\1699\ See, e.g., SIFMA (August 2011), supra note 5; APPA;
BlackRock, supra note 5; SIFMA (August 2011), supra note 5; ABA
Committees, supra note 5; FIA/ISDA/SIFMA, supra note 5; Blackrock,
supra note 5.
---------------------------------------------------------------------------

    Under this rule, special entities transacting with more informed
and sophisticated SBS Entities will have the benefit of representation
by a qualified independent representative that has a duty to act in the
best interests of the entity. To the extent that some special entities
are less informed about security-based swaps and less able to unwind
biases that may exist in potentially conflicted recommendations than
other counterparties, this requirement may appropriately facilitate
stronger protections and superior capital allocation decisions by
special entities. Better informed special entities, such as large well-
informed pension funds that regularly transact in security-based swaps,
are likely to enjoy fewer benefits of this requirement. However, they
may also be more likely to use investment advisers in their current
security-based swap transactions, in which case they would need to make
that representation to an SBS Dealer under Rule 15Fh-5(b). In addition,
similar to our earlier discussion of suitability rules, to the extent
that special entities may be entering security-based swap transactions
with inferior risk-return characteristics as a result of internal
incentive conflicts or macro factors, such as reaching for yield in a
low interest rate environment, the benefits of these protections may be
muted.
    Further, special entities that transact with the SBS Dealer in a
variety of roles, such as investment adviser or underwriter, will
benefit from greater transparency about the capacity in which the
dealer is entering the security-based swap. For instance, if an SBS
Dealer currently engages in business with a special entity in the
capacity of an investment adviser, the SBS Dealer would be required to
disclose that it is not acting in such capacity if it is seeking to
enter into a security-based swap with the special entity. This may help
counterparties better understand the nature of the incentives of an SBS
Dealer in relation to a given security-based swap transaction.
    This rule will involve direct and indirect costs. SBS Entity
counterparties will incur costs of obtaining a reasonable basis to
believe that the special entity has a qualified independent
representative. Based on our estimates in Section V, all SBS Entities
acting as counterparties to special entities will incur an aggregate
initial cost of, approximately, $132,819,500.\1700\ Ongoing costs of
compliance with rules for counterparties of special entities will
involve updating representations and verifications for transactions
with third-party non-employee independent representatives, estimated at
$8,569,000.\1701\ In-house independent representatives will bear costs
of making representations to SBS Entities, which will involve an
aggregate initial compliance burden of, approximately, $137,104,000
with an ongoing cost of $8,569,000.\1702\
---------------------------------------------------------------------------

    \1700\ Aggregate initial cost: (In-house attorney at $380 per
hour) x 349,525 hours = $132,819,500.
    \1701\ Ongoing aggregate cost: (In-house attorney at $380 per
hour) x 22,500 hours = $8,569,000.
    \1702\ Initial cost: (In-house attorney at $380 per hour) x
360,800 hours = $137,104,000. We believe that in-house investment
advisers may be compensated similarly to in-house attorneys. To the
extent that the rate of compensation for independent representatives
may be lower, these figures may overestimate the aggregate initial
burden related to these final rules.
     Ongoing: (In-house attorney at $380 per hour) x 22,500 hours =
$8,569,000.
---------------------------------------------------------------------------

    In addition, some special entities may be entering security-based
swaps with SBS Entities that are not in their best interest, and advice
from qualified independent representatives may help inform special
entities and enable them to make better investment decisions.
Therefore, this rule may improve allocative efficiency of security-
based swap investments. However, as noted earlier, SBS Entities are
for-profit entities, and, to the extent that SBS Entities are currently
intermediating security-based swaps that are not in the best interests
of some of their special entity counterparties, the rule may lower an
SBS Entity's profitability of intermediating security-based swaps with
special entities. SBS Entities may attempt to recoup these costs in the
form of less attractive security-based swap terms, or become less
willing to transact with special entities. As an additional
consideration, entities with activity levels below de minimis
triggering SBS Dealer registration, but with positions large enough to
require Major SBS Participant registration will bear these costs of
intermediating transactions with special entities. If the costs of
intermediated security-based swaps with special entities are
substantial, some Major SBS Participants may reduce or stop transacting
with special entity counterparties.
    These costs may be lower if SBS Entities' special entity
counterparties provide representations that allow SBS Entities to take
advantage of the safe harbor in Rule 15Fh-5(b). Our data do not allow
us to estimate the number of

special entities currently relying on qualified independent
representatives since we cannot observe whether they have conflicts of
interest with SBS Entities that would preclude them from meeting
independence requirements of these final rules. However, we note that,
as reflected in the economic baseline, special entities represent
approximately 10.5% of account holders in DTCC TIW between 2006 and
2014. Only approximately 2% of special entities did not rely on
investment advisers in their single name CDS trades, with 85 unique
pairs of SBS Dealers and U.S. special entities transacting in single
name CDS. In 2014, there were 2 unique trading relationships between
likely SBS Dealers and special entities without a third party
investment adviser, representing approximately 0.039% of all
transactions in 2014. Therefore, the overwhelming majority of special
entities may already be relying on investment advisers in their
security-based swap transactions. However, we do not observe whether
advisors in TIW data meet the independence and qualification
requirements being adopted in these final rules. If a significant
fraction of third party representatives does not meet the qualified
independent representative requirements in these final rules, special
entity counterparties of SBS Entities may choose to replace third party
representatives with those that do have requisite qualifications and
independence, enabling continued transaction activity with SBS
Entities, or may lose access to SBS Entity intermediated OTC security-
based swaps.
    As estimated above, all special entity counterparties of SBS
Entities will face costs of making representations to SBS Entities
concerning their reliance on independent advisors acting in their best
interests. To the extent SBS Entities transact with special entities
that are not already relying on representatives, or are relying on
representatives that would not meet the qualification and independence
criteria in these final rules, such special entities would incur costs
of obtaining a new representative and making necessary representations,
if they wish to facilitate the SBS Entities' reliance on the safe
harbor. This may increase demand for the services of qualified
independent representatives, and independent representatives may
require higher compensation to reflect such higher demand. Such costs
will depend on the number of third-party representatives of special
entities that do not currently meet the independence and qualification
requirements of these final rules; the resulting increase in the demand
for new representation; and the supply of investment advisers not
currently representing special entities in security-based swaps that
would be considered qualified and independent under these final rules.
We lack data to quantify these effects and commenters did not provide
information that would enable such quantification. We are, therefore,
unable to estimate these costs.
    Under the final rules, SBS Entities may become counterparties of
special entities only if they have a reasonable basis to believe that
the special entity has a qualified independent representative. We note
that Rule 15Fh-1(b) allows SBS Entities to rely on written
representations of a counterparty to satisfy its due diligence
requirements. As a result, SBS Entities that can rely on
representations will not be required to conduct independent assessments
of the qualifications or independence of special entity
representatives, as proposed by some commenters.\1703\ These issues are
discussed in further detail in Section VI.C.4.iv below.
---------------------------------------------------------------------------

    \1703\ See, e.g., SIFMA (August 2011), supra note 5.
---------------------------------------------------------------------------

c. SBS Dealers as Advisors to Special Entities
    Rule 15Fh-2(a) introduces in a default presumption that an SBS
Dealer acts as an advisor to a special entity when it recommends a
security-based swap or a trading strategy that involves the use of a
security-based swap to the special entity. The rule provides a safe
harbor, where an SBS Dealer will not be acting as advisor when a
special entity represents that it acknowledges that the SBS Dealer is
not acting as an advisor, that the special entity will rely on advice
from a qualified independent representative, and the SBS Dealer
discloses to the special entity that it is not undertaking to act in
the best interest of the special entity. The rule also provides a safe
harbor for SBS Dealers transacting with ERISA special entities, where
the SBS Dealer will not be acting as an advisor if the special entity
represents that it has an ERISA fiduciary; the fiduciary represents in
writing that it acknowledges that the SBS Dealer is not acting as an
advisor; and the special entity represents either that it will comply
in good faith with written policies and procedures designed to ensure
that any recommendation received from the SBS Dealer involving a
security-based swap transaction is evaluated by a fiduciary, or that
any recommendation received from the SBS Dealer involving a security-
based swap transaction will be evaluated by a fiduciary.
    Rule 15Fh-4(b) establishes requirements for an SBS Dealer acting as
an advisor to special entities. Rule 15Fh-4(b)(1) provides that an SBS
Dealer acting as an advisor to a special entity shall have a duty to
make a reasonable determination that any security-based swap or trading
strategy involving a security-based swap recommended by the SBS Dealer
is in the best interests of the special entity. Rule 15Fh-4(b)(2)
requires an SBS Dealer acting as an advisor to a special entity to make
reasonable efforts to obtain such information that the SBS Dealer
considers necessary to make such a determination.
    The final rules except transactions executed on registered or
exempt SEFs or registered national securities exchanges if an SBS
Dealer does not know the identity of the counterparty at a reasonably
sufficient time prior to execution to permit compliance with these
final obligations.
    As discussed in detail in earlier sections, SBS Dealers enjoy
informational advantages relative to their nondealer counterparties,
and are for profit entities with business interests that may conflict
with those of their counterparties in principal and/or agency
transactions. Hence, SBS Dealers may have conflicts of interest related
to the security-based swaps and the securities underlying them.\1704\
Such conflicts of interest may influence SBS Dealer recommendations to
their counterparties. The final business conduct rules may lessen the
reliance of special entities on SBS Dealer recommendations, but, they
may also limit special entities' access to security-based swap related
investment advice and OTC security-based swaps.
---------------------------------------------------------------------------

    \1704\ See Sections VI.A and VI.C.2 for a more detailed
discussion of informational asymmetries and conflicts of interest
related to security-based swap dealing activity.
---------------------------------------------------------------------------

    Special entity counterparties may be aware of these fundamental
incentives of SBS Dealers and of the complexity and opacity of
security-based swaps, and may be able to recognize and parse out the
potential bias in dealer recommendations. As discussed above, special
entities represent a small fraction of market participants and almost
exclusively rely on investment advisers. We also note that, to the
extent special entities are currently allocating capital inefficiently
in security-based swaps, they may be doing so for reasons unrelated to
SBS Dealer recommendations, such as reaching for yield in a low
interest rate environment,

or as a result of fund manager incentive conflicts. If special entity
participation in security-based swap markets is driven by these other
factors and is not a result of reliance on SBS Dealer recommendations,
the benefits of these rules may be reduced.
    As we have noted in prior sections, based on TIW data for 2006
through 2014, approximately 98% of special entities transacting in
single name CDS trades in TIW rely on advisors. We lack data to
estimate how many of these advisors may be considered qualified
independent representatives for the purposes of the safe harbor.
However, we recognize that the economic effects of this rule may be
significantly reduced if many SBS Dealers avail themselves of the safe
harbor in their transactions with and recommendations to special
entities.
    We note that under the final rules, when an SBS Dealer makes a
recommendation to a special entity, and obtains the representations and
makes the disclosures required by the safe harbor, the SBS Dealer will
not be required to comply with the best interest standard in Rule 15Fh-
4(b). However, if, in such cases the special entity counterparty has
less than $50 million in assets (and therefore, does not meet the
institutional counterparty definition), the SBS Dealer will still be
required to comply with its customer-specific suitability obligations
in Rule 15Fh-3(f)(1)(ii). This provision imposes customer-specific
suitability obligations on SBS Dealers who cannot take advantage of the
institutional suitability alternative in Rule 15Fh-3(f)(2). This may
enhance potential counterparty protection and allocative efficiency
benefits of the final special entity rules relative to the alternative
of not imposing customer-specific suitability obligations with respect
to special entities under the safe harbor with less than $50 million in
assets. Our data do not allow us to estimate how many special entities
would fall under the $50 million asset size threshold; asset size
thresholds for special entities at which the intended information and
counterparty protection benefits of these final rules become
significant; or the extent to which asset size and special entity
sophistication may be correlated in security-based swap markets.
    We also recognize that this approach diverges from the
institutional suitability alternative adopted by the CFTC as part of
business conduct standards for Swap Entities. As a result, all SBS
Dealers that are dually registered with the CFTC as Swap Dealers will
face two different standards of care in swaps and security-based swaps
when making recommendations to special entities with less than $50
million in assets. As a result, dually registered SBS Dealers may
choose not to rely on the institutional suitability alternative when
making recommendations to special entities with less than $50 million
in both swap and security-based swap markets. This aspect of the
alternative may increase costs that SBS Dealers will incur as a result
of advising and transacting with small special entities in security-
based swaps. SBS Dealers may reduce their provision of advice to small
special entities or pass on such costs to counterparties in the form of
higher transaction costs or a decreased willingness to intermediate
over-the-counter security-based swaps. Further, as discussed above, the
Commission believes that suitability obligations for special entities
with less than $50 million in assets may increase the potential
counterparty protection and allocative efficiency benefits of the final
special entity rules. Therefore, the primary economic effects of these
rules depend on the degree to which special entities rely on conflicted
SBS Dealer recommendations in their security-based swap decisions, the
value of biased security-based swap recommendations by SBS Dealers, the
relative cost of outside investment advice concerning security-based
swaps, and the fraction of SBS Dealers that will be able to take
advantage of the qualified independent representative safe harbor.
    Therefore, the primary economic effects of these rules depend on
the degree to which special entities rely on conflicted SBS Dealer
recommendations in their security-based swap decisions, the value of
biased security-based swap recommendations by SBS Dealers, the relative
cost of outside investment advice concerning security-based swaps, and
the fraction of SBS Dealers that will be able to take advantage of the
qualified independent representative safe harbor.
    SBS Dealers will be unable to recommend security-based swaps that
are not in special entities' best interests, and will therefore forego
potential incremental profits from such transactions. SBS Dealer ``best
interest'' determinations concerning recommended security-based swaps
may potentially give rise to dealer liability or litigation risk if
there are differences of opinion concerning the relative merits of
different security-based swaps and counterparties incur losses. SBS
Dealer registration is not currently required, disclosure of litigation
reserves by SBS Dealers is not mandatory, and the economic magnitude of
such costs will depend on how special entities, their representatives
and SBS Dealers will respond to these final rules. Therefore, we are
unable to estimate these costs. However, we recognize that some SBS
Dealers may incur such costs. In addition, the aggregate initial costs
of revising representations and collecting requisite information from
special entities related to the requirements for SBS Dealers serving as
advisors to special entities are estimated at $741,000.\1705\
---------------------------------------------------------------------------

    \1705\ Initial cost: (In-house attorney at $380 per hour) x
((250 hours to draft, review and revise the representations in
standard SBS documentation) + (1,700 hours to collect information
from each special entity) = $741,000.
---------------------------------------------------------------------------

    SBS Dealers that are most affected by these costs may respond to
the final rules by ceasing to provide security-based swap
recommendations to special entities, limiting special entities' access
to such investment advice, or by decreasing their willingness to
intermediate OTC security-based swaps with special entities. However,
we note that SBS Dealers that lose the most profit as a result of the
requirement to provide advice in their counterparties' best interests
may have been issuing more conflicted recommendations that were not in
the special entities' best interests. Therefore, special entities may
lose access to such conflicted advice, but the remaining advice by SBS
Dealers should be consistent with special entities' best interest.
d. Independent Representation: Alternatives
    We have considered alternatives that result in tightening of the
independence requirements for representatives, for instance, through
the imposition of a longer look back period in the associated person
prong of the independence definition. More stringent independence
requirements may mitigate potential conflicts of interest and biases in
security-based swap recommendations registered representatives make to
special entities. However, as tabulated in Table 2, the majority of
market participants rely on investment advisers for their security-
based swap transactions, and more stringent definitions will limit the
number of representatives qualified to advise special entities in
security-based swaps. A decrease in the supply of independent
representatives may increase the cost of retaining independent
representation and limit access by smaller, less sophisticated
counterparties that benefit from independent advice and representation

in opaque and complex security-based swap transactions. Further, more
stringent independence requirements may decrease the level of
specialized expertise of representatives. We have received mixed
comments on the relative merits of various definitions of independence,
commenters did not quantify the economic costs or benefits of the
alternatives \1706\ and no such data is available at present time. As
indicated earlier, the independence definition being adopted is
consistent with the CFTC's approach in swap markets.
---------------------------------------------------------------------------

    \1706\ See, e.g., Better Markets (August 2011), supra note 5;
NAIPFA, supra note 5; CFA, supra note 5; FIA/ISDA/SIFMA, supra note
5; APPA; BlackRock, supra note 5; SIFMA (August 2011), supra note 5;
and Blackrock, supra note 5.
---------------------------------------------------------------------------

    Finally, we have considered eliminating the independent
representative safe harbor from the special entity requirements, as
suggested by some commenters.\1707\ To the extent that unsophisticated
counterparties rely on independent outside advisors or professional
portfolio managers acting in their best interest, the economic effects
of potential biases in SBS Dealer recommendations may be mitigated.
Sophisticated entities and entities relying on independent advice from
qualified fiduciaries are less likely to benefit from SBS Dealer best
interest recommendations, particularly in light of the disclosures
being adopted as part of these final rules. At the same time, the costs
of SBS Entity advice under the best interest standard would be passed
on to special entities, increasing costs of security-based swaps and
potentially limiting market access for special entities. Further, SBS
Entities may have superior information about security-based swaps, but
face information asymmetries concerning the nature of financial and
business risks of their counterparties. Special entities may be better
able to assess the relative merits of a given security-based swap
transaction when relying on independent qualified representatives, as
opposed to engaging SBS Entities to make such recommendations under a
best interest standard.
---------------------------------------------------------------------------

    \1707\ Better Markets (August 2011), supra note 5; CFA, supra
note 5; and AFSCME, supra note 5.
---------------------------------------------------------------------------

    Similarly, prohibiting SBS Dealers from selling derivatives when
the special entity would be better served by more traditional debt
instruments, as suggested by one commenter,\1708\ will impede market
access by special entities to a potentially valuable vehicle for risk
mitigation. For some special entities, particularly for sophisticated
entities, entities relying on independent advice from qualified
advisors, and entities with risk management needs best addressed by OTC
security-based swaps, such costs are likely to be significant. Further,
this alternative would preclude special entities from accessing one of
the vehicles for trading on negative information about risks of the
underlying securities. Excluding informed and sophisticated special
entities from security-based swaps markets may decrease price
efficiency and liquidity, and fragment swap, security-based swap and
underlying reference security markets. However, if such special
entities are prohibited from accessing OTC security-based swaps, these
entities would be able to access standardized security-based swaps
traded on registered national exchanges or SEFs. This may increase the
volume of security-based swap trades transacted on these platforms.
---------------------------------------------------------------------------

    \1708\ See CFA, supra note 5.
---------------------------------------------------------------------------

e. Reliance on Representations
    Rule 15Fh-1(b) allows SBS Entities to rely on the written
representations of a counterparty to satisfy its due diligence
requirements, unless they have information that would cause a
reasonable person to question the accuracy of the representation. While
these final rules impose new costs on SBS Entities, Rule 15Fh-1(b) will
enable SBS Entities to rely on representations in lieu of independent
due diligence, under certain circumstances. Since SBS Entities may be
able to rely on representations to fulfil the requirements in these
final rules, we expect they will do so when the costs of reliance on
representations are lower than those of independent due diligence, to
the extent that special entities are willing and able to provide
representations that meet the requirements of the rule. This may,
therefore, provide potentially beneficial flexibility to SBS Entities
in managing their compliance obligations under these final rules.
    Relying on special entities' representations concerning the
qualifications, and independence of investment representatives should
be less costly for SBS Entities than conducting independent substantive
evaluations of qualifications and independence of their counterparties'
representatives. To the extent that the best interest standard
introduces costs for SBS Entities, and to the extent that the qualified
independent representative safe harbor may mitigate these costs as
discussed in prior sections, Rule 15Fh-1(b) may enable SBS Entities to
make recommendations and serve as counterparties to special entities at
lower costs under reliance on counterparty representations than under
independent due diligence. However, if an SBS Entity has information
that would lead a reasonable person to question the accuracy of the
representation, SBS Entities will be required to perform independent
due diligence.
    We have considered an ``actual knowledge'' standard as an
alternative to the reliance on representation standard. Under an
``actual knowledge'' standard, an SBS Entity can rely on a
representation unless it knows that the representation is inaccurate.
The alternative could allow SBS Entities to rely on questionable
representations insofar as they do not have actual knowledge that the
representation is inaccurate, even if they have information that would
cause reasonable persons to question their accuracy. As a result, this
alternative would reduce the benefits of the verification of status,
know your counterparty, suitability and special entity requirements and
result in weaker protections for counterparties to SBS Entities.
However, SBS Entities would be able to rely on counterparty
representations with respect to a potentially greater set of
transactions and counterparties. To the extent that reliance on
representations may lower SBS Entity costs from these final business
conduct rules, this actual knowledge standard alternative for reliance
on representations has the potential to further reduce costs.
    We have received mixed comments on the relative merits of these
standards, with some commenters supporting the actual knowledge
standard,\1709\ others supporting the reasonable person reliance
standard,\1710\ and others opposing both standards as too low.\1711\
None of the commenters quantified the potential economic costs or
benefits of the proposed standards, and we lack information or data to
quantify the above economic effects. For instance, we lack information
about the number of transactions between special entities and SBS
Entities conducted in reliance on representations, the accuracy of
which reasonable persons would question but where SBS Entities lack
actual knowledge of falsehood, and the costs of independently
evaluating a representative's qualifications and independence which
will depend on an individual SBS Entity's choice to

perform due diligence in house and the efficiency of related internal
business processes, or to retain a third party due diligence provider
and the related choice of service provider. In addition, we have
received comment that, where SBS Dealers are required to conduct
independent due diligence, they may face potential litigation risk if
they approve a representative who is subsequently determined to be
lacking expertise, as well as potential litigation from representatives
whom they have chosen to disqualify, which may discourage SBS Dealers
from intermediating OTC security-based swaps with certain groups of
counterparties.\1712\ Commenters have not provided any information to
enable us to quantify these costs and we have no data to enable such
quantification.
---------------------------------------------------------------------------

    \1709\ See, e.g., SIFMA (August 2011), supra note 5; FIA/ISDA/
SIFMA, supra note 5; CCMR, supra note 5; APPA, supra note 5;
BlackRock, supra note 5); ABC (2011); ABA Committees, supra note 5.
    \1710\ See, e.g., Better Markets (2011).
    \1711\ See CFA, supra note 5 and AFSCME, supra note 5.
    \1712\ See ABC, supra note 5.
---------------------------------------------------------------------------

    We note that under CFTC rules, Swap Entities are subject to the
reasonable person reliance standard being adopted in these final rules.
We also note that swap and security-based swap markets are
interconnected, market participants transact across these markets, and
many SBS Entities are expected to be dually-registered as Swap
Entities. If the same dealers face differential compliance costs of
transacting over the counter with the same special entities in, for
instance, single name and index CDS, dealing activity may flow to the
market with lower compliance costs, potentially fragmenting price
discovery and liquidity. Further, the standard being adopted is likely
more timely and cost effective than an approach permitting no reliance
on representations.
    We have also considered alternative approaches involving a higher
standard for reliance on representations or requiring SBS Entities to
conduct an independent analysis of conflicts and qualifications of each
independent representative of a special entity, with which they may be
negotiating swaps. This approach may enhance SBS Entities' due
diligence with respect to representatives of special entity
counterparties, but may decrease the willingness or ability of SBS
Entities to provide special entities with access to security-based
swaps.\1713\ As an additional consideration, we understand that most
market participants in swap markets and Swap Entities have adopted a
multilateral protocol as a means of complying with the CFTC external
business conduct rules. While we understand that the representations
contained in the protocol only expressly address swap transactions, we
have received comment that factual matters addressed by those
representations typically do not vary between swap and security-based
swap transactions. To the extent that cross-market participation of
dealers and non-dealer counterparties is a significant feature of
security-based swap markets, requiring dually-registered SBS Entities
to obtain separate representations or conduct independent due diligence
specifically addressing security-based swaps may impose additional
costs, which may be passed on to counterparties and limit their access
to OTC security-based swaps.\1714\ In addition, as discussed above, we
have received comment that requiring SBS Dealers to conduct independent
due diligence may lead to potential litigation risk from approving
representatives subsequently determined to be lacking expertise or
representatives that are disapproved. According to the comment letter,
this may discourage SBS Dealers from intermediating OTC security-based
swaps with certain groups of counterparties.\1715\ The commenter did
not provide any estimate of such potential costs and the Commission has
no data to enable such quantification. However, we recognize that these
costs may be significant, and it is unclear that the independent due
diligence alternative is superior to the reliance on representation
approach being adopted.
---------------------------------------------------------------------------

    \1713\ See, e.g., NAIPFA, supra note 5.
    \1714\ See SIFMA (November 2015), supra note 5.
    \1715\ See ABC, supra note 5.
---------------------------------------------------------------------------

f. Magnitude of the Economic Effects
    When considering the likely magnitude of the economic effects of
special entity rules discussed above, we note that, based on data for
November 2006 through December 2014, approximately 98% of special
entities relied on investment advisors for their single name CDS trades
in DTCC-TIW, and only approximately 2% of special entities acted as a
transacting agents.\1716\ We lack data or other information to estimate
how many investment advisers currently representing special entities in
security-based swap markets will be considered qualified and
independent for the purposes of compliance with these final rules, or
how many SBS Entities would be able to rely on the independent
representative safe harbor in their transactions with special entities.
Commenters did not provide data that would enable such quantification.
In addition, we lack data on the associations of investment advisers
with SBS Entities in the past year, the extent of their advisory roles
in relationships with special entities, the existence of conflicts of
interest, and other information. Therefore, we cannot quantify how many
special entities may be able to rely on representations. However, in
light of special entities' heavy reliance on investment advisers in
security-based swap transactions, it is unclear whether a substantial
portion of special entities rely on SBS Entity recommendations in their
security-based swap transactions.
---------------------------------------------------------------------------

    \1716\ Approximately 95% of special entities relied on SEC
registered investment advisers, and another 3% of special entities
used unregistered investment advisers. See Table 2 of the economic
baseline, Section VI.B supra.
---------------------------------------------------------------------------

    We also recognize similarities between the CFTC's business conduct
standards, FINRA rules, and the rules being adopted, as well as
extensive cross-market participation--all of which may reduce both the
economic costs (if dually registered entities have already restructured
their compliance infrastructure to comply with similar rules) and the
benefits of these rules (if, for instance, special entities have
learned about potential biases in recommendations from new market
practices of the same dealers in other financial markets). We note that
our final business conduct standards include transaction level
requirements. Therefore, as we discuss and estimate above, some
benefits and costs related to individual security-based transactions
are still likely to accrue to special entities, their qualified
independent representatives, and SBS Entities; even those already
subject to similar rules in other markets. Further, some SBS Entities
and potential new entrants may not be cross-registered with the CFTC or
with FINRA, and may, therefore, not already be subject to similar rules
in other markets.
    Finally, the rules relating to transactions with special entities
will not apply to security-based swaps executed on registered or exempt
SEFs or registered national security exchanges, where SBS Entities do
not know the identity of the counterparty at a reasonably sufficient
time prior to execution of the transaction to permit the SBS Entity to
comply with the obligations of the rules. Therefore, special entities
would not receive the benefits of additional counterparty protections
of these rules when transacting anonymously through SEFs or registered
national securities exchanges. However, as noted earlier these final
rules may increase the costs of SBS Entities and reduce their
information rents, which may lead SBS Entities to seek to recover lost
profits through more adverse terms of OTC swaps sold to special
entities, or reduced willingness to transact with special entities.
Since anonymous SEF

or exchange traded security-based swaps will not be subject to these
final requirements, the risk that special entities will lose access to
security-based swaps may be reduced.
5. Fraud, Fair and Balanced Communications, Supervision
a. Antifraud
    The final business conduct rules include a set of antifraud
provisions covering SBS Entity transactions with all counterparties,
and with special entities. With respect to special entities, rules
15Fh-4(a)(1) and 15Fh-4(a)(2) prohibit SBS Entities from employing any
device, scheme, or artifice to defraud special entities, and from
engaging in any transaction, practice or course of business that
operates as a fraud or deceit. Rule 15Fh-4(a)(3) imposes a general ban
on SBS Entities engaging in any act, practice, or course of business
that is fraudulent, deceptive or manipulative.
    To the extent fraudulent, deceptive or manipulative conduct may
affect the choice of the SBS Entity's counterparty and the decision to
enter into a given swap, antifraud protections may lead to an increased
flow of transactions to SBS Entities not engaging in fraudulent
practices. To the extent that the risk of fraud may affect the
willingness of market participants to transact in security-based swap
markets, antifraud protections may increase the willingness of non-SBS
or Swap Entity counterparties to participate in security-based swap
markets. We recognize that, as indicated by a commenter, general
antifraud and anti-manipulation provisions of existing federal
securities laws and Commission rules offer similar protections.\1717\
Therefore, the magnitude of these economic benefits relative to the
economic baseline is expected to be de minimis. Further, in light of
SBS Entities' ongoing statutory antifraud obligations, we anticipate
that entities likely to trigger SBS Entity registration requirements
have already developed policies and procedures necessary for compliance
with these final rules. Therefore, the magnitude of the economic costs
to SBS Entities from these final rules is expected to be de minimis as
well.
---------------------------------------------------------------------------

    \1717\ See Barnard, supra note 5.
---------------------------------------------------------------------------

    The Commission is not establishing a policies and procedures safe
harbor for non-scienter violations, or provisions regarding the
protection for counterparty confidential information. As an alternative
to these final rules, the Commission could adopt such a safe harbor.
For instance, the Commission could adopt a rule where an SBS Entity
would be able to establish an affirmative defense by demonstrating that
it did not act intentionally or recklessly, and complied in good faith
with written policies and procedures reasonably designed to meet this
particular requirement. The adoption of such a safe harbor may reduce
compliance and litigation costs related to nonscienter fraudulent,
deceptive or abusive practices or conduct that may occur despite SBS
Entities having developed and implemented all relevant policies and
procedures, acting in good faith. However, a safe harbor against fraud
may weaken counterparty protections in a market for complex and opaque
securities.
b. Fair and Balanced Communications
    Under rule 15Fh-3(g), SBS Entities are required to communicate with
counterparties in a fair and balanced manner based on principles of
fair dealing and good faith. As discussed in Sections I and II, this
rule is harmonized with FINRA's communications with the public rule. To
the extent that up to 16 likely SBS Entities may be cross-registered as
broker-dealers, some SBS Entities are already complying with these
requirements with respect to securities transactions. Specifically, all
communications must provide a sound basis for evaluating a given
security-based swap or trading strategy, communications may not imply
that past performance will recur, or make exaggerated and unwarranted
claims. Rule 15Fh-3(g) clarifies the kinds of communications that would
be consistent with fair dealing or good faith communications. In
conjunction with the antifraud rules and enhanced disclosure
requirements, the fair and balanced communications rule aims to provide
transparency to market participants transacting with SBS Entities. To
the extent to which counterparties of SBS Entities may have asymmetric
information or are less sophisticated, this requirement may help
protect counterparties and improve their ability to select the most
appropriate security-based swap and counterparty.
    We recognize that the requirement may impose costs on SBS Entities.
As indicated in Section V, the related initial aggregate costs are
estimated at $917,400 for the industry, with ongoing costs of
approximately $125,400.\1718\
---------------------------------------------------------------------------

    \1718\ Initial internal cost: (In-house attorney $380 per hour)
x 330 = $125,400. Initial external legal counsel costs: $330,000 +
$462,000 = 792,000. Ongoing costs: (In-house attorney $380 per hour)
x 330 = $125,400.
---------------------------------------------------------------------------

c. Supervision
    Rule 15Fh-3(h) requires SBS Entities to establish and maintain a
supervision system and diligently supervise their business and the
activities of their associated persons. At a minimum the supervisory
system must (1) designate at least one person with supervisory
authority for each type of a business in which the SBS Entity engages
that requires registration as an SBS Entity; (2) use reasonable efforts
to determine that all supervisors are qualified; and (3) establish,
maintain and enforce written policies and procedures addressing the
supervision of the types of security-based swap business an SBS Entity
is engaged in and the activities of its associated persons, that are
reasonably designed to prevent violations of applicable securities
laws, and rules and regulations thereunder. The rule lists specific
types of policies and procedures that must be included.
    In addition, SBS Entities and their associated persons will not be
deemed to have failed to diligently supervise if (1) the SBS Entity has
certain written policies and procedures and a documented system for
applying them that would reasonably be expected to prevent and detect,
insofar as practicable, any violation of the federal securities laws
and the rules and regulations thereunder relating to security-based
swaps; and (2) the SBS Entity or its associated person has reasonably
discharged the duties and obligations required by such written policies
and procedures and system, and did not have a reasonable basis to
believe they were not being followed.
    Lastly, SBS Entities have an obligation to promptly amend written
supervisory policies and procedures when there are material changes to
applicable securities laws, rules and regulations, or when there are
material changes to the SBS Entity's business or supervisory system.
SBS Entities are also required to promptly communicate any material
amendments to their supervisory procedures to all associated persons to
whom such amendments are relevant based on their activities and
responsibilities.
    The Commission recognizes that these final supervision rules may
impose certain burdens and costs on SBS Entities. Specifically, SBS
Entities will be required to establish and maintain a supervision
system consistent with the minimum requirements articulated in Rule
15Fh-3(h); to diligently supervise their business and the activities of
their associated persons; and to amend their written supervisory
policies and procedures when material changes

occur to applicable laws, rules or regulations or to their business or
supervisory systems, and promptly communicate such amendments to all
associated persons to whom such amendments are relevant.\1719\ Based on
estimates in Section V, compliance with the supervision rules may
involve an aggregate initial cost of $39,317,850 and an ongoing cost of
$8,405,100 for all SBS Entities.\1720\ In addition, these final rules
impose new supervision requirements on SBS Entities, which may increase
the probability and related costs of responding to legal actions.
However, to the extent that these supervision rules may enhance
compliance with federal securities laws and Commission rules and
regulations thereunder, the probability and costs of responding to
regulatory inquiries and private actions may actually decrease.
---------------------------------------------------------------------------

    \1719\ See Section V for an estimate of burdens and costs
related to the diligent supervision rules.
    \1720\ Initial internal cost: (Compliance manager $283 per hour)
x 103,950 = $29,417,850. Initial external legal counsel costs:
$9,900,000. Ongoing costs: (Compliance manager $283 per hour) x
29,700 = $8,405,100.
---------------------------------------------------------------------------

    We have considered the alternative of excluding Major SBS
Participants from the scope of the supervision rules and have received
mixed comment on the issue, as discussed in Section II. One commenter
indicated that the rule may impose burdensome and costly supervisory
procedures on Major SBS Participants that are not appropriate given
their non-dealer role in the marketplace, and the potential costs of
compliance ``would be without any meaningful offsetting benefit for
other market participants or the financial markets as a whole.'' \1721\
The commenter did not provide any data to quantify potential costs or
benefits for Major SBS Participants. We recognize that these rules
impose requirements and costs on Major SBS Participants they are not
currently required to bear, as reflected in our estimates. We also note
that the Commission elsewhere estimated that only between zero and five
entities may seek to register with the Commission as Major SBS
Participants. The Commission continues to believe that due to their
large positions in security-based swaps, activities of Major SBS
Participants may pose significant risks, such as market and
counterparty risks, in security-based swap markets, as discussed in
Section II above, the Commission believes the application of the rules
is thus appropriate.
---------------------------------------------------------------------------

    \1721\ See MFA, supra note 5.
---------------------------------------------------------------------------

6. CCO Rules
    Rule 15Fk-1 requires an SBS Entity to designate a CCO, and imposes
certain duties and responsibilities on that CCO, including the
preparation of an annual compliance report. In addition, under Rule
15Fk-1(d), the compensation and removal of the CCO require the approval
of a majority of the board of directors of the SBS Entity. We note that
the adopted SBS Entity registration forms already require SBS Entities
to designate an individual to serve as a CCO, which enters into an
economic baseline against which we are assessing the effects of these
final rules. Therefore, the primary economic effects of these final CCO
rules stem from the annual compliance report requirement, other duties
of the CCO, and CCO compensation and removal requirements.
a. Annual Compliance Report, Conflicts of Interest, Policies and
Procedures
    Rule 15Fk-1(c) requires each SBS Entity's CCO to prepare and sign
an annual compliance report containing a description of the SBS
Entity's written policies and procedures described in paragraph (b) of
the rule, including the code of ethics and conflict of interest
policies. The report must also contain a description of: the SBS
Entity's assessment of the effectiveness of its policies and procedures
relating to its business as an SBS Entity; any material changes to the
SBS Entity's policies and procedures; any areas for improvement, and
recommended potential or prospective changes or improvements to the SBS
Entity's compliance program and resources devoted to compliance; any
material non-compliance matters; and the financial, managerial,
operational, and staffing resources set aside for compliance with the
Exchange Act and the rules and regulations thereunder relating to its
business as an SBS Entity, including any material deficiencies in such
resources. Further, SBS Entities must promptly submit an amended
compliance report if material errors or omissions in the report are
identified. The submission of the annual compliance report as required
by the final rules may help the Commission assess the compliance
activities of SBS Entities.
    In addition, Rule 15Fk-1(b)(2) requires the CCO to take reasonable
steps to ensure that the SBS Entity establishes, maintains and reviews
policies and procedures reasonably designed to achieve compliance with
the Act and the rules and regulations thereunder relating to its
business as an SBS Entity by: Reviewing the compliance of the SBS
Entity; and taking reasonable steps to ensure that the SBS Entity
establishes policies and procedures for the remediation and handling of
non-compliance issues. Rule 15Fk-1(b)(3) requires the CCO, in
consultation with the board of directors or senior officer, to take
reasonable steps to resolve any material conflicts of interest that may
arise; and Rule 15Fk-1(b)(4) requires the CCO to administer each policy
and procedure required to be established under Section 15F of the
Exchange Act and the rules and regulations thereunder.
    Our final rules impose a set of duties and responsibilities on CCOs
of SBS Entities. As described in the economic baseline and discussed in
earlier sections, the Commission believes that a number of entities
that will seek to register as SBS Entities may be dually registered,
and may already be required to comply with some of these rules in swap
or reference security markets. However, we note that SBS Entity
registration is currently not required, and entities intermediating
security-based swaps, including dually registered entities, are not
required to comply with business conduct or CCO rules relating to their
business as an SBS Entity. Therefore, these rules impose a new set of
requirements on a population of SBS Entity registrants as they pertain
to security-based swap business. To the extent that CCO oversight may
facilitate compliance, the above rules may enhance compliance of SBS
Entities with federal securities laws and other Commission rules.\1722\
---------------------------------------------------------------------------

    \1722\ The Commission has elsewhere stated that strong internal
compliance programs lower the likelihood of non-compliance with
securities rules and regulations. See SDR Registration Release, 80
FR at 14543, supra note 1202.
---------------------------------------------------------------------------

    Based on our analysis in Section V, the establishment and
administration of the policies and procedures required under Rule 15Fk-
1 will involve a total initial cost of approximately $13,105,950, and
an ongoing cost of approximately $2,801,700 per year for all SBS
Entities.\1723\ Ongoing costs of preparation of an annual compliance
report by the CCO is estimated at approximately $2,480,775 for all SBS
Entities.\1724\
---------------------------------------------------------------------------

    \1723\ Initial cost of policies and procedures: (Compliance
manager at $283 per hour) x 34,650 hours = $9,805,950. Initial cost
of outside counsel: $3,300,000. Total initial cost: $9,805,950 +
$3,300,000 = $13,105,950. Ongoing cost: (Compliance manager at $283
per hour) x 9,900 hours = $2,801,700.
    \1724\ Ongoing cost of compliance reporting: (CCO at $485 per
hour) x 5,115 hours = $2,480,775.
---------------------------------------------------------------------------

    In addition, these rules impose new requirements concerning CCO
duties. These final rules also require the annual compliance report to
include a

certification by the CCO or senior officer, and may increase CCO or
senior officer liability when the CCO or senior officer executes the
required certification. If SBS Entity CCOs or senior officers are risk
averse, they may require additional liability insurance, higher
compensation or lower incentive pay as a fraction of overall
compensation. To the extent that liability may be a significant
consideration for some SBS Entities, this may lower the labor supply of
senior officers or CCOs in security-based swap markets.
b. CCO Removal and Compensation
    CCOs play a central role in monitoring compliance with federal
securities laws and regulations. These final rules elevate approval of
decisions regarding the compensation or removal of the CCO to the
board. As indicated in the proposing release, the Commission believes
that the approach being adopted may reduce inherent conflicts of
interest that arise when CCO compensation and removal decisions are
made by individuals whose compliance with applicable law and
regulations the CCO is responsible for monitoring.\1725\ The rule,
therefore, may mitigate CCO conflicts of interest within SBS Entities,
and may strengthen SBS Entity compliance with federal securities laws
and Commission rules, including these final business conduct rules.
---------------------------------------------------------------------------

    \1725\ See Proposing Release, 76 FR at 42451, supra note 3.
---------------------------------------------------------------------------

    SBS Entities are expected to be primarily large institutions and
may be part of organizational structures that include hundreds of
entities, with varying levels of business complexity. Many SBS Entities
may also be active in swap markets, while others may also perform
broker-dealer functions or have banking operations; yet others may
focus their primary business on security-based swaps. As a result,
different governance and oversight structures may be suitable for
different SBS Entities depending on their internal operations, business
complexity, and the role security-based swap transactions play in their
overall operations, among others. Therefore, the rule limits the
ability to delegate CCO compensation and removal decisions to a senior
officer, which may be optimal for some SBS Entities.
    CCO compensation and removal decisions require an understanding of
security-based swap markets and the SBS Entities' business
opportunities in such markets, compliance risks related to various SBS
Entity activities and transactions, the labor market for CCOs of SBS
Entities, and an ability to infer the quality of skills and effort
exerted by the CCO from performance. To the extent SBS Entity boards
lack specific expertise necessary to approve compensation and removal
decisions, such boards may currently delegate these functions to other
officers, such as head of compliance, chief risk officer, or other
persons. As a result of the final rules, such delegation will not be
permitted, and boards of some SBS Entities may be required to gather
additional information or gain expertise necessary to approve
compensation and removal decisions.
    SBS Entities that currently delegate these functions to other
officers may need to refocus board resources on the area of compliance.
As a result, SBS Entity boards may need to replace existing directors,
hire new directors, or retain the services of independent executive
search and compensation consultants that are familiar with security-
based swaps. This may detract from the time and resources SBS Entity
boards are able to invest in overseeing activities in other markets,
which may represent a larger fraction of the business and shareholder
profits for some SBS Entities. To the extent that SBS Entity boards
face time and resource constraints, they may also become less effective
at monitoring and advising SBS Entities in areas outside of compliance.
Further, the requirement that SBS Entity boards approve CCO
compensation and removal decisions, may increase the liability of SBS
Entity's directors, which may increase the costs of director liability
insurance and director compensation. Nevertheless, as discussed above,
the Commission continues to believe that these final rules may reduce
certain conflicts of interest related to CCO compensation and removal
decisions, which may strengthen SBS Entity compliance with federal
securities laws and Commission rules.
    The final rules do not address the appointment of the CCO. However,
the rules require the CCO to report directly to the board or senior
officer, and require decisions regarding the compensation and removal
of the CCO to be approved by the board. As a result, some SBS Entities
may separate reporting to and appointment by the senior officer, from
compensation and removal decisions by the board. The Commission
recognizes that appointment, compensation and removal decisions may be
inextricably intertwined, requiring an informed assessment of the CCO's
talent, abilities, expertise and performance when compared against
external candidates, as well as an understanding of the CCO labor
market. Further, a senior officer may have conflicts of interest in CCO
appointment decisions similar to those present in CCO compensation or
removal decisions. A potential separation of the CCO reporting line and
appointment decisions from compensation and removal decisions may
decrease the quality of these decisions. However, the ability of some
SBS Entity boards to continue to rely on senior officers for the CCO to
report to and for appointment decisions may mitigate some of the
resource drain on boards of SBS Entities discussed above.
    We have considered an alternative approach under which only
independent members of the board can approve decisions regarding the
compensation, appointment and removal of CCOs, as proposed by some
commenters,\1726\ as well as requiring certain minimum CCO
qualifications and governance practices. Independent directors may have
fewer conflicts of interest and may be less likely to be influenced by
CCOs, strengthening their oversight role, which may enhance SBS Entity
compliance with security laws, and rules and regulations thereunder. At
the same time, outside directors face an informational asymmetry with
respect to the SBS Entity's risks and investment opportunities, and may
lack an intimate understanding of the SBS Entity's business. We
understand that SBS Entities may trade off the value of specific
expertise in security-based swaps on the one hand, with the value of
independence in the face of potential conflicts of interest on the
other hand, in the context of each SBS Entity's operations. Requiring
specific CCO qualifications and other governance practices of all SBS
Entities may enhance compliance for some SBS Entities, but may also
involve potentially costly restructuring of internal governance
structures and operations while offering few benefits for other SBS
Entities as recognized by one commenter.\1727\
---------------------------------------------------------------------------

    \1726\ See, e.g., Barnard, supra note 5 and Better Markets
(August 2011), supra note 5.
    \1727\ See FIA/ISDA/SIFMA, supra note 5.
---------------------------------------------------------------------------

    Additionally, appropriate CCO qualifications may depend on the
CCO's functional roles and expertise, and business activities that the
SBS Entity engage in, particularly for SBS Entities that operate within
larger consolidated financial institutions with the same CCO. One-size-
fits-all qualification requirements or competency exams would restrict
the level and type of expertise of CCOs that SBS Entities are

able to retain, and would require some SBS Entities to remove the
current CCOs and search for new CCOs meeting the imposed qualification
requirements. Crucially, it is not clear how many SBS Entities
currently hire and retain underqualified CCOs. The Commission is not
requiring any particular level or type of competency or business
experience for a CCO as part of these final rules. However, as
discussed in Section II, the Commission believes that an SBS Entity's
CCO generally should be competent and knowledgeable regarding the
federal securities laws, empowered with full responsibility and
authority to develop appropriate policies and procedures for the SBS
Entity, as necessary, and responsible for monitoring compliance with
the SBS Entity's policies and procedures adopted pursuant to rules
under the Exchange Act. Similarly, mandatory quarterly or annual
meetings with the board or certain committees of SBS Entities, proposed
by one commenter,\1728\ may not mitigate potential conflicts of
interest involving CCOs, or facilitate compliance where such conflicts
or deficiencies stem from board or committee collective action
problems, weak monitoring or misaligned incentives, instead of a lack
of communication or information.
---------------------------------------------------------------------------

    \1728\ See Better Markets (October 2013), supra note 5.
---------------------------------------------------------------------------

    As discussed in Section II, commenters disagreed on the relative
merits of the approach being adopted and the alternatives above.\1729\
The above economic effects are not readily amenable to quantification.
Commenters did not provide data or other information that would
facilitate quantification of these effects; no such data is publicly
available. The overall effects of these competing considerations
regarding the CCO rules being adopted depend on internal governance
structures of SBS Entities, their organizational complexity, severity
of the conflicts of interest between SBS Entity CCOs and other
officers, reliance of existing SBS Entity boards on external executive
search and compensation consultants, importance of security-based swap
performance and compliance for SBS Entity profitability and
counterparty protections, optimal delegation of oversight, and the ways
in which SBS Entities may restructure their business in response to
these and other pending substantive Title VII rules.
---------------------------------------------------------------------------

    \1729\ See, e.g., FIA/ISDA/SIFMA, supra note 5, Better Markets,
supra note 5; CFA, supra note 5. Also see Section II.I supra.`
---------------------------------------------------------------------------

7. Pay To Play
    Rules 15Fh-5(a)(1)(vi) and 15Fh-6 impose a two-year time out period
after certain political contributions by security-swap dealers and
certain independent representatives. Rule 15Fh-6(b) generally prohibits
SBS Dealers from offering to enter into, or entering into, a security-
based swap or trading strategy involving a security-based swap with a
municipal entity within two years following any contribution to an
official of such municipal entity made by the SBS Dealer or any of its
covered associates. The rule also prohibits SBS Dealers and any covered
associates from providing or agreeing to provide payment to any person
to solicit a municipal entity to offer to enter into, or to enter into,
security-based swaps, unless such person is a regulated person. The
rule prohibits SBS Dealers and any covered associates from coordinating
or soliciting any person or political action committee to make
contributions to officials of a municipal entity, or to a political
party of a state or locality, with which the SBS Dealer is offering to
enter into, or has entered into, a security-based swap or a trading
strategy involving a security-based swap.
    Under Rule 15Fh-6(a)(2) covered associates will include general
partners, managing members, executive officers or other persons of
similar status or function; employees who solicit municipal entities to
enter security-based swaps with an SBS dealer, and all persons directly
or indirectly supervising such employees; and political action
committees controlled by such persons or SBS Dealers.
    These final rules also limit political contributions by independent
representatives in security-based swaps. Under Rule 15Fh-5(a) SBS
Entities who offer to enter into or enter into a security-based swap
with a special entity must have a reasonable basis to believe that the
special entity has a qualified independent representative. Rule 15Fh-
5(a)(1)(vi) provides that in the case of a special entity, a qualified
independent representative is a person that is subject to rules of the
Commission, the CFTC or an SRO prohibiting it from engaging in
specified activities if certain political contributions have been made,
except where the independent representative is an employee of the
special entity.
    As discussed in more detail below, our economic analysis of these
final rules reflects the fact that a large majority of entities
expected to seek registration as SBS Entities are expected to be dually
registered and required to comply with similar pay to play rules in
other markets.
    These final rules are intended to address pay to play relationships
that may interfere with the process by which municipal entities
allocate capital to security-based swaps to enhance returns or manage
risk on behalf of their stakeholders.\1730\ To the extent that these
final rules reduce the incidence of pay to play practices, municipal
entities may become less subject to conflicts of interest related to
political contributions by SBS Dealers. To the extent that conflicts of
interest related to political contributions may currently be affecting
capital allocation by municipal entities, resulting in inefficiencies
from conflicted counterparty or product selection, these rules may
benefit municipal entities and their stakeholders. Consistent with the
expected benefits articulated in the proposing release, these rules may
deter undue influence from SBS dealers and advisors. Therefore, these
rules may enhance counterparty protections of municipal entities and
increase allocative efficiency. In addition, these rules may also
encourage SBS Dealers to compete on the merits of the transaction.
Similarly, under Rule 15Fh-5 qualified independent representatives of
special entities in security-based swaps will be employees and
representatives subject to pay to play rules of the Commission, the
CFTC or an SRO, such as registered municipal advisors or registered
investment advisers. To the extent that some special entities may
currently rely on advisors that are not employees or registered
investment or municipal advisors, special entities may become less
affected by potential conflicts of interest of representatives, and
independent representatives may be encouraged to compete on their
qualifications, service quality, and cost. These benefits may flow
through to stakeholders of municipal entities, such as participants in
public pension plans and taxpayers.
---------------------------------------------------------------------------

    \1730\ See Proposing Release, 76 FR at 42450, supra note 3.
---------------------------------------------------------------------------

    To the extent that SBS Dealers are currently recovering the costs
from pay to play practices in the form of higher prices of security-
based swaps, these final rules may decrease transaction costs. We have
no data or other information on the prevalence of political
contributions of SBS Dealers, the number and contributions of their
covered associates, and transaction costs and non-price terms of
security-based swaps offered for sale to special entities. Such data is
not publicly available and commenters have not provided data to

enable such quantification. However, a study by Butler, Fauver and
Mortal (2009) found that negotiated bid deals had underwriter gross
spreads of 12-14 basis points (about one-seventh of the mean gross
spread) higher during the pay-to-play era.\1731\ The study concluded
that, when underwriting firms were routinely able to make political
campaign contributions to win underwriting business, gross spreads were
significantly higher, but only for those deals that were negotiated
that enable conflicted underwriter selection. This may indicate that,
absent pay to play rules, offerings subject to conflicts of interest
related to political contributions may not always be negotiated at
market rates. Pay to play rules may decrease certain costs to municipal
entities and their stakeholders, but may increase costs to dealers from
greater quality based competition.
---------------------------------------------------------------------------

    \1731\ See Alexander W. Butler, Larry Fauver, and Sandra Mortal,
Corruption, Political Connections, and Municipal Finance, 22 The
Review of Financial Studies 28-73 (2009).
     In a theoretical model by Cotton (2012), contributions may
increase access but not necessarily improve outcomes for some
agents, while contribution limits decrease rent extraction and may
encourage more evidence disclosure. See C. Cotton, Pay-to-play
Politics: Informational Lobbying and Contribution Limits When Money
Buys Access, 96 Journal of Public Economics 369-386 (2012).
---------------------------------------------------------------------------

    Several caveats apply. While the pay to play regime considered in
the study above examines the effects of the contribution limits in the
1994 pay to play reforms, and the contribution thresholds in these
final rules are comparable in magnitude, we cannot quantify the levels
at which certain political contributions by SBS Dealers and their
covered associates may give rise to conflicts of interest. However, we
note that de minimis thresholds in the final rules have been harmonized
with existing rules to which Swap Entities and investment advisers are
subject. We also note that the effect on spreads quantified above has
been estimated around the adoption of the MSRB pay to play rule. These
final rules follow pay to play rules adopted by the MSRB, the CFTC and
the Commission. In light of extensive cross-market participation and
expected dual registration of some entities, the economic effects of
these final rules may be smaller than those discussed above, if some
SBS Dealers and other market participants have already restructured
their business practices in security-based swap markets as a result of
existing pay to play rules in other markets.
    Finally, the two-year time out may disincentivize direct political
contributions to certain officials by SBS Dealers and their covered
associates. To the extent that SBS Dealers and covered associates may
increase contributions to other entities, such as 501(c) organizations
\1732\ or independent expenditure committees, which are not subject to
these final rules, and to the extent these other expenditures may
facilitate ongoing pay to play practices, the above benefits may be
reduced.
---------------------------------------------------------------------------

    \1732\ See, e.g., McCutcheon v. Federal Election Commission, 134
S.Ct. 1434, 1460 (2014).
---------------------------------------------------------------------------

    As a result of the pay to play rule, SBS Dealers will incur costs,
including costs of establishing and implementing policies and
procedures to monitor the political contributions made by the SBS
Dealer and its covered associates. As indicated in Section V, pay to
play rules will require collection of information regarding political
contributions of SBS Dealers and their covered associates, which may
cost up to $3,515,000 for all dealers.\1733\ Additionally, as discussed
in Section V above, SBS Dealers may incur one-time initial costs to
establish or enhance current systems to assist in their compliance with
the rule, estimated at up to $5,000,000 for all SBS Dealers.\1734\
Compliance costs imposed by the rule are expected to vary significantly
among SBS Dealers, depending on, among other things, the number of
covered associates and the supervisory structure of the SBS Dealer; the
degree to which compliance procedures are automated (such as policies
and procedures requiring pre-clearance); and the extent to which the
SBS Dealer may already have policies and procedures guiding political
contributions under ethics or compliance programs. Smaller SBS Dealers,
for example, would likely have a small number of covered associates,
and thus expend fewer resources to comply with the proposed rule.
However, to the extent that the cost of developing policies and
procedures may have a high fixed cost component, smaller SBS dealers
may incur costs that represent a higher percentage of net income.
Lastly, these costs will be greater for SBS Dealers with multiple
layers of supervision and a higher number of covered associates with
shorter tenures.
---------------------------------------------------------------------------

    \1733\ Initial cost: (In-house attorney at $380 per hour) x
9,250 hours = $3,515,000. This figure may overestimate the initial
cost burden on some SBS Dealers if some of the functions are
performed by in-house compliance managers instead of in-house
attorneys.
    \1734\ In the Advisers Act pay to play rule, the Commission
estimated that firms with over 15 covered associates incur, on
average, $100,000 startup costs. Assuming all SBS Dealers will have
over 15 covered associates, the initial cost is estimated at: 50 SBS
Dealers x $100,000 = $5,000,000. See Advisers Act Pay-to-Play
Release, supra note 1100 (adopting Advisers Act Rule 206(4)-5)).
---------------------------------------------------------------------------

    Under the final rules, the two-year time out on SBS dealing with
municipal entities is triggered when any of the covered associates has
contributed in excess of the de minimis thresholds. While developing
and implementing policies and procedures related to political
contributions and training covered associates may mitigate this risk,
some SBS Dealers may still trigger the time out despite these measures
due to contributions by one of their covered associates.
    Such SBS Dealers will incur costs from the loss of business with
municipal entities. We note that the final rules contain a safe harbor
for contributions by natural persons that predate the date of becoming
a covered associate by more than 6 months, if such associates do not
solicit municipal entities on behalf of the SBS Dealer. Further, if the
SBS Dealer discovers the triggering contribution under $350 within 4
months and secures a return of funds within 60 days, the prohibition
will not apply. In response to commenter concerns,\1735\ and consistent
with Advisers Act Rule 206(4)-5, the final rules provide up to two such
exemptions per year for dealers with 50 or fewer covered associates,
and up to three such exemptions for dealers with over 50 covered
associates. We do not have data or other information concerning the
number of general partners, managing members, executive officers or
other persons of similar status and function in SBS Entities; the
number of employees that solicit municipal entities to enter security-
based swaps with SBS Dealers; SBS Dealer supervisory structures for
such employees; or political action committees controlled by such
persons or SBS Dealers. However, the Commission has previously
estimated that as many as 423 natural persons may associate with each
SBS Dealer.\1736\ Therefore, we believe that many SBS Entities are
likely to be able to take advantage of up to 3 annual exemptions
against inadvertent violations described above.
---------------------------------------------------------------------------

    \1735\ FIA/ISDA/SIFMA, supra note 5.
    \1736\ See Rule of Practice 194 Proposing Release, 80 FR at
51710.
---------------------------------------------------------------------------

    The final rules also allow SBS Dealers to file applications for
exemptive relief, and outline a list of items to be addressed,
including, whether the SBS Dealer has developed policies and procedures
to monitor political contributions; the steps taken after discovery of
the contribution; and the apparent intent in making the

contribution based on the facts and circumstances of each case. These
safe harbors, combined with the ability to apply for exemptive relief,
may partly mitigate the direct and indirect costs of SBS Dealers
triggering the timeout and being precluded from dealing with municipal
entities.
    As discussed in Section V, the incidence of exemptive relief
related to MSRB Rule G-37 and the number of applications the Commission
has received under the Adviser's act pay to play rules may be
indicative of possible applications for exemptive relief under these
final rules. Recognizing that this is an estimate, we conservatively
estimate that the Commission may receive up to two applications for
exemptive relief per year with respect to pay to play rules,\1737\ at a
total ongoing cost of $25,600 per year.\1738\
---------------------------------------------------------------------------

    \1737\ FINRA has granted 17 exemptive letters related to Rule G-
37 between 1/2005 and 12/2015 (11 years) http://www.finra.org/industry/exemptive-letters. As of 1/2016 there were 665 SEC
registered muni advisers http://www.sec.gov/help/foia-docs-muniadvisorshtm.html. Using these figures, we obtain an estimate of
(17 applications/11 years) x (50 SBS Dealers/665) = 0.117
applications per year.
    In addition, the Commission has received 13 applications under
the Adviser's act (since the compliance date, approximately 4
years). As of 2/2016 there were 11,959 registered investment
advisers filing form ADV https://www.sec.gov/foia/docs/invafoia.htm.
Using these figures, (13 applications/4 years) x (50 SBS Dealers/
11,959) = 0.014 applications per year.
    \1738\ Ongoing cost: (Outside counsel at $400 per hour x 32
hours per application x 2) = $25,600.
---------------------------------------------------------------------------

    Costs of compliance with the final pay to play rules may be
recovered by SBS Dealers in the form of higher costs of security-based
swaps offered to municipal entities. If the costs are significant and
cannot be fully recovered from counterparties some SBS Dealers may
limit their security-based swap transactions with municipal entities
and reduce their access to OTC security-based swaps. However, the pay-
to-play rules do not apply to security-based swaps executed on national
registered exchanges or SEFs, where the security-based swap dealer does
not know the identity of the counterparty to the transaction at a
reasonably sufficient time prior to execution to permit the security-
based swap dealer to comply. Therefore, municipal entities will retain
access to more liquid and standardized security-based swaps executed on
SEFs or registered national exchanges, and will continue to be able to
rely on security-based swaps as a tool for risk mitigation.
    Once SBS Dealers have to comply with the rule, to the extent that
SBS Dealers currently engaging in pay to play practices enjoy a
competitive advantage over SBS Dealers that are not, they may lose some
of their business with municipal entities and related profits. However,
other SBS Dealers that do not currently engage in pay to play practices
may win business, and SBS Dealers may begin to seek competitive
advantages through lower transaction costs, more customized security-
based swaps, or superior execution, benefitting municipal entity
counterparties.
    If some SBS Dealers currently intermediating a significant volume
of transactions with municipal entities trigger the two-year time out,
it could limit the number of SBS Dealers able to offer to enter into or
enter into security-based swaps with municipal entities. However, the
lost market share is likely to be picked up by other SBS Dealers. The
presence and direction of any economic effects would depend on the
number of SBS Dealers that trigger the time outs; the market power of
the prohibited SBS Dealers; the market power of SBS Dealers that may be
able to step in; and the importance of bilateral relationships.
Further, municipal entities will continue to have unconstrained access
to security-based swaps transacted through SEFs or registered national
security exchanges.
    The Commission recognizes that these rules impose restrictions on
persons that can represent special entities in security-based swap
transactions of special entities with SBS Entities. As discussed in
Section II.H.6.f, under Rule 15Fh-5(a)(1)(vi), qualified independent
representatives of special entities must be subject to pay to play
rules of the Commission, the CFTC or an SRO, except where the
independent representative is an employee of the special entity. If
special entities currently rely on advisors not subject to pay to play
rules, or do not rely on independent advisors in their transactions
with SBS Entities in security-based swaps, they will incur costs
related to retaining qualified independent representatives. These costs
will depend on the type of advisor search the special entity would
choose to perform, the special entity's ability to delegate such
functions to current employees, and labor market conditions for
qualified independent representatives. Table 2 of the economic baseline
shows that the overwhelming majority of special entities transact
through SEC registered investment advisers already subject to similar
pay to play rules under the Adviser's Act. Special entities that do not
transact through SEC registered investment advisers likely rely on
municipal advisors subject to MSRB rules or employees in their
transactions with SBS Entities. While we have no data or other
information to enable us to identify what fraction of advisors
representing special entities would meet the qualified independent
representative requirements of these final rules, the above
considerations indicate that costs of pay to play rules for independent
representatives of special entities may be mitigated.
    However, the Commission recognizes that, to the extent that some
representatives currently intermediating special entity transactions
with SBS Entities would be prohibited from advising special entities
under these final rules, some representatives may incur costs related
to loss of business, and competition among qualified independent
representatives of special entities may decrease. At the same time,
representatives prohibited from such activities under these final rules
may seek to register as SEC registered investment advisers, MSRB
registered municipal advisors or special entity employees, becoming
subject to pay to play rules referenced in Rule 15Fh-5(a)(1)(vi) and
continuing to represent special entities in compliance with these final
rules. Therefore, the overall effect of pay to play rules on
competition among qualified independent representatives of special
entities is unclear.
    As a result of the two-year time out and other pay to play
requirements, SBS Dealers transacting with municipal entities, as well
as covered associates of SBS Dealers, may be less likely to make
certain political contributions and payments to political parties at or
above de minimis thresholds. This may result in a decrease in funding
by SBS Dealers and their covered associates for such campaigns through
direct contributions and political action committees. However, to the
extent that the two-year time out may disincentivize direct
contributions, SBS Dealers and covered associates may turn to other
avenues of political speech, such as contributing unlimited amounts to
501(c) organizations or independent expenditure committees, which are
not required to disclose donors and are not prohibited under these
final rules.\1739\ Therefore, the overall effect of these final rules
on the aggregate volume of political contributions by SBS Dealers and
their covered associates to campaigns is unclear.
---------------------------------------------------------------------------

    \1739\ See, e.g., McCutcheon v. Federal Election Commission, 134
S.Ct. 1434, 1460 (2014).
---------------------------------------------------------------------------

    As clarified in Section II, the Commission is adopting an approach,
under which these prohibitions will not be triggered for an SBS Dealer
or any of

its covered associates by contributions made before the SBS Dealer
registered with the Commission as such. We also note that these
prohibitions will not apply to contributions made before the compliance
date of the rule by newly covered associates to which the look back
applies. At the same time, if individuals who later become covered
associates make a triggering contribution on or after the compliance
date of this rule, the contribution would trigger the two-year time out
if it were made less than, as applicable, six months or two years
before the individual became a newly covered associate.
    We have also considered the alternative, under which dealers would
enjoy a safe harbor where the municipal entity is represented by a
qualified independent representative, as proposed by one
commenter.\1740\ Such an alternative would lower the scope of entities
and transactions affected by the pay to play prohibitions. As discussed
in earlier sections and discussed in the economic baseline,
approximately 98% of special entities rely on investment advisers in
their CDS transactions. While we do not have data or information
allowing us to conclude whether these investment advisers would be
considered independent qualified representatives under our final rules,
this alternative has the potential to substantially reduce the scope of
application of the pay to play rules. While this may reduce direct and
indirect costs of pay to play rules for SBS Dealers, this may also
reduce their benefits, if qualified independent advisor representation
does not fully resolve conflicts of interest related to prohibited
political contributions by SBS Dealers and covered associates.
---------------------------------------------------------------------------

    \1740\ See SIFMA (August 2011), supra note 5.
---------------------------------------------------------------------------

    Finally, we have considered the alternative of increasing or
decreasing the number of exemptions for inadvertent violations. The
ability of SBS Dealers to cure reduces the risk that some SBS Dealers
may trigger a two-year timeout as a result of inadvertent violations
due to prohibited contributions by covered associates, related losses,
and potential adverse effects on competition and market liquidity. At
the same time, increasing the number of automatic exceptions available
to SBS Dealers decreases their incentives to monitor their and their
covered associates' political contributions, and may facilitate ongoing
pay to play practices. We also note that, under the rules being
adopted, in addition to such automatic exceptions, SBS Dealers would be
able to apply with the Commission for exemptive relief.
    We do not have data or any other information concerning the sizes,
donors and recipients of political contributions of entities that may
trigger SBS Dealer registration and covered associates. No such
information is publicly available, and commenters did not provide data
enabling such quantification. Therefore, we cannot quantify the
magnitude of the above effects.
8. Scope
a. Inter-Affiliate Transactions
    The final business conduct rules are designed to facilitate
counterparty protections, reduce information asymmetries, and enable
Commission oversight. However, as discussed in Sections V and VI above,
these final rules impose direct and indirect compliance costs, and may
erode SBS Entities' profitability of dealing in security-based swaps,
which may reduce the incentive for dealers to intermediate SBS
transactions and provide liquidity to end users. We recognize, however,
that some market participants, such as complex and diversified
corporations or institutions, may in the regular course of business
enter into inter-affiliate security-based swaps to manage risk inside a
corporate group or to transfer risk to a treasury department or central
affiliate.
    When the economic interests of those affiliates are aligned
adequately, as would be found in the case of majority-ownership, such
security-based swaps serve to allocate or transfer risks within an
affiliated group, rather than to move those risks out of the group to
an unaffiliated third party. Therefore, the application of these final
business conduct rules to security-based swaps that SBS Entities enter
into with majority-owned affiliates is unlikely to yield enhanced
counterparty protections as discussed above. At the same time, SBS
Entities would incur costs related to compliance with these final rules
for such transactions. Therefore, the exclusion of such transactions
may avoid costs that are less likely to be offset by the economic
benefits considered above. Further, the CFTC excludes such swaps from
substantive business conduct requirements for Swap Entities. Imposing
these rules with respect to such security-based swaps would increase
the relative costs of transacting in security-based swap markets,
including single-name CDS, and swap markets, including index CDS. Such
an approach may fragment an otherwise integrated market and could lead
to a flight of liquidity to swap markets, with follow on effects on
market liquidity and price discovery. As indicated earlier, Rule 15Fh-
1(a) specifies that security-based swaps that SBS Entities enter into
with the majority-owned affiliates will be excluded from Rules 15Fh-
3(a) through 15Fh-3(f), 240.15Fh-4(b) and 240.15Fh-5. We note that CCO
and supervision rules will continue to apply to dealers engaging in
such swaps.
b. Opt Out
    These final rules are intended to strengthen counterparty
protections, reduce informational asymmetries between SBS Entities and
their counterparties, and enhance Commission oversight over security-
based swap markets. We recognize the inherent heterogeneity in the
level of general sophistication and informedness specific to security-
based swaps of various counterparties of SBS Entities, as suggested by
some commenters.\1741\ The final rules do not allow counterparties of
SBS Entities to opt out from some or all of the substantive business
conduct requirements, such as disclosures of material characteristics,
risks, conflicts of interest, incentives and clearing rights;
suitability assessments or pay to play rules. As a result, more
sophisticated and better informed counterparties of SBS Entities may
enjoy few benefits, but may incur costs from these final rules.
---------------------------------------------------------------------------

    \1741\ See, e.g., CalSTRS, supra note 5.
---------------------------------------------------------------------------

    The final rules reflect these competing considerations through a
reliance on representations approach, and in safe harbors and
alternatives, such as the institutional suitability alternative for
customer-specific suitability and the independent advisor safe harbor
for SBS Entities advising special entities. Further, some of the
requirements, such as pre-trade disclosures of material incentives,
risks and characteristics, will not apply to counterparties that are
themselves SBS or Swap Entities. Yet other rules impose requirements on
SBS Dealers, but not on Major SBS Participants, recognizing the central
role of dealers as intermediaries in security-based swap markets.
Finally, as discussed throughout the release, many of these final
business conduct requirements are harmonized with CFTC and FINRA
conduct rules, which do not allow counterparties to opt out of these or
similar protections.
    We also note that if counterparties are able to opt-out of some or
all of the substantive requirements, SBS Entities may have an incentive
to require opt-out of these final rules prior to transacting

with their counterparties, or cease business with such counterparties.
This effect is more likely to be present for SBS Entity--counterparty
relationships, in which counterparties have the least bargaining power,
such as less sophisticated counterparties that do not regularly access
security-based swap markets, do not have established relationships with
multiple dealers, and engage in low volumes of security-based swap
activity. This may result in smaller, less sophisticated and less
informed counterparties, which are ex ante most likely to benefit from
the disclosures and protections in these final rules, opting out of
business conduct rules or risking the loss of access to OTC security-
based swaps if opt out was permitted. However, we recognize that the
ability of counterparties to opt out of these final rules would give
such entities greater flexibility in structuring their relationships
with SBS Entities relative to the approach being adopted, and allow
them to trade off the benefits of counterparty protections and
information benefits of these final rules against potentially greater
costs and lower liquidity in SBS Entity intermediated OTC security-
based swaps under these final business conduct standards.
    Finally, these economic considerations are attenuated by the fact
that many of the final rules are not applicable to if the SBS Entity
does not know the identity of the counterparty at a reasonably
sufficient time prior to the execution of the transaction to permit the
SBS Entity to comply with the obligations of the rule and, in certain
instances, the transaction is executed on a registered national
exchange or a registered or exempt SEF.
9. Cross-Border Application
    As the Commission has indicated in other releases,\1742\ security-
based swap markets are global, and market data presented in the
economic baseline demonstrates extensive cross-border participation in
security-based swap markets. For instance, Figure 1 shows that, based
on DTCC-TIW data for 2014, approximately half of all new accounts
participating in the market are accounts with a domicile outside the
U.S. Viewed from the perspective of the domiciles of the counterparties
booking credit default swap (``CDS'') transactions, approximately 48
percent of price forming North American corporate single-name CDS
transactions from January 2008 to December 2014 were cross-border
transactions between a U.S.-domiciled counterparty and a foreign-
domiciled counterparty, and an additional 40 percent of such CDS
transactions were between two foreign-domiciled counterparties (see
Figure 3). Thus, only 12 percent of the global transaction volume by
notional volume between 2008 and 2014 was between two U.S.-domiciled
counterparties, using registered office location of the TIW accounts to
identify domiciles. Together, these data indicate that cross-border
transactions are a common feature of dealing activity in the security-
based swap market.
---------------------------------------------------------------------------

    \1742\ See, e.g., Cross-Border Adopting Release, 79 FR at 47280,
supra note 684; U.S. Activity Proposing Release, 80 FR at 27454.
---------------------------------------------------------------------------

    Further, SBS Dealers and other counterparties are highly
interconnected, with most dealers transacting with hundreds of
counterparties, and most non-dealers transacting with several
dealers.\1743\ The global scale of the security-based swap market
allows counterparties to access liquidity across jurisdictional
boundaries, providing market participants with opportunities to share
these risks with counterparties around the world. Because dealers
facilitate the great majority of security-based swap transactions, with
bilateral relationships that extend to potentially thousands of
counterparties, deficiencies in SBS Dealer disclosures, recommendations
of unsuitable security-based swaps, and informational asymmetries may
affect a large number of counterparties and have potentially
significant cross-border implications.
---------------------------------------------------------------------------

    \1743\ Based on an analysis of 2014 DTCC-TIW transaction data,
accounts likely to register with the Commission as SBS Dealers have
on average 759 unique counterparties (a median of 453 unique
counterparties). All other accounts (i.e., those more likely to
belong to non-dealers) averaged four unique counterparties (a median
of three counterparties).
---------------------------------------------------------------------------

a. Scope of Application to SBS Entities
    As discussed in Section III, business conduct requirements fall
into two categories: Entity-level business conduct requirements, such
as CCO rules and supervision, and transaction-level requirements, such
as disclosure and suitability. The final rules create certain
exceptions from application of the transaction-level business conduct
requirements to registered SBS Dealers and Major SBS Participants in
certain transactions. With respect to SBS Dealers, these transaction-
level requirements will apply to any transaction that constitutes an
SBS Dealer's U.S. business but not to any transaction that constitutes
its foreign business. For U.S. SBS Dealers, U.S. business includes all
of their transactions, except for certain transactions conducted
through a foreign branch. For foreign SBS Dealers, U.S. business
includes all of their transactions with U.S. persons (except for
certain transactions conducted through a foreign branch of a U.S.-
person counterparty) and transactions captured by the U.S. Activity
Test (i.e., transactions with another non-U.S. person that the foreign
SBS Dealer arranges, negotiates, or executes using personnel located in
a U.S. branch or office).
    The final rule creates a slightly different exception for Major SBS
Participants. U.S. Major SBS Participants must comply with the business
conduct requirements in all their transactions, except for certain
transactions conducted through a foreign branch, and foreign Major SBS
Participants must comply with the requirements in their transactions
with U.S. persons, except for certain transactions conducted through a
foreign branch. Under the final rule, the exception for foreign Major
SBS Participants does not incorporate a U.S. Activity Test.
    In considering the economic effects of this cross-border approach,
we recognize that the economic baseline reflects markets as they exist
today, in which compliance with business conduct standards for
security-based swaps is not required. Therefore, these final business
conduct rules will apply with respect to security-based swap
transactions intermediated by SBS Entities where they currently do not.
Under Exchange Act Section 15F, these requirements apply to registered
SBS Entities by virtue of their registration with the Commission and,
in the absence of any exceptions to the requirements, would apply to
all business of a registered SBS Entity. However, final Exchange Act
rules 3a71-3(c) and 3a67-10(d) create certain exceptions, as described
above, that limit the application of these requirements to a subset of
the transactions of a registered SBS Entity. For example, a foreign SBS
Dealer transacting with a foreign counterparty will not be subject to
Title VII transaction-level business conduct requirements if the
foreign SBS Dealer does not rely on personnel located in the United
States to arrange, negotiate or execute the swap, including with
respect to transactions in which the foreign SBS Dealer's counterparty
may have relied on personnel located in the United States.
    However, we recognize that the inclusion of the U.S. Activity Test
in the definition of ``U.S. business'' for foreign

dealers may increase the set of transactions that will be required to
comply with these final business conduct rules, relative to the
alternative under which foreign dealers transacting with foreign
counterparties are not subject to these final rules. We also recognize
that capturing transactions of foreign SBS Entities with U.S. persons
may increase the set of transactions subject to the final business
conduct rules as compared to the alternative of not capturing such
transactions.
    The final cross-border approach to the scope of the final business
conduct requirements may produce several benefits. First, classifying
certain rules, such as diligent supervision and CCO rules, as entity-
level requirements that apply to the entire security-based swap
business of the registered SBS Entity may facilitate Commission
oversight of registered SBS Entities and enhance compliance with
federal securities laws and Commission rules. For example, as discussed
in Section III and in the Cross-Border Proposing Release, supervision
and CCO rules are aimed at mitigating conflicts of interest and
enhancing compliance with securities laws, rules and regulations
thereunder by the entire registered SBS Entity. The Commission
continues to recognize that relevant conflicts of interest and non-
compliance may arise as a result of transactions comprising an SBS
Entity's foreign business. Further, we note that CCO duties include
establishing, maintaining, and reviewing policies and procedures
reasonably designed to ensure compliance with applicable Exchange Act
requirements that apply to the SBS Entity as a whole. As discussed in
Section III, the Commission is applying diligent supervision and CCO
duties rules at the entity level.
    Second, by imposing transaction-level requirements on transactions
of SBS Entities with U.S.-person counterparties, subject to a tailored
foreign branch exception, these final rules result in disclosure,
suitability, fair and balanced communications and special entity
requirements, among others, applying to transactions that are
particularly likely to raise the types of counterparty protection and
other concerns addressed by Title VII business conduct requirements,
whether carried out by U.S. or foreign SBS Entities. Specifically, this
approach to security-based swap transactions between registered SBS
Entities and U.S. persons may potentially enhance the expected
counterparty protection, reduce information asymmetry, and facilitate
Commission oversight benefits of these final rules to the U.S.
security-based swap market.
    Third, requiring registered foreign SBS Dealers (but not Major SBS
Participants) to comply with business conduct requirements with respect
to any transaction with another non-U.S.-person counterparty that the
foreign SBS Dealer arranges, negotiates, or executes using personnel
located in the United States will facilitate more uniform regulatory
treatment of the security-based swap activity of registered SBS Dealers
operating in the United States, mitigating potential competitive
distortions.\1744\ Although applying other business conduct frameworks
(such as broker-dealer regulation) to this activity may achieve similar
regulatory goals, the availability of exceptions, exclusions and safe
harbors may mean that alternative frameworks may not apply to certain
business structures used by registered SBS Dealers to carry out their
business in the United States.\1745\ Moreover, these alternative
frameworks may apply only to the U.S. intermediary of the foreign SBS
Dealer and not to the SBS Dealer itself. These final rules will avoid
these differences in application, along with the potential competitive
disparities they may create, by subjecting all registered SBS Dealers
engaged in transactions captured by the U.S. Activity test to the same
business conduct framework, including, among others, disclosure,
suitability, and fair and balanced communication rules. Applying
business conduct rules to all security-based swap trades arranged,
negotiated or executed by personnel located in the U.S. also may reduce
disparities between U.S. and foreign SBS Dealers competing for business
with the same foreign counterparties.
---------------------------------------------------------------------------

    \1744\ We recognize that, depending on the business structure
that a registered U.S. or foreign SBS Dealer employs, an
intermediary (such as an agent that is a registered broker-dealer)
may already be subject to certain business conduct requirements with
respect to the SBS Dealer's counterparty in the transaction.
However, we continue to believe that it may be important that
registered SBS Dealers themselves are subject to these final
business conduct requirements with respect to security-based swap
transactions that are part of their U.S. business. Because SBS
Dealers and their agents may allocate between themselves specific
responsibilities in connection with these business conduct
requirements, to the extent that these requirements overlap with
requirements applicable directly to the agent (for example, in its
capacity as a broker), and the SBS Dealer allocates responsibility
for complying with relevant requirements to its agent, we expect any
increase in costs arising from the proposed rules may be mitigated.
    \1745\ For example, Exchange Act section 3(a)(4)(B) excepts
banks from the definition of ``broker'' with respect to certain
activity.
---------------------------------------------------------------------------

    We recognize that foreign SBS Dealers transacting with foreign
counterparties may be subject to foreign regulations in addition to
these final rules, giving rise to potentially duplicative compliance
costs, pointed out by commenters.\1746\ However, as discussed in
Section III above, the Commission believes that requiring registered
foreign SBS Dealers to comply with the transaction-level business
conduct requirements with respect to these transactions may enhance
transparency, strengthen counterparty protections, and integrity of the
U.S. security-based swap market.
---------------------------------------------------------------------------

    \1746\ See, e.g., IIB (July 2015), supra note 10; ISDA (July
2015), supra note 10; SIFMA-AMG (July 2015), supra note 10; SIFMA/
FSR (July 2015), supra note 10, commenting on the U.S. Activity
Proposing Release.
---------------------------------------------------------------------------

    Moreover, the Commission is adopting a framework that would
potentially permit foreign SBS Dealers to satisfy their requirements
with respect to certain of the business conduct requirements by
complying with comparable requirements of a foreign jurisdiction.
Therefore, foreign SBS Dealers engaged in U.S. Activity may be able to
comply with these final rules by complying with foreign jurisdictions'
rules and regulations, to the extent that the Commission makes
substituted compliance determinations and the other prerequisites to
substituted compliance have been satisfied. This may mitigate the
potential for conflicting requirements and duplication in compliance
costs. We recognize that there will be limits to the availability of
substituted compliance, including the possibility that substituted
compliance may be permitted with regard to some requirements and not
others, or that, in certain circumstances, substituted compliance may
not be permitted with respect to any requirements with regard to a
particular jurisdiction depending on our assessment of the
comparability of the relevant foreign requirements and the availability
of supervisory and enforcement arrangements among the Commission and
relevant foreign financial regulatory authorities. However, the
Commission does not believe it would be appropriate to permit foreign
security-based swap dealers to satisfy these final business conduct
requirements by complying with foreign requirements when the
prerequisites to substituted compliance have not been satisfied.\1747\
---------------------------------------------------------------------------

    \1747\ See Section III, supra.
---------------------------------------------------------------------------

    As we noted earlier, these rules limit the scope of application of
these final business conduct requirements by excluding certain
transactions of registered foreign and U.S. SBS Entities from the
requirements. However, as we have also noted, relative to the baseline,

final Exchange Act rules 3a71-3(c) and 3a67-10(d), together with the
substantive rules being adopted in this release, should result in an
increase in costs and benefits from the baseline. Specifically, the
final approach to cross-border application of the final business
conduct rules may increase assessment and programmatic costs of
registered SBS Dealers, but may also increase related counterparty
protections, reduce informational asymmetries and enhance Commission
oversight.
    With respect to assessment costs, registered SBS Entities likely
will establish systems to identify transactions that are subject to the
business conduct requirements. Foreign SBS Entities will need to
establish systems to identify transactions with U.S. persons (including
whether the transaction is conducted through a foreign branch of that
person), and foreign SBS Dealers will need to establish systems to
identify transactions falling within the U.S. Activity Test. Similarly,
U.S. SBS Entities will incur additional assessment costs related to
identifying their own transactions conducted through a foreign branch,
including such transactions with U.S.-person counterparties that
constitute transactions conducted through a foreign branch of those
U.S.-person counterparties. Most of the assessment costs with respect
to analysis and systems to track transactions have been evaluated in
connection with other Commission rules; therefore, our economic
baseline includes all registered SBS Entities have those systems in
place. For instance, in the Cross-Border Adopting Release, the
Commission estimated foreign SBS Entity assessment costs with respect
to systems tracking transactions with U.S. persons for purposes of
counting transactions toward the major security-based swap participant
position thresholds and the security-based swap dealer de minimis
thresholds.\1748\ Similarly, in the U.S. Activity Adopting Release, the
Commission evaluated the assessment costs to SBS Dealers related to
including transactions falling within the U.S. Activity Test in a non-
U.S. person's dealer de minimis requirements.\1749\ Once registered,
these SBS Entities will be able to use these systems in connection with
identifying whether a transaction is subject to the transaction-level
business conduct requirements.
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    \1748\ See Cross-Border Adopting Release, 79 FR 47332-34
(evaluating foreign SBS Dealer assessment costs with respect to
systems tracking transactions with U.S. persons); id. at 47353-54
(evaluating foreign Major SBS Participant assessment costs with
respect to systems tracking transactions with U.S. persons). In that
release, the foreign branch exception applied only to U.S. banks
that were themselves registered SBS Dealers, and our evaluation of
analysis costs borne by such persons were based on a system that
would evaluate whether a counterparty was a U.S. person, whether
that counterparty was transacting through a foreign branch, and
whether that counterparty was a registered SBS Dealer, among other
things. See, e.g., Cross-Border Adopting Release, 79 FR 47353.
Because the analysis to determine whether the transaction-level
business conduct requirements apply in a transaction by a foreign
SBS Entity with a U.S. person involve only a determination whether
the counterparty is a U.S. person and whether it is transacting
through a foreign branch, we believe that the system whose costs
were estimated in these prior releases should be sufficient for the
analysis required by foreign SBS Entities under these rules.
    \1749\ See U.S. Activity Adopting Release, 81 FR 8627
(evaluating assessment costs to SBS Dealers with respect to systems
for tracking transactions arising from U.S. activity).
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    However, in addition to these previously evaluated costs, U.S. SBS
Entities conducting business through a foreign branch will need to
classify their counterparties and transactions to determine whether
business conduct transaction-level requirements apply. We believe that
the costs to a U.S. SBS Entity of creating systems to identify
transactions it conducts through a foreign branch with U.S.-person
counterparties and to determine whether any such transactions are
conducted through the foreign branch of its U.S.-person counterparties
may be similar to costs associated with the systems that foreign
persons are likely to establish to perform the dealer de minimis or
major participant threshold calculations. In both cases such systems
would have to flag a person's security-based swaps against the specific
criteria embedded in the final rules. Based on the methodology set out
in the Cross-Border Adopting Release for estimating costs of systems
designed to identify similar criteria,\1750\ we estimate these
assessment costs may include one-time programming costs of $14,904 and
ongoing annual costs of $16,612 per SBS Entity.\1751\ Based on a review
of DTCC-TIW data relating to single-name CDS activity in 2014, we
estimate that up to 5 U.S. SBS Dealers conducted dealing activity
through foreign branches, and we conservatively estimate that there may
be as many as 5 U.S. Major SBS Participants. Assuming that all ten of
these U.S. SBS Entities elected to establish a system to identify
transactions conducted through a foreign branch or conducted through
the foreign branch of their U.S. counterparties, the total assessment
costs associated with our final business conduct rules would be
approximately $149,040 in one-time annual programming costs and
$166,120 in ongoing annual costs.\1752\
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    \1750\ See Cross-Border Adopting Release, 79 FR 47332, note 681.
See also Definitions Adopting Release, 77 FR 30734-35, note 107.
    \1751\ In the Definitions Adopting Release, we estimated that
the one-time programming costs of $13,692 per entity and annual
ongoing assessment costs of $15,268. See Definitions Adopting
Release, 77 FR 30734-35, and accompanying text (providing an
explanation of the methodology used to estimate these costs). The
hourly cost figures in the Definitions Adopting Release for the
positions of Compliance Attorney, Compliance Manager, Programmer
Analyst, and Senior Internal Auditor were based on data from SIFMA's
Management & Professional Earnings in the Securities Industry 2010.
    For purposes of the cost estimates in this release, we have
updated these figures with more recent data as follows: The figure
for a Compliance Attorney is $334/hour, the figure for a Compliance
Manager is $283/hour, the figure for a Programmer Analyst is $220/
hour, and the figure for a Senior Internal Auditor is $209/hour,
each from SIFMA's Management & Professional Earnings in the
Securities Industry 2013, modified by SEC staff to account for an
1800-hour work-year and multiplied by 5.35 to account for bonuses,
firm size, employee benefits, and overhead. We also have updated the
Definitions Adopting Release's $464/hour figure for a Chief
Financial Officer, which was based on 2011 data, with a revised
figure of $500/hour, for a Chief Financial Officer with five years
of experience in New York, that is from http://www.payscale.com,
modified by Commission staff to account for an 1800-hour work-year
and multiplied by 5.35 to account for bonuses, firm size, employee
benefits, and overhead. See http://www.payscale.com (last visited
Apr. 16, 2014).
    Incorporating these new cost figures, the updated one-time
programming costs based upon our assumptions regarding the number of
hours required in the Definitions Adopting Release would be $14,904
per entity, i.e., (Compliance Attorney at $334 per hour for 2 hours)
+ (Compliance Manager at $283 per hour for 8 hours) + (Programmer
Analyst at $220 per hour for 40 hours) + (Senior Internal Auditor at
$209 per hour for 8 hours) + (Chief Financial Officer at $500 per
hour for 3 hours) = $14,904, and the annual ongoing costs would be
$16,612 per entity, i.e., ((Senior Internal Auditor at $209 per hour
for 16 hours) + Compliance Attorney at $334 per hour for 4 hours) +
(Compliance Manager at $283 per hour for 4 hours) + (Chief Financial
Officer at $500 per hour for 4 hours) + (Programmer Analyst at $220
per hour for 40 hours) = $16,612).
    \1752\ One-time annual programming cost: $14,904 x 10 U.S. SBS
Entities = $149,040. Ongoing annual cost: $16,612 x 10 U.S. SBS
Entities = $166,120.
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    As recognized in Section III above, SBS Entities would be permitted
to rely on certain representations provided to them by their U.S. bank
counterparties regarding whether a transaction is conducted through a
foreign branch. Initial costs to the U.S. bank counterparties of
developing related representations are estimated at $195,000.\1753\
Aggregate ongoing costs to the U.S. bank counterparties of
representations are estimated at approximately $190,000 per year.\1754\
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    \1753\ Initial cost: Outside counsel $100,000 + ((Attorney at
$380 per hour) x 250 hours = $95,000) = $195,000).
    \1754\ Ongoing cost: (In-house attorney at $380 per hour) x 500
hours = $190,000.

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    This scope of transactions subject to business conduct requirements
may also affect the programmatic costs incurred by participants in
security-based swap markets. For entities already required to register
as SBS Entities under current rules, this rule may increase the set of
transactions and counterparties to which they must apply business
conduct requirements, relative to the baseline under which no business
conduct requirements apply. We continue to recognize that requiring
compliance of foreign SBS Dealers transacting with foreign
counterparties where transactions were arranged, negotiated or executed
by personnel located in the United States may discourage reliance by
foreign SBS Entities on personnel located in the United States. Some
foreign SBS Dealers transacting with foreign counterparties may choose
to relocate their personnel outside of the United States, or replace
personnel located in the United States with personnel not located in
the United States to avoid compliance with these final rules. To the
extent that these final rules may increase the costs of foreign SBS
Entities, or influence competition between U.S. and foreign SBS
Dealers, the terms of security-based swaps intermediated by foreign SBS
Dealers may deteriorate and foreign SBS Dealers may become less willing
to intermediate security-based swap transactions. The approach taken in
this rule may mitigate some of the commenter concerns with the initial
proposal by focusing only on the location of the foreign dealer's or
its agent's market-facing personnel, and not the location of its
counterparties' activity.\1755\ Further, these final rules allow for
the possibility of substituted compliance for foreign SBS Dealers,
including in connection with their security-based swap activity with
foreign counterparties. Therefore, as discussed above, these costs may
be incurred primarily by foreign SBS Entities subject to less stringent
business conduct rules in their foreign jurisdictions, where the ex-
ante benefits of these final rules may be greater.\1756\
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    \1755\ See U.S. Activity Adopting Release, 81 FR 8634.
    \1756\ See, e.g., SIFMA-AMG (July 2015) supra note 10 and ISDA
(July 2015), supra note 10, on the U.S. Activity Proposing Release.
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    The Commission has received comment that this approach to the
application of business conduct requirements may impose costs of
additional disclosures and representations on asset managers servicing
foreign clients.\1757\ As we noted in Section III, these final rules do
not apply directly to asset managers, and asset managers will incur no
liability under these rules. However, we recognize that SBS Entities
may have certain expectations of asset managers in connection with the
transactions involving funds. Depending on how SBS Entities and asset
managers choose to allocate these responsibilities, asset managers may
incur some fraction of the costs estimated above. The commenter also
argued that the final rules may result in asset managers separating
block trades for U.S. and non-U.S. persons, for whom business conduct
eligibility has not been verified, and obtaining assurances that the
dealer's personnel arranging, negotiating or executing block trades for
non-U.S. persons is not based in the U.S. We recognize that, to the
extent this affects the ability of asset managers to find
counterparties to block trades with non-U.S. persons or the costs of
doing so, liquidity may become fragmented and execution price of
certain block trades may be adversely affected. We note that some asset
managers may be complying with similar requirements, such as those
under the Exchange Act and FINRA rules applicable to U.S. broker-
dealers related to transactions in cash securities that these broker-
dealers intermediate on behalf of foreign brokers.
---------------------------------------------------------------------------

    \1757\ See SIFMA-AMG (July 2015), supra note 10, at 4.
---------------------------------------------------------------------------

    We have considered the alternative of applying business conduct
rules to all security-based swap transactions of all registered SBS
Entities. This approach would increase the scope of transactions
subject to these substantive rules, increasing programmatic costs of
compliance by registered SBS Entities--costs that are likely to be
passed on to counterparties. Under the rules being adopted, the U.S.
business of foreign SBS Dealers excludes transactions conducted through
a foreign branch. Further, the final rule provides for an exception
from the transaction-level business conduct requirements when a foreign
Major SBS Participant (or a U.S. Major SBS Participant in a transaction
conducted through its foreign branch) enters into a transaction with a
foreign branch of a U.S. person.
    To the extent that potential losses on security-based swap
transactions may flow from foreign branches of U.S. persons to the U.S.
business of U.S. persons, excluding transactions of foreign SBS Dealers
with foreign branches of U.S. persons from the definition of U.S.
business may increase risks to U.S. persons and impact the integrity of
U.S. markets. However, compliance with business conduct requirements
with respect to security-based swap transactions between foreign SBS
Entities and foreign branches of U.S. persons would further increase
costs of foreign SBS Entities. Such costs may be passed along to
foreign branches of U.S. persons in the form of higher transaction
costs or reduced access to security-based swap transactions with
foreign SBS Entities.\1758\ We lack data regarding the reliance of U.S.
persons on foreign branches for their security-based swap activity with
foreign SBS Dealers, current business conduct practices of foreign SBS
Dealers in their relationships with foreign branches of U.S. persons,
and the value of bilateral relationships for this group of market
participants. Therefore, we are unable to quantify these effects.
However, the approach being adopted recognizes these competing risk and
access considerations.
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    \1758\ See Cross-Border Adopting Release, 79 FR at 47343, supra
note 684.
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    The Commission has also considered the alternative of applying
these final business conduct rules to all transactions that a U.S. SBS
Entity enters into, including any transaction conducted through its
foreign branch. Importantly, the definition of ``transactions conducted
through a foreign branch'' requires the transaction to be arranged,
negotiated or executed in the foreign branch.\1759\ The activities of
foreign branches of U.S. SBS Dealers relying on foreign personnel
transacting with foreign counterparties may not pose the same
compliance and counterparty risks in U.S. markets as those addressed by
these final business conduct requirements. As a result, this
alternative may produce fewer intended benefits associated with these
final rules, but would increase costs of U.S. SBS Dealers transacting