Newly-proposed SEC swap rules establish Dodd-Frank mandated business conduct standards for governing certain security-based swap transactions.  Proposed Rules 15Fh-1 through 15Fh-6 and 15Fk-1 seek to implement business conduct requirements described in Dodd-Frank.  Among other things, the proposed rules would require SBS dealers and major SBS participants to:

• Verify whether a counterparty is an eligible contract participant and whether it is a special entity.

• Disclose to the counterparty material information about the security-based swap, including material risks, characteristics, incentives and conflicts of interest.

• Provide the counterparty with information concerning the daily mark of the security-based swap.    

• Provide the counterparty with information regarding the ability to require clearing of the security-based swap.
  

• Communicate with counterparties in a fair and balanced manner based on principles of fair dealing and good faith.

• Establish a supervisory and compliance infrastructure.

• Designate a chief compliance officer that is required to fulfill the described duties and provide an annual compliance report.

The proposed rules also would require security-based swap dealers to:

• Determine that any recommendations they make regarding security-based swaps are suitable for their counterparties (this proposal is similar to the FINRA rule regarding suitability, including institutional suitability).

• Establish, maintain and enforce policies and procedures reasonably designed to obtain and retain a record of the essential facts concerning each known counterparty that are necessary to conduct business with such counterparty.

• Comply with rules designed to prevent “pay-to-play.”

The proposed rules also would define what it means to “act as an advisor” to a special entity, and would require that a security-based swap dealer who acts as an advisor to a special entity:

• Act in the “best interests” of the special entity. 

• Make reasonable efforts to obtain information that it needs to determine that the recommendation is in the “best interests” of the special entity.

In addition, the proposed rules would require security-based swap dealers and major security-based swap participants acting as counterparties to special entities to reasonably believe that the counterparty has an independent representative who meets the following requirements:

• Has sufficient knowledge to evaluate the transaction and risks.

• Is not subject to a statutory disqualification.

• Is independent of the security-based swap dealer or major security-based swap participant.

• Undertakes a duty to act in the best interests of the special entity.

• Makes appropriate disclosures of material information concerning the security-based swap.

• Provides written representations to the special entity regarding fair pricing and appropriateness of the security-based swap.

In addition, the independent representative would be subject to pay-to-play regulations, and if the special entity is an ERISA plan, the independent representative would be required to be a fiduciary under ERISA.

Other Regulators.   The SEC worked closely with the CFTC in preparing this proposal.  The CFTC also has proposed rules with respect to the external business conduct standards of swap dealers and major swap participants - see Business Conduct Standards for Swap Dealers and Major Swap Participants with Counterparties, 75 FR 80638 (CFTC 12/22/10).    [SEC PR 11-137, 6/29/11]