
or events that might lead to significant losses, the sensitivities of
the security-based swap to those factors and conditions, and the
approximate magnitude of the gains or losses the security-based swap
would experience under specified circumstances.\87\ SBS Entities should
also consider the unique risks and characteristics associated with a
particular security-based swap, class of security-based swap or trading
venue, and tailor their disclosures accordingly.\88\
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    \80\ By ``credit risk,'' we mean the risk that a party to a
security-based swap will fail to perform on an obligation under the
security-based swap. IOSCO Report at 3; BIS Report at 11.
    \81\ By ``settlement risk,'' we mean the risk that a party will
not receive funds or instruments from its counterparty at the
expected time, either as a result of a failure of the counterparty
to perform or a failure of the clearing agency to perform. See IOSCO
Report at 3.
    \82\ By ``market risk,'' we mean the risk to the value of a
security-based swap resulting from adverse movements in the level or
volatility of market prices. See BIS Report at 12.
    \83\ By ``liquidity risk,'' we mean the risk that a counterparty
may not be able to, or cannot easily, unwind or offset a particular
position at or near the previous market price because of inadequate
market depth or because of disruptions in the marketplace. See BIS
Report at 13.
    \84\ By ``operational risk,'' we mean the risk that deficiencies
in information systems or internal controls, including human error,
will result in unexpected loss. See IOSCO Report at p. 3; BIS Report
at 14.
    \85\ By ``legal risk,'' we mean the risk that agreements are
unenforceable or incorrectly or inadequately documented. See IOSCO
Report at p. 4; BIS Report at 16.
    \86\ See generally IOSCO Report; BIS Report.
    \87\ See CRMPG III Report at 60. These disclosures are intended
to be disclosures concerning the material risks and characteristics
of the security-based swap itself, not the material risks and
characteristics of the security-based swap with respect to a
particular counterparty. In other words, the proposed rule would not
require an SBS Entity to disclose different material risks and
characteristics to different counterparties solely because of the
identity or nature of the counterparty.
     As noted previously, proposed Rule 15Fh-3(b) would require
disclosures to be made in a manner reasonably designed to allow the
counterparty to assess the material risks and characteristics. In
addition, SBS Entities would have an on-going obligation to
communicate with counterparties in a fair and balanced manner based
on principles of fair dealing and good faith. See proposed Rule
15Fh-3(g) (discussed infra at Section II.C.5).
    \88\ We anticipate that SBS Entities may provide these
disclosures through various means, including scenario analysis. See,
e.g., CRMPG III Report at 60 (recommending that disclosure include
``rigorous scenario analyses and stress tests that prominently
illustrate how the instrument will perform in extreme scenarios, in
addition to more probable scenarios'').
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    An SBS Entity also should consider risks that may be associated
specifically with uncleared security-based swaps. Among other things,
the absence of a credit support agreement in an uncleared security-
based swap could create risks associated with the absence of a
bilateral obligation to post initial and variation margin.\89\ An SBS
Entity should consider whether the absence of provisions that would
typically be associated with a cleared security-based swap, for
example, could create a material risk that would need to be disclosed
in connection with a transaction involving a security-based swap that
is not submitted for clearing.\90\
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    \89\ We note that currently market participants often choose to
use a credit support agreement or annex specifying the applicable
valuation methodologies for the calculation of margin or collateral
and the mechanics for the exchange of margin or collateral in
connection with a security-based swap.
    \90\ With respect to uncleared security-based swaps, the
Commission expects to propose rules regarding a counterparty's right
to have any of its property received by an SBS Entity to margin,
guarantee, or secure the obligations of the counterparty in an
uncleared security-based swap segregated from the funds of the SBS
Entity. See Section 3E(f)(1)(A) of the Exchange Act, Public Law 111-
203, 124 Stat. 1376, 1775-1776 (to be codified at 15 U.S.C. 78c-
5(f)(1)(A)) (requiring an SBS Entity to notify a counterparty at the
beginning of a security-based transaction that the counterparty has
the right to require segregation of the funds or other property
supplied to margin, guarantee, or secure the obligations of the
counterparty).
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Request for Comments
    The Commission requests comments generally on all aspects of this
provision. In addition, we request comments on the following specific
issues:
     The documentation governing a security-based swap
transaction should include all of the terms agreed by the parties that
could affect the economic and other risks of the transaction. Should
the requirements for disclosure of material characteristics of a
security-based swap be deemed satisfied if the SBS Entity has entered
into a master agreement with and provided a trade acknowledgement (or
draft trade acknowledgement) or other documentation governing the
particular security-based swap to the counterparty? Why or why not? How
would such an approach provide meaningful disclosure to counterparties
regarding the risks of the transactions they are entering into? What
types of risks might not be readily apparent to a counterparty from a
review of the governing documentation for a transaction? Would the
timeliness of such disclosure be a problem if information on a trade
acknowledgement, for example, is not provided to a counterparty until
after the parties have entered into a security-based swap?
     Are there particular material risks or characteristics
that the Commission should specifically require an SBS Entity to
disclose to a counterparty? If so, which ones and why?
     Are there specific material risks or characteristics that
should be disclosed with respect to swaps that are not cleared, or are
not SEF- or exchange-traded? If so, which ones and why?
     Are there particular material risks or characteristics
that the Commission should specifically require an SBS Entity to
disclose when the counterparty is a special entity or a particular
category of special entity? If so, which ones and why? Should any such
special disclosure requirements apply to any categories of
counterparties other than special entities?
     Should the Commission require an SBS Entity to disclose
its anticipated profit for the security-based swap? If so, how should
an SBS Entity be required to compute profitability for purposes of the
rule? \91\ If the Commission were to adopt such a requirement, should
it be limited to transactions in which the counterparty is a special
entity, a particular category of special entity, or another type of
counterparty?
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    \91\ See Swap Financial Group, Dodd[hyphen]Frank Title VII:
Business Conduct and Special Entities Briefing for SEC/CFTC Joint
Working Group (Aug. 9, 2010) (on file with the Commission) (``Swap
Financial Group Presentation'') at 55 (describing profit as the
``[m]ark-up or `spread' between price charged to the client and cost
of dealer's hedge'').
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     Should the SBS Entity disclose or identify for the
counterparty information regarding the issuer of the underlying
security that is publicly available, such as whether the issuer of an
underlying security is subject to the

periodic reporting requirements of the Exchange Act?
     Is there a basis for distinguishing between the types of
disclosures that should be required to be provided by an SBS Dealer and
those that should be required to be provided by a Major SBS
Participant? If so, how should the types of disclosures required to be
provided by a Major SBS Participant differ from those that have been
proposed?
     Should the Commission specifically require scenario
analysis disclosure? Why or why not? If such analysis should be
required, should the Commission require the disclosure for uncleared
security-based swaps? Should the Commission limit the scenario analysis
disclosure requirement to ``high-risk complex security-based swaps,''
as described in the CRMPG III Report? If so, how should the
definitional hurdles outlined in the CRMPG III Report be addressed?
\92\ If not, why? Is there another standard the Commission should
consider for requiring scenario analysis?
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    \92\ See CRMPG III Report at 54-56 (``The definition of a high-
risk complex financial instrument is itself a complex subject. * * *
[T]he definitional challenge is better framed by identifying the key
characteristics of classes of high-risk complex financial
instruments that warrant special treatment in terms of sales and
marketing practices, disclosure practices, diligence standards, and,
more broadly, the level of sophistication required for all market
participants. * * * While issues surrounding leverage, market
liquidity, and price transparency are the key characteristics in
identifying high-risk complex financial instruments, other factors
have contributed to the problems witnessed during the credit market
crisis.'').
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     Should an SBS Entity be required to provide a scenario
analysis for any security-based swap, upon reasonable request by any
counterparty? What are the advantages and disadvantages to SBS Entities
and counterparties associated with such an analysis? If the cost varies
by type of security-based swap, please provide an average cost by
category of security-based swap.
     Should a scenario analysis provided by an SBS Entity to a
counterparty be required to be consistent with similar analyses
prepared by the SBS Entity for its own internal purposes (e.g., risk
management)? If not, how would they differ and why?
     We do not intend that the proposed rule require an SBS
Entity to disclose any information considered proprietary in nature.
Would disclosure of proprietary information be a concern under the
current formulation of the rule? If so, what types of proprietary
information might be subject to disclosure under the proposed rule? Is
there other information that could adequately substitute for purposes
of meaningful disclosure? What methods, if any, could be applied to
transform specific types of proprietary information into comparable
information suitable for a counterparty (e.g., aggregation, averaging)?
What other mechanisms, if any, could be used to protect proprietary
information while providing adequate disclosure to counterparties?
     As noted above, we understand that security-based swaps
are often entered into under a master agreement that governs the
relationship between the SBS Entity and its counterparty.\93\ In
particular, master agreements generally contain terms that govern all
succeeding security-based swaps and other derivatives between the
counterparties, and include provisions such as events of default,
cross-default provisions, additional termination events, payment
netting and close-out netting, and information regarding rights and
obligations as a result of particular events.\94\ Should the Commission
require the use of a master agreement for security-based swaps? If a
master agreement is required when parties enter into a security-based
swap, what particular issues should be addressed in the master
agreement? For example, should the master agreement be required to
address whether payment netting or close-out netting rights exist? If
the Commission does not require the use of a master agreement, should
it require that all security-based swaps include certain provisions
typically included in master agreements? If so, which provisions?
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    \93\ See, e.g., Thrifty Oil Co. v. Bank of America Nat'l Trust
and Sav. Ass'n, 322 F.3d 139, 143 (9th Cir. 2003) (describing use of
master agreements). We note that market participants may already
look to certain master agreements that are generally considered
covered by the swap safe harbors in the U.S. Bankruptcy Code
(``Bankruptcy Code''). Sections 362(b)(17) and 560 of the Bankruptcy
Code provide an exception to the automatic stay and ipso facto
prohibitions in the Bankruptcy Code to allow for the exercise of any
contractual right of any swap participant or financial participant
to cause the liquidation, termination, or acceleration of one or
more swap agreements, including netting and set-off rights. See 11
U.S.C. 362(b)(27) and 560. The definition of ``swap agreement''
under Section 101(53B)(v) of the Bankruptcy Code specifically
contemplates master agreements. See 11 U.S.C. 101(53B)(v).
    \94\ Parties may also choose to use a credit support agreement
or annex specifying the applicable valuation methodologies for the
calculation of margin or collateral and the mechanics for the
exchange of margin or collateral in connection with a security-based
swap.
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     Should an SBS Entity be required to disclose the absence
of certain material provisions typically contained in master agreements
for security-based swap transactions? \95\ Similarly, should an SBS
Entity be required to disclose if the documentation includes material
provisions that are unusual in light of typical master agreements? In
either case, how should the ``normal'' or ``typical'' master agreement
be defined? By reference to particular types of standardized master
agreements? If so, which ones? To what extent would a requirement to
provide a disclosure separate from a master agreement regarding the
material terms of the master agreement have the effect of incentivizing
counterparties to review their agreements less carefully (and instead
rely on the disclosure)? To what extent might disclosures regarding the
documentation between the parties potentially affect any interpretation
of the terms agreed by the parties in the event of a subsequent dispute
over such terms? How might that in turn affect the nature or usefulness
of the disclosures that SBS Entities might provide regarding their
documentation?
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    \95\ For example, absent provisions for payment netting or
close-out netting, questions may arise as to whether all of the
counterparty's trades with the particular SBS Entity would be taken
into account in calculating (1) net periodic payments, (2) one net
close-out amount in respect of a default by either party, and (3)
net margin obligations.
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     Should the Commission establish certain minimum standards
for the agreements governing security-based swaps? If so, what
standards and why?
d. Material Incentives or Conflicts of Interest
    Proposed Rule 15Fh-3(b)(2) would require that an SBS Entity
disclose all material incentives or conflicts it may have in connection
with a security-based swap.\96\ We preliminarily believe that the term
``incentives''--which is used in Section 15F(h)(3)(b)(ii) of the Dodd-
Frank Act--refers not to any profit or return that the SBS Entity would
expect to earn from the security-based swap itself, or from any related
hedging or trading activities of the SBS Entity, but rather to any
other financial arrangements pursuant to which an SBS Entity may have
an incentive to encourage the counterparty to enter into the
transaction. This disclosure would include, among other things,
information concerning any compensation (e.g., under revenue-sharing
arrangements) or other incentives the SBS Entity receives from any
source other than the counterparty in connection with the security-
based swap to be entered into with the counterparty, but would not
include, for

example, expected cash flows received from a transaction to hedge the
security-based swap or that the security-based swap is intended to
hedge.\97\
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    \96\ See Section 15F(h)(3)(B)(ii) of the Exchange Act, Public
Law 111-203, 124 Stat. 1376, 1790 (to be codified at 15 U.S.C. 78o-
10(h)(3)(B)(ii)) (providing that business conduct requirements
adopted by the Commission shall require disclosure by an SBS Entity
of ``any material incentives or conflicts of interest'' that the SBS
Entity may have in connection with the security-based swap).
    \97\ If an SBS Entity is also registered as a broker-dealer, it
would be subject to similar disclosure requirements under FINRA
rules in certain circumstances. See, e.g., FINRA Rule 2269,
Disclosure of Participation or Interest in Primary or Secondary
Distribution (``A member who is acting as a broker for a customer or
for both such customer and some other person, or a member who is
acting as a dealer and who receives or has promise of receiving a
fee from a customer for advising such customer with respect to
securities, shall, at or before the completion of any transaction
for or with such customer in any security in the primary or
secondary distribution of which such member is participating or is
otherwise financially interested, give such customer written
notification of the existence of such participation or interest.'').
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Request for Comments
    The Commission requests comments generally on all aspects of this
provision. In addition, we request comments on the following specific
issues:
     Are there specific material incentives or conflicts that
the Commission should require an SBS Entity to disclose to a
counterparty? Are there specific material incentives or conflicts that
should be disclosed with respect to security-based swaps that are not
cleared, or are not SEF- or exchange-traded?
     Should we require an SBS Entity to disclose affiliations
or material business relationships with a SEF or exchange? Why or why
not?
     Should we require an SBS Entity to disclose affiliations
or material business relationships with a clearing agency? Why or why
not?
     Should the Commission impose other more specific
requirements concerning the content of the required disclosures when
the counterparty is a special entity? If so, which ones and why? Should
such specific requirements apply only to certain categories of special
entities?
     Should the Commission impose other more specific
requirements concerning the content of the required disclosures when an