Font Size: AAA // Print // Bookmark

2012-5317

  • Federal Register, Volume 77 Issue 64 (Tuesday, April 3, 2012)[Federal Register Volume 77, Number 64 (Tuesday, April 3, 2012)]

    [Rules and Regulations]

    [Pages 20128-20215]

    From the Federal Register Online via the Government Printing Office [www.gpo.gov]

    [FR Doc No: 2012-5317]

    [[Page 20127]]

    Vol. 77

    Tuesday,

    No. 64

    April 3, 2012

    Part II

    Commodity Futures Trading Commission

    -----------------------------------------------------------------------

    17 CFR Parts 1, 3, and 23

    Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and

    Duties Rules; Futures Commission Merchant and Introducing Broker

    Conflicts of Interest Rules; and Chief Compliance Officer Rules for

    Swap Dealers, Major Swap Participants, and Futures Commission

    Merchants; Final Rule

    Federal Register / Vol. 77 , No. 64 / Tuesday, April 3, 2012 / Rules

    and Regulations

    [[Page 20128]]

    -----------------------------------------------------------------------

    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Parts 1, 3, and 23

    RIN 3038-AC96

    Swap Dealer and Major Swap Participant Recordkeeping, Reporting,

    and Duties Rules; Futures Commission Merchant and Introducing Broker

    Conflicts of Interest Rules; and Chief Compliance Officer Rules for

    Swap Dealers, Major Swap Participants, and Futures Commission Merchants

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Final rule.

    -----------------------------------------------------------------------

    SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)

    is adopting regulations to implement certain provisions of Title VII of

    the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-

    Frank Act). These regulations set forth reporting and recordkeeping

    requirements and daily trading records requirements for swap dealers

    (SDs) and major swap participants (MSPs). These regulations also set

    forth certain duties imposed upon SDs and MSPs registered with the

    Commission with regard to: Risk management procedures; monitoring of

    trading to prevent violations of applicable position limits; diligent

    supervision; business continuity and disaster recovery; disclosure and

    the ability of regulators to obtain general information; and antitrust

    considerations. In addition, these regulations establish conflicts-of-

    interest requirements for SDs, MSPs, futures commission merchants

    (FCMs), and introducing brokers (IBs) with regard to firewalls between

    research and trading and between clearing and trading. Finally, these

    regulations also require each FCM, SD, and MSP to designate a chief

    compliance officer, prescribe qualifications and duties of the chief

    compliance officer, and require that the chief compliance officer

    prepare, certify, and furnish to the Commission an annual report

    containing an assessment of the registrant's compliance activities.

    DATES: The rules are effective June 4, 2012. Specific compliance dates

    are discussed in the supplementary information.

    FOR FURTHER INFORMATION CONTACT: Frank N. Fisanich, Chief Counsel, 202-

    418-5949, ffisanich@cftc.gov, Division of Swap Dealer and Intermediary

    Oversight, Ward P. Griffin, Counsel, 202-418-5425, wgriffin@cftc.gov,

    Office of the General Counsel, and Hannah Ropp, Economist, 202-418-

    5228, hropp@cftc.gov, Office of the Chief Economist, Commodity Futures

    Trading Commission, Three Lafayette Centre, 1155 21st Street NW.,

    Washington, DC 20581.

    SUPPLEMENTARY INFORMATION:

    Table of Contents

    I. Background

    II. Comments on the Notices of Proposed Rulemaking

    A. Regulatory Structure

    B. Reporting, Recordkeeping, and Daily Trading Records

    Requirements for SDs and MSPs

    C. General Records Requirement--Sec. 23.201

    D. Daily Trading Records--Sec. 23.202

    E. Records; Retention and Inspection--Sec. 23.203

    F. Duties of Swap Dealers and Major Swap Participants

    G. Risk Management Program for SDs and MSPs--Sec. 23.600

    H. Monitoring of Position Limits--Sec. 23.601

    I. Diligent Supervision--Sec. 23.602

    J. Business Continuity and Disaster Recovery--Sec. 23.603

    K. General Information: Availability for Disclosure and

    Inspection--Sec. 23.606

    L. Antitrust Considerations--Sec. 23.607

    M. Conflicts of Interest Policies and Procedures by SDs, MSPs,

    FCMs, and IBs--Sec. 23.605, Sec. 1.71

    N. Designation of a Chief Compliance Officer; Required

    Compliance Policies; and Annual Report of an FCM, SD, or MSP

    III. Effective Dates and Compliance Dates

    A. Comments Regarding Compliance Dates

    B. Compliance Dates

    IV. Cost Benefit Considerations

    A. Introduction

    B. General Considerations

    C. Comments Regarding the Scope of the Proposed Rules

    D. Recordkeeping, Reporting, and Daily Trading Records

    Requirements for SDs and MSPs

    E. Duties and Risk Management Requirements of SDs and MSPs

    F. Conflicts-of-Interest Policies and Procedures for SDs, MSPs,

    FCMs, and IBs

    G. Designation of a Chief Compliance Officer, Required

    Compliance Policies, and Annual Report of an FCM, SD, or MSP

    H. Conclusion

    V. Related Matters

    A. Regulatory Flexibility Act

    B. Paperwork Reduction Act

    I. Background

    The Commission is hereby adopting Sec. 23.200 through Sec. 23.205

    \1\ setting forth reporting and recordkeeping requirements and daily

    trading records requirements for SDs and MSPs, as required under

    sections 4s(f) and 4s(g) of the Commodity Exchange Act (CEA); Sec.

    23.600 through Sec. 23.607 setting forth certain duties imposed upon

    SDs and MSPs with regard to: (1) Risk management procedures; (2)

    monitoring of trading to prevent violations of applicable position

    limits; (3) diligent supervision; (4) business continuity and disaster

    recovery; (5) conflicts of interest policies and procedures; (6)

    disclosure and the ability of regulators to obtain general information;

    and (7) antitrust considerations, as required under section 4s(j) of

    the CEA; Sec. 3.3 requiring FCMs, SDs, and MSPs to designate a chief

    compliance officer, prescribing qualifications and duties of the chief

    compliance officer, and requiring the chief compliance officer to

    prepare, certify, and furnish to the Commission an annual report

    containing an assessment of the registrant's compliance activities, as

    required under sections 4d(d) and 4s(k) of the CEA; and Sec. 1.71

    setting forth certain duties imposed on FCMs and IBs with regard to

    implementing conflicts of interest policies and procedures, as required

    under section 4d(c) of the CEA; as well as amendments to Sec. 3.1 to

    add chief compliance officers to the definition of ``principal'' and to

    add a new definition of ``board of directors.''

    ---------------------------------------------------------------------------

    \1\ Commission regulations referred to herein are found at 17

    CFR Ch. 1.

    ---------------------------------------------------------------------------

    II. Comments on the Notices of Proposed Rulemaking

    The final rules adopted herein were proposed in five separate

    notices of proposed rulemaking.\2\ Each proposed rulemaking was subject

    to an initial 60-day public comment period and a re-opened comment

    period of 30 days.\3\ The Commission received a total of approximately

    114 comment letters directed specifically at the proposed rules.\4\ The

    Commission considered

    [[Page 20129]]

    each of these comments in formulating the final regulations.\5\

    ---------------------------------------------------------------------------

    \2\ See 75 FR 76666 (Dec. 9, 2010) (Reporting, Recordkeeping,

    and Daily Trading Records Requirements for Swap Dealers and Major

    Swap Participants (Recordkeeping NPRM)); 75 FR 71397 (Nov. 23, 2010)

    (Regulations Establishing and Governing the Duties of Swap Dealers

    and Major Swap Participants (Duties NPRM)); 75 FR 70152 (Nov. 17,

    2010) (Implementation of Conflicts of Interest Policies and

    Procedures by Futures Commission Merchants and Introducing Brokers

    (FCM/IB Conflicts NPRM)); 75 FR 71391 (Nov. 23, 2010)

    (Implementation of Conflicts of Interest Policies and Procedures by

    Swap Dealers and Major Swap Participants (SD/MSP Conflicts NPRM));

    and 75 FR 70881 (Nov. 19, 2010) (Designation of a Chief Compliance

    Officer; Required Compliance Policies; and Annual Report of a

    Futures Commission Merchant, Swap Dealer, or Major Swap Participant

    (CCO NPRM)).

    \3\ See 76 FR 25274 (May 4, 2011) (extending or re-opening

    comment periods for multiple Dodd-Frank proposed rulemakings).

    \4\ Comment files for each proposed rulemaking can be found on

    the Commission Web site, www.cftc.gov.

    \5\ The Commission also reviewed the proposed rule of the

    Securities and Exchange Commission concerning business conduct

    standards for security-based swap dealers and major security-based

    swap participants. See 76 FR 42396 (July 18, 2011).

    ---------------------------------------------------------------------------

    The Chairman and Commissioners, as well as Commission staff,

    participated in numerous meetings with representatives of potential SDs

    and MSPs, existing FCMs, trade associations, public interest groups,

    traders, and other interested parties. In addition, the Commission has

    consulted with other U.S. financial regulators including: (i) The

    Securities and Exchange Commission (SEC); (ii) the Board of Governors

    of the Federal Reserve System; (iii) the Office of the Comptroller of

    the Currency; and (iv) the Federal Deposit Insurance Corporation. Staff

    from each of these agencies has had the opportunity to provide oral

    and/or written comments to this adopting release, and the final

    regulations incorporate elements of the comments provided. The

    Commission intends to work with the Federal Deposit Insurance

    Corporation (FDIC) to establish appropriate information-sharing

    arrangements to ensure that the FDIC has the information it needs to

    exercise authority under Title II of the Dodd-Frank Act or the Federal

    Deposit Insurance Act with regard to any SD or MSP registered with the

    Commission.

    The Commission is mindful of the benefits of harmonizing its

    regulatory framework with that of its counterparts in foreign

    countries. The Commission has therefore monitored global advisory,

    legislative, and regulatory proposals, and has consulted with foreign

    regulators in developing the final regulations.

    A. Regulatory Structure

    The proposed regulations did not differentiate between SDs and MSPs

    that may be a division of a larger entity or institution, but not a

    separate legal entity. The proposed regulations also did not

    differentiate between SDs and MSPs, but, rather, applied identical

    rules to both types of entities. The proposals, however, solicited

    comments on whether certain provisions of the proposed regulations

    should be modified or adjusted to reflect the differences among SDs or

    MSPs. In addition, the proposed regulations tracked the scope of the

    statutory text, and did not, by their terms, apply only to the swap

    activities of SDs and MSPs.

    In its comment letter, Cargill, Incorporated (Cargill) argued that

    the proposed rules should recognize Congressional intent to permit a

    business with a swap dealing division to be subject to SD regulation

    only for the activities of that division. Cargill recommended that the

    Commission make clear that the Commission's regulations only apply to

    the swap dealing business of an SD that is a division of a larger

    company, and not to the other business activities of the company.

    MetLife, Inc. (MetLife), the Managed Funds Association (MFA),

    BlackRock, and the Asset Management Group of the Securities Industry

    and Financial Markets Association (AMG) each argued that the Dodd-Frank

    Act does not require that the Commission to apply the same rules to

    MSPs as those applied to SDs and that MSPs should not be subject to the

    same regulations as SDs because MSPs do not engage in market-making

    activities.

    The Securities Industry and Financial Markets Association (SIFMA)

    and the Federal Home Loan Banks (FHLBs) each recommended that the

    Commission's regulations should allow registrants that are regulated by

    a prudential regulator to comply with the Commission's regulations on a

    substituted compliance basis by complying with comparable regulations

    of their prudential regulator.

    In response to Cargill's comment, the Commission is including a new

    definition of ``swaps activities'' in the final regulations, as

    follows: ``Swaps activities means a registrant's activities related to

    swaps and any product used to hedge such swaps, including, but not

    limited to, futures, options, other swaps or security-based swaps, debt

    or equity securities, foreign currency, physical commodities, and other

    derivatives.''

    The Commission is using this term in the final regulations to (i)

    limit the scope of the risk management requirements in Sec. 23.600 to

    only the swap activities of SDs and MSPs; (ii) define the extent of the

    recordkeeping requirement in Sec. 23.201; and (iii) limit the scope of

    the duties and responsibilities of the chief compliance officer of an

    SD or MSP in Sec. 3.3 to the swaps activities of SDs and MSPs.\6\

    ---------------------------------------------------------------------------

    \6\ In addition, the Commission anticipates that under its

    further definition of ``swap dealer,'' an SD that has applied for

    and received a limited purpose designation from the Commission will

    be subject to these regulations only for the categories or

    activities for which the limited purpose designation is granted.

    ---------------------------------------------------------------------------

    The Commission is not modifying the regulations to differentiate

    between SDs and MSPs. The Commission observes that no provision of

    sections 4s(f), (g), (j), and (k) of the CEA, as added by the Dodd-

    Frank Act, differentiates between the duties and requirements of SDs

    and those of MSPs. The Commission thus has determined that the intent

    of sections 4s(f), (g), (j), and (k) is to apply the same requirements

    to MSPs and SDs, and the Commission is taking the same approach in the

    final regulations. The Commission believes that to the extent the final

    regulations are not applicable to an MSP's activities, the MSP is not

    burdened by being subject to the regulations.

    The Commission has considered but rejected a substituted compliance

    regime with respect to the final rule for registrants subject to

    regulation by a prudential regulator. The Commission notes that section

    4s(e) of the CEA grants prudential regulators exclusive authority to

    prescribe capital and margin requirements for SDs and MSPs that are

    banks, but does not extend such authority to any other part of section

    4s. Because SDs and MSPs will be registrants of the Commission, the

    Commission has determined that its interest in ensuring that all

    registrants are subject to consistent regulation outweighs any burden

    that may be placed on registrants that are subject to regulation by a

    prudential regulator. However, the Commission observes that many of its

    final regulations are modeled on prudential regulations and

    supervision. Thus the two regimes would be broadly consistent.

    B. Reporting, Recordkeeping, and Daily Trading Records Requirements for

    SDs and MSPs

    As added by section 731 of the Dodd-Frank Act, sections 4s(f) and

    4s(g) of the CEA established reporting and recordkeeping requirements

    and daily trading records requirements for SDs and MSPs.

    Section 4s(f)(1) requires SDs and MSPs to ``make such reports as

    are required by the Commission by rule or regulation regarding the

    transactions and positions and financial condition of the registered

    swap dealer or major swap participant.'' In the Recordkeeping NPRM, the

    Commission proposed regulations, pursuant to sections 4s(f)(1)(B)(i)

    and (ii) of the CEA, prescribing the books and records requirements of

    ``all activities related to the business of swap dealers or major swap

    participants,'' regardless of whether or not the entity has a

    prudential regulator.

    In addition, the Commission proposed regulations in the

    Recordkeeping NPRM pursuant to section 4s(g)(1) of the CEA, requiring

    that SDs and MSPs ``maintain daily trading records of the swaps of the

    registered swap dealer and major swap participant and all related

    records (including related cash and forward transactions) and recorded

    [[Page 20130]]

    communications, including electronic mail, instant messages, and

    recordings of telephone calls.'' The Commission notes that section

    4s(g)(3) requires that daily trading records for each swap transaction

    be identifiable by counterparty, and section 4s(g)(4) specifies that

    SDs and MSPs maintain a ``complete audit trail for conducting

    comprehensive and accurate trade reconstructions.'' The Commission

    received 14 comment letters in response to the Recordkeeping NPRM and

    considered each in formulating the final rules.

    C. General Records Requirement--Sec. 23.201

    Proposed Sec. 23.201 set forth the records that SDs and MSPs must

    maintain. The records required under the proposed rule included full

    and complete swap transaction information, including all documents on

    which swap information is originally recorded.

    1. Additional Types of Records To Be Retained

    In the Recordkeeping NPRM, the Commission requested comments

    regarding whether additional types of records other than those

    specified in the proposed rules should be required to be kept by SDs

    and MSPs. The Commission also requested comment regarding whether

    drafts of documents should be kept.

    The Working Group of Commercial Energy Firms (The Working Group)

    commented that the current proposal is sufficient and any additional

    record retention requirements would be of little value to the

    Commission. Chris Barnard, however, recommended that drafts of

    documents should also be kept, arguing that the decision process

    leading up to a final document can be very informative. In order to

    regulate the use of high-frequency and algorithmic trading strategies,

    Better Markets, Inc. (Better Markets) recommended that the Commission

    require SDs and MSPs that employ high-frequency and algorithmic trading

    strategies to maintain records of each strategy employed including a

    description of the strategy and its objectives and the algorithms

    employed, and to maintain a record of every order, cancellation, and

    trade that occurs in the implementation of each strategy, indexed to

    the electronic record of the strategy description and properly time

    stamped.

    Having considered these comments and the comments discussed below

    regarding specific recordkeeping requirements, the Commission has

    determined that the record retention requirements as proposed are

    sufficient and has not included any additional requirements in the

    final rules. With respect to Better Markets' comment, the Commission

    notes that pursuant to Sec. 23.600(d)(9), as adopted in this release

    and discussed further below, SDs and MSPs are required to ensure that

    use of trading programs is subject to policies and procedures governing

    their use, supervision, maintenance, testing, and inspection, and that

    such policies and procedures are subject to a recordkeeping requirement

    pursuant to Sec. 23.600(g).

    2. Reliance on Records of Swap Data Repositories

    The proposed regulations did not address whether an SD or MSP may

    rely on reporting a swap to a swap data repository (SDR) as a means of

    meeting their recordkeeping requirements. Proposed Sec. 23.203(b)(2)

    required records of any swap to be kept for the life of the swap and

    for a period of five years following the termination, maturity,

    expiration, transfer, assignment, or novation date of the swap.

    The International Swaps and Derivatives Association (ISDA) and

    SIFMA (together, ISDA & SIFMA) requested that the Commission clarify

    the extent to which SDs and MSPs may rely upon SDRs to retain records

    beyond the time periods that registrants currently retain such records.

    ISDA & SIFMA did not elaborate on the current retention periods for

    swaps records, nor did they explain how this approach would work in the

    absence of established SDRs for all types of swaps.

    At this time, the Commission has determined not to permit SDs and

    MSPs to rely solely on SDRs to meet their recordkeeping obligations

    under the rules. The Commission believes that reliance on SDRs may be a

    cost-efficient alternative in the future, but such reliance would be

    premature at the present time. Additionally, the Commission believes

    that SDs and MSPs must maintain complete records of their swaps for the

    purposes of risk management. The data that is required to be reported

    to an SDR may not be sufficient for these purposes.

    3. Transaction Records Maintained in a Form and Manner Identifiable and

    Searchable by Transaction and Counterparty--Sec. Sec. 23.201(a)(1),

    23.202(a), and 23.202(b)

    Proposed Sec. 23.201(a)(1) required SDs and MSPs to keep

    transaction records in a form identifiable and searchable by

    transaction and by counterparty. Proposed Sec. Sec. 23.202(a) and

    23.202(b) also required SDs and MSPs to keep daily trading records for

    each swap and any related cash or forward transaction as a separate

    electronic file identifiable and searchable by transaction and

    counterparty.

    ISDA & SIFMA recommended that the decision whether to maintain each

    transaction record as a separate electronic file be left to the

    reporting counterparties. ISDA & SIFMA argued that SDs and MSPs

    routinely store data across a number of systems, and that aggregating

    transaction data from all systems into a single electronic file would

    require enormous investment across market participants and would

    require a substantial implementation period.

    The Working Group argued that tying records of unfilled or

    cancelled orders, correspondence (e.g., voice records, email, and

    instant messages), journals, memoranda, and other records required by

    proposed Sec. 23.201(a)(1) to each individual transaction in a manner

    that is identifiable and searchable by transaction would create an

    enormous technical burden, likely requiring the review, sorting, and

    assignment of such data to each transaction manually by individual

    employees. The Working Group recommended therefore that the Commission

    allow SDs and MSPs to maintain records of the required information in

    the form and manner currently employed by such firms, not in a single

    comprehensive file, if such records would be readily accessible and

    could be provided to the Commission within a reasonable amount of time

    following a request.

    The Commission agrees with the comments, in part, and is modifying

    the proposed rules to remove the provision in Sec. 23.202(a) and Sec.

    23.202(b) that requires each transaction record to be maintained as a

    separate electronic file. The Commission believes that this

    modification will make the requirement less burdensome for SDs and MSPs

    because it will allow such registrants to maintain searchable databases

    of the required records without the added cost and time needed to

    compile records into individual electronic files. The Commission notes

    that the rule, as modified, does not require the raw data in such

    databases to be tagged with transaction and counterparty identifiers so

    long as the SD or MSP can readily access and identify records

    pertaining to a transaction or counterparty by running a search on the

    raw data. In response to The Working Group's comments, the Commission

    confirms that swap records can be maintained under current market

    practice so long as the records are readily accessible, are

    identifiable and searchable by transaction and counterparty, and

    otherwise meet the

    [[Page 20131]]

    requirements of Sec. 1.31, as required under Sec. 23.203.

    However, the Commission observes that section 4s(g)(3) of the CEA

    requires registrants to ``maintain daily trading records for each

    counterparty in a manner and form that is identifiable with each swap

    transaction.'' In accordance with this statutory provision, the rules

    clarify that such trading records should be searchable by transaction

    and by counterparty. Maintaining records in this manner may prove

    costly for some SDs and MSPs, but this approach is required by statute

    and necessary for accurate audit trail construction, which is paramount

    for successful enforcement of trade practice cases.

    4. Business Records--Sec. 23.201(b)

    As proposed, Sec. 23.201(b) required SDs and MSPs to keep full,

    complete, and systematic business records, including records related to

    corporate governance, financial records, complaints, and marketing and

    sales materials.

    The Working Group acknowledged that market participants presently

    retain records that would qualify as business records under the

    proposal, although not in a single comprehensive file. The Working

    Group recommended that the Commission permit these records to be

    retained as they currently are in the normal course of business, as

    long as such records can be readily accessed and provided to the

    Commission upon request. For example, many entities retain financial

    records within their accounting departments, while marketing and sales

    materials would be retained separately within another division. The

    Working Group also recommended that the Commission clarify that when a

    subsidiary is determined to be an SD or MSP, but its parent company is

    not, business records should only be required to be retained for the

    subsidiary.

    In response to The Working Group's comments, the Commission

    confirms that the rule does not require SDs and MSPs to keep the

    required business records in a single comprehensive file. So long as

    SDs and MSPs are keeping full, complete, and systematic business

    records that are available for inspection or disclosure, the

    requirements of Sec. 23.201(b) would be met. The Commission also notes

    that the rule applies only to registered SDs and MSPs, and, therefore,

    the rules would not apply to the parent company of a registrant unless

    the parent company is also an SD or MSP.

    5. Records of Complaints Received--Sec. 23.201(b)

    Proposed Sec. 23.201(b) required SDs and MSPs to retain a record

    of complaints received, certain identifying information about the

    complainant, and a record of the disposition of the complaint.

    MFA commented that the requirement to retain a record of complaints

    is inappropriate for MSPs because, except in the event such entities

    are registered as commodity trading advisors or commodity pool

    operators: (a) Entities that may be classified as MSPs would not be

    members of NFA or similar organizations; and (b) the filing of such

    complaints against entities that may be classified as MSPs is neither

    customary nor consistent with such entities' activities in the market.

    Having considered MFA's comment, the Commission is adopting the

    rule as proposed. MSPs are, by definition, market participants that

    have a substantial position in swaps, that have outstanding swaps that

    create substantial counterparty exposure that could have serious

    adverse effects on the financial stability of the U.S. financial

    markets, or that are highly leveraged. Consequently, the Commission

    believes it is possible that a record of complaints, or a pattern of

    complaints, made against an MSP could be of regulatory value to the

    Commission. The Commission also notes that pursuant to the Commission's

    MSP registration rule, each MSP registered with the Commission is also

    required to be a member of at least one registered self-regulatory

    organization (SRO).\7\

    ---------------------------------------------------------------------------

    \7\ See 17 CFR 170.16 Registration of Swap Dealers and Major

    Swap Participants, 77 FR 2613 (Jan. 19, 2012) (stating ``Each person

    registered as a swap dealer or a major swap participant must become

    and remain a member of at least one futures association that is

    registered under section 17 of the Act and that provides for the

    membership therein of such swap dealer or major swap participant, as

    the case may be, unless no such futures association is so

    registered.''), available at www.cftc.gov.

    ---------------------------------------------------------------------------

    6. Records of Marketing and Sales Materials--Sec. 23.201(b)(4)

    Proposed Sec. 23.201(b)(4) required SDs and MSPs to retain copies

    of all marketing and sales presentations, advertisements, literature,

    and communications, and a record of the SD's or MSP's compliance with

    applicable Federal requirements, Commission regulations, and the rules

    of any SRO related to marketing and sales materials.

    MFA commented that because MSPs are not market makers, they do not

    produce such materials for public dissemination. Therefore, MFA felt

    that the concerns about SD marketing and sales materials that

    necessitate the SDs' recordkeeping requirement are inapplicable to

    MSPs.

    The Commission has decided not to remove MSPs from the relevant

    provisions of the rule because MSPs would need to comply with the

    recordkeeping requirement only to the extent that they produce such

    materials. To the extent that an MSP does not produce marketing or

    sales materials, the requirements of the rule would be inapplicable.

    7. Records of Date and Time of Reports To Swap Data Repositories and

    Data Reported in Real-Time--Sec. 23.201(c) and Sec. 23.201(d)

    Proposed Sec. 23.201(c) required SDs and MSPs to retain a record

    of the date and time the SD or MSP reported data or information to SDRs

    under proposed Part 45. Proposed Sec. 23.201(d) required SDs and MSPs

    to retain a record of the date and time the SD or MSP reported

    information for purposes of real-time public reporting under proposed

    Part 43.

    With regard to such records, The Working Group requested that the

    Commission clarify that the record of the date and time of reports to

    SDRs and for real-time public reporting be to the minute, and not to

    the second.

    The proposed rule did not specify the form of the depiction of time

    in records of reports made under parts 43 or 45, other than to say that

    the record must include the ``date and time.'' The Commission confirms

    that SDs and MSPs may record time for the purpose of Sec. 23.201 in

    their discretion, so long as they comply with any independent

    requirements under Parts 43 and 45.

    8. Records of a ``Rationale'' for Certain Swap Determinations--Sec.

    23.201(d)(2) & (3)

    Proposed Sec. 23.201(d)(2) and (3) required SDs and MSPs to retain

    a record of the rationale for reporting a less specific data field than

    is required under the proposed real-time public reporting requirements

    in part 43, and a record of the rationale for determining that a swap

    is a large notional swap as required under proposed part 43.

    The Working Group requested clarification as to what the Commission

    is seeking with respect to a ``rationale'' for these scenarios. The

    Working Group questions what purpose this information would serve, or

    what benefit the Commission hopes to derive for purposes of carrying

    out its duties under the CEA.

    [[Page 20132]]

    The Commission has determined that any substantive recordkeeping

    requirements necessary for compliance with Part 43 will be taken up in

    that part and thus has deleted the proposed ``rationale'' requirements

    from Sec. 23.201.

    D. Daily Trading Records--Sec. 23.202

    Section 4s(g)(1) of the CEA requires that SDs and MSPs maintain

    daily trading records of their swaps and ``all related records

    (including related cash and forward transactions).'' Section 4s(g)(1)

    also requires that SDs and MSPs maintain recorded communications,

    including electronic mail, instant messages, and recordings of

    telephone calls. Section 4s(g)(2) provides that the daily trading

    records shall include such information as the Commission shall require

    by rule or regulation. Proposed Sec. 23.202 prescribed daily trading

    record requirements, which would include trade information related to

    pre-execution, execution, and post-execution data.

    1. Records of Pre-Execution Trade Information--Sec. 23.202(a)(1)

    Proposed Sec. 23.202(a)(1) required SDs and MSPs to make and keep

    records of pre-execution trade information, including records of all

    oral and written communications concerning quotes, solicitations, bids,

    offers, instructions, trading, and prices that lead to the execution of

    a swap, however communicated.

    The Air Transport Association of America, Inc. (ATA) commented that

    the current telephone recording systems in use by SDs and MSPs may not

    meet all of the proposed rule's requirements, and that implementing

    telephone recording systems that are compliant with the requirements

    would impose a significant additional cost. The ATA's members

    recognized that there may be benefits from the recording requirement,

    but they are uncertain that those benefits outweigh the costs of

    purchasing new, or upgrading existing, telephone phone recording and

    retrieval systems. The ATA is concerned that the cost of complying with

    all of the various rules proposed by the Commission will erect

    unnecessarily high barriers to entry for SDs, foreclosing all but the

    largest firms from acting as SDs.

    MFA commented that it would be inappropriate to impose on MSPs the

    additional burden of maintaining a record of all oral communications

    made or received because the SDs with which MSPs enter into swaps would

    record such information. For the same reasons, MFA commented that the

    Commission should not require MSPs to create records of the date and

    time of quotations received or the date and time of execution of each

    swap and each related cash or forward transaction.

    The Working Group argued that even if technology exists to record

    the required data in a format searchable by transaction and

    counterparty, it would not be possible to identify pre-execution data

    specified by the Commission as being applicable to a specific trade

    because traders and other commercial employees typically engage in

    ongoing dialogue with counterparties over an extended period of time

    and do not initiate communications specific to a single trade. The

    Working Group commented that it would be extremely difficult and time

    consuming to review manually each communication by a specific trader to

    determine which conversations or documents ultimately led to the

    execution of a particular swap and then assign that communication to a

    unified file.

    ISDA & SIFMA asserted that where pre-execution records are

    maintained today they are captured prior to the execution of a swap and

    as such they are not linked to a trade. ISDA & SIFMA argued that while

    it may be possible potentially to search by counterparty with some

    investment in additional technology, it would not be possible to search

    by transaction because the infrastructure to link to a transaction is

    not in place today and the procedural and technical feasibility to do

    so has not been contemplated nor evaluated. ISDA & SIFMA strongly

    recommended that the Commission limit the rule to a description of data

    required as part of a trading record without dictating how such data

    should be stored and, in particular, that the Commission exclude oral

    communications from the electronic searchability requirement.

    Having considered these comments, the Commission is modifying the

    proposed rule to remove the requirement that each transaction record be

    maintained as a separate electronic file, which should be less

    burdensome for SDs and MSPs because it will allow these registrants to

    maintain searchable databases of the required records without the added

    cost and time needed to compile the required records into individual

    electronic files. The Commission notes that section 4s(g)(3) of the CEA

    requires registrants to ``maintain daily trading records for each

    counterparty in a manner and form that is identifiable with each swap

    transaction.'' The rule as adopted clarifies that such counterparty

    records must be searchable by transaction and by counterparty.

    Maintaining records in this form may prove costly for some registrants,

    but such form is mandated by the CEA.

    However, in light of commenters' concerns, the Commission is

    adopting Sec. 23.206, which delegates to the Director of the Division

    of Swap Dealer and Intermediary Oversight the authority to establish an

    alternative compliance schedule for requirements of Sec. 23.202 that

    are found to be technologically and economically impracticable for an

    SD or MSP affected by Sec. 23.202. The purpose of Sec. 23.206 is to

    facilitate the ability of the Commission to provide a technologically

    practicable compliance schedule for affected SDs or MSPs that seek to

    comply in good faith with the requirements of Sec. 23.202.

    In order to obtain relief under Sec. 23.206, an affected SD or MSP

    must submit a request for relief to the Director of the Division of

    Swap Dealer and Intermediary Oversight. SDs and MSPs submitting

    requests for relief must specify the basis in fact supporting their

    claims that compliance with Sec. 23.202 would be technologically or

    economically impracticable. Such a request may include a recitation of

    the specific costs and technical obstacles particular to the entity

    seeking relief and the efforts the entity intends to make in order to

    ensure compliance according to an alternative compliance schedule.

    Relief granted under Sec. 23.206 shall not cause a registrant to be

    out of compliance or deemed in violation of any registration

    requirements.

    Such requests for an alternative compliance schedule shall be acted

    upon by the Director of the Division of Swap Dealer and Intermediary

    Oversight or designees thereto within 30 days from the time such a

    request is received. If not acted upon within the 30 day period, such

    request will be deemed approved.

    The Commission notes that some commenters to a proposed Commission

    rulemaking to amend Sec. 1.35,\8\ which would require voice recording

    for futures and swap trading by FCMs and other registrants, raised

    questions about statements made in the preamble of the Recordkeeping

    NPRM. In that preamble, the Commission stated that proposed Sec.

    23.202 ``would not establish an affirmative new requirement to create

    recordings of all telephone conversations if the complete audit trail

    requirement can be met through other means, such as electronic

    messaging or trading.'' \9\ For avoidance of doubt, the Commission

    notes that the rule requires

    [[Page 20133]]

    a record of ``all oral and written communications provided or received

    concerning quotes, solicitations, bids, offers, instructions, trading,

    and prices, that lead to the execution of a swap.'' Thus, to the extent

    this pre-execution trade information does not include information

    communicated by telephone, the Commission confirms that an SD or MSP is

    under no obligation to create recordings of its telephone

    conversations. If, however, any of this pre-execution trade information

    is communicated by telephone, the SD or MSP must record such

    communications.

    ---------------------------------------------------------------------------

    \8\ See Comments to Adaptation of Commission Regulations to

    Accommodate Swaps, 76 FR 33066, 33088-89 (June 7, 2011), available

    on the Commission's Web site: www.cftc.gov.

    \9\ See Recordkeeping NPRM, 75 FR at 76668.

    ---------------------------------------------------------------------------

    With respect to MFA's comments, section 4s(g)(4) of the CEA applies

    to both SDs and MSPs. Consequently, the audit trail requirements of the

    proposed rules apply equally to both SDs and MSPs because it is

    necessary that all Commission registrants have complete and accurate

    daily trading records. Moreover, the Commission notes that MFA did not

    provide any factual support for its assertion that every swap entered

    by an MSP would have an SD as the counterparty.

    2. Records of Source and Time of Quotations--Sec. 23.202(a)(1)(ii)

    Proposed Sec. 23.202(a)(1)(ii) required SDs and MSPs to make and

    keep a record of the date and time, using Coordinated Universal Time

    (UTC), by timestamp or other timing device, for each quotation provided

    to, or received from, a counterparty prior to execution of a swap.

    The Working Group argued that the Commission should not require a

    timestamp for every quote given or received, as the timestamp is

    unnecessary, overly burdensome, and would not assist in trade

    reconstruction. Further, The Working Group argued that most entities do

    not currently capture or store this information, that it would be

    difficult to do so, particularly given that quotations may be developed

    by multiple sources, and retention of the time of quotations will add

    additional compliance costs on market participants. The Working Group

    also requested clarification as to the meaning of ``reliable timing

    data for the initiation'' of a transaction.

    MFA commented that the Commission should not require MSPs to create

    records of the date and time of quotations received or the date and

    time of execution of each swap and each related cash or forward

    transaction. MFA argued that since SDs should keep such records in

    connection with their market-making activities, to require an MSP

    customer to maintain the same records would be duplicative and a

    significant and unnecessary burden on MSPs.

    Having considered these comments, the Commission is adopting the

    rule as proposed. As noted above, the Commission observes that section

    4s(g)(4) of the CEA requires both SDs and MSPs to maintain a complete

    audit trail for conducting comprehensive and accurate trade

    reconstructions. The Commission therefore believes that the audit trail

    requirements of the rule should apply to both SDs and MSPs because it

    is necessary that all Commission registrants have complete and accurate

    daily trading records. As explained above, no support has been offered

    for MFA's assertion that an SD will be the counterparty to every swap

    executed with an MSP. Additionally, a comprehensive and accurate trade

    reconstruction necessarily entails a reconstruction of the sequence of

    events leading up to a trade and that this sequence cannot be

    reconstructed accurately without reliable timing information. It is

    noteworthy that commenters were unable to provide any alternative to

    the timestamp requirement. Therefore, the Commission is retaining the

    timestamp requirement in the final rule.

    With respect to The Working Group's concern regarding the

    ``reliable timing data'' requirement, the Commission confirms that the

    form of ``reliable timing data'' could be a timestamp, but the exact

    form is left to the discretion of the registrant.

    3. Timestamp for Quotations Using Universal Coordinated Time (UTC)--

    Sec. 23.202(a)(1)(ii)

    The proposed regulation required SDs and MSPs to record the time of

    each quotation provided to or received from a counterparty prior to

    execution using Universal Coordinated Time.

    ISDA & SIFMA commented that the value derived by moving the

    industry to UTC appears minimal when compared to the costs involved.

    ISDA & SIFMA provided the Commission with no quantitative data

    regarding these purported additional costs.

    Having considered ISDA & SIFMA's comment, the Commission is

    adopting the rule as proposed. The use of UTC in the rule reflects a

    consistent approach taken by the Commission in this rule and the

    Commission's final rules for real-time public reporting \10\ and the

    swap data reporting rule.\11\ By requiring the use of UTC in Sec.

    23.202, the Commission is ensuring that the requirements of Part 23,

    Part 43, and Part 45 remain consistent to the extent possible.

    ---------------------------------------------------------------------------

    \10\ See Real-Time Public Reporting of Swap Transaction Data, 77

    FR 1182, 1251 (Jan. 9, 2012).

    \11\ See Swap Data Recordkeeping and Reporting Requirements, 77

    FR 2136, 2212 (Jan. 13, 2012).

    ---------------------------------------------------------------------------

    4. Records of Time of Execution--Sec. 23.202(a)(2)(iv)

    Proposed Sec. 23.202(a)(2)(iv) required SDs and MSPs to record the

    date and time of execution of each swap to the nearest minute.

    The Working Group argued that the proposed rule conflicts with both

    the proposed real-time reporting rule and proposed swap data

    recordkeeping and reporting rule, which required that the time of

    execution be displayed to the second, rather than minute. The Working

    Group requested that the Commission be consistent in all of the its

    recordkeeping and reporting rules, and further requested that the

    Commission adopt a minute requirement, rather than displaying to the

    second.

    The Commission is adopting the rule as proposed. The Commission

    notes that the ``nearest minute'' standard is the standard for futures

    orders under existing Sec. 1.35. The Commission also notes that the

    final swap data recordkeeping and reporting rule does not require the

    time of execution be displayed to the second.\12\ While the proposed

    real-time reporting rule would require a registrant to record the time

    of execution to the second in some instances, the Commission believes

    recordkeeping to the nearest minute is sufficient for purposes of

    maintaining daily trading records and is consistent with Sec. 1.35.

    ---------------------------------------------------------------------------

    \12\ See Swap Data Recordkeeping and Reporting Requirements, 77

    FR 2136, 2212, 2215 (Jan. 13, 2012).

    ---------------------------------------------------------------------------

    5. Records of Reconciliation Processes--Sec. 23.202(a)(3)(iii)

    Proposed Sec. 23.202(a)(3)(iii) required SDs and MSPs to keep

    records of portfolio reconciliation results, categorized by transaction

    and counterparty.

    ISDA & SIFMA commented that maintaining records of reconciliation

    processes by transaction and counterparty may be particularly

    problematic because this data is not required to be captured in other

    markets, such as securities or bond markets, and significant additional

    infrastructure development would thus be required before this data

    could be captured and stored. ISDA & SIFMA recommended an ongoing

    dialogue between the Commission and the industry to understand the

    requirements for systems needed to meet the

    [[Page 20134]]

    requirements of the proposed rule, in particular the degree to which

    retained data will need to be identifiable and searchable.

    The records of portfolio reconciliation results required under the

    rule are the minimum needed to monitor an SD's or MSP's compliance with

    the Commission's proposed Sec. 23.502 on portfolio reconciliation.\13\

    Thus, the Commission is adopting the rule as proposed.

    ---------------------------------------------------------------------------

    \13\ See Confirmation, Portfolio Reconciliation, and Portfolio

    Compression Requirements for Swap Dealers and Major Swap

    Participants, 75 FR 81519, 81531 (Dec. 28, 2010).

    ---------------------------------------------------------------------------

    6. Daily Trading Records for Cash and Forward Transactions Related to a

    Swap--Sec. 23.202(b)

    Proposed Sec. 23.202(b) required SDs and MSPs to keep daily

    trading records, similar to those SDs and MSPs are required to keep for

    swaps, for related cash and forward transactions, defined under

    proposed Sec. 23.200 as ``a purchase or sale for immediate or deferred

    physical shipment or delivery of an asset related to a swap where the

    swap and the related cash or forward transaction are used to hedge,

    mitigate the risk of, or offset one another.''

    The Working Group urged the Commission to recognize that, although

    participants in physical energy commodity markets use swaps and futures

    to hedge underlying physical positions, they do not, as a general

    matter, execute such transactions specifically for the purpose of

    hedging a specified underlying physical position. Rather, according to

    The Working Group, the predominant practice in physical energy markets

    is to hedge underlying physical positions on a portfolio or aggregate

    basis. Given the wide use of portfolio hedging in energy markets, The

    Working Group believes it would be difficult for energy market

    participants to link physical positions with arguably ``related'' swap

    transactions. The Working Group believes that compliance with proposed

    Sec. 23.202(b) would impose a large number of very expensive and

    burdensome requirements on millions of physical transactions that are

    undertaken by commercial energy firms that are also parties to swap

    transactions.

    ISDA & SIFMA commented that hedging and risk mitigation activities

    referred to in the proposed daily trading records rule are typically

    not executed with respect to specific trades; rather they are executed

    against the overall positions of business units such as trading desks

    and that it would not be possible to link cash and forward transactions

    to a specific swap. ISDA & SIFMA also commented that the reference to

    ``hedge'' also requires clarity to know the extent to which it comports

    with existing definitions in the CEA.

    Having considered these comments, the Commission is adopting the

    rule as proposed. The Commission notes that section 4s(g)(1) of the CEA

    requires registrants to ``maintain daily trading records of their swaps

    * * * and related records (including related cash and forward

    transactions) * * *.'' Rule Sec. 23.200 defines ``related cash and

    forward transactions'' as ``a purchase or sale for immediate or

    deferred physical shipment or delivery of an asset related to a swap

    where the swap and the related cash and forward transaction are used to

    hedge, mitigate the risk of, or offset one another.'' The Commission

    observes that the definition requires that a ``related cash and forward

    transaction'' be related to at least one swap, but does not prohibit

    such transaction from being related to more than one swap, or a swap

    from being related to more than one related cash or forward

    transaction. Therefore, the Commission believes the commenters'

    concerns that compliance with the rule is not possible in the context

    of portfolio hedging is misplaced. In addition, in response to the

    comments received, the Commission confirms that this definition is used

    solely for purposes of SD and MSP recordkeeping and is not intended to

    define hedging transactions for any other purpose or any other

    Commission regulation.

    E. Records; Retention and Inspection--Sec. 23.203

    1. Swap and Related Cash or Forward Record Retention Period--Sec.

    23.203(b)(2)

    Proposed Sec. 23.203(b)(2) required SDs and MSPs to retain records

    of any swap or related cash or forward transaction until the

    termination or maturity of the transaction and for a period of five

    years after such date.

    MFA commented that the vast majority of its members do not

    currently keep records of transactions for five years following the

    termination, expiration, or maturity of the transactions and compliance

    with this rule would be burdensome and costly. MFA recommended that the

    Commission not impose this record retention requirement on MSPs.

    The Working Group argued that the long-term electronic storage of

    significant amounts of pre-execution communications will prove costly

    over the proposed five-year period. The Working Group recommended that

    the Commission re-evaluate whether all records subject to the proposed

    rule's retention requirements require a five year retention period.

    ISDA & SIFMA recommended that further analysis and consultation be

    performed on the costs and benefits of holding records of all oral and

    written communications that lead to execution of a swap for the life of

    a swap plus five years. ISDA & SIFMA commented that they would be

    supportive of a voice recording obligation aligned to the rules of the

    UK Financial Services Authority, which are to retain recordings for a

    minimum period of six months.

    By contrast, Chris Barnard recommended that records should be

    required to be kept indefinitely rather than the general five years

    under the proposal.

    Having considered these comments, the Commission notes that

    proposed revisions to Commission regulation Sec. 1.31 require

    retention of swap transaction records for a period of five years

    following the termination, expiration, or maturity of a swap,\14\ and

    that Sec. 23.203 is consistent with retention requirements under the

    final swap data reporting rule.\15\ However, in response to commenters'

    concerns regarding retention of pre-execution trade information, the

    Commission is revising the rule to require that voice recordings need

    be kept for only one year. The Commission believes that the one-year

    retention period for voice recordings will enable the Commission to

    execute its enforcement responsibilities under the CEA adequately while

    minimizing the costs imposed on SDs and MSPs.

    ---------------------------------------------------------------------------

    \14\ See Adaptation of Commission Regulations to Accommodate

    Swaps, 76 FR 33066, 33088 (June 7, 2011).

    \15\ See 17 CFR 45.2, Swap Data Recordkeeping and Reporting

    Requirements, 77 FR 2136, 2198 (Jan. 13, 2012).

    ---------------------------------------------------------------------------

    2. ``Readily Accessible''--Sec. 23.203(b)(1) and (b)(2)

    The proposed regulation required SDs and MSPs to have both general

    records and swaps and related cash or forward transaction records

    readily accessible for the first two years of the applicable retention

    period.

    The Working Group recommended that the Commission clarify whether

    the requirement that retained records be ``readily accessible'' means

    readily accessible by the registrant or by the Commission.

    In response, the Commission observes that the term ``readily

    accessible'' has been the operative standard in Sec. 1.31 of the

    Commission's regulations for several years. Specifically, Sec. 1.31

    requires that

    [[Page 20135]]

    ``[a]ll books and records required to be kept by the Act or by these

    regulations shall be kept for a period of five years from the date

    thereof and shall be readily accessible during the first 2 years of the

    5-year period.'' In response to The Working Group's request for

    clarification, the Commission expects a registrant to be able to access

    such records promptly, and such records ``shall be open to inspection

    by any representative of the Commission or the United States Department

    of Justice.'' \16\

    ---------------------------------------------------------------------------

    \16\ Regulation 1.31 further provides that ``[a]ll such books

    and records shall be open to inspection by any representative of the

    Commission or the United States Department of Justice.''

    ---------------------------------------------------------------------------

    3. Records To Be Retained in Accordance With Commission Regulation

    1.31--Sec. 23.203(b)

    Proposed Sec. 23.203(b) required SDs and MSPs to maintain records

    in accordance with existing Sec. 1.31.

    The Working Group commented that Sec. 1.31 appears to apply to

    written documents, including electronic images of such documents, and

    does not seem suitable for electronic records such as those in a

    trading system, that do not originate from a written document. To be

    made workable for purposes of complying with the Commission's proposed

    requirements, The Working Group recommended that Sec. 1.31 be revised

    to reflect current technologies and industry practices relating to

    digitized data storage.

    The Commission has considered The Working Group's comment, but is

    adopting the rule as proposed. The Commission believes that The Working

    Group's concerns about Sec. 1.31 have been addressed by a subsequent

    rule proposal to amend Sec. 1.31 to reflect current technologies and

    industry practices related to digitized data storage.\17\ If these

    amendments are finalized, the Commission believes that Sec. 1.31 will

    be compatible with electronic records in a trading system and other

    records that do not originate from a written document.

    ---------------------------------------------------------------------------

    \17\ See Adaptation of Commission Regulations to Accommodate

    Swaps, 76 FR 33066, 33088 (June 7, 2011).

    ---------------------------------------------------------------------------

    F. Duties of SDs and MSPs

    As part of an overall business conduct regime for SDs and MSPs,

    section 4s(j) of the CEA, as added by section 731 of the Dodd-Frank

    Act, sets forth certain duties for SDs and MSPs, including the duty to:

    (1) Monitor trading to prevent violations of applicable position

    limits; (2) establish risk management procedures adequate for managing

    the day-to-day business of the SD or MSP; (3) disclose to the

    Commission and to applicable prudential regulators \18\ general

    information relating to swaps trading, practices, and financial

    integrity; (4) establish and enforce internal systems and procedures to

    obtain information needed to perform all of the duties prescribed by

    Commission regulations; (5) implement conflict-of-interest systems and

    procedures; and (6) refrain from taking any action that would result in

    an unreasonable restraint of trade or impose a material anticompetitive

    burden on trading or clearing. In its Duties NPRM, the Commission

    proposed six regulations to implement section 4s(j), specifically

    addressing risk management, monitoring of positions limits, diligent

    supervision, business continuity and disaster recovery, the

    availability of general information, and antitrust considerations. The

    Commission's proposed conflicts of interest policies and procedures

    were the subject of the separate SD/MSP Conflicts NPRM and are

    discussed below. The Commission received 20 comment letters in response

    to the Duties NPRM and considered each in formulating the final rules.

    ---------------------------------------------------------------------------

    \18\ This term is defined for the purposes of this rulemaking

    and has the same meaning as section 1(a)(39) of the CEA, which

    includes the Board of Governors of the Federal Reserve System, the

    Office of the Comptroller of the Currency, the Federal Deposit

    Insurance Corporation, the Farm Credit Association, and the Federal

    Housing Finance Agency.

    ---------------------------------------------------------------------------

    G. Risk Management Program for SDs and MSPs--Sec. 23.600

    The Commission proposed Sec. 23.600, which required SDs and MSPs

    to establish and maintain a risk management program reasonably designed

    to monitor and manage the risks associated with their business as an SD

    or MSP. Proposed Sec. 23.600 specifically required the risk management

    program established by SDs and MSPs to consist of written policies and

    procedures; to have its risk management policies and procedures

    approved by the governing body of the SD or MSP; and to establish a

    risk management unit independent from the business trading unit to

    administer the risk management program.

    1. Definitions--Sec. 23.600(a)

    The Commission proposed definitions of ``affiliate,'' ``business

    trading unit,'' ``clearing unit,'' ``governing body,'' ``prudential

    regulator,'' and ``senior management.'' \19\ The definitions set forth

    in Sec. 23.600(a) will apply only to provisions contained in Sec.

    23.600. The Commission is adopting the definitions largely as proposed,

    with the exceptions discussed below.

    ---------------------------------------------------------------------------

    \19\ No comments were received on the proposed Sec. 23.600(a)

    definitions of ``affiliate,'' ``clearing unit,'' or ``prudential

    regulator.'' With the exception of one change to the definition of

    ``prudential regulator'', the Commission has decided to adopt those

    definitions as proposed.

    ---------------------------------------------------------------------------

    a. Business Trading Unit--Sec. 23.600(a)(2)

    SIFMA recommended that (i) the Commission modify the definition of

    ``business trading unit'' to delete the phrase ``or is involved in''

    and replace it with ``directly engaged in'' to avoid inclusion of risk

    management, legal, credit, and operations personnel, all of whom could

    be deemed to be ``involved in'' business trading unit activities; and

    (ii) the Commission clarify that independent financial control

    functions that perform price verification for internal purposes (as

    opposed to providing prices to clients) are excluded from the business

    trading unit.

    The Commission did not intend to include risk management, legal,

    credit, and operations personnel in the definition and has revised the

    definition to exclude such personnel. However, the Commission does not

    believe that only those personnel ``directly engaged in'' pricing,

    trading, sales, marketing, advertising, solicitation, structuring, or

    brokerage activities sufficiently captures those personnel intended to

    be included by the definition for purposes of the rule. Thus, the

    Commission is modifying the proposed definition to exclude risk

    management, legal, credit, and operations personnel, but also to

    include specifically personnel exercising direct supervisory authority

    over the performance of business trading unit functions. Per SIFMA's

    recommendation, the Commission also has modified the definition to

    exclude price verification for risk management purposes from the list

    of business trading unit functions. The Commission believes that the

    definition as revised will be less burdensome for registrants, but

    retains the original intent of the definition.

    b. Governing Body and Senior Management--Sec. 23.600(a)(3) and (4)

    Cargill recommended that the Commission expand the definitions of

    governing body and senior management to include the governing body or

    senior management of the division of a larger company. Cargill, SIFMA,

    and MetLife also recommended that the Commission permit a management

    committee or board committee to serve the function of a governing body.

    SIFMA further requested that the Commission confirm that governing body

    and senior management approvals required under the proposed rules may

    occur at the holding company level.

    [[Page 20136]]

    SIFMA recommended that the Commission not limit the definition of

    ``senior management'' to direct reports of the chief executive officer,

    but include any other officer having supervisory or management

    responsibility (including at the consolidated group level) for any

    organizational unit, department or division. BG Americas & Global LNG

    (BGA) argued that the requirement that the risk management unit report

    directly to a senior officer that reports directly to the CEO is too

    rigid and does not reflect the reality of most energy trading

    companies.

    In response to commenters, the Commission is modifying the proposed

    definition of ``governing body'' to allow an SD or MSP to designate as

    its governing body ``(1) a board of directors; (2) a body performing a

    function similar to a board of directors; (3) any committee of a board

    or body; or (4) the chief executive officer of a registrant, or any

    such board, body, committee or officer of a division of a registrant,

    provided that the registrant's swaps activities for which registration

    with the Commission is required are wholly contained in a separately

    identifiable division.'' The Commission believes that under this

    definition the governing body of an SD or MSP could include a board

    committee or the governing body or senior management of a division,

    provided that the swaps activities of an SD or MSP are wholly contained

    in a separately identifiable division.

    Likewise, in response to commenters, the Commission is modifying

    the proposed definition of ``senior management'' to provide increased

    flexibility in registrant governance structures. The Commission is

    revising the proposed definition to require only that senior management

    consist of officers of the SD or MSP that have been ``specifically

    granted the authority and responsibility by the registrant's governing

    body to fulfill the requirements of senior management.''

    The Commission believes that the increased flexibility permitted by

    the revised definitions of ``governing body'' and ``senior management''

    will be less burdensome for SDs and MSPs, but retains the Commission's

    intent to have accountability at the highest level of management.

    2. Scope of Risk Management Program--Sec. 23.600(b)

    The proposed regulations required SDs and MSPs to establish,

    document, maintain, and enforce a system of risk management policies

    and procedures designed to monitor and manage the risks associated with

    the business of the SD or MSP and the Risk Management Program to take

    into account risks posed by affiliates and take an integrated approach

    to risk management at the consolidated entity level.

    The Working Group, MetLife, and the Office of the Comptroller of

    the Currency argued that Sec. 23.600 should be limited to the risks

    associated with swaps activities, and not other business lines in which

    the SD or MSP may engage. The Working Group also recommended that the

    rule be revised to require the risk management program to take into

    account only swaps-related risks posed by affiliates and take an

    integrated approach to risk management at the consolidated entity level

    to the extent the SD or MSP deems necessary to enable effective risk

    and compliance oversight.

    Based on these comments, the Commission has determined that the

    risk management rules will be limited in scope to apply only to the

    swaps activities of SDs and MSPs and is modifying proposed Sec.

    23.600(b)(1) as recommended by The Working Group.

    On the other hand, the Commission has rejected The Working Group's

    recommendation that SDs and MSPs consider only swaps-related risks

    posed by affiliates. The Commission believes that an SD or MSP should

    be aware of all risks posed by affiliates, and the rule should require

    the SD's or MSP's Risk Management Program to be integrated into overall

    risk management considerations at the consolidated entity level.

    However, the Commission is modifying proposed Sec. 23.600(c)(1)(ii) to

    reflect the fact that Risk Management Programs within an SD or MSP may

    not have the authority to direct other divisions of a larger company.

    Further, the Commission recognizes that some SDs and MSPs will be

    part of a larger holding company structure that may include affiliates

    that are engaged in a wide array of business activities. The Commission

    understands with respect to these entities, that in some instances, the

    top level company in the holding company structure is in the best

    position to evaluate the risks that an affiliate of an SD or MSP may

    pose to the enterprise, as it has the benefit of an organization-wide

    view and because an affiliate's business may be wholly unrelated to

    swaps activities. Therefore, to the extent an SD or MSP is part of a

    holding company with an integrated risk management program, the SD or

    MSP may address affiliate risks and comply with Sec. 23.600(c)(1)(ii)

    through its participation in a consolidated entity risk management

    program.

    3. Flexibility To Design Risk Management Program--Sec. 23.600(b)

    The proposed regulation required a registrant's risk management

    program to include certain enumerated elements: identification of risks

    and risk tolerance limits; periodic risk exposure reports; a new

    product policy; policies and procedures to monitor and manage market

    risk, credit risk, liquidity risk, foreign currency risk, legal risk,

    operational risk, and settlement risk; use of central counterparties;

    compliance with margin and capital requirements; and monitoring of

    compliance with risk management program.

    The Working Group and the Edison Electric Institute (EEI) commented

    that proposed Sec. 23.600 requires a level of detail in the Risk

    Management Program not provided for in the Dodd-Frank Act, and

    recommended that the final rules be flexible enough to allow firms to

    adapt their existing compliance and risk management measures, and not

    cause firms to add entirely new compliance or risk management

    infrastructure.

    Having considered these comments, the Commission is adopting the

    rule substantially as proposed. The Commission believes that the

    requirements of the rules represent prudent risk management practices,

    but do not prescribe rigid organizational structures. The Commission

    also believes the ``policies and procedures'' approach provides an

    adequate amount of flexibility that will allow registrants to rely upon

    any existing compliance or risk management capabilities to meet the

    requirements of the proposed rules. The Commission further believes

    that nothing would prevent firms from relying upon existing compliance

    and risk management programs to a significant degree.

    4. Risk Management Policies and Procedures--Sec. 23.600(b)(2)

    Proposed Sec. 23.600(b)(2) required that a registrant's risk

    management program be described in written policies and procedures,

    that such policies and procedures be approved in writing by the

    registrant's governing body, and that such policies and procedures be

    provided to the Commission upon registration and following any material

    change.

    SIFMA recommended that the Commission clarify that written risk

    management policies and procedures need not be documented in a single,

    consolidated set, so long as such policies and procedures address all

    of the elements of the risk management program required by the proposed

    rules. Cargill commented that registrants

    [[Page 20137]]

    should not be required to furnish risk management policies and

    procedures to the Commission, as such policies and reports can be

    obtained by the Commission by special call or reviewed during

    examinations. By way of contrast, Chris Barnard recommended that the

    Commission expand the reporting requirement to include public

    disclosure to allow for market participants to assess a registrant's

    approach to risk management and increase confidence in the swap

    markets.

    In response to SIFMA's and Cargill's comments, the Commission is

    modifying the proposed rule to provide that an SD's or MSP's written

    policies and procedures must be provided upon application for

    registration to the Commission, or to a futures association registered

    under section 17 of the CEA, if directed by the Commission, but

    thereafter only upon request of the Commission. Additionally, the

    Commission confirms that, so long as the required policies and

    procedures are maintained in a reasonably useable and accessible

    fashion, the rule is not intended to mandate the form or manner of

    documentation or retention.

    With respect to Mr. Barnard's recommendation, the Commission is not

    adopting a public disclosure requirement because registrants' risk

    management policies and procedures may contain sensitive or proprietary

    information.

    5. Risk Management Unit--Sec. 23.600(b)(5)

    Proposed Sec. 23.600(b)(5) required SDs and MSPs to establish a

    risk management unit that reports directly to senior management, that

    is independent from the business trading unit, and that has sufficient

    authority and resources to carry out the risk management program

    required by the proposed regulations.

    SIFMA recommended that the Commission clarify that different risk

    management processes may be managed by independent control functions,

    organized by relevant discipline or specialization, and that such

    functions, so long as they comply with the independence and other

    requirements applicable to the risk management unit, need not be part

    of a single risk management unit. To facilitate a functional working

    relationship, The Working Group recommended that the Commission clarify

    that separation of the risk management unit and business trading unit

    requires only separate and independent oversight of business unit and

    risk management unit personnel, but not actual physical separation of

    such personnel.

    BGA recommends that the Commission allow the risk and trading units

    to report to a shared senior officer, as long as the senior officer

    does not participate in directing, organizing, or executing trades.

    According to BGA, this would be consistent with the Federal Energy

    Regulatory Commission's requirement for achieving independence between

    franchised public utilities and their market-regulated power sales

    affiliates, and would achieve the appropriate level of independence

    without requiring companies to overhaul their existing management

    structures.

    Better Markets commented that simply requiring Risk Management Unit

    independence is inadequate and recommends that the Commission ensure

    independence with rules similar to those proposed to ensure

    independence of research analysts in proposed Sec. 23.605, while

    Cargill requested that the Commission provide greater flexibility in

    how SDs arrange monitoring and compliance of their risk management

    program, rather than rigidly requiring complete independence from the

    business trading unit.

    Having considered these comments, the Commission is adopting the

    rule as proposed. While Sec. 23.600(b)(5) does not require a

    registrant's risk management unit to be a formal division in the

    registrant's organizational structure, the Commission expects that an

    SD or MSP will be able to identify all personnel responsible for

    required risk management activities as its ``risk management unit''

    even if such personnel fulfill other functions in addition to their

    risk management activities. In addition, Sec. 23.600(b)(5) permits SDs

    and MSPs to establish dual reporting lines for risk management

    personnel performing functions in addition to their risk management

    duties, but the rule would not permit a member of the risk management

    unit to report to any officer in the business trading unit for any non-

    risk management activity. The Commission believes that such dual

    reporting invites conflicts of interest and would violate the rule's

    risk management unit independence requirement.

    As requested by The Working Group, the Commission confirms that

    independence of the risk management unit from the business trading unit

    does not require physical separation.

    The Commission notes that per the revised definition of ``senior

    management'' discussed above, the risk management unit will not be

    required to report to an officer that reports directly to the CEO, but

    to ensure the independence of the risk management unit, the rule would

    not permit the risk management unit and business trading unit to report

    to a shared senior officer. The Commission also believes, however, that

    reporting line independence is sufficient to ensure accountability for

    the independence of the risk management unit, and, therefore, is not

    requiring firewalls of the type required in Sec. 23.605 to ensure

    research analysts are free from conflicts of interest, as proposed by

    the Better Markets comment.

    6. Risk Measurement Frequency--Sec. 23.600(c)(4)

    Proposed Sec. 23.600(c)(4) required registrants to measure their

    market, credit, liquidity, and foreign currency risk daily.

    MetLife commented that the daily risk measuring required by the

    proposed rule may be excessive for some MSPs, may require substantial

    information technology and human capital investments, and recommended

    that the frequency of risk measuring should be determined by an MSP's

    risk management unit and governing body, rather than be mandated by the

    Commission.

    The Commission is adopting the rule as proposed. MSPs are, by

    definition, market participants that have a substantial position in

    swaps, and have outstanding swaps that create substantial counterparty

    exposure that could have serious adverse effects on the financial

    stability of the U.S. financial markets, or are highly leveraged.

    Therefore, the Commission believes that it is entirely appropriate to

    require such market participants to measure their market, credit,

    liquidity, and foreign currency risk at least daily.

    7. Approval of Exceptions to Risk Tolerance Limits--Sec.

    23.600(c)(1)(i)

    Proposed Sec. 23.600(c)(1)(i) required that risk tolerance limits

    be approved by an SD's or MSP's senior management and governing body

    and that exceptions to such limits be approved, at a minimum, by a

    supervisor in the risk management unit.

    SIFMA recommended that, subject to aggregate risk limits

    established for the relevant trading supervisor's authority, trading

    supervisors, rather than risk management personnel, should have the

    authority to approve risk tolerance limit exceptions. SIFMA argued that

    the required quarterly risk exposure reports provided to a registrant's

    senior management and governing body are an adequate check on decision-

    making by trading supervisors.

    [[Page 20138]]

    In response to SIFMA's comments, the Commission is revising

    proposed Sec. 23.600(c)(1)(i) to remove the provision that requires

    risk management personnel to approve exceptions to risk tolerance

    limits. Instead, the Commission has determined that exceptions, along

    with the risk tolerance limits, must be subject to written policies and

    procedures. With this change, SDs and MSPs are free to grant discretion

    to trading supervisors to approve risk tolerance limit exceptions

    within the overall risk tolerance limits approved by the registrant's

    senior management and governing body.

    8. New Product Policy--Sec. 23.600(c)(3)

    Proposed Sec. 23.600(c)(3) required SDs and MSPs to include a new

    product policy in their risk management programs. The proposed

    regulations required that such policies include an assessment of the

    risks of any new product prior to engaging in transactions and

    specifically required an assessment of potential counterparties; the

    product's economic function; pricing methodologies; legal and

    regulatory issues; market, credit, liquidity, foreign currency,

    operational, and settlement risks; product risk characteristics; and

    whether the product would alter the overall risk profile of the

    registrant.

    The Working Group recommended that the regulations require only

    that (i) before an SD or MSP offers a new product, it must conduct due

    diligence that is commensurate with the risks associated with such

    product, and (ii) the decision to offer the product be approved by

    appropriate risk management and business unit personnel. In addition,

    the Working Group suggested that the Commission provide that the

    determination as to whether a product is ``new'' should be left to the

    SD or MSP.

    SIFMA recommended that (i) the Commission clarify that a registrant

    may structure its new product approval framework so as to focus on only

    those risk elements that are deemed to be relevant to the product at

    issue, rather than rigidly following the enumerated list in Sec.

    23.600(c)(3); (ii) the Commission allow registrants to provide

    contingent or limited preliminary approval of new products at a risk

    level that would not be material to the registrant, in order to provide

    registrants with the opportunity to obtain experience with the product

    and to facilitate development of appropriate risk management processes

    for such product; and (iii) the Commission harmonize its new product

    policy rules with existing regulatory guidance in this area from

    banking regulators, the SEC, and SROs.

    In response to the commenters' suggestions, the Commission confirms

    that the list of risks in Sec. 23.600(c)(3)(ii) only need be

    considered if relevant to the new product, and the Commission is

    modifying the first sentence of the proposed rule to include the phrase

    ``all relevant risks associated with the new product.''

    In response to SIFMA's recommendation, the Commission also is

    revising the proposed rule to permit SDs and MSPs to grant limited

    preliminary approval of new products (i) at a risk level that would not

    be material to the registrant, and (ii) solely for the purpose of

    facilitating development of appropriate operational and risk management

    processes for such product.

    The Commission is not making any other changes to the rule as

    proposed. The new product policy was adapted from existing banking and

    SEC guidance in this area, and the Commission believes the rule as

    proposed provides adequate guidance with respect to the factors to be

    considered in determining whether a product is ``new'' and whether the

    product presents new risks that should be addressed prior to engaging

    in any transaction involving the new product.

    9. Reporting of Risk Exposure Reports to the Commission--Sec.

    23.600(c)(2)(ii)

    Proposed Sec. 23.600(c)(2)(ii) required SDs and MSPs to provide

    their senior management and governing body with quarterly Risk Exposure

    Reports detailing the registrant's risk exposure and any

    recommendations for changes to the risk management program, and copies

    of these reports were required to be furnished to the Commission within

    five business days of providing them to senior management.

    The Working Group recommended that the Commission provide a

    standard form of report for any report to be required under the

    proposed rules, and to clarify what the governing body or senior

    management is expected to do with information delivered under the

    rules. The Working Group and Cargill also recommended that Risk

    Exposure Reports should be required to be submitted to the Commission

    only upon request so as not to drain Commission resources.

    The Commission is not modifying the proposed rule to require SDs'

    and MSPs' periodic Risk Exposure Reports to be submitted to the

    Commission only upon request. As discussed below, the rule will require

    SDs and MSPs to provide these reports to their senior management and

    governing body no less than quarterly, thus the Commission believes

    that also furnishing the reports to the Commission quarterly will not

    be an additional burden.

    In response to The Working Group, the Commission has determined not

    to provide a standard, prescriptive form for the report; rather the

    form of the report is left to the discretion of the registrant.

    In response to The Working Group's request for clarification about

    what management is supposed to do with Risk Exposure Reports, the

    Commission believes these reports will serve important informational

    purposes related to the key risks associated with the registrants'

    swaps activities and help to ensure accountability at the highest

    levels for those swap activities of registrants.

    10. Reporting to Senior Management and/or Governing Body--Sec.

    23.600(c)(2)(ii)

    Proposed Sec. 23.600(c)(2)(ii) required SDs and MSPs to provide

    their senior management and governing body with Risk Exposure Reports

    detailing the registrant's risk exposure, and any recommendations for

    changes to the risk management program, quarterly and upon any material

    change in the risk exposure of the registrant.

    The Working Group and Cargill each commented that Risk Exposure

    Reports should be provided to senior management and governing body

    annually. The Working Group argued that quarterly reporting would be

    too costly and burdensome, would take resources away from risk

    monitoring, and the frequency may force firms to disclose risk

    exposures before remedial steps can be taken.

    The Commission is adopting the rule as proposed. The Commission

    does not believe that provision of Risk Exposure Reports to senior

    management and the governing body of a registrant four times a year is

    overly burdensome, but rather will provide management with the

    information necessary to monitor and make adjustments to risk levels in

    a timely manner.

    11. Frequency of Review, Testing, and Audit--Sec. 23.600(e)

    Proposed Sec. 23.600(e) required SDs and MSPs to review and test

    their risk management programs quarterly using internal or external

    auditors independent of the business trading unit.

    The Working Group, Cargill, and MetLife each recommended that both

    the frequency and the scope of audits of the risk management program be

    left to the discretion of the registrant, so long

    [[Page 20139]]

    as such audits are effective and are conducted at least annually. The

    Working Group and Cargill argued that this regime would provide the

    desired results without the unnecessary cost and administrative burden

    imposed by the proposed rules. The Working Group also recommended that

    the Commission define or clarify what ``testing'' of the Risk

    Management Program requires.

    Having considered these comments, the Commission is modifying

    proposed Sec. 23.600(e) to require only annual testing and audit of an

    SD's or MSP's Risk Management Program. The Commission has determined

    not to specify testing procedures at this time, but to leave the design

    and implementation of testing procedures to the reasonable judgment of

    each registrant.

    12. Risk Categories--Sec. 23.600(c)(4)

    As proposed, Sec. 23.600(c)(4) required SD and MSP risk management

    programs to include, at a minimum, certain enumerated elements,

    including policies and procedures to monitor and manage market risk,

    credit risk, liquidity risk, foreign currency risk, legal risk, and

    operational risk.

    SIFMA recommended that the Commission clarify that so long as the

    enumerated risks in Sec. 23.600(c)(4) are systematically monitored and

    managed, the Commission does not intend to require that each enumerated

    risk be subject to distinct risk management processes.

    While the rule requires that each enumerated risk must be the

    subject of distinct risk management policies and procedures, Commission

    does not intend to mandate specific risk management processes. The

    specific methods of monitoring and managing all risks associated with

    the swaps activities of an SD or MSP are left to the discretion of the

    registrant.

    13. Market Risk--Sec. 23.600(c)(4)(i)

    Proposed Sec. 23.600(c)(4)(i) required SDs and MSPs to measure

    their market risk daily, including exposure due to unique product

    characteristics, volatility of prices, basis and correlation risks,

    leverage, sensitivity of option positions, and position concentration.

    The proposed rule would require that if valuation data is derived from

    pricing models, that such models be validated by qualified, independent

    persons.

    The Working Group recommended that metrics for options,

    particularly the sensitivity for options, be required to be measured on

    a frequency less than daily, as metrics can require complex

    calculations, some of which must be done outside the trading or risk

    management system. The Working Group also recommended that the

    Commission clarify that models may be verified by independent, but

    internal, qualified persons.

    In response to The Working Group's comments, the Commission

    clarifies that, to the extent that an input for measurement of market

    risk has a reasonable degree of accuracy over a period longer than one

    day, it would be permissible for a registrant's risk management

    policies to reflect the conclusion that such an input would not need to

    be calculated daily for purposes of the daily measurement of a

    registrant's market risk. The Commission also is modifying the proposed

    rule to clarify that pricing models may be verified by qualified,

    independent internal persons.

    14. General Ledger Reconciliation--Sec. 23.600(c)(4)(i)(C)

    The proposed regulations required SDs and MSPs to reconcile profits

    and losses resulting from valuations with the general ledger at least

    once each business day.

    The Working Group commented that, to the extent that transaction

    valuations are tracked daily, they ordinarily would be tracked in the

    firm's trading or risk management system, not the general ledger

    system. The Working Group recommended that consolidation to the general

    ledger only be required monthly.

    Having considered these comments, the Commission has determined

    that the rule need not require daily reconciliation to the general

    ledger in order to address the need to manage the risk of a failure to

    account properly for profits and losses. The Commission therefore is

    revising the proposed rule to require only that SDs and MSPs have

    policies and procedures to ensure ``periodic reconciliation of profits

    and losses resulting from valuations with the general ledger.''

    15. Establishment of Credit Limits Prior to Trading--Sec. 23.600(d)(2)

    Proposed Sec. 23.600(d)(2) required that SDs and MSPs have

    policies and procedures requiring traders to transact only with

    counterparties for whom credit limits have been established.

    The Working Group recommended that the Commission allow discretion

    to make exceptions to the requirement that trades only be executed with

    counterparties for which credit limits have been established for

    certain limited risk transactions. Arguing that some transactions carry

    no counterparty credit risk and that some SDs and MSPs may hedge their

    counterparty credit risk, SIFMA recommended that, instead of requiring

    establishment of credit limits prior to trading, the Commission require

    only that a credit risk evaluation be made prior to trading.

    The Commission is adopting the rule as proposed. The Commission

    observes that the rule does not define ``credit limit'' and thus

    provides sufficient discretion to SDs and MSPs to implement policies

    addressing limited counterparty credit risk transactions.

    16. Credit Risk Measurement--Sec. 23.600(c)(4)(ii)(A)

    Proposed Sec. 23.600(c)(4)(ii)(A) required SDs and MSPs to have

    credit risk policies and procedures providing for daily measurement of

    overall credit exposure to ensure compliance with counterparty credit

    limits.

    Better Markets argued that the Commission's proposal for rules

    relating to credit risk are inadequate insofar as they do not provide

    guidance on how credit risk is to be measured. Better Markets

    recommended that the Commission's rules relating to management of

    credit risk require measurement of credit risk using the same

    techniques employed by derivatives clearing organizations (DCOs)

    registered with the Commission. Better Markets also specifically

    recommended that the Commission require credit risk policies of SDs and

    MSPs to address (i) the risk posed by collateral triggers (like credit

    rating downgrades) that may require immediate funding under stressful

    circumstances, and (ii) the credit risk of futures commission merchants

    (FCMs) acting for the SD or MSP as its clearing member.

    Having considered Better Market's comments, the Commission is

    adopting the rule as proposed. The Commission believes it need not

    specify a credit risk measurement methodology because the adequacy of a

    registrant's individual credit risk measurement methodology will be

    assessed upon a review of a registrant's policies and procedures during

    registration or upon examination. The Commission also believes that

    credit risk to FCMs would be covered by the required monitoring and

    risk management of clearing members by DCOs and the Commission.

    17. Liquidity Risk--Sec. 23.600(c)(4)(iii)(B)

    The proposed rules required SDs and MSPs to test their procedures

    for liquidating all non-cash collateral in a timely manner and without

    significant effect on price.

    SIFMA argued that firms assess the types of collateral that they

    are willing to accept based on the risk, volatility,

    [[Page 20140]]

    liquidity, and other characteristics of the collateral and additionally

    establish conservative haircuts for the valuation of collateral, not

    through testing by actual or simulated disposition of collateral. SIFMA

    therefore recommended that the Commission not require testing of

    liquidation procedures by simulated disposition, but only require

    policies and procedures for identifying acceptable collateral and

    establishing appropriate haircuts, taking into account reasonably

    anticipatable adverse price movements.

    The proposed rule was not intended to impose a requirement that

    registrants test collateral liquidation procedures by means of actual

    or simulated disposition. However, to clarify this matter, the

    Commission is revising the proposed rule to require policies and

    procedures that ``assess'' rather than ``test'' procedures to liquidate

    all non-cash collateral in a timely manner without significant effect

    on price.

    18. Foreign Currency Risk--Sec. 23.600(c)(4)(iv)

    Proposed Sec. 23.600(c)(4) required SDs and MSPs to measure the

    amount of capital exposed to fluctuations in the value of foreign

    currency daily.

    The Working Group recommended that the Commission permit the

    frequency of measurement of capital exposed to fluctuations in the

    value of foreign currency to be left to the discretion of the firm,

    rather than mandating daily measurement.

    The Commission believes that the foreign exchange markets are fluid

    and quick moving, and, therefore, the requirement for daily measurement

    is not excessive. Accordingly, the Commission is adopting the rule as

    proposed with respect to foreign currency risk.

    19. Legal Risk--Sec. 23.600(c)(4)(v)

    Proposed Sec. 23.600(c)(4)(v) required SDs' and MSPs' risk

    management policies and procedures to address determinations that

    transactions and netting arrangements entered into by the registrant

    have a sound legal basis and documentation tracking to ensure

    completeness of transaction documentation.

    SIFMA recommended that the Commission require only policies and

    procedures to identify and evaluate the legal risks arising in

    connection with the registrant's business.

    The Commission is making no changes to the rule as proposed. The

    Commission believes that the two enumerated requirements with respect

    to legal risk are of special importance with respect to trade

    processing and risk measurement, but are by no means exhaustive of the

    legal risks arising in connection with a registrant's business, all of

    which must be identified by the registrant's risk management policies

    and procedures.

    20. Operational Risk--Sec. 23.600(c)(4)(vi)

    Proposed Sec. 23.600(c)(4)(vi) required SDs and MSPs to establish

    policies and procedures for managing operational risks, including

    procedures accounting for reconciliation of all operating and

    information systems.

    The Working Group and SIFMA recommended that the Commission clarify

    what is meant by ``reconciliation of operating and information

    systems,'' as information contained in systems may be reconciled, but

    systems themselves may not be.

    Chris Barnard recommended that the proposed rule be expanded and be

    more specific about the types of operational risk to be monitored and

    controlled, arguing that operational risk failures effectively allow

    other types of risk, such as credit risk and market risk to be

    excessive. Mr. Barnard also recommended that the proposed rule be

    expanded to require management for the increased risks inherent in

    using programs or models from external providers or vendors to avoid

    using ``black boxes'' without controls and review.

    The Commission agrees with commenters that data within operating

    and information systems should be reconciled, rather than the systems

    themselves. Consequently, the Commission is modifying the proposed rule

    to refer to reconciliation of data within operating and information

    systems. As modified, the Commission believes that the rule is

    sufficiently specific to enable SDs and MSPs to establish policies and

    procedures for adequately managing operational risks, and as such, the

    Commission is making no changes to the rule based on Mr. Barnard's

    comments. Nonetheless, the Commission notes that Mr. Barnard's concern

    about black boxes is addressed, in part, by the requirement to have

    policies and procedures governing the use and supervision of trading

    programs under proposed Sec. 23.600(d)(9), as discussed further below.

    21. Use of Central Counterparties--Sec. 23.600(c)(5)

    Proposed Sec. 23.600(c)(5) required SDs and MSPs to establish

    policies and procedures related to central clearing of swaps, including

    policies that require the use of clearing when a swap is subject to a

    mandatory clearing determination issued by the Commission, policies

    setting forth conditions for the voluntary use of central clearing as a

    means of mitigating counterparty credit risk, and policies requiring

    diligent investigation into the adequacy of financial resources and

    risk management procedures of any central counterparty through which

    the registrant clears.

    The Working Group argued that the adequacy of resources and risk

    management at CCPs registered with the Commission should be monitored

    by the Commission, not individual firms. EEI requested that the

    Commission clarify that proposed Sec. 23.600(c)(5) is not seeking to

    require SDs to use central clearing to mitigate risk if clearing is not

    required under a valid exemption.

    The Commission is adopting the rule regarding use of central

    counterparties as proposed. The Commission's registration of a central

    counterparty as a DCO is based on a determination that the applicant

    meets core principles under the Commodity Exchange Act and Commission

    regulations. It does not, however, serve as a substitute for the due

    diligence of registrants who must evaluate the use of a central

    counterparty in light of their own circumstances. In addition, SDs and

    MSPs may elect to clear swaps that are not required to be cleared on a

    voluntary basis through central counterparties that are not registered

    with the Commission. In those instances, an SD or MSP engaging in some

    manner of due diligence prior to submitting a swap for clearing would

    be part of a prudent risk management program. In response to EEI's

    comment, the Commission observes that the rule would require only that

    registrants evaluate the use of central clearing as a means of

    mitigating counterparty credit risk and as part of their overall risk

    management strategy. Moreover, the rule expressly notes the exception

    from mandatory clearing that is provided for under section 2(h)(7) of

    the CEA.

    22. Business Trading Unit--Sec. 23.600(d)

    As proposed, Sec. 23.600(d) required SDs and MSPs to establish

    policies and procedures that require all trading policies to be

    approved by the governing body of the registrant.

    The Working Group recommended that the governing body of an SD or

    MSP be permitted to delegate approval of trading policies to those with

    expertise.

    The revisions to the definition of governing body discussed above,

    which allows for a governing body to consist of a committee or the CEO,

    sufficiently address the Working Group's concerns.

    [[Page 20141]]

    The Commission thus has made no changes to the rule.

    23. Transaction Entry by Traders--Sec. 23.600(d)(5)

    Proposed Sec. 23.600(d)(5) required SDs and MSPs to establish

    policies and procedures that require each trader to follow established

    policies and procedures for executing and confirming all transactions.

    Further, in a discussion about the independence of the risk management

    unit in the preamble to the proposal, the Commission stated that

    ``personnel responsible for recording transactions in the books of the

    swap dealer or major swap participant cannot be the same as those

    responsible for executing transactions.''

    The Working Group requested clarification about requirements for

    transaction entry based on the statements made in the preamble to the

    proposal. The Working Group argued that if the reference to recording

    transactions in the books of a firm is intended to refer to entries

    into the general ledger system, then the Working Group agreed that this

    process should be subject to the usual segregation of duties

    requirements that protect the general ledger system, but that there is

    no reasonable basis to prohibit individuals who execute transactions

    from entering the information regarding such transactions into a firm's

    trading or risk management system.

    BGA commented that typical practice is for traders to enter the

    trade into the deal monitoring system, and then the risk control group

    performs a daily review of all new and amended trading activity. BGA

    explained that the mid-office risk control review is followed by a

    second review of the trade activity performed by the back-office

    confirmations group, which generates confirmations and performs

    portfolio reconciliations to match key trade attributes with

    counterparties. BGA requested clarification that the reference to

    ``recording transactions in the books'' in the proposal preamble is not

    intended to restrict the initial recording of the trade into the deal

    capture system by the trader, but refers to the daily review and

    confirmation and portfolio reconciliation processes performed by the

    mid and back offices.

    SIFMA requested that the Commission confirm that compliance with

    the rule would not preclude trading personnel from entering the trades

    they execute into a registrant's trade capture system, provided that

    the registrant has appropriate policies and procedures reasonably

    designed to identify the entry of fictitious trades or the failure to

    accurately enter actual trades.

    In response to these comments, the Commission confirms that the

    rule is not intended to restrict the initial recording of trades into a

    trade capture system by the trader. Rather, the rule requires traders

    to follow established policies and procedures governing trade execution

    and confirmation.

    24. Monitoring of Trading--Sec. 23.600(d)(4) & (d)(9)

    As proposed, Sec. 23.600(d)(4) required SDs and MSPs to establish

    policies and procedures designed to monitor each trader throughout the

    trading day to prevent the trader from exceeding any limit to which the

    trader is subject, or from otherwise incurring undue risk. The proposed

    regulations also require registrants to ensure that trade discrepancies

    are brought to the immediate attention of senior management and are

    documented.

    The Working Group, with respect to internal limits, recommended

    that daily monitoring should be at the product desk level, not the

    trader level, as market practice is to set internal limits at the desk

    level. Also, the Working Group and SIFMA requested that the Commission

    clarify that ``monitor each trader throughout the trading day'' does

    not mean continuous monitoring, and recommended that the Commission

    remove the requirement that firms monitor traders to prevent traders

    from ``incurring undue risk'' because the meaning of the phrase is

    ambiguous. The Working Group also recommended that the Commission

    define ``trade discrepancies'' and add a materiality standard to the

    escalation requirement.

    MetLife commented that intraday monitoring of traders may be

    excessive for some MSPs, especially MSPs that use swaps only for

    hedging purposes. MetLife recommended that the Commission allow the

    type of monitoring and its frequency to be determined by an MSP's risk

    management unit and governing body.

    Having considered these comments, the Commission is revising the

    proposed rule to require monitoring be performed to prevent the

    incurrence of ``unauthorized risk'' rather than ``undue risk.'' The

    Commission believes this formulation better reflects the intent of the

    rule, which is to ensure that SDs and MSPs have instituted safeguards

    against the risk of losses to the firm due to rogue trading.

    In response to The Working Group's comment requesting a definition

    of ``trade discrepancies,'' the Commission notes that the term ``trade

    discrepancies'' is intended to refer to any discrepancies between the

    SD or MSP and its counterparties and to any discrepancies in records or

    systems of the SD or MSP. Also in response to The Working Group's

    recommendation that the proposed rule be modified to add a materiality

    standard for reporting of trade discrepancies to management, the

    Commission is modifying the rule to require that only trade

    discrepancies that are not immaterial, clerical errors be brought to

    the immediate attention of management of the business trading unit. The

    rule continues to require that all trade discrepancies be documented.

    The Commission has made no other changes to the rule based on the

    comments received. The Commission believes that prudent risk management

    requires intraday monitoring of traders to detect prohibited activity

    that may be otherwise undetectable. The Commission notes that the rule

    requires monitoring of traders to prevent traders from ``exceeding any

    limit to which the trader is subject'' but does not specify the types

    of limits to be monitored. Thus, the Commission observes that the

    setting of limits requiring intraday monitoring is left to the

    discretion of each SD and MSP.

    In addition, the Commission is finalizing the requirement that SDs

    and MSPs have policies and procedures governing the use and supervision

    of trading programs under proposed Sec. 23.600(d)(9), but deleting the

    term ``algorithmic'' from the rule text. This rule is an important

    measure for ensuring that SDs and MSPs monitor their trading

    activities. In addition to the risk management requirements under this

    rule, the Commission notes that the use of trading programs would be

    subject to, among other things, any applicable prohibitions on

    disruptive trading practices under the CEA and Commission regulations.

    The Commission also anticipates addressing the related issues of

    testing and supervision of electronic trading systems and mitigation of

    the risks posed by high frequency trading.

    25. Brokers--Sec. 23.600(d)(8)

    Proposed Sec. 23.600(d)(8) required SDs and MSPs to establish

    policies and procedures to ensure that the risk management unit reviews

    broker's statements, reconciles brokers' charges to estimates, reviews

    and monitors broker's commissions, and initiates payment to brokers.

    The Working Group, SIFMA, and MetLife each recommended that the

    risk management unit not be tasked with reviewing brokers' statements,

    monitoring commissions or initiating broker payments, as these

    functions are

    [[Page 20142]]

    currently handled by operations or other control units.

    The Commission agrees with commenters that review of brokers'

    statements, monitoring commissions or initiating broker payments need

    not be performed by risk management personnel. The Commission is

    revising the proposed rule to replace this requirement with a

    requirement that risk management policies and procedures include

    periodic audit of broker's statements and payments by persons

    independent of the business trading unit. This change provides the

    relief requested by commenters while maintaining the requirement that

    risks connected to the use of brokers are adequately monitored and

    managed.

    H. Monitoring of Position Limits--Sec. 23.601

    To implement section 4s(j)(1) of the CEA, the Commission proposed

    Sec. 23.601 in the Duties NPRM, which required SDs and MSPs to

    establish policies and procedures to monitor, detect, and prevent

    violations of applicable position limits established by the Commission,

    a designated contract market (DCM), or a swap execution facility (SEF),

    and to monitor for and prevent improper reliance upon any exemptions or

    exclusions from such position limits. Proposed Sec. 23.601 also

    required SDs and MSPs to: (i) Convert all swap positions into

    equivalent futures positions using the methodology set forth in

    Commission regulations; (ii) provide training to all relevant personnel

    on applicable position limits on an annual basis and promptly upon any

    change to applicable position limits; (iii) test its procedure for

    monitoring and preventing position limit violations for adequacy and

    effectiveness each month; (iv) audit its position limit procedures

    annually; (v) implement an early warning system designed to alert

    senior management when position limits are in danger of being breached;

    and (vi) report any detected violation of applicable position limits to

    the registrant's governing body and to the Commission. Only four market

    participants and trade groups provided comments on the Commission's

    proposal.

    1. Monitoring for Violations of Position Limits--Sec. 23.601(a)

    The Working Group argued that it is not possible to determine

    whether transactions that individual traders enter into violate

    position limits without placing the transactions in the context of an

    entire portfolio and any relevant hedge exemptions. The Working Group

    requested clarification that the requirement for intraday monitoring of

    traders under proposed Sec. 23.600(d)(4) does not require monitoring

    of individual traders for violations of position limits, and that

    monitoring for violations of position limits is only required in the

    context of aggregate swaps and futures portfolios.

    The Commission believes that The Working Group's request for

    clarification is outside the scope of these rules. The level at which

    monitoring for violations of position limits will be required is

    subject to the final position limit rules,\20\ and the Commission

    directs SDs and MSPs to review new Sec. 151.7 of the final position

    limit rules for guidance when establishing the Position Limit

    Procedures required by this rule.

    ---------------------------------------------------------------------------

    \20\ See 17 CFR 151.7, Position Limits for Futures and Swaps, 76

    FR 71626, 71692 (Nov. 18, 2011) (adopting 17 CFR 151.7 pertaining to

    the aggregation of positions).

    ---------------------------------------------------------------------------

    BGA expressed concern about the requirement that an SD or MSP

    ``prevent violations'' of position limits established by the

    Commission. BGA argued that despite having a robust compliance program,

    it is impossible for an SD or MSP to ``prevent violations'' because a

    company cannot before-the-fact prevent a trader from entering a deal

    that causes a position limit violation. Thus, BGA recommended that the

    Commission clarify that as long as an SD or MSP provides training on

    the position limits and establishes and enforces policies for

    monitoring, detecting, and curing violations, they will have met the

    obligation to ``prevent violations.''

    The Commission agrees with BGA that SDs and MSPs should be held to

    a standard of reasonableness in regard to efforts to prevent violations

    of position limits. The Commission therefore is revising the proposed

    rule to state that ``[e]ach swap dealer and major swap participant

    shall establish and enforce written policies and procedures that are

    reasonably designed to monitor for and prevent violations of applicable

    position limits * * *'' (modification to rule text in italics).

    2. Training on Applicable Position Limits--Sec. 23.601(c)

    SIFMA recommended that the Commission revise Sec. 23.601(c) to

    provide that a change in position limit levels will not trigger

    ``training,'' but only require effective notification. The Commission

    agrees with SIFMA's view and is revising the proposed rule accordingly.

    3. Diligent Monitoring and Diligent Supervision To Ensure Compliance--

    Sec. 23.601(d)

    SIFMA recommended that the Commission clarify that monitoring for

    compliance with position limits need not be performed by risk

    management personnel, but may be performed by independent compliance,

    operations, or supervisory personnel.

    The rule does not require that position limit monitoring be

    performed by risk management personnel, nor was such a requirement

    intended. The Commission confirms that monitoring procedures may be

    conducted at the discretion of the SD or MSP.

    4. Reporting Violations to the Governing Body and the Commission--Sec.

    23.601(e)

    The Working Group and MetLife doubted the utility of alerting the

    governing body of nonmaterial violations of position limits as required

    under proposed Sec. 23.601(e), and recommended that the Commission

    require alerting the governing body only when a violation is material

    and allow registrants to define escalation procedures based on

    materiality in their Position Limit Procedures.

    The Commission does not believe that reporting of position limit

    violations to the governing body of the registrant should be subject to

    a materiality standard and is adopting the rule as proposed. The

    Commission intends the reporting rule to ensure accountability for

    compliance with position limits at the highest levels of management and

    believes applying a materiality standard to such reporting would

    undermine the intention of the rule and introduce unnecessary

    complication for registrants trying to determine how much of a breach

    would amount to a material breach. However, the Commission observes

    that a registrant's governing body could take into account the

    magnitude of the breach and other facts and circumstances in

    remediating its monitoring program. For instance, a governing body

    would respond differently to small, inadvertent breaches that are

    promptly corrected than larger, repeated violations.

    With respect to reporting of position limit violations to the

    Commission, The Working Group argued that the reporting of on-exchange

    violations of position limits to the Commission is already done by DCMs

    and will likely be the responsibility of SEFs as well, so SDs and MSPs

    should not be required to report on-exchange violations to avoid

    inundating the Commission with redundant information. The Working Group

    conceded, however, that if

    [[Page 20143]]

    position limit rules require the aggregation of exchange-traded swaps

    and over-the-counter swaps, then SDs and MSPs should be required to

    report position limit violations that occur because of over-the-counter

    swaps, but recommended that such reporting requirement be subject to a

    materiality standard.

    The Commission agrees that on-exchange position limit violations

    need not be reported to the Commission by registrants, as they will be

    reported by DCMs or SEFs and has modified the final rule accordingly.

    5. Testing and Audit of Position Limit Procedures--Sec. 23.601(f) and

    (h)

    With respect to monthly testing of Position Limit Procedures

    required under proposed Sec. 23.601(f) and annual audit required under

    proposed Sec. 23.601(h), SIFMA recommended that testing and audit of

    Position Limit Procedures be required only annually and not be required

    to be done all at the same time, The Working Group recommended that

    testing only be required on a semi-annual basis (or on a more frequent

    basis as the firm might determine to be effective), and MetLife

    requested that the Commission permit the frequency of testing to be

    determined by an MSP based on the extent of its swap activities.

    MetLife also recommended that there be a clear exemption from testing

    requirements for MSPs that do not trade in swaps for which position

    limits have been established. SIFMA requested that the Commission

    clarify that testing should consist of testing for accurate capture of

    all relevant desk positions by position reporting systems and that

    Sec. 23.601(h) be revised to allow for ``agreed upon procedures'' for

    external auditors.

    Having considered these comments, the Commission has determined

    that monthly testing of Position Limit Procedures by registrants may be

    unduly burdensome, but believes that only annual or semi-annual testing

    would be inadequate as such could allow violations to remain undetected

    for long periods. The Commission therefore is modifying the proposed

    rule to require quarterly testing, and, in response to the comment of

    MetLife, only if the registrant trades in swaps for which position

    limits have been established. The annual audit requirement is being

    adopted as proposed. In response to the request of SIFMA, the

    Commission confirms that testing of Position Limit Procedures is

    expected to entail testing of the accuracy of capture of all relevant

    desk positions by position reporting systems.

    6. Quarterly Reporting of Compliance With Position Limits--Sec.

    23.601(g)

    With respect to quarterly reporting of compliance with position

    limits to the chief compliance officer, senior management, and

    governing body under proposed Sec. 23.601(g), The Working Group

    recommended that the proposed rule should be revised to require only

    annual reports to the entity's senior management and governing body.

    As stated above, the Commission intends the reporting rule to

    ensure accountability for compliance with applicable position limits at

    the highest levels of management. The Commission believes that the

    burden of quarterly reporting is outweighed by the benefit of timely

    notification to decision makers within the SD and MSP of the entity's

    record of compliance with applicable position limits, thus providing a

    timely opportunity to adjust or revise Position Limit Procedures to

    prevent future violations, if necessary.

    I. Diligent Supervision--Sec. 23.602

    Proposed Sec. 23.602 was intended to implement section 4s(h)(1)(B)

    of the CEA, which requires each SD and MSP to conform with Commission

    regulations related to diligent supervision of the business of the SD

    and MSP. The proposed regulations required SDs and MSPs to establish a

    system to supervise all activities relating to its business performed

    by its partners, members, officers, employees, and agents, that such

    system be reasonably designed to achieve compliance with the CEA and

    Commission regulations, that such system designate a person with

    authority to carry out the supervisory responsibilities of the SD or

    MSP, and that all such supervisors meet qualification standards that

    the Commission finds necessary or appropriate.

    The Working Group recommended that the Commission not require

    designation of a single individual with responsibility for supervision,

    but should allow for designation of a reporting line and that

    designated supervisors should be permitted to delegate supervisory

    authority. The Working Group also recommended that SDs and MSPs be

    given discretion to determine supervisor qualifications, rather than

    meet ``qualification standards as the Commission finds necessary or

    appropriate.''

    MFA recommended that the Commission clarify that the rules do not

    impose any new (a) fiduciary obligations or duties (i.e., duties beyond

    those to which participants in the futures and derivatives markets

    would otherwise be subject to by agreement or by operation of common

    law), or (b) supervisory duties on market participants. MFA argued that

    proposed Sec. 23.602 (Diligent Supervision) is similar to the NFA's

    supervision rule for FCMs (Compliance Rule 2-9), and MFA is concerned

    that Sec. 23.602 may impose fiduciary and supervisory obligations on

    registrants similar to those that the NFA imposes on FCMs with respect

    to third parties.

    In response to The Working Group's first comment, the Commission is

    revising the proposed rule to require ``at least one person'' rather

    than ``a person'' be designated with authority to carry out supervisory

    responsibilities, which should permit SDs and MSPs more flexibility in

    designing and implementing the required supervisory system. With

    respect to the remaining comments of The Working Group, the Commission

    believes that full accountability for compliance with the CEA and

    Commission regulations is best served by requiring designation of

    individuals with supervisory responsibility and that reporting line

    responsibility is not adequate.

    With respect to MFA's comments, the Commission observes that the

    rule relates generally to the supervision necessary to achieve

    compliance with the CEA and Commission regulations by the registrant.

    Many of the specific activities to be supervised are subject to the CEA

    and other Commission rules that are outside the scope of this

    rulemaking. The Commission does not intend that Sec. 23.602 impose a

    fiduciary duty on SDs or MSPs beyond that which would otherwise exist.

    Other than the foregoing, the Commission has adopted the rule as

    proposed.

    J. Business Continuity and Disaster Recovery--Sec. 23.603

    Proposed Sec. 23.603 required SDs and MSPs to establish a business

    continuity and disaster recovery plan that includes procedures for and

    the maintenance of back-up facilities, systems, infrastructure,

    personnel, and other resources to achieve the timely recovery of data

    and documentation and to resume operations generally within the next

    business day. The proposed regulations also required SDs and MSPs to

    have their business continuity and disaster recovery plan tested

    annually by qualified, independent internal audit personnel or a

    qualified third party audit service.

    Tellefsen and Company, L.L.C. (Tellefsen) commented that most, if

    not all, of potential SDs have the technology and network

    infrastructure in place to

    [[Page 20144]]

    achieve a next day recovery time objective. However, Tellefsen

    recommended that the Commission carefully evaluate the business

    continuity management capabilities of MSPs before establishing a hard

    date by which these metrics must be in place, as the Commission may

    have greatly underestimated the time and scope of work for firms to

    develop, implement and test their business continuity management

    capabilities (Tellefsen estimates 68-200 person days). The Working

    Group also argued that the Commission should not require next business

    day recovery for non-systemically important SDs or MSPs, but should

    only require recovery ``reasonably promptly.''

    The Working Group argued that the Commission should not require

    staffing of back-up facilities to avoid the burden of requiring two

    persons for the same job. The Working Group also recommended that the

    Commission should not require annual testing of the business continuity

    and disaster recovery plan by independent auditors because independent

    audits would be too costly.

    SIFMA recommended that the Commission clarify that an SD's or MSP's

    business continuity and disaster recovery plan may be part of a

    consolidated plan established for the various entities in a holding

    company group if they share common personnel, premises, resources,

    systems, and infrastructure. SIFMA also recommended that the Commission

    permit SDs and MSPs subject to the business continuity and disaster

    recovery requirements of a prudential regulator, or other regulator

    determined to be comparable by the Commission, to comply with Sec.

    23.603 on a substituted compliance basis.

    The Commission believes that Tellefsen's concerns regarding the

    ability of MSPs to comply with the required recovery period will be

    addressed through the phased implementation of the rule, discussed

    below.

    In response to The Working Group's comment regarding staffing of

    back-up facilities, the Commission is modifying the proposed rule to

    clarify that, so long as prompt recovery is reasonably ensured, SDs and

    MSPs may provide for alternative staffing of back-up facilities as

    required under the circumstances. The Commission also agrees with the

    Working Group that annual testing may be performed by qualified

    internal personnel and is modifying the proposed rule accordingly.

    However, the Commission believes that independent audits are required

    to ensure that business continuity and disaster recovery plans remain

    in compliance with the rule, but that annual audits would be

    unnecessary and unduly burdensome and costly. Therefore, the Commission

    is revising the proposed rule to require independent audits only every

    three years.

    The Commission believes that all SDs and MSPs may be critically

    important to the proper functioning of the swaps market. SDs are

    critical participants in the swap market and MSPs may, by definition,

    have exposures that could have serious adverse effects on the financial

    stability of the United States. Therefore, the Commission continues to

    believe that a one business day recovery period is the necessary

    objective for SDs' and MSPs' business continuity and disaster recovery

    plans. Accordingly, the Commission is not modifying the final rule in

    this respect.

    In response to SIFMA's comments, the Commission confirms that so

    long as a consolidated business continuity and disaster recovery plan

    established for the various entities in a holding company group that

    includes an SD or MSP, or any such plan that is required by a

    prudential regulator of the SD or MSP, meets the requirements of the

    rule, such SD or MSP would be in compliance with the Commission's rule.

    The Commission believes that this result is contemplated by the rule as

    proposed and so is not modifying the rule in this respect.

    K. General Information: Availability for Disclosure and Inspection--

    Sec. 23.606

    Proposed Sec. 23.606 required SDs and MSPs to make available for

    disclosure and inspection by the Commission and the SD's or MSP's

    prudential regulator, all information required by, or related to, the

    CEA and Commission regulations.

    The Working Group recommended that the Commission clarify what is

    meant by ``available for disclosure'' if such is different from

    ``available for inspection.'' The Working Group also argued that SDs

    and MSPs should not be required to revise information systems to store

    information specifically required by each Commission rule, because

    storage would require extensive investigation that is unnecessary to

    ensure compliance with the rule.

    Having considered The Working Group's comments, the Commission is

    adopting the rule as proposed. The Commission does not believe the rule

    specifies or requires any particular storage medium or methodology, but

    rather only requires SDs and MSPs to have information systems capable

    of producing the required information promptly. The Commission also has

    determined not to define further ``available for disclosure'' or

    ``available for inspection'' because it believes these terms as

    employed in the rule have their plain meanings.

    L. Antitrust Considerations--Sec. 23.607

    Proposed Sec. 23.607 prohibited SDs and MSPs from adopting any

    process or taking any action that results in any unreasonable restraint

    of trade or imposes any material anticompetitive burden on trading or

    clearing, unless necessary or appropriate to achieve the purposes of

    the CEA. The proposed rule also required SDs and MSPs to adopt policies

    and procedures to prevent such actions.

    SIFMA agreed with the Commission's proposed policies and procedures

    approach. SIFMA argued however that Sec. 23.607(a) goes further, by

    imposing a blanket prohibition on a registrant adopting any process or

    taking any action that results in any unreasonable restraint of trade,

    or imposes any material anticompetitive burden on trading or clearing

    (unless necessary or appropriate to achieve the purposes of the CEA).

    SIFMA expressed concern that, given the counterparty rescission and

    private right of action provisions of the CEA, this prohibition could

    introduce additional private liability that is unnecessary in light of

    the enforcement authority of the Commission and antitrust authorities

    and existing private rights of action under the antitrust laws. SIFMA

    therefore recommended that the Commission delete Sec. 23.607(a) and

    instead rely upon the policies and procedures requirement included in

    Sec. 23.607(b).

    Having considered SIFMA's comments, the Commission is adopting the

    rule as proposed. The blanket prohibition in Sec. 23.607(a) is taken

    directly from the statutory provision and appropriately implements the

    prohibition in section 4s(j)(6) of the CEA.

    M. Conflicts of Interest Policies and Procedures by SDs, MSPs, FCMs,

    and IBs--Sec. 23.605, Sec. 1.71

    As discussed above, section 4s(j) of the CEA, as added by section

    731 of the Dodd-Frank Act, sets forth certain duties for SDs and MSPs,

    including the duty to implement conflict-of-interest systems and

    procedures. Specifically, section 4s(j)(5) mandates that SDs and MSPs

    implement conflict-of-interest systems and procedures that ``establish

    structural and institutional safeguards to ensure that the activities

    of any person

    [[Page 20145]]

    within the firm relating to research or analysis of the price or market

    for any commodity or swap or acting in a role of providing clearing

    activities or making determinations as to accepting clearing customers

    are separated by appropriate informational partitions within the firm

    from the review, pressure, or oversight of persons whose involvement in

    pricing, trading, or clearing activities might potentially bias their

    judgment or supervision and contravene the core principles of open

    access and the business conduct standards described in this Act.''

    Section 4s(j)(5) further requires that such systems and procedures

    ``address such other issues as the Commission determines to be

    appropriate.'' Proposed Sec. 23.605, as set forth in the SD/MSP

    Conflicts NPRM, addressed the statutory mandate of section 4s(j)(5).

    In relevant part, section 732 of the Dodd-Frank Act amended section

    4d of the CEA by creating a new subsection (c), which mandates that the

    Commission ``require that futures commission merchants and introducing

    brokers implement conflict-of-interest systems and procedures.'' New

    section 4d(c) mandates that such systems and procedures ``establish

    structural and institutional safeguards to ensure that the activities

    of any person within the firm relating to research or analysis of the

    price or market for any commodity are separated by appropriate

    informational partitions within the firm from the review, pressure, or

    oversight of persons whose involvement in trading or clearing

    activities might potentially bias the judgment or supervision of the

    persons.'' New section 4d(c) further requires that such systems and

    procedures ``address such other issues as the Commission determines to

    be appropriate.'' Proposed Sec. 1.71, as set forth in the FCM/IB

    Conflicts NPRM, addressed the statutory mandate of section 4d(c).

    As proposed, Sec. Sec. 23.605 and 1.71 were identical in all

    material respects. The Commission received 29 comment letters to the

    SD/MSP Conflicts NPRM and 26 comment letters to the FCM/IB Conflicts

    NPRM. Many commenters provided comments addressing identical provisions

    or issues in both proposed rules. The discussion below thus addresses

    comments to both proposed rules unless otherwise indicated.

    1. Compliance Oversight by Self-Regulatory Organizations (SROs)

    Although proposed Sec. Sec. 23.605 and 1.71 prescribed the

    implementation of conflict-of-interest policies and procedures by SDs,

    MSPs, FCMs, and IBs, the proposal did not address compliance oversight

    by SROs. Nonetheless, the Commission received comments on whether the

    conflict-of-interest policies and procedures mandated under sections

    4s(j)(5) and 4d(c) of the CEA should be prescribed by the Commission or

    by an SRO.

    The Futures Industry Association (FIA), ISDA, and SIFMA, in a joint

    comment, argued that an SRO should oversee and enforce the conflict-of-

    interest requirements on SDs, MSPs, FCMs, and IBs. FIA, ISDA, and SIFMA

    stated that SROs would be in a better position than the Commission to

    address the likely need for future amendments to the rule. The comment

    suggested that the Commission establish a framework governing the

    implementation of conflict-of-interest policies and procedures, and

    instruct the appropriate SRO to write detailed compliance requirements

    within that framework, including the execution of audit and compliance

    functions, and the issuance of specific guidance that would be subject

    to the Commission's review and approval. In a separate comment, JP

    Morgan expressed a general agreement with the points raised in the FIA/

    ISDA/SIFMA letter.

    Michael Greenberger and UNITE HERE commented that the monitoring

    and enforcement of the implementation of conflict-of-interest policies

    and procedures for SDs and MSPs should be carried out by the

    Commission, as opposed to SROs.

    Having considered the comments, the Commission is adopting the rule

    as proposed on this issue. Unlike section 15D of the Securities

    Exchange Act of 1934, which mandated that conflict-of-interest rules be

    adopted either by the SEC, or by a registered securities association or

    national securities exchange, sections 4s(j)(5) and 4d(c) of the CEA as

    added by sections 731 and 732 of the Dodd-Frank Act, respectively,

    direct the CFTC to promulgate such rules. The Commission will continue

    to collaborate with SROs on conflict-of-interest policies and

    procedures, particularly with respect to their effectiveness.

    2. Exemptive Relief

    The Commission's proposal in the FCM/IB NPRM did not expressly

    address issues surrounding the Commission's exemptive authority.

    Nonetheless, the Committee on Futures and Derivatives Regulation of the

    New York City Bar Association argued that, due to the unprecedented

    scope and breadth of the Commission's rulemakings, the Commission will

    encounter situations it had not previously considered, rules that do

    not operate in the manner intended, or unintended consequences when the

    rules are applied in a specific context. In such situations, exemptive

    relief would be appropriate and the Commission should prepare for such

    situations by providing Commission staff with the authority to grant

    exemptive relief in each rule. Having considered the comment, the

    Commission does not believe it appropriate to address exemptive relief

    in this rule. Rather, any person may submit a request for an exemptive,

    no-action or interpretive letter, in accordance with the procedures set

    forth in Commission Regulation 140.99.\21\ Further, should any person,

    in the future, believe that an amendment to a Commission regulation is

    warranted, such person may petition the Commission for an amendment in

    accordance with the procedures set forth in Commission Regulation

    13.2.\22\

    ---------------------------------------------------------------------------

    \21\ 17 CFR 140.99.

    \22\ 17 CFR 13.2.

    ---------------------------------------------------------------------------

    3. Consistent Conflicts-of-Interest Treatment Between FCMs/IBs and SDs/

    MSPs

    Pierpont Securities Holdings LLC expressed agreement with the

    Commission's proposal to apply Sec. 23.605 and Sec. 1.71 in a manner

    that is consistent with one another. The consistency is particularly

    important in situations where a FCM is an affiliate of, or dually

    registered as, an SD or MSP. The Commission acknowledges the comment

    and notes its belief that such consistent treatment is reasonable and

    reflects the statutory directives and policy goals underlying sections

    4d(c) and 4s(j)(5) of the CEA, as amended by sections 732 and 731 of

    the Dodd-Frank Act, respectively.

    4. Definitions--Sec. 23.605(a), Sec. 1.71(a)

    a. Business Trading Unit--Sec. 23.605(a)(2), Sec. 1.71(a)(2)

    The proposed rules defined the term ``business trading unit'' as

    ``any department, division, group, or personnel of a [SD, MSP, FCM, or

    IB] or any of its affiliates, whether or not identified as such, that

    performs or is involved in any pricing, trading, sales, marketing,

    advertising, solicitation, structuring, or brokerage activities on

    behalf of a [SD, MSP, FCM, or IB].''

    The Commission received a comment from the FHLBs, and a joint

    comment from FIA, ISDA, and SIFMA, arguing that the Commission should

    clarify that Sec. 23.605(a)(2) and Sec. 1.71(a)(2) apply to

    traditional ``front office'' functions and not to those functions that

    support the

    [[Page 20146]]

    front office, such as legal, compliance, operations, credit, and human

    resources functions. FIA/ISDA/SIFMA noted that in order to fulfill

    legal, compliance, and risk management functions, firms are integrated

    such that the exclusion of such control and/or support functions should

    be excluded from the definitions of business trading unit and clearing

    unit. In a separate comment, JP Morgan expressed a general agreement

    with the points raised in the FIA/ISDA/SIFMA letter.

    In the preambles of the SD/MSP and FCM/IB NPRMs, the Commission

    noted that the proposed rules are not intended to hinder the execution

    of sound risk management programs by SDs, MSPs, FCMs, IBs, or by any

    affiliate of an SD, MSP, FCM, or IB. The Commission's proposals largely

    addressed the issue raised by the commenters in the proposed

    definitions of ``non-research personnel'' at Sec. 23.605(a)(5) and

    Sec. 1.71(a)(5), which carved out legal and compliance personnel from

    those definitions. In addition, the final rule modified the definition

    of non-research personnel to those employees who are not directly

    responsible for, or otherwise not directly involved in, research or

    analysis intended for inclusion in a research report. The Commission

    believes its prior statements and these changes should clarify the

    scope of the definitions.

    Nonetheless, upon reviewing the comments, the Commission has

    determined it appropriate to modify the definitions. The rule language,

    as originally proposed, is amended in the final rules to: (1) Clarify

    that the term includes those persons who directly perform or exercise

    supervisory authority over the performance of the tasks listed in the

    rule, and not those who merely are ``involved in'' such activities,

    such as the legal, compliance, human resources, risk management,

    operations, and other support functions; and (2) exclude price

    verification for risk management purposes from the types of pricing

    activities covered by the definitions. The Commission believes that

    these changes will address the issues raised by the commenters while

    ensuring that the rule text properly reflects the intent of the

    Commission.

    b. Clearing Unit--Sec. 23.605(a)(3), Sec. 1.71(a)(3)

    The proposed rules defined the term ``clearing unit'' as ``any

    department, division, group, or personnel of a [SD, MSP, FCM, or IB] or

    any of its affiliates, whether or not identified as such, that performs

    or is involved in any proprietary or customer clearing activities on

    behalf of a [SD, MSP, FCM, or IB].''

    Similar to the concerns raised in comments on the proposed

    definition of ``business trading unit,'' FIA, ISDA, and SIFMA, in a

    joint comment, argued that the Commission should clarify that Sec.

    23.605 and Sec. 1.71 applies to traditional ``front office'' functions

    and not to functions that support the front office, such as legal,

    compliance, operations, credit, and human resources functions. In a

    separate comment, JP Morgan expressed a general agreement with the

    points raised in the FIA/ISDA/SIFMA letter.

    As stated above with respect to the comments received on the

    proposed definition of ``business trading unit,'' the Commission noted

    in the preambles to the SD/MSP and FCM/IB Conflicts NPRMs that the

    proposed rules are not intended to hinder the execution of sound risk

    management programs by SDs, MSPs, FCMs, IBs, or by any affiliate of an

    SD, MSP, FCM, or IB. The NPRMs largely addressed the issue raised by

    the commenters in the proposed definitions of ``non-research

    personnel'' at Sec. 23.605(a)(5) and Sec. 1.71(a)(5), which carved

    out legal and compliance personnel from that definition. The Commission

    reiterates its prior statements on this issue, which should make clear

    the scope of the definitions.

    Nonetheless, upon reviewing the comments, the Commission has

    determined it appropriate to modify the definitions. The rule language,

    as originally proposed, is amended in the final rules to clarify that

    the term includes those persons or groups who perform or exercise

    supervisory authority over the performance of the tasks listed in the

    rules, and not those who merely are ``involved in'' such activities.

    The Commission believes that these changes will address the issues

    raised by the commenters while ensuring that the rule text properly

    reflects the intent of the Commission.

    c. Non-Research Personnel--Sec. 23.605(a)(5)

    The proposed rule defined the term ``non-research personnel'' as

    ``any employee of the business trading unit or clearing unit, or any

    other employee of the [SD] or [MSP] who is not directly responsible

    for, or otherwise involved with, research concerning a derivative,

    other than legal or compliance personnel.''

    EEI argued that the Commission should limit the definition of non-

    research personnel to include only those persons involved with trading,

    pricing, or clearing activities, and not to other areas.

    Upon reviewing the comment, the Commission is adopting the language

    as originally proposed. The Commission believes that changing the

    language in the manner suggested by the commenter would increase the

    risk that SDs or MSPs might attempt to evade the restrictions set forth

    in the rule.

    d. Public Appearance--Sec. 23.605(a)(6), Sec. 1.71(a)(6)

    The proposed rules defined the term ``public appearance'' as ``any

    participation in a conference call, seminar, forum (including an

    interactive electronic forum) or other public speaking activity before

    15 or more persons, or interview or appearance before one or more

    representatives of the media, radio, television or print media, or the

    writing of a print media article, in which a research analyst makes a

    recommendation or offers an opinion concerning a derivatives

    transaction.\23\ This term does not include a password-protected

    webcast, conference call, or similar event with 15 or more existing

    customers, provided that all of the event participants previously

    received the most current research report or other documentation that

    contains the required applicable disclosures, and that the research

    analyst appearing at the event corrects and updates during the public

    appearance any disclosures in the research report that are inaccurate,

    misleading, or no longer applicable.''

    ---------------------------------------------------------------------------

    \23\ The Commission notes that SD and MSP communications with

    counterparties and potential counterparties also are addressed in

    the Commission's external business conduct standards rules. See

    Subpart H of Part 23 of the Commission's Regulations, Business

    Conduct Standards for Swap Dealers and Major Swap Participants with

    Counterparties, 77 FR 9734 (Feb. 17, 2012).

    ---------------------------------------------------------------------------

    FIA, ISDA, and SIFMA, in a joint comment, argued that the

    definition of public appearance (speaking before 15 or more

    ``persons'') should articulate that the term ``person'' includes both a

    customer that is a natural person and one that is an entity. For

    example, if a single institutional customer sends 16 employees to a

    forum held by an SD, MSP, FCM, or IB, each of those employees should

    not be counted as a ``person;'' rather, employees from a single

    institutional customer should be deemed to be one ``person'' at that

    forum, for purposes of the rule. In a separate comment, JP Morgan

    expressed a general agreement with the points raised in the FIA/ISDA/

    SIFMA letter.

    Upon reflection, the Commission agrees with the commenters, and is

    altering the rules to incorporate the

    [[Page 20147]]

    recommendation offered by the commenter. Specifically, the Commission

    is modifying the rule to clarify that the term ``persons'' in this

    context refers to either natural persons or entities. Thus, for

    example, if a single entity sends multiple natural persons as

    representatives to a public speaking activity that may be subject to

    the rule, such natural persons would be counted as a single ``person''

    for purposes of determining whether the public speaking activity meets

    the definition of ``public appearance.''

    e. Research Department--Sec. 23.605(a)(8), Sec. 1.71(a)(8)

    The proposed rules defined the term ``research department'' as

    ``any department or division that is principally responsible for

    preparing the substance of a research report relating to any derivative

    on behalf of a [SD, MSP, FCM, or IB], including a department or

    division contained in an affiliate of a [SD, MSP, FCM, or IB].''

    FIA, ISDA, and SIFMA, in a joint comment, argued that the scope of

    ``research department,'' and the restrictions imposed by the proposed

    rules concerning research departments, should not apply to the global

    affiliates of an SD, MSP, FCM, or IB. FIA/ISDA/SIFMA posited that the

    imposition of such restrictions on global affiliates would create

    significant logistical hurdles and expenses for multinational firms,

    especially in situations where an affiliate has no significant

    interaction with the SD, MSP, FCM, or IB. Further, FIA/ISDA/SIFMA

    suggested that local regulations governing non-US affiliates may not

    permit such non-US affiliates to comply with the rules. As an

    alternative, FIA/ISDA/SIFMA suggested that the Commission limit the

    rules to requiring disclosure ``on third party research reports,'' and

    focus the Commission's enforcement resources on SDs, MSPs, FCMs, and

    IBs that attempt to evade the rule by moving research analysts to

    affiliates. In a separate comment, JP Morgan expressed a general

    agreement with the points raised in the FIA/ISDA/SIFMA letter.

    Upon reviewing the comments, the Commission has determined it

    appropriate to adopt the rules as originally proposed. The Commission

    believes that the alternatives suggested by FIA/ISDA/SIFMA would

    increase the risk of evasion by multinational registrants. Such risk of

    evasion outweighs any benefit to be derived from the proffered

    alternative. However, to clarify any ambiguity that may exist in the

    rules adopted herein, the Commission confirms that a holding company

    need not examine the research functions of all of its affiliates under

    these rules; rather, a holding company needs only to look at those

    research groups doing research on behalf of an SD, MSP, FCM, or IB. In

    light of its stated intent, the Commission believes that the cost-

    effectiveness of the rules will be promoted.

    f. Research Report--Sec. 23.605(a)(9), Sec. 1.71(a)(9)

    The proposed rules defined the term ``research report'' as: ``[A]ny

    written communication (including electronic) that includes an analysis

    of the price or market for any derivative, and that provides

    information reasonably sufficient upon which to base a decision to

    enter into a derivatives transaction.'' However, the proposals

    expressly excluded four categories of communications from coverage by

    the definitions.

    FIA, ISDA, and SIFMA, in a joint comment, argued that the

    exclusions from the definition of ``research report'' should be

    expanded to include general market discussions and other communications

    that are not ``research reports'' in other regulatory contexts. The

    definitions should be limited to those research reports analyzing a

    specific derivative or futures transaction. Exclusions set forth in

    other regulatory contexts--specifically NASD Rule 2711(a)(9)(A) and SEC

    Regulation AC--should be included in the Commission's definitions of

    ``research report.'' FIA/ISDA/SIFMA further argued that communications

    produced by a business trading unit labeled as a ``trading/sales desk

    product'' and as ``non-research'' should be excluded from the

    definitions of research report. In a separate comment, JP Morgan

    expressed a general agreement with the points raised in the FIA/ISDA/

    SIFMA letter.

    EEI argued that the Commission should exclude from the definition

    any communication between an SD or MSP, and its regulator, concerning

    hedging activity. The commenter posited that firms with small trading

    operations should be permitted to publish occasional research reports

    to justify trading decisions, without being subject to the rules set

    forth in the SD/MSP Conflicts NPRM.

    The National Futures Association (NFA) argued that the definition

    in proposed Sec. 1.71(a)(9) was too broad and suggested that the

    definition be limited to reports containing material information at a

    level of detail that amounts to ``a call to action to the customer,''

    or that could have a price impact on the market for a particular

    product. NFA also argued that the definition should include an

    exception for general market commentary, similar to NASD Rule 2711.

    Newedge USA LLC (Newedge) also argued that the definition in proposed

    Sec. 1.71(a)(9) was too broad, because any discussion of a derivative

    that references the underlying physical commodity or financial

    instrument could be deemed to provide ``information reasonably

    sufficient upon which to base a decision to enter into a derivatives

    transaction.'' Newedge contended that the definition of research report

    should be restricted to ``any written communication * * * including an

    analysis of the price/market for any specific derivative contract, and

    that provides information reasonably sufficient upon which to base a

    decision to enter into a transaction involving such specific derivative

    contract.''

    ADM Investor Services Inc. commented on the differences between

    daily research reports and weekly and monthly research reports, arguing

    that proposed Sec. 1.71(a)(9) unnecessarily threatened existing

    industry practices, particularly with respect to opening and closing

    comments or intraday market comments by IBs, which do not consist of

    detailed research but could be covered by the proposed definition of

    ``research report.''

    Having considered the comments, the Commission has determined it

    appropriate to modify the exclusions to the definitions of ``research

    report,'' as that term was proposed in the SD/MSP and FCM/IB Conflicts

    NPRMs. Specifically, the Commission agrees with FIA/ISDA/SIFMA's

    recommendation that ``commentaries on economic, political, or market

    conditions'' and ``statistical summaries of multiple companies'

    financial data, including listings of current ratings'' should be

    excluded from the definitions of research report. With regard to the

    exclusion for commentaries on economic or market conditions, the

    Commission believes that there are distinguishing characteristics

    between research reports setting forth factual statements about the

    market for specific derivatives and commentaries that provide opinion

    on general economic, political, or market conditions. Accordingly, the

    Commission has modified the rules to incorporate those two exclusions

    into the definitions of ``research report.''

    However, the Commission does not believe that other types of

    communications should be excluded from the definitions, because they

    could represent the core focus of a research department doing research

    on behalf of an SD, MSP, FCM, or IB, e.g., asset

    [[Page 20148]]

    classes, economic variables commonly referenced in derivatives, and on-

    the-run swap rates. Adopting the NASD 2711 exclusion for analysis

    concerning economic variables (e.g. rates, inflation) that are commonly

    referenced in derivatives, would create an exception that would swallow

    the rule. For example, research conducted on trends in the interest

    rate, gold, or oil markets are inextricably linked to the swap markets

    that reference those underlying assets or rate.

    The Commission believes that the changes adopted herein will

    increase consistency with NASD Rule 2711, which was promulgated

    pursuant to section 15D of the Securities Exchange Act. The Commission

    believes that the rules, in final form, provide SDs, MSPs, FCMs, and

    IBs with sufficient flexibility concerning solicitation materials

    generated by the trading unit, given the exclusion from coverage of

    ``[a]ny communication generated by an employee of the business trading

    unit that is conveyed as a solicitation for entering into a derivatives

    transaction, and is conspicuously identified as such.'' \24\

    ---------------------------------------------------------------------------

    \24\ The Commission notes that SD and MSP communications with

    counterparties and potential counterparties are addressed in the

    Commission's external business conduct standards rules. See Subpart

    H of Part 23 of the Commission's Regulations, Business Conduct

    Standards for Swap Dealers and Major Swap Participants with

    Counterparties, 77 FR 9734 (Feb. 17, 2012).

    ---------------------------------------------------------------------------

    5. Policies and Procedures--Sec. 23.605(b)

    As proposed, Sec. 23.605(b) required each SD and MSP to ``adopt

    and implement written policies and procedures reasonably designed to

    ensure that the [SD] or [MSP] and its employees comply with the

    provisions of this rule.'' Chris Barnard commented that the prevention

    of SDs and MSPs from engaging in activities with actual, perceived, or

    potential conflicts of interest will improve transparency and

    confidence in the markets, and will reduce risk. The Commission

    acknowledges the comment and is adopting Sec. 23.605(b) without

    revision.

    6. Research Analysts and Research Reports--Sec. 23.605(c), Sec.

    1.71(c)

    a. Separation of Research Analysts From Business Trading Unit and

    Clearing Unit--Sec. 23.605(c)(1)

    Proposed Sec. Sec. 23.605 and 1.71 prescribed certain restrictions

    on the relationship between the research department and all non-

    research personnel. Such restrictions included limitations on

    influencing the content of research reports, the supervision of

    research analysts, and the review or approval of research reports.

    With regard to this proposed rule, MFA suggested that the

    Commission provide additional clarity on the proposed rule by further

    describing the bright lines of separation between the research

    department and non-research personnel. For example, the commenter

    queried whether an SD may house its research department and trading

    department in the same building or on the same floor, and whether

    different key cards for entry into each department are required by the

    rule. Additionally, BlackRock commented that the Commission ``should

    explicitly exempt entities whose research personnel produce reports for

    internal use only.''

    After reviewing the comments, the Commission believes that the

    comments raised by the commenters may best be addressed through

    clarification of the underlying intent of the rule. Accordingly, the

    Commission has determined it appropriate to adopt the rule as it was

    originally proposed. First, with respect to MFA's comments, the rule

    does not expressly require physical separation of the research

    department and all non-research personnel; however, such separation

    will be considered by the Commission to be a good practice by

    registrants in order to minimize the risk of violating the rule.

    Second, with respect to BlackRock's comments, the Commission believes

    that the issue of internal research reports is adequately addressed by

    proposed Sec. 23.605(a)(9)(iv), which excluded from the definition of

    ``research report'' any ``internal communications that are not given to

    current or prospective customers.'' \25\

    ---------------------------------------------------------------------------

    \25\ This language is being adopted by the Commission as

    proposed; however, the provision has been renumbered as Sec.

    23.605(a)(9)(vi).

    ---------------------------------------------------------------------------

    b. Conflicts of Interest Adequately Addressed by Existing Commission

    and NFA Rules

    Proposed Sec. 1.71 did not discuss the issue of whether existing

    Commission and NFA rules adequately address the directives set forth in

    section 4d(c) of the CEA as amended by section 732 of the Dodd-Frank

    Act. Nonetheless, the Commission received comments that raised the

    issue.

    NFA commented that certain of its existing rules address issues

    raised in the Commission's rule proposal, and that the specific

    requirements related to research reports that may not be directly

    applicable to derivatives could have unintended consequences. K&L Gates

    LLP (on behalf of Peregrine Financial Group Inc.), ADM Investor

    Services Inc., John Stewart & Associates Inc., and Stewart-Peterson

    Group Inc. each argued that the issues addressed by the proposed rule

    are already addressed through existing rules.

    Swaps and Derivatives Market Association commented that the

    proposed rules should be adopted as they were originally proposed.

    After considering the comments, the Commission has determined it

    appropriate to adopt the rule, as it was originally proposed, on this

    issue. Although certain Commission and NFA rules tangentially address

    the issues set forth in the proposed rule, section 732 of the Dodd-

    Frank Act directed the Commission to take certain actions beyond the

    requirements previously promulgated in the rules of the Commission and

    NFA. Further, given the similarities between section 4d(c) of the CEA

    as amended by section 732 of the Dodd-Frank Act, and section 15D of the

    Securities Exchange Act of 1934, the Commission believes that it is

    important to provide a measure of specificity with respect to the

    conflict-of-interest policies and procedures mandated under section

    4d(c) and Sec. 1.71. Such specificity will promote consistency in the

    marketplace. Further, by maintaining consistency--to the extent

    warranted--with NASD Rule 2711, the Commission believes that the

    proposed rule will minimize disruption to the marketplace, given that

    such standards are well-established in the financial industry.

    c. Treatment of Small IBs

    As proposed, Sec. 1.71 did not establish a separate standard for

    small IBs. However, in the preamble of the proposed rule, the

    Commission expressly invited comment on how these rules should apply to

    FCMs and IBs, considering the varying size and scope of the operations

    of such firms. The preamble noted, as an example of how the rule could

    be adjusted to account for firms of different sizes, that NASD Rule

    2711(k) provides an exception from certain requirements for `small

    firms,' defined to include those firms that over the past three years

    have participated in ten or fewer investment banking services

    transactions and generated $5 million or less in gross investment

    banking services revenues from those transactions. The Commission

    solicited comment on whether a similar approach should be adopted for

    small FCMs and IBs. Moreover, the exceptions to the definition of

    research report were designed to address issues typically found in

    smaller firms where individuals in the trading unit perform

    [[Page 20149]]

    their own research to advise their clients or potential clients.

    Several commenters suggested that small IBs should be excepted from

    the proposed rule. NFA argued that the proposed rule effectively could

    prohibit the business model of a number of firms that provide an

    important service to the industry, particularly with respect to

    agriculture. The commenter suggested that, in adopting an exception for

    small IBs, the Commission could consider the following factors: A

    firm's gross annual revenue, number of associated persons, number of

    annual futures transactions, and nature of the customer base. National

    Introducing Brokers Association, ADM Investor Services Inc., John

    Stewart & Associates Inc., and Stewart-Peterson Group Inc. each argued

    that implementing the proposed rules would be prohibitively costly,

    burdensome, and unnecessary for small IBs, particularly for IBs dealing

    with agricultural commodities, and would force small IBs out of

    business. Chris Barnard noted that small IBs lack the capacity to carry

    the proportionately heavier regulatory burden set forth in the proposed

    rule, and as such, some regulatory mitigation would be beneficial,

    based on number of staff or revenues. Multiple commenters also

    commented on the limited market price impact of research reports

    created or distributed by small IBs, as well as the potential that the

    normal duties of associated persons may be deemed to be research

    activities for purposes of the rule.

    The Commission recognizes and agrees with certain concerns raised

    by the commenters. Thus, upon review of the comments, the Commission is

    adopting a separate regulatory standard for small IBs, reflecting the

    alternative set forth in the preamble of the proposed rule. Section

    4d(c) of the CEA mandates the establishment of ``appropriate

    informational partitions'' within FCMs and IBs, and all such firms are

    bound by that statutory requirement. However, the Commission recognizes

    that the size of an IB plays a significant role in determining the

    appropriateness of such partitions. Accordingly, the rule, in its final

    form, establishes a separate standard for any IB that has generated,

    over the preceding 3 years, $5 million or less in aggregate gross

    revenues from its activities as an IB. This standard is similar to

    language in NASD Rule 2711 that was raised expressly as a possible

    alternative in the preamble of the proposed rule.

    For any IB meeting those financial requirements, Sec. 1.71(c) of

    the rule would not apply. Further, Sec. 1.71(b) has been changed to

    set forth a separate policies and procedures requirement for small IBs.

    The recommended language of new Sec. 1.71(b)(2) largely mirrors the

    statutory requirement of section 4d(c). However, the Commission

    believes that small IBs should be subject to Sec. 1.71(e) (policies

    and procedures mandating disclosure of material incentives and

    conflicts of interest) and Sec. 1.71(f) (recordkeeping and

    reporting).\26\ The Commission believes that these changes to the rule,

    as originally proposed, will address the concerns raised by the

    commenters and limit the cost burden imposed on small IBs.

    ---------------------------------------------------------------------------

    \26\ The provisions of Sec. 1.71(d) are applicable only to

    FCMs.

    ---------------------------------------------------------------------------

    Finally, the Commission notes that commentaries on market

    conditions have been excluded from the definition of ``research

    report,'' as discussed above.

    d. Insider Trading and Futures Markets

    Proposed Sec. 1.71 did not address insider trading in the futures

    markets, or how that issue impacts the implementation of section 732 of

    the Dodd-Frank Act. Nonetheless, the Commission received comments on

    the issue. Specifically, K&L Gates LLP (on behalf of Peregrine

    Financial Group Inc.), John Stewart & Associates Inc., ADM Investor

    Services Inc., and Stewart-Peterson Group Inc. each argued that the

    proposed rules inappropriately relied upon established rules in the

    securities industry, claiming that no ban on insider trading exists in

    the futures industry. Further, ADM Investor Services Inc. and Stewart-

    Peterson Group Inc. each contended that only the publication of a U.S.

    Department of Agriculture market report could have a dramatic effect on

    the futures market.

    Having considered the comments, the Commission has determined not

    to modify the rule on this issue. Section 732 of the Dodd-Frank Act

    directed the Commission to take actions concerning conflict-of-interest

    policies and procedures, and in that provision, Congress included

    language previously included in section 15D of the Securities Exchange

    Act of 1934. Section 15D directed that regulatory language be

    promulgated to implement that statute, and those regulatory standards

    are now well-established in the financial industry. Given the

    similarities in statutory language, coupled with the well-established

    principles set forth in NASD Rule 2711, the Commission believes that it

    is important to provide a measure of specificity with respect to the

    conflict-of-interest policies and procedures mandated under section

    4d(c) and the proposed rule. Such specificity will promote consistency

    and certainty in the marketplace. Further, by maintaining consistency--

    to the extent warranted--the Commission believes that the final rule

    will minimize disruption to the marketplace.

    e. Exception for FCMs If Engaged in Only a de minimis Amount of

    Proprietary Trading

    Proposed Sec. 1.71 did not set forth a de minimis exception for

    FCMs. Nonetheless, the Commission received a comment from Newedge,

    which argued that FCMs engaging in minimal proprietary trading should

    not be subject to the provisions relating to research analysts. The

    commenter stated that the proposed rule would impose unnecessary

    burdens, and that a firm that engages in only limited proprietary

    trading does not present a risk of conflicts of interest.

    Having considered the comment, the Commission does not believe it

    appropriate to modify the proposed rule on this issue. The imposition

    of a de minimus exception to the conflicts rule is inconsistent with

    the statutory directive that Congress set forth in section 732 of the

    Dodd-Frank Act, which does not distinguish between proprietary trading

    and trading for the accounts of customers. Moreover, the limited nature

    of a firm's proprietary trading does not serve to negate the issues

    intended to be addressed through the statutory mandate.

    f. Lack of Examples of Research-Related Conflicts of Interest in the

    Futures Industry

    Proposed Sec. 1.71 did not cite specific examples of conflicts of

    interest in the futures industry, nor did it discuss the prevalence of

    conflicts in the industry. Nonetheless, the Commission received

    comments relating to those issues. K&L Gates LLP (on behalf of

    Peregrine Financial Group Inc.) commented that the Commission failed to

    cite any evidence of conflicts of interest arising from the publication

    of research reports. NFA commented that it had issued guidance

    prohibiting a FCM or IB from trading in a security futures product in

    anticipation of the issuance of a related research report, but that the

    commenter was unaware of any instances of conflicts of interest in

    research reports of security futures products. Further, Senator Carl

    Levin commented that the Commission should encourage compliance by

    developing examples of potential or actual conflicts of interest that

    should be disclosed to investors.

    After considering the comments, the Commission has decided not to

    modify

    [[Page 20150]]

    the proposed rule on this issue. Section 732 of the Dodd-Frank Act

    directed the Commission to take certain actions concerning conflict-of-

    interest policies and procedures. Specifically, as noted in the

    preamble of proposed Sec. 1.71, section 732 ``requires, in relevant

    part, that FCMs and IBs implement conflicts of interest systems and

    procedures that `establish structural and institutional safeguards to

    ensure that the activities of any person within the firm relating to

    research or analysis of the price or market for any commodity are

    separated by appropriate informational partitions within the firm from

    the review, pressure, or oversight of persons whose involvement in

    trading or clearing activities might potentially bias the judgment or

    supervision of the persons.''' This statutory language draws heavily

    from section 15D of the Securities Exchange Act, which was established

    through the Sarbanes-Oxley Act of 2002. The Commission believes that

    the provisions of the proposed rule relating to conflicts of interest

    represent a prudent implementation of the statutory directive.

    As noted above, the regulatory requirements promulgated pursuant to

    section 15D--which are similar to the requirements contained in the

    rule--are now well-established in the financial industry. Given the

    similarities in statutory language, coupled with the well-established

    principles set forth in NASD Rule 2711, the Commission believes that

    the proposed rule will promote consistency and certainty, while

    minimizing disruption, in the marketplace. With respect to Senator

    Levin's recommendation that the Commission should develop examples of

    potential or actual conflicts of interest, the Commission notes the

    many examples cited in Senator Levin's comment letter,\27\ but declines

    to provide additional examples so as not to pre-judge the scope of

    possible future enforcement actions.

    ---------------------------------------------------------------------------

    \27\ See, e.g., SEC Fact Sheet on Global Analyst Research

    Settlements, SEC (Apr. 28, 2003), available at http://www.sec.gov/news/speech/factsheet.htm; Hans G. Heidle and Xi Li, Is There

    Evidence of Front-Running Before Analyst Recommendations? An

    Analysis of the Quoting Behavior of Nasdaq Market Makers, Nov. 10,

    2003, available at http://www.afajof.org; Joint Report by NASD and

    the NYSE On the Operation and Effectiveness of the Research Analyst

    Conflict of Interest Rules (Dec. 2005), available at http://www.finra.org/Industry/Issues/ResearchAnalystRules/.

    ---------------------------------------------------------------------------

    g. Restriction on Non-Research Personnel From ``Influencing the

    Content'' of Research Reports--Sec. 23.605(c)(1)(i), Sec.

    1.71(c)(1)(i)

    The proposed rule provided that ``[n]onresearch personnel shall not

    influence the content of a research report of the [SD, MSP, FCM, or

    IB].''

    NFA commented that non-research personnel should be allowed to

    influence the content of a research report under certain circumstances

    and, further, that paragraph (i) should be eliminated from proposed

    Sec. 1.71(c)(1). FIA, ISDA, and SIFMA, in a joint comment, argued that

    the proposed prohibition on ``influencing the content'' should be

    eliminated because it would impair ordinary communications between

    research and non-research personnel. As an alternative, FIA/ISDA/SIFMA

    suggested that non-research personnel should be prohibited only from

    ``directing the views and opinions expressed in research reports.'' In

    a separate comment, JP Morgan expressed a general agreement with the

    points raised in the FIA/ISDA/SIFMA letter.

    Better Markets commented that the Commission should clarify and

    further restrict the communications covered by the provisions.

    Specifically, Better Markets argued that Sec. 23.605 and Sec. 1.71

    should be expanded not only to prohibit non-research personnel from

    influencing the content of a research report or any decision to publish

    a research report, but also any decision not to publish a report or to

    refrain from including relevant information.

    Upon consideration of the comments, the Commission agrees with the

    suggestions raised by both FIA/ISDA/SIFMA and Better Markets and is

    incorporating the suggestions into the final rules. Specifically, the

    Commission is modifying both proposed rules to remove the phrase

    ``shall not influence the content of a research report'' and replacing

    it with the phrase ``shall not direct a research analyst's decision to

    publish a research report of the [SD, MSP, FCM, or IB], and non-

    research personnel shall not direct the views and opinions expressed in

    a research report'' The Commission believes that the changes

    accommodate the concerns raised by the commenters while still

    reflecting the intent of the proposed rules.

    h. Restriction on Research Analyst Supervision by Business Trading Unit

    or Clearing Unit--Sec. 23.605(c)(1)(ii), Sec. 1.71(c)(1)(ii)

    The proposed rules provided that ``[n]o research analyst may be

    subject to the supervision or control of any employee of the [SD's,

    MSP's, FCM's, or IB's] business trading unit or clearing unit, and no

    personnel engaged in pricing, trading or clearing activities may have

    any influence or control over the evaluation or compensation of a

    research analyst.''

    FIA, ISDA, and SIFMA, in a joint comment, suggested that the

    Commission limit the scope of the rules, whereby employees of business

    trading and clearing units would be prohibited only from acting as

    direct supervisors of research analysts. In a separate comment, JP

    Morgan expressed a general agreement with the points raised in the FIA/

    ISDA/SIFMA letter.

    Upon reviewing the comment, the Commission has decided not to

    change the language of the proposed rules in the manner suggested by

    the commenter. Any influence on research analysts by non-research

    senior management responsible for pricing, trading, or clearing

    activities would undermine the conflict-of-interest requirements

    mandated by new sections 4d(c) and 4s(j)(5) of the CEA and set forth in

    the rules. However, the Commission has determined it appropriate to

    clarify the language of the rules, as they had been originally

    proposed, by using the defined terms ``business trading unit'' and

    ``clearing unit'' to designate those personnel who may not have

    influence or control over the evaluation or compensation of a research

    analyst.

    i. Trading Ahead of Research Report Publication

    Proposed Sec. 1.71 did not expressly impose restrictions against

    trading ahead of the publication of a research report. Senator Carl

    Levin commented that the Commission should add provisions akin to FINRA

    Rule 5280 (Trading Ahead of Research Reports) in order to improve the

    quality of research reports and the integrity of the marketplace. The

    Commission observes that it did not propose a trading ahead prohibition

    in its original proposals. However, the Commission believes that the

    restrictions on communications already included in the rules will

    minimize the opportunities for such activities to take place.\28\

    Moreover, the Commission will continue to monitor

    [[Page 20151]]

    this issue and may incorporate such a restriction in a future

    rulemaking.

    ---------------------------------------------------------------------------

    \28\ The Commission also notes that depending on the facts and

    circumstances, improperly trading ahead or front running

    counterparty orders may constitute fraudulent, deceptive or

    manipulative conduct under sections 4b and 6(c)(1) of the CEA, and

    Sec. 180.1 of Commission regulations, among other fraudulent,

    deceptive, and manipulative practices protections under the CEA and

    Commission regulations.

    ---------------------------------------------------------------------------

    j. Requirement That Legal/Compliance Personnel Supervise Communication

    Between Research and Non-Research Personnel--Sec. 23.605(c)(1)(iv)

    The proposed rule permitted non-research personnel to review a

    research report before its publication ``as necessary only to verify

    the factual accuracy of information in the research report, to provide

    for non-substantive editing, to format the layout or style of the

    research report, or to identify any potential conflicts of interest.''

    However, such review (1) may only be conducted through authorized legal

    or compliance personnel, and (2) must be properly documented.

    EEI commented that the Commission should exempt communications that

    are factual in nature from oversight by legal and compliance personnel,

    positing that coverage of such communications would hinder

    unnecessarily the development of research reports and unnecessarily

    burden legal/compliance personnel.

    After considering the comment, the Commission has decided to

    promulgate the rule as it was originally proposed. The Commission

    believes that involvement by legal or compliance personnel in such

    communications will reduce significantly the risk that non-research

    personnel will act in an unlawful manner, inadvertently or otherwise.

    k. Restrictions on Research Analyst Communications--Sec. 23.605(c)(2),

    Sec. 1.71(c)(2)

    The proposed rules provided that ``[a]ny written or oral

    communication by a research analyst to a current or prospective

    counterparty, or to any employee of the [SD, MSP, FCM, or IB], relating

    to any derivative must not omit any material fact or qualification that

    would cause the communication to be misleading to a reasonable

    person.''

    FIA, ISDA, and SIFMA, in a joint comment, argued that the proposed

    rule would burden an affected firm's operations--especially firms with

    foreign offices--and suggested that internal communications within a

    firm should be exempt from the material facts or qualifications

    required to be communicated to prospective and current customers. FIA/

    ISDA/SIFMA further noted that neither NASD Rule 2210 nor similar SRO

    rules contain equivalent restrictions, and that firms should be

    permitted to consider the nature of the audience when assessing whether

    a particular communication is misleading. FIA/ISDA/SIFMA also argued

    that the phrase ``or to any employee'' should be struck from proposed

    Sec. Sec. 23.605(c)(2) and 1.71(c)(2). In a separate comment, JP

    Morgan expressed general agreement with the points raised in the FIA/

    ISDA/SIFMA letter.

    Upon review of the comments, the Commission has determined it

    appropriate to change the rules to eliminate restrictions on

    communications to employees of an SD, MSP, FCM, or IB. The Commission

    believes that by deleting the phrase ``or to any employee of the [SD,

    MSP, FCM, or IB],'' the cost concerns implicated by requiring

    registrants to monitor internal communications will be addressed

    without producing a materially adverse impact on the effectiveness of

    the rules. To the extent that commenters stated that firms should be

    permitted to consider the nature of the audience when assessing whether

    a particular communication is misleading, the Commission notes that

    such matters will be governed by the Commission's existing anti-fraud

    standards.

    l. Restriction on Influence of Business Trading Unit and Clearing Unit

    on Research Analyst Compensation--Sec. 23.605(c)(3), Sec. 1.71(c)(3)

    Proposed Sec. Sec. 23.605(c)(3) and 1.71(c)(3) provided that an

    SD, MSP, FCM, or IB ``may not consider as a factor in reviewing or

    approving a research analyst's compensation his or her contributions to

    the [SD's, MSP's, FCM's, or IB's] trading or clearing business'' and

    that ``[n]o employee of the business trading unit or clearing unit of

    the [SD, MSP, FCM, or IB] may influence the review or approval of a

    research analyst's compensation.''

    FIA, ISDA, and SIFMA, in a joint comment, contended that research

    management should be able to solicit input from business trading and

    clearing unit personnel, particularly as non-research personnel may be

    in a better position to receive feedback from clients concerning the

    performance of research personnel. FIA/ISDA/SIFMA suggested that the

    Commission exempt from Sec. Sec. 23.605(c)(1)(ii) and 1.71(c)(1)(ii)

    any personnel who occupy non-trading or non-clearing positions, and who

    are not employed in the business trading or clearing units. FIA/ISDA/

    SIFMA, as well as Newedge, further argued that research management

    decisions concerning the performance evaluation of research analysts

    should be subject to firm-wide compensation guidelines, as long as they

    are non-discriminatory and non-prejudicial. In a separate comment, JP

    Morgan expressed a general agreement with the points raised in the FIA/

    ISDA/SIFMA letter. Newedge complained of a lack of clarity as to which

    personnel of a firm engaged exclusively or substantially in clearing

    activities, and not proprietary trading, would be available to

    supervise and evaluate research analysts. Newedge also argues that

    senior officers and employees of departments other than business

    trading and clearing units should be allowed to have input on

    compensation decisions.

    Michael Greenberger argued that research management should be

    prohibited from soliciting any input of business trading and clearing

    units concerning a research analyst's compensation or performance

    evaluation, even if the influence is indirect or if research management

    maintains the ability to make all final decisions on such

    determinations. Better Markets commented that the provision should be

    broadened. For example, Better Markets argued that a research analyst's

    contribution to the trading business of an affiliate should be

    prohibited from being considered when determining compensation. The

    commenter further noted that, in addition to prohibiting a research

    analyst's contributions to the trading business from being considered

    in respect of an analyst's compensation, ``consideration of adverse

    effects on such trading business'' must be also prohibited from being

    considered.

    After considering the comments, the Commission has determined it

    appropriate to change the language as set forth in the original

    proposal. As revised, the rules permit personnel of a business trading

    unit or clearing unit to forward communications by a client or customer

    to research department management, to the extent that such

    communications relate to feedback, ratings, and other indicators of a

    research analyst's performance provided by the client or customer. The

    Commission believes that the change will address certain concerns

    raised by FIA/ISDA/SIFMA and Newedge while not detracting from the

    policy goals underlying the provision. Beyond that change, the

    Commission has decided not to modify further the language that was

    originally proposed. Maintaining a firewall around research analyst

    compensation decisions is crucial to implementing effective conflict-

    of-interest policies and procedures. Nonetheless, to address an issue

    raised by FIA/ISDA/SIFMA, the Commission wishes to clarify the intent

    of the rule. Specifically, the rule is not intended to prohibit

    management decisions concerning the performance evaluation of research

    analysts from being subject

    [[Page 20152]]

    to firm-wide compensation guidelines, as long as they are non-

    discriminatory and non-prejudicial.

    m. Relevance of a Promise of Favorable Research to Futures Market--

    Sec. 1.71(c)(4)

    As proposed, Sec. 1.71(c)(4) prohibits an FCM or IB from

    ``directly or indirectly offer[ing] favorable research, or

    threaten[ing] to change research, to an existing or prospective

    customer as consideration or inducement for the receipt of business or

    compensation.'' K&L Gates LLP (on behalf of Peregrine Financial Group

    Inc.) commented that the provision may be relevant in the context of

    research on a particular company, but it has no relevance in terms of a

    report on soybeans or the Euro.

    After reviewing the comment, the Commission has decided not to

    modify the proposed rule on this issue. The Commission believes that

    the provision appropriately addresses the statutory directive and is an

    important component of firewall protection. Moreover, inclusion of this

    provision will maintain consistency with the conflict-of-interest

    provisions proposed for SDs and MSPs.

    n. Disclosure of Conflicts by Research Analysts in Research Reports and

    Public Appearances--Sec. 23.605(c)(5), Sec. 1.71(c)(5)

    Proposed Sec. Sec. 23.605(c)(5)(i) and 1.71(c)(5)(i) required that

    an SD, MSP, FCM, or IB ``disclose in research reports and a research

    analyst must disclose in public appearances: (1) Whether the research

    analyst maintains, from time to time, a financial interest in any

    derivative of a type that the research analyst follows, and the general

    nature of the financial interest; and (2) any other actual, material

    conflicts of interest of the research analyst or [SD, MSP, FCM, or IB]

    of which the research analyst has knowledge at the time of publication

    of the research report or at the time of the public appearance.''

    FIA, ISDA, and SIFMA, in a joint comment, argued that Sec. Sec.

    23.605(c)(5)(i) and 1.71(c)(5)(i) should be limited to disclosing

    whether a research analyst maintains a relevant financial interest ``at

    the time of publication of the report/time of public appearance,''

    rather than the phrase ``from time to time.'' FIA/ISDA/SIFMA also

    contended that the phrase ``any other actual, material conflict of

    interest of the research analyst'' is vague and would be burdensome to

    implement, requiring coordination among various business units and the

    creation of special databases in order to comply with the rule. In a

    separate comment, JP Morgan expressed a general agreement with the

    points raised in the FIA/ISDA/SIFMA letter. NFA also commented on the

    difficulty for FCMs to remain current on an analyst's financial

    interests, and that the Commission should clarify that the term ``of a

    type that the research analyst follows'' (Sec. 1.71(c)(5)(i)) refers

    to interest rate swaps, credit swaps, equity swaps, and other commodity

    swaps, consistent with the characterization of swaps set forth in the

    Commission's proposed product definitions.

    Senator Carl Levin commented that the Commission should use this

    rule not only to ensure the integrity of research reports, but also to

    impose a broader duty on FCMs and IBs to more completely disclose any

    adverse interest. The commenter suggested that the rule should prohibit

    firms from betting on the failure of instruments they designed and sold

    to customers.

    EEI suggested that the Commission modify the proposed rule to

    provide a de minimis exception from the research analyst financial

    interest disclosure requirements, and that a research analyst should be

    required only to identify relevant financial interests.

    Upon review of the comments, the Commission is modifying the

    language of Sec. Sec. 23.605(c)(5) and 1.71(c)(5) to remove the phrase

    ``from time to time.'' The Commission believes that this change will

    address the issue raised by FIA/ISDA/SIFMA. However, the Commission has

    determined that a de minimus exception would be inappropriate given the

    difficulty of deciding when a financial interest is de minimis in this

    context. Further, the Commission believes that the cost concerns of

    FIA/ISDA/SIFMA are misplaced. The rules require disclosure of ``any

    other actual, material conflicts of interest of the research analyst or

    [SD or MSP] of which the research analyst has knowledge at the time of

    publication of the research report or at the time of the public

    appearance'' (emphasis added).\29\ Thus, the disclosure requirement is

    limited to conflicts of which the research analyst has knowledge, and

    the SD, MSP, FCM, or IB need not construct the databases suggested by

    FIA/ISDA/SIFMA in order to comply with the rule.

    ---------------------------------------------------------------------------

    \29\ The Commission notes that in an action brought for failure

    to disclose a material conflict of interest of an SD or MSP in a

    research report or public appearance, the onus will be on the SD or

    MSP to show that they had policies and procedures reasonably

    designed to ensure that the research analyst had no knowledge of the

    material conflict of interest of the SD or MSP.

    ---------------------------------------------------------------------------

    o. Disclosure of Conflicts in Third-Party Research Reports--Sec.

    23.605(c)(5)(iv), Sec. 1.71(c)(5)(iv)

    As proposed, Sec. Sec. 23.605(c)(5)(iv) and 1.71(c)(5)(iv)

    required that if an SD, MSP, FCM, or IB distributes or makes available

    third-party research reports, each report must be accompanied by

    certain disclosures or an internet link to the appropriate disclosures,

    subject to certain conditions and qualifications.

    EEI argued that the required disclosures are unnecessary because

    third-parties are, by definition, independent of an SD or MSP. FIA,

    ISDA, and SIFMA, in a joint comment, stated that it was unclear what

    disclosures must be made in connection with the distribution of

    independent third-party research reports, given that, by definition,

    the SD, MSP, FCM, or IB has no role in the content or creation of an

    ``independent third-party research report.'' In a separate comment, JP

    Morgan expressed a general agreement with the points raised in the FIA/

    ISDA/SIFMA letter.

    Upon review of the comments, the Commission is adopting the rule as

    proposed. Third-party research reports provided by a registrant may be

    interpreted by recipients as carrying the endorsement of the registrant

    and may present conflicts-of-interest issues in the same way as

    research reports originating with the registrant's own research

    analysts. The Commission believes that the disclosures will afford

    recipients with a clear understanding of conflicts posed by a

    particular report.

    p. Application of Proposed Research Conflicts Rules to Research Reports

    Covering Derivatives and Securities

    The proposed rules and accompanying preambles did not address how

    the proposed requirements would apply to research reports that contain

    information that is subject to the rule and information that is

    securities-related.

    FIA, ISDA, and SIFMA, in a joint comment, questioned how Sec.

    23.605 and Sec. 1.71 would apply to a research report that addresses

    multiple products (i.e., both derivatives and securities), or to a

    report discussing a product that may be a derivative, security, or

    both. FIA/ISDA/SIFMA suggested that only the derivatives section of a

    report discussing securities and derivatives should be subject to the

    proposed regulations. In a separate comment, JP Morgan expressed a

    general agreement with the points raised in the FIA/ISDA/SIFMA letter.

    Upon review of the comments, the Commission has decided not to

    change

    [[Page 20153]]

    the language that was originally proposed. To the extent that

    securities underlie the derivatives discussed in the report, or to the

    extent that securities are otherwise intertwined with the discussion of

    derivatives, the Commission believes that any such discussion of

    securities should be subject to the Commission's rules. SDs, MSPs,

    FCMs, and IBs will be registered with the Commission, and the swaps and

    futures in which they transact will be within the Commission's

    jurisdiction. Because the value of each swap and future intrinsically

    may be based on the value of one or more underlying instruments,

    research reports by SDs, MSPs, FCMs, or IBs that analyze such

    underlying instruments should be addressed by the conflict-of-interest

    policies and procedures mandated under sections 4d(c) and 4s(j)(5) of

    the CEA.

    q. Application of Proposed Research Conflicts Rules to Research

    Analysts Covering Derivatives and Securities

    The proposed rules and accompanying preambles did not address how

    the proposed requirements would apply to research analysts that work

    with derivatives subject to the Commission's rules and securities

    subject to rules promulgated by the SEC or FINRA.

    FIA, ISDA, and SIFMA, in a joint comment, queried how the rule

    would apply to research analysts registered with both futures and

    securities regulators. FIA/ISDA/SIFMA suggested that the Commission

    confirm that individuals subject to both Sec. 23.605 or Sec. 1.71 and

    securities regulations must only comply with Sec. 23.605 or Sec. 1.71

    when acting in the capacity as a ``research analyst,'' as defined by

    Sec. 23.605 or Sec. 1.71. FIA/ISDA/SIFMA also raised concerns with

    respect to inconsistencies between Sec. Sec. 23.605 and 1.71 and other

    rules promulgated in the securities or futures context. In a separate

    comment, JP Morgan expressed a general agreement with the points raised

    in the FIA/ISDA/SIFMA letter.

    Having considered the comments, the Commission confirms that

    individuals subject to both Sec. 23.605 or Sec. 1.71 and securities

    regulations must only comply with Sec. 23.605 or Sec. 1.71 when

    acting in the capacity of a ``research analyst,'' as defined by Sec.

    23.605 or Sec. 1.71. SDs, MSPs, FCMs, and IBs will be registered with

    the Commission, and the swaps and futures in which they transact will

    be within the Commission's jurisdiction. Because the value of each swap

    and future intrinsically may be based on the value of one or more

    underlying instruments, research reports by SDs, MSPs, FCMs, and IBs

    analyzing such underlying instruments should be addressed by the

    conflict-of-interest policies and procedures mandated by new sections

    4d(c) and 4s(j)(5) of the CEA.

    7. Clearing Activities--Sec. 23.605(d), Sec. 1.71(d)

    a. Separation of Clearing Unit From Business Trading Unit--Sec.

    23.605(d)(1) and (2); Separation of Business Trading Unit and Clearing

    Unit--Sec. 1.71(d)(1) and (2)

    As proposed, Sec. 23.605(d)(1) provided that ``[n]o [SD] or [MSP]

    shall directly or indirectly interfere with or attempt to influence the

    decision of any affiliated clearing member of a [DCO] with regard to

    the provision of clearing services and activities,'' while proposed

    Sec. 1.71(d)(1) congruently provided that ``[n]o [FCM] shall permit

    any affiliated [SD] or [MSP] to directly or indirectly interfere with,

    or attempt to influence, the decision of the clearing unit personnel of

    the [FCM] with regard to the provision of clearing services and

    activities. * * *''

    Likewise, proposed Sec. 23.605(d)(2) provided that ``[e]ach [SD

    and MSP] shall create and maintain an appropriate informational

    partition, as specified in section 4s(j)(5)(A) of the Act, between

    business trading units of the [SD or MSP] and clearing member personnel

    of any affiliated clearing member of a [DCO],'' while proposed Sec.

    1.71(d)(2) congruently provided that ``[e]ach [FCM] shall create and

    maintain an appropriate informational partition between business

    trading units of an affiliated [SD] or [MSP] and clearing unit

    personnel of the [FCM].''

    MFA commented that it supports the prohibition of SDs and MSPs from

    directly or indirectly interfering with, or attempting to influence,

    the decision of any affiliated clearing member of a DCO with regard to

    clearing services and activities, as well as the informational

    partitions between business trading personnel and personnel of an

    affiliated clearing member. Pierpont Securities Holdings LLC also

    supported the Commission's proposals, contending that the informational

    partitions between a business trading unit and a clearing unit within a

    large financial institution must be established and maintained as to

    all personnel, not just supervisory personnel, and the penalties for

    violating those restrictions must be meaningful.

    Swaps and Derivatives Market Association filed two comments on

    these rules, both of which were supportive of the proposals. In the

    first comment, the commenter argued that the proposed separation of

    trading and clearing units in Sec. 23.605(d) should be expanded so as

    to require ``distant physical separation'' of the two. The commenter

    also expressed support for requiring the use of objective criteria in

    determining whether to accept clearing customers. In the second letter,

    the commenter contended that the restrictions set forth in Sec.

    23.605(d), as proposed, correctly address key areas where conflicts

    arise, and that the independence of clearing members is essential to

    accomplish several policy goals of the Dodd-Frank Act. In the second

    comment, the commenter stated its belief that the firewalls mandated by

    the proposed rules ``are critical to reducing potential conflicts

    between the trading unit of an FCM, IB, SD, or MSP and their clearing

    unit.''

    Michael Greenberger also expressed support for Sec. 23.605(d), as

    proposed, noting that attempts to tie clearing decisions to trade

    execution decisions would raise potential conflicts of interest, which

    could serve to block access to clearing and prevent competition among

    execution venues. The commenter also noted that mandatory public

    disclosure of client acceptance criteria by SDs and MSPs is consistent

    with legislative intent. Likewise, Pierpont Securities Holdings LLC

    also expressed support for the Commission's proposal, in particular the

    requirements that no direct or indirect interference or influence be

    permitted by the business trading unit on the clearing unit as to (i)

    whether clearing services will be provided and (ii) how clearing fees

    will be set.

    The Principal Traders Group supported a rule preventing

    interference by the business trading unit of an SD or MSP, with respect

    to the decision of an affiliated FCM to accept a client for clearing

    services, but preferred that the rule be presented in the form

    recommended by FIA/ISDA/SIFMA below.

    In contrast, FIA, ISDA, and SIFMA, in a joint comment, commented

    that the proposed rules would alter the business operations of

    integrated financial services firms to the detriment of clients and in

    a manner disproportionate to achieving the regulatory goals the

    Commission has identified, including the promotion of effective risk

    management. The commenters also argued that the Commission's proposed

    application of the conflicts rules to FCM clearing activities is not

    contemplated by section 732 of the Dodd-Frank Act. FIA/ISDA/SIFMA

    argued that the proposed rules would impair an SD's/MSP's ability to

    follow risk management best practices. FIA/ISDA/SIFMA

    [[Page 20154]]

    recommended that the Commission not adopt the proposed rules, but

    instead adopt a rule that prohibits an affiliated SD or MSP from

    obtaining information from an affiliated FCM's clearing personnel

    concerning transactions conducted by FCM clients with either their own

    clients or with independent SDs or MSPs. FIA/ISDA/SIFMA also expressed

    support for a rule that would require each FCM's clearing unit to have

    independent management that makes its own final decisions regarding

    clients to which it will offer clearing services as well as the terms

    for those services. FIA/ISDA/SIFMA also suggested that the Commission

    clarify that the rule does not mandate that firms publicize client

    sales and on-boarding decisions.

    UBS Securities LLC echoed certain points made in the FIA/ISDA/SIFMA

    comment, particularly with respect to the ability of a financial

    services firm to operate its swap clearing business as a partnership

    with its trading business in order to serve clients, while JP Morgan

    agreed with the FIA/ISDA/SIFMA comment discussed above. JP Morgan also

    posited that while ``it would be appropriate for the CFTC to issue

    rules prohibiting any activity intended to restrict open access to

    clearing, * * * we believe a SD/MSP should be permitted to work and

    share information with its clearing member affiliate to promote and

    facilitate a client's access to clearing services or to define the

    parameters pursuant to which clearing services will be offered.''

    The FHLBs argued that the proposed rule goes beyond the standards

    set forth in the Dodd-Frank Act and that the proposed rule ``overly

    restricts the ability of [SDs and MSPs] to run their trading and

    clearing operations and effectively service the needs of their end-user

    counterparties.'' The proposed rule also could inhibit SDs and MSPs

    ``from taking prudent, well-informed and timely actions in situations

    with respect to the closing out of transactions, in a default scenario

    or otherwise.''

    NFA commented that Sec. 1.71(d) is too broad and may negatively

    impact a firm's ability to share information about customers to make

    credit and risk determinations. UBS Securities LLC echoed certain of

    the points made in the FIA/ISDA/SIFMA comment, particularly with

    respect to the ability of a financial services firm to operate its swap

    clearing business as a partnership with its trading business in order

    to serve clients. Newedge commented that the proposed rule would limit

    firms' ability to coordinate, credit, risk, and other policies, and

    suggested that rather than prohibiting an affiliated SD or MSP from

    interfering with a FCM's decision to provide clearing services, Sec.

    1.71(d) should prohibit a FCM from permitting business trading unit

    personnel of an affiliated SD or MSP from interfering with the FCM's

    decision to provide clearing services.

    Commenters have expressed divergent views on this issue, with some

    commenters strongly favoring the Commission's proposed rules (and, to a

    certain extent, requesting that the rule be expanded), while others

    have advocated that the provision not be adopted. Upon consideration of

    all the comments, the Commission has determined it appropriate to

    promulgate the rules largely as they were originally proposed. The

    separation of the FCM clearing unit from the interference or influence

    of an affiliated SD or MSP is crucial to promoting open access to

    clearing. Open access to clearing will be essential for the expansion

    of client clearing needed for market participants to comply with the

    mandatory clearing of swaps as determined by the Commission under

    section 723 of the Dodd-Frank Act. The Commission believes that the

    promulgation of the language as proposed would be ``appropriate,'' as

    that term is used in section 4d(c) as amended by section 732 of the

    Dodd-Frank Act. Moreover, the Commission does not believe the rule will

    hamper risk management. The Commission notes that it has proposed

    straight-through processing rules,\30\ counterparty clearing

    documentation rules,\31\ and clearing member risk management rules \32\

    that would, if adopted, minimize the counterparty risk to an SD or MSP

    with respect to transactions required or intended to be cleared.

    ---------------------------------------------------------------------------

    \30\ See Requirements for Processing, Clearing, and Transfer of

    Customer Positions, 76 FR 13101, 13109 (Mar. 10, 2011).

    \31\ See Customer Clearing Documentation and Timing of

    Acceptance for Clearing, 76 FR 45730, 45737 (Aug. 1, 2011).

    \32\ See Clearing Member Risk Management, 76 FR 45724, 45729

    (Aug. 1, 2011).

    ---------------------------------------------------------------------------

    In response to commenters' concerns about an FCM's ability to

    manage a default scenario without the benefit of the trading expertise

    in the business trading unit, the Commission is modifying proposed

    Sec. 1.71(d)(2)(i) to permit the business trading unit of an

    affiliated SD or MSP to participate in the activities of an FCM during

    an event of default. Specifically, the business trading unit personnel

    would be permitted to participate in the activities of the FCM, as

    necessary, during any default management undertaken by a derivatives

    clearing organization that results from an event of default and for the

    purposes of transferring, liquidating, or hedging any proprietary or

    customer positions as a result of an event of default.

    In addition, the Commission is including the term ``clearing

    unit,'' as defined in Sec. 23.605(a), in the relevant provisions of

    Sec. 23.605(d). This change will serve to clarify the scope of the

    informational partition between the SD or MSP and the personnel or

    division of a clearing member responsible for the provision of clearing

    services.

    To clarify an issue raised by FIA/ISDA/SIFMA, the Commission notes

    that SDs and MSPs are not required to publicize their client sales and

    on-boarding decisions; rather, the criteria used in making those

    decisions should be publicly available and objective. In other words,

    ``all such decisions regarding the acceptance of customers for clearing

    should be made in accordance with publicly disclosed, objective,

    written criteria,'' as stated in the preamble of the proposed rule.

    b. Division of Clearing Unit Into Self-Clearing Unit and Customer

    Clearing Unit

    The proposed rules did not distinguish between a self-clearing unit

    (clearing for an SD's or MSP's own trades) and a customer clearing unit

    (clearing for customers and competitors). However, Swaps and

    Derivatives Market Association commented that the proposed rules should

    differentiate between the two units. Having considered that comment,

    the Commission has decided not to modify the language in the manner

    suggested by the commenter. The Commission believes that subdividing

    the clearing unit into two separate sub-units would create an

    unnecessary complication that could erode the firewall mandated by the

    statute.

    c. Prohibition on Business Unit Personnel of an SD or MSP From

    Supervising Personnel of an Affiliated DCO-Clearing Member--Sec.

    23.605(d)(2); Restrictions on SD and MSP Business Trading Unit

    Supervision of Clearing Unit of Affiliated FCM--Sec. 1.71(d)(2)(ii)

    As proposed, Sec. 23.605(d)(2) provided that, at a minimum, the

    Sec. 23.605(d)(2) informational partitions ``shall require that no

    employee of a business trading unit of a [SD] or [MSP] shall supervise,

    control, or influence any employee of a clearing member of a

    derivatives clearing organization,'' while proposed, Sec.

    1.71(d)(2)(ii) congruently provided that ``[n]o employee of a business

    trading unit of an affiliated [SD] or [MSP] shall supervise, control,

    or

    [[Page 20155]]

    influence any employee of a clearing unit of the [FCM].''

    FIA, ISDA, and SIFMA, in a joint comment, posited that because

    employees of a business trading unit and a clearing unit may be

    supervised by the same manager, Sec. Sec. 23.605(d)(2) and

    1.71(d)(2)(ii) should be amended to prohibit an employee of an SD or

    MSP from acting as a direct supervisor of any non-management personnel

    of an affiliated FCM's clearing unit. The commenter also suggested that

    salespeople be permitted to associate with an SD or MSP and with an

    affiliated FCM, and be permitted to act for clients at both entities.

    Further, the commenter argued that a carve-out should be added to

    Sec. Sec. 23.605(d) and 1.71(d) enabling an SD parent to exercise risk

    management over its affiliated FCM (e.g., approving credit and risk

    parameters for common and distinct customers) in a manner that is non-

    discriminatory, non-prejudicial, and for the sole purpose of complying

    with group risk and credit policies and parameters. In a separate

    comment, JP Morgan expressed a general agreement with the points raised

    in the FIA/ISDA/SIFMA letter.

    After reviewing the comment, the Commission has decided to adopt

    the rule with certain modifications. Any influence on clearing unit

    personnel by upper-level supervisors involved in business trading unit

    activities would undermine the conflict-of-interest requirements

    mandated by new sections 4d(c) and 4s(j)(5) of the CEA, as amended by

    sections 731 and 732 of the Dodd-Frank Act, respectively, and set forth

    in the rule. Moreover, the Commission does not believe that the rule

    language should be changed to permit sales personnel to act for both

    the trading unit and the clearing unit. The risks associated with this

    approach, in terms of potential undue influence and interference with

    clearing decisions has been well-supported by commenters, as discussed

    above.

    With regard to proposed Sec. 1.71(d), the Commission is making

    certain changes to clarify the intent of the rule. In particular, Sec.

    1.71(d)(1)(vi) is modified to prohibit an affiliated SD or MSP from

    interfering with or influencing decisions related to setting a

    particular customer's fees for clearing services based upon criteria

    that are not generally available and applicable to other customers of

    the FCM. Additionally, as proposed Sec. 1.71(d)(2)(i) required that

    the informational partitions between the business trading unit of the

    affiliated SD or MSP and the clearing unit personnel of the FCM include

    a prohibition on any business trading unit personnel participating in

    any way with the provision of clearing services. As modified, the rule

    clarifies that business trading unit personnel may not condition or tie

    the provision of trading services to the provision of clearing services

    or otherwise participate in clearing services by improperly

    incentivizing or encouraging the use of the affiliated FCM.\33\ In

    addition, as discussed above, business trading unit personnel would be

    permitted to participate in the activities of the FCM in the event of a

    default.

    ---------------------------------------------------------------------------

    \33\ The Commission generally would not view as ``improper''

    making available discounted clearing services in connection with

    trading activities, provided that the business trading unit

    personnel comply with applicable prohibitions and restrictions on

    their interactions with the clearing unit. The Commission emphasizes

    in this regard that in Sec. 1.71(d)(2), the term ``improperly''

    modifies both the term ``incentivizing'' and the term

    ``encouraging'' and that the term ``otherwise'' is intended to

    clarify that other ``improper'' activities, similar to conditioning

    or tying, could be subject to Sec. 1.71(d)(2). Such ``improper''

    activities are limited to those that wrongfully interfere with, or

    attempt to influence, a decision of the affiliated FCM's clearing

    unit personnel specified in Sec. 1.71(d)(1).

    ---------------------------------------------------------------------------

    8. Undue Influence on Customers--Sec. 1.71(e)

    As proposed, Sec. 1.71(e) mandated that FCMs and IBs ``adopt and

    implement written policies and procedures that mandate the disclosure

    to its customers of any material incentives and any material conflicts

    of interest regarding the decision of a customer as to the trade

    execution and/or clearing of the derivatives transaction.''

    K&L Gates LLP (on behalf of Peregrine Financial Group Inc.)

    commented that existing Commission regulations already impose risk

    disclosure requirements on FCMs and IBs, and that the proposed rule

    inappropriately imports a concept from the securities industry into the

    futures industry.

    Better Markets submitted two comment letters in support of the

    proposal. In the first comment, the commenter suggested that the rule

    should extend to the affiliates of an FCM or IB, and that the

    disclosure should include the nature and amounts of the relevant

    interests. In the second comment, the commenter suggested that the rule

    be expanded so that any incentives received by FCMs or SDs in exchange

    for use of various market infrastructures must be fully disclosed.

    Swaps and Derivatives Market Association submitted a comment supporting

    Sec. 1.71(e), as proposed.

    Having considered the comments, the Commission has determined it

    appropriate to adopt the rule as it was originally proposed. The

    Commission believes that in order to ensure that counterparties are

    adequately informed of any material incentives or conflicts prior to

    the execution of a transaction, it is essential that FCMs and IBs be

    required to adopt and implement written policies and procedures that

    require the advance disclosure of such conflicts. In addition to

    addressing issues of customer protection, the policies and procedures

    will promote consistency with proposed Sec. 23.605(e). Further, to the

    extent that Better Markets commented that the rule should be expanded

    to include disclosures of certain incentives received by FCMs and IBs,

    the Commission believes that the recommendation is beyond the scope of

    this rule.

    9. Undue Influence on Customers--Sec. 23.605(e)

    As proposed, Sec. 23.605(e) mandated that SDs and MSPs ``adopt and

    implement written policies and procedures that mandate the disclosure

    to its counterparties of any material incentives and any material

    conflicts of interest regarding the decision of a counterparty: (1)

    Whether to execute a derivative on a swap execution facility or

    designated contract market; or (2) Whether to clear a derivative

    through a derivatives clearing organization.''

    FIA, ISDA, and SIFMA, in a joint comment, noted that the proposed

    rule overlaps with disclosures proposed by the Commission in a separate

    notice of proposed rulemaking.\34\ The commenter argued that the

    provision should be narrowed and, alternatively, that the Commission

    could require SDs and MSPs to provide customers with an annual

    disclosure document describing potential conflicts that may exist among

    the firm, its affiliates, clients, and employees. In a separate

    comment, JP Morgan expressed a general agreement with the points raised

    in the FIA/ISDA/SIFMA letter.

    ---------------------------------------------------------------------------

    \34\ See Business Conduct Standards for SDs and MSPs with

    Counterparties, 75 FR 80638, 80659 (Dec. 22, 2010).

    ---------------------------------------------------------------------------

    Better Markets submitted two comment letters addressing the

    provision at issue. In the first comment, the commenter suggested that

    the Commission extend the disclosure requirements in several respects.

    In the second comment, the commenter reiterated its belief that

    incentives of SDs and MSPs received in exchange for use of various

    market infrastructures should be fully disclosed. Michael Greenberger,

    UNITE HERE, and Swaps and Derivatives Market Association each submitted

    comments supporting Sec. 23.605(e), as proposed.

    [[Page 20156]]

    After considering the comments, the Commission has determined it

    appropriate to adopt the rule as it was originally proposed. The

    Commission believes that in order to ensure that counterparties are

    adequately informed of any material incentives or conflicts prior to

    the execution of a transaction, it is essential that SDs and MSPs be

    required to adopt and implement written policies and procedures that

    require the advance disclosure of such conflicts. In addition to

    addressing issues of customer protection, the policies and procedures

    will promote the efficient use of trading facilities and DCOs for swap

    transactions, by ensuring that counterparties are adequately informed

    of any material incentives or conflicts of an SD or MSP that could

    impact the execution and clearing decisions of the counterparty.

    N. Designation of a Chief Compliance Officer; Required Compliance

    Policies; and Annual Report of an FCM, SD, or MSP

    Section 4d(d) of the CEA, as added by section 732 of the Dodd-Frank

    Act, requires that each FCM designate an individual to serve as its

    chief compliance officer (CCO). Likewise, section 4s(k) of the CEA as

    added by section 731 of the Dodd-Frank Act requires that each SD and

    MSP designate an individual to serve as its CCO. The CCO NPRM proposed

    Sec. 3.3(a) to codify these requirements for FCMs, SDs, and MSPs, and

    prescribed certain qualifications for the position.

    Section 4s(k)(2) of the CEA sets forth certain duties to be

    performed by a CCO of an SD and MSP, and section 4d(d) of the CEA

    requires the Commission to promulgate rules concerning the duties of a

    CCO of an FCM. The CCO NPRM proposed Sec. 3.3(d) to codify the duties

    set forth in section 4s(k)(2) and applied them uniformly to FCMs, SDs,

    and MSPs.

    Section 4s(k)(3) of the CEA requires that the CCO of an SD or MSP

    annually prepare and sign a report containing a description of the

    registrant's compliance with the CEA and regulations promulgated under

    the CEA, and a description of each policy and procedure of the CCO,

    including the code of ethics and conflicts of interest policies.

    Proposed Sec. 3.3([e]) \35\ codified this requirement and applied

    these requirements to CCOs of FCMs as well.

    ---------------------------------------------------------------------------

    \35\ The proposed regulations misnumbered the subsections of

    Sec. 3.3 such that two subsections were designated as ``(d).'' To

    avoid confusion, this release re-designates such sections correctly

    in brackets.

    ---------------------------------------------------------------------------

    The Commission received 25 comment letters and Commission staff

    participated in one meeting in response to the CCO NPRM and considered

    each in formulating the final rules.

    1. Identical Rules Applicable to SDs, MSPs, and FCMs

    The Commission proposed uniform rules applicable to SDs, MSPs, and

    FCMs.

    Rosenthal Collins Group, LLC (Rosenthal) and Newedge commented that

    Congress did not intend for CCOs of FCMs to be subject to the same

    requirements as CCOs for SDs and MSPs, and it is ``overkill'' for CCOs

    of ``pure'' FCMs to be subject to the same requirements as CCOs of SDs

    and MSPs. However, Rosenthal conceded that an FCM that is also an SD or

    MSP should comply with the more stringent requirements.

    NFA questioned why there was no explanation of the decision to

    extend identical requirements to CCOs of FCMs. NFA argued that it is

    more important to harmonize with FINRA Rule 3010 and FINRA Interpretive

    Material 3010-1, Rule 3012, and Rule 3130 because 55% of FCMs are also

    broker-dealers (BDs) registered with the SEC.

    The FHLBs commented that they are already subject to Federal

    Housing Finance Agency (FHFA) regulation, such as internal control

    systems under 12 CFR 917.6, and requested that the Commission defer to

    this regime because duplicative regulations will not increase

    transparency and may cause some limited SDs to leave the business.

    Better Markets supported extension of the same duties to FCMs

    because of their critical role in the market that will expand

    dramatically with the increased use of clearing. The National Society

    of Compliance Professionals (NSCP) also supported application of

    identical CCO requirements to all registrants, provided the NSCP's

    suggested modifications to the rule were made. The Council of

    Institutional Investors (CII) commented that extending the same duties

    to CCOs of FCMs would be comprehensive and consistent, and may help

    mitigate regulatory uncertainties.

    FIA and SIFMA agreed with NSCP that the CCO requirements for SDs,

    MSPs, and FCMs can be harmonized in an identical regime, provided the

    suggested changes to the rule are made to bring the rule into harmony

    with the traditional financial services compliance model. FIA and SIFMA

    also noted that the more traditional compliance model would be

    consistent with the approach the Commission took with regard to retail

    foreign exchange dealers (RFEDs).\36\

    ---------------------------------------------------------------------------

    \36\ RFEDs are required to designate a CCO and prepare an annual

    compliance certification under current Commission regulations. See

    17 CFR 5.18(j).

    ---------------------------------------------------------------------------

    With regard to comments that CCOs of FCMs should be subject to

    different or lesser standards than SDs or MSPs, the Commission notes

    that FCMs are subject to fiduciary duty standards,\37\ and agrees with

    Better Markets that the role of FCMs likely will grow in importance as

    client clearing of swaps increases. The Commission also agrees with CII

    that the Commission has an interest in consistent regulation of its

    registrants. As discussed below, after considering the comments of

    NSCP, FIA, SIFMA, and others, the Commission is making a number of

    changes to the final rule to harmonize the rule to the extent possible

    with the traditional financial services compliance model. Therefore,

    the Commission is not promulgating different rules for FCMs. The

    Commission further notes that whereas the Dodd-Frank Act required that

    FCMs designate CCOs, the Act did not establish a similar requirement

    that BDs must designate CCOs under the securities laws. Accordingly,

    the distinction between treatment of FCMs and BDs has a statutory

    basis.

    ---------------------------------------------------------------------------

    \37\ See Joint Report of the SEC and the CFTC on Harmonization

    of Regulation at 68 (Oct. 16, 2009), available at www.cftc.gov/PressRoom/PressReleases/pr5735-09 (discussing relevant case law

    establishing a fiduciary duty standard for FCMs).

    ---------------------------------------------------------------------------

    In response to comments regarding consistency with RFED and FINRA

    rules, the Commission believes that the changes to the rule discussed

    below will broadly harmonize the rule with the standard currently

    applicable to CCOs of RFEDs and the standards applicable to the CCOs of

    BDs.

    The Commission recognizes that there may be some overlap with FHFA

    rules for the FHLBs. However, the Commission believes that the two

    approaches are broadly compatible. For example, the FHFA requires

    senior management to establish and implement an effective system to

    track internal control weaknesses and the actions taken to correct

    them, and to monitor and report to the bank's board on the

    effectiveness of the internal control system, whereas the Commission's

    rule requires the CCO to establish, in consultation with the board or

    the senior officer, procedures for the handling, management response,

    remediation, retesting, and closing of noncompliance issues, and to

    have a meeting with the board or senior officer at least once a year.

    These provisions are compatible if the CCO works in

    [[Page 20157]]

    consultation with the senior officer (as permitted under Sec. 3.3 as

    adopted) to establish a monitoring system. The board would receive the

    benefit of two views on effectiveness of compliance policies--one from

    managers who implement the policies, and one from a monitor of the

    managers, who is the CCO.

    2. Harmonization With CCO Rule of the Financial Industry Regulatory

    Authority (FINRA)

    Although the Commission reviewed and considered the existing FINRA

    rules for BDs' CCOs, the duties and requirements of a CCO under section

    4s(k) of the CEA are far more specific than the general policies,

    procedures, and testing requirements of the FINRA rule. Thus, the

    proposed rule necessarily differed in both form and substance from the

    FINRA rule, which was not mandated by statute.

    FIA and SIFMA argued that the proposal should be harmonized with

    existing precedent for compliance models in the financial services

    industry (such as those applicable to BDs), and that NFA, of which SDs

    and MSPs will be required to be members, should have primary

    responsibility for setting compliance standards.

    Newedge argued that jointly registered BD-FCMs should be able to

    apply the requirements of FINRA Rule 3130, which Newedge considers to

    be better designed, and only comply with the Commission's rules if no

    comparable provision exists in Rule 3130. Newedge also argued that NFA

    has extensive experience dealing with FCM CCOs and is best positioned

    to determine their proper role.

    Rosenthal commented that the substantial experience of FINRA and

    NFA in dealing with conduct and compliance should be relied upon, with

    FINRA Rule 3130 as a guide.

    Market participants \38\ in a May 17, 2011 meeting (May Meeting)

    with Commission staff stated that the Commission's rules differed from

    FINRA's rules in three main ways: resolution vs. mitigation of

    conflicts, the term ``ensure compliance'' in the Commission's rules,

    and whether the CEO or the CCO certifies the annual report. The

    participants also stated that, without revisions to the proposed rule,

    they would be required to prepare two annual reports: one for FINRA and

    one for the Commission.

    ---------------------------------------------------------------------------

    \38\ Representatives from the SEC and Commission staff met with

    industry participants including representatives of FIA, SIFMA, UBS

    Financial Services, Inc., MF Global, Morgan Stanley, JPMorgan Chase

    & Co., Pershing, Alliance Bernstein, and Newedge USA on May 17,

    2011. See http://comments.cftc.gov/PublicComments/.

    ---------------------------------------------------------------------------

    Having considered these comments, the Commission has determined it

    is unable to conform the rule fully to match the FINRA standard for

    CCOs of BDs and still meet the statutory requirements of section 4s(k).

    However, the Commission believes the purpose of the rule is

    supplemental to--not contradictory with--the relevant provisions of

    FINRA Rules 3010, 3012, and 3130.

    As explained by commenters, the CCO customarily has acted as an

    advisor, and has not had the ability to enforce compliance policies by

    directing staff or making hiring and firing decisions. By way of

    contrast, new section 4s(k) of the CEA requires that the CCO resolve

    conflicts of interest, be responsible for administering certain

    policies and procedures, and ensure compliance with the CEA. While the

    Commission has attempted to be responsive to the traditional role of

    compliance officers in the financial services industry, the Commission

    does not believe that FINRA's rules provide a model that would

    encompass all of the statutory provisions in section 4s(k). The

    Commission believes, however, that the changes to the rule discussed

    below will broadly harmonize the final rule with FINRA standards and

    allow a CCO of a dual registrant to fulfill the duties required by both

    rules without undue duplication or contradiction.

    Notably, as explained above, the Dodd-Frank Act required that FCMs

    designate CCOs, whereas the Act did not establish a similar requirement

    that BDs must designate CCOs under the securities laws. Accordingly,

    the distinction between treatment of FCMs and BDs has a statutory

    basis.

    3. Regulatory Structure

    In the CCO NPRM, the Commission requested comment on whether the

    structure of the proposed rules allows for sufficient flexibility.

    EEI urged the Commission to follow the Federal Energy Regulatory

    Commission's approach by setting forth principles or attributes of an

    effective compliance program while leaving the details to the

    registrant.

    Rosenthal argued that the rule should allow for flexibility because

    the role of a CCO varies, and should not be a ``one size fits all,''

    while NSCP commented that the proposed rules ``strike an appropriate

    balance'' between aspirational standards and forcing all entities to

    conform to one standard. Cargill commented that if the scope of the

    rules is limited to a registrant's swap dealing division, the

    provisions in the proposed rule are ``in general reasonable and provide

    flexibility so that each swap dealer can apply the general requirements

    to its own business structure.''

    Commodity Markets Council (CMC) requested that the Commission

    clarify whether registration as an SD due to activities in one

    commodity would require compliance obligations for all activities of an

    integrated firm, require compliance obligations on the activities of an

    involved affiliate, or require compliance obligations for just those

    activities in the underlying commodity.

    NFA and the FHLBs commented that the rules should explicitly permit

    the CCO to share any other executive role, such as CEO, to provide

    flexibility for smaller firms. NFA also argued that the rules should

    recognize that compliance expertise may reside with more than one

    individual, and thus the Commission should consider allowing an entity

    to designate multiple CCOs, so that each CCO's primary area of

    responsibility is defined, and each CCO should be required to perform

    duties and responsibilities with respect to their defined area. NFA

    also recommended that CCOs explicitly be permitted to consult with

    other employees, outside consultants, lawyers, and accountants.

    Newedge, Hess Corporation (Hess), and The Working Group argued that

    affiliated FCM/SD/MSPs that are separate legal entities should be

    permitted to share the same CCO to increase compliance efficiency. The

    Working Group also argued that the CCO of affiliated registrants should

    be allowed to report to a board of an affiliated entity that controls

    both entities. Better Markets, on the other hand, commented that a

    senior CCO should have overall responsibility of each affiliated and

    controlled entity, even if individual entities within the group have

    CCOs. Better Markets also recommended that the rule require the CCO

    office to be located remotely from the trading floor.

    In response to EEI's recommendation that the Commission set forth

    general principles akin to those required by FERC, the Commission

    observes that the statutory regime established by Congress would not

    permit such an approach.

    The Commission agrees with commenters that CCOs should be permitted

    to ``wear multiple hats.'' In other words, the Commission confirms that

    a CCO may share additional executive responsibilities and/or be an

    existing officer within the entity. This is particularly appropriate in

    smaller firms, which may lack sufficient scale to employ a stand-alone

    CCO. However, employing a stand-alone CCO may be

    [[Page 20158]]

    appropriate in a larger firm, depending on the scale of its operations

    and degree of the CCO's responsibilities. Additionally, the Commission

    confirms that nothing in the rules would prohibit multiple legal

    entities from designating the same individual as CCO, but the rule as

    adopted will require the CCO to report to each entity's board or senior

    officer, rather than to the board or senior officer of a consolidated

    corporate parent.

    The Commission has determined not to permit designation of multiple

    CCOs with delineated areas of responsibility because this arrangement

    would not comply with sections 4d(d) and 4s(k) of the CEA, which

    require FCMs, SDs, and MSPs to ``designate an individual to serve as

    chief compliance officer.'' In response to NFA's concern about CCOs

    being able to rely on the expertise of others, the annual report

    certification language in the rule as adopted containing the qualifier

    ``to the best of his or her knowledge and reasonable belief'' would

    permit the CCO to rely on other experts for statements made in the

    annual report.

    As previously noted, the Commission is clarifying in the final

    rules that the CCO's duties extend only to the activities of the

    registrant that are regulated by the Commission, namely, swaps

    activities of SDs and MSPs and the derivatives activities included in

    the definition of FCM under section 1(a)(28) of the CEA.

    4. Public Availability of the Annual Report

    The Working Group commented that it is likely that the annual

    report will not be considered confidential information protected from

    Freedom of Information Act requests, and could expose registrants to

    legal and reputational risk if made public. The Working Group also

    argued that the report may force firms to make disclosures prior to

    having remedial actions agreed with the Commission and put into effect,

    and could grant valuable insight to competitors. The Working Group

    recommended that the Commission take steps to ensure that the

    information remains confidential and should make explicit that there is

    no private right of action for misstatements and inaccurate content in

    the report. EEI also expressed concern about disclosure of confidential

    or proprietary information if the report would be made public. FIA and

    SIFMA recommended that the Commission make the report nonpublic by

    including it in the list of exempted items in Commission regulation

    Sec. 145.5.

    In response to these comments, the Commission notes that a

    registrant may request confidential treatment under Sec. 145.9 for

    information submitted to the Commission under these regulations.

    Accordingly, an FCM, SD, or MSP must petition for confidential

    treatment of its annual report under Sec. 145.9 if it wants the

    Commission to determine that a particular annual report should be

    subject to confidentiality.

    5. Definitions--Sec. 3.1

    Proposed amendments to Part 3 of the Commissions regulations in the

    CCO NPRM added chief compliance officers to the definition of

    ``principal'' in Sec. 3.1(a)(1), and added definitions of ``compliance

    policies'' and ``board of directors'' at Sec. 3.1(g) and (h),

    respectively.

    a. Definition of ``Principal''--Sec. 3.1(a)(1)

    The proposed regulations modified the definition of ``principal''

    in Part 3 to include a CCO as an example of a person ``having the

    power, directly or indirectly, through agreement or otherwise, to

    exercise a controlling influence over the entity's activities that are

    subject to regulation by the Commission.''

    Rosenthal argued that declaring the CCO to be a principal adds no

    incentive for qualified individuals to become a CCO because he or she

    could be liable outside his/her area of competence or control.

    Rosenthal also argued that it should be the firm's responsibility to

    comply, with ultimate responsibility for compliance placed with the

    firm's senior management. EEI argued that the proposal is overly

    prescriptive, that requiring the CCO to be a principal would require

    significant changes to current practice, and that the reporting

    structure should be left to each individual firm. On the other hand,

    Cargill commented that the requirement to be listed as a principal

    applies statutory disqualification standards that are clear and

    objective.

    NFA recommended that the proposed change to the definition of

    ``principal'' be modified to mention the CCO earlier in the definition

    rather than listing the position as an example of a person with

    supervisory authority over business personnel (i.e., a position with

    power to exercise a controlling influence). NFA stated that the rule

    should clarify that the CCO is not a line supervisor, nor does the CCO

    have supervisory authority over personnel.

    FIA and SIFMA argued that, although the FINRA CCO rules require the

    CCO to register as a ``general securities principal,'' FINRA has

    explicitly stated that this ``does not create the presumption that a

    chief compliance officer has supervisory responsibilities or is

    otherwise a control person.'' FIA and SIFMA recommended that the

    Commission make a similar qualifying statement when promulgating the

    final rules.

    Considering these comments, the Commission is modifying the

    proposed rule to list the position of CCO within the definition of

    principal separately for each type of entity as recommended by NFA,

    rather than as an example of someone in a position to exercise a

    controlling influence. The Commission believes that this modification

    addresses the issue sufficiently, without the need to incorporate the

    qualifying statement recommended by FIA and SIFMA. However, this change

    should not be interpreted to undermine the CCO's ability to fulfill the

    CCO's duties as provided for under the CEA and by Commission

    regulation.

    b. Definition of Compliance Policies--Sec. 3.1(g)

    The proposed regulations defined ``compliance policies'' broadly to

    include all policies required to be adopted or established by the

    registrant pursuant to the CEA and regulations, including a code of

    ethics.

    The Working Group requested that the Commission clarify that the

    proposed rules do not require that a firm must adopt a code of ethics,

    but only that in its annual report the firm provide a description of a

    code of ethics to the extent that it has one.

    The National Whistleblowers Center (NWC) recommended that the

    Commission establish a rule that provides contact with internal

    compliance departments with the same whistleblower protection as

    contacts with the Commission. NWC also recommended that the Commission

    require registrants to adopt a code of ethics and conduct that contain

    rigorous whistleblower protections. Finally, NWC recommended that the

    Commission require an effective compliance program with the following

    components: Consistent enforcement of the company's code of conduct;

    professional management of the help line; vigorous enforcement of non-

    retaliation policies; effective compliance and ethics risk-assessment;

    integration of clear, measurable compliance and ethics goals into the

    registrant's annual plan; direct access and reporting by the CCO to a

    compliance-savvy board; strong compliance and ethics infrastructure;

    compliance audits to uncover law-breaking; CEO action to promote

    compliance; and shared learning within the registrant.

    [[Page 20159]]

    In order to achieve maximum consistency across the CCO provisions

    for SDs, MSPs, FCMs, DCOs, SDRs, and SEFs, the Commission has deleted

    the definition of ``compliance policies'' from the rule. The Commission

    believes this definition is unnecessary given the overall changes to

    the scope of the review required by the annual report, discussed below.

    The changes to the scope of the review of the annual report track the

    language of the statute in that the annual report will require a

    description of the written policies and procedures, including a code of

    ethics and conflicts of interest policies. The annual report separately

    will require a description of material compliance with the CEA and

    Commission regulations.

    In response to The Working Group's comment, the Commission notes

    that the statute requires that the CCO prepare and sign an annual

    report that contains a description of each policy and procedure,

    including the code of ethics and conflicts of interest policies.

    Whether a firm decides to adopt a separate code of ethics in

    furtherance of this requirement is left to its discretion.

    In response to NWC's comments, the Commission takes note of NWC's

    points related to whistleblowers as sound practices. However, these

    additional requirements, such as requiring specific whistleblower

    provisions in codes of ethics or conduct are outside the scope of this

    rulemaking.

    6. Designation of Chief Compliance Officer--Sec. 3.3(a)

    Proposed Sec. 3.3(a) required each SD, MSP, and FCM to designate

    an individual as a CCO and provide the CCO with the full responsibility

    and authority to develop and enforce, in consultation with the board or

    senior officer, appropriate policies and procedures to fulfill the

    duties set forth in the CEA and regulations.

    EEI argued that a CCO should work in concert with business and

    control functions to assure appropriate policies are in place, but that

    the proposed rules go beyond what is required by the CEA by

    inappropriately imposing upon the CCO full responsibility to develop

    and enforce all policies. Newedge also commented that CCOs generally do

    not have full responsibility to develop and enforce compliance

    policies, and cites a Security Industry Association White Paper that

    states: ``* * * there is a huge difference between the role of the

    Compliance Department and its personnel, and the overall broad firm

    responsibility `to comply' with applicable rules and regulations. The

    Compliance Department plays an integral support function for firm

    compliance programs, but only senior management and business line

    supervisors ultimately are responsible for ensuring firm compliance

    with laws and regulations.''

    Rosenthal commented that the Commission's rules should be revised

    in a manner that reflects the view that the CCO is only an advisor to

    management and should not be viewed as an enforcer of policies within

    the FCM, as that would represent a ten-year step backward in

    governance.

    In an attempt to balance the traditional role of compliance

    officers in the financial service industry with the statutory

    requirements and policy objectives of promoting a strong culture of

    compliance, the Commission is revising proposed Sec. 3.3(a) to (i)

    remove the requirement that a CCO be provided with ``full''

    responsibility and authority; (ii) remove the requirement that a CCO

    ``enforce'' policies and procedures; (iii) limit the responsibilities

    of the CCO to the ``swaps activities'' of SDs and MSPs, and the FCMs'

    derivatives activities included in the definition of FCM under section

    1(a)(28) of the CEA; and (iv) clarify that a CCO need only develop

    policies and procedures to fulfill the duties set forth in, and ensure

    compliance with, the CEA and Commission regulations. The Commission is

    making the changes to Sec. 3.3(a) to alleviate commenters' concerns

    about the use of the term ``enforce'' and about the scope of the CCO's

    duty to develop policies and procedures.

    7. Reporting Line--Sec. 3.3(a)(1) & (2)

    Proposed Sec. 3.3(a)(1) required that the CCO report to the board

    of directors or the senior officer of a registrant, that the board or

    senior officer approve the compensation of the CCO, and that the board

    or senior officer meet with the CCO at least once a year to discuss the

    effectiveness of compliance policies and their administration by the

    CCO. Proposed Sec. 3.3(a)(2) also prohibited the board or senior

    officer of a registrant from delegating its authority over the CCO,

    including the authority to remove the CCO.

    The CCO NPRM requested comment on the degree of flexibility in the

    reporting structure, including whether it would be more appropriate for

    a CCO to report to the board or the senior officer; whether the board

    or the senior officer is a stronger advocate on compliance matters;

    whether the proposed reporting structure should address issues related

    to affiliates; and whether the rule should include a provision

    requiring a majority of the board to remove the CCO. The proposal also

    requested comment regarding whether it is necessary to adopt rules for

    the CCO regarding conflicts of interest between compliance interests,

    commercial interests, and ownership interests of a registrant.

    Cargill recommended that the definition of board of directors be

    expanded to include a governing body of a division, such as a

    management committee, if the SD registration applies to activities

    within a division of a larger company, rather than the company as a

    whole. Cargill also recommended that the Commission add a definition of

    ``senior officer'' and that it include a senior officer of a division,

    because a division might be more familiar with the swaps activities of

    an SD. Cargill and The Working Group each argued that a requirement

    that a CCO can be removed only by a majority of the members of a

    governing body would be inflexible, and should not be added to the

    rules.

    The Working Group argued that the CCO should be allowed to report

    to a board of an affiliated entity that controls both the affiliate and

    the registrant. The Working Group also argued that the CCO should be

    permitted to operate under the direction of other corporate officers,

    even middle level officers, so that the CCO is not an independent

    inspector general that operates outside the traditional reporting

    structure within a corporate entity. EEI also argued that the proposal

    is overly prescriptive and recommends that the reporting structure be

    left to each individual firm. Similarly, FIA and SIFMA commented that

    although the board is the ultimate supervisory authority, the CCO

    should not be required to directly report to it. Instead, firms should

    be free to determine the reporting structure as long as independence

    and authority as a control function is maintained. FIA and SIFMA

    recommended, for example, that the CCO be allowed to report to the

    chief legal officer or the chief risk officer.

    On the other hand, Rosenthal commented that the CCO should report

    to the board or, if the registrant is not a corporation, to the senior

    officer. Rosenthal also commented that the CCO should be prohibited

    from receiving any transaction or customer-based compensation to

    insulate the CCO from potential conflicts. NSCP also agreed that CCOs

    should report to senior management and have compensation set by

    managers that are not influenced by the profitability of particular

    business units. NSCP noted that new Organizational Sentencing

    Guidelines consider whether individuals with operational responsibility

    for compliance and ethics have direct

    [[Page 20160]]

    reporting obligations to the governing authority or an appropriate

    subgroup thereof (like an audit committee of a board), which the

    proposed rules would require. NSCP recommended that a provision be

    added to the proposed rules to make it illegal for a registrant to

    coerce a CCO improperly, similar to the one for CCOs of investment

    companies and independent public accountants.

    Better Markets and Chris Barnard recommended that decisions to

    designate or terminate a CCO, as well as compensation decisions, be

    prescribed as the sole responsibility of independent members of the

    board of directors, or audit committee, acting by majority vote, and

    not the responsibility of the executive officer. Better Markets also

    recommended that both the board and the senior officer be required to

    meet with the CCO to discuss the effectiveness of compliance policies,

    and that such meetings be held at least quarterly. Better Markets

    further recommended that the CCO's duties be performed in consultation

    with both the board and the senior officer.

    National Whistleblowers Center (NWC) recommended that the term

    ``senior officer'' be defined as the CEO or chairman of the board, and

    should not be the general counsel or a subordinate employee to the CEO.

    NWC believes that the rule should permit the CCO to report to the full

    board at any time with no interference from a board committee or a CEO.

    NWC also argued that the rule should prohibit termination of the CCO

    unless the CCO is presented the opportunity to address the board.

    MetLife requested that the definition of board of directors include

    ``(or committee of such board or governing body)'' to permit it to

    continue its current practice of delegating particular responsibilities

    to expert committees of the whole board (i.e., audit, finance,

    investments, risk, and compensation). NFA also sought additional

    flexibility in the reporting structure for CCOs, provided that the

    firm's business unit is not permitted to impose undue pressure on a CCO

    regarding compliance.

    Newedge recommended that the CCO be required to meet at least

    quarterly with the board or senior officer to discuss the effectiveness

    of compliance policies.

    The Working Group believes it is not necessary to address conflicts

    of interest between compliance interests and commercial interests in

    the rule because the independent audit requirements imposed by the

    Sarbanes Oxley Act already address such conflicts.

    Having considered these comments, the Commission will not permit

    CCOs to report to committees of a board of directors. Section 4s(k) of

    the CEA requires the CCO to ``report directly'' to the board or the

    senior officer of the SD or MSP. In other contexts (for example the

    risk management duties rules for SDs and MSPs discussed above),

    reporting to committees of the board is permitted. However, in this

    context, the Commission believes that the statutory requirement that

    the CCO report directly to the board or senior officer does not afford

    such discretion. The Commission is guided by the policy objectives of

    section 4s(k) in reaching the same conclusion with regard to FCMs, and

    observes that no currently registered FCM requested that the CCO report

    to a committee of the board. Indeed, Rosenthal, and FCM, agreed with

    the requirement that CCOs for FCMs report to a board of directors if

    the entity has one, or the senior officer, if the entity does not have

    a board.

    In response to Cargill's comments, the Commission notes that under

    the CEA and under the rules as adopted, a registrant may elect to have

    the CCO report to the senior officer of the registrant. Because,

    ``senior officer'' is not defined, if a division of a larger company is

    a registered SD, then the CCO of such registrant could report to the

    senior officer of that division.

    In order to preserve CCO independence, the Commission is not

    changing the requirement that only the board or the senior officer can

    hire, set compensation for, and remove the CCO. However, in order to

    promote consistency among the CCO rules for registrants and registered

    entities, the Commission is modifying proposed Sec. 3.3(a)(1) and (2)

    to (i) require only that the CCO and board or senior officer meet once

    a year and at the election of the CCO, but not mandate the content of

    such meeting; and (ii) to clarify that only the board or senior officer

    may remove the CCO.

    The Commission believes that additional requirements, such as

    providing the CCO an opportunity to address the board prior to removal,

    requiring more frequent meetings between the CCO and the board or

    senior officer, restricting the composition of CCO compensation, or

    mandating independent director approval, would be overly prescriptive

    and unnecessary to achieve the purposes of the rule. Similarly, the

    Commission believes that a provision prohibiting improper coercion is

    unnecessary because the rule adequately ensures CCO independence

    through a direct reporting line to the board or senior officer and by

    requiring compensation decisions to be made by the board or a senior

    officer.

    8. Qualifications--Sec. 3.3(b)

    As proposed, Sec. 3.3(b) required the CCO to have the background

    and skills appropriate for fulfilling the responsibilities of the

    position, and prohibited an individual who is statutorily disqualified

    under sections 8a(2) or 8a(3) of the CEA from serving.\39\ The proposal

    requested comments regarding whether additional limitations should be

    placed on CCOs, such as a prohibition on designating a registrant's

    counsel as CCO.

    ---------------------------------------------------------------------------

    \39\ These CEA sections contain an extensive list of matters

    that constitute grounds pursuant to which the Commission may refuse

    to register a person, including, without limitation, felony

    convictions, commodities or securities law violations, and bars or

    other adverse actions taken by financial regulators.

    ---------------------------------------------------------------------------

    NFA argued that the statement that no individual disqualified from

    registration under section 8a(2)-(3) of the CEA may serve as a CCO is

    redundant because an SD, MSP, or FCM's registration could be denied or

    revoked under section 8a(2)-(3) of the CEA if any principal of the

    registrant is subject to a statutory disqualification. NFA argues that

    inclusion of this qualification in the proposed rule could appear to

    convey a different standard for CCOs than for other principals.

    Cargill commented that the requirement for a CCO to have ``the

    background and skills appropriate'' is a commendable aspirational goal

    but is too vague a standard for Federal law, and is best reserved as a

    business decision. Cargill agreed that the requirement to be listed as

    a principal applies statutory disqualification standards that are clear

    and objective.

    Newedge recommended that CCOs be required to pass a specific

    compliance examination and obtain a specific compliance license, as is

    the case in the securities world. On the other hand, NSCP does not

    believe that CCOs should have to pass a qualification exam or otherwise

    have a certain number of years in the industry, given the diversity of

    the registrant community. The Working Group also commented that wide

    latitude for qualifications of a CCO is necessary.

    EEI argues that the general counsel and other attorneys should be

    allowed to be the CCO because they are subject to ethics considerations

    and a prohibition on conflicts in their representation. NFA also

    recommended that the CCO be permitted to be an attorney who represents

    the registrant or its board as long as the conflict can be

    [[Page 20161]]

    managed and duties discharged. Rosenthal and Hess felt that persons

    with legal training may be well-suited as CCOs, and that the rule

    requirement to demonstrate compliance proficiency is reasonable. To the

    contrary, Better Markets argued that a CCO should not be permitted to

    be an attorney that represents the SD, MSP, or FCM, or its board

    because the potential conflict would disqualify such an attorney.

    Having considered these comments, the Commission is adopting the

    rule substantially as proposed, with only a technical change to clarify

    the references to sections 8a(2) and 8a(3) of the CEA. The Commission

    believes it is important for the ``Qualifications'' section of the rule

    to put registrants on notice of the possible disqualification of CCO

    candidates pursuant to the CEA. The benefit of such notice outweighs

    the concern of creating an appearance of a different standard for CCOs

    than for other principals. The Commission is retaining the ``background

    and skills'' qualification in the final rule because the standard

    effectively will prohibit appointment of unqualified persons as CCO.

    However, the Commission does not believe that it is necessary to

    require a proficiency exam for CCOs at this time.

    The Commission also agrees with Better Markets that there may be a

    potential conflict if a member of the legal department or the general

    counsel of a registrant also served as the registrant's CCO. The

    Commission notes that the final rules for SDRs prohibited members of

    the legal department or the entity's general counsel from serving as

    CCO.\40\ On the other hand, the final rules for derivative clearing

    organizations did not include the same prohibition.\41\ Given the

    diversity of FCMs and probable diversity of SDs and MSPs and cost

    considerations, the Commission is taking a flexible approach in these

    final rules and is not prohibiting a member of the legal department or

    general counsel from serving as CCO for an SD, MSP, or FCM. However,

    should a CCO be a member of the registrant's legal department, the

    Commission expects the CCO and registrant to articulate clearly the

    segregation of that individual's CCO and non-CCO responsibilities. All

    reports required under sections 4d(d) and 4s(k) of the CEA, as well as

    the rules promulgated pursuant thereto, are meant to be made available

    to the Commission, and as such, they should not be subject to the

    attorney-client privilege, the work-product doctrine, or other similar

    protections.

    ---------------------------------------------------------------------------

    \40\ See Swap Data Repositories: Registration Standards, Duties

    and Core Principles, 76 FR 54538, 54584 (Sept. 1, 2011).

    \41\ See 17 CFR 39.10; Derivatives Clearing Organization General

    Provisions and Core Principals, 76 FR 69334, 69434 (Nov. 8, 2011).

    ---------------------------------------------------------------------------

    9. Duty To Establish Compliance Policies--Sec. 3.3(d)(1)

    Proposed Sec. 3.3(d)(1) required the CCO to establish the

    registrant's compliance policies in consultation with the board of

    directors or senior officer.

    Hess and Newedge each argued that the proposal concentrates too

    much of the compliance function on a single individual to the exclusion

    of other members of senior management and day-to-day business line

    supervisors. Hess argued that overemphasis on the independent role of

    the CCO and concentrating responsibility is less effective than

    integration. Instead, Hess recommended that the CCO should remain the

    monitor of the compliance monitors, which they could not be if they are

    responsible for compliance.

    The Commission believes that section 4s(k) of the CEA requires that

    the CCO administer the compliance policies, but that it does not

    require the CCO to establish all of a registrant's compliance policies.

    To alleviate some of the commenters' concerns regarding concentration

    of the compliance function, the Commission is revising the proposed

    rule to track more closely the statutory language of section 4s(k).

    10. Duty To Resolve Conflicts of Interest--Sec. 3.3(d)(2)

    Following section 4s(k)(2)(C) of the CEA, proposed Sec. 3.3(d)(2)

    required the CCO, in consultation with the board or senior officer, to

    resolve any conflicts of interest that may arise.

    NFA commented that resolution of conflicts of interest should rest

    with the board or the senior officer, in consultation with the CCO. FIA

    and SIFMA also commented that the CCO should not be deemed to be a

    business line supervisor and the rule should not fundamentally change

    the role of the CCO, which has customarily been an independent advisor

    to the business line supervisors that are ultimately responsible for

    compliance. FIA and SIFMA argued that when Congress used the term

    ``resolve any conflicts of interest that may arise,'' Congress did not

    mean resolve in the executive or managerial sense, requiring a CCO to

    examine the facts and determine the course of action. Instead, FIA and

    SIFMA recommended that the rule be revised to provide a definition of

    ``resolving conflicts of interest'' that reads: ``designing a system of

    conflict identification, assessment and resolution, advising on

    conflict avoidance or mitigation alternatives, and escalating

    inadequate management responses to conflicts to senior management. * *

    *'' Newedge commented that the CEO and business line supervisors are in

    a better position than the CCO to resolve conflicts. Newedge believes

    that any transfer of regulatory responsibility currently held by

    executive officers to the CCO could have the unintended effect of

    reducing the amount of time and level of concern such officers will

    spend on compliance matters.

    Participants in the May Meeting with Commission staff stated that

    the phrase ``resolve any conflicts of interest'' would traditionally be

    interpreted as eliminating a conflict of interest, but that elimination

    is not always preferable. The participants commented that further

    interpretation is needed to permit conflicts of interest to be

    addressed, mitigated, or conditioned as well. Participants argued that

    the role of a compliance officer is to advise the business line of

    acceptable and unacceptable alternatives, and if the business line

    chooses an unacceptable alternative, then the compliance officer must

    escalate the problem until an acceptable alternative is selected.

    However, participants strongly believed that the compliance officer

    should not be the actual decision maker in the resolution.

    Having considered these comments, the Commission is not removing

    the requirement that the CCO ``resolve'' conflicts of interest from the

    rule because the requirement is provided for in section 4s(k)(2)(C) of

    the CEA. However, the Commission confirms, as suggested by commenters,

    that the term ``resolve'' encompasses both elimination of the conflict

    of interest as well as mitigation of the conflict of interest, and that

    the CCO's role in ``resolving'' conflicts of interest may involve

    actions other than making the final decision. The Commission notes that

    the SEC has taken a similar approach in the preamble of its equivalent

    CCO proposal.\42\

    ---------------------------------------------------------------------------

    \42\ See Business Conduct Standards for Security-Based Swap

    Dealers and Major Swap Participants, 76 FR 42396, 42436 (July 18,

    2011) (stating ``we would anticipate that the CCO's role with

    respect to such resolution and mitigation of conflicts of interest

    would include the recommendation of one or more actions, as well as

    the appropriate escalation and reporting with respect to any issues

    related to the proposed resolution of potential or actual conflicts

    of interest, rather than decisions relating to the ultimate final

    resolution of such conflicts'').

    ---------------------------------------------------------------------------

    [[Page 20162]]

    11. Duty To Review and Ensure Compliance--Sec. 3.3(d)(3)

    Following the statutory text of section 4s(k)(2)(E) of the CEA,

    proposed Sec. 3.3(d)(3) required the CCO to review and ``ensure

    compliance'' by the registrant with the registrant's compliance

    policies and all applicable laws and regulations.

    FIA and SIFMA argued that the term ``ensure compliance'' needs to

    be clarified, because the common usage of the word (i.e., to guarantee)

    goes well beyond any existing compliance model and creates a standard

    that is impossible to satisfy. FIA and SIFMA further argued that the

    requirement to remediate non-compliance issues, and the discussion of

    management's response to remediation, acknowledges that instances of

    noncompliance are not wholly preventable by any person, and that it is

    management's responsibility for implementing compliance policies.

    Instead, FIA and SIFMA recommended that the phrase should mean taking

    reasonable steps to adopt, review, test, and modify compliance

    policies, and pointed to the Commission's RFED rule, which requires

    each RFED to designate a CCO that must certify that the RFED has in

    place policies and procedures ``reasonably designed to achieve

    compliance with the Act, rules, regulations and orders thereunder.''

    FIA and SIFMA also recommended that the Commission add a provision in

    the definition of compliance policies and procedures to include

    ``procedures for escalating inadequate management responses to apparent

    material violations of compliance policies and procedures to the

    appropriate level of senior management * * * depending on the facts and

    circumstances of the issues being addressed.''

    The Working Group argued that the requirement to ``ensure

    compliance'' should not be adopted literally from the statute, because

    it is an impossible task. The Working Group recommended that the rules

    be revised to avoid suggestions that an incident of noncompliance by a

    firm might constitute or evidence a failure by a CCO to meet its

    statutory or regulatory responsibilities.

    NSCP argued that ``ensure compliance'' imposes a level of

    responsibility on a CCO that cannot be discharged and is inconsistent

    with the customary role of a compliance officer. Instead, NSCP

    recommended that the CCO ``administer the system of compliance that is

    designed to ensure compliance with compliance policies and applicable

    law.'' NSCP concedes that although the statutory language may be viewed

    as constraining, it offers section 501 of the Gramm-Leach-Bliley Act as

    an example of constraining language modified by regulation. NSCP stated

    that section 501 of that act required financial institutions to adopt

    safeguards to ``ensure the security and confidentiality of personal

    information,'' but that banking regulators modified the standard to

    require adoption of safeguards ``designed to ensure the security and

    confidentiality of personal information.'' NSCP further argued that the

    business units within registrants either obey the law or violate it,

    and a CCO is limited to providing guidance, monitoring for compliance,

    and reporting on the business activities.

    NFA commented that it should not be the duty of the CCO to ensure

    compliance by the FCM, SD, or MSP because it is an impracticable

    standard and imposes a duty to supervise a firm's business activities.

    NFA argued that the rules improperly redefine a CCO's duties, and

    registrants will have difficulty retaining CCOs who are willing to

    perform these duties. NFA believes that FINRA's Rule 3130 sets forth

    the appropriate role of a CCO.

    Participants in the May Meeting with Commission staff stated that

    the CCO's responsibility to escalate (repeatedly if necessary) a

    problem that has not been resolved could serve as a possible meaning of

    the term ``ensure compliance'' when applied to the CCO position.

    EEI believes that a basic tenet of modern compliance is that

    compliance departments advise, monitor, assist, and escalate to a

    governing body if necessary. EEI argued that the act of complying must

    be borne and executed by the business, and imposing responsibility on

    the CCO could abrogate responsibility of senior management and other

    employees.

    Newedge believes that the CCO should be required only to review

    whether a registrant has established policies designed to achieve

    compliance and that the responsibility to enforce compliance should lie

    with the business line. Newedge believes the enormity of the

    obligations assigned to the CCO would result in inadequate means of

    ensuring compliance, defeating the plain purpose of the statute.

    In response to the comments received regarding the role of the CCO

    in ensuring compliance, the Commission is modifying the proposed rule

    to provide that the CCO must take ``reasonable steps to ensure

    compliance.'' The Commission believes that this approach is responsive

    to commenters' concerns, is consistent with the final rules for SDRs

    \43\ and DCOs,\44\ and is broadly consistent with the SEC's proposal

    for the duties of a CCO of a security-based swap dealer or a major

    security-based swap participant.\45\

    ---------------------------------------------------------------------------

    \43\ See Swap Data Repositories: Registration Standards, Duties

    and Core Principles, 76 FR at 54584 (stating that the duties of an

    SDR's CCO include ``[t]aking reasonable steps to ensure compliance

    with the [CEA] and Commission regulations'').

    \44\ See Derivatives Clearing Organization General Provisions

    and Core Principals, 76 FR at 69434 (stating that the duties of a

    DCO's CCO include ``[t]aking reasonable steps to ensure compliance

    with the [CEA] and Commission regulations'').

    \45\ See Business Conduct Standards for Security-Based Swap

    Dealers and Major Security-Based Swap Participants, 76 FR 42396,

    42458-59 (July 18, 2011) (requiring the CCO of a security-based swap

    dealer or major security-based swap participant to ``[e]stablish,

    maintain and review policies and procedures reasonably designed to

    ensure compliance with the Act and the rules and regulations

    thereunder'').

    ---------------------------------------------------------------------------

    In response to comments advocating a purely advisory role for the

    CCO, the Commission observes that the role of the CCO required under

    the CEA, as amended by the Dodd-Frank Act, goes beyond what has been

    represented by commenters as the customary and traditional role of a

    compliance officer. While the Commission does not believe, as some

    commenters have suggested, that the CCO's duties under the CEA or Sec.

    3.3 requires that the CCO be granted ultimate supervisory authority by

    a registrant, it is the Commission's expectation that the CCO will, at

    a minimum, be afforded supervisory authority over all staff acting at

    the direction of the CCO. Recent events have demonstrated the

    importance of the active compliance monitoring duties required of the

    CCO under the Dodd-Frank Act, as implemented through these regulations.

    12. Duty To Prepare, Sign, and Certify Compliance Annual Report--Sec.

    3.3(d)(6)

    Proposed Sec. 3.3(d)(6) required the CCO of an SD, MSP, or FCM to

    prepare, sign, and certify, under penalty of law, the annual report

    specified in section 4s(k)(3) of the CEA.

    Rosenthal commented that FINRA's approach to certification is

    preferable, i.e., that the CEO certifies that the firm has processes to

    establish, maintain, review, test, and modify written compliance

    policies and written supervisory procedures reasonably designed to

    achieve compliance with securities laws, regulations, and FINRA rules,

    based on a report by the CCO. FIA, SIFMA, and Newedge each argued that

    section 4s(k)(3) of the CEA requires the CCO to sign the annual report,

    but does not require the CCO to certify the report. FIA, SIFMA, MFA,

    Newedge,

    [[Page 20163]]

    and NFA all recommended that the rule be revised to require the CEO to

    certify the report. Participants in the May Meeting with Commission

    staff stated that requiring the CEO, rather than the CCO, to make a

    certification as to whether policies are in place that are reasonably

    designed to ensure compliance appropriately shares responsibility

    between compliance and business management. FIA and SIFMA recommended

    that if the Commission requires the CCO to certify the annual report,

    then with respect to any Commission registrant that is also a BD, the

    Commission also should require the CEO to make the certification

    Rosenthal argued that requiring the CCO to certify under penalty of

    law will make the CCO liable for firm infractions and will give

    disgruntled customers a roadmap for frivolous lawsuits. Newedge also

    believes that the requirement to certify under penalty of law is not

    fair or practicable because whoever certifies will have to rely on many

    individuals to compile the report. On the other hand, Hess commented

    that the certification language strikes an appropriate balance such

    that strict liability is not imposed for inadvertent errors. NSCP

    commented that the certification that the report is accurate and

    complete should have a materiality qualifier added to it. Participants

    in the May Meeting with Commission staff requested clarification as to

    how the certification of the accuracy and completeness of the

    information in the annual report might be kept separate from matters of

    opinion expressed in the annual report. The participants urged the

    Commission to adopt a standard for the annual report certification that

    is reasonably attainable.

    FIA and SIFMA requested that the Commission clarify that criminal

    liability for the certification will not apply (absent a knowing and

    willful materially false and misleading statement) because there is no

    indication that Congress ever thought CCOs should be subject to

    criminal liability. Similarly, NSCP requested that the Commission

    clarify whether ``under penalty of law'' means liability under 18

    U.S.C. 1001 for a false statement to a Federal officer. FIA and SIFMA

    also felt that imposing criminal liability for annual report

    certifications would make it hard to fill the position of CCO.

    EEI argued that although section 4s(k)(3) of the CEA requires the

    CCO to certify the report, any additional content requirements for the

    annual report beyond what section 4s(k)(3) requires will make the

    certification more difficult.

    In response to these comments, with respect to certification by the

    CCO, the Commission is modifying the proposed rule to permit either the

    CCO or the CEO to make the required certification. Section 4s(k)(3)(A)

    of the CEA requires the CCO to sign the annual report and section

    4s(k)(3)(B)(ii) requires that the annual report contain a certification

    that, under penalty of law, the compliance report is accurate and

    complete. Given the statutory provisions and under these circumstances,

    the Commission believes it is appropriate to afford SDs, MSPs, and FCMs

    the discretion to choose whether the CCO or CEO will make the

    certification.

    The Commission disagrees with commenters that a mere certification

    that policies are in place that are reasonably designed to achieve

    compliance would satisfy the requirements of section 4s(k)(3) of the

    CEA. The Commission believes that the statute also requires a CCO to

    assess how compliance policies are implemented.

    The Commission is of the view that limiting the certification with

    the qualifier ``to the best of his or her knowledge and reasonable

    belief'' addresses commenters' concerns of overbroad liability because

    the rule would not impose liability for compliance matters that are

    beyond the certifying officer's knowledge and reasonable belief at the

    time of certification. If the certifying officer has complied in good

    faith with policies and procedures reasonably designed to confirm the

    accuracy and completeness of the information in the annual report, both

    the registrant and certifying officer would have a basis for defending

    accusations of false, incomplete, or misleading statements or

    representations made in the annual report.

    With respect to requests for clarification of the liability that

    may attach to the certification ``under penalty of law,'' the

    Commission notes that administrative, civil, and/or criminal liability

    could be imposed on the registrant or the certifying officer or both,

    either directly or vicariously. As explained in the NPRM, possible

    violations could include a claim of failure to supervise or false

    statements to the Commission, and the Commission could seek an

    injunction against future violations, civil monetary penalties, and/or

    any other appropriate relief. Additionally, criminal penalties may be

    sought by criminal authorities for willful violations of the CEA or

    Commission regulations, in appropriate cases.

    The Commission is declining to add a materiality qualifier to the

    certification, as suggested by commenters. This approach is consistent

    with the statutory text, with the approach taken in final rules for

    SDRs \46\ and DCOs,\47\ and with proposed CCO rules for SEFs.\48\

    ---------------------------------------------------------------------------

    \46\ See Swap Data Repositories: Registration Standards, Duties

    and Core Principles, 76 FR at 54584.

    \47\ See Derivatives Clearing Organization General Provisions

    and Core Principals, 76 FR at 69435.

    \48\ See Core Principles and Other Requirements for Swap

    Execution Facilities, 76 FR 1214, 1252 (Jan. 7, 2011).

    ---------------------------------------------------------------------------

    13. Description and Review of Compliance in Annual Report--Sec.

    3.3([e])(1) and (2)

    The proposed regulation required the annual report to contain a

    description of the compliance by the registrant with respect to the CEA

    and regulations; a description of each of the registrant's compliance

    policies; and a review of each applicable requirement under the CEA and

    regulations, and, with respect to each, identification of the policies

    that ensure compliance, an assessment as to the effectiveness of the

    policies, discussion of areas of improvement, and recommendations of

    potential or prospective changes or improvements to its compliance

    program and resources devoted to compliance.

    NSCP, The Working Group, EEI, and Hess each argued that the level

    of detail contemplated by the rule would impose unnecessary burdens on

    the CCO with little offsetting benefits. NSCP argued that a better

    approach would be to follow the SEC requirements for annual reviews of

    compliance by registered investment advisers. NSCP stated that such

    reviews must reflect review of the adequacy of policies established and

    the effectiveness of their implementation (SEC Rule 206(4)-7(b)). NSCP

    believes the proposed rule is overbroad and discourages reporting of

    compliance issues to the CCO because if every issue, no matter how

    trivial, must be reported and recorded, there may be a chilling effect

    on open communication. NSCP believes that the key issue should be

    whether material issues were escalated and remedied. Newedge argued

    that thousands of Federal, SRO, and internal rules apply, so the report

    should contain a summation of compliance, with details only for areas

    of material noncompliance.

    FIA and SIFMA argued that a one-size-fits-all approach to the

    annual report requirements is not appropriate because some registrants

    are not public reporting companies, some have customers while others

    only conduct

    [[Page 20164]]

    proprietary trading, some deal with retail customers while others only

    deal with sophisticated counterparties, and some are small and local,

    while others are large, integrated institutions with thousands of

    employees worldwide.

    FIA and SIFMA recommended that the Commission specify the material

    issues that should be discussed, so that there is no second guessing

    with respect to the adequacy of the report, and that the Commission

    clarify that compliance policies only include those relating to the CEA

    and Commission regulations. FIA, SIFMA, and NFA also argued that the

    report should identify the policies that are reasonably designed to

    result in compliance, not that ensure compliance. Hess recommended that

    the annual report contain only a summary of the registrant's compliance

    policies and procedures. CMC commented that the scope of activities

    included in the annual report should be limited to those directly

    triggering the requirement of a CCO. EEI argued that inclusion of

    descriptions of violations in the report to the Commission should not

    be decided by the CCO, but should be decided on a case-by-case basis by

    the registrant's governing body. NFA requested that a materiality

    qualifier be added to the requirement that registrants include a

    description of non-compliance.

    Better Markets recommended that the board approve the annual report

    in its entirety or specify where and why it disagrees with any

    provision, and then CCOs should provide the report to the Commission

    either as approved or with statements of disagreement.

    The Working Group recommended that the Commission develop a

    standard form of report and guidance as to how such report needs to be

    completed.

    In response to the comments received, the Commission is modifying

    the proposed requirements for the annual report in Sec. 3.3([e]) to

    (i) require the annual report to contain a description of the

    registrant's policies and procedures, rather than a description of the

    compliance of the registrant; (ii) require the annual report to

    identify the registrant's policies and procedures that ``are reasonably

    designed'' to ensure compliance, rather than those that ensure

    compliance; (iii) require a description of material non-compliance

    issues. The Commission agrees with commenters that certain information

    need be reported only if it is materially significant and that the

    requirement to ``ensure compliance'' can be interpreted to mean

    ``safeguard'' rather than ``guarantee.''

    14. Certification of Compliance With Sections 619 and 716 of the Dodd-

    Frank Act in Annual Report--Sec. 3.3([e])(3)

    The proposed regulation required registrants to include in the

    annual report a certification of compliance with sections 619 and 716

    of the Dodd-Frank Act (the Volcker Rule and Derivatives Push-Out), and

    any rules adopted pursuant to these sections.

    NFA recommended that the certification of compliance with sections

    619 and 716 of Dodd-Frank be deleted, arguing that the Commission

    should wait for the implementing rulemakings for such sections before

    determining certification requirements.

    FIA and SIFMA commented that the requirement to certify compliance

    with the Volcker Rule and Derivatives Push-Out provisions should be

    included as part of the rulemaking that will address the scope and

    requirements of those provisions, but not be prematurely included in

    the CCO rule.

    In consideration of these comments, the Commission has determined

    not to finalize this provision.

    15. Description of Compliance Resources in Annual Report--Sec.

    3.3([e])(6)

    Proposed Sec. 3.3([e])(6) required the annual report to contain a

    description of the registrant's financial, managerial, operational, and

    staffing resources set aside for compliance with the CEA and

    regulations, including any deficiencies in such resources.

    FIA and SIFMA argued that the CCO is not in a position to describe

    the financial, material, operational, and staffing resources set aside

    for compliance. FIA and SIFMA recommended that the CCO only be required

    to describe the resources of the compliance department and any

    recommendations that the CCO has made to senior management with regard

    to financial, managerial, operational, or staffing resources.

    The Working Group argued that a description of deficiencies in

    resources dedicated to compliance would require a CCO to identify

    potential shortcomings and report them in a document likely to be

    available to the public, which could materially hinder the CCO's

    ability to function as an integral member of the management team.

    Having considered these comments, the Commission is adopting the

    rule as proposed, but with the addition of a materiality standard with

    respect to the description of any deficiency. The Commission does not

    believe that the required description of resources available for

    compliance would hinder the CCO's ability to fulfill his or her duties

    in coordination with others in the firm. The rule requires a

    description of compliance resources, but does not prescribe the form or

    manner of this description, which the Commission views as within the

    reasonable discretion of the registrant.

    16. Delineation of Roles of the Board and Senior Officer in Addressing

    Conflicts of Interest in Annual Report--Sec. 3.3([e])(7)

    The proposed regulations required the annual report to include a

    delineation of the roles and responsibilities of a registrant's board

    of directors or senior officer, relevant board committees, and staff in

    addressing any conflicts of interest, including any necessary

    coordination with, or notification of, other entities, including

    regulators.

    FIA and SIFMA argued that the Sarbanes-Oxley Act already requires

    public companies to report the roles and responsibilities of its board,

    senior officers, and committees in resolving conflicts of interest, so

    the Commission should allow such reporting to satisfy this content

    requirement for the annual report. NFA also recommended that the

    reporting of any necessary coordination with, or notification of other

    entities, including regulators, should be deleted.

    In response to FIA, SIFMA, and NFA's comments, the Commission is

    deleting Sec. 3.3([e])(7) from the final rule. This provision is not

    essential to the Commission's evaluation of registrants' compliance

    programs, and if it is relevant to a material compliance matter, it

    will be provided to the Commission pursuant to Sec. 3.3([e])(6). The

    Commission also notes that removing this provision will make the CCO

    requirements for FCMs, SDs, and MSPs more consistent with the CCO

    requirements for SDRs and DCOs, and those proposed for SEFs.

    17. Recordkeeping--Sec. 3.3([g])

    Proposed Sec. 3.3([g]) required FCMs, SDs, and MSPs to maintain

    records of its compliance policies, materials provided to the board in

    connection with its review of the annual compliance report, and work

    papers that form the basis of the annual compliance report.

    The Working Group argued that retaining all materials relating to

    the preparation of the report will cause the CCO to retain all

    materials for fear of an audit that second-guesses the CCO's

    materiality judgments, or the CCO will limit his or her inquiries to

    avoid making a determination of materiality. The Working Group

    recommended that

    [[Page 20165]]

    materials to be retained should be only those germane to the content of

    the compliance report.

    Better Markets recommended adding a requirement that discussions

    between a CCO and traders or executives with oversight of traders

    involving compliance and trading practices and strategies be recorded

    by the CCO and retained in the CCO's records. Better Markets believes

    this requirement is necessary because the duties of the CCO could come

    into conflict with the interests of traders and managers.

    The Commission is adopting the rule as proposed. In response to The

    Working Group's comment, the Commission believes the rule sufficiently

    qualifies the materials that must be retained by stating that the

    records must be ``relevant'' to the annual report. With regard to

    Better Markets' recommendation that CCOs record discussions with

    traders and executives regarding compliance and trading practices, the

    Commission believes that this material will be covered by the rules to

    the extent that the annual report requires the CCO to assess the

    effectiveness of the registrant's policies and procedures and describe

    any material non-compliance issues and the corresponding action taken.

    Consequently, any conflicts that arise between the CCO and the trading

    unit of an SD, MSP, or FCM in which the CCO believes that the

    requirements of the CEA and Commission regulations, including risk

    management obligations, are not being met, must be included in the

    annual report. Additionally, under Sec. 3.3(g)(1)(iii), all records of

    that conflict as described in the annual report must be maintained. The

    Commission further notes that in such instances, it would be good

    practice for the CCO to make and maintain records of all discussions

    with traders and management.

    III. Effective Dates and Compliance Dates

    In the Duties NPRM, Recordkeeping NPRM, and CCO NPRM, the

    Commission requested comment on the length of time necessary for

    registrants to come into compliance with the proposed rules.

    A. Comments Regarding Compliance Dates

    The Working Group recommended that the Commission not require

    compliance with proposed Sec. Sec. 23.600 through 23.607 for at least

    two years, not require compliance with proposed Sec. Sec. 23.200

    through 23.205 for six to twelve months to provide adequate time to

    develop the necessary information technology systems and business

    practices, and not require compliance with the CCO designation

    requirement of proposed Sec. 3.3 for one year after registration. With

    respect to Sec. 23.601, The Working Group also commented that if

    complex requirements are included in position limit rules, such as the

    requirement to convert customized bilateral transactions into futures-

    equivalents, substantially more time will be required for firms to

    design and implement procedures to monitor compliance with position

    limits. With respect to proposed Sec. 3.3, The Working Group commented

    that entities should be able first to hire a CCO and then be permitted

    a reasonable period of time in which to write, test, and implement

    policies and procedures. With respect to all of the proposed rules, The

    Working Group recommended that the Commission provide an extended

    transition period for firms that have not been prudentially regulated

    by a financial regulator and might require substantial corporate

    restructuring.

    FIA, ISDA, SIFMA, and the Financial Services Forum argued that if

    existing systems are not easily adaptable to Sec. Sec. 23.200 through

    23.205, the Commission must provide sufficient time for registrants to

    make the necessary changes in an orderly manner, but no specific time

    period was provided. FIA, ISDA, SIFMA, and the Financial Services Forum

    also recommended that compliance with proposed Sec. 3.3 should not be

    required until after the regulatory requirements under section 4s of

    the CEA for which the CCO is responsible are finalized and become

    effective.

    Cargill recommended that the Commission provide SDs with at least

    one year to come into compliance with proposed Sec. Sec. 23.600

    through 23.607 following the effective date of the rules. Cargill also

    stated that one year was a reasonable period to comply with proposed

    Sec. 3.3.

    MetLife recommended that the Commission allow one year from

    registration as an MSP to comply with the proposed Sec. Sec. 23.600

    through 23.607, because such compliance will require hiring required

    human capital resources, build out of necessary information technology,

    development of policies and procedures and internal vetting of a

    mandated risk management program. MetLife also stated that it would it

    would require one year after registration to recruit a CCO and develop

    a compliance program in compliance with proposed Sec. 3.3.

    NSCP stated that 18 months was necessary for registrants that do

    not currently have a CCO to comply with proposed Sec. 3.3.

    The Bank of Tokyo-Mitsubishi UFJ, Ltd., Mizuho Corporate Bank,

    Ltd., and Sumitomo Mitsui Banking Corporation recommended that the

    effective date of the rules be deferred until December 31, 2012.

    The Commission received no comments related to the length of time

    necessary for registrants to come into compliance with the rules

    proposed in the SD/MSP Conflicts NPRM and FCM/IB Conflicts NPRM.

    B. Compliance Dates

    Having considered the comments received, the Commission is adopting

    the effective and compliance dates as set forth below.

    1. Reporting, Recordkeeping and Daily Trading Records of SDs and MSPs--

    Sec. Sec. 23.200-23.205

    The effective date of Sec. Sec. 23.200 through 23.205 will be the

    date that is 60 days after publication of the final rules in the

    Federal Register.

    SDs and MSPs that are currently regulated by a U.S. prudential

    regulator or are registrants of the SEC must comply with Sec. Sec.

    23.200, 23.201, 23.202, 23.203, 23.204, and 23.205 by the date that is

    the later of 90 days after publication of these final rules in the

    Federal Register or the date on which SDs and MSPs are required to

    apply for registration pursuant to Sec. 3.10. SDs and MSPs that are

    not currently regulated by a U.S. prudential regulator and are not

    registrants of the SEC must comply with Sec. Sec. 23.200, 23.201,

    23.202, 23.203, 23.204, and 23.205 by the date that is the later of 180

    days after publication of these final rules in the Federal Register or

    the date on which SDs and MSPs are required to apply for registration

    pursuant to Sec. 3.10.

    2. Duties of SDs and MSPs--Sec. Sec. 23.600 Through 23.607

    The effective date of Sec. Sec. 23.600 through 23.607 will be the

    date that is 60 days after publication of the final rules in the

    Federal Register.

    With respect to Sec. 23.600 (Risk Management Program), SDs and

    MSPs that are currently regulated by a U.S. prudential regulator or are

    registrants of the SEC must comply with Sec. 23.600 by the date that

    is the later of 90 days after publication of this final rule in the

    Federal Register or the date on which SDs and MSPs are required to

    apply for registration pursuant to Sec. 3.10. SDs and MSPs that are

    not currently regulated by a U.S. prudential regulator and are not

    registrants of the SEC must comply with Sec. 23.600 by the date that

    is the later of 180 days after publication of this final rule in the

    Federal Register or the date

    [[Page 20166]]

    on which SDs and MSPs are required to apply for registration pursuant

    to Sec. 3.10.

    With respect to Sec. 23.603 (Business Continuity and Disaster

    Recovery), SDs and MSPs that are currently regulated by a U.S.

    prudential regulator or are registrants of the SEC must comply with

    Sec. 23.603 by the date that is the later of 180 days after

    publication of this final rule in the Federal Register or the date on

    which SDs and MSPs are required to apply for registration pursuant to

    Sec. 3.10. SDs and MSPs that are not currently regulated by a U.S.

    prudential regulator and are not registrants of the SEC must comply

    with Sec. 23.603 by the date that is the later of 270 days after

    publication of this final rule in the Federal Register or the date on

    which SDs and MSPs are required to apply for registration pursuant to

    Sec. 3.10.

    With respect to Sec. 23.601 (Monitoring of Position Limits), Sec.

    23.602 (Diligent Supervision), Sec. 23.605 (Conflicts of Interest

    Policies and Procedures), Sec. 23.606 (General Information:

    Availability for Disclosure and Inspection), and Sec. 23.607

    (Antitrust Considerations), SDs and MSPs must comply with Sec. Sec.

    23.601, 23.602, 23.605, 23.606, and 23.607 by the later of the

    effective date of these rules or the date on which SDs and MSPs are

    required to apply for registration pursuant to Sec. 3.10.

    3. Conflicts of Interest Policies and Procedures by FCMs and IBs--Sec.

    1.71

    The effective date of Sec. 1.71 will be the date that is 60 days

    after publication of the final rule in the Federal Register.

    FCMs and IBs that are registered with the Commission as of the

    effective date of this rule must comply with Sec. 1.71 by such

    effective date except that such FCMs need not comply with Sec. 1.71(d)

    until the later of the effective date or the date on which SDs and MSPs

    are required to apply for registration pursuant to Sec. 3.10. FCMs and

    IBs that are not registered with the Commission as of the effective

    date of this rule must comply with Sec. 1.71 upon registration with

    the Commission, except that such FCMs need not comply with Sec.

    1.71(d) until the later of their registration or the date on which SDs

    and MSPs are required to apply for registration pursuant to Sec. 3.10.

    4. Chief Compliance Officer of FCMs, SDs, and MSPs--Sec. 3.3

    The effective date of Sec. 3.3 and the amendments to Sec. 3.1

    will be the date that is 60 days after publication of the final rule in

    the Federal Register.

    With respect to Sec. 3.3 (Chief Compliance Officer), SDs and MSPs

    that are currently regulated by a U.S. prudential regulator or are

    registrants of the SEC, must comply with Sec. 3.3 by the date that is

    the later of 180 days after publication of this final rule in the

    Federal Register or the date on which SDs and MSPs are required to

    apply for registration pursuant to Sec. 3.10. SDs and MSPs that are

    not currently regulated by a U.S. prudential regulator and are not

    registrants of the SEC must comply with Sec. 3.3 by the date that is

    the later of 360 days after publication of this final rule in the

    Federal Register or the date on which SDs and MSPs are required to

    apply for registration pursuant to Sec. 3.10. FCMs that are (1)

    registered with the Commission as of the effective date of the rule,

    and (2) currently regulated by a U.S. prudential regulator or are

    registrants of the SEC, must comply with Sec. 3.3 by the date that is

    180 days after publication of this final rule in the Federal Register.

    FCMs that are (1) registered with the Commission as of the effective

    date of the rule, and (2) not currently regulated by a U.S. prudential

    regulator and are not registrants of the SEC must comply with Sec. 3.3

    by the date that is 360 days after publication of this final rule in

    the Federal Register. FCMs that are not registered with the Commission

    as of the effective date of this rule must comply with Sec. 3.3 upon

    registration with the Commission.

    IV. Cost Benefit Considerations

    A. Introduction

    The swaps markets, which have grown exponentially in recent years,

    are now an integral part of the nation's financial system. As the

    financial crisis of 2008 demonstrated, inadequate understanding,

    oversight, and management of swaps can contribute to systemic risk.\49\

    The internal business conduct standards that the Commission is

    promulgating for SDs and MSPs in this rulemaking are an important

    element of the ``improve[d] financial architecture'' that Congress

    intended in enacting the Dodd-Frank Act.\50\ For, as entities that,

    respectively, engage in swap dealing activities \51\ and ``whose

    outstanding swaps create substantive counterparty exposure that could

    have serious adverse effects on the financial stability of the United

    States banking system or financial markets,'' \52\ the standards that

    SDs and MSPs follow (or fail to follow) in transacting their swaps may

    have repercussions for financial system stability more broadly.

    Effective systemic risk management for swaps begins with effective

    internal risk management protocols of individual SDs and MSPs.

    ---------------------------------------------------------------------------

    \49\ As the U.S. Senate Committee on Banking, Housing, and Urban

    Affairs explained in reporting what became the Dodd-Frank Act, while

    a ``downturn in the national housing market'' was the 2008 financial

    crisis' ``first trigger:''

    * * * the use of unregulated derivatives products based on

    [faulty mortgage loans was among the elements that] only served to

    spread and magnify the risk. The system operated on the wholesale

    misunderstanding of, or complete disregard for the risks inherent in

    the underlying assets and the complex instruments they were backing

    * * *' Technology, plus globalization, plus finance has created

    something quite new, often called ``financial technology.'' Its

    emergence is a bit like the discovery of fire--productive and

    transforming when used with care, but enormously destructive when

    mishandled' * * * Gaps in the regulatory structure allowed these

    risks and products to flourish outside the view of those responsible

    for overseeing the financial system.

    S. Rep. No. 111-176, at 43 (2010) (quoting former Comptroller of

    the Currency, Eugene Ludwig; citations omitted).

    \50\ Id. at 228. Stated another way, they are an aspect of that

    legislation's ``comprehensive regulation and rules'' to achieve a

    ``strengthened infrastructure for the financial system * * *

    intended to make the system more resilient and resistant to the

    adverse effects of financial instability.'' Id. at 228-29.

    \51\ CEA section 1(a)(49)(A).

    \52\ CEA section 1(a)(33)(A)(ii).

    ---------------------------------------------------------------------------

    Title VII of the Dodd-Frank Act mandates the Commission to

    establish risk management requirements for SDs and MSPs. Specifically,

    Section 731 adds new section 4s of the CEA that, among other things:

    Establishes reporting, recordkeeping, and daily trading

    records requirements for SDs and MSPs.\53\

    ---------------------------------------------------------------------------

    \53\ CEA section 4s(f)&(g).

    ---------------------------------------------------------------------------

    Defines and imposes duties on SDs and MSPs with regard to:

    (1) Risk management procedures,\54\ (2) monitoring of trading to

    prevent violations of applicable position limits,\55\ (3) diligent

    supervision,\56\ (4) disclosure and the ability of regulators to obtain

    general information,\57\ and (5) antitrust considerations.\58\

    ---------------------------------------------------------------------------

    \54\ CEA section 4s(j)(2).

    \55\ CEA section 4s(j)(1).

    \56\ CEA section 4s(h)(1).

    \57\ CEA section 4s(j)(3).

    \58\ CEA section 4s(j)(6).

    ---------------------------------------------------------------------------

    Establishes conflicts-of-interest requirements for SDs and

    MSPs to establish information partitions between research and trading

    and between trading and clearing.\59\

    ---------------------------------------------------------------------------

    \59\ CEA section 4s(j)(5).

    ---------------------------------------------------------------------------

    Requires each SD and MSP to designate a chief compliance

    officer, set out qualifications and duties of the chief compliance

    officer, and require that the chief compliance officer prepare, sign,

    and furnish to the Commission an annual report containing an assessment

    of the registrant's compliance activities.\60\

    ---------------------------------------------------------------------------

    \60\ CEA section 4s(k).

    ---------------------------------------------------------------------------

    Additionally, Dodd-Frank Act section 732 amends section 4d of the

    CEA to add conflict of interest requirements for

    [[Page 20167]]

    FCMs and IBs,\61\ and a chief compliance officer requirement for

    FCMs.\62\ This rulemaking implements these provisions of sections 4s

    and 4d of the CEA.

    ---------------------------------------------------------------------------

    \61\ CEA section 4d(c).

    \62\ CEA section 4d(d).

    ---------------------------------------------------------------------------

    Section 15(a) \63\ of the CEA requires the Commission to consider

    the costs and benefits of its actions before promulgating a regulation

    under the CEA or issuing an order. Section 15(a) further specifies that

    the costs and benefits shall be evaluated in light of the following

    five broad areas of market and public concern: (1) Protection of market

    participants and the public; (2) efficiency, competitiveness and

    financial integrity of futures markets; (3) price discovery; (4) sound

    risk management practices; and (5) other public interest

    considerations. To the extent that these new regulations reflect the

    statutory requirements of the Dodd-Frank Act, they will not create

    costs and benefits beyond those resulting from Congress's statutory

    mandates in the Dodd-Frank Act.\64\ However, to the extent that the new

    regulations reflect the Commission's own determinations regarding

    implementation of the Dodd-Frank Act's provisions, such Commission

    determinations may result in other costs and benefits. It is these

    other costs and benefits resulting from the Commission's own

    determinations pursuant to and in accordance with the Dodd-Frank Act

    that the Commission considers with respect to the section 15(a)

    factors.

    ---------------------------------------------------------------------------

    \63\ 7 U.S.C. 19(a).

    \64\ Certain commenters, such as The Working Group and the

    FHLBs, posit that there is no benefit to be derived from internal

    business conduct standards as mandated by Congress and that the

    mandated provisions do not generate sufficient benefits relative to

    costs or contribute to the purposes (e.g., mitigating systemic risk

    and enhancing transparency) of the Dodd-Frank Act. As such, these

    commenters' concerns fall outside the Commission's regulatory

    discretion to implement sections 4s and 4d of the CEA and fail to

    raise issues subject to consider under section 15(a).

    ---------------------------------------------------------------------------

    The Commission is obligated to estimate the burden of and provide

    supporting statements for any collections of information it seeks to

    establish under considerations contained in the PRA, 44 U.S.C. 3501 et

    seq., and to seek approval of those requirements from the OMB. To the

    extent costs of the rulemaking are associated with collections of

    information, the estimated burden and support for such collections of

    information, as well as the consideration of comments thereto, are

    discussed in the PRA section of this rulemaking and the information

    collection requests filed with OMB as required by that statute. The

    Commission has also considered these costs, which it incorporates

    herein by reference, in its CEA section 15(a) analysis.

    In each of the NPRMs encompassed within this final rulemaking, the

    Commission asked for public comment on the costs and benefits of the

    proposed regulations, and specifically invited commenters to submit

    ``any data or other information * * * quantifying or qualifying'' the

    costs and benefits of the proposal.\65\ The Commission also separately

    requested comments on the overall costs and benefits of the proposed

    rules implementing the Dodd-Frank Act.\66\ The Commission received

    approximately 51 comments addressing the cost and benefit

    considerations of the proposed rules, but few commenters presented to

    the Commission quantitative data pertinent to any of the proposed

    rulemakings, and no commenter stated whether such data is ascertainable

    with a degree of certainty that could inform Commission deliberations.

    After conducting a review of applicable academic literature, the

    Commission is not aware of any research reports or studies that are

    directly relevant to its considerations of costs and benefits of these

    final rules.

    ---------------------------------------------------------------------------

    \65\ See SD/MSP Conflicts NPRM, 75 FR at 71395; FCM/IB Conflicts

    NPRM, 75 FR at 70157; Duties NPRM, 75 FR at 71404; Recordkeeping

    NPRM, 75 FR at 76673; and CCO NPRM, 75 FR at 70886.

    \66\ Id.

    ---------------------------------------------------------------------------

    The Commission considered the comments on the costs and benefits of

    the proposed rules and, in particular, reasonable alternatives

    suggested by commenters. As detailed in the discussions of each

    rulemaking above, the Commission is adopting alternatives or

    modifications to the proposed rules where, in the Commission's

    judgment, the alternative or modification accomplishes the same

    regulatory objective in a less burdensome manner. Indeed, the

    Commission has sought to reduce the burden on market participants to

    the extent doing so satisfies the statute's requirements and does not

    undermine important benefits that the Commission believes the statute

    was intended to promote. In addition to benefits, the costs of the

    regulations and the steps the Commission has taken to mitigate them are

    discussed below.

    Notwithstanding the paucity of available quantitative information,

    the Commission has endeavored to estimate quantifiable costs and

    benefits of the final rules when possible. Where estimation or

    quantification is not feasible, the Commission provides a qualitative

    assessment of the relevant costs and benefits. In the following

    discussion, the Commission: (i) Addresses comments regarding the

    effects of these final rules in terms of their material costs and

    benefits; (ii) considers the material cost and benefit implications of

    these final rules in comparison to baseline costs imposed by the

    statutory requirements and discusses cost mitigation undertaken in

    modifying the rules as proposed; and (iii) considers the material costs

    and benefits of the final rules in light of the five broad areas of

    market and public concern pursuant to section 15(a) of the CEA. After

    discussing some general considerations applicable to all rulemaking

    areas covered by this release and comments regarding rule scope, the

    cost-benefit considerations are divided among the following rulemaking

    areas: recordkeeping; duties and risk management; conflicts-of-interest

    policies and procedures; and designation of a CCO.

    B. General Considerations

    This rulemaking generated an extensive record, which is discussed

    at length throughout this notice as it relates to the substantive

    provisions in the final rules. A number of commenters stated that they

    would incur significant, though largely unquantified, costs because of

    the proposed rules. Others identified benefits attributable to the

    proposed rules or more stringent requirements. The Commission carefully

    considered these comments and the alternatives proposed in them.\67\

    ---------------------------------------------------------------------------

    \67\ These comments also have been addressed in other sections

    of this release. This section's consideration of costs and benefits

    reviews and assesses them to the more narrow extent that they raise

    relative cost/benefit issues. A complete policy analysis of, and

    response to, these comments can be found in section II of this

    release.

    ---------------------------------------------------------------------------

    In response to the Commission's invitation for comments on the

    overall costs and benefits of the proposed rules,\68\ Better Markets

    stated that the Commission's cost-benefit analyses in the notices of

    proposed rulemaking may have understated the benefits of the proposed

    rules.\69\ Better Markets argued

    [[Page 20168]]

    that adequate assessment of the costs and benefits of any single

    proposed rule or element of such a rule would be difficult or

    impossible without considering the integrated regulatory system of the

    Dodd-Frank Act as a whole. According to Better Markets:

    ---------------------------------------------------------------------------

    \68\ See SD/MSP Conflicts NPRM, 75 FR at 71395; FCM/IB Conflicts

    NPRM, 75 FR at 70157; Duties NPRM, 75 FR at 71404; Recordkeeping

    NPRM, 75 FR at 76673; and CCO NPRM, 75 FR at 70886.

    \69\ See Letter from Better Markets dated June 3, 2011(comment

    file for 75 FR 71397 (Regulations Establishing and Governing the

    Duties of Swap Dealers and Major Swap Participants)). On the other

    hand, certain commenters, such as The Working Group and the FHLBs,

    posit that there is no benefit to be derived from internal business

    conduct standards as mandated by Congress and that the mandated

    provisions do not generate sufficient benefits relative to costs or

    contribute to the purposes (e.g., mitigating systemic risk and

    enhancing transparency) of the Dodd-Frank Act.

    It is undeniable that the Proposed Rules are intended and

    designed to work as a system. Costing-out individual components of

    the Proposed Rules inevitably double counts costs which are

    applicable to multiple individual rules. It also prevents the

    consideration of the full range of benefits that arise from the

    system as a whole that provides for greater stability, reduces

    systemic risk and protects taxpayers and the public treasury from

    ---------------------------------------------------------------------------

    future bailouts.

    Better Markets also stated that an accurate cost benefit assessment

    must include the avoided risk of a new financial crisis and opined that

    one measure of this is the still accumulating cost of the 2008

    financial crisis.\70\ The Commission agrees with Better Markets that

    the proposed rules should operate in a coordinated manner to improve

    and protect financial markets; notwithstanding this, the Commission

    must (and has) conducted a cost-benefit analysis with respect to this

    specific rulemaking.

    ---------------------------------------------------------------------------

    \70\ The comment letter cited Andrew G. Haldane, Executive

    Director for Financial Stability of the Bank of England, who

    estimated the worldwide cost of the crisis in terms of lost output

    at between $60 trillion and $200 trillion, depending primarily on

    the long term persistence of the effects.

    ---------------------------------------------------------------------------

    Recognizing that there will be costs incurred to comply with the

    regulations, the Commission believes there are significant benefits to

    be gained from these requirements, including but not limited to,

    increased risk management and enhanced transparency. While the

    Commission notes that the costs and benefits stemming from these

    regulations, in large part, are attributable to the baseline statutory

    mandate, each subsection herein further details the costs and benefits

    of the numerous discrete provisions of the rules in order to inform

    market participants more fully of the costs and benefits anticipated by

    the Commission.

    As a general matter across these rules, the Commission sought to

    ease the burden for market participants through tailored phasing in of

    compliance requirements. In each of the Duties NPRM, Recordkeeping

    NPRM, and CCO NPRM, the Commission requested comment on the length of

    time necessary for registrants to come into compliance with the

    proposed rules. These comments are enumerated in section III.A., and

    the Commission considered those comments in adopting compliance dates

    for each rule as set forth in section III.B. above. The approach

    recommended by commenters and accepted by the Commission recognizes and

    generally differentiates between registrants that have been previously

    regulated by the SEC or a prudential regulator and those that have not

    been previously regulated. The Commission has elected to provide

    additional time for compliance, where appropriate, for those that have

    not been previously regulated. In many instances, the Commission is

    providing more time for all market participants beyond the statutorily

    prescribed minimum of 60 days.

    C. Comments Regarding the Scope of the Proposed Rules

    Several commenters questioned the scope of the proposed rules and

    implicitly, if not expressly, whether the breadth as proposed was

    appropriate in light of the costs that would result to certain

    registrants. Comments illustrative of the concerns are discussed below.

    The FHLBs articulated several reasons \71\ for exempting them from

    the proposed internal business conduct standard rules. First, they

    maintain that subjecting FHLBs to internal business conduct standards

    could cause them to cease offering swaps transactions to their risk-

    hedging members, depriving their members of a competitive swap

    transaction counterparty and potentially increasing members' hedging

    costs. Second, they maintain that many of the requirements duplicate

    those imposed by their prudential regulator, the Federal Housing

    Finance Agency (FHFA), thus there is no incremental benefit

    attributable to the additional costs of complying with the proposed

    rules.\72\

    ---------------------------------------------------------------------------

    \71\ In addition to the two reasons discussed, the FHLBs also

    expressed that, unlike external business conduct standards, the

    internal business conduct standards as mandated by Congress in the

    Dodd-Frank Act do not generate benefits to justify their costs. As

    noted above, this concern falls beyond the Commission's

    implementation discretion.

    \72\ SIFMA made a similar argument with respect to all SDs and

    MSPs that are subject to regulation by a prudential regulator.

    ---------------------------------------------------------------------------

    The Commission finds the FHLB's position unpersuasive. First, the

    concern that FHLBs would cease transacting swaps is undermined by the

    FHLB's position that the proposed rules in large part duplicate the

    requirements of its prudential regulator; if internal business conduct

    standards would likely curb the FHLBs' swaps activity, presumably that

    would have occurred already. Second, the Commission construes the

    FHLB's position to be inconsistent with the statutory intent of

    sections 4s(f), (g), (j), and (k)--i.e., consistent Commission

    oversight of SDs and MSPs, regardless of whether they are also subject

    to regulation by a prudential regulator. For, in the one area that

    Congress intended the Commission to defer to prudential regulation with

    respect to SDs and MSPs--capital and margin requirements--it provided

    so expressly.\73\ There is no such express language requiring

    prudential regulation deference in sections 4s(f), (g), (j), and (k).

    This gives rise to a negative inference that, with respect to them,

    Congress intended the Commission to establish uniform requirements for

    SDs and MSPs, notwithstanding any overlapping prudential regulation. In

    addition, to the extent that, as the FHLBs assert, FHFA rules are

    substantively similar with the proposed rules, compliance with the

    proposed rules should not present substantial additional compliance

    costs.

    ---------------------------------------------------------------------------

    \73\ See CEA section 4s(e).

    ---------------------------------------------------------------------------

    The Working Group suggested that the proposed rules would impose

    substantial costs with no corresponding increase in risk management and

    compliance effectiveness. The Commission disagrees. It believes that

    its final internal business conduct standards will enhance risk

    management by requiring, among other things: (1) SDs and MSPs to have a

    complete understanding of the various risks that the entity faces; and

    (2) entities to monitor their traders for compliance with trading

    policies established by the SD or MSP. These final rules also require

    that SDs and MSPs have sound recordkeeping policies in place, which

    will ensure that swap transactions are fully memorialized. Sound risk

    management and internal controls on an individual firm level is the

    basis of systemic risk mitigation.

    Other commenters (MetLife, MFA, BlackRock, and AMG) argued that the

    Dodd-Frank Act does not require the Commission to apply the same rules

    to MSPs as those applied to SDs, and that MSPs should not be subject to

    the same regulations as SDs because MSPs do not engage in market-making

    activities. These commenters contend that the costs of compliance would

    be too high for MSPs. The Commission believes that the statutory

    baseline under sections 4s(f), (g), (j), and (k) of the CEA is

    identical treatment of SDs and MSPs. The statutory provisions of

    sections 4s(f), (g), (j), and (k) of the CEA do not distinguish between

    the requirements applied to SDs and those applied to MSPs.

    Additionally, in response to claims that the costs will be too high for

    MSPs, the Commission notes that if an

    [[Page 20169]]

    MSP does not engage in certain activities, the regulations pertaining

    to those activities are not applicable. Therefore, in these cases, the

    Commission believes MSPs would be relieved of any burden such

    regulations present.

    Finally, Cargill recommended that the Commission make clear that

    the Commission's regulations only apply to the swap dealing business of

    an SD that is a division of a larger company, and not to the other,

    non-swaps-related business activities of the company.\74\ The

    Commission has accepted the alternative proposed by Cargill by

    including a new definition of ``swaps activities'' in the final

    regulations and by limiting the scope of several requirements to fit

    this definition. Adopting this alternative approach should allow

    entities to understand their duties and requirements under the final

    regulations more clearly and reduce costs by limiting the scope of the

    rules' applicability.

    ---------------------------------------------------------------------------

    \74\ Presumably, Cargill believes that limiting application of

    Commission regulations to a specific division, rather than the

    entirety of a larger company, will result in cost savings, although

    it does not directly advance this argument.

    ---------------------------------------------------------------------------

    D. Recordkeeping, Reporting, and Daily Trading Records Requirements for

    Swap Dealers and Major Swap Participants

    As added by section 731 of the Dodd-Frank Act, sections 4s(f) and

    4s(g) of the CEA establish reporting and recordkeeping requirements and

    daily trading records requirements for SDs and MSPs. Section 4s(f)(1)

    requires SDs and MSPs to ``make such reports as are required by the

    Commission by rule or regulation regarding the transactions and

    positions and financial condition of the registered swap dealer or

    major swap participant.'' In the Recordkeeping NPRM, the Commission

    proposed regulations, pursuant to sections 4s(f)(1)(B)(i) and (ii) of

    the CEA, prescribing the books and records requirements for ``all

    activities related to the business of swap dealers or major swap

    participants,'' regardless of whether or not the entity has a

    prudential regulator, as required by statute. In addition, the

    Commission proposed regulations in the Recordkeeping NPRM pursuant to

    section 4s(g)(1) of the CEA, requiring that SDs and MSPs ``maintain

    daily trading records of the swaps of the registered swap dealer and

    major swap participant and all related records (including related cash

    and forward transactions) and recorded communications, including

    electronic mail, instant messages, and recordings of telephone calls.''

    The Commission notes that section 4s(g)(3) requires that daily trading

    records for each swap transaction be identifiable by counterparty, and

    section 4s(g)(4) specifies that SDs and MSPs maintain a ``complete

    audit trail for conducting comprehensive and accurate trade

    reconstructions.''

    The Commission received 14 comment letters on the Recordkeeping

    NPRM. The Commission considered each in formulating the final rules,

    including any alternatives proposed and cost or benefit concerns

    expressed. Of the 14 comments received, five addressed issues relevant

    to the costs and benefits of the proposed rules, but no letters

    provided any quantitative data to support their claims. The comment

    letters focused on 9 areas of the rule that are most relevant to the

    Commission's consideration of costs and benefits. Each of these areas

    is discussed below. A more detailed discussion can be found in section

    II.B-E. above.

    1. Additional Types of Records

    In the Recordkeeping NPRM, the Commission requested comments

    regarding whether additional types of records other than those

    specified in the proposed rules under Sec. 23.201 should be required

    to be kept by SDs and MSPs. The Commission also requested comment

    regarding whether drafts of documents should be kept. Having considered

    the comments received,\75\ the Commission is not requiring any

    additional types of records in the final rule. Although the Commission

    agrees that drafts may provide information regarding the development of

    transactions, the Commission does not believe that the marginal

    incremental value of such information is sufficient to require draft

    retention. The Commission also notes that pertinent pre-execution trade

    information that may appear in drafts is already subject to retention

    under the daily trading records rule.

    ---------------------------------------------------------------------------

    \75\ The Working Group commented that the current proposal is

    sufficient. Chris Barnard, however, recommended that drafts of

    documents should also be kept, arguing that the decision process

    leading up to a final document can be very informative.

    ---------------------------------------------------------------------------

    2. Reliance on SDRs for Recordkeeping Requirements

    The proposed regulations did not address whether an SD or MSP could

    fulfill the recordkeeping requirements by reporting a swap to a swap

    data repository (SDR), but ISDA & SIFMA requested that the Commission

    consider the extent to which SDs and MSPs may rely upon SDRs to retain

    records beyond the time periods that registrants currently retain such

    records. ISDA & SIFMA did not elaborate on the current retention

    periods for swaps records, nor did they explain how this approach would

    work in the absence of established SDRs for all types of swaps. The

    Commission considered this alternative to its recordkeeping rules, but

    determined that it is premature at this time to permit SDs and MSPs to

    rely solely on SDRs to meet their recordkeeping obligations under the

    rules. Additionally, the Commission believes that SDs and MSPs must

    maintain complete records of their swaps for the purposes of risk

    management. The data that is required to be reported to an SDR may not

    be sufficient for these purposes. At present, SDRs are new entities

    under the Dodd-Frank Act with no track record of operation; and, for

    particular swaps asset classes, SDRs have yet to be established. As

    SDRs evolve, the proposed alternative may prove appropriate, but the

    Commission believes that putative cost-savings benefits attributable to

    SDR record retention in lieu of individual firm record retention are

    too speculative presently to justify modification of the proposed

    rules.

    3. Records in a Single Electronic File, Searchable by Transaction and

    Counterparty

    Proposed Sec. 23.201(a)(1) required SDs and MSPs to keep

    transaction records in a form identifiable and searchable by

    transaction and by counterparty. Proposed Sec. Sec. 23.202(a) and

    23.202(b) also required SDs and MSPs to keep daily trading records for

    each swap and any related cash or forward transaction as a separate

    electronic file identifiable and searchable by transaction and

    counterparty. Commenters had several concerns with the costs of

    complying with this requirement.\76\ In particular, commenters objected

    to the burden of maintaining the records required for each transaction

    in a separate electronic file and with maintaining the records in a

    manner searchable by transaction and counterparty. No commenter

    quantified the exact cost of these requirements, but the Commission

    recognizes that SDs and MSPs would incur costs to comply with both

    requirements. The Commission retained the requirement that trading

    records be searchable by transaction and

    [[Page 20170]]

    counterparty because it interprets this to be the statutory minimum

    imposed by section 4s(g)(3) of the CEA, i.e., that registrants

    ``maintain daily trading records for each counterparty in a manner and

    form that is identifiable with each swap transaction.'' However, the

    Commission is modifying the proposed rules to remove the provision in

    Sec. 23.202(a) and Sec. 23.202(b) that requires each transaction

    record to be maintained as a separate electronic file. The Commission

    believes that this modification trims the rule's requirements to the

    baseline required by statute, reducing the burden to the maximum extent

    possible.

    ---------------------------------------------------------------------------

    \76\ ISDA & SIFMA argued that SDs and MSPs routinely store data

    across a number of systems, and that aggregating transaction data

    from all systems into a single electronic file would require a large

    investment across market participants and would require a

    substantial implementation period. The Working Group also argued

    that tying relevant records to each individual transaction in a

    manner that is identifiable and searchable by transaction would

    create a heavy technical burden.

    ---------------------------------------------------------------------------

    4. Form of Maintaining Business Records

    As proposed, Sec. 23.201(b) required SDs and MSPs to keep full,

    complete, and systematic business records, including records related to

    corporate governance, financial records, complaints, and marketing and

    sales materials. The Working Group recommended that, to minimize

    burden, the Commission permit these records to be retained as they

    currently are in the normal course of business. Responding to this

    concern, the Commission confirms that the rule does not require SDs and

    MSPs to keep the required business records in a single comprehensive

    file so long as such records can be readily accessed and provided to

    the Commission upon request. This confirmation as requested by The

    Working Group will minimize the burden on SDs and MSPs with regard to

    establishing new recordkeeping policies.

    5. Records of Complaints Received by MSPs

    Proposed Sec. 23.201(b) required SDs and MSPs to retain a record

    of complaints received, certain identifying information about the

    complainant, and a record of the disposition of the complaint. Without

    quantifying any cost, MFA commented that, because MSPs do not have

    customers nor make markets in swaps, it is unwarranted to subject them

    to the burden of retaining a complaint record. The Commission finds

    MFA's position unpersuasive and is adopting the rule as proposed. The

    Commission has no basis to find that the burden of maintaining a

    complaint record will impose significant cost on MSPs. Moreover, the

    Commission believes that the relevant consideration is not whether MSPs

    have customers or whether they make markets, but the fact that they

    have substantial swaps positions and the potential significance of

    their swaps activities that defines them as MSPs. Given this, the

    Commission believes a record of complaints, particularly if it

    establishes a pattern, could be of important regulatory value.

    6. Recording of Pre-Execution Trade Information, Including Voice

    Recordings

    Proposed Sec. 23.202(a)(1) required SDs and MSPs to make and keep

    records of pre-execution trade information, including records of all

    oral and written communications concerning quotes, solicitations, bids,

    offers, instructions, trading, and prices that lead to the execution of

    a swap, however communicated. As explained above, the Commission has

    eliminated the requirement that pre-execution trade information be

    maintained in a separate electronic file for each transaction.

    Otherwise the Commission is adopting the rule as proposed despite

    commenters concerns as to the cost of the required recording \77\

    because it believes the information specified in the rule is the

    minimum necessary to maintain an audit trail as statutorily required by

    section 4s(g)(4) of the CEA.

    ---------------------------------------------------------------------------

    \77\ ATA commented that the current telephone recording systems

    in use by SDs and MSPs may not meet all of the proposed rule's

    requirements, and that implementing telephone recording systems that

    are compliant with the requirements would impose a significant

    additional cost. Notably, ATA did not propose any alternative ways

    that the Commission might achieve the statutory requirement of the

    CEA in a less burdensome manner.

    ---------------------------------------------------------------------------

    7. Timestamp for Quotations Using Universal Coordinated Time (UTC)

    Proposed Sec. 23.202 required SDs and MSPs to use Universal

    Coordinated Time to record the time of each quotation provided to, or

    received from, a counterparty prior to execution; the time of swap and

    related cash and forward transaction execution; and the time of swap

    confirmation. The rule's use of UTC reflects an approach consistent

    with the Commission's final rules for real-time public reporting,\78\

    and the swap data reporting rule.\79\ By requiring the use of UTC in

    Sec. 23.202, the Commission is ensuring that the requirements of Part

    23, Part 43, and Part 45 remain consistent to the extent possible. The

    Commission sees important benefits deriving from required UTC

    consistency in reporting and recordkeeping: avoiding the need to

    convert timestamps created in many different time zones is essential

    for timely and efficient automated processing of large amounts of

    market and pricing data by the Commission and others. Based on its

    belief that rapid automated processing is critical to the success of

    its regulatory mission, the Commission disagrees with the comments of

    ISDA & SIFMA in their joint letter that the value of this benefit is

    ``minimal'' relative to the cost of moving to UTC, which cost they did

    not quantify. Moreover, the Commission believes that UTC works in

    complimentary tandem with Part 43 and Part 45 measures that promote

    straight-through-processing.\80\

    ---------------------------------------------------------------------------

    \78\ See Real-Time Public Reporting of Swap Transaction Data, 77

    FR 1182, 1251 (Jan. 9, 2012).

    \79\ See Swap Data Recordkeeping and Reporting Requirements, 77

    FR 2136, 2212 (Jan. 13, 2012).

    \80\ Straight-through processing was considered a ``critical

    risk mitigate'' in a 2005 report released by an industry group

    chaired by the then-chairman of Goldman Sachs and composed of

    representatives from Citigroup, JP Morgan Chase, and Morgan Stanley,

    among other prominent financial institutions. See Counterparty Risk

    Management Policy Group II, Toward Greater Financial Stability: A

    Private Sector Perspective, July 27, 2005, p. 84. Publicly available

    at http://fcic-static.law.stanford.edu/cdn_media/fcic-docs/2005-07-25%20Counterparty%20Risk%20Management%20Policy%20Group-%20Toward%20Greater%20Financial%20Stability.pdf.

    ---------------------------------------------------------------------------

    8. Daily Trading Records for Cash and Forward Transactions Related to a

    Swap

    Proposed Sec. 23.202(b) required SDs and MSPs to keep daily

    trading records, similar to those SDs and MSPs are required to keep for

    swaps, for related cash and forward transactions.\81\ The Commission is

    adopting the rule as proposed because section 4s(g)(1) of the CEA

    requires registrants to ``maintain daily trading records of their swaps

    * * * and related records (including related cash and forward

    transactions) . * * *'' No commenter objected to the proposed

    definition of ``related cash and forward transactions,'' although

    commenters argued that hedging and risk mitigation activities referred

    to in the proposed daily trading records rule typically are not

    executed with respect to specific trades and that it would not be

    possible to link cash and forward transactions to a specific swap.\82\

    The Working Group also argued that compliance with proposed Sec.

    23.202(b) would impose expensive and burdensome requirements on

    millions of physical transactions that are undertaken by commercial

    energy firms that are also parties to swap transactions. No commenter

    proposed, and the Commission has not identified, an alternative to

    achieve the statutory requirement in a less burdensome manner, however.

    Thus, the

    [[Page 20171]]

    Commission is adopting the rule as proposed.

    ---------------------------------------------------------------------------

    \81\ See definition under proposed Sec. 23.200, ``a purchase or

    sale for immediate or deferred physical shipment or delivery of an

    asset related to a swap where the swap and the related cash or

    forward transaction are used to hedge, mitigate the risk of, or

    offset one another.''

    \82\ ISDA & SIFMA and The Working Group made this point.

    ---------------------------------------------------------------------------

    9. Record Retention Period

    Proposed Sec. 23.203(b)(2) required SDs and MSPs to retain records

    of any swap or related cash or forward transaction until the

    termination or maturity of the transaction and for a period of five

    years after such date. The Commission notes that proposed revisions to

    Commission regulation Sec. 1.31 require retention of swap transaction

    records for a period of five years following the termination,

    expiration, or maturity of a swap,\83\ and that Sec. 23.203 is

    consistent with retention requirements under the final swap data

    reporting rule.\84\ However, to mitigate costs in response to

    commenters' concerns \85\ regarding retention of pre-execution trade

    information, the Commission is revising the rule to reduce the voice

    recording retention period to one year. The Commission considered a

    six-month retention period for voice recordings, as recommended by ISDA

    & SIFMA, but determined that for swaps, particularly long tenor swaps,

    a longer period is necessary in order to give trade discrepancies an

    opportunity to surface. In addition, the Commission believes that a

    one-year retention period is necessary to make the audit trail most

    useful for the Commission's enforcement purposes. The Commission

    believes the benefit of available voice recordings to clear up latent

    trade discrepancies and aide in enforcement actions justifies the

    incremental cost of an additional six-month retention period.

    ---------------------------------------------------------------------------

    \83\ See Adaptation of Commission Regulations to Accommodate

    Swaps, 76 FR 33066, 33088 (June 7, 2011).

    \84\ See Swap Data Recordkeeping and Reporting Requirements, 77

    FR 2136, 2212 (Jan. 13, 2012).

    \85\ See MFA (stating that the vast majority of its members do

    not keep records of transactions for five years and compliance with

    rule as proposed would be burdensome and costly); The Working Group

    (long-term electronic storage of significant amounts of pre-

    execution communication will prove costly over five-year period);

    ISDA (supporting a voice recording obligation aligned to the six-

    month minimum required by the UK Financial Services Authority);

    SIFMA (same). Chris Barnard, conversely, recommended that records

    should be required to be kept indefinitely rather than the general

    five years under the proposal. Mr. Barnard argued that documents can

    be scanned after five years, so there is no practical reason for

    limiting the retention period and the information would be useful

    for future analytical purposes.

    ---------------------------------------------------------------------------

    Costs

    Sections 4s(f) and (g) of the CEA require SDs and MSPs to adopt and

    implement certain reporting and recordkeeping requirements. The costs

    and benefits that necessarily result from these basic statutory

    requirements are considered to be the ``baseline'' against which the

    costs and benefits of the Commission's final rules are compared or

    measured. The ``baseline'' level of costs includes the costs that

    result from the following activities required by the statute:

    Keeping books and records of all activities related to the

    business of the SD or MSP in such form and manner and for such period

    as may be prescribed by the Commission;

    Maintaining daily trading records of swaps and related

    cash or forward transactions and recorded communications, including

    electronic mail, instant messages, and recordings of telephone calls,

    and including such information as the Commission shall require;

    Maintaining daily trading records for each counterparty in

    a manner and form that is identifiable with each swap;

    Maintaining a complete audit trail for conducting

    comprehensive and accurate trade reconstructions.

    Compliance with the statutory baseline alone would result in costs

    for SDs and MSPs. For example, the requirement to maintain recorded

    communications would include the cost of a telephonic recording system.

    Similarly, compliance with the statutory provisions would require data

    storage and retrieval systems.

    Congress mandated that the Commission adopt rules to implement each

    of the statutory provisions. With regard to its implementation

    decisions, the Commission has determined the following to be costs to

    SDs and MSPs to comply with the final regulations regarding

    recordkeeping obligations under Part 23:

    Compiling transaction, position, and business records;

    Compiling records of data reported to an SDR;

    Compiling records of real-time reporting data;

    Compiling daily trading records for swaps of pre-trade

    information, including all oral and written communications concerning

    quotes, solicitations, bids, offers, instructions, trading, and prices

    that lead to the execution of a swap, however communicated; execution

    trade information, including the name of the counterparty, the terms of

    each swap, the date and time of execution; and post-execution trade

    information;

    Compiling daily trading records for related cash and

    forward transactions of pre-trade information, including all oral and

    written communications concerning quotes, solicitations, bids, offers,

    instructions, trading, and prices that lead to the execution of a

    related cash or forward transaction, however communicated; execution

    trade information, including the name of the counterparty, the terms of

    each swap, the date and time of execution; and post-execution trade

    information;

    Data storage, in physical and/or digital format, in most

    cases for the term of a swap plus five years;

    Telephonic recording system (to record voice calls related

    to transactions); and

    Software and/or hardware updates to existing systems to

    capture and maintain the required records and to convert to Coordinated

    Universal Time.

    With regard to the reporting requirements, the Commission has

    determined that compliance with the requirements relating to reporting

    swap data to an SDR and the real-time public reporting of swap

    transaction data will constitute compliance with such reporting

    requirements in section 4s(f). The reporting rules set forth in this

    release consist of cross-references to the reporting requirements in

    the rules relating to the reporting of swaps to an SDR and the real-

    time public reporting of swap transaction data. Accordingly, the

    Commission has considered the costs and benefits of reporting swap data

    to an SDR and real-time public reporting in those final rulemakings;

    therefore, those costs and benefits are not addressed in this

    rulemaking.\86\

    ---------------------------------------------------------------------------

    \86\ See Swap Data Recordkeeping and Reporting Requirements, 77

    FR 2136 (Jan. 13, 2012); and Real-Time Public Reporting of Swap

    Transaction Data, 77 FR 1182 (Jan. 9, 2012).

    ---------------------------------------------------------------------------

    As discussed, in adhering to its mandate from Congress, where

    possible the Commission also has attempted to alleviate the burdens on

    affected entities. In this regard, the Commission sought to minimize

    recordkeeping costs by eliminating the requirement that daily trading

    records of swaps and related cash and forward transactions be

    maintained as a separate electronic file.

    Based on the available data, the Commission has been unable to

    reliably quantify the cost of compliance with the recordkeeping

    rules.\87\ Although the rules were adapted from existing recordkeeping

    regulations from a variety of sources including the Commission's

    regulations and those of the SEC, such regulations have evolved over

    time and reliable quantitative data is generally not available

    regarding the costs of compliance with such requirements. A 1998

    adopting release for the SEC's rules for OTC derivatives dealers

    [[Page 20172]]

    (including recordkeeping rules) cited commenters estimates in a range

    from $75,000 to $500,000 per year. Although dated, these SEC estimates

    provide a measure from which to very roughly attempt to gauge

    compliance costs.\88\ Moreover, because financial entities that will

    likely be required to register as SDs are currently subject to

    prudential regulation or other form of regulatory oversight, the

    Commission believes they will already have some form of recordkeeping

    policies and procedures in place.

    ---------------------------------------------------------------------------

    \87\ To better inform this assessment, the Commission has

    conducted a review of applicable academic literature, but found no

    research reports or studies that are directly relevant to its

    considerations of costs and benefits of these final rules.

    \88\ See OTC Derivatives Dealers, 63 FR 59362, 59391 (Nov. 3,

    1998).

    ---------------------------------------------------------------------------

    In contrast, the Commission anticipates that entities that are not

    subject to prudential regulation may incur greater costs to develop the

    infrastructure to comply with these recordkeeping requirements. In this

    respect, one commenter presented a report prepared by National Economic

    Research Associates, Inc. (NERA) stating that (1) compliance by certain

    entities with the proposed requirement that SDs and MSPs retain instant

    messages and tie them to transaction identifiers would entail average

    initial retention costs of $464,000 and average incremental ongoing

    annual costs of $228,000; (2) that the retention of phone calls would

    entail an average initial investment of $649,000 with additional annual

    costs of $382,000; and (3) that the requirement to time stamp

    transactions and use unique identifiers for transactions would entail

    average initial setup costs of $2,800,000 and average annual costs of

    $302,000.\89\ The Commission notes that the required use of unique

    identifiers is the subject of another rulemaking not adopted in this

    release.

    ---------------------------------------------------------------------------

    \89\ NERA, Cost-Benefit Analysis of the CFTC's Proposed Swap

    Dealer Definition Prepared for the Working Group of Commercial

    Energy Firms, December 20, 2011. In this late-filed comment

    supplement, NERA concludes that cost-benefit considerations compel

    excluding entities ``engaged in production, physical distribution or

    marketing of natural gas, power, or oil that also engage in active

    trading of energy derivatives''--termed ``nonfinancial energy

    companies'' in the report--from regulation as SDs, including these

    recordkeeping and reporting rules.

    ---------------------------------------------------------------------------

    Certain of the costs associated with these recordkeeping rules

    result from collections of information subject to the Paperwork

    Reduction Act. Costs attributable to collections of information subject

    to the PRA are discussed further in section V.B.1. below. The

    Commission has also considered these costs, which it incorporates by

    reference herein, in its section 15(a) analysis.

    Benefits

    The Commission believes these recordkeeping requirements will

    contribute to important, though unquantifiable, benefits intended by

    the Dodd-Frank Act. More specifically, complete, rigorous transactional

    recordkeeping promotes both external and internal risk management by

    providing an audit trail of past transactions. A strong audit trail, in

    turn generates a number of benefits, including the following:

    It facilitates a firm's ability to recognize and manage

    its risk, thereby enhancing the risk management of the market as a

    whole.

    It acts as a disincentive to engage in unduly risky or

    injurious conduct in that the conduct will be traceable.

    In the event such conduct does occur, it provides a

    mechanism for policing such conduct, both internally as part of a

    firm's compliance efforts and externally by regulators.

    It provides a basis for efficiently resolving

    transactional disputes.

    And, it supports SDR reporting in that it provides a

    backstop to confirm the accuracy of reported information.

    Section 15(a) Determination

    1. Protection of Market Participants and the Public

    The Commission believes that, by generating the benefits identified

    above, these rules provide important protections to swap market

    participants and the public. The recordkeeping requirements: (1)

    Promote the ability of SDs and MSPs to manage their risks through

    accurate and timely recordkeeping; (2) create disincentives for

    conduct, such as rogue trading, that could be injurious to the firm (as

    well as the market generally) by requiring a comprehensive audit trail;

    (3) support internal compliance efforts by requiring that complaints

    and other pertinent documents be retained; and (4) facilitate

    resolution of trade disputes. Public protection also is enhanced in

    that effective comprehensive, internal risk management improves risk

    management for the market as a whole. Moreover, the rules serve as an

    important link in the risk reduction chain envisioned by Congress in

    enacting the Dodd-Frank Act. Working in concert with other Dodd-Frank

    Act requirements, these rules further the goal of avoiding market

    disruptions and the resulting financial losses to market participants

    and the general public.

    The Commission believes that any incremental costs of the final

    rules over those necessitated by the statutory baseline of sections

    4s(f) and (g) of the CEA do not hinder the goal of effective protection

    of market participants and the public. Because some basic level of

    recordkeeping is fundamental to any financial undertaking, the

    Commission assumes that all likely SDs and MSPs currently keep records

    of some sort for their own internal control purposes. Therefore, the

    incremental costs of complying with the specific requirements of the

    Commission's final rules are unlikely to lead SDs or MSPs to withdraw

    from the market or cause SDs and MSPs to make investments in updating

    recordkeeping systems that would otherwise be directed to activities

    that increase protection of market participants or the public.

    2. Efficiency, Competitiveness, and Financial Integrity of Markets \90\

    ---------------------------------------------------------------------------

    \90\ Although by its terms CEA section 15(a)(2)(B) applies to

    futures markets only, the Commission finds this factor useful in

    analyzing regulations pertaining to swaps markets as well.

    ---------------------------------------------------------------------------

    Accurate recordkeeping is foundational to sound risk management and

    the financial integrity of SDs and MSPs, which impacts the financial

    integrity of markets. As illustrated by the collapse of firms during

    the 2008 financial crisis, poor recordkeeping can substantially impair

    resolution of customer claims.\91\ Additionally, the recordkeeping

    rules will enhance the financial integrity of the markets by ensuring

    that swap transactions, especially those that are bilaterally executed

    and require the exchange of margin, are documented and recorded in a

    prompt and accurate manner. Market efficiency and competitiveness is

    benefited by accurate and timely recordkeeping and the creation of a

    complete audit trail to the extent that those requirements facilitate

    Commission's enforcement actions against market manipulation and other

    market abuses.

    ---------------------------------------------------------------------------

    \91\ See In re Lehman Brothers Holdings Inc., 08-13555, and

    Giddens v. Barclays Capital Inc., 09-01732, U.S. Bankruptcy Court,

    Southern District of New York; see also Lehman Derivatives Records a

    ``Mess,'' Barclays Executive Says, available at http://www.bloomberg.com/news/2010-08-30/lehman-derivatives-records-a-mess-barclays-executive-says.html (reporting on testimony provided in

    previously cited Lehman bankruptcy proceeding).

    ---------------------------------------------------------------------------

    On the other hand, compliance with the rules is likely to require

    investment in recordkeeping, storage, and other back office systems;

    investment costs that otherwise could be used to enhance the efficiency

    and competitiveness of front office trading operations. For example,

    the telephonic recording systems that are required for recording oral

    communications may introduce new costs for SDs and MSPs that those

    [[Page 20173]]

    entities would prefer to avoid in favor of enhancing trading

    operations.

    3. Price Discovery

    The Commission has identified no likely material impact on price

    discovery from the costs and benefits of these recordkeeping rules.

    4. Sound Risk Management

    The Commission believes that proper recordkeeping--though likely to

    require initial investment in recordkeeping and other back office

    systems--is essential to risk management because it facilitates an

    entity's awareness of its transactions, positions, trading activity,

    internal operations, and any complaints made against it, among other

    things. Such awareness supports sound internal risk management policies

    and procedures by ensuring that decision-makers within SDs and MSPs are

    fully informed about the entity's activities and can take steps to

    mitigate and address significant risks faced by the firm. When

    individual market participants engage in sound risk management

    practices, the entire market benefits. Accordingly, the Commission

    believes that these final rules, notwithstanding potential costs

    identified above, will promote the public interest in sound risk

    management.

    5. Other Public Interest Considerations

    The Commission has not identified any other public interest

    considerations that could be impacted by these recordkeeping and

    reporting obligations for SDs and MSPs.

    E. Duties and Risk Management Requirements of Swap Dealers and Major

    Swap Participants

    As part of an overall business conduct regime for SDs and MSPs,

    section 4s(j) of the CEA, as added by section 731 of the Dodd-Frank

    Act, sets forth certain duties for SDs and MSPs. In its Duties NPRM,

    the Commission proposed six regulations to implement section 4s(j),

    specifically addressing risk management, monitoring of positions

    limits, diligent supervision, business continuity and disaster

    recovery, the availability of general information, and antitrust

    considerations. The Commission's proposed conflicts-of-interest

    policies and procedures were the subject of the separate SD/MSP

    Conflicts NPRM.

    As described in detail in the preamble, the Commission in preparing

    these final rules sought and incorporated comment from the public. The

    Commission received 20 comment letters on the Duties NPRM, and

    considered each in formulating the final rules. Of the 20, eight

    comments addressed issues relevant to the costs and benefits of the

    proposed rules, but only two provided any quantitative data to support

    their claims. The comments focused on seven areas of the rules that are

    most relevant to the Commission's consideration of costs and benefits.

    Each of these areas is discussed below. A more detailed discussion of

    the Commission's policy decisions can be found in sections II.F-L.

    above.

    1. Scope of Risk Management Program

    The proposed regulations required SDs and MSPs to establish,

    document, maintain, and enforce a system of risk management policies

    and procedures designed to monitor and manage the risks associated with

    the business of the SD or MSP. The Working Group, MetLife, and the

    Office of the Comptroller of the Currency, argued in favor of limiting

    Sec. 23.600 to the risks associated with swaps activities, and not

    other business lines in which an entity may engage.\92\ The Commission

    agrees with the commenters that its regulatory purpose is the

    management of the risk associated with SDs' and MSPs' swaps activities,

    not risks from their non-swaps activities, and is modifying the rule as

    they proposed. That is, the Commission is including a new definition of

    ``swaps activities'' in the final regulations and thus limiting the

    scope of several requirements. Clearly delimiting the activities of

    registrants subject to the rule in this way reduces the compliance

    burden of Sec. 23.600.

    ---------------------------------------------------------------------------

    \92\ Although not expressly stated by these commenters, the

    Commission presumes that burden concerns motivate their limitation

    requests, at least in part.

    ---------------------------------------------------------------------------

    The Commission, however, declines to adopt The Working Group's

    recommendation that the rule be limited further with respect to

    affiliates and consolidated entity risk management.\93\ The Commission

    believes that considering the risks posed by affiliates is part of

    ``robust and professional'' risk management as required by section

    4s(j), and provides a benefit to the registrant, its counterparties,

    and the swap market in the form of increased security and stability of

    the registrant. In the Commission's view, it is not unreasonably

    burdensome to require management of risk posed by affiliates--whether

    in the form of inter-affiliate transactions or otherwise--given their

    potential to be of the same kind and magnitude as risks posed by other

    swap counterparties. Likewise, the benefit of increased security and

    stability results from integrating the registrant's risk management

    program with risk management at the consolidated entity level, if

    applicable, where a top level company may be in the best position to

    evaluate risk due to its organization-wide view. Again, in light of

    this benefit, the Commission does not believe integration of an SD's or

    MSP's Risk Management Program into overall risk management at the

    consolidated entity level would be unduly burdensome.

    ---------------------------------------------------------------------------

    \93\ More specifically, The Working Group recommended that the

    rule be revised to require the risk management program to take into

    account only swaps-related risks posed by affiliates and take an

    integrated approach to risk management at the consolidated entity

    level only to the extent the SD or MSP deems necessary to enable

    effective risk and compliance oversight. Presumably, The Working

    Group recommended these alternatives out of an unexpressed concern

    for increased costs necessitated by monitoring and managing other

    risks posed by affiliates or being required to take an integrated

    approach to risk management; it did not quantify these however.

    ---------------------------------------------------------------------------

    2. Risks Covered by the Risk Management Program

    The proposed regulation required a registrant's risk management

    program to include certain enumerated elements: Identification of risks

    and risk tolerance limits; periodic risk exposure reports; a new

    product policy; policies and procedures to monitor and manage market

    risk, credit risk, liquidity risk, foreign currency risk, legal risk,

    and operational risk; use of central counterparties; compliance with

    margin and capital requirements; monitoring of compliance with risk

    management program; and approval of trading policies and monitoring of

    traders.

    In response to comments received, the Commission is modifying the

    rule in several respects as discussed specifically below. The

    Commission believes that each of these changes will reduce the

    compliance burden on SDs and MSPs. More generally, the Commission

    believes the rules allow registrants to manage their costs by relying

    upon existing compliance or risk management capabilities to a large

    extent.\94\ In this respect, the rules generally only require

    ``policies and procedures'' to monitor and manage the enumerated risks,

    but do not prescribe the content of such policies and procedures or

    require any specific control systems.

    ---------------------------------------------------------------------------

    \94\ Comments of The Working Group, SIFMA, EEI, and MetLife,

    each of whom suggested that proposed Sec. 23.600 be flexible enough

    to allow firms to adapt their existing compliance and risk

    management measures, and not cause firms to add entirely new

    compliance or risk management infrastructure.

    ---------------------------------------------------------------------------

    Risk Tolerance Limits: With respect to risk tolerance limit

    exceptions, the

    [[Page 20174]]

    Commission agrees with commenters \95\ that requiring approval by risk

    management personnel would be more costly without materially enhancing

    benefits than allowing SDs and MSPs the flexibility to structure their

    approval process in accordance with written policies and procedures.

    Accordingly, the Commission has modified the rule to reflect this

    approach.

    ---------------------------------------------------------------------------

    \95\ With respect to exceptions to risk tolerance limits, SIFMA

    recommended that trading supervisors, rather than risk management

    personnel, should have the authority to approve risk tolerance limit

    exceptions because the quarterly risk exposure reports provided to a

    registrant's senior management and governing body are an adequate

    check on decision-making by trading supervisors. Presumably, SIFMA

    believes trading supervisor approval presents less costs than risk

    management unit approval.

    ---------------------------------------------------------------------------

    New Product Policy Requirement: Concerning the new product policy

    requirement, the Commission notes that the rule was adapted from

    existing regulatory guidance in this area,\96\ and thus believes some

    SDs and MSPs already have such a policy in place; for them, the

    requirement would not impose any new burden. The Commission rejects the

    more limited alternative approach recommended by the Working Group--

    i.e., that before offering a new product an SD or MSP need only conduct

    due diligence that is commensurate with the risks associated with a new

    product, and receive approval from appropriate risk management and

    business unit personnel within the firm. While The Working Group's

    recommended approach may be less costly for some unspecified number of

    registrants that to date have not implemented a new product policy in

    line with the proposed rule and existing regulatory guidance, the

    Commission believes that the benefits to SDs, MSPs, and financial

    markets of greater scrutiny for new products, which may entail degrees

    of risk that are not initially evident, are sufficient to adopt the

    rule substantially as proposed. However, the Commission believes that

    SIFMA's recommended alternative--allowing approval of new products on a

    contingent or preliminary limited-time basis at a non-material risk

    level for the registrant to gain product experience and develop

    appropriate risk management processes for the product--better addresses

    the unforeseen risk potential. Accordingly, the Commission considers

    SIFMA's proposed alternative preferable on cost/benefit grounds to the

    rule as proposed and has modified the rule in line with it.

    ---------------------------------------------------------------------------

    \96\ See OCC's Comptroller's Handbook, Risk Management of

    Financial Derivatives at 7 (Jan. 1997); Federal Reserve Board's

    Trading and Capital-Markets Activities Manual.

    ---------------------------------------------------------------------------

    Reconciliation of Profits and Losses to the General Ledger: The

    Commission has responded to commenters that objected to the burden of

    daily reconciliation by modifying the rule to require periodic, rather

    than daily, reconciliation. The Commission believes this modification,

    increases the flexibility available to registrants to design cost-

    effective procedures best suited to their own circumstances.

    Assessing Liquidity of Non-Cash Collateral: With respect to

    assessing liquidity of non-cash collateral, the Commission agrees with

    commenters that testing by simulated disposition presented an

    unnecessary cost to SDs and MSPs \97\ and has adjusted the final rule

    to provide flexibility for registrants to design procedures to fit

    their own circumstances.

    ---------------------------------------------------------------------------

    \97\ SIFMA recommended that the Commission not require testing

    of liquidation procedures by simulated disposition, but only require

    policies and procedures for identifying acceptable collateral and

    establishing appropriate haircuts, taking into account reasonably

    anticipatable adverse price movements, arguing that simulated

    disposition could be costly during periods of market stress.

    ---------------------------------------------------------------------------

    Foreign Currency Risk: With respect to foreign currency risk,

    rather than mandating daily measurement, The Working Group recommended

    relaxing the rule to allow firms discretion with respect to how

    frequently capital exposed to fluctuations in the value of foreign

    currency needs to be measured. The Commission is rejecting The Working

    Group's recommendation because daily measurement is necessary for

    effective prudent risk management because the foreign currency markets

    are fluid, quick moving, and potentially volatile. Given the wide

    availability of foreign currency pricing information at a low cost, the

    Commission does not believe that the cost of daily measurement is

    unduly burdensome in light of the benefit of consistent management of

    foreign currency risk.

    Monitoring of Trading Requirements: Concerning the monitoring of

    trading requirements, the Commission agrees with commenters that the

    proposed rule's requirement that traders be monitored to prevent the

    incurrence of ``undue risk'' is vague and thus potentially burdensome

    to implement. To add clarity, the Commission is revising the rule to

    require monitoring of trading to prevent the incurrence of

    ``unauthorized risk.'' \98\

    ---------------------------------------------------------------------------

    \98\ The Working Group and SIFMA requested that the Commission

    remove the requirement that firms monitor traders to prevent traders

    from ``incurring undue risk'' because the meaning of the phrase is

    ambiguous and presumably more costly to monitor under such standard.

    ---------------------------------------------------------------------------

    The Commission also agrees with The Working Group's recommendation

    that the proposed rule be modified to add a materiality standard for

    reporting of trade discrepancies to management. Accordingly, the

    Commission is modifying the rule to require that only trade

    discrepancies that are not immaterial, clerical errors be brought to

    the immediate attention of management of the business trading unit.

    Use of Brokers: The Commission agrees with commenters recommending

    against tasking the risk management unit with reviewing brokers'

    statements, monitoring commissions or initiating broker payments;

    allowing these functions to be handled by operations or other control

    units, and presumably lowering the cost of compliance. The Commission

    has narrowed the rule to require risk management units to periodically

    audit brokers' statements and payments only. The Commission believes

    that this modification retains the benefits of the rule (independent

    oversight of the use of brokers), while lowering the cost of compliance

    by not requiring modifications to current operations.

    3. Risk Exposure Reports

    Proposed Sec. 23.600(c)(2)(ii) required SDs and MSPs to provide

    their senior management and governing body with quarterly Risk Exposure

    Reports detailing the registrant's risk exposure and any

    recommendations for changes to the risk management program. Copies of

    these reports were required to be furnished to the Commission within

    five business days of providing them to senior management. The Working

    Group and Cargill suggested as an alternative that SDs' and MSPs'

    periodic Risk Exposure Reports be required only annually and submitted

    to the Commission only upon request. They argued that quarterly reports

    will be costly, distract risk management personnel from their primary

    responsibilities, and tax Commission resources to review reports that

    frequently. The Commission is declining to modify the rule as suggested

    because, as recent events have shown, it is important that financial

    firm management have frequent information about the risk exposures

    faced. This affords prompt corrective action important to maintain

    financial stability. The potential costs of instability in the

    financial markets have been exhibited in a number of recent failures of

    major financial institutions, such as Long Term Capital Management,

    Bear Stearns, Lehman Brothers, and others. The Commission believes that

    any incremental additional burden of providing Risk Exposure Reports on

    a quarterly rather than annual basis is not

    [[Page 20175]]

    significant and is warranted by the benefit of Commission oversight and

    early risk detection capability.

    4. Frequency of Risk Management Program Testing

    Proposed Sec. 23.600(e) required SDs and MSPs to review and test

    their risk management programs quarterly using internal or external

    auditors independent of the business trading unit. As explained in more

    detail below, commenters objected to the costs of quarterly risk

    management program testing required by the rule. The Commission is

    modifying proposed Sec. 23.600(e) to require only annual testing and

    audit of an SD's or MSP's risk management program, having been

    persuaded by the comments of The Working Group, Cargill, and MetLife,

    each of which recommended that both the frequency and the scope of

    audits of the risk management program be left to the discretion of the

    registrant so long as such audits are effective and are conducted at

    least annually. The Working Group and Cargill argued that this regime

    would provide the desired results without the unnecessary cost and

    administrative burden imposed by the proposed rules. The Commission

    agrees that the regulatory purpose of periodic testing will be met by

    annual testing. In order to further lessen the burden on SDs and MSPs,

    the Commission has determined not to specify testing procedures at this

    time, but to leave the design and implementation of testing procedures

    to the reasonable judgment of each registrant based on their own

    circumstances.

    5. Monitoring of Position Limits

    Proposed Sec. 23.601 required SDs and MSPs to establish policies

    and procedures to monitor, detect, and prevent violations of applicable

    position limits established by the Commission, a designated contract

    market (DCM), or a swap execution facility (SEF), and to monitor for

    and prevent improper reliance upon any exemptions or exclusions from

    such position limits.

    One commenter presented a report prepared by NERA stating that

    compliance with proposed Sec. 23.601 for certain entities would entail

    average incremental start-up costs of $245,000 and average incremental

    ongoing annual costs of $228,000.\99\ The Commission observes that the

    incremental average costs provided by NERA do not differentiate between

    the costs of compliance with proposed Sec. 23.601 and the costs of

    compliance with section 4s(j)(1) of the CEA, which requires each SD and

    MSP to ``monitor its trading in swaps to prevent violations of

    applicable position limits.'' Accordingly, the Commission believes that

    the cost estimates presented by NERA exceed the incremental costs

    attributable to Commission rulemaking. The NERA report, however,

    provides insufficient information to allow the Commission to assess the

    magnitude of the excess.

    ---------------------------------------------------------------------------

    \99\ NERA Economic Consulting, Cost-Benefit Analysis of the

    CFTC's Proposed Swap Dealer Definition Prepared for the Working

    Group of Commercial Energy Firms, December 20, 2011. In this late-

    filed comment supplement, NERA argues that cost-benefit

    considerations compel excluding entities ``engaged in production,

    physical distribution or marketing of natural gas, power, or oil

    that also engage in active trading of energy derivatives''--termed

    ``nonfinancial energy companies'' in the report--from regulation as

    swap dealers, including Sec. 23.601.

    ---------------------------------------------------------------------------

    As discussed in more detail below, the Commission has also

    quantified certain costs of a monitoring regime based on the assumption

    that a firm could choose to implement a particular monitoring regime

    from a wide range of compliance systems, based on the specific,

    individual needs of the firm. Several other commenters requested that

    the rule be modified to lessen the cost burden on registrants.\100\ The

    Commission is reducing the burden on SDs and MSPs by modifying the rule

    as follows: (1) Require policies and procedures reasonably designed to

    monitor for and prevent violations of applicable position limits; (2)

    require only notification to relevant personnel of changes to

    applicable position limits (rather than training); (3) except on-

    exchange violations of position limits from the Commission reporting

    requirement; (4) require testing of position limit procedures only if

    the registrant has transactions in instruments for which position

    limits have been established; and (5) require testing of position limit

    procedures quarterly (rather than monthly).

    ---------------------------------------------------------------------------

    \100\ SIFMA recommended that testing of Position Limit

    Procedures be required only annually and not be required to be done

    all at the same time, The Working Group recommended that testing

    only be required on a semi-annual basis, and MetLife requested that

    the Commission permit the frequency of testing to be determined by

    an MSP based on the extent of its swap activities. MetLife also

    recommended that there be a clear exemption from testing

    requirements for MSPs that do not trade in swaps for which position

    limits have been established. BGA recommended that the Commission

    clarify that as long as an SD or MSP provides training on the

    position limits and establishes and enforces policies for

    monitoring, detecting, and curing violations, they will have met the

    obligation to ``prevent violations.'' SIFMA recommended that the

    Commission revise Sec. 23.601(c) to provide that a change in

    position limit levels will not trigger ``training,'' but only

    require effective notification. The Working Group and MetLife

    recommended that the Commission require alerting the governing body

    only when a violation is material. The Working Group argued that the

    reporting of on-exchange violations of position limits to the

    Commission is already done by DCMs and will likely be the

    responsibility of SEFs as well, so SDs and MSPs should not be

    required to report on-exchange violations.

    ---------------------------------------------------------------------------

    With respect to quarterly reporting of compliance with position

    limits to the chief compliance officer, senior management, and

    governing body under proposed Sec. 23.601(g), The Working Group

    recommended that the proposed rule should be revised to require only

    annual reports to the entity's senior management and governing body,

    but did not quantify the cost burden of quarterly reporting. The

    Commission recognizes that generating such reports will entail costs in

    the form of preparing and transmitting the reports as required by the

    rule, but is unable to quantify the cost because the reports will vary

    greatly depending on the trading volume of individual SDs and MSPs in

    products for which position limits have been established. As discussed

    above with respect to Risk Exposure Reports, the Commission believes

    that the benefit of such reporting will be timely notification to

    decision makers within the SD and MSP of the entity's record of

    compliance with applicable position limits, thus providing a timely

    opportunity to adjust or revise Position Limit Procedures to prevent

    future violations, if necessary, and avoiding the costs to the public

    of excessive speculation.

    6. Diligent Supervision

    Proposed Sec. 23.602 required SDs and MSPs to: (1) Establish a

    system to supervise all activities relating to its business performed

    by its partners, members, officers, employees, and agents; (2) have

    that system be reasonably designed to achieve compliance with the CEA

    and Commission regulations; (3) have that system designate a person

    with authority to carry out the supervisory responsibilities of the SD

    or MSP; and (4) have all such supervisors meet qualification standards

    that the Commission finds necessary or appropriate.

    The benefits of diligent supervision result from increased

    compliance with the regulatory standards of the CEA and the rules of

    the Commission. The standards that SDs and MSPs follow (or fail to

    follow) in transacting their swaps may have repercussions for financial

    system stability more broadly. Effective systemic risk management for

    swaps depends upon effective internal risk management protocols of

    individual SDs and MSPs and effective internal risk management in turn

    depends not

    [[Page 20176]]

    just on appropriate policies and procedures, but on diligent

    supervision by the registrant to ensure that such policies and

    procedures are actually followed.

    No commenters provided quantitative data on the cost of complying

    with the diligent supervision rule, but several commenters requested

    changes to the rule to lessen the compliance costs of SDs and MSPs.

    The Working Group recommended that the Commission not require

    designation of a single individual with responsibility for supervision.

    The Commission considered whether permitting SDs and MSPs to designate

    more than a single individual for supervisory responsibilities would

    lessen the benefits of the rule and determined that it would not.

    Accordingly, the Commission is modifying the rule to require SDs and

    MSPs to designate ``at least one person'' (rather than ``a person'')

    with authority to carry out supervisory responsibilities.

    The Working Group also recommended that SDs and MSPs be given

    discretion to determine supervisor qualifications, presumably because

    such a standard would entail fewer compliance costs then the standard

    proposed (i.e., ``training, experience, competence, and such other

    qualification standards as the Commission finds necessary or

    appropriate''). The Commission considered whether the benefits of the

    rule could be maintained with this change, and determined they could

    not. Accordingly, the Commission is declining to modify the rule on

    this point because it believes that full accountability for compliance

    with the CEA and Commission regulations is best served by requiring

    designation of individuals with objective qualifications.

    7. Business Continuity and Disaster Recovery

    Proposed Sec. 23.603 required SDs and MSPs to establish a business

    continuity and disaster recovery plan that includes procedures for and

    the maintenance of back-up facilities, systems, infrastructure,

    personnel, and other resources to achieve the timely recovery of data

    and documentation and to resume operations generally within the next

    business day. The proposed regulations also required SDs and MSPs to

    have their business continuity and disaster recovery plan tested

    annually by qualified, independent internal audit personnel or a

    qualified third party audit service. The Commission believes that all

    SDs and MSPs may be critically important to the proper functioning of

    the swaps market. SDs are critical participants in the swaps market and

    MSPs may have counterparty exposures that could have serious adverse

    effects on the financial stability of the United States. Therefore, the

    Commission believes the benefit of the rule is that it ensures, to the

    extent practicable, that system failures or natural disaster will not

    stop the proper functioning of the swaps market for more the one

    business day.

    With respect to costs, the Commission again believes that it is not

    possible to reasonably quantify the industry-wide costs of a business

    continuity and disaster recovery program for SDs and MSPs because such

    costs necessarily flow from the size of the SD or MSP and the scope of

    activities in which it engages. One commenter stated that most SDs have

    the technology and network infrastructure in place to achieve a next

    day recovery time objective, reducing the incremental costs of

    compliance for these registrants. But the commenter also believes that

    some MSPs may have to develop and implement a plan from scratch. The

    commenter estimates that it would take up to 200 personnel days for

    MSPs to comply with this requirement. Thus, at eight hours a day and

    $100 per hour,\101\ the upper end of personnel costs related to

    implementation for an MSP would be $160,000. In response, the

    Commission is lengthening the time for compliance to one year from the

    publication date of the final rule in the Federal Register for

    registrants that have not been previously regulated by a U.S.

    prudential regulator and are not SEC registrants. No other commenter

    provided cost estimates of compliance with the rule. Nevertheless,

    several commenters requested changes to the rule to reduce the cost of

    compliance.\102\

    ---------------------------------------------------------------------------

    \101\ See section V.B. below for a discussion of the

    Commission's use of this hourly wage rate.

    \102\ The Working Group argued that the Commission should not

    require next business day recovery for non-systemically important

    SDs or MSPs, but should only require recovery ``reasonably

    promptly.'' The Working Group also argued that the Commission should

    not require staffing of back-up facilities to avoid the burden of

    requiring two persons for the same job, and recommended that the

    Commission should not require annual testing of the business

    continuity and disaster recovery plan by independent auditors

    because independent audits would be too costly.

    ---------------------------------------------------------------------------

    To further reduce the compliance burden, the Commission is

    additionally modifying the rule as follows: (1) Requiring procedures

    for alternative staffing (rather than back-up personnel); (2) requiring

    annual testing (rather than auditing); and (3) requiring auditing only

    once every three years. The Commission believes that these changes will

    lower compliance costs without reducing benefits.

    Finally, SIFMA recommended that the Commission clarify that an SD's

    or MSP's business continuity and disaster recovery plan may be part of

    a consolidated plan established for the various entities in a holding

    company group. The Commission confirmed this could be the case.

    Costs

    Section 4s(j) of the CEA imposes certain duties and risk management

    requirements on SDs and MSPs. The costs and benefits that necessarily

    result from these basic statutory requirements are considered to be the

    ``baseline'' against which the costs and benefits of the Commission's

    final rules are compared or measured. The ``baseline'' level of costs

    includes the costs that result from the following activities required

    by the statute:

    Monitoring of trading in swaps to prevent violations of

    applicable position limits;

    Establishing robust and professional risk management

    systems;

    Disclosing to the Commission and applicable prudential

    regulators general information related to swaps and establishing

    internal systems and procedures to provide such information;

    Foregoing any process or action that results in any

    unreasonable restraint of trade, or impose any material anticompetitive

    burden on trading and clearing.

    Compliance with the statutory baseline alone would result in costs

    for SDs and MSPs. For example, the requirement to monitor trading in

    swaps to prevent violations of applicable position limits would include

    the cost of designing and implementing monitoring procedures.

    Similarly, compliance with the statutory provisions would require

    establishment of robust and professional risk management policies and

    procedures.

    Congress mandated that the Commission adopt rules to implement each

    of the statutory provisions. With regard to its implementation

    decisions, the Commission has determined the following to be costs to

    SDs and MSPs to comply with the final regulations regarding duties and

    risk management:

    Compiling and reporting certain risk assessment reports;

    Establishing, implementing, testing, and reviewing risk

    management policies and procedures;

    Auditing of policies and procedures;

    Ensuring the monitoring of traders and of applicable

    position limits;

    [[Page 20177]]

    Implementing diligent supervision policies and procedures;

    and

    Implementing, testing, and reviewing business continuity

    and disaster recovery policies and procedures.

    In adhering to its mandate from Congress, where possible the

    Commission has attempted to alleviate the burdens on affected entities.

    The Commission has modified the definition of ``governing body'' to

    provide additional flexibility and potentially eliminate the need for

    some registrants to change their current internal governance

    structures, thereby reducing compliance costs. The Commission has

    clarified that the requirements for a risk management program are

    confined to ``swaps activities'' of registrants, rather than the ``day-

    to-day business'' of the registrant, thereby avoiding the potential

    burden associated with an SD's or MSP's need to extend the program to

    any non-swaps business lines. In addition, risk management policies and

    procedures are required to be provided to the Commission only upon

    request, rather than upon any material change, reducing the reporting

    burden on registrants.

    Risk management unit personnel are permitted to fulfill other

    duties. This should provide cost-lowering flexibility and potentially

    eliminate the need for some registrants to change current practices

    dramatically. The Commission also will permit limited preliminary

    approval for new products for testing purposes, reducing the necessary

    time and burden of new product analysis. Pricing models may be

    validated by internal personnel, eliminating the burden of hiring an

    external auditor to validate potentially valuable proprietary

    information. The requirement to reconcile profits and losses to the

    general ledger on a daily basis has been removed. Entities may perform

    an assessment of collateral liquidation procedures, instead of

    performing a potentially time-intensive and expensive test.

    The proposed quarterly testing of risk management programs and

    position limit procedures has been reduced to annual testing to reduce

    costs. The proposed monthly testing of position limit procedures has

    been reduced to quarterly testing. To reduce the burden on senior

    management, only material trade discrepancies are required to be

    brought to senior management. The proposed employee training on

    position limits change has been modified to a notice requirement.

    Position limit violations that occur ``on-exchange'' are no longer

    required to be reported to the Commission by registrants, as the

    exchange will notify the Commission. Finally, business continuity and

    disaster recovery plans are required to be audited triennially (not

    annually, as proposed).

    With respect to quantifying the cost of compliance with the final

    rules, one commenter stated that the cost of implementing a

    comprehensive risk management program will be substantial. The

    commenter analogizes the cost to the cost of implementing a compliance

    program and cites FERC administrative proceedings that required

    implementation of compliance programs at a cost of $1,000,000 to

    $2,000,000. The same commenter also estimates that a required audit of

    the risk management program would cost $24,000 per audit ($96,000

    annually). Another commenter stated that implementation of a business

    continuity and disaster recovery program could take up to 200 personnel

    days. At eight hours a day and $100 per hour,\103\ implementation

    personnel costs alone could thus cost a registrant $160,000. The

    Commission believes these estimates may be on the high end of the range

    of potential costs, given that some likely SDs are subject to

    prudential regulation or other form of regulatory oversight currently

    and will already have some form of risk management and business

    continuity program in place.\104\ By contrast, costs are expected to be

    higher for those entities not currently regulated or not currently

    implementing risk management policies and procedures. In this respect,

    one commenter presented a report prepared by NERA estimating that

    compliance with the proposed rules for some entities in this category

    would entail annual incremental costs of $224,000.\105\

    ---------------------------------------------------------------------------

    \103\ See section V.B. below for a discussion of the

    Commission's use of this wage rate.

    \104\ The Commission notes that in 2006 the UK FSA conducted a

    cost benefit analysis when promulgating requirements related to

    ensuring effective risk controls, including requirements for

    implementing effective policies and procedures to identify, manage,

    monitor, and report current and possible risks. The UK FSA was

    adopting rules that replaced existing guidance and concluded from

    survey results that the incremental aggregate cost of compliance for

    approximately 2000-2500 firms was [pound]10.5 to 14 million in one-

    off costs ($16.4 to 21.9 million at the current exchange rate, or

    $8,200 to $10,950 per firm) and [pound]7 to 9.2 million in ongoing

    costs ($10.9 to 14.4 million at the current exchange rate, or $5,450

    to $7,200 per firm). See FSA Consultation Paper 06/9, Organisational

    Systems and Controls: Common Platform for Firms, Annex 2 (May 2006).

    \105\ NERA, Cost-Benefit Analysis of the CFTC's Proposed Swap

    Dealer Definition Prepared for the Working Group of Commercial

    Energy Firms, December 20, 2011. In the late-filed comment

    supplement, NERA estimates these costs for entities ``engaged in

    production, physical distribution or marketing of natural gas,

    power, or oil that also engage in active trading of energy

    derivatives''--termed ``nonfinancial energy companies'' in the

    report. The figure cited includes costs to maintain a risk

    management program, quarterly audits of the program, and annual

    audits of swap trading relationship documentation, the last of which

    is required under a separate rulemaking proposal not being adopted

    in this release.

    ---------------------------------------------------------------------------

    The Commission also has estimated potential costs to implement a

    tracking and monitoring system for position limits; the Commission

    anticipates that a firm could choose to implement a monitoring regime

    from a wide range of potential compliance systems, based on the

    specific, individual needs of the firm.\106\ For example, a firm may

    elect to use an automatic software system, which may include high

    initial costs but lower long-term operational and labor costs.

    Conversely, a firm may decide to use a less capital-intensive system

    that requires more human labor to monitor positions. Thus, taking this

    range into account, the Commission anticipates, on average, labor costs

    per entity ranging from 40 to 1,000 annual labor hours, $5,000 to

    $100,000 in total annualized capital/start-up costs, and $1,000 to

    $20,000 in annual operating and maintenance costs.\107\ The Commission

    contrasts this estimate with that provided by one commenter stating

    that compliance with proposed Sec. 23.601 by non-financial energy

    companies would entail average incremental start-up costs of $245,000

    and average incremental ongoing annual costs of $228,000.\108\

    ---------------------------------------------------------------------------

    \106\ See Position Limits for Futures and Swaps, 76 FR 71626,

    71667 (Nov. 18, 2011).

    \107\ These costs would likely be lower for firms with positions

    far below the speculative limit, as those firms may not need

    comprehensive, real-time analysis of their swaps positions for

    position limit compliance to observe whether they are at or near the

    limit. Costs may be higher for firms with very large or very complex

    positions, as those firms may need comprehensive, real-time analysis

    for compliance purposes. Due to the variation in both number of

    positions held and degree of sophistication in existing risk

    management systems, it is not feasible for the Commission to provide

    a greater degree of specificity as to the particularized costs for

    SDs and MSPs.

    \108\ NERA, Cost-Benefit Analysis of the CFTC's Proposed Swap

    Dealer Definition Prepared for the Working Group of Commercial

    Energy Firms, December 20, 2011. See also text accompanying note 103

    for a discussion of these figures.

    ---------------------------------------------------------------------------

    Other than as indicated with respect to monitoring for position

    limits, the limited cost data provided by commenters discussed above,

    and costs resulting from collections of information subject to the

    Paperwork Reduction Act (incorporated by reference herein), the

    Commission has little or no reliable quantitative data from which to

    reasonably estimate the costs of compliance with the duties and risk-

    management rules.\109\ The

    [[Page 20178]]

    Commission's review of applicable academic literature yielded no

    research reports or studies directly relevant to its considerations of

    costs of the final rules. Moreover, because it largely refrained from

    establishing prescriptive requirements under Sec. 23.600--requiring

    certain policies and procedures while leaving their design and

    formulation to the discretion of each individual registrant--the

    Commission believes that many of the costs associated with the rules

    will be highly specific to each entity, and thus difficult to quantify

    for an individual firm or on an aggregated basis. Certain of the costs

    associated with these rules addressing duties and risk management

    requirements of SDs and MSPs result from collections of information

    subject to the Paperwork Reduction Act. Costs attributable to

    collections of information subject to the PRA are discussed further in

    section V.B.2. below. The Commission has also considered these costs,

    which it incorporates by reference herein, in its section 15(a)

    analysis.

    ---------------------------------------------------------------------------

    \109\ Although the rules were adapted from existing risk

    management guidance from a variety of sources including the Federal

    Reserve and the OCC, such guidance has been built up incrementally

    over a period of time and the overall costs of compliance with such

    guidance has not been quantified.

    ---------------------------------------------------------------------------

    Benefits

    The Commission believes that the central, driving role of SDs and

    MSPs in swaps markets--markets that can be systemically critical as

    recent events have shown--requires that SDs and MSPs give due regard

    to, and properly manage, the risks they incur as part of their day-to-

    day businesses. The impact of an SD or MSP default may be greater than

    the impact to the entity alone, and of potentially profound

    significance to the financial system broadly. Given this, the

    Commission believes these regulations prescribing internal risk

    management requirements better assure the protection of market

    participants and the public.

    In promulgating the regulations governing the duties of SDs and

    MSPs, the Commission has created a framework that requires proper

    internal oversight but also ensures that these participants retain the

    flexibility to comply in the manner best suited for their individual

    needs. While the Commission recognizes that the costs incurred by

    participants to comply with these regulations may be significant, the

    Commission also believes that the strength of critical market

    participants like SDs and MSPs is a vital component in the strength of

    the financial system as a whole. By requiring entities to monitor the

    risks arising from their operations actively and rigorously, the

    Commission believes that an entity's default risk will decrease

    substantially. Should an emergency situation--such as a natural

    disaster--occur, the largest derivatives market participants will have

    systems in place to resume full operation within one business day,

    mitigating the effects of a major crisis for the financial system as a

    whole. The Commission also recognizes that, given the systemic

    importance of these entities, ensuring proper risk management within

    SDs and MSPs helps to protect the public against major market

    disruptions and financial losses.

    In addition, the registrants will benefit from the required

    oversight of their internal operations. The required monitoring is

    designed to protect an entity from ``rogue'' or unauthorized trading.

    Further, the required monitoring of applicable position limits protects

    the entity from an unforeseen violation that could lead to, among other

    things, an enforcement action from an exchange or the Commission.

    Moreover, the regulations require identification and monitoring of

    several different kinds of risk, allowing entities to realize and

    correct potential issues before problems (and associated costs)

    escalate. Finally, the stability of any entity rests on its ability to

    manage the risks inherent in its business; by requiring stringent

    internal oversight, the Commission believes these regulations will aid

    in the growth and competitiveness of SDs and MSPs by ensuring the

    stability that flows from the most basic forms of risk management.

    Section 15(a) Determination

    1. Protection of Market Participants and the Public

    The Commission believes that requiring prudent risk management

    policies and procedures lessens the risk of market disruptions and

    financial losses that could greatly impact not only a particular SD or

    MSP, but also other market participants and the public at large. The

    Commission also believes that requiring entities to assess and monitor

    their level of risk, as well as the adequacy of their own risk

    management policies and procedures, helps to: (i) Protect the entity

    from undue impacts from unanticipated market events, (ii) ensure swift

    recovery after a disaster or other emergency, and (iii) promotes the

    stability of the entity. The business practices of SDs and MSPs are of

    critical importance to the integrity and stability of the derivatives

    markets; this makes proper oversight and risk mitigation essential to

    the well-being of the financial system.

    The Commission does not believe that the costs associated with

    these rules will have a detrimental effect on the protection of market

    participants or the public. It is possible that the costs associated

    with these rules will require that SDs and MSPs modify their business

    decisions in order to allocate more resources to risk management,

    monitoring traders, business continuity, and diligent supervision of

    personnel.

    2. Efficiency, Competitiveness, and Financial Integrity of Markets

    \110\

    ---------------------------------------------------------------------------

    \110\ Although by its terms section 15(a)(2)(B) of the CEA

    applies to futures markets only, the Commission finds this factor

    useful in analyzing regulations pertaining to swaps markets as well.

    The Commission has identified no impact to futures markets.

    ---------------------------------------------------------------------------

    The Commission believes that effective internal risk management and

    oversight helps protect the financial integrity of individual SDs and

    MSPs. Their financial integrity, in turn, promotes the financial

    integrity of derivatives markets by helping to foster confidence in the

    stability of the financial system. Further, the regulations are

    designed to ensure that SDs and MSPs can sustain their market

    operations and meet their financial obligations to market participants,

    further protecting the financial integrity of derivatives markets.

    Additionally, the Commission believes that these regulations, as

    carefully tailored to minimize costs beyond those required by the

    statute, will enhance the efficiency and competitiveness of markets to

    the extent that SDs and MSPs have sound risk management programs and

    proper monitoring of traders. Monitoring traders to ensure that they do

    not engage in manipulative or other disruptive market behaviors is

    crucial to the efficiency of markets.

    3. Price Discovery

    The Commission has identified no likely material impact on price

    discovery from the costs and benefits of these duties and risk

    management rules.

    4. Sound Risk Management

    The regulations go to the heart of sound risk management for key

    market participants and for the swaps market generally. The rules

    require SDs and MSPs to establish policies and procedures for: (i)

    Monitoring and managing traders and all risks associated with their

    swaps activities, including market, credit, liquidity, foreign

    currency, legal, and operational risk; (ii) business continuity

    planning, and (iii) diligent supervision. Such policies and procedures

    will ensure that the largest derivatives market

    [[Page 20179]]

    participants understand the risks associated with their swaps

    activities, take steps to mitigate those risks when appropriate, and

    are prepared for managing crisis situations. In essence, these rules

    create risk management benefits by working to prevent SDs and MSPs from

    having to default on their financial obligations, potentially

    threatening overall financial stability in the process.

    The costs associated with these rules will likely require that SDs

    and MSPs allocate more resources to risk management, monitoring

    traders, business continuity, and diligent supervision of personnel.

    The Commission does not foresee that the allocation of these additional

    resources will have a detrimental effect on sound risk management.

    5. Other Public Interest Considerations

    The Commission has not identified any other public interest

    considerations that could be impacted by these duties and risk

    management requirements for SDs and MSPs.

    F. Conflicts-of-Interest Policies and Procedures for SDs, MSPs, FCMs,

    and IBs

    Section 4s(j) of the CEA, as added by section 731 of the Dodd-Frank

    Act, sets forth certain duties for SDs and MSPs, including the duty to

    implement conflict-of-interest systems and procedures. Specifically,

    section 4s(j)(5) mandates that SDs and MSPs implement conflict-of-

    interest systems and procedures that establish safeguards to ensure

    that research activities and the provision of clearing services are

    separated by appropriate informational partitions from the review,

    pressure, or oversight of persons whose involvement in pricing,

    trading, or clearing activities might potentially bias their judgment

    or supervision. Section 4s(j)(5) further requires that such systems and

    procedures ``address such other issues as the Commission determines to

    be appropriate.'' The proposed regulations, as set forth in the SD/MSP

    Conflicts NPRM, addressed the statutory mandate of section 4s(j)(5).

    Similarly, section 732 of the Dodd-Frank Act amended section 4d of

    the CEA by creating a new subsection (c), which mandates that the

    Commission ``require that futures commission merchants and introducing

    brokers implement conflict-of-interest systems and procedures.'' New

    section 4d(c) mandates that such systems and procedures establish

    firewalls between research and trading or clearing. New section 4d(c)

    further requires that such systems and procedures ``address such other

    issues as the Commission determines to be appropriate.'' The proposed

    regulations, as set forth in the FCM/IB Conflicts NPRM, addressed the

    statutory mandate of section 4d(c).

    As described in detail in the preamble, the Commission, in

    preparing these final rules, sought and incorporated comment from the

    public. In the SD/MSP Conflicts NPRM and the FCM/IB Conflicts NPRM, the

    Commission requested comment on the Commission's consideration of costs

    and benefits and invited commenters to provide data quantifying the

    costs and benefits of the proposed regulations.\111\ The Commission

    received 29 comment letters to the SD/MSP Conflicts NPRM and 26 comment

    letters to the FCM/IB Conflicts NPRM. Many commenters provided comments

    addressing identical provisions or issues in both proposed rules. The

    Commission considered each in formulating the final rules, including

    any alternatives and cost concerns. Of the comment letters received, 21

    letters addressed issues relevant to the costs and benefits of the

    proposed rules, but no letters provided any quantitative data to

    support their claims.

    ---------------------------------------------------------------------------

    \111\ See SD/MSP Conflicts NPRM, 75 FR at 71395 and FCM/IB

    Conflicts NPRM, 75 FR at 70157.

    ---------------------------------------------------------------------------

    With regard to the conflicts provisions, the comment letters

    focused on 16 areas of the rule that are most relevant to the

    Commission's consideration of costs and benefits. Each of these areas

    is discussed below. A more detailed discussion can be found in section

    II.M. above.

    1. Compliance Oversight by SROs

    The Commission declines the recommendation of commenters \112\ to

    delegate conflicts of interest oversight to an SRO because sections

    4d(c) and 4s(j)(5) of the CEA direct the Commission exclusively to

    promulgate such rules. In this regard, the CEA differs from section 15D

    of the Securities Exchange Act of 1934, which mandates that conflict-

    of-interest rules be adopted either by the SEC or by an SRO. Therefore,

    the cost savings that the commenters asserted would result from the

    delegation of oversight and rulemaking authority to an SRO are in fact

    not an option that the Commission may consider under the statutory

    framework provided by the Congress.

    ---------------------------------------------------------------------------

    \112\ FIA, ISDA, SIFMA, and JP Morgan suggested that the

    Commission instruct an appropriate SRO to write detailed compliance

    requirements within a framework set forth by the Commission because

    SROs would be in a better position than the Commission to address

    the likely need for future amendments to the rule. The Commission

    presumes that the commenters believe that this alternative

    arrangement would streamline compliance requirements resulting in

    cost savings. The Commission notes, however, that the comments of

    Michael Greenberger and UNITE HERE supported monitoring and

    enforcement of the implementation of conflict-of-interest policies

    and procedures by the Commission, as opposed to SROs.

    ---------------------------------------------------------------------------

    2. Non-Research Personnel

    EEI argued that the Commission should limit the definition of non-

    research personnel \113\ to only those persons involved with trading,

    pricing, or clearing activities because implementing the restrictions

    on communications between research analysts and all non-research

    personnel as the proposed rule more broadly defined the term will be

    burdensome. Sections 4d(c) and 4s(j)(5) of the CEA require

    informational partitions between research analysts and persons involved

    in pricing, trading, or clearing activities. The Commission recognizes

    that extending the requirement for informational partitions above the

    statutory minimum to all non-research personnel may cause registrants

    to experience some incremental cost increase, though EEI did not

    provide any quantification. Notwithstanding this, however, the

    Commission is adopting the definition as proposed because it believes

    doing so closes a significant window that could be exploited to evade

    the statutory purpose--i.e., to ensure that research reports published

    by registrants are free from bias. The Commission believes that

    informational partitions only between research analysts and persons

    involved in pricing, trading, or clearing activities are unlikely to

    ensure that research reports are free from bias because other personnel

    may have similar motives for influencing the content of research

    reports, or may be subject to the influence of pricing, trading, or

    clearing personnel and thus present an avenue of indirect influence on

    research personnel. The Commission observes that the definition and use

    of the term ``non-research personnel'' was adapted from NASD rule 2711,

    which also prohibits all non-research personnel from reviewing or

    approving a securities research report prior to publication.\114\ Thus,

    despite some potential

    [[Page 20180]]

    incremental cost to registrants, the Commission believes that ensuring

    unbiased registrant research reports accords with statutory intent and

    justifies the increased burden.

    ---------------------------------------------------------------------------

    \113\ The proposed rule defined the term ``non-research

    personnel'' as ``any employee of the business trading unit or

    clearing unit, or any other employee of the [SD] or [MSP] who is not

    directly responsible for, or otherwise involved with, research

    concerning a derivative, other than legal or compliance personnel.''

    \114\ See NASD rule 2711(b)(2) (stating ``no employee of the

    investment banking department or any other employee of the member

    who is not directly responsible for investment research (`non-

    research personnel'), other than legal or compliance personnel, may

    review or approve a research report of the member before its

    publication'').

    ---------------------------------------------------------------------------

    3. Public appearances by research personnel

    The proposed rules defined the term ``public appearance'' as ``any

    participation in a conference call, seminar, forum (including an

    interactive electronic forum) or other public speaking activity before

    15 or more persons * * *.'' FIA, ISDA, and SIFMA argued that the

    definition of public appearance should articulate that the term

    ``person'' includes both a customer that is a natural person and one

    that is an entity. The Commission presumes these commenters to be

    concerned that requiring public-appearance disclosures when the 15-

    person threshold is crossed due to attendance by multiple

    representatives of one entity increases the disclosure burden with no

    attendant increase in benefit. The Commission agrees and is modifying

    the rule accordingly.

    4. Research department

    FIA, ISDA, and SIFMA, in a joint comment, objected that the

    imposition of the rule's restrictions to research departments \115\ of

    global affiliates would create logistical difficulties and expense for

    multinational firms; this impact was not quantified by the commenters.

    FIA, ISDA, and SIFMA suggested that the Commission limit the rules to

    requiring disclosure ``on third party research reports.'' The

    Commission believes that the rule helps ensure that the research

    reports produced by or on behalf of an SD, MSP, FCM, or IB, on which

    consumers may rely in making investment or risk management decisions,

    are not biased in favor of the financial interest of the SD, MSP, FCM,

    or IB--a benefit. This, in turn, promotes consumer confidence in such

    reports--another benefit. Therefore, because it believes that the

    alternative suggested by FIA, ISDA, and SIFMA would be unacceptably

    porous and invite evasion by registrants that move their research

    function to an affiliate, the Commission is adopting the rule as

    proposed. The Commission believes that ensuring that the intended

    benefits of the rule are not depleted through evasion justifies any

    incremental cost of extending the rule to affiliates of registrants. In

    addition, the Commission believes that the increased costs are not as

    significant as posited by the commenters. A registrant need not examine

    the research functions of all of its affiliates under these rules;

    rather, the rules only require that a registrant apply the

    informational partitions of the rules to those research groups doing

    research on behalf of an SD, MSP, FCM, or IB.

    ---------------------------------------------------------------------------

    \115\ The proposed rules defined the term ``research

    department'' as ``any department or division that is principally

    responsible for preparing the substance of a research report

    relating to any derivative * * * including a department or division

    contained in an affiliate * * *.''

    ---------------------------------------------------------------------------

    5. Research Report

    As proposed, the definition of the term ``research report''

    expressly excluded four categories of communications from coverage.

    After considering the comments received, the Commission is expanding

    the list of exclusions as recommended to include ``commentaries on

    economic, political or market conditions'' and ``statistical summaries

    of multiple companies' financial data, including listings of current

    ratings.'' As modified, the Commission believes the rule strikes a

    reasonable balance between the need to identify research reports on

    which an investor or risk manager may rely in making a decision to

    enter into a swap or other derivative that may also be subject to

    potential bias in favor of the financial interest of an SD, MSP, FCM,

    or IB, and those research reports on which an investor or risk manager

    may rely, but that are not likely to be subject to such bias. The

    benefits of the rule as modified are that the rules foster less biased

    research reports without burdening registrants with unnecessary

    restrictions on those research reports that, by their nature, are not

    likely to be subject to bias. To maintain these benefits, the

    Commission declines to broaden the definitional exclusion as suggested

    by commenters \116\ to communications the Commission believes could

    represent the core focus of a research department--e.g., asset classes,

    economic variables commonly referenced in derivatives, and on-the-run

    swap rates--and thus be susceptible to bias.

    ---------------------------------------------------------------------------

    \116\ FIA, ISDA, and SIFMA argued for the expansion of the

    exclusions that the Commission has accepted. FIA/ISDA/SIFMA further

    argued that communications produced by a business trading unit

    labeled as a ``trading/sales desk product'' and as ``non-research''

    should be excluded from the definitions of research report. In a

    separate comment, JP Morgan expressed a general agreement with the

    points raised in the FIA/ISDA/SIFMA letter. EEI argued that the

    Commission should exclude from the definition any communication

    between an SD or MSP, and its regulator, concerning hedging activity

    because firms with small trading operations should be permitted to

    publish occasional research reports to justify trading decisions,

    without being subject the proposed rules. NFA also argued that the

    definition in proposed Sec. 1.71(a)(9) was too broad and suggested

    that the definition be limited in a number of ways similar to NASD

    Rule 2711. Newedge also argued that the definition was too broad and

    suggested a more narrow definition of research report.

    ---------------------------------------------------------------------------

    6. Conflicts of Interest Adequately Addressed by Existing Commission

    and NFA Rules; FCM de minimis Exception

    NFA commented that existing NFA rules address issues raised in

    proposed Sec. 1.71, and that the rule could have unintended

    consequences. K&L Gates LLP (on behalf of Peregrine Financial Group

    Inc.), ADM Investor Services Inc., John Stewart & Associates Inc., and

    Stewart-Peterson Group Inc. each agreed with NFA that existing rules of

    NFA and the Commission are sufficient, and thus the additional

    compliance costs imposed by the rules are not justified.

    The Commission believes that sections 4d(c) and 4s(j)(5) of the CEA

    require registrants to institute safeguards beyond what has been

    previously required in the rules of the Commission and NFA, and,

    accordingly, is adopting the rule substantially as proposed. For

    example, the statutory provisions require ``structural and

    institutional safeguards'' to ensure that research and trading

    functions are ``separated by appropriate informational partitions,'' a

    requirement not imposed by existing NFA or Commission rules. Thus, to

    the extent institution of these additional safeguards incur added

    costs, these are attributable to the statutory requirements imposed by

    Congress. Moreover, by providing specificity under the rules with

    respect to the conflict-of-interest requirement and by maintaining

    consistency with NASD Rule 2711, the Commission believes that the rule

    will minimize disruption to the market and minimize the additional

    compliance costs required by the CEA because the rules rely on well-

    established standards.

    7. FCM de minimis Exception

    Newedge commented that FCMs engaging in minimal proprietary trading

    should not be subject to the burdens of the rule relating to research

    analysts because such a firm does not present a risk of conflicts of

    interest. Again, the Commission notes that sections 4d(c) and 4s(j)(5)

    of the CEA require registrants to institute ``structural and

    institutional safeguards'' to ensure that research and trading

    functions are ``separated by appropriate informational partitions,''

    and that neither of these sections makes an allowance for a de minimis

    amount of trading or research. Thus, the Commission cannot adopt the

    alternative approach suggested by Newedge because the imposition of a

    de minimis exception to the conflicts rule

    [[Page 20181]]

    is inconsistent with the statutory directive that Congress set forth.

    Moreover, the Commission does not believe that the limited nature of a

    firm's proprietary trading negates the issues intended to be addressed

    through the statutory mandate because a firm engaged in trading solely

    on behalf of customers can increase its commissions by encouraging an

    increase in trading activity through research reports.

    8. Small IB Exception

    In the FCM/IB Conflicts NPRM, the Commission invited comment on how

    the proposed rules should apply to FCMs and IBs, considering the

    varying size and scope of the operations of such firms. A number of

    commenters requested relief for small IBs on grounds that the burden to

    them would be high and could discourage them from providing research to

    the detriment of customers seeking to hedge commercial risk.\117\ Given

    the mandate of section 4d(c) of the CEA to establish ``appropriate

    informational partitions'' within all FCMs and IBs, the Commission is

    not able to exempt small firms from the statutory requirements.

    ---------------------------------------------------------------------------

    \117\ NFA, National Introducing Brokers Association, ADM

    Investor Services Inc., John Stewart & Associates Inc., and Stewart-

    Peterson Group Inc. each argued that implementing the proposed rules

    would be prohibitively costly, burdensome, and unnecessary for small

    IBs, particularly for IBs dealing with agricultural commodities

    where the IB may have only a few employees engaged in both research

    and trading for customers, and would force an unspecified number of

    small IBs out of business. Chris Barnard noted that small IBs lack

    the capacity to carry the proportionately heavier regulatory burden

    set forth in the proposed rule, and as such, some regulatory

    mitigation would be beneficial based on number of staff or revenues.

    Multiple commenters also commented on the limited market price

    impact of research reports created or distributed by small IBs.

    ---------------------------------------------------------------------------

    The Commission, however, recognizes that an IB's size is a

    significant factor in determining the ``appropriateness'' of the

    informational partitions required by section 4d(c). Thus, in light of

    the burden to small IBs and the attendant loss of research benefits for

    consumers that could result, the Commission has modified Sec. 1.71(b)

    to set forth a separate policies and procedures requirement for small

    IBs designed to provide them greater flexibility in determining the

    appropriate informational partitions required under their own

    circumstances.\118\

    ---------------------------------------------------------------------------

    \118\ The threshold to qualify for this small IB alternative is

    $5 million or less in aggregate gross revenues generated over the

    preceding 3 years from activities as an IB. This approach is similar

    to that taken in NASD Rule 2711 and was raised as a possible

    alternative in the preamble of the proposed rule.

    ---------------------------------------------------------------------------

    9. Restriction on Non-Research Personnel From ``Influencing the

    Content'' of Research Reports

    The proposed rules provided that non-research personnel shall not

    influence the content of a research report. In response to commenters'

    concerns that the proposed standard was unnecessarily broad and would

    tend to chill all communications, including those beneficial to

    research integrity, between research and non-research personnel, the

    Commission is modifying the rules in line with suggested alternatives

    to provide instead that non-research personnel shall not direct the

    views and opinions expressed in a research report.\119\ The Commission

    believes that accepting this change will reduce the compliance burden

    of registrants because it directs compliance efforts toward ensuring

    that the views and opinions expressed in research reports are those of

    the research analyst, rather than attempting to prohibit all

    influence.\120\

    ---------------------------------------------------------------------------

    \119\ FIA, ISDA, SIFMA, and JP Morgan argued that the proposed

    prohibition on ``influencing the content'' should be eliminated

    because it would impair ordinary communications between research and

    non-research personnel. As an alternative, FIA/ISDA/SIFMA suggested

    that non-research personnel should be prohibited only from

    ``directing the views and opinions expressed in research reports.''

    Better Markets argued that the rules should be expanded to include

    any decision not to publish a report or to refrain from including

    relevant information.

    \120\ The Commission further modified the rules in response to

    commenters to provide that non-research personnel shall not direct a

    research analyst's decision to publish a research report. The

    Commission believes this is a burden-neutral modification to provide

    clarification, however.

    ---------------------------------------------------------------------------

    10. Restriction on Research Analyst Supervision by Business Trading

    Unit or Clearing Unit

    The proposed rules prohibited (1) supervision or control of a

    research analyst by any employee of the registrant's business trading

    unit or clearing unit, and (2) influence or control over the evaluation

    or compensation of a research analyst by personnel engaged in pricing,

    trading, or clearing activities. The intent of the rules is to foster

    research free of bias that may result from research analysts'

    expectation of increased compensation for producing research reports

    favorable to the financial interests of personnel in the business

    trading unit or clearing unit--a benefit.

    FIA, ISDA, and SIFMA recommended--presumably on the basis that

    requiring a separate reporting line adds to the compliance burden--that

    the restriction only apply to direct supervision of research analysts,

    and not to others further up the management chain. No commenter

    provided quantitative information with respect to the costs of such

    burden. The Commission believes that it has resolved the concerns of

    commenters through (1) changes to the definitions of ``business trading

    unit'' and ``clearing unit'' discussed in section II.M above, and (2)

    using those definitions to designate personnel who may not have

    influence or control over the evaluation or compensation of a research

    analyst. As modified, the definitions reach only those performing

    certain functions in the unit and those supervising the performance of

    those functions. The Commission believes the threat to research analyst

    independence that would result from permitting supervision by any

    member of the business trading unit or clearing unit, as defined in the

    final rules, justifies adopting the rule as proposed.

    11. Requirement That Legal/Compliance Personnel Supervise Communication

    Between Research and Non-Research Personnel

    The proposed rules permitted non-research personnel to review a

    research report before its publication for limited purposes, such as

    verifying factual accuracy. Such review: (1) May only be conducted

    through authorized legal or compliance personnel, and (2) must be

    properly documented. In this respect, the rules maintain consistency

    with NASD Rule 2711 and the Commission believes that such consistency

    will minimize compliance costs because the rules rely on well-

    established standards. In addition, the Commission notes that the

    benefit of this provision is that it maintains the independence of the

    views and opinions expressed in research reports while improving the

    accuracy of such reports. The rules accomplish these benefits by

    balancing the need for some review of research reports by non-research

    personnel, while ensuring the review is limited in scope by requiring

    the presence of legal or compliance personnel.

    EEI recommended that the Commission exempt communications that are

    factual in nature from oversight by legal and compliance personnel,

    arguing that such oversight unnecessarily burdens legal/compliance

    personnel. EEI did not further qualify or quantify the costs implicated

    by the proposed exemption. Upon consideration of the alternative's

    cost/benefit ramifications, the Commission determined to adopt the rule

    as proposed. The Commission finds the suggested alternative

    unacceptable for several reasons. First, the Commission does not

    believe that registrants will be able to distinguish easily

    [[Page 20182]]

    communications that are ``factual in nature'' from those that are not,

    likely resulting in more uncertainty and needed review by legal and

    compliance personnel, not less. In addition, the Commission believes

    that allowing for communications that are merely ``factual in nature''

    opens an avenue for evasion that could undermine the rules' intended

    benefits.

    12. Restrictions on Research Analyst Communications

    The proposed rules provided that a research analysts' written or

    oral communication relating to any derivative must not omit any

    material fact or qualification that would cause the communication to be

    misleading to a reasonable person. The requirement, as proposed,

    applied to external communications to a current or prospective

    counterparty as well as internal communications to any employee of the

    registrant. The Commission intends the rules to promote research report

    integrity--i.e., help ensure that reports are both unbiased in favor of

    a registrant's financial interests and factually accurate in material

    respects. The Commission anticipates that the cost attendant to achieve

    the accuracy component of this intended benefit is any increased time a

    registrant spends ensuring that research analysts' reports are free of

    material misleading inaccuracies.

    FIA, ISDA, SIFMA, and JP Morgan commented that the proposed rule

    would materially burden an affected firm's operations because it

    applies to internal communications as well as external communications.

    Upon consideration of the potentially significant cost of including

    internal communications relative to the limited gain in intended

    benefits, the Commission is modifying the rules to exclude

    communications with employees of the registrant from the requirement.

    13. Restriction on Influence of Business Trading Unit and Clearing Unit

    on Research Analyst Compensation

    Proposed Sec. Sec. 23.605(c)(3) and 1.71(c)(3) precludes (1) a

    registrant from considering a research analyst's contribution to the

    trading or clearing business as a factor in his or her compensation

    review or approval, and (2) a review or approval role for business

    trading or clearing unit personnel with respect to a research analyst's

    compensation. As articulated above, the Commission believes that the

    benefit of unbiased research flows directly from a research analyst's

    independence, which is compromised if the analyst's compensation is

    subject to business trading or clearing unit influence.

    The Commission recognizes that the rule, to some incremental

    extent, may add to compliance costs, although no commenter specifically

    articulated or quantified this impact. After considering the comments

    received,\121\ the Commission has determined to revise the proposed

    rule to relieve the compliance burden by permitting communications to

    research department management relating to client or customer feedback,

    ratings, and other indicators of a research analyst's performance. The

    Commission does not believe that this relaxation will negatively impact

    research independence. The Commission declines to further modify the

    rule, however, based on its belief that maintaining a firewall around

    research analyst compensation decisions is crucial to implementing

    effective conflict-of-interest policies and procedures and ensuring the

    benefits of unbiased research reports. The Commission also confirms

    that the rule does not prohibit compensation decisions from being

    subject to non-discriminatory and non-prejudicial firm-wide

    compensation guidelines.

    ---------------------------------------------------------------------------

    \121\ FIA, ISDA, SIFMA, and JP Morgan contended that research

    management should be able to solicit input from business trading and

    clearing unit personnel concerning the performance of research

    personnel. FIA/ISDA/SIFMA, as well as Newedge, further argued that

    research management decisions should be subject to firm-wide

    compensation guidelines. By contrast, Michael Greenberger argued

    that research management should be prohibited from soliciting any

    input of business trading and clearing units concerning a research

    analyst's compensation or performance evaluation, even if the

    influence is indirect or if research management maintains the

    ability to make all final decisions on such determinations. Better

    Markets commented that the provision should be broadened.

    ---------------------------------------------------------------------------

    14. Disclosure of Conflicts by Research Analysts in Research Reports

    and Public Appearances; Disclosure of Conflicts in Third-Party Research

    Reports

    Proposed Sec. Sec. 23.605(c)(5)(i) and 1.71(c)(5)(i) required

    certain disclosures in registrants' research reports and at research

    analysts' public appearances. Specifically, it required disclosure of

    whether the analyst that prepared the report or makes the appearance

    maintains, from time to time, a financial interest in the types of

    derivatives that the analyst follows, the general nature of such

    interest, and any other material conflicts of interest of which the

    research analyst has knowledge. Additionally, as proposed, Sec. Sec.

    23.605(c)(5)(iv) and 1.71(c)(5)(iv) required that, if a registrant

    distributes or makes available third-party research reports, each

    report be accompanied by certain disclosures pertinent to conflicts of

    interest. The required disclosures benefit consumers of research

    reports produced by SDs, MSPs, FCMs, and IBs because they alert the

    consumers of such reports to interests that may influence the content

    of such reports, allowing the consumer to make an independent judgment

    as to their value.

    Several commenters recommended changes that could lessen the

    incremental (though unquantified) compliance costs of the rule by

    curtailing the required disclosures.\122\ The Commission has considered

    these comments and has determined that the benefits of the rule will be

    maintained without subjecting registrants to the burden of determining

    and disclosing financial interests that are maintained ``from time to

    time.'' Thus, the Commission is modifying the language of Sec. Sec.

    23.605(c)(5) and 1.71(c)(5) to remove the phrase ``from time to time,''

    such that a research analyst need only disclose whether she maintains a

    relevant financial interest at the time of publication of the report or

    the time of a public appearance. However, the Commission is not

    adopting a de minimis exception, due to the difficulty of deciding when

    a financial interest is de minimis in this context. A de minimis

    exception would require a registrant to determine the threshold point

    at which a financial interest poses a threat of conflicts of interest--

    a nebulous standard; such determination is likely to increase the costs

    of compliance of the rule over the cost that would be incurred to

    simply disclose all financial interests.

    ---------------------------------------------------------------------------

    \122\ FIA, ISDA, and SIFMA argued that Sec. Sec.

    23.605(c)(5)(i) and 1.71(c)(5)(i) should be limited to disclosing

    whether a research analyst maintains a relevant financial interest

    at the time of publication of the report/time of public appearance,

    rather than ``from time to time'' as provided in the rule. EEI

    suggested that the Commission modify the proposed rule to provide a

    de minimis exception to the disclosure requirements, such that a

    research analyst should be required only to identify relevant

    financial interests.

    ---------------------------------------------------------------------------

    Commenters also raised concerns regarding the burden of required

    disclosures when distributing research reports produced by a third-

    party.\123\ The Commission considered the burden of disclosure in this

    context in light of maintaining the benefit of disclosure of

    information necessary for consumers to judge the content of research

    reports. The Commission has determined not to modify the rule in regard

    to third-party research disclosures. It believes that

    [[Page 20183]]

    third-party research reports distributed by a registrant may be

    interpreted as carrying the endorsement of the registrant and thus may

    present conflicts-of-interest issues in the same way as research

    reports originating with the registrant's own research analysts;

    accordingly, the same level of disclosure is appropriate.

    ---------------------------------------------------------------------------

    \123\ FIA, ISDA, SIFMA, JP Morgan, and EEI argued that the

    required disclosures with respect to third-party research reports

    are unnecessary because third-parties are, by definition,

    independent.

    ---------------------------------------------------------------------------

    Finally, commenters also contended that the phrase ``any other

    actual, material conflict of interest of the research analyst'' is

    vague and would be burdensome to implement, requiring coordination

    among various business units and the creation of special databases in

    order to comply with the rule. The Commission believes that the cost

    concerns of commenters are misplaced in this regard. The rules require

    disclosure of ``any other actual, material conflicts of interest of the

    research analyst or [SD, MSP, FCM, or IB] of which the research analyst

    has knowledge at the time of publication of the research report or at

    the time of the public appearance'' (emphasis added). Thus, the

    disclosure requirement is limited to conflicts of which the research

    analyst has knowledge, and the SD, MSP, FCM, or IB need not construct

    the databases suggested by commenters in order to comply with the rule.

    15. Separation of Clearing Unit From Business Trading Unit

    As proposed, Sec. 23.605(d) and Sec. 1.71(d) prohibited

    interference by an SD or MSP with the decisions of clearing members,

    including FCMs, regarding the provision of clearing services and

    activities. The proposed rules also required informational partitions

    between business trading units and clearing member personnel. In

    addition, the proposals prohibited any employee of a business trading

    unit from supervising or controlling any employee of a clearing member.

    The Commission believes the benefits of the rules are that, to the

    extent practicable, the rules protect fair and open access to clearing

    by ensuring that decisions to accept clearing customers are not

    motivated solely by considerations of trading profits.

    Commenters raised a number of cost concerns related to operation of

    the rule, as follows:

    Sales personnel should be able to act for both the trading

    unit and the clearing unit to offer a full range of services to

    customers efficiently; \124\

    ---------------------------------------------------------------------------

    \124\ FIA/ISDA/SIFMA and JP Morgan argue that sales personnel

    should be permitted to act for both units. UBS Securities LLC also

    argued that the rule inhibits the ability of a financial services

    firm to operate its swap clearing business as a partnership with its

    trading business in order to serve clients. Similarly, the FHLBs

    argued that the proposed rule overly restricts the ability of SDs

    and MSPs to run their trading and clearing operations and

    effectively serve the needs of their end-user counterparties.

    ---------------------------------------------------------------------------

    The rules will impair a registrant's ability to follow

    risk management best practices by requiring independent risk

    assessments in the trading unit and clearing unit for the same

    counterparty, rather than a consolidated risk assessment; \125\

    ---------------------------------------------------------------------------

    \125\ FIA/ISDA/SIFMA and the FHLBs argued that the proposed

    rules would impair an SD's/MSP's ability to follow risk management

    best practices. NFA commented that Sec. 1.71(d) is too broad and

    may negatively impact a firm's ability to share information about

    customers to make credit and risk determinations.

    ---------------------------------------------------------------------------

    The rule should be limited to prohibiting a trading unit

    from obtaining information about the transactions or positions of

    customers of the clearing unit; \126\

    ---------------------------------------------------------------------------

    \126\ FIA/ISDA/SIFMA recommended that the Commission not adopt

    the proposed rules, but instead adopt a rule that prohibits an

    affiliated SD or MSP from obtaining information from an affiliated

    FCM's clearing personnel concerning transactions conducted by FCM

    clients with either their own clients or with independent SDs or

    MSPs.

    ---------------------------------------------------------------------------

    No commenter provided any quantitative information regarding the

    expected costs of complying with the rules.

    Having considered the costs of compliance as presented by

    commenters in light of the benefits of open access to clearing, the

    Commission has determined it appropriate to promulgate the rules

    largely as they were originally proposed. Despite the varying

    incremental costs of any needed corporate structure reorganization and

    instituting informational partitions, the Commission believes the

    separation of the FCM clearing unit from the interference or influence

    of an affiliated SD or MSP is crucial to promoting open access to

    clearing and securing the benefits to market participants and the

    stability of the financial system itself expected to follow from

    increased central clearing.\127\ Open access to clearing will be

    essential for the expansion of client clearing needed for market

    participants to comply with the mandatory clearing of swaps as

    determined by the Commission under section 723 of the Dodd-Frank Act.

    Specifically, the Commission does not believe that the rule language

    should be changed to permit sales personnel to act for both the trading

    unit and the clearing unit. The risks associated with this approach, in

    terms of potential undue influence and interference with clearing

    decisions, has been well-supported by commenters.\128\

    ---------------------------------------------------------------------------

    \127\ In September 2009, the G-20 Leaders agreed in Pittsburgh

    that ``all standardised OTC derivative contracts should be traded on

    exchanges or electronic trading platforms, where appropriate, and

    cleared through central counterparties by end-2012 at the latest.''

    \128\ MFA and Pierpont Securities Holdings LLC commented that

    they support the Commission's proposals. Swaps and Derivatives

    Market Association contended that that the restrictions correctly

    address key areas where conflicts arise, and that the independence

    of clearing members is essential to accomplish several policy goals

    of the Dodd-Frank Act. Michael Greenberger also expressed support

    for Sec. 23.605(d), noting that attempts to tie clearing decisions

    to trade execution decisions would raise potential conflicts of

    interest, which could serve to block access to clearing and prevent

    competition among execution venues.

    ---------------------------------------------------------------------------

    However, in response to commenters' concerns about an FCM's ability

    to manage a default scenario without the benefit of the trading

    expertise in the business trading unit, the Commission is modifying

    proposed Sec. 1.71(d)(2)(i) to permit the business trading unit of an

    affiliated SD or MSP to participate in the activities of an FCM during

    an event of default. Specifically, the business trading unit personnel

    would be permitted to participate in the activities of the FCM, as

    necessary, during any default management undertaken by a derivatives

    clearing organization and for the purposes of transferring,

    liquidating, or hedging any proprietary or customer positions as a

    result of an event of default.

    16. Undue Influence on Customers

    As proposed, Sec. 1.71(e) required that FCMs and IBs adopt and

    implement written policies and procedures that mandate the disclosure

    of any material incentives and any material conflicts of interest

    regarding the decision of a customer as to trade execution and/or

    clearing of a derivatives transaction. Proposed Sec. 23.605(e)

    mandated that SDs and MSPs adopt policies and procedures requiring

    disclosure to counterparties of any material incentives and conflicts

    of interest regarding the decision of a counterparty: (1) Whether to

    execute a derivative on a swap execution facility or designated

    contract market; or (2) whether to clear a derivative through a

    derivatives clearing organization. The Commission believes that the

    rules benefit counterparties by ensuring that they are adequately

    informed of any material incentives or conflicts prior to the execution

    of a transaction, and benefit the market by promoting the efficient use

    of trading facilities and clearing for swap transactions.

    Some commenters objected to the rule on the grounds that existing

    Commission regulations already impose risk disclosure requirements on

    FCMs and IBs. FIA, ISDA, SIFMA, and JP Morgan argued that the

    Commission could reduce the burden of the rules by

    [[Page 20184]]

    requiring SDs and MSPs to provide customers with an annual disclosure

    document describing potential conflicts that may exist among the firm,

    its affiliates, clients, and employees.

    After considering costs of compliance with the rule in light of the

    benefits outlined above, and the underlying statutory requirements, the

    Commission has determined it appropriate to adopt the rules as

    originally proposed. The Commission believes that the disclosure of

    conflicts of interest in this context are materially different from the

    risk disclosures required of FCMs and IBs under existing Commission

    regulations and, therefore, existing regulations are inadequate to

    secure the benefits of the rule outlined above. In addition, the

    Commission notes that the rule does not prohibit an SD or MSP from

    providing its customers with an annual disclosure document, and the

    Commission confirms that such would be permitted assuming that such

    document is sufficient to meet the requirements of the rule.

    Costs

    Sections 4d(c) and 4s(j)(5) of the CEA require FCMs, IBs, SDs, and

    MSPs, to adopt and implement certain conflict of interest systems,

    procedures and safeguards, including research firewalls. The costs and

    benefits that necessarily result from these basic statutory

    requirements are considered to be the ``baseline'' against which the

    costs and benefits of the Commission's final rules are compared or

    measured. The ``baseline'' level of costs includes the costs that

    result from the following activities required by the statute:

    FCMs and IBs must establish structural and institutional

    safeguards to ensure that the activities of any person within the firm

    relating to research or analysis of the price or market for any

    commodity are separated by appropriate informational partitions within

    the firm from the review, pressure, or oversight of persons whose

    involvement in trading or clearing activities might potentially bias

    the judgment or supervision of the persons.

    SDs and MSPs must establish structural and institutional

    safeguards to ensure that the activities of any person within the firm

    relating to research or analysis of the price or market for any

    commodity or swap are separated by appropriate informational partitions

    within the firm from the review, pressure, or oversight of persons

    whose involvement in pricing, trading, or clearing activities might

    potentially bias their judgment or supervision and contravene the core

    principles of open access and the business conduct standards described

    in the CEA.

    SDs and MSPs must establish structural and institutional

    safeguards to ensure that the activities of any person within the firm

    acting in a role of providing clearing activities or making

    determinations as to accepting clearing customers are separated by

    appropriate informational partitions within the firm from the review,

    pressure, or oversight of persons whose involvement in pricing,

    trading, or clearing activities might potentially bias their judgment

    or supervision and contravene the core principles of open access and

    the business conduct standards described in the CEA.

    Compliance with the statutory baseline alone would result in costs

    for FCMs, IBs, SDs, and MSPs. For example, the requirement to establish

    informational partitions would include the cost of identifying

    personnel involved in research or analysis of the price or market for

    any commodity or swap, identifying personnel involved in pricing,

    trading, or clearing activities, and designing and implementing

    communication policies and procedures.

    Congress mandated that the Commission adopt rules to implement each

    of the statutory provisions. With regard to its implementation

    decisions, the Commission has determined the following to be potential

    costs to FCMs, IBs, SDs, and MSPs to comply with the final regulations

    regarding conflicts-of-interest policies and procedures:

    Identifying reports that qualify as research reports;

    Maintaining records of public appearances by research

    analysts; and

    Designing and implementing policies and procedures

    regarding:

    Legal or compliance participation in communications

    between research analysts and non-research personnel regarding the

    content of research reports;

    Oversight of research analyst communications regarding

    omissions of material facts or qualifications that would cause the

    communication to be misleading to a reasonable person;

    Communication of any client or customer feedback on

    research analyst performance from the business trading unit or clearing

    unit to research department management;

    Implementing the prohibition on promises of favorable

    research by research analysts;

    Discovering, monitoring, and disclosing financial

    interests maintained by research analysts;

    Implementing the prohibition on retaliation against

    research analysts;

    Implementing the prohibition of interference with or

    influence on decisions with regard to the provision of clearing

    services or activities; and

    Disclosing material incentives and conflicts-of-interest

    regarding exchange trading or clearing decisions by counterparties.

    In adhering to its mandate from Congress, where possible the

    Commission has attempted to alleviate the burdens on affected entities.

    The Commission has narrowed the definitions of ``business trading

    unit'' and ``clearing unit'' to include fewer registrant personnel

    affected by the rules. The Commission has narrowed the definition of

    ``public appearance'' to include fewer appearances by research analysts

    that would require the disclosures mandated by the rules. The

    Commission has broadened the number of exclusions from the definition

    of ``research report'' such that there are fewer subject areas that

    would be covered by the rules. The Commission has provided a separate

    regulatory standard for small IBs that will lessen the compliance

    burden on such firms. The Commission also has narrowed the prohibition

    on non-research personnel involvement in producing content of research

    reports, and removed the need to police internal communications from

    research analysts for omissions of material facts or qualifications.

    The Commission has permitted trading and clearing units to provide

    client and customer feedback on research analyst performance to

    research department management and removed the need to determine and

    document financial interests of research analysts maintained ``from

    time to time'' for disclosure purposes. Finally, the Commission has

    permitted business trading unit personnel to participate in the

    activities of an FCM, as necessary, during any default management

    undertaken by a derivatives clearing organization and for the purposes

    of transferring, liquidating, or hedging any proprietary or customer

    positions as a result of an event of default.

    Other than costs resulting from collections of information subject

    to the Paperwork Reduction Act, incorporated by reference herein, the

    Commission has no reliable quantitative data from which to reasonably

    estimate the costs of compliance with these conflict of interest

    rules.\129\ No commenter provided any quantitative data on the costs of

    compliance with the rules as

    [[Page 20185]]

    proposed. The Commission's review of applicable academic literature

    yielded no research reports or studies directly relevant to its

    considerations of costs of the final rules.

    ---------------------------------------------------------------------------

    \129\ Although the rules were adapted from NASD rule 2711, that

    rule was promulgated by an SRO (now FINRA), which was not required

    to conduct a cost-benefit analysis of the rule prior to

    promulgation.

    ---------------------------------------------------------------------------

    The Commission anticipates that many entities may currently have,

    pursuant to other regulation, the informational partitions required by

    the rules in place. The Commission notes that dually registered FCMs

    and BDs are more likely to have implemented such informational

    partitions under other regulatory regimes \130\ than entities that are

    subject to such requirements for the first time. Costs, therefore, are

    expected to be higher for those entities not currently dually

    registered or not currently implementing conflicts of interest policies

    and procedures. Certain of the costs associated with these conflict of

    interest rules result from collections of information subject to the

    Paperwork Reduction Act. Costs attributable to collections of

    information subject to the PRA are discussed further in section V.B.3.

    below. The Commission has also considered these costs, which it

    incorporates by reference herein, in its section 15(a) analysis.

    ---------------------------------------------------------------------------

    \130\ In this respect, the Commission observes that 55% of

    current FCMs are also registered as BDs with the SEC, and thus may

    already have informational partitions between research and trading

    as required under the rules of FINRA. See letter from NFA, dated

    Jan. 18, 2011 (comment file for 75 FR 70881 (Designation of a Chief

    Compliance Officer; Required Compliance Polices; and Annual Report

    of a FCM, SD, or MSP)). The Commission also notes that in 2003 the

    UK FSA conducted a cost benefit analysis when promulgating conflicts

    of interest rules and guidance with respect to investment research

    and issues of securities. The UK FSA concluded that because UK firms

    were required to comply with their existing statutory obligations

    including management of conflicts of interest when carrying out

    regulated activity, the ``total compliance costs relating to [the

    FSA's] new proposed rule and supporting guidance on objective

    investment research will be of no more than minimal significance.''

    See FSA Consultation Paper 205, Conflicts of Interest: Investment

    Research and Issues of Securities, Annex 1 (October 2003); FSA

    Consultation Paper 171, Conflicts of Interest: Investment Research

    and Issues of Securities, Annex 5 (February 2003).

    ---------------------------------------------------------------------------

    Benefits

    The Commission believes that the proper informational partitions

    between research and trading and between clearing and trading,

    including restrictions on communications, supervision, and compensation

    oversight, help to ensure that research being released by SDs, MSPs,

    FCMs, and IBs and decisions related to trade execution and clearing are

    not tainted by inappropriate incentives. Because this research may be

    relied upon by a public that views such entities as experts in

    derivatives markets by virtue of their intimate knowledge of the

    products and markets, it is imperative that the information released

    therein is as accurate and free of conflicts of interest as possible.

    Similarly, because the importance of central clearing in derivatives

    markets necessitates free and open access to clearing, unrestrained by

    any potential conflicts of interest, it is imperative that access to

    clearing is not impeded by any inappropriate motivation. The rules

    adopted in this release require entities to establish appropriate

    policies and procedures to accomplish these benefits.

    In addition, by ensuring that decisions on clearing activities

    remain separate from decisions relating to trade execution and other

    proprietary activities, the final regulations promote competitiveness

    in futures and swaps markets by ensuring open access to clearing.

    Central clearing is a pillar of derivatives reform initiatives,

    contributing heavily to the efficiency and safety of derivatives

    markets; barriers to clearing access may have an adverse effect on that

    efficiency and safety.

    To the extent that a research report informs the financial

    investment in derivatives markets, protecting the integrity of that

    report aids in the protection of the financial integrity of markets.

    Moreover, requiring registrants to disclose any potential conflicts

    of interest further affords the public the opportunity to make

    judgments regarding the information provided to them in the written

    reports and public appearances of research analysts. The Commission's

    mission to ensure fair and orderly markets relies in part on the

    transparency of certain market information, in order to provide

    potential investors the accurate information necessary to make informed

    decisions.

    Section 15(a) Determination

    1. Protection of Market Participants and the Public

    The Commission believes that, as a result of these rules, market

    participants and the public are better protected from the potential

    harm that may occur when financial research reports are not insulated

    from the bias of registrants' own financial interests. This bias holds

    strong potential to operate as an incentive for registrants to produce

    and distribute research reports tainted by misleading, unbalanced, and/

    or inaccurate information. Such tainted reports, in turn, may induce

    market participants to engage in a financial transaction that they

    otherwise would not. Thus, the Commission believes that these

    regulations perform an important consumer protection function in the

    markets it regulates. While, in theory regulation could discourage some

    SDs, MSPs, FCMs, or IBs from making research reports public, the

    Commission believes the rules are carefully tailored to minimize costs

    beyond those required by the statute. The Commission also believes that

    SDs, MSPs, FCMs, and IBs likely will use research reports as a tool to

    differentiate themselves from competitors. In addition, the Commission

    believes that by insulating clearing services from pricing and trading

    bias, the regulations foster fair and open access to central clearing.

    2. Efficiency, Competitiveness, and Financial Integrity of Markets

    \131\

    ---------------------------------------------------------------------------

    \131\ Although by its terms CEA section 15(a)(2)(B) applies to

    futures markets only, the Commission finds this factor useful in

    analyzing regulations pertaining to swaps markets as well.

    ---------------------------------------------------------------------------

    The final rules promote the efficiency, competitiveness, and

    financial integrity of futures and swaps markets \132\ by prohibiting

    an entity's trading personnel from manipulating research reports or

    otherwise biasing the information contained in research reports to

    their own financial advantage. To the extent the research produced by

    registrants is used to inform financial strategies, the integrity of

    that research is beneficial to the financial integrity of derivatives

    markets. The final rules strive to ensure the integrity of research

    performed by Commission registrants. Sound research also promotes

    market efficiency insofar as the increased dissemination of reliable,

    unbiased market information is acted upon by market participants in

    their decision-making. As discussed above, the Commission does not

    believe that the costs of these regulations, as carefully tailored to

    minimize costs beyond those required by the statute, will materially

    decrease market efficiency by leading to less sharing of relevant

    market information, particularly in light of the competitive incentives

    to do so.

    ---------------------------------------------------------------------------

    \132\ Although by its terms CEA section 15(a)(2)(B) applies to

    futures markets only, the Commission finds this factor useful in

    analyzing regulations pertaining to swaps markets as well.

    ---------------------------------------------------------------------------

    Because the final rules promote fair and open access to central

    clearing, they also promote the financial integrity of derivatives

    markets--both futures and swaps markets. Greater access to central

    clearing ensures that more market participants will have the option to

    mitigate the counterparty credit risk that they face when entering into

    derivatives transactions. Protecting market participants from

    discrimination in the provision of clearing services will foster

    [[Page 20186]]

    a competitive environment for the provision of clearing services and

    afford market participants greater choice in clearing members. While

    the Commission recognizes that some costs are attendant to the required

    firewall between trading and clearing, the Commission does not believe

    that these costs, as carefully tailored to minimize costs beyond those

    required by the statute, are sufficient to materially inhibit the

    provision of clearing services.

    3. Price Discovery

    To the extent that insulating research reports from registrant

    financial bias results in hedgers and investors making more accurately

    informed investment decisions, reported trade and transaction prices

    should better reflect the intrinsic value. This promotes the price

    discovery function of derivative markets. In contrast, where there is

    no check on the integrity of registrant research materials and market

    actors transact on the basis of misleading or inaccurate information,

    resulting prices may be distorted. Because the rules are carefully

    tailored to minimize costs, the Commission does not believe these rules

    will reduce liquidity to hinder price discovery.

    4. Sound Risk Management

    The final rules regarding informational partitions between clearing

    and trading will contribute to sound risk management because the

    separation of the FCM clearing unit from the interference or influence

    of an affiliated SD or MSP promotes open access to clearing. Open

    access to clearing will be essential for the expansion of client

    clearing needed for market participants to comply with the mandatory

    clearing of swaps as determined by the Commission under section 723 of

    the Dodd-Frank Act. The mandatory central clearing of swaps is one of

    the primary responses to the 2008 financial crisis, as central clearing

    is believed to promote sound risk management in the swap markets. While

    the Commission recognizes that some costs are attendant to the required

    firewall between trading and clearing, the Commission does not believe

    that these costs, as carefully tailored to minimize costs beyond those

    required by the statute, are sufficient to materially inhibit the

    provision of clearing services and the risk management benefit these

    services afford.

    5. Other Public Interest Considerations

    The Commission has not identified any other public interest

    considerations impacted by these conflicts-of-interest rules.

    G. Designation of a Chief Compliance Officer, Required Compliance

    Policies, and Annual Report of an FCM, SD, or MSP

    The CCO NPRM proposed several rules addressing chief compliance

    officer (CCO) designation and certain CCO requirements:

    Proposed Sec. 3.3(a) codified the statutory requirements

    that each FCM, SD, and MSP designate a CCO and prescribed certain

    qualifications for the position.\133\

    ---------------------------------------------------------------------------

    \133\ Section 4d(d) of the CEA requires that each FCM designate

    an individual to serve as its chief compliance officer (CCO).

    Likewise, section 4s(k) of the CEA requires that each SD and MSP

    designate an individual to serve as its CCO.

    ---------------------------------------------------------------------------

    Proposed Sec. 3.3(d) codified the CCO duties defined in

    section 4s(k)(2) for SDs and MSPs, and extended their application to

    FCMs.\134\

    ---------------------------------------------------------------------------

    \134\ Section 4d(d) of the CEA authorizes the Commission to

    promulgate rules concerning the duties of a CCO of an FCM.

    ---------------------------------------------------------------------------

    Proposed Sec. 3.3([e]) \135\ codified the requirements of

    section 4s(k)(3) of the CEA for SDs and MSPs--i.e., that the CCO

    annually prepare and sign a report containing descriptions of: (i) The

    registrant's compliance with the CEA and regulations promulgated under

    the CEA, and (ii) each policy and procedure of the CCO, including the

    code of ethics and conflicts-of-interest policies--and extended their

    application to FCMs pursuant section 4d(d) of the CEA.

    ---------------------------------------------------------------------------

    \135\ The proposed regulations mis-numbered the subsections of

    Sec. 3.3 such that two subsections were designated as ``(d).'' To

    avoid confusion, this release re-designates such sections correctly

    in brackets.

    ---------------------------------------------------------------------------

    Of the 25 comment letters the Commission received on the CCO NPRM,

    17 raised issues relevant to the consideration of the proposed rules'

    material costs and benefits; two of these provided some quantitative

    data relevant to costs and benefits.

    The comments relevant to costs and benefits can be classified with

    respect to the following 10 aspects, each of which is discussed

    below.\136\

    ---------------------------------------------------------------------------

    \136\ A more detailed discussion of the comments can be found in

    section II.N. above.

    ---------------------------------------------------------------------------

    1. Decision To Extend Same Requirements to FCMs as SDs and MSPs

    The Commission proposed uniform rules applicable to SDs, MSPs, and

    FCMs. After reviewing the comments received,\137\ the Commission is

    adopting the same requirements for SDs, MSPs, and FCMs. The Commission

    recognizes commenters' concerns (though not substantiated with

    quantitative data) that subjecting FCMs to the same CCO requirements as

    applied to SDs and MSPs by section 4s(k) of the CEA (as codified in

    these rules) may increase costs for FCMs as compared to a less

    prescriptive approach. The Commission believes these costs may vary

    widely among FCMs, depending on the activities in which an FCM engages

    and the size and complexity of an FCM's operations.\138\ Lacking

    quantitative information requested of commenters, the Commission has

    looked to public sources to estimate the boundaries of this range. In

    this regard, it finds the estimates contained in the SEC's 2003

    published final compliance program rules for investment companies and

    investment advisers informative and, in lieu of FCM-specific

    information, a reasonable proxy for estimating an FCM compliance cost

    range.\139\ The SEC estimated costs for developing a compliance

    program, depending on the manner chosen, ranging from $1,000 to

    $200,000.\140\

    ---------------------------------------------------------------------------

    \137\ Comments from Rosenthal, Newedge, and NFA advocated

    separate treatment for FCMs, given the Commission's separate

    statutory authority over them. A number of other commenters,

    including Better Markets, NSCP, and CII generally supported

    extension of the same duties to FCMs (provided that certain

    modifications were made to the proposed rules).

    \138\ In this respect, the Commission observes that 55% of

    current FCMs are also registered as BDs with the SEC, and thus will

    already have a CCO and significant compliance regimes as required

    under the rules of FINRA. See letter from NFA, dated Jan. 18, 2011

    (comment file for 75 FR 70881 (Designation of a Chief Compliance

    Officer; Required Compliance Polices; and Annual Report of a FCM,

    SD, or MSP)). FCMs that do not currently have a CCO or a compliance

    program may choose to develop a program in-house if their activities

    are limited and the regulatory requirements well-understood. Other

    FCMs may choose to purchase an off-the-shelf compliance manual and

    adjust it to correspond to their regulatory requirements. Still

    others may hire a third-party compliance firm, a law firm, or an

    accounting firm to draft a firm-specific manual. As of 2003, when

    the SEC published final compliance program rules for investment

    companies and investment advisers, the costs for these options

    ranged from $1,000 to $200,000. See Compliance Programs of

    Investment Companies and Investment Advisers, 68 FR 74714 (Dec. 24,

    2003).

    \139\ See Compliance Programs of Investment Companies and

    Investment Advisers, 68 FR 74714 (Dec. 24, 2003).

    \140\ The SEC considered the same three alternative compliance

    avenues as noted above for FCMs. See id.

    ---------------------------------------------------------------------------

    Notwithstanding these costs, the Commission believes the same

    considerations and benefits, discussed further below, that warrant

    these regulations for SDs and MSPs, warrant them for FCMs as well. As

    recent Congressional hearings in the wake of the MF Global bankruptcy

    have highlighted, an FCM's conduct holds potential to cause severe

    negative impact to market participants and the public.\141\ In that the

    statutory

    [[Page 20187]]

    requirements of the CEA and Commission regulations under it seek to

    prevent harm to market participants and the public by FCMs, the

    Commission believes that requiring a robust CCO function within FCMs is

    an important benefit of these regulations. A CCO will serve as a focal

    point to better monitor and assure FCM legal compliance. Moreover, the

    Commission believes the role of FCMs likely will grow in importance as

    client clearing of swaps increases, fostering commensurate growth in

    the benefits of active compliance monitoring by CCOs of FCMs to the

    security and stability of swaps markets. The Commission also expects

    that consistent regulation of its registrants is likely to benefit the

    Commission's regulatory mission by increasing the efficiency of

    registrant oversight.

    ---------------------------------------------------------------------------

    \141\ See Press Release, Senate Committee on Agriculture,

    Nutrition & Forestry, Senator Pat Roberts: We Need Answers on MF

    Global * * * Futures Still Critical to Risk Management (Dec. 1,

    2011), available at http://www.ag.senate.gov/hearings/continuing-oversight-of-the-wall-street-reform-and-consumer-protection-act

    (prepared remarks of Sen. Pat Roberts, ranking subcommittee member,

    at December 1, 2011 Senate Committee on Agriculture, Nutrition &

    Forestry).

    ---------------------------------------------------------------------------

    2. Harmonization With Other Regulatory Regimes

    After reviewing comments,\142\ the Commission is modifying its

    proposal to reduce the cost burden by harmonizing the CCO requirements

    for SDs, MSPs, and FCMs with the traditional compliance model as

    reflected in other regulatory regimes--including regimes established by

    FINRA for broker-dealers (BDs), the FHFA, and by the Commission for

    RFEDs--to the extent consistent with section 4s(k) of the CEA.\143\

    Specifically, the Commission has modified the rule to (1) require that

    the CCO ``administer'' the compliance policies of the registrant

    (rather than establish compliance polices); (2) confirm, as suggested

    by commenters, that the CCO's role in ``resolving'' conflicts of

    interest may involve actions other than making the final decision; (3)

    provide that the CCO must take ``reasonable steps to ensure

    compliance'' (rather than simply ``ensure compliance''); and (4) permit

    either the CCO or the CEO to make the required certification of the

    annual report.

    ---------------------------------------------------------------------------

    \142\ See e.g., NFA's comment letter and representatives of

    market participants in a May meeting with SEC and Commission staff

    (see http://comments.cftc.gov/PublicComments/) were concerned with

    differences between the Commission's proposed rules and FINRA's

    rules and recommended harmonization. The FHLBs commented that they

    are subject to FHFA regulation and requested that the Commission not

    impose duplicative regulations for them. Edison Electric Institute

    (EEI) urged the Commission to follow the Federal Energy Regulatory

    Commission's approach by setting forth principles of an effective

    compliance program while leaving the details to the registrant. FIA

    and SIFMA noted that the more traditional compliance model-- RFEDs

    are required to designate a CCO and prepare an annual compliance

    certification under current Commission regulations (see 17 CFR

    5.18(j).)--would be consistent with the approach the Commission took

    with regard to RFEDs. FIA and SIFMA, along with Newedge and

    Rosenthal, argued that the Commission should harmonize its rules

    with those of FINRA and defer to NFA's experience in determining the

    proper role for the CCO.

    \143\ To the extent the other regulatory regimes prescribe CCO

    rules more general than those specifically required by section

    4s(k), they do not conform to statutory requirements and are not

    implemented in the final rules. However, the Commission believes the

    more specific requirements of section 4s(k) are supplemental--not

    contradictory--to the more general ``policies, procedures, and

    testing'' requirements of the rules of the other regulatory regimes.

    ---------------------------------------------------------------------------

    3. Flexibility in Rule's Structure

    In the CCO NPRM, the Commission requested comment on whether the

    structure of the proposed rules allows for sufficient flexibility,

    thereby permitting FCMs, SDs, and MSPs to control costs by tailoring

    their compliance programs to their individual circumstances. The

    comments received raised the following issues with cost-benefit

    implications:

    Allowing a CCO to perform other duties in addition to

    compliance duties; \144\

    ---------------------------------------------------------------------------

    \144\ NFA and the FHLBs commented that the rules explicitly

    should permit the CCO to share any other executive role, such as

    CEO, to provide flexibility for smaller firms.

    ---------------------------------------------------------------------------

    Designation of multiple CCOs with defined areas of

    responsibility; \145\

    ---------------------------------------------------------------------------

    \145\ NFA also argued that the rules should recognize that

    compliance expertise may reside with more than one individual, and

    thus the Commission should consider allowing an entity to designate

    multiple CCOs, so that each CCO's primary area of responsibility is

    defined, and each CCO should be required to perform duties and

    responsibilities with respect to their defined area.

    ---------------------------------------------------------------------------

    Allowing a single officer to be CCO for multiple

    affiliated entities; \146\

    ---------------------------------------------------------------------------

    \146\ Newedge, Hess, and The Working Group argued that

    affiliated FCMs, SDs, and MSPs that are separate legal entities

    should be permitted to share the same CCO to increase compliance

    efficiency.

    ---------------------------------------------------------------------------

    Allowing CCOs of multiple affiliated entities to report to

    the board of a holding company that controls all affiliated entities;

    \147\

    ---------------------------------------------------------------------------

    \147\ The Working Group also argued and that the CCO of

    affiliated registrants should be allowed to report to a board of an

    affiliated entity that controls both entities.

    ---------------------------------------------------------------------------

    Allowing CCOs to consult with other employees, outside

    consultants, lawyers, and accountants in fulfilling their duties; \148\

    ---------------------------------------------------------------------------

    \148\ NFA also recommended that CCOs explicitly be permitted to

    consult with other employees, outside consultants, lawyers, and

    accountants.

    ---------------------------------------------------------------------------

    Requiring a senior CCO to have responsibility for multiple

    affiliated entities, even if each has its own CCO; and \149\

    ---------------------------------------------------------------------------

    \149\ Better Markets commented that a senior CCO should have

    overall responsibility of each affiliated and controlled entity,

    even if individual entities within the group have CCOs.

    ---------------------------------------------------------------------------

    Requiring the CCO to be located remotely from the business

    trading unit.\150\

    ---------------------------------------------------------------------------

    \150\ Better Markets recommended that the rule require the CCO

    office to be located remotely from the trading floor.

    ---------------------------------------------------------------------------

    Having considered these comments, the Commission has taken steps to

    reduce the cost burden on registrants by expanding the flexibility

    allowed under the proposed rule. Specifically, the Commission agrees

    that firms, especially small firms, could reduce costs if a CCO were

    permitted to perform additional duties and therefore confirms that a

    CCO may share additional executive responsibilities and/or be an

    existing officer within the entity. In addition, the final rule would

    allow registrants to recognize cost savings by not prohibiting multiple

    legal entities from designating the same individual as CCO. The

    Commission also is not requiring the CCO to be remotely located from

    the business trading unit. Moreover, the Commission is modifying the

    rule to permit either the CCO or the CEO to make the certification

    required in the annual report, as requested by commenters. This change

    will reduce the compliance costs insofar as it may make it easier to

    recruit and retain qualified candidates for CCO. In response to NFA's

    concern about CCOs being able to rely on the expertise of others,

    presumably in part to reduce the cost of personally developing the

    requisite expertise, the Commission confirms that the qualifying

    language ``to the best of his or her knowledge and reasonable belief''

    in the annual report certification required by the rule permits the CCO

    or CEO to rely on other experts for statements made in the annual

    report.

    With respect to two of the above-noted issues, however, the

    statutory language does not afford the Commission flexibility to relax

    requirements. Specifically, section 4s(k) of the CEA requires the CCO

    to report to each registrant's board or senior officer, rather than to

    the board or senior officer of a consolidated corporate parent, so the

    Commission is unable to adjust the rule to permit the CCOs of multiple

    affiliated entities to report to the board of a holding company.

    Similarly, the statutory language of sections 4d(d) and 4s(k) of the

    CEA--requiring FCMs, SDs, and MSPs to ``designate an individual to

    serve as chief compliance officer''--provides the

    [[Page 20188]]

    Commission no latitude to permit designation of multiple CCOs with

    delineated areas of responsibility. The Commission notes that any costs

    of these requirements are directly attributable to the statutory

    requirements of Congress, and not to Commission action.

    4. Limited Scope of the Rule

    Proposed Sec. 3.3(a) required each SD, MSP, and FCM to designate

    an individual as a CCO and provide the CCO with the full responsibility

    and authority to develop and enforce, in consultation with the board or

    senior officer, appropriate policies and procedures to fulfill the

    duties set forth in the CEA and regulations. The proposed rule also

    required the CCO to establish policies and procedures required to be

    established by a registrant pursuant to the CEA and Commission

    regulations. The Commission believes that the benefits of the rule

    consist of consolidating oversight of compliance by FCMs, SDs, and MSPs

    in a single individual, thereby reducing the risk that compliance

    matters will be subject to inconsistent policies and procedures or that

    compliance matters will not receive the attention necessary to be

    effective.

    Commenters \151\ criticized the proposed rule for two reasons, each

    presumably based in part on the cost of expanding the traditional role

    of a CCO:

    ---------------------------------------------------------------------------

    \151\ Rosenthal commented that the Commission's rules should be

    revised in a manner that reflects the view that the CCO is only an

    advisor to management and should not be viewed as an enforcer of

    policies within the FCM. EEI and Newedge argued that the proposed

    rules go beyond what is required by the CEA by inappropriately

    imposing upon the CCO full responsibility to develop and enforce all

    policies.

    ---------------------------------------------------------------------------

    A CCO should not be viewed as an enforcer of compliance

    polices; and

    A CCO should not be required to develop all compliance

    policies.

    The Commission agrees with commenters that the rule could be

    modified to maintain the benefits identified above while imposing less

    burden on registrants. The Commission is therefore narrowing proposed

    Sec. 3.3(a) by (i) removing the requirement that a CCO be provided

    with ``full'' responsibility and authority; (ii) removing the

    requirement that a CCO ``enforce'' policies and procedures; (iii)

    limiting the responsibilities of the CCO to (a) the ``swaps

    activities'' of SDs and MSPs and (b) FCMs' derivatives activities

    included in the definition of FCM under section 1(a)(28) of the CEA;

    and (iv) clarifying that a CCO need only develop policies and

    procedures to fulfill the duties set forth in, and ensure compliance

    with, the CEA and Commission regulations. The Commission believes that

    the rule as modified will achieve the benefits of consolidated

    compliance oversight without imposing costs on registrants that are

    unnecessary to achieve this goal.

    5. CCO Reporting Line

    Proposed Sec. 3.3(a)(1) required that the CCO report to the board

    of directors or the senior officer of a registrant, that the board or

    senior officer approve the compensation of the CCO, and that the board

    or senior officer meet with the CCO at least once a year to discuss the

    effectiveness of compliance policies and their administration by the

    CCO. Proposed Sec. 3.3(a)(2) also prohibited the board or senior

    officer of a registrant from delegating its authority over the CCO,

    including the authority to remove the CCO. The Commission believes that

    these aspects of the rule will ensure CCO independence from influence,

    interference, or retaliation from business trading unit personnel and

    freedom from conflicts of interest in performance of the CCO's duties.

    The Commission believes CCO independence is crucial to achieving the

    benefits of the CCO role as envisioned under the statutory provisions

    of the CEA because an independent CCO is more likely to: (i) Question

    business line decisions, (ii) speak out on non-compliance issues and

    raise them with senior management and the board, and (iii) have stature

    within the firm to successfully institute a culture of compliance.

    Commenters raised the following issues with respect to the above-

    described aspects of the proposed rule:

    The CCO should be permitted to report to the governing

    body or senior officer of a division, rather than to the board; \152\

    ---------------------------------------------------------------------------

    \152\ Cargill recommended that the definition of board of

    directors be expanded to include a governing body of a division,

    such as a management committee, and that the Commission add a

    definition of ``senior officer'' to include a senior officer of a

    division, because a division might be more familiar with the swaps

    activities of an SD.

    ---------------------------------------------------------------------------

    The CCO should be permitted to report to a board

    committee, rather than to the whole board; \153\

    ---------------------------------------------------------------------------

    \153\ MetLife requested that the definition of board of

    directors include expert committees of the whole board.

    ---------------------------------------------------------------------------

    The CCO should be permitted to report to the board of a

    holding company; \154\

    ---------------------------------------------------------------------------

    \154\ The Working Group argued that the CCO should be allowed to

    report to a board of an affiliated entity.

    ---------------------------------------------------------------------------

    The CCO should be permitted to report to an officer other

    than the senior officer; \155\

    ---------------------------------------------------------------------------

    \155\ EEI, FIA, SIFMA, NFA, and The Working Group argued that

    the CCO should be permitted to operate under the direction of

    corporate officers other than the senior officer, as long as

    independence and authority as a control function is maintained.

    ---------------------------------------------------------------------------

    CCO compensation and termination decisions should be

    reserved to the independent members of the board; \156\

    ---------------------------------------------------------------------------

    \156\ Better Markets and Chris Barnard recommended that

    decisions to designate or terminate a CCO, as well as compensation

    decisions, be prescribed solely by independent members of the board,

    acting by majority vote.

    ---------------------------------------------------------------------------

    The CCO should be permitted to report to the full board at

    any time, without interference; \157\ and

    ---------------------------------------------------------------------------

    \157\ NWC recommended that (1) the term ``senior officer'' be

    defined as the CEO or chairman of the board, (2) the rule should

    permit the CCO to report to the full board at any time with no

    interference from a board committee or a CEO, and (3) that the rule

    should prohibit termination of the CCO unless the CCO is presented

    the opportunity to address the board.

    ---------------------------------------------------------------------------

    The CCO should have the right to address the board prior

    to termination.\158\

    ---------------------------------------------------------------------------

    \158\ Id.

    ---------------------------------------------------------------------------

    Having considered the costs and benefits implications of these

    issues, the Commission is adopting the rule as proposed. Section 4s(k)

    of the CEA requires the CCO to ``report directly'' to the board or the

    senior officer of the SD or MSP. The Commission believes, therefore,

    that despite the costs imposed the statutory requirement that the CCO

    report directly to the board or senior officer does not permit a firm

    to have its CCO report to a board committee, the independent members of

    the board, the board of a holding company, or any officer other than

    the senior officer.

    The Commission recognizes that adopting some commenters'

    recommendations would increase the independence of the CCO. The

    Commission has declined to modify the rule to include such

    recommendations because it believes the benefits outlined above will be

    sufficiently assured by the rule as adopted herein and thus the

    additional burden of more stringent independence requirements is

    unnecessary at this time.

    6. Qualifications of the CCO

    As proposed, Sec. 3.3(b) required the CCO to have the background

    and skills appropriate for fulfilling the responsibilities of the

    position, and prohibited an individual who is statutorily disqualified

    under sections 8a(2) or 8a(3) of the CEA from serving. The Commission

    rationale for this is that a well-qualified CCO, without a history of

    disqualifying attributes, is

    [[Page 20189]]

    more likely to fulfill the duties of the position successfully and have

    the stature and experience to demand the respect necessary to instill a

    culture of compliance. The Commission believes that an effective CCO

    serves an important role in guarding against registrant failures and

    misfeasance, and the resulting losses to customers and other market

    participants.

    Commenters criticized the above-described aspects of the proposed

    rule as follows, but no commenter provided any quantitative data to

    justify their arguments:

    It is unnecessary to include statutory disqualification as

    a qualification for the CCO; \159\

    ---------------------------------------------------------------------------

    \159\ NFA argued that the prohibition on individuals who are

    disqualified by statute is unnecessary because an SD, MSP, or FCM's

    registration could be denied or revoked under section 8a(2)-(3) of

    the CEA if any principal of the registrant is subject to a statutory

    disqualification.

    ---------------------------------------------------------------------------

    ``Background and skills appropriate for fulfilling the

    responsibilities of the position'' is too vague a standard--

    qualifications should be left to the discretion of the firm; \160\

    ---------------------------------------------------------------------------

    \160\ Cargill commented that the requirement for a CCO to have

    ``the background and skills appropriate'' is a commendable

    aspirational goal but is too vague a standard for Federal law, and

    is best reserved as a business decision. The Working Group also

    commented that wide latitude for qualifications of a CCO is

    necessary.

    ---------------------------------------------------------------------------

    The Commission should require CCOs to pass a specific

    compliance examination and be licensed; \161\ and

    ---------------------------------------------------------------------------

    \161\ Newedge recommended that CCOs be required to pass a

    specific compliance examination and obtain a specific compliance

    license, as is the case in the securities world.

    ---------------------------------------------------------------------------

    The Commission should prohibit members of a firm's legal

    department from acting as CCO due to potential conflicts of

    interest.\162\

    ---------------------------------------------------------------------------

    \162\ Better Markets argued that a CCO should not be permitted

    to be an attorney that represents the SD, MSP, or FCM, or its board

    because the potential conflict would disqualify such an attorney.

    ---------------------------------------------------------------------------

    Based on the issues raised by commenters, the Commission presumes

    that commenters are concerned about the cost of locating, recruiting,

    and compensating a CCO that meets the necessary qualifications, or

    about the costs to the market if CCOs are not well-qualified and fail

    to fulfill their duties under the CEA and rule. The Commission

    estimates that a well-qualified CCO for an FCM, SD, or MSP is likely to

    be compensated at approximately $216,000 per year.\163\

    ---------------------------------------------------------------------------

    \163\ The Commission staff estimates concerning the wage rates

    are based on salary information for the securities industry compiled

    by SIFMA. The salary estimate was taken from SIFMA Report on

    Management & Professional Earnings in the Securities Industry 2010.

    Staff took an average of the last two years of salary estimates for

    Chief Compliance Officers, modified to account for inflation as well

    as overhead and other benefits, then adjusted upward based on the

    additional responsibility demanded from SD, MSP, and FCM CCOs as

    required by the CEA (as noted by commenters).

    ---------------------------------------------------------------------------

    Having considered the costs and benefits implications of these

    issues, the Commission is adopting the rule as proposed. Given the

    duties and responsibilities of the CCO as set forth in the CEA and the

    rule, the Commission believes that the cost to FCMs, SDs, and MSPs to

    hire a well-qualified person to act as CCO are appropriate given the

    critical role the CCO will play in ensuring registrants comply with the

    CEA and Commission regulations. Moreover, the Commission believes the

    qualifications required by the rule as proposed are sufficient to

    ensure the necessary level of CCO qualification without need to adopt

    the more restrictive CCO qualifications (e.g., an examination and

    licensing requirement and/or legal counsel bar) recommended by some

    commenters. To maintain flexibility in the rule for the wide variety of

    registrants that will be affected, the Commission also is not defining

    what the ``background and skills appropriate for fulfilling the

    responsibilities of the position'' would be, leaving this determination

    to the discretion of the registrant as appropriate to their unique

    circumstances.

    7. Role of the CCO

    As proposed, Sec. 3.3 established a number of duties for the CCO.

    Proposed Sec. 3.3(d)(1) required the CCO to establish the registrant's

    compliance policies in consultation with the board of directors or

    senior officer. Proposed Sec. 3.3(d)(2) required the CCO, in

    consultation with the board or senior officer, to resolve any conflicts

    of interest that may arise. Proposed Sec. 3.3(d)(3) required the CCO

    to review and ``ensure compliance'' by the registrant with the

    registrant's compliance policies and all applicable laws and

    regulations.

    Commenters criticized the above-described aspects of the proposed

    rule as follows:

    Responsibility for resolving conflicts of interest belongs

    more appropriately to the board or senior officer, not a CCO; \164\

    ---------------------------------------------------------------------------

    \164\ NFA commented that resolution of conflicts of interest

    should rest with the board or the senior officer, in consultation

    with the CCO. FIA and SIFMA argued that when Congress used the term

    ``resolve any conflicts of interest that may arise,'' Congress did

    not mean resolve in the executive or managerial sense. Newedge

    commented that the CEO and business line supervisors are in a better

    position than the CCO to resolve conflicts. Participants in the May

    Meeting with Commission staff stated that resolving a conflict would

    traditionally be interpreted as eliminating the conflict, but that

    elimination is not always preferable and the compliance officer

    should not be the actual decision maker in the resolution.

    ---------------------------------------------------------------------------

    Responsibility for ensuring compliance belongs more

    appropriately to the board or senior officer, not a CCO; \165\

    ---------------------------------------------------------------------------

    \165\ NSCP argued that ``ensure compliance'' imposes a level of

    responsibility on a CCO that cannot be discharged and is

    inconsistent with the customary role of a compliance officer. Hess

    argued that the proposal concentrates too much of the compliance

    function on a single individual and recommended that the CCO should

    remain the monitor of the compliance monitors. FIA, SIFMA, The

    Working Group, Newedge, and NFA each argued that requiring the CCO

    to ensure compliance goes beyond existing compliance models and

    creates a standard that is impossible to satisfy. FIA and SIFMA

    further argued that the requirement to remediate non-compliance

    issues acknowledges that instances of noncompliance are not wholly

    preventable by any person. FIA and SIFMA recommended that ``ensure

    compliance'' should mean taking reasonable steps to adopt, review,

    test, and modify compliance policies. EEI and participants in the

    May Meeting with Commission staff stated that ensuring compliance

    could mean that the CCO escalates a problem that has not been

    resolved.

    ---------------------------------------------------------------------------

    The transfer of regulatory responsibility from executive

    officers to the CCO may result in executive officers spending less time

    and attention to compliance matters; \166\

    ---------------------------------------------------------------------------

    \166\ Newedge believes that any transfer of regulatory

    responsibility currently held by executive officers to the CCO could

    have the unintended effect of reducing the amount of time such

    officers spend on compliance matters.

    ---------------------------------------------------------------------------

    Firms will have difficulty retaining a CCO who is willing

    to perform the duties set forth in the rule.\167\

    ---------------------------------------------------------------------------

    \167\ NFA also argued that the rules improperly redefine a CCO's

    duties, and registrants will have difficulty retaining CCOs who are

    willing to perform these duties.

    ---------------------------------------------------------------------------

    Having considered the cost and benefit implications of these

    issues, the Commission presumes that commenters are concerned in part

    about the cost of expanding their compliance departments to fulfill

    duties currently or traditionally handled by other executive officers

    or departments. In response to this concern, the Commission is adopting

    the final rule as follows: (1) The Commission is revising proposed

    Sec. 3.3(d)(1) to track more closely the statutory language of section

    4s(k) and require that the CCO ``administer'' the compliance policies

    of the registrant; (2) the Commission is not removing the requirement

    that the CCO ``resolve'' conflicts of interest from the rule because

    the requirement is provided for in section 4s(k)(2)(C) of the CEA, but

    confirms, as suggested by commenters, that the CCO's role in

    ``resolving'' conflicts of interest may involve actions other than

    making the final decision; and (3) the Commission is modifying proposed

    Sec. 3.3(d)(3) to provide that the CCO must take ``reasonable steps to

    ensure compliance.''

    [[Page 20190]]

    The foregoing changes align the rule to the duties of the CCO for

    SDs and MSPs as set forth in the CEA, and, thus, the costs of these

    requirements are directly attributable to the statutory requirements of

    Congress, and not to Commission action. The Commission's decision to

    extend the same requirements to CCOs for FCMs is explained in detail

    above.

    8. Certification of the Annual Report by the CCO ``Under Penalty of

    Law''

    Proposed Sec. 3.3(d)(6) required the CCO of an SD, MSP, or FCM to

    prepare, sign, and certify, under penalty of law, the annual report

    specified in section 4s(k)(3) of the CEA.

    Commenters criticized the above-described aspects of the proposed

    rule as follows:

    The CEO, not the CCO, should certify the annual report;

    \168\

    ---------------------------------------------------------------------------

    \168\ Rosenthal commented that FINRA's approach to certification

    is preferable, i.e., the CEO certifies that the firm has processes

    to establish, maintain, review, test, and modify written compliance

    policies and written supervisory procedures reasonably designed to

    achieve compliance with securities laws, regulations, and FINRA

    rules. FIA, SIFMA, and Newedge each argued that section 4s(k)(3) of

    the CEA requires the CCO to sign the annual report, but does not

    require the CCO to certify the report. FIA, SIFMA, MFA, Newedge, and

    NFA all recommended that the rule be revised to require the CEO to

    certify the report. Participants in the May Meeting with Commission

    staff stated that requiring the CEO to make the certification

    appropriately shares responsibility between compliance and business

    management. FIA and SIFMA recommended that, with respect to any

    Commission registrant that is also a BD, the Commission should

    require the CEO to make the certification.

    ---------------------------------------------------------------------------

    Requiring the CCO to certify the annual report under

    penalty of law will make it difficult for registrants to retain a CCO

    and, thus, should not be required; \169\ and

    ---------------------------------------------------------------------------

    \169\ FIA and SIFMA felt that imposing criminal liability for

    annual report certifications would hinder the ability to fill the

    position of CCO. FIA and SIFMA requested that the Commission clarify

    that criminal liability for the certification will not apply (absent

    a knowing and willful materially false and misleading statement)

    because there is no indication that Congress ever thought CCOs

    should be subject to criminal liability. Similarly, NSCP requested

    that the Commission clarify whether ``under penalty of law'' means

    liability under 18 U.S.C. 1001 for a false statement to a Federal

    officer. Rosenthal argued that requiring the CCO to certify under

    penalty of law will make the CCO liable for firm infractions and

    will give disgruntled customers a roadmap for frivolous lawsuits.

    Newedge also believes that the requirement to certify under penalty

    of law is not fair or practicable because whoever certifies will

    have to rely on many individuals to compile the report. On the other

    hand, Hess commented that the certification language strikes an

    appropriate balance such that strict liability is not imposed for

    inadvertent errors.

    ---------------------------------------------------------------------------

    The required certification should be subject to a

    materiality qualifier.\170\

    ---------------------------------------------------------------------------

    \170\ NSCP commented that the certification that the report is

    accurate and complete should have a materiality qualifier added to

    it. Participants in the May Meeting with Commission staff urged the

    Commission to adopt a standard for the annual report certification

    that is reasonably attainable.

    ---------------------------------------------------------------------------

    Having considered the cost-benefit implications of these issues and

    the arguments raised by commenters, the Commission is modifying the

    requirement that the CCO make the required certification of the annual

    report to allow the registrant the discretion to choose whether the CCO

    or the CEO makes the certification. As explained by commenters, this

    change will make it easier and less costly for registrants to recruit

    and retain candidates for the position of CCO.

    However, consistent with the statutory text in section

    4s(k)(3)(B)(ii) of the CEA, the Commission is also declining to add a

    materiality qualifier to the certification, as suggested by commenters.

    Moreover, not qualifying certification on materiality is consistent

    with the approach taken in final rules for SDRs \171\ and DCOs,\172\

    and with proposed CCO rules for SEFs; \173\ the Commission expects

    consistent regulation of its registrants and registered entities to

    benefit the Commission's regulatory mission by increasing the

    efficiency of oversight. The Commission believes that limiting the

    CCO's certification requirement with the qualifier ``to the best of his

    or her knowledge and reasonable belief'' sufficiently mitigates

    commenters' liability costs concerns because the rule would not impose

    liability for compliance matters that are beyond the certifying

    officer's knowledge and reasonable belief at the time of certification.

    ---------------------------------------------------------------------------

    \171\ See Swap Data Repositories: Registration Standards, Duties

    and Core Principles, 76 FR at 54584.

    \172\ See Derivatives Clearing Organization General Provisions

    and Core Principals, 76 FR at 69435.

    \173\ See Core Principles and Other Requirements for Swap

    Execution Facilities, 76 FR 1214, 1252 (Jan. 7, 2011).

    ---------------------------------------------------------------------------

    Having modified the rule as described above, and otherwise confined

    the rule to the requirements of the CEA, the Commission believes that

    the costs of these requirements are directly attributable to the

    statutory requirements of Congress, and not to Commission action. The

    Commission's decision to extend the same requirements to CCOs for FCMs

    is explained in detail above.

    9. Content of the Annual Report

    The proposed regulation required the annual report to contain (1) a

    description of the compliance by the registrant with respect to the CEA

    and regulations; (2) a description of each of the registrant's

    compliance policies; (3) a review of each applicable requirement under

    the CEA and regulations, and, with respect to each, identification of

    the policies that ensure compliance, an assessment as to the

    effectiveness of the policies, discussion of areas of improvement, and

    recommendations of potential or prospective changes or improvements to

    its compliance program and resources devoted to compliance; (4) a

    description of the registrant's financial, managerial, operational, and

    staffing resources set aside for compliance with the CEA and

    regulations, including any deficiencies in such resources; (5) a

    delineation of the roles and responsibilities of a registrant's board

    of directors or senior officer, relevant board committees, and staff in

    addressing any conflicts of interest, including any necessary

    coordination with, or notification of, other entities, including

    regulators; and (6) a certification of compliance with sections 619 and

    716 of the Dodd-Frank Act (the Volcker Rule and Derivatives Push-Out),

    and any rules adopted pursuant to these sections. The proposed rule

    also required FCMs, SDs, and MSPs to maintain records of its compliance

    policies, materials provided to the board in connection with its review

    of the annual compliance report, and work papers that form the basis of

    the annual compliance report.

    The Commission believes the benefits of the annual report result

    from the focus on compliance with the CEA and Commission regulations.

    The annual requirement to compile in a single document the results of a

    registrant's compliance policies and procedures should serve as an

    efficient means to focus the registrant's board and senior management

    on areas requiring additional compliance resources or changes to

    business practices; it also will provide the Commission with a detailed

    overview of the state of compliance of the industry as a whole. This

    annual and ongoing compliance focus will result in increased industry

    compliance, thereby increasing market security and stability. A secure

    and stable market fosters increased market confidence and increased

    activity by investors and hedgers managing risk.

    Commenters raised the following issues with respect to the above-

    described aspects of the proposed rule:

    Overbreadth concerns with the requirements for the content

    of the annual report; \174\

    ---------------------------------------------------------------------------

    \174\ NSCP, The Working Group, EEI, and Hess each argued that

    the level of detail contemplated by the rule would impose

    unnecessary burdens on the CCO with little offsetting benefits. NSCP

    argued that a better approach would be to follow the SEC

    requirements for annual reviews of compliance by registered

    investment advisers. NSCP believes the proposed rule is overbroad

    and discourages reporting of compliance issues to the CCO. Newedge

    argued that thousands of Federal, SRO, and internal rules apply, so

    the report should contain a summation of compliance, with details

    only for areas of material noncompliance. FIA and SIFMA argued that

    a one-size-fits-all approach to the annual report requirements is

    not appropriate because registrants vary in size and focus. FIA,

    SIFMA, and The Working Group recommended that the Commission specify

    the material issues that should be discussed, or provide a standard

    form. FIA, SIFMA, and NFA also argued that the report should

    identify the policies that are reasonably designed to result in

    compliance, not that ensure compliance. Hess recommended that the

    annual report contain only a summary of the registrant's compliance

    policies and procedures. CMC commented that the scope of activities

    included in the annual report should be limited to those directly

    triggering the requirement of a CCO. EEI argued that inclusion of

    descriptions of violations in the report should be decided on a

    case-by-case basis by the registrant's governing body. NFA requested

    that a materiality qualifier be added to the requirement that

    registrants include a description of non-compliance. FIA and SIFMA

    argued that the CCO is not in a position to describe the financial,

    material, operational, and staffing resources set aside for

    compliance, rather the CCO only should be required to describe the

    resources of the compliance department and any recommendations that

    the CCO has made to senior management with regard to the same. FIA

    and SIFMA argued that the Sarbanes-Oxley Act already requires public

    companies to report the roles and responsibilities of its board,

    senior officers, and committees in resolving conflicts of interest,

    so the Commission should allow such reporting to satisfy this

    content requirement for the annual report. NFA also recommended that

    the reporting of any necessary coordination with, or notification of

    other entities, including regulators, should be deleted. NFA, FIA,

    and SIFMA recommended that the certification of compliance with

    sections 619 and 716 of the Dodd-Frank Act be deleted, arguing that

    the Commission should wait for the implementing rulemakings for such

    sections before determining certification requirements.

    ---------------------------------------------------------------------------

    [[Page 20191]]

    Concern that the annual report is not subject to board

    approval or a board addendum noting any disagreement with the report;

    \175\

    ---------------------------------------------------------------------------

    \175\ Better Markets recommended that the board approve the

    annual report in its entirety or specify where and why it disagrees

    with any provision, and then CCOs should provide the report to the

    Commission either as approved or with statements of disagreement.

    ---------------------------------------------------------------------------

    Concern that some requirements for the content of the

    annual report are inappropriate for a document that may be publicly

    available; \176\ and

    ---------------------------------------------------------------------------

    \176\ The Working Group argued that a description of

    deficiencies in resources dedicated to compliance would require a

    CCO to identify potential shortcomings and report them in a document

    likely to be available to the public, which could materially hinder

    the CCO's ability to function as an integral member of the

    management team.

    ---------------------------------------------------------------------------

    Concern that, absent a materiality qualifier, the

    recordkeeping obligations will be unduly burdensome.\177\

    ---------------------------------------------------------------------------

    \177\ The Working Group argued that retaining all materials

    relating to the preparation of the report will cause the CCO to

    retain all materials for fear of an audit that second-guesses the

    CCO's materiality judgments, or the CCO will limit his or her

    inquiries to avoid making a determination of materiality. The

    Working Group recommended that materials to be retained should be

    only those germane to the content of the compliance report.

    ---------------------------------------------------------------------------

    In response to comments, the Commission has reduced the cost burden

    of the annual report by modifying the rule as follows: (1) Requiring a

    description of the registrant's policies and procedures, rather than a

    description of the compliance of the registrant; (2) requiring

    identification of the registrant's policies and procedures that ``are

    reasonably designed'' to ensure compliance, rather than those that

    ensure compliance; (3) including a required description of material

    non-compliance issues; (4) including a materiality standard with

    respect to the description of any deficiency in compliance resources;

    (5) deleting the proposed delineation of the roles and responsibilities

    of a registrant's board of directors or senior officer, relevant board

    committees, and staff in addressing any conflicts of interest; and (6)

    removing the requirement to certify compliance with sections 619 and

    716. The Commission has not modified the recordkeeping requirement

    because it believes the rule sufficiently qualifies the materials that

    must be retained by stating that the records must be ``relevant'' to

    the annual report.

    The Commission observes that section 4s(k) of the CEA requires the

    annual report and specifies that it contain a description of the

    compliance of the SD or MSP with respect to the CEA, and a description

    of each policy and procedure of the SD or MSP of the CCO (including the

    code of ethics and conflict-of-interest policies). To the extent that

    the rule also requires these descriptions, the Commission believes that

    the costs of these requirements are attributable to statutory

    requirements not subject to Commission discretion. The Commission's

    decision to extend the same requirements to CCOs for FCMs is explained

    in detail above. Therefore, the Commission believes the modified rule

    would impose modest costs, attributable to the narrow requirements of:

    (i) Listing any material changes to compliance policies and procedures;

    and (ii) describing the financial, managerial, operational, and

    staffing resources set aside for compliance, including any material

    deficiencies. The Commission believes the benefits of these

    requirements warrant the limited incremental costs to comply.

    Costs

    Section 4s(k) requires SDs and MSPs to designate a CCO and

    undertake certain other compliance measures. The costs and benefits

    that necessarily result from these basic statutory requirements are

    considered to be the ``baseline'' against which the costs and benefits

    of the Commission's final rules are compared or measured. The

    ``baseline'' level of costs includes the costs that result from the

    following activities required by the statute:

    Designating a CCO;

    Corporate governance changes to require the CCO to report

    directly to the board or senior officer;

    Reviewing the compliance of the SD and MSP with section 4s

    of the CEA;

    Requiring the CCO, in consultation with the board or the

    senior officer, to resolve any conflicts of interest;

    Administration of each policy and procedure required to be

    established under section 4s;

    Ensuring compliance with the CEA and Commission

    regulations relating to swaps;

    Establishing procedures for the handling, management

    response, remediation, retesting, and closing of non-compliance issues;

    Preparing and signing a compliance report containing a

    description of compliance and a description of each policy and

    procedure of the SD or MSP; and

    Furnishing the annual report to the Commission along with

    each appropriate financial report.

    Similarly Section 4d(d) defines a statutory ``baseline'' against

    which the costs and benefits of the Commission's final rules are to be

    measures with respect to FCMs. That ``baseline'' cost level is defined

    by those costs that result from an FCM's CCO designation.

    Compliance with the statutory baselines alone will result in costs

    for FCMs, SDs and MSPs. For example, designating a CCO that reports to

    the board or senior officer could include the cost of board action and

    the salary of the CCO. Similarly, preparing and signing a compliance

    report containing a description of compliance and each compliance

    policy and procedure entails the cost of the CCO's time.

    Congress mandated that the Commission adopt rules to implement each

    of the statutory provisions. The following implementation decisions may

    cause affected entities to incur costs to comply with the final

    regulations regarding designation of a CCO, the duties of the CCO, and

    the annual report:

    Extending the statutory and rule requirements applicable

    to SDs and MSPs to FCMs;

    Providing the CCO with authority to develop, in

    consultation with the board

    [[Page 20192]]

    or senior officer, appropriate policies and procedures;

    Requiring the board or senior officer to appoint the CCO,

    approve the CCO's compensation, and meet with the CCO once a year;

    Requiring designation of a CCO with the background and

    skills appropriate for fulfilling the responsibilities of the position

    and that is not statutorily disqualified;

    Submission of a Form 8-R to the Commission for the CCO as

    a principal of the firm;

    Listing any material changes to compliance policies and

    procedures in the annual report; and

    Describing the financial, managerial, operational, and

    staffing resources set aside for compliance, including any material

    deficiencies, in the annual report.

    As discussed, the Commission has attempted, wherever possible, to

    alleviate burdens for registrants while remaining consistent with the

    CEA. The Commission has taken steps to reduce the responsibilities of

    the CCO and lower staffing and corporate governance costs for the

    entity by permitting the CCO to perform other duties and act as the CCO

    for more than one entity. The Commission has removed the requirement

    that the CCO be provided with the authority to enforce compliance

    policies and procedures, limited the CCO's duties to those directly

    required by the CEA and Commission regulations relating only to the

    swaps activities of SDs and MSPs and the derivatives activities

    included in the definition of FCM under section 1(a)(28) of the CEA,

    and required the CCO be responsible for administering, not

    establishing, compliance policies. The Commission also is permitting

    either the CCO or the CEO to certify the annual report.

    The Commission estimates a base salary for a Chief Compliance

    Officer in the financial services industry at approximately $216,000

    per year, as explained above. Because entities may designate a current

    employee as the CCO, some SDs, MSPs, or FCMs may not need to hire an

    additional member of staff. For example, entities currently regulated

    by prudential authorities already may have a CCO or another employee

    who could serve as a CCO; other entities may determine it is more cost-

    effective based on their current business models to designate a current

    employee as CCO, perhaps adjusting that individual's salary

    accordingly. Because of the wide variety of possibilities in

    determining the compensation of a CCO, the Commission finds it is

    impossible to estimate a cost burden for the industry of the statutory

    requirement to designate a CCO.

    One commenter presented a report prepared by NERA stating that

    designation of a CCO and preparation of an annual compliance report by

    certain entities would entail average incremental start-up costs of

    $445,000 and average incremental ongoing annual costs of $760,000.\178\

    The Commission observes that the incremental average costs provided by

    NERA do not differentiate between the costs of compliance with proposed

    Sec. 3.3 and the costs of compliance with sections 4d(d) and 4s(k) of

    the CEA absent Commission rulemaking. Accordingly, the Commission

    believes that the cost estimates presented by NERA exceed the

    incremental costs attributable to Commission rulemaking. The NERA

    report, however, provides insufficient information to allow the

    Commission to assess the magnitude of the excess.

    ---------------------------------------------------------------------------

    \178\ NERA, Cost-Benefit Analysis of the CFTC's Proposed Swap

    Dealer Definition Prepared for the Working Group of Commercial

    Energy Firms, December 20, 2011. In this late-filed comment

    supplement, NERA concludes that cost-benefit considerations compel

    excluding entities ``engaged in production, physical distribution or

    marketing of natural gas, power, or oil that also engage in active

    trading of energy derivatives''--termed ``nonfinancial energy

    companies'' in the report--from regulation as swap dealers,

    including Sec. 3.3.

    ---------------------------------------------------------------------------

    Other than as indicated below with respect to CCO compensation and

    costs resulting from collections of information subject to the

    Paperwork Reduction Act, incorporated by reference herein, the

    Commission has no reliable quantitative data from which to reasonably

    estimate the costs of compliance associated with the CCO's duties and

    the annual report required by the rules in this release. After

    conducting a review of applicable academic literature, the Commission

    is not aware of any research reports or studies that are directly

    relevant to its considerations of costs and benefits of the final

    rules. The Commission anticipates that many entities may currently have

    a CCO pursuant to other regulations. The Commission notes that dually

    registered FCMs and BDs are more likely to have a CCO \179\ than

    entities that are subject to such requirement for the first time.\180\

    Costs, therefore, are expected to be higher for those entities not

    currently dually registered. Registrants that do not currently have a

    CCO or a compliance program may choose to develop a program in-house if

    their activities are limited and the regulatory requirements well-

    understood. Other registrants may choose to purchase an off-the-shelf

    compliance manual and adjust it to correspond to their regulatory

    requirements. Still others may hire a third-party compliance firm, a

    law firm, or an accounting firm to draft a firm-specific manual. As of

    2003, when the SEC published final compliance program rules for

    investment companies and investment advisers, the costs for these

    options ranged from $1,000 to $200,000.\181\

    ---------------------------------------------------------------------------

    \179\ In this respect, the Commission observes that 55% of

    current FCMs are also registered as BDs with the SEC, and thus may

    already have a CCO as required under the rules of FINRA. See letter

    from NFA, dated Jan. 18, 2011 (comment file for 75 FR 70881

    (Designation of a Chief Compliance Officer; Required Compliance

    Polices; and Annual Report of a FCM, SD, or MSP)).

    \180\ The Commission notes that in 2006 the UK FSA conducted a

    cost benefit analysis when promulgating requirements related to

    ensuring effective compliance with the applicable regulatory

    framework, including a requirement that a compliance officer be

    appointed that reports to the governing body and has the necessary

    authority and responsibility for the compliance oversight function.

    The UK FSA was adopting rules that replaced existing guidance and

    concluded from survey results that the incremental aggregate cost of

    compliance for approximately 2000-2500 firms was [pound]4.5 to 5.5

    million in one-off costs ($7.1 to 8.6 million at the current

    exchange rate, or $3,550 to $4,300 per firm) and [pound]6.5 to 8.5

    million in ongoing costs ($10.1 to 13.3 million at the current

    exchange rate, or $5,050 to $6,650 per firm). See FSA Consultation

    Paper 06/9, Organisational Systems and Controls: Common Platform for

    Firms, Annex 2 (May 2006).

    \181\ See Compliance Programs of Investment Companies and

    Investment Advisers, 68 FR 74714 (Dec. 24, 2003). The Commission

    notes that significant differences in the activities and structures

    of investment advisors and SDs/MSPs/FCMs may create significant

    differences in the costs incurred by the respective entities; these

    SEC estimates provide at best an imperfect measure from which to

    very roughly attempt to gauge compliance costs for affected

    entities.

    ---------------------------------------------------------------------------

    Certain of the costs associated with these CCO, compliance policy,

    and annual report rules result from collections of information subject

    to the Paperwork Reduction Act. Costs attributable to collections of

    information subject to the PRA are discussed further in section V.B.3.

    below. The Commission has also considered these costs, which it

    incorporates by reference herein, in its section 15(a) analysis.

    Benefits

    The Commission believes that the CCO rules will protect market

    participants and the public by promoting compliance with the CEA and

    Commission regulations through (1) the designation and effective

    functioning of the CCO, and (2) the establishment of a framework for

    preparation of a meaningful annual review of an FCM's, SD's, and MSP's

    compliance program. As a qualified, impartial, accountable focal point,

    the CCO is an effective vehicle to ensure that vital market actors--

    SDs, MSPs, and FCMs--comply with the law and

    [[Page 20193]]

    regulations, including those designed to contain systemic risk through

    appropriate risk management efforts. In this way, these rules foster

    financial integrity and responsible risk management practices to

    protect the public from the adverse consequences of FCM, SD, or MSP

    failure or misfeasance that an effective compliance program may help to

    prevent.

    The annual compliance report will help FCMs, SDs, MSPs, and the

    Commission to assess whether the registrant has mechanisms in place to

    address adequately compliance problems that could lead to a failure of

    the registrant. It also will assist the Commission in determining

    whether the registrant remains in compliance with the CEA and the

    Commission's regulations, including the customer protection regime for

    segregation of customer funds, supervision of trading activities, and

    risk management. Such compliance will protect market participants and

    the public from market disruptions and financial losses resulting from

    the failure or misfeasance of a registrant.

    Section 15(a) Determination

    1. Protection of Market Participants and the Public

    The Commission believes that the compliance measures specified in

    these rules reinforce the CEA's protections for swap market

    participants, futures markets participants, and the public. Just as the

    CEA's regulation of futures and swaps transactions promotes the

    ``national public interest by providing a means for managing and

    assuming price risks, discovering prices, or disseminating pricing

    information through trading in liquid, fair, and financially secure

    trading facilities'' \182\ so do these rules by ensuring, through a

    CCO, that entities are in compliance with CEA regulations.

    Concentrating compliance responsibility in one individual with

    independent authority, rather than dispersing it throughout an

    organization (and thus potentially diminishing accountability), is one

    example of this. Compliance evaluation and preparation of an annual

    report are other examples. Thus, taken together, these requirements set

    out a compliance regime that endeavors to ensure protection for market

    participants and public that the CEA is intended to provide. Moreover,

    to the extent that provisions of the CEA diminish the potential for

    harmful market disruptions and attendant financial losses to market

    participants and the general public as Congress intended in enacting

    the Dodd-Frank Act, these rules enhance that protection.

    ---------------------------------------------------------------------------

    \182\ Section 3(a) of the CEA.

    ---------------------------------------------------------------------------

    While the Commission recognizes there are costs associated with

    this rulemaking and the mandate from Congress it represents, the

    Commission believes that, as discussed above, it has included measures

    to afford firms flexibility in the designation of a CCO, as well as

    other made other burden-reducing changes to the proposed rules. It

    believes these measures minimize the costs attributable to

    implementation decisions within its statutory authority. The Commission

    does not believe that any such incremental costs undermine effective

    protection of market participants and the public, but rather will be a

    worthwhile investment toward enhancing that protection.

    2. Efficiency, Competitiveness, and Financial Integrity of Markets

    183

    Secure and stable SDs, MSPs, and FCMs are critical components of

    the efficient, competitive, and financially sound functioning of

    derivatives markets--futures and swaps. The financial integrity of

    these markets, in particular, is achieved through layers of protection.

    Requirements for an effective FCM, SD, and MSP compliance program will

    add a new layer of protection to ensure that registrants remain

    compliant with the CEA and Commission regulations, and in particular

    those relating to risk management, diligent supervision, and system

    safeguards.

    ---------------------------------------------------------------------------

    \183\ Although by its terms CEA section 15(a)(2)(B) applies to

    futures markets only, the Commission finds this factor useful in

    analyzing regulations pertaining to swaps markets as well.

    ---------------------------------------------------------------------------

    An effective CCO will provide benefits to FCMs, SDs, and MSPs and

    the markets they serve by implementing and overseeing compliance

    measures that enhance the safety and efficiency of registrants and

    reduce systemic risk. Reliable and financially sound FCMs, SDs, and

    MSPs are essential for the stability of the derivatives markets they

    serve, and for the greater public, which benefits from a sound

    financial system.

    The Commission believes that to the extent there are any

    incremental costs associated with these rules attributable to the

    implementation decisions within its statutory authority, they are

    competitively neutral. They do not favor or disfavor any class of

    market participant over others. In other words, no entity should have a

    greater advantage over another based on these rules alone.

    3. Price Discovery

    The Commission has identified no likely material impact on price

    discovery from the costs and benefits of these rules pertaining to CCO

    designation and related compliance requirements.

    4. Sound Risk Management

    The Commission believes these rules promote sound risk management.

    The regulatory provisions that interpret or implement the statutory

    requirements for the CCO and annual report serve to reinforce and

    ensure the effectiveness of FCM, SD, and MSP compliance programs,

    including their risk management components. Compliance with Sec.

    23.600 (risk management program) and related regulations encompasses,

    among other things, policies and procedures for monitoring and managing

    of credit exposures to counterparties, market risk, liquidity risk,

    settlement risk, and other applicable risk exposures. Compliance with

    Sec. 1.14 (risk assessment recordkeeping requirements for FCMs) and

    related regulations encompasses, among other things, policies and

    procedures for monitoring and managing of credit risk, market risk, and

    other applicable risk exposures. The CCO has responsibility to ensure

    that the FCM, SD, or MSP is compliant with these regulations. Costs

    attendant to satisfying CCO and annual report requirements in these

    rules represent an investment towards improved risk management, not a

    diminution from them.

    5. Other Public Interest Considerations

    The Commission does not believe that the rule will have a material

    effect on public interest considerations other than those identified

    above.

    H. Conclusion

    Having considered the costs and benefits of the final rules in

    light of the factors enumerated in section 15(a)(2) of the CEA, the

    Commission is adopting the rules as set forth in this release.

    V. Related Matters

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) \184\ requires that agencies

    consider whether the rules they propose will have a significant

    economic impact on a substantial number of small entities and if so,

    provide a regulatory flexibility analysis respecting the impact. The

    Commission has already established certain definitions of ``small

    entities'' to

    [[Page 20194]]

    be used in evaluating the impact of its rules on such small entities in

    accordance with the RFA.\185\ SDs and MSPs are new categories of

    registrant. Accordingly, the Commission noted in the proposals that it

    had not previously addressed the question of whether such persons were,

    in fact, small entities for purposes of the RFA.

    ---------------------------------------------------------------------------

    \184\ 5 U.S.C. 601 et seq.

    \185\ 47 FR 18618 (Apr. 30, 1982).

    ---------------------------------------------------------------------------

    In this regard, the Commission explained that it previously had

    determined that FCMs should not be considered to be small entities for

    purposes of the RFA, based, in part, upon FCMs' obligation to meet the

    minimum financial requirements established by the Commission to enhance

    the protection of customers' segregated funds and protect the financial

    condition of FCMs generally. Like FCMs, SDs will be subject to minimum

    capital and margin requirements, and are expected to comprise the

    largest global financial firms--and the Commission is required to

    exempt from designation as an SD entities that engage in a de minimis

    level of swaps dealing in connection with transactions with or on

    behalf of customers. Accordingly, for purposes of the RFA for the

    proposals and future rulemakings, the Commission proposed that SDs not

    be considered ``small entities'' for essentially the same reasons that

    it had previously determined FCMs not to be small entities.

    The Commission further explained that it had also previously

    determined that large traders are not ``small entities'' for RFA

    purposes, with the Commission considering the size of a trader's

    position to be the only appropriate test for the purpose of large

    trader reporting. The Commission then noted that MSPs maintain

    substantial positions in swaps, creating substantial counterparty

    exposure that could have serious adverse effects on the financial

    stability of the United States banking system or financial markets.

    Accordingly, for purposes of the RFA for the proposals and future

    rulemakings, the Commission proposed that MSPs not be considered

    ``small entities'' for essentially the same reasons that it previously

    had determined large traders not to be small entities.

    The Commission concluded its RFA analysis applicable to SDs and

    MSPs as follows: ``The Commission is carrying out Congressional

    mandates by proposing these rules. The Commission is incorporating

    registration of SDs and MSPs into the existing registration structure

    applicable to other registrants. In so doing, the Commission has

    attempted to accomplish registration of SDs and MSPs in the manner that

    is least disruptive to ongoing business and most efficient and

    expeditious, consistent with the public interest, and accordingly

    believes that these registration rules will not present a significant

    economic burden on any entity subject thereto.''

    The Commission did not receive any comments on its analysis of the

    application of the RFA to SDs and MSPs.

    The final rules will also impact FCMs and IBs, each of which is

    addressed separately in the following paragraphs.

    In its proposals, the Commission explained that it had previously

    established certain definitions of ``small entities'' to be used in

    evaluating the impact of the Commission's rules on such small entities

    in accordance with the RFA. In the Commission's ``Policy Statement and

    Establishment of Definitions of `Small Entities' for Purposes of the

    Regulatory Flexibility Act,'' \186\ the Commission concluded that

    registered FCMs should not be considered to be small entities for

    purposes of the RFA. The Commission's determination in this regard was

    based, in part, upon the obligation of registered FCMs to meet the

    capital requirements established by the Commission. Likewise, the

    Commission determined ``that, for the basic purpose of protection of

    the financial integrity of futures trading, Commission regulations can

    make no size distinction among registered FCMs.'' \187\ Thus, with

    respect to registered FCMs, the Commission believes that the proposed

    regulations will not have a significant economic impact on a

    substantial number of small entities.

    ---------------------------------------------------------------------------

    \186\ 47 FR 18618, Apr. 30, 1982.

    \187\ Id. at 18619.

    ---------------------------------------------------------------------------

    The Commission previously has determined that, for purposes of the

    RFA, the Commission should ``evaluate within the context of a

    particular rule proposal whether all or some [IBs] should be considered

    to be small entities and, if so, to analyze the economic impact on

    [IBs] of any such rule at that time. Specifically, the Commission

    recognizes that the [IB] definition, even as narrowed to exclude

    certain persons, undoubtedly encompasses many business enterprises of

    variable size.'' \188\ At present, IBs are subject to various existing

    rules that govern and impose minimum requirements on their internal

    compliance operations, based on the nature of their business. The

    Commission believes that the amendments will merely augment the

    existing compliance requirements of such persons to address potential

    conflicts of interest within such firms. To the extent that certain IBs

    may be considered to be small entities, the Commission believes that

    the final rules will not have a significant economic impact.

    ---------------------------------------------------------------------------

    \188\ 48 FR 35248, 35276, Aug. 3, 1983.

    ---------------------------------------------------------------------------

    The Commission did not receive any comments on its analysis of the

    application of the RFA to FCMs and IBs.

    Accordingly, pursuant to Section 605(b) of the RFA, 5 U.S.C.

    605(b), the Chairman, on behalf of the Commission, certifies that these

    rules and rule amendments will not have a significant economic impact

    on a substantial number of small entities.

    B. Paperwork Reduction Act

    The Commission may not conduct or sponsor, and a registrant is not

    required to respond to, a collection of information unless it displays

    a currently valid Office of Management and Budget (OMB) control number.

    The Commission's adoption of Sec. Sec. 23.200 through 23.205

    (Reporting, Recordkeeping, and Daily Trading Records), 23.600 (Risk

    Management Program), 23.601 (Monitoring of Position Limits), 23.602

    (Diligent Supervision), 23.603 (Business Continuity and Disaster

    Recovery), 23.605 (Conflicts of Interest Policies and Procedures for

    SDs and MSPs), 23.606 (General Information: Availability for Disclosure

    and Inspection), 23.607 (Antitrust Considerations), 3.3 (Chief

    Compliance Officer), and 1.71 (Conflicts of Interest Policies and

    Procedures for FCMs and IBs) impose new information collection

    requirements on registrants within the meaning of the Paperwork

    Reduction Act.\189\

    ---------------------------------------------------------------------------

    \189\ 44 U.S.C. 3501 et seq.

    ---------------------------------------------------------------------------

    Accordingly, the Commission requested and OMB assigned control

    numbers for the required collections of information. The Commission has

    submitted this notice of final rulemaking along with supporting

    documentation for OMB's review in accordance with 44 U.S.C. 3507(d) and

    5 CFR 1320.11. The title for these collections of information are

    ``Reporting, Recordkeeping, and Daily Trading Records Requirements for

    Swap Dealers and Major Swap Participants, OMB control number 3038-

    0087,'' ``Regulations Establishing and Governing the Duties of Swap

    Dealers and Major Swap Participants, OMB control number 3038-0084,''

    ``Conflicts of Interest Policies and Procedures by Swap Dealers and

    Major Swap

    [[Page 20195]]

    Participants, OMB control number 3038-0079,'' ``Annual Report for Chief

    Compliance Officer of Registrants, OMB control number 3038-0080,'' and

    ``Conflicts of Interest Policies and Procedures by Futures Commission

    Merchants and Introducing Brokers, OMB control number 3038-0078.''

    \190\ Many of the responses to this new collection of information are

    mandatory.

    ---------------------------------------------------------------------------

    \190\ These collections include certain collections required

    under the Business Conduct Standards with Counterparties rulemaking,

    as stated in that rulemaking. See Business Conduct Standards for

    Swap Dealers and Major Swap Participants with Counterparties, 77 FR

    9734 (Feb. 17, 2012).

    ---------------------------------------------------------------------------

    The Commission protects proprietary information according to the

    Freedom of Information Act and 17 CFR part 145, ``Commission Records

    and Information.'' In addition, Section 8(a)(1) of the CEA strictly

    prohibits the Commission, unless specifically authorized by the Act,

    from making public ``data and information that would separately

    disclose the business transactions or market positions of any person

    and trade secrets or names of customers.'' The Commission also is

    required to protect certain information contained in a government

    system of records according to the Privacy Act of 1974, 5 U.S.C. 552a.

    The regulations require each respondent to furnish certain

    information to the Commission and to maintain certain records.\191\ The

    Commission invited the public and other Federal agencies to comment on

    any aspect of the information collection requirements discussed in the

    Recordkeeping NPRM, the Duties NPRM, the CCO NPRM, the SD/MSP Conflicts

    NPRM, and the FCM/IB Conflicts NPRM. Pursuant to 44 U.S.C.

    3506(c)(2)(B), the Commission solicited comments in order to: (i)

    Evaluate whether the proposed collections of information were necessary

    for the proper performance of the functions of the Commission,

    including whether the information will have practical utility; (ii)

    evaluate the accuracy of the Commission's estimates of the burden of

    the proposed collections of information; (iii) determine whether there

    are ways to enhance the quality, utility, and clarity of the

    information to be collected; and (iv) minimize the burden of the

    collections of information on those who are to respond, including

    through the use of automated collection techniques or other forms of

    information technology.

    ---------------------------------------------------------------------------

    \191\ See 75 FR at 76674 (maintain transaction and position

    records of swaps, including daily trading records of swaps and

    related cash and forward transactions; business records; records of

    data and information reported to SDRs and for real time public

    reporting purposes).

    See 75 FR at 71404 (establish a risk management program,

    including specific policies for compliance with position limits and

    to ensure business continuity and disaster recovery; policies to

    prevent unreasonable restraints of trade and anticompetitive

    burdens; establish systems to diligently supervise the activities

    relating to its business; and make certain information available for

    disclosure and inspection by the Commission).

    See 75 FR at 71395 (adopt conflicts of interest policies and

    procedures; recordkeeping obligations related to implementation of

    policies and procedures designed to ensure compliance with

    Commission regulations; document certain communications between non-

    research and research personnel; record of the basis for

    determination of research personnel compensation; provision of

    certain disclosures to recipients of research reports).

    See 76 FR at 70887 (prepare a Form 8-R designating a CCO; draft

    and maintain certain compliance policies and procedures; annually

    prepare and furnish to the Commission an annual report describing

    the registrant's compliance policies and resources and compliance

    with the CEA and Commission regulations; amend previously furnished

    annual reports, if necessary; and maintain records related to

    compliance policies and annual reports).

    See 75 FR at 70157 (adopt conflicts of interest policies and

    procedures; recordkeeping obligations related to implementation of

    policies and procedures designed to ensure compliance with

    Commission regulations; document certain communications between non-

    research and research personnel; record of the basis for

    determination of research personnel compensation; provision of

    certain disclosures to recipients of research reports).

    ---------------------------------------------------------------------------

    It is not currently known how many SDs and MSPs will become subject

    to these rules, and this will not be known to the Commission until the

    registration requirements for these entities become effective. In its

    rule proposals, the Commission took ``a conservative approach'' to

    calculating the burden hours of this information collection by

    estimating that as many as 300 SDs and MSPs would register.\192\ Since

    publication of the proposals in late 2010, the Commission has met with

    industry participants and trade groups, discussed extensively the

    universe of potential registrants with NFA, and reviewed public

    information about SDs active in the market and certain trade groups.

    Over time, and as the Commission has gathered more information on the

    swaps market and its participants, the estimate of the number of SDs

    and MSPs has decreased. In its FY 2012 budget drafted in February 2011,

    the Commission estimated that 140 SDs might register with the

    Commission.\193\ After recently receiving additional specific

    information from NFA on the regulatory program it is developing for SDs

    and MSPs,\194\ however, the Commission believes that approximately 125

    SDs and MSPs, including only a handful of MSPs, will register. While

    the Commission originally estimated there might be approximately 300

    SDs and MSPs, based on new estimates provided by NFA, the Commission

    now estimates that there will be a combined number of 125 SDs and MSPs

    that will be subject to new information collection requirements under

    these rules.\195\

    ---------------------------------------------------------------------------

    \192\ 75 FR at 76671, 75 FR at 71402, 75 FR at 71394, and 75 FR

    70885.

    \193\ CFTC, President's Budget and Performance Plan Fiscal Year

    2010, p. 13-14 (Feb. 2011), available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/cftcbudget2012.pdf. The

    estimated 140 SDs includes ``[a]pproximately 80 global and regional

    banks currently known to offer swaps in the United States;''

    ``[a]pproximately 40 non-bank swap dealers currently offering

    commodity and other swaps;'' and ``[a]pproximately 20 new potential

    market makers that wish to become swap dealers.'' Id.

    \194\ Letter from Thomas W. Sexton, Senior Vice President and

    General Counsel, NFA to Gary Barnett, Director, Division of Swap

    Dealer and Intermediary Oversight, CFTC (Oct. 20, 2011) (NFA Cost

    Estimates Letter).

    \195\ NFA Letter (Oct. 20, 2011) (estimating that there will be

    125 SDs and MSPs required to register with NFA).

    ---------------------------------------------------------------------------

    For purposes of the PRA, the term ``burden'' means the ``time,

    effort, or financial resources expended by persons to generate,

    maintain, or provide information to or for a Federal Agency.''

    In each of the NPRMs the Commission estimated the cost burden of

    the proposed regulations based upon an average salary of $100 per hour.

    In response to this estimate, The Working Group commented that,

    inclusive of benefit costs and allocated overhead, the per hour average

    salary estimate for compliance and risk management personnel should be

    significantly higher than $120. FIA and SIFMA stated that some of the

    compliance policies required by the proposed regulations will be

    drafted by both in-house lawyers and outside counsel, so the blended

    hourly rate should be roughly $400.

    The Commission notes that its estimate of $100 per hour was based

    on recent Bureau of Labor Statistics findings, including the mean

    hourly wage of an employee under occupation code 23-1011, ``Lawyers,''

    that is employed by the ``Securities and Commodity Contracts

    Intermediation and Brokerage Industry,'' which is $82.22. The mean

    hourly wage of an employee under occupation code 11-3031, ``Financial

    Managers,'' (which includes operations managers) in the same industry

    is $74.41.\196\ Taking these data, the Commission then increased its

    hourly wage estimate in recognition of the fact that some registrants

    may be large financial institutions whose employees' salaries may

    exceed the mean wage. The Commission also observes that SIFMA's

    ``Report on

    [[Page 20196]]

    Management & Professional Earnings in the Securities Industry--2010''

    estimates the average wage of a compliance attorney and a compliance

    staffer in the U.S. at only $46.31 per hour.

    ---------------------------------------------------------------------------

    \196\ See http://www.bls.gov/oes/2099/mayowe23.1011.htm and

    http://www.bls.gov/oes/current/oes113031.htm.

    ---------------------------------------------------------------------------

    The Commission recognizes that some registrants may hire outside

    counsel with expertise in the various regulatory areas covered by the

    regulations discussed herein. While the Commission is uncertain about

    the billing rates that registrants may pay for outside counsel, the

    Commission believes that such counsel may bill at a rate of several

    hundred dollars per hour. Outside counsel may be able to leverage its

    expertise to reduce substantially the number of hours needed to fulfill

    a requested assignment, but a registrant that uses outside counsel may

    incur higher costs than a registrant that does not use outside counsel.

    Any determination to use outside counsel is at the discretion of the

    registrant. Having considered the comments received and having reviewed

    the available data, the Commission has determined that $100 per hour

    remains a reasonable estimate of the per hour average salary for

    purposes of its PRA analysis. The Commission also notes that this

    determination is consistent with the Commission's estimate for the

    hourly wage for CCOs under the recently adopted DCO final rules.\197\

    ---------------------------------------------------------------------------

    \197\ See Derivatives Clearing Organization General Provisions

    and Core Principals, 76 FR at 69428.

    ---------------------------------------------------------------------------

    The Commission received comments related to the PRA for three of

    its notices of proposed rulemaking: Recordkeeping, Duties, and CCO. No

    comments were received with regard to the two Conflicts proposals.

    1. Recordkeeping NPRM

    With respect to the voice recording requirements of the

    Recordkeeping NPRM, as explained in more detail above, ATA commented

    that telephone recording systems that are compliant with all of these

    requirements would impose a significant additional cost to dealers. The

    Working Group commented that the long-term electronic storage of

    significant amounts of pre-execution communications will prove costly

    over the proposed five-year period. The Working Group also commented

    that requiring records of physical positions linked with related swap

    transactions would impose very expensive and burdensome requirements on

    millions of physical transactions that are undertaken by commercial

    energy firms that are also parties to swap transactions.

    With respect to the record retention requirements in the

    Recordkeeping NPRM, MFA commented that maintaining records of

    transactions for 5 years following the termination, expiration, or

    maturity of the transactions would constitute an additional

    administrative burden and entail substantial additional cost. ISDA &

    SIFMA also believe that recordkeeping of all oral and written

    communications that may lead to execution of a swap for the life of a

    swap plus five years could impose a heavy cost burden to implement and

    maintain, for only a small incremental benefit and would be more

    supportive of a voice recording obligation to retain recordings for a

    minimum period of six months. The Commission notes that it is modifying

    the retention period for voice recordings to one year, which should

    minimize the burden on SDs and MSPs.

    Notably, none of these commenters suggested specific revised

    calculations with regard to the Commission's burden estimate.

    Accordingly, the only change that the Commission is making to its

    estimation of burdens associated with its Recordkeeping rules is the

    change to reflect the new estimate of the number of SDs and MSPs. The

    Commission now estimates the burden to be 2096 hours, at an annual cost

    of $209,600 [2096 x $100 per hour] for each SD and MSP, and the

    aggregate hour burden cost for all registrants is 262,000 burden hours

    and $26,200,000 [262,000 x $100 per hour].

    In addition to the per hour burden discussed above, the Commission

    anticipated that SDs and MSPs may incur certain start-up costs in

    connection with the proposed recordkeeping obligations. Such costs

    would include the expenditures related to developing and installing new

    technology or reprogramming or updating existing recordkeeping

    technology and systems to enable the SD or MSP to collect, capture,

    process, maintain, and re-produce any newly required records. Based on

    comments received regarding system installation or upgrades that may be

    needed to meet the requirements of the rules, the Commission is

    doubling its estimate of programming burden hours associated with

    technology improvements to be 320 hours, rather than 160 hours.

    The Commission received no comments with respect to its programming

    wage estimate of $60 per hour. Accordingly, the Commission has revised

    only the estimate of the start-up burden associated with the required

    technological improvements with respect to the number of burden hours.

    The Commission estimates that the start-up burden would be $19,200 [$60

    x 320 hours] per affected registrant or $2,400,000 in the aggregate for

    all registrants.

    2. Duties NPRM

    The burden associated with regulations proposed in the Duties NPRM

    will result from the development of the required policies and

    procedures, satisfaction of various reporting obligations, and the

    documentation of required testing.

    The Working Group commented that the Commission's average personnel

    cost estimate of $20,450 per effected entity significantly understates

    the cost of compliance with the proposed rules for commercial firms

    that are deemed SDs or MSPs. Specifically, the Working Group stated

    that a commercial energy firm will require at least five new fulltime

    employees at 1,800 hours per year, not the 204.5 hours per year

    estimated by the Commission; and the Commission's analysis does not

    consider any necessary information technology expenditures or third-

    party costs.

    The Working Group also commented that quarterly documentation of

    risk management testing should be 200 personnel-hours per quarter at a

    cost of $96,000 per year for each registrant, rather than 1 personnel-

    hour per quarter at a cost of $400 per year as estimated by the

    Commission.

    With respect to the reporting requirements proposed in the Duties

    NPRM, The Working Group argued that Risk Exposure Reports should be

    provided to senior management and governing body annually, not

    quarterly because quarterly reporting would be too costly and

    burdensome.

    With respect to the documentation of testing requirements proposed

    in the Duties NPRM, The Working Group recommended that both the

    frequency and the scope of audits of the risk management program be

    left to the discretion of registrants in order to lessen the cost and

    administrative burden imposed by the proposed rules. Cargill

    recommended that testing of the risk management program be required

    annually rather than quarterly. Cargill stated that a quarterly

    requirement is excessive and unduly expensive. MetLife stated that

    monthly testing of position limit monitoring procedures and quarterly

    testing of the risk management program may be excessive, costly, and

    overly burdensome for some MSPs and that the frequency of testing

    should be determined by the MSP based on the extent of its swap

    activities.

    In the Duties NPRM, the burden per registrant was estimated to be

    204.5

    [[Page 20197]]

    hours per year, at an annual cost of $20,450. Based on comments

    received, as discussed above, the Commission is changing the required

    risk management testing from quarterly to annually. The Commission also

    is accepting The Working Group's contention that it will take more than

    160 hours annually to draft, file, and update the Risk Management

    Program materials, including the entity's position limit procedures and

    its business continuity and disaster recovery plan. While the

    Commission does not agree with the estimate that the new rules will

    require at least five new fulltime employees at 1,800 hours per year,

    the Commission accepts that on average it will take 900 hours to comply

    with the information collection required by these provisions. The

    Commission also agrees with The Working Group's revised estimation of

    200 hours for documentation of risk management testing and is

    increasing its estimate from four hours. Finally, the Commission is

    increasing its estimate of the burden hours associated with quarterly

    documentation of position limit compliance from two hours to 10 hours

    to account for the required testing. Accordingly, the Commission has

    revised its overall burden estimate to be 1148.5 hours per year per

    registrant, at an annual cost of $114,850. The aggregate cost for all

    registrants (with a revised estimate of 125 SDs and MSPs) is 143,562.5

    burden hours and $14,356,250 [143,562.5 x $100 per hour].

    3. SD/MSP Conflicts NPRM and FCM/IB Conflicts NPRM

    The Commission received no comments related to its estimates of the

    information collection burden with respect to either the SD/MSP

    Conflicts NPRM or the FCM/IB Conflicts NPRM. Accordingly, the only

    change that the Commission is making to its estimation of burdens

    associated with its Conflicts rules is the change to reflect the new

    estimate of the number of SDs and MSPs. The Commission estimates the

    overall burden to be 44.5 hours per year per SD and MSP, at an annual

    cost of $4,450 [44.5 x $100 per hour], and the aggregate cost for all

    SDs and MSPs (with a revised estimate of 125 SDs and MSPs) is 5562.5

    burden hours and $556,250 [5562.5 x $100 per hour]. There are currently

    159 registered FCMs and 1,645 registered IBs that will be required to

    comply with the proposed conflicts of interest provisions (or a total

    of 1,804 registrants). The Commission estimates the burden to be 44.5

    hours, at an annual cost of $4,450 for each FCM and IB, and the

    aggregate cost for all FCMs and IBs is 80,278 burden hours and

    $8,027,800 [80,278 burden hours x $100 per hour].

    4. CCO NPRM

    With respect to the annual compliance report requirement in the CCO

    NPRM, NSCP commented the level of detail required by the annual report

    would impose unnecessary burdens on the CCO with little offsetting

    benefits. NSCP argues that a better approach would be to require a

    review of the adequacy of policies and the effectiveness of their

    implementation. EEI commented that the annual report requirements would

    be so lengthy and detailed that the usefulness of the annual report

    would be greatly diminished. The Working Group recommended that the

    Commission provide a standardized form for the annual report because

    such would mutually benefit the Commission and registrants. The Working

    Group also believes the annual report as proposed would be

    unnecessarily exhaustive, and without a materiality limitation, the

    report would be of limited use to the Commission and costly for firms

    to produce. The Working Group also objected to the requirement that

    firms preserve all materials relating to the preparation of an annual

    report because such would not promote any compliance policy other than

    facilitating regulatory enforcement actions. The Working Group believes

    that the scope of provisions means that a firm will spend considerable

    resources to meet its obligations under the compliance report, and

    preparation of the report will be quite expensive because the scope of

    policies and procedures will be very broad. The Working Group estimates

    that the burden of preparing a report is, at a minimum, 160 hours, 4

    times the Commission's estimate.

    FIA and SIFMA provided the following revised cost assessment: Form

    8-R and related matters are 10 hours, not 1 hour; preparing, updating

    and maintaining policies and procedures is 1000 hours, not 80 hours;

    preparing the annual report is 500 hours not 40 hours; annually

    amending the annual report is 50 hours and not 5 hours; and

    recordkeeping is closer to 500 hours, not 10 hours. Therefore, FIA and

    SIFMA estimate that the total cost per registrant is closer to $800,000

    and the total to the industry is $350 million.

    Despite the fact that FIA and SIFMA did not provide an explanation

    for any of their revised burden estimates, the Commission is accepting

    their arguments, in part, and is revising its burden estimate to

    reflect some of their comments.

    The Commission is not modifying the amount of time required to

    prepare and file a Form 8-R designating the chief compliance officer.

    This form requests only the information necessary about the individual

    designated as CCO that is necessary for the Commission to appropriately

    exercise its statutory registration and compliance oversight functions.

    This information generally includes the name, addresses, location of

    records, regulatory and disciplinary histories, and other similarly

    straightforward matters--all of which should be in the possession of

    the applicant and readily available for the applicant to provide. Most

    notably, the PRA estimates provided for these forms are averages that

    do not necessarily reflect the actual time expended by each and every

    individual to complete the forms.

    The Commission is modifying its burden estimate for the amount of

    time it will take to draft and update compliance policies from 80 hours

    annually to 900 hours, which reflects half of a full-time employee's

    time. Additionally, the Commission is revising the burden estimate

    associated with preparing and furnishing to the Commission an annual

    report that describes the respondent's compliance policies and

    resources and the respondent's compliance with the CEA and Commission

    regulations. The Commission had estimated that it would take 40 hours

    per year. The revised estimate would double that number to 80 hours per

    year, which is in line with estimates made by the DCO final rulemaking.

    The Commission is maintaining its original estimate for the time

    required to amend a previously furnished annual report when material

    errors or omissions are identified at 5 hours annually, but the

    Commission is doubling the time estimate required to maintain records

    related to respondent's compliance policies and annual reports from 10

    hours to 20 hours. With regard to recordkeeping required under the CCO

    rules, the Commission notes that much of the burden associated with

    this requirement has been included in the overall recordkeeping

    estimates for SDs and MSPs, and in existing regulations for FCMs, all

    of which require general business records to be kept.

    There are 159 FCMs currently registered with the Commission and it

    is anticipated that there will be approximately 125 SDs and MSPs that

    will register with the Commission. Thus, the total number of

    respondents is expected to be 284. Based on comments received and the

    changes to the rules discussed above, the Commission has revised its

    estimate of the burden

    [[Page 20198]]

    associated with the regulations to be 1,006 hours, at a cost of

    $100,600 annually for each respondent. Based upon the above, the

    aggregate cost for all respondents is 285,704 burden hours [1,006 hours

    x 284 respondents] and $28,570,400 [285,704 burden hours x $100 per

    hour].

    List of Subjects

    17 CFR Part 1

    Brokers, Commodity futures, Conflicts of interest, Reporting and

    recordkeeping requirements.

    17 CFR Part 3

    Administrative practice and procedure, Brokers, Commodity futures,

    Major swap participants, Reporting and recordkeeping requirements, Swap

    dealers.

    17 CFR Part 23

    Antitrust, Commodity futures, Conduct standards, Conflict of

    Interests, Major swap participants, Reporting and recordkeeping, Swap

    dealers, Swaps.

    For the reasons stated in the preamble, the CFTC amends 17 CFR

    parts 1, 3, and 23 as follows:

    PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

    0

    1. The authority citation for part 1 is revised to read as follows:

    Authority: 7 U.S.C. 1a, 2, 2a, 5, 6, 6a, 6b, 6b-1, 6c, 6d, 6e,

    6f, 6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2,

    7b, 7b-3, 8, 9, 9a, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 18, 19,

    21, 23 and 24, as amended by Title VII of the Dodd-Frank Wall Street

    Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376

    (July 21, 2010).

    0

    2. Section 1.71 is added to read as follows:

    Sec. 1.71 Conflicts of interest policies and procedures by futures

    commission merchants and introducing brokers.

    (a) Definitions. For purposes of this section, the following terms

    shall be defined as provided.

    (1) Affiliate. This term means, with respect to any person, a

    person controlling, controlled by, or under common control with, such

    person.

    (2) Business trading unit. This term means any department,

    division, group, or personnel of a futures commission merchant or

    introducing broker or any of its affiliates, whether or not identified

    as such, that performs, or personnel exercising direct supervisory

    authority over the performance of, any pricing (excluding price

    verification for risk management purposes), trading, sales, marketing,

    advertising, solicitation, structuring, or brokerage activities on

    behalf of a futures commission merchant or introducing broker or any of

    its affiliates.

    (3) Clearing unit. This term means any department, division, group,

    or personnel of a futures commission merchant or any of its affiliates,

    whether or not identified as such, that performs, or personnel

    exercising direct supervisory authority over the performance of, any

    proprietary or customer clearing activities on behalf of a futures

    commission merchant or any of its affiliates.

    (4) Derivative. This term means:

    (i) A contract for the purchase or sale of a commodity for future

    delivery;

    (ii) A security futures product;

    (iii) A swap;

    (iv) Any agreement, contract, or transaction described in section

    2(c)(2)(C)(i) or section 2(c)(2)(D)(i) of the Act; and

    (v) Any commodity option authorized under section 4c of the Act;

    and (vi) any leverage transaction authorized under section 19 of the

    Act.

    (5) Non-research personnel. This term means any employee of the

    business trading unit or clearing unit, or any other employee of the

    futures commission merchant or introducing broker, other than an

    employee performing a legal or compliance function, who is not directly

    responsible for, or otherwise not directly involved in, research or

    analysis intended for inclusion in a research report.

    (6) Public appearance. This term means any participation in a

    conference call, seminar, forum (including an interactive electronic

    forum) or other public speaking activity before 15 or more persons

    (individuals or entities), or interview or appearance before one or

    more representatives of the media, radio, television or print media, or

    the writing of a print media article, in which a research analyst makes

    a recommendation or offers an opinion concerning a derivatives

    transaction. This term does not include a password-protected Webcast,

    conference call or similar event with 15 or more existing customers,

    provided that all of the event participants previously received the

    most current research report or other documentation that contains the

    required applicable disclosures, and that the research analyst

    appearing at the event corrects and updates during the public

    appearance any disclosures in the research report that are inaccurate,

    misleading, or no longer applicable.

    (7) Research analyst. This term means the employee of a futures

    commission merchant or introducing broker who is primarily responsible

    for, and any employee who reports directly or indirectly to such

    research analyst in connection with, preparation of the substance of a

    research report relating to any derivative, whether or not any such

    person has the job title of ``research analyst.''

    (8) Research department. This term means any department or division

    that is principally responsible for preparing the substance of a

    research report relating to any derivative on behalf of a futures

    commission merchant or introducing broker, including a department or

    division contained in an affiliate of a futures commission merchant or

    introducing broker.

    (9) Research report. This term means any written communication

    (including electronic) that includes an analysis of the price or market

    for any derivative, and that provides information reasonably sufficient

    upon which to base a decision to enter into a derivatives transaction.

    This term does not include:

    (i) Communications distributed to fewer than 15 persons;

    (ii) Commentaries on economic, political or market conditions;

    (iii) Statistical summaries of multiple companies' financial data,

    including listings of current ratings;

    (iv) Periodic reports or other communications prepared for

    investment company shareholders or commodity pool participants that

    discuss individual derivatives positions in the context of a fund's

    past performance or the basis for previously-made discretionary

    decisions;

    (v) Any communications generated by an employee of the business

    trading unit that is conveyed as a solicitation for entering into a

    derivatives transaction, and is conspicuously identified as such; and

    (vi) Internal communications that are not given to current or

    prospective customers.

    (b) Policies and procedures. (1) Except as provided in paragraph

    (b)(2) of this section, each futures commission merchant and

    introducing broker subject to this rule must adopt and implement

    written policies and procedures reasonably designed to ensure that the

    futures commission merchant or introducing broker and its employees

    comply with the provisions of this rule.

    (2) Small Introducing Brokers. An introducing broker that has

    generated, over the preceding 3 years, $5 million or less in aggregate

    gross revenues from its activities as an introducing broker must

    establish structural and institutional safeguards reasonably

    [[Page 20199]]

    designed to ensure that the activities of any person within the firm

    relating to research or analysis of the price or market for any

    commodity or derivative are separated by appropriate informational

    partitions within the firm from the review, pressure, or oversight of

    persons whose involvement in trading or clearing activities might

    potentially bias the judgment or supervision of the persons.

    (c) Research analysts and research reports. (1) Restrictions on

    relationship with research department. (i) Non-research personnel shall

    not direct a research analyst's decision to publish a research report

    of the futures commission merchant or introducing broker, and non-

    research personnel shall not direct the views and opinions expressed in

    a research report of the futures commission merchant or introducing

    broker.

    (ii) No research analyst may be subject to the supervision or

    control of any employee of the futures commission merchant's or

    introducing broker's business trading unit or clearing unit, and no

    employee of the business trading unit or clearing unit may have any

    influence or control over the evaluation or compensation of a research

    analyst.

    (iii) Except as provided in paragraph (c)(1)(iv) of this section,

    non-research personnel, other than the board of directors and any

    committee thereof, shall not review or approve a research report of the

    futures commission merchant or introducing broker before its

    publication.

    (iv) Non-research personnel may review a research report before its

    publication as necessary only to verify the factual accuracy of

    information in the research report, to provide for non-substantive

    editing, to format the layout or style of the research report, or to

    identify any potential conflicts of interest, provided that:

    (A) Any written communication between non-research personnel and

    research department personnel concerning the content of a research

    report must be made either through authorized legal or compliance

    personnel of the futures commission merchant or introducing broker or

    in a transmission copied to such personnel; and

    (B) Any oral communication between non-research personnel and

    research department personnel concerning the content of a research

    report must be documented and made either through authorized legal or

    compliance personnel acting as an intermediary or in a conversation

    conducted in the presence of such personnel.

    (2) Restrictions on communications. Any written or oral

    communication by a research analyst to a current or prospective

    customer relating to any derivative must not omit any material fact or

    qualification that would cause the communication to be misleading to a

    reasonable person.

    (3) Restrictions on research analyst compensation. A futures

    commission merchant or introducing broker may not consider as a factor

    in reviewing or approving a research analyst's compensation his or her

    contributions to the futures commission merchant's or introducing

    broker's trading or clearing business. Except for communicating client

    or customer feedback, ratings and other indicators of research analyst

    performance to research department management, no employee of the

    business trading unit or clearing unit of the futures commission

    merchant or introducing broker may influence the review or approval of

    a research analyst's compensation.

    (4) Prohibition of promise of favorable research. No futures

    commission merchant or introducing broker may directly or indirectly

    offer favorable research, or threaten to change research, to an

    existing or prospective customer as consideration or inducement for the

    receipt of business or compensation.

    (5) Disclosure requirements. (i) Ownership and material conflicts

    of interest. A futures commission merchant or introducing broker must

    disclose in research reports and a research analyst must disclose in

    public appearances whether the research analyst maintains a financial

    interest in any derivative of a type, class, or category that the

    research analyst follows, and the general nature of the financial

    interest.

    (ii) Prominence of disclosure. Disclosures and references to

    disclosures must be clear, comprehensive, and prominent. With respect

    to public appearances by research analysts, the disclosures required by

    paragraph (c)(5) of this section must be conspicuous.

    (iii) Records of public appearances. Each futures commission

    merchant and introducing broker must maintain records of public

    appearances by research analysts sufficient to demonstrate compliance

    by those research analysts with the applicable disclosure requirements

    under paragraph (c)(5) of this section.

    (iv) Third-party research reports. (A) For the purposes of

    paragraph (c)(5)(iv) of this section, ``independent third-party

    research report'' shall mean a research report, in respect of which the

    person or entity producing the report:

    (1) Has no affiliation or business or contractual relationship with

    the distributing futures commission merchant or introducing broker, or

    that futures commission merchant's or introducing broker's affiliates,

    that is reasonably likely to inform the content of its research

    reports; and

    (2) Makes content determinations without any input from the

    distributing futures commission merchant or introducing broker or from

    the futures commission merchant's or introducing broker's affiliates.

    (B) Subject to paragraph (c)(5)(iv)(C) of this section, if a

    futures commission merchant or introducing broker distributes or makes

    available any independent third-party research report, the futures

    commission merchant or introducing broker must accompany the research

    report with, or provide a web address that directs the recipient to,

    the current applicable disclosures, as they pertain to the futures

    commission merchant or introducing broker, required by this section.

    Each futures commission merchant and introducing broker must establish

    written policies and procedures reasonably designed to ensure the

    completeness and accuracy of all applicable disclosures.

    (C) The requirements of paragraph (c)(5)(iv)(B) of this section

    shall not apply to independent third-party research reports made

    available by a futures commission merchant or introducing broker to its

    customers:

    (1) Upon request; or

    (2) Through a Web site maintained by the futures commission

    merchant or introducing broker.

    (6) Prohibition of retaliation against research analysts. No

    futures commission merchant or introducing broker, and no employee of a

    futures commission merchant or introducing broker who is involved with

    the futures commission merchant's or introducing broker's trading or

    clearing activities, may, directly or indirectly, retaliate against or

    threaten to retaliate against any research analyst employed by the

    futures commission merchant or introducing broker or its affiliates as

    a result of an adverse, negative, or otherwise unfavorable research

    report or public appearance written or made, in good faith, by the

    research analyst that may adversely affect the futures commission

    merchant's or introducing broker's present or prospective trading or

    clearing activities.

    (7) Small Introducing Brokers. An introducing broker that has

    generated, over the preceding 3 years, $5 million or less in aggregate

    gross revenues from its activities as an introducing broker is

    [[Page 20200]]

    exempt from the requirements set forth in this paragraph (c).

    (d) Clearing activities. (1) No futures commission merchant shall

    permit any affiliated swap dealer or major swap participant to directly

    or indirectly interfere with, or attempt to influence, the decision of

    the clearing unit personnel of the futures commission merchant to

    provide clearing services and activities to a particular customer,

    including but not limited to a decision relating to the following:

    (i) Whether to offer clearing services and activities to a

    particular customer;

    (ii) Whether to accept a particular customer for the purposes of

    clearing derivatives;

    (iii) Whether to submit a customer's transaction to a particular

    derivatives clearing organization;

    (iv) Whether to set or adjust risk tolerance levels for a

    particular customer;

    (v) Whether to accept certain forms of collateral from a particular

    customer; or

    (vi) Whether to set a particular customer's fees for clearing

    services based upon criteria that are not generally available and

    applicable to other customers of the futures commission merchant.

    (2) Each futures commission merchant shall create and maintain an

    appropriate informational partition between business trading units of

    an affiliated swap dealer or major swap participant and clearing unit

    personnel of the futures commission merchant to reasonably ensure

    compliance with the Act and the prohibitions specified in paragraph

    (d)(1) of this section. At a minimum, such informational partitions

    shall require that:

    (i) No employee of a business trading unit of an affiliated swap

    dealer or major swap participant may review or approve the provision of

    clearing services and activities by clearing unit personnel of the

    futures commission merchant, make any determination regarding whether

    the futures commission merchant accepts clearing customers, or in any

    way condition or tie the provision of trading services upon or to the

    provision of clearing services or otherwise participate in the

    provision of clearing services by improperly incentivizing or

    encouraging the use of the affiliated futures commission merchant. Any

    employee of a business trading unit of an affiliated swap dealer or

    major swap participant may participate in the activities of the futures

    commission merchant as necessary for (A) participating in default

    management undertaken by a derivatives clearing organization during an

    event of default; and (B) transferring, liquidating, or hedging any

    proprietary or customer positions during an event of default;

    (ii) No employee of a business trading unit of an affiliated swap

    dealer or major swap participant shall supervise, control, or influence

    any employee of a clearing unit of the futures commission merchant; and

    (iii) No employee of the business trading unit of an affiliated

    swap dealer or major swap participant shall influence or control

    compensation or evaluation of any employee of the clearing unit of the

    futures commission merchant.

    (e) Undue influence on customers. Each futures commission merchant

    and introducing broker must adopt and implement written policies and

    procedures that mandate the disclosure to its customers of any material

    incentives and any material conflicts of interest regarding the

    decision of a customer as to the trade execution and/or clearing of the

    derivatives transaction.

    (f) Records. All records that a futures commission merchant or

    introducing broker is required to maintain pursuant to this regulation

    shall be maintained in accordance with Commission Regulation Sec. 1.31

    and shall be made available promptly upon request to representatives of

    the Commission.

    PART 3--REGISTRATION

    0

    3. The authority citation for part 3 is revised to read as follows:

    Authority: 5 U.S.C. 552, 552b; 7 U.S.C. 1a, 2, 6a, 6b, 6b-1,

    6c, 6d, 6e, 6f, 6g, 6h, 6i, 6k, 6m, 6n, 6o, 6p, 6s, 8, 9, 9a, 12,

    12a, 13b, 13c, 16a, 18, 19, 21, and 23, as amended by Title VII of

    the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub.

    L. 111-203, 124 Stat. 1376 (Jul. 21, 2010).

    0

    4. Amend Sec. 3.1 by revising paragraph (a)(1) and by adding

    paragraphs (h) and (i) to read as follows:

    Sec. 3.1 Definitions.

    (a) * * *

    (1) If the entity is organized as a sole proprietorship, the

    proprietor and chief compliance officer; if a partnership, any general

    partner and chief compliance officer; if a corporation, any director,

    the president, chief executive officer, chief operating officer, chief

    financial officer, chief compliance officer, and any person in charge

    of a principal business unit, division or function subject to

    regulation by the Commission; if a limited liability company or limited

    liability partnership, any director, the president, chief executive

    officer, chief operating officer, chief financial officer, chief

    compliance officer, the manager, managing member or those members

    vested with the management authority for the entity, and any person in

    charge of a principal business unit, division or function subject to

    regulation by the Commission; and, in addition, any person occupying a

    similar status or performing similar functions, having the power,

    directly or indirectly, through agreement or otherwise, to exercise a

    controlling influence over the entity's activities that are subject to

    regulation by the Commission;

    * * * * *

    (h) Swaps activities. Swaps activities means, with respect to a

    registrant, such registrant's activities related to swaps and any

    product used to hedge such swaps, including, but not limited to,

    futures, options, other swaps or security-based swaps, debt or equity

    securities, foreign currency, physical commodities, and other

    derivatives.

    (i) Board of directors. Board of directors means the board of

    directors, board of governors, or equivalent governing body of a

    registrant.

    0

    5. Add Sec. 3.3 to read as follows:

    Sec. 3.3 Chief compliance officer.

    (a) Designation. Each futures commission merchant, swap dealer, and

    major swap participant shall designate an individual to serve as its

    chief compliance officer, and provide the chief compliance officer with

    the responsibility and authority to develop, in consultation with the

    board of directors or the senior officer, appropriate policies and

    procedures to fulfill the duties set forth in the Act and Commission

    regulations relating to the swap dealer's or major swap participant's

    swaps activities, or to the futures commission merchant's business as a

    futures commission merchant and to ensure compliance with the Act and

    Commission regulations relating to the swap dealer's or major swap

    participant's swaps activities, or to the futures commission merchant's

    business as a futures commission merchant.

    (1) The chief compliance officer shall report to the board of

    directors or the senior officer of the futures commission merchant,

    swap dealer, or major swap participant. The board of directors or the

    senior officer shall appoint the chief compliance officer, shall

    approve the compensation of the chief compliance officer, and shall

    meet with the chief compliance officer at least once a year and at the

    election of the chief compliance officer.

    (2) Only the board of directors or the senior officer of the

    futures commission merchant, swap dealer, or major swap participant may

    remove the chief compliance officer.

    [[Page 20201]]

    (b) Qualifications. The individual designated to serve as chief

    compliance officer shall have the background and skills appropriate for

    fulfilling the responsibilities of the position. No individual

    disqualified, or subject to disqualification, from registration under

    section 8a(2) or 8a(3) of the Act may serve as a chief compliance

    officer.

    (c) Submission with registration. Each application for registration

    as a futures commission merchant under Sec. 3.10, a swap dealer under

    Sec. 23.21, or a major swap participant under Sec. 23.21, must

    include a designation of a chief compliance officer by submitting a

    Form 8-R for the chief compliance officer as a principal of the

    applicant pursuant to Sec. 3.10(a)(2).

    (d) Chief compliance officer duties. The chief compliance officer's

    duties shall include, but are not limited to:

    (1) Administering the registrant's policies and procedures

    reasonably designed to ensure compliance with the Act and Commission

    regulations;

    (2) In consultation with the board of directors or the senior

    officer, resolving any conflicts of interest that may arise;

    (3) Taking reasonable steps to ensure compliance with the Act and

    Commission regulations relating to the swap dealer's or major swap

    participant's swaps activities, or to the futures commission merchant's

    business as a futures commission merchant;

    (4) Establishing procedures, in consultation with the board of

    directors or the senior officer, for the remediation of noncompliance

    issues identified by the chief compliance officer through a compliance

    office review, look-back, internal or external audit finding, self-

    reported error, or validated complaint;

    (5) Establishing procedures, in consultation with the board of

    directors or the senior officer, for the handling, management response,

    remediation, retesting, and closing of noncompliance issues; and

    (6) Preparing and signing the annual report required under

    paragraphs (e) and (f) of this section.

    (e) Annual report. The chief compliance officer annually shall

    prepare a written report that covers the most recently completed fiscal

    year of the futures commission merchant, swap dealer, or major swap

    participant, and provide the annual report to the board of directors or

    the senior officer. The annual report shall, at a minimum:

    (1) Contain a description of the written policies and procedures,

    including the code of ethics and conflicts of interest policies, of the

    futures commission merchant, swap dealer, or major swap participant;

    (2) Review each applicable requirement under the Act and Commission

    regulations, and with respect to each:

    (i) Identify the policies and procedures that are reasonably

    designed to ensure compliance with the requirement under the Act and

    Commission regulations;

    (ii) Provide an assessment as to the effectiveness of these

    policies and procedures; and

    (iii) Discuss areas for improvement, and recommend potential or

    prospective changes or improvements to its compliance program and

    resources devoted to compliance;

    (3) List any material changes to compliance policies and procedures

    during the coverage period for the report;

    (4) Describe the financial, managerial, operational, and staffing

    resources set aside for compliance with respect to the Act and

    Commission regulations, including any material deficiencies in such

    resources; and

    (5) Describe any material non-compliance issues identified, and the

    corresponding action taken.

    (f) Furnishing the annual report to the Commission. (1) Prior to

    furnishing the annual report to the Commission, the chief compliance

    officer shall provide the annual report to the board of directors or

    the senior officer of the futures commission merchant, swap dealer, or

    major swap participant for its review. Furnishing the annual report to

    the board of directors or the senior officer shall be recorded in the

    board minutes or otherwise, as evidence of compliance with this

    requirement.

    (2) The annual report shall be furnished electronically to the

    Commission not more than 90 days after the end of the fiscal year of

    the futures commission merchant, swap dealer, or major swap

    participant, simultaneously with the submission of Form 1-FR-FCM, as

    required under Sec. 1.10(b)(2)(ii), simultaneously with the Financial

    and Operational Combined Uniform Single Report, as required under Sec.

    1.10(h), or simultaneously with the financial condition report, as

    required under section 4s(f) of the Act, as applicable.

    (3) The report shall include a certification by the chief

    compliance officer or chief executive officer of the registrant that,

    to the best of his or her knowledge and reasonable belief, and under

    penalty of law, the information contained in the annual report is

    accurate and complete.

    (4) The futures commission merchant, swap dealer, or major swap

    participant shall promptly furnish an amended annual report if material

    errors or omissions in the report are identified. An amendment must

    contain the certification required under paragraph (f)(3) of this

    section.

    (5) A futures commission merchant, swap dealer, or major swap

    participant may request from the Commission an extension of time to

    furnish its annual report, provided the registrant's failure to timely

    furnish the report could not be eliminated by the registrant without

    unreasonable effort or expense. Extensions of the deadline will be

    granted at the discretion of the Commission.

    (6) A futures commission merchant, swap dealer, or major swap

    participant may incorporate by reference sections of an annual report

    that has been furnished within the current or immediately preceding

    reporting period to the Commission. If the futures commission merchant,

    swap dealer, or major swap participant is registered in more than one

    capacity with the Commission, and must submit more than one annual

    report, an annual report submitted as one registrant may incorporate by

    reference sections in the annual report furnished within the current or

    immediately preceding reporting period as the other registrant.

    (g) Recordkeeping. (1) The futures commission merchant, swap

    dealer, or major swap participant shall maintain:

    (i) A copy of the registrant's policies and procedures reasonably

    designed to ensure compliance with the Act and Commission regulations;

    (ii) Copies of materials, including written reports provided to the

    board of directors or the senior officer in connection with the review

    of the annual report under paragraph (e) of this section; and

    (iii) Any records relevant to the annual report, including, but not

    limited to, work papers and other documents that form the basis of the

    report, and memoranda, correspondence, other documents, and records

    that are created, sent or received in connection with the annual report

    and contain conclusions, opinions, analyses, or financial data related

    to the annual report.

    (2) All records or reports that a futures commission merchant, swap

    dealer, or major swap participant are required to maintain pursuant to

    this section shall be maintained in accordance with Sec. 1.31 and

    shall be made available promptly upon request to representatives of the

    Commission and to representatives of the applicable prudential

    regulator, as defined in 1a(39) of the Act.

    [[Page 20202]]

    PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

    0

    6. The authority citation for part 23 is revised to read as follows:

    Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s,

    6t, 9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, and 21 as amended by the

    Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L.

    111-203, 124 Stat. 1376 (Jul. 21, 2010).

    0

    7. Add Subpart F, Sec. Sec. 23.200, 23.201, 23.202, 23.203, 23.204,

    23.205, and 23.206 to read as follows:

    Subpart F--Reporting, Recordkeeping, and Daily Trading Records

    Requirements for Swap Dealers and Major Swap Participants

    Sec.

    23.200 Definitions.

    23.201 Required records.

    23.202 Daily trading records.

    23.203 Records; retention and inspection.

    23.204 Reporting to swap data repositories.

    23.205 Real-time public reporting.

    23.206 Delegation of authority to the Director of the Division of

    Swap Dealer and Intermediary Oversight to establish an alternative

    compliance schedule to comply with daily trading records.

    Subpart F--Reporting, Recordkeeping, and Daily Trading Records

    Requirements for Swap Dealers and Major Swap Participants

    Sec. 23.200 Definitions.

    For purposes of subpart F, the following terms shall be defined as

    provided.

    (a) Business trading unit means any department, division, group, or

    personnel of a swap dealer or major swap participant or any of its

    affiliates, whether or not identified as such, that performs, or

    exercises supervisory authority over the performance of, any pricing

    (excluding price verification for risk management purposes), trading,

    sales, purchasing, marketing, advertising, solicitation, structuring,

    or brokerage activities on behalf of a registrant.

    (b) Clearing unit means any department, division, group, or

    personnel of a registrant or any of its affiliates, whether or not

    identified as such, that performs any proprietary or customer clearing

    activities on behalf of a registrant.

    (c) Complaint means any formal or informal complaint, grievance,

    criticism, or concern communicated to the swap dealer or major swap

    participant in any format relating to, arising from, or in connection

    with, any trading conduct or behavior or with the swap dealer or major

    swap participant's performance (or failure to perform) any of its

    regulatory obligations, and includes any and all observations,

    comments, remarks, interpretations, clarifications, notes, and

    examinations as to such conduct or behavior communicated or documented

    by the complainant, swap dealer, or major swap participant.

    (d) Executed means the completion of the execution process.

    (e) Execution means, with respect to a swap, an agreement by the

    parties (whether orally, in writing, electronically, or otherwise) to

    the terms of a swap that legally binds the parties to such swap terms

    under applicable law.

    (f) Governing body. This term means:

    (1) A board of directors;

    (2) A body performing a function similar to a board of directors;

    (3) Any committee of a board or body; or

    (4) The chief executive officer of a registrant, or any such board,

    body, committee, or officer of a division of a registrant, provided

    that the registrant's swaps activities for which registration with the

    Commission is required are wholly contained in a separately

    identifiable division.

    (g) Prudential regulator has the meaning given to such term in

    section 1a(39) of the Commodity Exchange Act and includes the Board of

    Governors of the Federal Reserve System, the Office of the Comptroller

    of the Currency, the Federal Deposit Insurance Corporation, the Farm

    Credit Association, and the Federal Housing Finance Agency, as

    applicable to the swap dealer or major swap participant.

    (h) Registered entity has the meaning given to such term in section

    1a(40) of the Commodity Exchange Act, and includes boards of trade

    designated as contract markets, derivatives clearing organizations,

    swap execution facilities, and swap data repositories.

    (i) Related cash or forward transaction means a purchase or sale

    for immediate or deferred physical shipment or delivery of an asset

    related to a swap where the swap and the related cash or forward

    transaction are used to hedge, mitigate the risk of, or offset one

    another.

    (j) Swaps activities means, with respect to a registrant, such

    registrant's activities related to swaps and any product used to hedge

    such swaps, including, but not limited to, futures, options, other

    swaps or security-based swaps, debt or equity securities, foreign

    currency, physical commodities, and other derivatives.

    (k) Swap confirmation means the consummation (electronically or

    otherwise) of legally binding documentation (electronic or otherwise)

    that memorializes the agreement of the parties to all the terms of the

    swap. A confirmation must be in writing (whether electronic or

    otherwise) and must legally supersede any previous agreement

    (electronically or otherwise).

    Sec. 23.201 Required records.

    (a) Transaction and position records. Each swap dealer and major

    swap participant shall keep full, complete, and systematic records,

    together with all pertinent data and memoranda, of all its swaps

    activities. Such records shall include:

    (1) Transaction records. Records of each transaction, including all

    documents on which transaction information is originally recorded. Such

    records shall be kept in a form and manner identifiable and searchable

    by transaction and by counterparty, and shall include:

    (i) All documents customarily generated in accordance with market

    practice that demonstrate the existence and nature of an order or

    transaction, including, but not limited to, records of all orders

    (filled, unfilled, or cancelled); correspondence; journals; memoranda;

    ledgers; confirmations; risk disclosure documents; statements of

    purchase and sale; contracts; invoices; warehouse receipts; documents

    of title; and

    (ii) The daily trading records required to be kept in accordance

    with Sec. 23.202.

    (2) Position records. Records of each position held by each swap

    dealer and major swap participant, identified by product and

    counterparty, including records reflecting whether each position is

    ``long'' or ``short'' and whether the position is cleared. Position

    records shall be linked to transaction records in a manner that permits

    identification of the transactions that established the position.

    (3) Records of transactions executed on a swap execution facility

    or designated contract market or cleared by a derivatives clearing

    organization. Records of each transaction executed on a swap execution

    facility or designated contract market or cleared by a derivatives

    clearing organization maintained in compliance with the Act and

    Commission regulations.

    (b) Business records. Each swap dealer and major swap participant

    shall keep full, complete, and systematic records of all activities

    related to its business as a swap dealer or major swap participant,

    including but not limited to:

    (1) Governance. (i) Minutes of meetings of the governing body and

    relevant committee minutes, including handouts and presentation

    materials;

    (ii) Organizational charts for its governing body and relevant

    [[Page 20203]]

    committees, business trading unit, clearing unit, risk management unit,

    and all other relevant units or divisions;

    (iii) Biographies or resumes of managers, senior supervisors,

    officers, and directors;

    (iv) Job descriptions for manager, senior supervisor, officer, and

    director positions, including job responsibilities and scope of

    authority;

    (v) Internal and external audit, risk management, compliance, and

    consultant reports (including management responses); and

    (vi) Business and strategic plans for the business trading unit.

    (2) Financial records. (i) Records reflecting all assets and

    liabilities, income and expenses, and capital accounts as required by

    the Act and Commission regulations; and

    (ii) All other financial records required to be kept under the Act

    and Commission regulations.

    (3) Complaints. (i) A record of each complaint received by the swap

    dealer or major swap participant concerning any partner, member,

    officer, employee, or agent. The record shall include the complainant's

    name, address, and account number; the date the complaint was received;

    the name of all persons identified in the complaint; a description of

    the nature of the complaint; the disposition of the complaint, and the

    date the complaint was resolved.

    (ii) A record indicating that each counterparty of the swap dealer

    or major swap participant has been provided with a notice containing

    the physical address, email or other widely available electronic

    address, and telephone number of the department of the swap dealer or

    major swap participant to which any complaints may be directed.

    (4) Marketing and sales materials. All marketing and sales

    presentations, advertisements, literature, and communications, and a

    record documenting that the swap dealer or major swap participant has

    complied with, or adopted policies and procedures reasonably designed

    to establish compliance with, all applicable Federal requirements,

    Commission regulations, and the rules of any self-regulatory

    organization of which the swap dealer or major swap participant is a

    member.

    (c) Records of data reported to a swap data repository. With

    respect to each swap, each swap dealer and major swap participant shall

    identify, retain, and produce for inspection all information and data

    required to be reported in accordance with part 45 of this chapter,

    along with a record of the date and time the swap dealer or major swap

    participant made the report.

    (d) Records of real-time reporting data. Each swap dealer and major

    swap participant shall identify, retain, and produce for inspection all

    information and data required to be reported in accordance with part 43

    of this chapter, along with a record of the date and time the swap

    dealer or major swap participant made the report.

    Sec. 23.202 Daily trading records.

    (a) Daily trading records for swaps. Each swap dealer and major

    swap participant shall make and keep daily trading records of all swaps

    it executes, including all documents on which transaction information

    is originally recorded. Each swap dealer and major swap participant

    shall ensure that its records include all information necessary to

    conduct a comprehensive and accurate trade reconstruction for each

    swap. Each swap dealer and major swap participant shall maintain each

    transaction record in a manner identifiable and searchable by

    transaction and counterparty.

    (1) Pre-execution trade information. Each swap dealer and major

    swap participant shall make and keep pre-execution trade information,

    including, at a minimum, records of all oral and written communications

    provided or received concerning quotes, solicitations, bids, offers,

    instructions, trading, and prices, that lead to the execution of a

    swap, whether communicated by telephone, voicemail, facsimile, instant

    messaging, chat rooms, electronic mail, mobile device, or other digital

    or electronic media. Such records shall include, but are not limited

    to:

    (i) Reliable timing data for the initiation of the trade that would

    permit complete and accurate trade reconstruction; and

    (ii) A record of the date and time, to the nearest minute, using

    Coordinated Universal Time (UTC), by timestamp or other timing device,

    for each quotation provided to, or received from, the counterparty

    prior to execution.

    (2) Execution trade information. Each swap dealer and major swap

    participant shall make and keep trade execution records, including:

    (i) All terms of each swap, including all terms regarding payment

    or settlement instructions, initial and variation margin requirements,

    option premiums, payment dates, and any other cash flows;

    (ii) The trade ticket for each swap (which, together with the time

    of execution of each swap, shall be immediately recorded electronically

    for further processing);

    (iii) The unique swap identifier, as required by Sec. 45.4(a), for

    each swap;

    (iv) A record of the date and time of execution of each swap, to

    the nearest minute, using Coordinated Universal Time (UTC), by

    timestamp or other timing device;

    (v) The name of the counterparty with which each such swap was

    executed, including its unique counterparty identifier, as required by

    Sec. 45.4(b);

    (vi) The date and title of the agreement to which each swap is

    subject, including but not limited to, any swap trading relationship

    documentation and credit support arrangements;

    (vii) The product name of each swap, including its unique product

    identifier, as required by Sec. 45.4(c);

    (viii) The price at which the swap was executed;

    (ix) Fees or commissions and other expenses, identified by

    transaction; and

    (x) Any other information relevant to the swap.

    (3) Post-execution trade information. Each swap dealer and major

    swap participant shall make and keep records of post-execution trade

    information containing an itemized record of all relevant post-trade

    processing and events.

    (i) Records of post-trade processing and events shall include all

    of the following, as applicable:

    (A) Confirmation;

    (B) Termination;

    (C) Novation;

    (D) Amendment;

    (E) Assignment;

    (F) Netting;

    (G) Compression;

    (H) Reconciliation;

    (I) Valuation;

    (J) Margining;

    (K) Collateralization; and

    (L) Central clearing.

    (ii) Each swap dealer and major swap participant shall make and

    keep a record of all swap confirmations, along with the date and time,

    to the nearest minute, using Coordinated Universal Time (UTC), by

    timestamp or other timing device; and

    (iii) Each swap dealer and major swap participant shall make and

    keep a record of each swap portfolio reconciliation, including the

    number of portfolio reconciliation discrepancies and the number of swap

    valuation disputes (including the time-to-resolution of each valuation

    dispute and the age of outstanding valuation disputes, categorized by

    transaction and counterparty);

    (iv) Each swap dealer and major swap participant shall make and

    keep a

    [[Page 20204]]

    record of each swap portfolio compression exercise in which it

    participates, including the dates of the compression, the swaps

    included in the compression, the identity of the counterparties

    participating in the exercise, the results of the compression, and the

    name of the third-party entity performing the compression, if any; and

    (v) Each swap dealer and major swap participant shall make and keep

    a record of each swap that it centrally clears, categorized by

    transaction and counterparty.

    (4) Ledgers. Each swap dealer and major swap participant shall make

    and keep ledgers (or other records) reflecting the following:

    (i) Payments and interest received;

    (ii) Moneys borrowed and moneys loaned;

    (iii) The daily calculation of the value of each outstanding swap;

    (iv) The daily calculation of current and potential future exposure

    for each counterparty;

    (v) The daily calculation of initial margin to be posted by the

    swap dealer or major swap participant for each counterparty and the

    daily calculation of initial margin to be posted by each counterparty;

    (vi) The daily calculation of variation margin payable to or

    receivable from each counterparty;

    (vii) The daily calculation of the value of all collateral, before

    and after haircuts, held by or posted by the swap dealer or major swap

    participant;

    (viii) All transfers of collateral, including any substitutions of

    collateral, identifying in sufficient detail the amounts and types of

    collateral transferred; and

    (ix) All charges against and credits to each counterparty's

    account, including funds deposited, withdrawn, or transferred, and

    charges or credits resulting from losses or gains on transactions.

    (b) Daily trading records for related cash and forward

    transactions. Each swap dealer and major swap participant shall make

    and keep daily trading records of all related cash or forward

    transactions it executes, including all documents on which the related

    cash or forward transaction information is originally recorded. Each

    swap dealer and major swap participant shall ensure that its records

    include all information necessary to conduct a comprehensive and

    accurate trade reconstruction for each related cash or forward

    transaction. Each swap dealer and major swap participant shall maintain

    each transaction record in a manner identifiable and searchable by

    transaction and by counterparty. Such records shall include, but are

    not limited to:

    (1) A record of all oral and written communications provided or

    received concerning quotes, solicitations, bids, offers, instructions,

    trading, and prices, that lead to the conclusion of a related cash or

    forward transaction, whether communicated by telephone, voicemail,

    facsimile, instant messaging, chat rooms, electronic mail, mobile

    device, or other digital or electronic media;

    (2) Reliable timing data for the initiation of the transaction that

    would permit complete and accurate trade reconstruction;

    (3) A record of the date and time, to the nearest minute, using

    Coordinated Universal Time (UTC), by timestamp or other timing device,

    for each quotation provided to, or received from, the counterparty

    prior to execution;

    (4) A record of the date and time of execution of each related cash

    or forward transaction, to the nearest minute, using Coordinated

    Universal Time (UTC), by timestamp or other timing device;

    (5) All terms of each related cash or forward transaction;

    (6) The price at which the related cash or forward transaction was

    executed; and

    (7) A record of the daily calculation of the value of the related

    cash or forward transaction and any other relevant financial

    information.

    Sec. 23.203 Records; retention and inspection.

    (a) Location of records. (1) Records. All records required to be

    kept by a swap dealer or major swap participant by the Act and by

    Commission regulations shall be kept at the principal place of business

    of the swap dealer or major swap participant or such other principal

    office as shall be designated by the swap dealer or major swap

    participant. If the principal place of business is outside of the

    United States, its territories or possessions, then upon the request of

    a Commission representative, the swap dealer or major swap participant

    must provide such records as requested at the place in the United

    States, its territories, or possessions designated by the

    representative within 72 hours after receiving the request.

    (2) Contact information. Each swap dealer and major swap

    participant shall maintain for each of its offices a listing, by name

    or title, of each person at that office who, without delay, can explain

    the types of records the swap dealer or major swap participant

    maintains at that office and the information contained in those

    records.

    (b) Record retention. (1) The records required to be maintained by

    this chapter shall be maintained in accordance with the provisions of

    Sec. 1.31, except as provided in paragraphs (b)(2) and (3) of this

    section. All records required to be kept by the Act and by Commission

    regulations shall be kept for a period of five years from the date the

    record was made and shall be readily accessible during the first two

    (2) years of the five-year period. All such records shall be open to

    inspection by any representative of the Commission, the United States

    Department of Justice, or any applicable prudential regulator. Records

    relating to swaps defined in section 1a(47)(A)(v) shall be open to

    inspection by any representative of the Commission, the United States

    Department of Justice, the Securities and Exchange Commission, or any

    applicable prudential regulator.

    (2) Records of any swap or related cash or forward transaction

    shall be kept until the termination, maturity, expiration, transfer,

    assignment, or novation date of the transaction, and for a period of

    five years after such date. Such records shall be readily accessible

    until the termination, maturity, expiration, transfer, assignment, or

    novation date of the transaction and during the first two years of the

    5-year period following such date. Provided, however, that records of

    oral communications communicated by telephone, voicemail, mobile

    device, or other digital or electronic media pursuant to Sec.

    23.202(a)(1) and (b)(1) shall be kept for a period of one year. All

    such records shall be open to inspection by any representative of the

    Commission, the United States Department of Justice, or any applicable

    prudential regulator. Records relating to swaps defined in section

    1a(47)(A)(v) shall be open to inspection by any representative of the

    Commission, the United States Department of Justice, the Securities and

    Exchange Commission, or any applicable prudential regulator.

    (3) Records of any swap data reported in accordance with part 45 of

    this chapter shall be maintained in accordance with the requirements of

    Sec. 45.2 of this chapter.

    Sec. 23.204 Reports to swap data repositories.

    (a) Reporting of swap transaction data to swap data repositories.

    Each swap dealer and major swap participant shall report all

    information and data in accordance with part 45 of this chapter.

    (b) Electronic reporting of swap transaction data. Each swap dealer

    and major swap participant shall have the electronic systems and

    procedures

    [[Page 20205]]

    necessary to transmit electronically all information and data required

    to be reported in accordance with part 45 of this chapter.

    Sec. 23.205 Real-time public reporting.

    (a) Real-time public reporting of swap transaction and pricing

    data. Each swap dealer and major swap participant shall report all

    information and swap transaction and pricing data required to be

    reported in accordance with the real-time public recording requirements

    in part 43 of this chapter.

    (b) Electronic reporting of swap transaction data. Each swap dealer

    and major swap participant shall have the electronic systems and

    procedures necessary to transmit electronically all information and

    data required to be reported in accordance with part 43 of this

    chapter.

    Sec. 23.206 Delegation of authority to the Director of the Division

    of Swap Dealer and Intermediary Oversight to establish an alternative

    compliance schedule to comply with daily trading records.

    (a) The Commission hereby delegates to the Director of the Division

    of Swap Dealer and Intermediary Oversight or such other employee or

    employees as the Director may designate from time to time, the

    authority to establish an alternative compliance schedule for

    requirements of Sec. 23.202 that are found to be technologically or

    economically impracticable for an affected swap dealer or major swap

    participant that seeks, in good faith, to comply with the requirements

    of Sec. 23.202 within a reasonable time period beyond the date on

    which compliance by such swap dealer or major swap participant is

    otherwise required.

    (b) A request for an alternative compliance schedule under this

    section shall be acted upon by the Director of the Division of Swap

    Dealer and Intermediary Oversight within 30 days from the time such a

    request is received, or it shall be deemed approved.

    (c) Relief granted under this section shall not cause a registrant

    to be out of compliance or deemed in violation of any registration

    requirements.

    (d) Notwithstanding any other provision of this section, in any

    case in which a Commission employee delegated authority under this

    section believes it appropriate, he or she may submit to the Commission

    for its consideration the question of whether an alternative compliance

    schedule should be established. Nothing in this section shall be deemed

    to prohibit the Commission, at its election, from exercising the

    authority delegated in this section.

    0

    8. Add Subpart J, consisting of Sec. Sec. 23.600 through 23.607, to

    read as follows:

    Subpart J--Duties of Swap Dealers and Major Swap Participants

    Sec.

    23.600 Risk Management Program for swap dealers and major swap

    participants.

    23.601 Monitoring of position limits.

    23.602 Diligent supervision.

    23.603 Business continuity and disaster recovery.

    23.604 [Reserved]

    23.605 Conflicts of interest policies and procedures.

    23.606 General information: availability for disclosure and

    inspection.

    23.607 Antitrust considerations.

    Subpart J--Duties of Swap Dealers and Major Swap Participants

    Sec. 23.600 Risk Management Program for swap dealers and major swap

    participants.

    (a) Definitions. For purposes of subpart J, the following terms

    shall be defined as provided.

    (1) Affiliate. This term means, with respect to any person, a

    person controlling, controlled by, or under common control with, such

    person.

    (2) Business trading unit. This term means any department,

    division, group, or personnel of a swap dealer or major swap

    participant or any of its affiliates, whether or not identified as

    such, that performs, or personnel exercising direct supervisory

    authority over the performance of any pricing (excluding price

    verification for risk management purposes), trading, sales, marketing,

    advertising, solicitation, structuring, or brokerage activities on

    behalf of a registrant.

    (3) Clearing unit. This term means any department, division, group,

    or personnel of a registrant or any of its affiliates, whether or not

    identified as such, that performs, or personnel exercising direct

    supervisory authority over the performance of any proprietary or

    customer clearing activities on behalf of a registrant.

    (4) Governing body. This term means:

    (1) A board of directors;

    (2) A body performing a function similar to a board of directors;

    (3) Any committee of a board or body; or

    (4) The chief executive officer of a registrant, or any such board,

    body, committee, or officer of a division of a registrant, provided

    that the registrant's swaps activities for which registration with the

    Commission is required are wholly contained in a separately

    identifiable division.

    (5) Prudential regulator. This term has the same meaning as section

    1a(39) of the Commodity Exchange Act and includes the Board of

    Governors of the Federal Reserve System, the Office of the Comptroller

    of the Currency, the Federal Deposit Insurance Corporation, the Farm

    Credit Association, and the Federal Housing Finance Agency, as

    applicable to the swap dealer or major swap participant.

    (6) Senior management. This term means, with respect to a

    registrant, any officer or officers specifically granted the authority

    and responsibility to fulfill the requirements of senior management by

    the registrant's governing body.

    (7) Swaps activities. This term means, with respect to a

    registrant, such registrant's activities related to swaps and any

    product used to hedge such swaps, including, but not limited to,

    futures, options, other swaps or security-based swaps, debt or equity

    securities, foreign currency, physical commodities, and other

    derivatives.

    (b) Risk management program. (1) Purpose. Each swap dealer and

    major swap participant shall establish, document, maintain, and enforce

    a system of risk management policies and procedures designed to monitor

    and manage the risks associated with the swaps activities of the swap

    dealer or major swap participant. For purposes of this regulation, such

    policies and procedures shall be referred to collectively as a ``Risk

    Management Program.''

    (2) Written policies and procedures. Each swap dealer and major

    swap participant shall maintain written policies and procedures that

    describe the Risk Management Program of the swap dealer or major swap

    participant.

    (3) Approval by governing body. The Risk Management Program and the

    written risk management policies and procedures shall be approved, in

    writing, by the governing body of the swap dealer or major swap

    participant.

    (4) Furnishing to the Commission. Each swap dealer and major swap

    participant shall furnish a copy of its written risk management

    policies and procedures to the Commission, or to a futures association

    registered under section 17 of the Act, if directed by the Commission,

    upon application for registration and thereafter upon request.

    (5) Risk management unit. As part of its Risk Management Program,

    each swap dealer and major swap participant shall establish and

    maintain a risk management unit with sufficient authority; qualified

    personnel; and financial, operational, and other resources to carry out

    the risk management program established pursuant to this regulation.

    The risk management unit shall report directly to senior management and

    shall be

    [[Page 20206]]

    independent from the business trading unit.

    (c) Elements of the Risk Management Program. The Risk Management

    Program of each swap dealer and major swap participant shall include,

    at a minimum, the following elements:

    (1) Identification of risks and risk tolerance limits. (i) The Risk

    Management Program should take into account market, credit, liquidity,

    foreign currency, legal, operational, settlement, and any other

    applicable risks together with a description of the risk tolerance

    limits set by the swap dealer or major swap participant and the

    underlying methodology in written policies and procedures. The risk

    tolerance limits shall be reviewed and approved quarterly by senior

    management and annually by the governing body. Exceptions to risk

    tolerance limits shall be subject to written policies and procedures.

    (ii) The Risk Management Program shall take into account risks

    posed by affiliates and the Risk Management Program shall be integrated

    into risk management at the consolidated entity level.

    (iii) The Risk Management Program shall include policies and

    procedures for detecting breaches of risk tolerance limits set by the

    swap dealer or major swap participant, and alerting supervisors within

    the risk management unit and senior management, as appropriate.

    (2) Periodic Risk Exposure Reports. (i) The risk management unit of

    each swap dealer and major swap participant shall provide to senior

    management and to its governing body quarterly written reports setting

    forth the market, credit, liquidity, foreign currency, legal,

    operational, settlement, and any other applicable risk exposures of the

    swap dealer or major swap participant; any recommended or completed

    changes to the Risk Management Program; the recommended time frame for

    implementing recommended changes; and the status of any incomplete

    implementation of previously recommended changes to the Risk Management

    Program. For purposes of this regulation, such reports shall be

    referred to as ``Risk Exposure Reports.'' The Risk Exposure Reports

    also shall be provided to the senior management and the governing body

    immediately upon detection of any material change in the risk exposure

    of the swap dealer or major swap participant.

    (ii) Furnishing to the Commission. Each swap dealer and major swap

    participant shall furnish copies of its Risk Exposure Reports to the

    Commission within five (5) business days of providing such reports to

    its senior management.

    (3) New product policy. The Risk Management Program of each swap

    dealer and major swap participant shall include a new product policy

    that is designed to identify and take into account the risks of any new

    product prior to engaging in transactions involving the new product.

    The new product policy should include the following elements:

    (i) Consideration of the type of counterparty with which the new

    product will be transacted; the product's characteristics and economic

    function; and whether the product requires a novel pricing methodology

    or presents novel legal and regulatory issues.

    (ii) Identification and analysis of all relevant risks associated

    with the new product and how they will be managed. The risk analysis

    should include an assessment, if relevant, of any product, market,

    credit, liquidity, foreign currency, legal, operational, settlement,

    and any other risks associated with the new product. Product risk

    characteristics may include, if relevant, volatility, non-linear price

    characteristics, jump-to-default risk, and any correlation between the

    value of the product and the counterparty's creditworthiness.

    (iii) An assessment, signed by a supervisor in the risk management

    unit, as to whether the new product would materially alter the overall

    entity-wide risk profile of the swap dealer or major swap participant.

    If the new product would materially alter the overall risk profile of

    the swap dealer or major swap participant, the new product must be pre-

    approved by the governing body before any transactions are effectuated.

    (iv) A requirement that the risk management unit review the risk

    analysis to identify any necessary modifications to the Risk Management

    Program and implement such modifications prior to engaging in

    transactions involving the new product.

    (v) Notwithstanding the foregoing, a swap dealer's or major swap

    participant's new product policy may include provisions permitting

    limited preliminary approval of new products--

    (A) At a risk level that would not be material to the swap dealer

    or major swap participant; and

    (B) Solely in order to provide the swap dealer or major swap

    participant with the opportunity to facilitate development of

    appropriate operational and risk management processes for such product.

    (4) Specific risk management considerations. The Risk Management

    Program of each swap dealer and major swap participant shall include,

    but not be limited to, policies and procedures necessary to monitor and

    manage the following risks:

    (i) Market risk. Market risk policies and procedures shall take

    into account, among other things:

    (A) Daily measurement of market exposure, including exposure due to

    unique product characteristics, volatility of prices, basis and

    correlation risks, leverage, sensitivity of option positions, and

    position concentration, to comply with market risk tolerance limits;

    (B) Timely and reliable valuation data derived from, or verified

    by, sources that are independent of the business trading unit, and if

    derived from pricing models, that the models have been independently

    validated by qualified, independent external or internal persons; and

    (C) Periodic reconciliation of profits and losses resulting from

    valuations with the general ledger.

    (ii) Credit risk. Credit risk policies and procedures shall take

    into account, among other things:

    (A) Daily measurement of overall credit exposure to comply with

    counterparty credit limits;

    (B) Monitoring and reporting of violations of counterparty credit

    limits performed by personnel that are independent of the business

    trading unit; and

    (C) Regular valuation of collateral used to cover credit exposures

    and safeguarding of collateral to prevent loss, disposal,

    rehypothecation, or use unless appropriately authorized.

    (iii) Liquidity risk. Liquidity risk policies and procedures shall

    take into account, among other things:

    (A) Daily measurement of liquidity needs;

    (B) Assessing procedures to liquidate all non-cash collateral in a

    timely manner and without significant effect on price; and

    (C) Application of appropriate collateral haircuts that accurately

    reflect market and credit risk.

    (iv) Foreign currency risk. Foreign currency risk policies and

    procedures shall take into account, among other things:

    (A) Daily measurement of the amount of capital exposed to

    fluctuations in the value of foreign currency to comply with applicable

    limits; and

    (B) Establishment of safeguards against adverse currency

    fluctuations.

    (v) Legal risk. Legal risk policies and procedures shall take into

    account, among other things:

    (A) Determinations that transactions and netting arrangements

    entered into have a sound legal basis; and

    [[Page 20207]]

    (B) Establishment of documentation tracking procedures designed to

    ensure the completeness of relevant documentation and to resolve any

    documentation exceptions on a timely basis.

    (vi) Operational risk. Operational risk policies and procedures

    shall take into account, among other things:

    (A) Secure and reliable operating and information systems with

    adequate, scalable capacity, and independence from the business trading

    unit;

    (B) Safeguards to detect, identify, and promptly correct

    deficiencies in operating and information systems; and

    (C) Reconciliation of all data and information in operating and

    information systems.

    (vii) Settlement risk. Settlement risk policies and procedures

    shall take into account, among other things:

    (A) Establishment of standard settlement instructions with each

    counterparty;

    (B) Procedures to track outstanding settlement items and aging

    information in all accounts, including nostro and suspense accounts;

    and

    (C) Procedures to ensure timely payments to counterparties and to

    resolve any late payments.

    (5) Use of central counterparties. Each swap dealer and major swap

    participant shall establish policies and procedures relating to its use

    of central counterparties. Such policies and procedures shall:

    (i) Require the use of central counterparties where clearing is

    required pursuant to Commission regulation or order, unless the

    counterparty has properly invoked a clearing exemption under Commission

    regulations;

    (ii) Set forth the conditions for the voluntary use of central

    counterparties for clearing when available as a means of mitigating

    counterparty credit risk; and

    (iii) Require diligent investigation into the adequacy of the

    financial resources and risk management procedures of any central

    counterparty through which the swap dealer or major swap participant

    clears.

    (6) Compliance with margin and capital requirements. Each swap

    dealer and major swap participant shall satisfy all capital and margin

    requirements established by the Commission or prudential regulator, as

    applicable.

    (7) Monitoring of compliance with Risk Management Program. Each

    swap dealer and major swap participant shall establish policies and

    procedures to detect violations of the Risk Management Program; to

    encourage employees to report such violations to senior management,

    without fear of retaliation; and to take specified disciplinary action

    against employees who violate the Risk Management Program.

    (d) Business trading unit. Each swap dealer and major swap

    participant shall establish policies and procedures that, at a minimum:

    (1) Require all trading policies be approved by the governing body

    of the swap dealer or major swap participant;

    (2) Require that traders execute transactions only with

    counterparties for whom credit limits have been established;

    (3) Provide specific quantitative or qualitative limits for traders

    and personnel able to commit the capital of the swap dealer or major

    swap participant;

    (4) Monitor each trader throughout the trading day to prevent the

    trader from exceeding any limit to which the trader is subject, or from

    otherwise incurring unauthorized risk;

    (5) Require each trader to follow established policies and

    procedures for executing and confirming all transactions;

    (6) Establish means to detect unauthorized trading activities or

    any other violation of policies and procedures;

    (7) Ensure that all trade discrepancies are documented and, other

    than immaterial, clerical errors, are brought to the immediate

    attention of management of the business trading unit;

    (8) Ensure that broker statements and payments to brokers are

    periodically audited by persons independent of the business trading

    unit;

    (9) Ensure that use of trading programs is subject to policies and

    procedures governing the use, supervision, maintenance, testing, and

    inspection of the program; and

    (10) Require the separation of personnel in the business trading

    unit from personnel in the risk management unit.

    (e) Review and testing. (1) Risk Management Programs shall be

    reviewed and tested on at least an annual basis, or upon any material

    change in the business of the swap dealer or major swap participant

    that is reasonably likely to alter the risk profile of the swap dealer

    or major swap participant.

    (2) The annual reviews of the Risk Management Program shall include

    an analysis of adherence to, and the effectiveness of, the risk

    management policies and procedures, and any recommendations for

    modifications to the Risk Management Program. The annual testing shall

    be performed by qualified internal audit staff that are independent of

    the business trading unit being audited or by a qualified third party

    audit service reporting to staff that are independent of the business

    trading unit. The results of the quarterly reviews of the Risk

    Management Program shall be promptly reported to and reviewed by, the

    chief compliance officer, senior management, and governing body of the

    swap dealer or major swap participant.

    (3) Each swap dealer and major swap participant shall document all

    internal and external reviews and testing of its Risk Management

    Program and written risk management policies and procedures including

    the date of the review or test; the results; any deficiencies

    identified; the corrective action taken; and the date that corrective

    action was taken. Such documentation shall be provided to Commission

    staff, upon request.

    (f) Distribution of risk management policies and procedures. The

    Risk Management Program shall include procedures for the timely

    distribution of its written risk management policies and procedures to

    relevant supervisory personnel. Each swap dealer and major swap

    participant shall maintain records of the persons to whom the risk

    management policies and procedures were distributed and when they were

    distributed.

    (g) Recordkeeping. (1) Each swap dealer and major swap participant

    shall maintain copies of all written approvals required by this

    section.

    (2) All records or reports that a swap dealer or major swap

    participant is required to maintain pursuant to this regulation shall

    be maintained in accordance with Commission Regulation Sec. 1.31 and

    shall be made available promptly upon request to representatives of the

    Commission and to representatives of applicable prudential regulators.

    Sec. 23.601 Monitoring of position limits.

    (a) Each swap dealer and major swap participant shall establish and

    enforce written policies and procedures that are reasonably designed to

    monitor for and prevent violations of applicable position limits

    established by the Commission, a designated contract market, or a swap

    execution facility, and to monitor for and prevent improper reliance

    upon any exemptions or exclusions from such position limits. For

    purposes of this regulation, such policies and procedures shall be

    referred to as ``Position Limit Procedures.'' The Position Limit

    Procedures shall be incorporated into

    [[Page 20208]]

    the Risk Management Program of the swap dealer or major swap

    participant.

    (b) For purposes of the Position Limit Procedures, each swap dealer

    and major swap participant shall convert all swap positions into

    equivalent futures positions using the methodology set forth in

    Commission regulations.

    (c) Each swap dealer and major swap participant shall provide

    training to all relevant personnel on applicable position limits on an

    annual basis and shall promptly notify personnel upon any change to

    applicable position limits. Each swap dealer and major swap participant

    shall maintain records of such training and notifications including the

    substance of the training, the identity of those receiving training,

    and the identity of those notified of changes to applicable position

    limits.

    (d) Each swap dealer and major swap participant shall diligently

    monitor its trading activities and diligently supervise the actions of

    its partners, officers, employees, and agents to ensure compliance with

    the Position Limit Procedures of the swap dealer or major swap

    participant.

    (e) The Position Limit Procedures of each swap dealer and major

    swap participant shall implement an early warning system designed to

    detect and alert its senior management when position limits are in

    danger of being breached (such as when trading has reached a percentage

    threshold of the applicable position limit, and when position limits

    have been exceeded). Any detected violation of applicable position

    limits shall be reported promptly to the firm's governing body. Any

    detected violation of applicable position limits, other than on-

    exchange violations reported to the Commission by a designated contract

    market or a swap execution facility, shall be reported promptly to the

    Commission. Each swap dealer and major swap participant shall maintain

    a record of any early warning received, any position limit violation

    detected, any action taken as a result of either, and the date action

    was taken.

    (f) Each swap dealer and major swap participant that transacts in

    instruments for which position limits have been established by the

    Commission, a designated contract market, or a swap execution facility

    shall test its Position Limit Procedures for adequacy and effectiveness

    at least once each calendar quarter and maintain records of such tests;

    the results thereof; any action that is taken as a result thereof

    including, without limitation, any recommendations for modifications to

    the firm's Position Limit Procedures; and the date action was taken.

    (g) Each swap dealer and major swap participant shall document its

    compliance with applicable position limits established by the

    Commission, a designated contract market, or a swap execution facility

    in a written report on a quarterly basis. Such report shall be promptly

    reported to and reviewed by the chief compliance officer, senior

    management, and governing body of the swap dealer or major swap

    participant, and shall include, without limitation, a list of all early

    warnings received, all position limit violations, the action taken in

    response, the results of the quarterly position limit testing required

    by this regulation, any deficiencies in the Position Limit Procedures,

    the status of any pending amendments to the Position Limit Procedures,

    and any action taken to amend the Position Limit Procedures to ensure

    compliance with all applicable position limits. Each swap dealer and

    major swap participant shall retain a copy of this report.

    (h) On an annual basis, each swap dealer and major swap participant

    shall audit its Position Limit Procedures as part of the audit of its

    Risk Management Program required by Commission regulations.

    (i) All records required to be maintained pursuant to these

    regulations shall be maintained in accordance with Commission

    Regulation Sec. 1.31 and shall be made available promptly upon request

    to representatives of the Commission and to representatives of

    applicable prudential regulators.

    Sec. 23.602 Diligent supervision.

    (a) Supervision. Each swap dealer and major swap participant shall

    establish and maintain a system to supervise, and shall diligently

    supervise, all activities relating to its business performed by its

    partners, members, officers, employees, and agents (or persons

    occupying a similar status or performing a similar function). Such

    system shall be reasonably designed to achieve compliance with the

    requirements of the Commodity Exchange Act and Commission regulations.

    (b) Supervisory System. Such supervisory system shall provide, at a

    minimum, for the following:

    (1) The designation, where applicable, of at least one person with

    authority to carry out the supervisory responsibilities of the swap

    dealer or major swap participant for all activities relating to its

    business as a swap dealer or major swap participant.

    (2) The use of reasonable efforts to determine that all supervisors

    are qualified and meet such standards of training, experience,

    competence, and such other qualification standards as the Commission

    finds necessary or appropriate.

    Sec. 23.603 Business continuity and disaster recovery.

    (a) Business continuity and disaster recovery plan required. Each

    swap dealer and major swap participant shall establish and maintain a

    written business continuity and disaster recovery plan that outlines

    the procedures to be followed in the event of an emergency or other

    disruption of its normal business activities. The business continuity

    and disaster recovery plan shall be designed to enable the swap dealer

    or major swap participant to continue or to resume any operations by

    the next business day with minimal disturbance to its counterparties

    and the market, and to recover all documentation and data required to

    be maintained by applicable law and regulation.

    (b) Essential components. The business continuity and disaster

    recovery plan of a swap dealer or major swap participant shall include

    the following components:

    (1) Identification of the documents, data, facilities,

    infrastructure, personnel and competencies essential to the continued

    operations of the swap dealer or major swap participant and to fulfill

    the obligations of the swap dealer or major swap participant.

    (2) Identification of the supervisory personnel responsible for

    implementing each aspect of the business continuity and disaster

    recovery plan and the emergency contacts required to be provided

    pursuant to this regulation.

    (3) A plan to communicate with the following persons in the event

    of an emergency or other disruption, to the extent applicable to the

    operations of the swap dealer or major swap participant: employees;

    counterparties; swap data repositories; execution facilities; trading

    facilities; clearing facilities; regulatory authorities; data,

    communications and infrastructure providers and other vendors; disaster

    recovery specialists and other persons essential to the recovery of

    documentation and data, the resumption of operations, and compliance

    with the Commodity Exchange Act and Commission regulations.

    (4) Procedures for, and the maintenance of, back-up facilities,

    systems, infrastructure, alternative staffing and other resources to

    achieve the timely recovery of data and documentation and to resume

    operations as soon as reasonably

    [[Page 20209]]

    possible and generally within the next business day.

    (5) Maintenance of back-up facilities, systems, infrastructure and

    alternative staffing arrangements in one or more areas that are

    geographically separate from the swap dealer's or major swap

    participant's primary facilities, systems, infrastructure and personnel

    (which may include contractual arrangements for the use of facilities,

    systems and infrastructure provided by third parties).

    (6) Back-up or copying, with sufficient frequency, of documents and

    data essential to the operations of the swap dealer or major swap

    participant or to fulfill the regulatory obligations of the swap dealer

    or major swap participant and storing the information off-site in

    either hard-copy or electronic format.

    (7) Identification of potential business interruptions encountered

    by third parties that are necessary to the continued operations of the

    swap dealer or major swap participant and a plan to minimize the impact

    of such disruptions.

    (c) Distribution to employees. Each swap dealer and major swap

    participant shall distribute a copy of its business continuity and

    disaster recovery plan to relevant employees and promptly provide any

    significant revision thereto. Each swap dealer and major swap

    participant shall maintain copies of the business continuity and

    disaster recovery plan at one or more accessible off-site locations.

    Each swap dealer and major swap participant shall train relevant

    employees on applicable components of the business continuity and

    disaster recovery plan.

    (d) Commission notification. Each swap dealer and major swap

    participant shall promptly notify the Commission of any emergency or

    other disruption that may affect the ability of the swap dealer or

    major swap participant to fulfill its regulatory obligations or would

    have a significant adverse effect on the swap dealer or major swap

    participant, its counterparties, or the market.

    (e) Emergency contacts. Each swap dealer and major swap participant

    shall provide to the Commission the name and contact information of two

    employees who the Commission can contact in the event of an emergency

    or other disruption. The individuals identified shall be authorized to

    make key decisions on behalf of the swap dealer or major swap

    participant and have knowledge of the firm's business continuity and

    disaster recovery plan. The swap dealer or major swap participant shall

    provide the Commission with any updates to this information promptly.

    (f) Review and modification. A member of the senior management of

    each swap dealer and major swap participant shall review the business

    continuity and disaster recovery plan annually or upon any material

    change to the business. Any deficiencies found or corrective action

    taken shall be documented.

    (g) Testing and audit. Each business continuity and disaster

    recovery plan shall be tested annually by qualified, independent

    internal personnel or a qualified third party service. The date the

    testing was performed shall be documented, together with the nature and

    scope of the testing, any deficiencies found, any corrective action

    taken, and the date that corrective action was taken. Each business

    continuity and disaster recovery plan shall be audited at least once

    every three years by a qualified third party service. The date the

    audit was performed shall be documented, together with the nature and

    scope of the audit, any deficiencies found, any corrective action

    taken, and the date that corrective action was taken.

    (h) Business continuity and disaster recovery plans required by

    other regulatory authorities. A swap dealer or major swap participant

    shall comply with the requirements of this regulation in addition to

    any business continuity and disaster recovery requirements that are

    imposed upon the swap dealer or major swap participant by its

    prudential regulator or any other regulatory or self-regulatory

    authority.

    (i) Recordkeeping. The business continuity and disaster recovery

    plan of the swap dealer and major swap participant and all other

    records required to be maintained pursuant to this section shall be

    maintained in accordance with Commission Regulation Sec. 1.31 and

    shall be made available promptly upon request to representatives of the

    Commission and to representatives of applicable prudential regulators.

    Sec. 23.604 [Reserved]

    Sec. 23.605 Conflicts of interest policies and procedures.

    (a) Definitions. For purposes of this section, the following terms

    shall be defined as provided.

    (1) Affiliate. This term means, with respect to any person, a

    person controlling, controlled by, or under common control with, such

    person.

    (2) Business trading unit. This term means any department,

    division, group, or personnel of a swap dealer or major swap

    participant or any of its affiliates, whether or not identified as

    such, that performs, or personnel exercising direct supervisory

    authority over the performance of, any pricing (excluding price

    verification for risk management purposes), trading, sales, marketing,

    advertising, solicitation, structuring, or brokerage activities on

    behalf of a swap dealer or major swap participant or any of its

    affiliates.

    (3) Clearing unit. This term means any department, division, group,

    or personnel of a swap dealer or major swap participant or any of its

    affiliates, whether or not identified as such, that performs, or

    personnel exercising direct supervisory authority over the performance

    of, any proprietary or customer clearing activities on behalf of a swap

    dealer or major swap participant or any of its affiliates.

    (4) Derivative. This term means:

    (i) A contract for the purchase or sale of a commodity for future

    delivery;

    (ii) A security futures product;

    (iii) A swap;

    (iv) Any agreement, contract, or transaction described in section

    2(c)(2)(C)(i) or section 2(c)(2)(D)(i) of the Act;

    (v) Any commodity option authorized under section 4c of the Act;

    and

    (vi) Any leverage transaction authorized under section 19 of the

    Act.

    (5) Non-research personnel. This term means any employee of the

    business trading unit or clearing unit, or any other employee of the

    swap dealer or major swap participant, other than an employee

    performing a legal or compliance function, who is not directly

    responsible for, or otherwise not involved in, research or analysis

    intended for inclusion in a research report.

    (6) Public appearance. This term means any participation in a

    conference call, seminar, forum (including an interactive electronic

    forum) or other public speaking activity before 15 or more persons

    (individuals or entities), or interview or appearance before one or

    more representatives of the media, radio, television or print media, or

    the writing of a print media article, in which a research analyst makes

    a recommendation or offers an opinion concerning a derivatives

    transaction. This term does not include a password-protected Webcast,

    conference call or similar event with 15 or more existing customers,

    provided that all of the event participants previously received the

    most current research report or other documentation that contains the

    required applicable disclosures, and that the research analyst

    appearing at the event corrects and updates during the public

    appearance any disclosures in the research report that are

    [[Page 20210]]

    inaccurate, misleading, or no longer applicable.

    (7) Research analyst. This term means the employee of a swap dealer

    or major swap participant who is primarily responsible for, and any

    employee who reports directly or indirectly to such research analyst in

    connection with, preparation of the substance of a research report

    relating to any derivative, whether or not any such person has the job

    title of ``research analyst.''

    (8) Research department. This term means any department or division

    that is principally responsible for preparing the substance of a

    research report relating to any derivative on behalf of a swap dealer

    or major swap participant, including a department or division contained

    in an affiliate of a swap dealer or major swap participant.

    (9) Research report. This term means any written communication

    (including electronic) that includes an analysis of the price or market

    for any derivative, and that provides information reasonably sufficient

    upon which to base a decision to enter into a derivatives transaction.

    This term does not include:

    (i) Communications distributed to fewer than 15 persons;

    (ii) Commentaries on economic, political, or market conditions;

    (iii) Statistical summaries of multiple companies' financial data,

    including listings of current ratings;

    (iv) Periodic reports or other communications prepared for

    investment company shareholders or commodity pool participants that

    discuss individual derivatives positions in the context of a fund's

    past performance or the basis for previously-made discretionary

    decisions;

    (v) Any communications generated by an employee of the business

    trading unit that is conveyed as a solicitation for entering into a

    derivatives transaction, and is conspicuously identified as such; and

    (vi) Internal communications that are not given to current or

    prospective customers.

    (b) Policies and procedures. Each swap dealer and major swap

    participant subject to this rule must adopt and implement written

    policies and procedures reasonably designed to ensure that the swap

    dealer or major swap participant and its employees comply with the

    provisions of this rule.

    (c) Research analysts and research reports. (1) Restrictions on

    relationship with research department. (i) Non-research personnel shall

    not direct a research analyst's decision to publish a research report

    of the swap dealer or major swap participant, and non-research

    personnel shall not direct the views and opinions expressed in a

    research report of the swap dealer or major swap participant.

    (ii) No research analyst may be subject to the supervision or

    control of any employee of the swap dealer's or major swap

    participant's business trading unit or clearing unit, and no employee

    of the business trading unit or clearing unit may have any influence or

    control over the evaluation or compensation of a research analyst.

    (iii) Except as provided in paragraph (c)(1)(iv) of this section,

    non-research personnel, other than the board of directors and any

    committee thereof, shall not review or approve a research report of the

    swap dealer or major swap participant before its publication.

    (iv) Non-research personnel may review a research report before its

    publication as necessary only to verify the factual accuracy of

    information in the research report, to provide for non-substantive

    editing, to format the layout or style of the research report, or to

    identify any potential conflicts of interest, provided that:

    (A) Any written communication between non-research personnel and

    research department personnel concerning the content of a research

    report must be made either through authorized legal or compliance

    personnel of the swap dealer or major swap participant or in a

    transmission copied to such personnel; and

    (B) Any oral communication between non-research personnel and

    research department personnel concerning the content of a research

    report must be documented and made either through authorized legal or

    compliance personnel acting as an intermediary or in a conversation

    conducted in the presence of such personnel.

    (2) Restrictions on communications. Any written or oral

    communication by a research analyst to a current or prospective

    counterparty relating to any derivative must not omit any material fact

    or qualification that would cause the communication to be misleading to

    a reasonable person.

    (3) Restrictions on research analyst compensation. A swap dealer or

    major swap participant may not consider as a factor in reviewing or

    approving a research analyst's compensation his or her contributions to

    the swap dealer's or major swap participant's trading or clearing

    business. Except for communicating client or customer feedback,

    ratings, and other indicators of research analyst performance to

    research department management, no employee of the business trading

    unit or clearing unit of the swap dealer or major swap participant may

    influence the review or approval of a research analyst's compensation.

    (4) Prohibition of promise of favorable research. No swap dealer or

    major swap participant may directly or indirectly offer favorable

    research, or threaten to change research, to an existing or prospective

    counterparty as consideration or inducement for the receipt of business

    or compensation.

    (5) Disclosure requirements. (i) Ownership and material conflicts

    of interest. A swap dealer or major swap participant must disclose in

    research reports and a research analyst must disclose in public

    appearances:

    (A) Whether the research analyst maintains a financial interest in

    any derivative of a type, class, or, category that the research analyst

    follows, and the general nature of the financial interest; and

    (B) Any other actual, material conflicts of interest of the

    research analyst or swap dealer or major swap participant of which the

    research analyst has knowledge at the time of publication of the

    research report or at the time of the public appearance.

    (ii) Prominence of disclosure. Disclosures and references to

    disclosures must be clear, comprehensive, and prominent. With respect

    to public appearances by research analysts, the disclosures required by

    this paragraph (c)(5) must be conspicuous.

    (iii) Records of public appearances. Each swap dealer and major

    swap participant must maintain records of public appearances by

    research analysts sufficient to demonstrate compliance by those

    research analysts with the applicable disclosure requirements under

    this paragraph (c)(5).

    (iv) Third-party research reports. (A) For the purposes of this

    paragraph (c)(5)(iv), ``independent third-party research report'' shall

    mean a research report, in respect of which the person or entity

    producing the report:

    (1) Has no affiliation or business or contractual relationship with

    the distributing swap dealer or major swap participant, or that swap

    dealer's or major swap participant's affiliates, that is reasonably

    likely to inform the content of its research reports; and

    (2) Makes content determinations without any input from the

    distributing swap dealer or major swap participant or that swap

    dealer's or major swap participant's affiliates.

    (B) Subject to paragraph (c)(5)(iv)(C) of this section, if a swap

    dealer or major swap participant distributes or makes available any

    independent third-party

    [[Page 20211]]

    research report, the swap dealer or major swap participant must

    accompany the research report with, or provide a Web address that

    directs the recipient to, the current applicable disclosures, as they

    pertain to the swap dealer or major swap participant, required by this

    section. Each swap dealer and major swap participant must establish

    written policies and procedures reasonably designed to ensure the

    completeness and accuracy of all applicable disclosures.

    (C) The requirements of paragraph (c)(5)(iv)(B) of this section

    shall not apply to independent third-party research reports made

    available by a swap dealer or major swap participant to its customers:

    (1) Upon request; or

    (2) Through a Web site maintained by the swap dealer or major swap

    participant.

    (6) Prohibition of retaliation against research analysts. No swap

    dealer or major swap participant, and no employee of a swap dealer or

    major swap participant who is involved with the swap dealer's or major

    swap participant's pricing, trading, or clearing activities, may,

    directly or indirectly, retaliate against or threaten to retaliate

    against any research analyst employed by the swap dealer or major swap

    participant or its affiliates as a result of an adverse, negative, or

    otherwise unfavorable research report or public appearance written or

    made, in good faith, by the research analyst that may adversely affect

    the swap dealer's or major swap participant's present or prospective

    pricing, trading, or clearing activities.

    (d) Clearing activities. (1) No swap dealer or major swap

    participant shall directly or indirectly interfere with or attempt to

    influence the decision of the clearing unit of any affiliated clearing

    member of a derivatives clearing organization to provide clearing

    services and activities to a particular customer, including but not

    limited to a decision relating to the following:

    (i) Whether to offer clearing services and activities to a

    particular customer;

    (ii) Whether to accept a particular customer for the purposes of

    clearing derivatives;

    (iii) Whether to submit a customer's transaction to a particular

    derivatives clearing organization;

    (iv) Whether to set or adjust risk tolerance levels for a

    particular customer;

    (v) Whether to accept certain forms of collateral from a particular

    customer; or

    (vi) Whether to set a particular customer's fees for clearing

    services based upon criteria that are not generally available and

    applicable to other customers of the swap dealer or major swap

    participant.

    (2) Each swap dealer and major swap participant shall create and

    maintain an appropriate informational partition, as specified in

    section 4s(j)(5)(A) of the Act, between business trading units of the

    swap dealer or major swap participant and clearing units of any

    affiliated clearing member of a derivatives clearing organization to

    reasonably ensure compliance with the Act and the prohibitions

    specified in paragraph (d)(1) of this section. At a minimum, such

    informational partitions shall require that no employee of a business

    trading unit of a swap dealer or major swap participant shall

    supervise, control, or influence any employee of the clearing unit of

    any affiliated clearing member of a derivatives clearing organization.

    (e) Undue influence on counterparties. Each swap dealer and major

    swap participant must adopt and implement written policies and

    procedures that mandate the disclosure to its counterparties of any

    material incentives and any material conflicts of interest regarding

    the decision of a counterparty:

    (1) Whether to execute a derivative on a swap execution facility or

    designated contract market; or

    (2) Whether to clear a derivative through a derivatives clearing

    organization.

    (f) All records that a swap dealer or major swap participant is

    required to maintain pursuant to this regulation shall be maintained in

    accordance with Commission Regulation Sec. 1.31 and shall be made

    available promptly upon request to representatives of the Commission

    and to representatives of the applicable prudential regulator, as

    defined in 7 U.S.C. 1a(39).

    Sec. 23.606 General information: availability for disclosure and

    inspection.

    (a) Disclosure of information. (1) Each swap dealer and major swap

    participant shall make available for disclosure to and inspection by

    the Commission and its prudential regulator, as applicable, all

    information required by, or related to, the Commodity Exchange Act and

    Commission regulations, including:

    (i) The terms and condition of its swaps;

    (ii) Its swaps trading operations, mechanisms, and practices;

    (iii) Financial integrity and risk management protections relating

    to swaps; and

    (iv) Any other information relevant to its trading in swaps.

    (2) Such information shall be made available promptly, upon

    request, to Commission staff and the staff of the applicable prudential

    regulator, at such frequency and in such manner as is set forth in the

    Commodity Exchange Act, Commission regulations, or the regulations of

    the applicable prudential regulator.

    (b) Ability to provide information. (1) Each swap dealer and major

    swap participant shall establish and maintain reliable internal data

    capture, processing, storage, and other operational systems sufficient

    to capture, process, record, store, and produce all information

    necessary to satisfy its duties under the Commodity Exchange Act and

    Commission regulations. Such systems shall be designed to produce the

    information within the time frames set forth in the Commodity Exchange

    Act and Commission regulations or upon request, as applicable.

    (2) Each swap dealer and major swap participant shall establish,

    implement, maintain, and enforce written procedures for the capture,

    processing, recording, storage, and production of all information

    necessary to satisfy its duties under the Commodity Exchange Act and

    Commission regulations.

    (c) Record retention. All records or reports that a swap dealer or

    major swap participant is required to maintain pursuant to this

    regulation shall be maintained in accordance with Commission Regulation

    Sec. 1.31 and shall be made available promptly upon request to

    representatives of the Commission and to representatives of applicable

    prudential regulators.

    Sec. 23.607 Antitrust considerations.

    (a) No swap dealer or major swap participant shall adopt any

    process or take any action that results in any unreasonable restraint

    of trade, or impose any material anticompetitive burden on trading or

    clearing, unless necessary or appropriate to achieve the purposes of

    the Commodity Exchange Act.

    (b) Consistent with its obligations under paragraph (a) of this

    section, each swap dealer and major swap participant shall adopt

    policies and procedures to prevent actions that result in unreasonable

    restraint of trade, or impose any material anticompetitive burden on

    trading or clearing.

    Issued in Washington, DC, on February 23, 2012, by the

    Commission.

    David A. Stawick,

    Secretary of the Commission.

    Note: The following appendices will not appear in the Code of

    Federal Regulations:

    [[Page 20212]]

    Appendices to Swap Dealer and Major Swap Participant Recordkeeping and

    Reporting, Duties, and Conflicts of Interest Policies and Procedures;

    Futures Commission Merchant and Introducing Broker Conflicts of

    Interest Policies and Procedures; Swap Dealer, Major Swap Participant,

    and Futures Commission Merchant Chief Compliance Officer--Commission

    Voting Summary and Statements of Commissioners

    Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Chilton and

    Wetjen voted in the affirmative; Commissioners Sommers and O'Malia

    voted in the negative.

    Appendix 2--Statement of Chairman Gary Gensler

    I support the internal business conduct rule, which will lower

    the risk that swap dealers pose to the rest of the economy. These

    rules are the result of a critical reform in the Dodd-Frank Wall

    Street reform and Consumer Protection Act (Dodd-Frank Act) where

    Congress gave the Commodity Futures Trading Commission (CFTC)

    authority to write rules overseeing swap dealer business conduct.

    This rule is a collection of five CFTC proposals in four key areas.

    First, the final rule establishes a number of duties for swap

    dealers (SDs) and major swap participants (MSPs), including a risk

    management program with policies and procedures to monitor and

    manage the risks associated with their swap activities. Among the

    requirements are: (a) Ensuring the risk management program takes

    into account market risk, credit risk, liquidity risk, foreign

    currency risk, legal risk, operational risk, settlement risk, and

    risk posed by traders; (b) establishing a system of diligent

    supervision by qualified personnel over the SD and MSP activities;

    and (c) ensuring risk management issues are elevated within

    management.

    Second, the final rule establishes firewalls to protect against

    conflicts of interest that can arise between trading and research

    units of SDs, MSPs, futures commission merchants (FCMs), and

    introducing brokers. In addition, the rules establish a firewall

    between clearing and trading that will protect against conflicts of

    interest relating to a firm's clearing activities. A 2009 Commission

    study on harmonization between the Securities and Exchange

    Commission and the CFTC recommended that the Commission establish

    these firewalls, which are based upon similar protections in the

    securities markets.

    Third, the final rule establishes the reporting, recordkeeping

    and daily trading requirements for SDs and MSPs. Importantly, this

    section creates an audit trail detailing the full history of trades

    so the SD or MSP can better ensure compliance internally, and, when

    appropriate, the CFTC can be a more effective cop on the beat.

    Fourth, the final rule establishes requirements for the

    designation of a chief compliance officer of SDs, MSPs and FCMs.

    This compliance officer will ensure that the firm's policies and

    procedures comply with the CEA and Commission regulations. The

    officer will prepare an annual report describing the registrant's

    compliance with its own policies, as well as CEA and Commission

    regulations.

    Appendix 3--Statement of Commissioner Scott O'Malia

    The latest issue of The Economist features an article titled

    ``Over-regulated America'' \198\ that features as its archetype for

    excessive and badly-written regulation our own Dodd-Frank Act. The

    problem, the article points out, is that rules that sound reasonable

    on their own may impose a huge collective burden due, in part, to

    their complexity. Part of the problem is that we, as The Economist

    points out, are under the impression that we can anticipate and

    regulate for every eventuality. In our hubris, The Economist warns,

    our overreaching tends to defeat our good intentions and creates

    loopholes and perhaps unintentional safe-harbors, leaving our rules

    ineffectual and subject to abuse. The solution The Economist offers

    isn't so unfamiliar, at least to this Commissioner. It is rather

    simple. It is just that: Rules need to be simple. Echoing President

    Obama's 2011 Executive Order 13563 ``Improving Regulation and

    Regulatory Review'' \199\ (which applies equally to independent

    Federal agencies such as the Commodity Futures Trading Commission

    (the ``Commission'' or ``CFTC'') per a subsequent Executive Order

    \200\), The Economist advises that we ought to cut out the verbiage

    and focus on writing rules that articulate broad goals and prescribe

    only what is strictly necessary to achieve them.

    ---------------------------------------------------------------------------

    \198\ Over-regulated America, Economist, Feb. 18, 2012, at 9.

    \199\ Exec. Order No. 13,563, 76 FR 3821 (Jan. 21, 2011).

    \200\ Exec. Order No. 13,579, 76 FR 41,587 (July 14, 2011).

    ---------------------------------------------------------------------------

    In my own words, in several prior statements, I have argued that

    we must ensure that regulations are accessible, consistent, written

    in plain language, guided by empirical data, and are easily

    understood. I cautioned that, with each piecemeal rulemaking, we

    risk creating redundancies and inconsistencies that result in

    costs--both opportunity costs and economic costs--without

    corresponding benefits. Consistent with Executive Order 13563, which

    reaffirms prior guidance on the subject of regulatory review issued

    in the 1993 Executive Order 12866 \201\ as well as Office of

    Management and Budget (``OMB'') guidance to Federal agencies with

    respect to said Executive Order,\202\ agencies like the CFTC must go

    out of their way to ensure responsible rulemaking by, among other

    things, undertaking thorough cost-benefit analyses, both

    qualitatively and quantitatively, to ensure that new rules do not

    impose unreasonable costs.

    ---------------------------------------------------------------------------

    \201\ Exec. Order No. 12,866, 58 FR 51,735 (Oct. 4, 1993).

    \202\ OMB Circular A-4, available at http://www.whitehouse.gov/sites/default/files/omb/assets/regulatory_matters_pdf/a-4.pdf.

    ---------------------------------------------------------------------------

    I accepted wholeheartedly the mission put upon this

    administration by the President to ``[T]o root out regulations that

    conflict, that are not worth the cost, or that are just plain

    dumb.'' \203\ Today, in furtherance of that mission, I will not

    support the final rules governing various internal business conduct

    standards for futures commission merchants, introducing brokers,

    swap dealers and major swaps participants (the ``Internal Business

    Conduct Rules''). These rules fail to articulate necessary and clear

    performance objectives, are needlessly complex, and create a

    collective burden without the benefit of even an appropriate

    baseline cost-benefit analysis. The fact that OMB's Office of

    Information and Regulatory Affairs \204\ has concurred \205\ with

    our determination that this set of rules qualifies as a ``Major

    Rule'' under the Congressional Review Act with an annual effect on

    the economy of more than $100 million without a fulsome discussion

    of anticipated costs, let alone an analysis based on reasoned

    assumptions or evaluation of the impacts of this rulemaking against

    the pre-statutory baseline, is regulatory malpractice in my book.

    While we set the bar low here at the Commission for our cost-benefit

    analyses, and accept what is ``reasonably feasible,'' this

    rulemaking is nothing but unreasonably feeble.

    ---------------------------------------------------------------------------

    \203\ Barack Obama, Toward a 21st-Century Regulatory System,

    Wall St. J., Jan. 18, 2011, at A17.

    \204\ The Office of Information and Regulatory Affairs

    (``OIRA''), among other things, reviews draft regulations under

    Executive Order 12866. See Office of Information and Regulatory

    Affairs (``OIRA'') Q & As, available at: http://www.whitehouse.gov/omb/OIRA_QsandAs.

    \205\ I use this term loosely since the only verification we

    received at the Commission was a perfunctory email from an OMB

    employee stating, ``OMB concurs that the rule is major.'' It is

    unclear as to what data OMB could have relied upon in reaching its

    conclusion.

    ---------------------------------------------------------------------------

    After reviewing the Internal Business Conduct Rules, I have

    reached a tipping point and can no longer tolerate the application

    of such weak standards to analyzing the costs and benefits of our

    rulemakings. Our inability to develop a quantitative analysis, or to

    develop a reasonable comparative analysis of legitimate options,

    hurts the credibility of this Commission and undermines the quality

    of our rules. I believe it is time for professional help, and I will

    be following up this statement with a letter to the Director of the

    OMB seeking an independent review of the Internal Business Conduct

    Rules to determine whether or not this rulemaking fully complies

    with the President's Executive Orders and the OMB guidance found in

    OMB Circular A-4. To the extent that OMB finds any concerns with the

    Commission's economic analysis, I hope that it will provide specific

    recommendations as to how the Commission can improve its cost-

    benefit analysis and analytical capabilities.

    Lest anyone think that I am inadvertently waiving a work-product

    or other privilege, the Commission's May 13, 2011 internal Staff

    Guidance on Cost-Benefit Considerations for Final Rulemakings under

    the Dodd-Frank Act (``Staff Guidance'') was made public as Exhibit 2

    to the CFTC's Office of Inspector General's June 13, 2011 Review of

    Cost-Benefit Analyses Performed by the CFTC in

    [[Page 20213]]

    Connection with Rulemakings Undertaken Pursuant to the Dodd-Frank

    Act, which is available on the CFTC's Web site.\206\ While it is not

    my intent to walk you through the Staff Guidance (or the Inspector

    General's report for that matter), I do think it warrants attention

    for the inattention it gives to both the principles of Executive

    Orders 13563 and 12866 and OMB guidance found in Circular A-4 (``OMB

    Circular A-4''). More specifically, and among other things, the

    Staff Guidance provides that each rulemaking team should,

    ``incorporate the principles of Executive Order 13563 to the extent

    they are consistent with section 15(a) [of the Commodity Exchange

    Act] and it is reasonably feasible to do so.'' Keep in mind that

    while Section 15(a) of the Commodity Exchange Act requires the CFTC

    to consider the costs and benefits of its proposed regulations, the

    Commission has interpreted the language of section 15(a) to neither

    require quantification of such costs and benefits, nor to require

    the agency to determine whether the benefits exceed costs or whether

    the proposed rules are the most cost-effective means of reaching

    goals.\207\ ``Rather, section 15 simply requires the Commission to

    `consider the costs and benefits' of its action.'' \208\ That was a

    direct quote from the Federal Register.

    ---------------------------------------------------------------------------

    \206\ Office of the Inspector General of the Commodity Futures

    Trading Commission, A Review of Cost-Benefit Analyses performed by

    the Commodity Futures Trading Commission in Connection with

    Rulemakings Undertaken Pursuant to the Dodd-Frank Act, June 13,

    2011, available at: www.cftc.gov/ucm/groups/public/@aboutcftc/documents/file/oig_investigation_061311.pdf.

    \207\ A New Regulatory Framework for Trading Facilities,

    Intermediaries and Clearing Organizations, 66 FR 14,262, 14,267

    (March 9, 2001).

    \208\ Id.

    ---------------------------------------------------------------------------

    Further, under the Staff Guidance--and clearly consistent with

    the Commission's interpretation of section 15--rulemaking teams need

    only quantify costs and benefits ``to the extent it is reasonably

    feasible and appropriate to address comments received.'' As

    additional guidance, staff is advised that ``reasonably feasible and

    appropriate'' means ``the extent to which (i) certain analyses,

    quantitative or qualitative, is [sic] needed to address comments

    received (``appropriate'') and (ii) whether such an analysis may be

    performed with available resources (``reasonably feasible'').

    Accordingly, our interpretation of our duties pursuant to section

    15(a) and Staff Guidance provides that we need not quantify the

    costs or benefits of our rules unless we need to do so in order to

    respond to comments, and that we can do so with whatever resources

    are immediately at our fingertips. As for the Executive Orders, it

    appears that we will incorporate their principles only when they

    neatly align with our own interpretation of section 15(a), and only

    when we can do so without utilizing the resources immediately within

    our coffers.

    Setting the bar this low is pretty remarkable. Indeed, former

    Commissioner and Acting Chairman William P. Albrecht recently

    remarked that expecting any detailed cost-benefit analysis of the

    proposed Dodd-Frank rules is impossible in part because, ``[T]he

    CFTC has never had to develop CBA expertise.'' \209\ Commissioner

    Albrecht advised that, ``A good starting point might be to require

    more detailed analysis of the costs of alternative means of

    accomplishing a particular goal. This would help the agency develop

    CBA expertise and should, over time, lead to a deeper understanding

    of the costs of regulation.'' \210\

    ---------------------------------------------------------------------------

    \209\ William P. Albrecht, Cost Benefit Analysis and the

    Commodity Futures Trading Commission (``CFTC''), Discussion Paper,

    May 2011, available at http://www.rff.org/RFF/Documents/RFF-DP-11-24.pdf.

    \210\ Id. at 9.

    ---------------------------------------------------------------------------

    I believe that Commissioner Albrecht's advice is already well-

    articulated in both Executive Orders and OMB Circular A-4 as

    incorporated directly into the Staff Guidance. However, the

    Commission skirts these requirements and apparently refuses to

    develop expertise. Instead, the Commission limits itself to

    responding to comments, but only when it doesn't require any

    analysis beyond that which it did for the proposal.

    Additionally, as in today's final rulemaking, the Commission has

    determined, in contradiction of OMB guidance directly on point, that

    in setting the baseline for comparison of the costs and benefits of

    regulatory alternatives, it may set the ``baseline'' to incorporate

    the costs of statutorily mandated rulemakings, regardless of how the

    CFTC has interpreted the statutory goals and regardless of the

    existence of alternative means to comply with such goals. Thereby,

    the Commission is relying on an arbitrary presumption that, ``To the

    extent that * * * new regulations reflect the statutory requirements

    of the Dodd-Frank Act, they will not create costs and benefits

    beyond those resulting from Congress's statutory mandates in the

    Dodd-Frank Act.'' \211\ What does this mean? Well, according to the

    Commission in this rulemaking, it means that for commenters who

    ``posit that there is no benefit to be derived from internal

    business conduct standards as mandated by Congress and that the

    mandated provisions do not generate sufficient benefits relative to

    costs or contribute to the purposes (e.g. mitigating systemic risk

    and enhancing transparency) of the Dodd-Frank Act. * * * these

    commenters' concerns fall outside the Commission's regulatory

    discretion to implement sections 4s and 4d of the CEA and fail to

    raise issues subject to consider[ation] under section 15(a).'' \212\

    That is, the Commission will ignore comments related to required

    rulemaking provisions that mirror statutory language in spite of the

    fact that the Commission always has some level of discretion in

    determining the means to achieve such mandates. Rather the

    Commission will consider comments on new regulations ``that reflect

    the Commission's own determinations regarding implementation of the

    Dodd-Frank Act's provisions. * * * It is these other costs and

    benefits * * * that the Commission considers with respect to the

    section 15(a) factors.'' \213\ It is unacceptable that the

    Commission ignores pre-Dodd-Frank reality and establishes its own

    economic baseline for its rulemakings. This practice defies not only

    common sense, but rigorous and competent economic analysis as well.

    ---------------------------------------------------------------------------

    \211\ See Swap Dealer and Major Swap Participant Recordkeeping

    and Reporting, Duties, and Conflicts of Interest Policies and

    Procedures; Futures Commission Merchant and Introducing Broker

    Conflicts of Interest Policies and Procedures; Swap Dealer, Major

    Swap Participant, and Futures Commission Merchant Chief Compliance

    Officer, Final Rule, at Section IV of the Preamble.

    \212\ Id. at Section IV of the Cost Benefit Considerations, note

    64.

    \213\ Id. at Section IV of the Preamble.

    ---------------------------------------------------------------------------

    I will briefly highlight how these rules not only fail to

    include a rational, rigorous, and sustainable cost-benefit analysis,

    but fail to articulate necessary and clear performance objectives,

    are complex, and create an unjustifiable cumulative burden within

    this rule and when considered with other CFTC regulations and those

    of prudential regulators.

    I believe the Commission has failed to carefully and precisely

    identify a clear baseline against which the Commission measured

    costs and benefits and the range of alternatives under consideration

    in this rule. Specifically, the Commission's cost-benefit analysis

    with regard to this rule fails to comply with the basic direction in

    OMB Circular A-4 to establish an appropriate baseline that includes

    an evaluation of the pre-statutory baseline in light of the range of

    Commission discretion as to the manner in which the rules implement

    the statutory goals of section 4s.\214\ The circular also directs

    the Commission to consider alternatives available ``for the key

    attributes or provisions of the rule.'' \215\ The Circular goes on

    to recommend that, ``It is not adequate simply to report a

    comparison of the agency's preferred option to the chosen baseline.

    Whenever you report the benefits and the costs of alternative

    options, you should present both total and incremental benefits and

    costs.'' \216\ It is at this most basic level of analysis where the

    Commission has failed to provide alternative options for

    consideration or has failed to justify its choice of regulation with

    a specific cost-benefit analysis.

    ---------------------------------------------------------------------------

    \214\ OMB Circular A-4 at 15-16.

    \215\ Id. at 16.

    \216\ Id.

    ---------------------------------------------------------------------------

    In two examples articulated by the Commission, the Internal

    Business Conduct Rules dismisses out of hand, and without specific

    justification the concerns raised by two commenters: (1) The Federal

    Home Loan Banks who raised concerns regarding compliance burdens and

    duplicative nature of regulations for comparably regulated entities;

    and (2) The Working Group of Commercial Energy Firms, which raised

    concerns that the rules failed to provide benefits with regard to

    risk management and compliance that matched, much less exceeded, the

    cost of compliance. Both concerns were dismissed without

    consideration of alternatives and without any attempt to quantify

    the cited costs.

    With regard to recordkeeping requirements, the Internal Business

    Conduct Rules impose a substantial burden on Swap

    [[Page 20214]]

    Dealers (``SDs'') and Major Swap Participants (``MSPs'') to maintain

    extensive audio recordings including the requirement to tag each

    taped conversation and make it searchable by transaction and

    counterparty. Understandably, section 4s(g) does require the

    maintenance of such daily trading records for each counterparty and

    that they be identifiable with each swap transaction. However, in

    spite of enormous technological challenges it is unclear as to

    whether or not the Commission undertook any independent effort to

    determine the technical challenges of implementing such a system,

    including, whether such technology currently exists, the costs of

    acquiring and installing such technology, and whether such a system

    could be developed and/or installed within the timetable set by the

    Commission. The Commission has failed the fundamental test in

    Circular A-4 to establish an appropriate baseline and consider a

    range of alternatives with associated costs and benefits. Although

    the Commission modified its original proposal to not require each

    telephone record to be kept as a single file, it fails to quantify

    the specific cost of complying with a costly and technically

    challenging mandate. Moreover, in determining that such audio

    recordings are to be maintained for a one-year period, the

    Commission provides no analytical support for this retention period

    over a more reasonable six-month period other than to say that such

    period will be ``most useful for the Commission's enforcement

    purposes.'' \217\

    ---------------------------------------------------------------------------

    \217\ See Swap Dealer and Major Swap Participant Recordkeeping

    and Reporting, Duties, and Conflicts of Interest Policies and

    Procedures; Futures Commission Merchant and Introducing Broker

    Conflicts of Interest Policies and Procedures; Swap Dealer, Major

    Swap Participant, and Futures Commission Merchant Chief Compliance

    Officer, Final Rule, at Section IV of the Preamble.

    ---------------------------------------------------------------------------

    Further, the Commission also ignored commenters' requests to

    allow firms to rely on swap data repositories (``SDRs'') for

    recordkeeping requirements. The analysis states:

    The Commission considered this alternative to its recordkeeping

    rules, but determined that it is premature at this time to permit

    SDs and MSPs to rely solely on SDRs to meet their recordkeeping

    obligations under the rules. * * * At present, SDRs are new entities

    under the Dodd-Frank Act with no track record of operations; and,

    for particular swap asset classes, SDRs have yet to be

    established.\218\

    ---------------------------------------------------------------------------

    \218\ Id.

    ---------------------------------------------------------------------------

    In addition to finalizing rules governing registration

    standards, duties and core principles for SDRs,\219\ the Commission

    has already voted on the final rules that establish and compel the

    reporting of swap transaction information to SDRs for purposes of

    real-time public reporting (the ``Real-Time Reporting Rule'') and to

    ensure that complete data concerning swaps is available to

    regulators throughout the existence of each swap and for fifteen

    years following termination.\220\ In addition, the track record of

    entities that will likely be our first registered SDRs is considered

    proven as data from these repositories in both rates and credit have

    been used to establish the foundation for today's re-proposal of

    Procedures to Establish Appropriate Minimum Block Sizes For Large

    Notional Off-Facility Swaps and Block Trades; Further Measures to

    Protect the Identities of Parties to Swap Transactions (the ``Block

    Proposal'').

    ---------------------------------------------------------------------------

    \219\ Swap Data Repositories: Registration Standards, Duties and

    Core Principles, 76 FR 54,538 (Sept. 1, 2011) (to be codified at 17

    CFR partart 49).

    \220\ Real-Time Public Reporting of Swap Transaction Data, 76 FR

    1,182 (Jan. 9, 2012) (to be codified at 17 CFR part 43); Swap Data

    Recordkeeping and Reporting Requirements, 76 FR 2,136 (Jan. 13,

    2012) (to be codified at 17 CFR partpart 45).

    ---------------------------------------------------------------------------

    If the Commission truly has doubts as to the fidelity and

    reliability SDR data, then it ought not to have relied upon it in a

    proposed rulemaking. That being said, although the analysis seems to

    indicate that the Commission considered alternatives, it is curious

    as to how the Commission came to the conclusion that the Internal

    Business Conduct Rules are cost-effective, given that they require

    firms to keep duplicative and redundant trade records when all

    trades must be reported to an SDR and stored by the SDR for the life

    of the swap, plus an additional fifteen years--which is ten years

    more than our rules require that such records be kept by

    registrants.

    I would also point out that the Real-Time Reporting Rule

    provides that a party to a publicly-reportable swap transaction

    satisfies its real-time reporting requirements by executing the swap

    on or pursuant to the rules of an exchange or swap execution

    facility.\221\ That is, SDs and MSPs, among others, may rely on

    exchanges and swap execution facilities to report all on-exchange

    trades; there is no mandated separate reporting requirement.

    However, the Internal Business Conduct Rules undermine this relief

    by requiring redundant recordkeeping and by mandating that SDs and

    MSPs save all transaction records and by failing to trust our own

    regulatory-creation to actually serve as a repository for all trade

    data as envisioned by Dodd-Frank Act. I have serious concerns about

    the Commission's ability to monitor and reconcile two sets of

    records, which is the rationale put forth in this final rule.

    ---------------------------------------------------------------------------

    \221\ Real-Time Public Reporting of Swap Transaction Data, 76 FR

    1,182, 1,244 (Jan. 9, 2012) (to be codified at 17 CFR part 43).

    ---------------------------------------------------------------------------

    Ironically, the SDRs were created in the Dodd-Frank Act to

    facilitate market transparency and reporting. The Commission could

    provide greater transparency into its own cost-benefit analysis by

    disclosing its assumptions and data to support its conclusions. OMB

    Circular A-4 outlines standards for transparency with the following

    direction, ``A good analysis should be transparent and your results

    must be reproducible. You should clearly set out the basic

    assumptions, methods and data underlying the analysis and discuss

    the uncertainties associated with your estimates.'' \222\ It goes on

    to recommend that, ``To provide greater access to your analysis, you

    should generally post it, with all the supporting documents, on the

    internet so the public can review the findings.'' \223\ I presume

    the Commission feels that this level of compliance is not

    appropriate, given that the commenters failed to demand it, and is

    simply not reasonably feasible.

    ---------------------------------------------------------------------------

    \222\ OMB Circular A-4 at 17.

    \223\ Id.

    ---------------------------------------------------------------------------

    One of my major criticisms is that the Internal Business Conduct

    Rules, and, in particular, section 23.600--Risk Management Program

    for Swap Dealers and Major Swap Participants, attempt to cover every

    possible contingency instead of articulating goals and performance

    objectives. Section 4s(j)(2) simply requires that the SD or MSP

    ``establish robust and professional risk management systems adequate

    for managing the day-to-day business of the swap dealer or major

    swap participant.'' Could anyone truly argue that that provision

    could not stand largely on its own as a performance objective? Did

    the Commission need to specify to the nth degree the behavior and

    manner of compliance that SDs and MSPs must adopt in order to meet

    that objective? And in doing so, has the Commission created

    loopholes and unintentional safe harbors for those who meet the

    regulatory requirements, but still manage to violate other

    provisions of the Commodity Exchange Act and regulations?

    Another concern is that the Internal Business Conduct Rules do

    not provide for substituted compliance with any of these

    requirements for SDs and MSPs for which the CFTC is not their

    prudential regulator. While one distinct part of the preamble

    regarding rules pertaining to business continuity and disaster

    recovery suggest that if an SD or MSP is subject to other rules that

    meet the requirements of the Commission's rule, then such SD or MSP

    would be in compliance with the Commission's rule, the rules

    themselves do not evidence any attempts to coordinate our regulatory

    requirements with those of our fellow prudential regulators through

    the explicit provision for substituted compliance. More egregiously,

    section 23.603(h)--Business Continuity and Disaster Recovery Plans

    Required by Other Regulatory Authorities, specifically requires SDs

    and MSPs to comply with the business continuity and disaster

    recovery requirements of this regulation ``in addition to any

    business continuity and disaster recovery requirements that are

    imposed on the swap dealer or major swap participant by its

    prudential regulator or any other regulatory or self-regulatory

    authority.'' \224\ There is no quantification or qualification of

    costs and benefits of this regulatory decision, and I am not

    surprised.

    ---------------------------------------------------------------------------

    \224\ Swap Dealer and Major Swap Participant Recordkeeping and

    Reporting, Duties, and Conflicts of Interest Policies and

    Procedures; Futures Commission Merchant and Introducing Broker

    Conflicts of Interest Policies and Procedures; Swap Dealer, Major

    Swap Participant, and Futures Commission Merchant Chief Compliance

    Officer, Final Rule, at Sec. 23.603(h).

    ---------------------------------------------------------------------------

    I believe our reasonably ``feasible standard'' as articulated in

    our own Staff Guidance has caused us to miss any marker for

    identifying and using the best, most innovative and least burdensome

    tools to meet the regulatory ends laid out in section 4s of the

    Commodity Exchange Act. We

    [[Page 20215]]

    should be held accountable for not only failing to even attempt to

    meet the goals set by the President, but for deliberately eschewing

    them. I agree with Chairman Albrecht that the CFTC ought to be

    required to undertake more rigorous cost-benefit analyses. I believe

    all of our analyses should be more rigorous. While it may not solve

    all of our problems with putting out complex and inefficient

    regulations, as noted by Chairman Albrecht, it should help.\225\ I

    will be sending a letter to Acting OMB Director Jeffrey Zients

    requesting his assistance in determining just how far off the

    baseline the Commission has fallen. If OMB Circular A-4 means

    anything at all, then OMB should take action and hold the Commission

    to the Circular's standards.

    ---------------------------------------------------------------------------

    \225\ Albrecht, supra, at 10.

    ---------------------------------------------------------------------------

    Appendix 4--Statement of Chairman Gensler and Commissioners Chilton and

    Wetjen

    The Commission fully considered all comments and the costs and

    benefits of its actions in this rulemaking. The preamble of this

    Federal Register release specifically addresses issues concerning

    compliance burdens and recordkeeping requirements. Indeed, the

    preamble addresses the comments received in response to, and

    proffers the Commission's rationale for, each of the final rules

    promulgated herein. The final rules also contain numerous examples

    in which the recommendations of commenters have been adopted and

    incorporated into the final rule text. Further, all comments

    relevant to the Commission's consideration of costs and benefits

    were expressly addressed in the Commission's discussion of its cost-

    benefit considerations.

    With respect to comments received in response to the

    recordkeeping rules, for example, the Commission is aware that the

    technology exists to implement a recording system as required under

    section 4s(g) of the Commodity Exchange Act (CEA). Indeed, other

    regulatory regimes across the globe already require such recording.

    As explained in the preamble to the proposed recordkeeping rules, in

    2008, the United Kingdom's Financial Services Authority (FSA)

    implemented rules relating to the recording and retention of voice

    conversations and electronic communications, including a recent

    determination that all financial service firms will be required to

    record any relevant communication by employees on their work cell

    phones.\226\ The FSA implemented this requirement based on

    significant technological advancements in recent years, particularly

    with respect to the cost of capturing and retaining copies of

    electronic material, including telephone communications, which have

    made recordkeeping requirements for digital and electronic

    communications more economically feasible and systemically prudent.

    Similar rules mandating the recording of certain voice and/or

    telephone conversations have been promulgated by the Hong Kong

    Securities and Futures Commission and by the Autorit[eacute] des

    March[eacute]s Financiers in France, and have been recommended by

    the International Organization of Securities Commissions

    (IOSCO).\227\ Moreover, as noted on the Commission's Web site,

    Commission staff met with two firms that provide elements of the

    technology needed for compliance with the recording rules under

    section 4s(g). These meetings, as well as the international

    requirements, informed the Commission's response to comments

    received.

    ---------------------------------------------------------------------------

    \226\ 75 FR 76666, 76668-69 (Dec. 9, 2010) (Reporting,

    Recordkeeping, and Daily Trading Records Requirements for Swap

    Dealers and Major Swap Participants) (citing Financial Services

    Authority, ``Policy Statement: Telephone Recording: Recording of

    voice conversations and electronic communications,'' (March 2008)).

    \227\ Id. at 76669 (citing Code of Conduct for Persons Licensed

    by or Registered with the Securities and Futures Commission para.

    3.9 (2010) (H.K.); General Regulation of the Autorit[eacute] des

    March[eacute]s Financiers art. 313-51 (2010) (Fr.); and Press

    Release, International Organization of Securities Commissions,

    ``IOSCO Publishes Recommendations to Enhance Commodity Futures

    Markets Oversight,'' (Mar. 5, 2009), http://www.iosco.org/news/pdf/IOSCONEWS137.pdf).

    ---------------------------------------------------------------------------

    In addition, one commenter asked that swap dealers (SDs) and

    major swap participants (MSPs) be permitted to rely upon swap data

    repositories (SDRs) to retain records beyond the time periods that

    registrants currently retain such records. In concluding that SDs

    and MSPs must retain their own records as well as submit a certain

    subset of data to SDRs, the Commission did not call into question

    the integrity of its final swap data reporting rules or SDRs

    themselves; rather, the Commission determined that the retention of

    such records by SDs and MSPs is necessary for purposes of risk

    management and monitoring the entity's trading activities for

    unlawful conduct, among other things. Certain trade execution

    information that is critical for risk management and monitoring

    purposes, such as reconciliations to the general ledger, will not be

    retained at SDRs.

    With regard to cost-benefit considerations of these elements of

    the recordkeeping rules, as well as for all of the final rules, the

    Commission strove to limit the burden on SDs and MSPs to the extent

    reasonably possible. For instance, as originally proposed, the

    recording requirement (discussed above) included a provision that

    would have required each transaction record to be maintained as a

    separate electronic file. The Commission dropped this requirement

    and clarified that the rule permits the data to be stored in

    databases that do not need to be tagged with transaction and

    counterparty identifiers so long as the SD or MSP can readily access

    and identify records by running a search on the data. By making this

    change, the Commission responded to comments and limited the rule's

    requirements to those dictated by statute,\228\ reducing the burden

    to the extent reasonably possible.

    ---------------------------------------------------------------------------

    \228\ See, e.g., CEA Sec. 4s(g)(3) (``Each registered swap

    dealer and major swap participant shall maintain daily trading

    records for each counterparty in a manner and form that is

    identifiable with each swap transaction.'').

    ---------------------------------------------------------------------------

    Additionally, during the February 23, 2011 public meeting at

    which the Commission adopted these final rules, there was discussion

    of a concern relating to the technological and economic feasibility

    of the recordkeeping requirements. Responding to the concern, the

    Commission adopted 5 CFR 23.206, which delegates to the Director of

    the Division of Swap Dealer and Intermediary Oversight ``the

    authority to establish an alternative compliance schedule for

    requirements of Sec. 23.202 that are found to be technologically or

    economically impracticable for an affected swap dealer or major swap

    participant that seeks, in good faith, to comply with the

    requirements of Sec. 23.202 within a reasonable time period beyond

    the date on which compliance by such swap dealer or major swap

    participant is otherwise required.''

    In sum, in this rulemaking the Commission has adequately

    addressed comments and considered the costs and benefits of its

    actions as required by section 15(a) of the CEA.

    [FR Doc. 2012-5317 Filed 4-2-12; 8:45 am]

    BILLING CODE 6351-01-P

    Last Updated: April 3, 2012



See Also:

OpenGov Logo

CFTC's Commitment to Open Government

Gavel and Book

Follow the Status of Enforcement Actions