United States: SEC Addresses Treatment Of Special Entities Under SBS Business Conduct Requirements

Last Updated: November 8 2018
Article by Nihal S. Patel

The SEC issued a "Commission Statement" to provide relief from aspects of the security-based swap dealer ("SBSD") business conduct rules, primarily the treatment of special entities. The SEC stated that the action is in response to "practical compliance difficulties" raised by market participants. The relief allows market participants to rely on representations in the context of complying with CFTC external business conduct requirements.

In particular, the statement takes the following "no-action" positions that are "limited to the Commission's enforcement discretion . . . and does not modify or change any contractual rights between counterparties to security-based swaps."

  • An SBSD may treat a non-ERISA benefit plan as a non-special entity under Exchange Act Rule 15Fh-2 if it previously represented that it is not a "special entity" for purposes of CFTC business conduct requirements, subject to certain disclosure obligations.
  • An SBSD may rely on certain representations given by a special entity for purposes of CFTC business conduct rules in determining that it satisfies the safe harbor to be deemed not to "act as an advisor to a special entity" under Exchange Act Rule 15Fh-2.
  • An SBSD may rely on certain representations given by a special entity for purposes of CFTC business conduct rules in satisfying the safe harbor for certain requirements applicable to an SBSD acting as a counterparty to a special entity under Exchange Act Rule 15Fh-5.
  • An SBSD may, "unless it has information that would cause a reasonable person to question the accuracy of the representation if the representation were given in relation to security-based swaps," rely on representations from a counterparty or its representative (not limited to special entities) previously given in relation to "swaps" for purposes of Exchange Act Rule 15Fh-1.

The relief provided in the statement "applies only to the exercise of [the SEC's] enforcement discretion," and lasts until five years after the compliance date for the SBS entity registration rules.

Commentary / Nihal Patel

The SEC's objective and the result of the Statement are entirely reasonable. It makes little sense to require market participants to re-document relationships for SBS when substantially similar work has long-since been undertaken for swaps. With that said, the Statement is a bit of an oddity in form and scope.

First, it reads like a staff no-action letter, except that it comes directly from the Commission. This is consistent with previous statements from SEC Chairman Jay Clayton and Commissioner Hester Peirce, in which they expressed a preference for Commission, rather than staff action. But it is not clear what exactly is the effect of the Statement from an administrative law perspective. Is it some kind of rulemaking? Guidance? Something in between? It clearly is not formal rulemaking - there is no solicitation of comments nor economic analysis. That said, it is to be published in the Federal Register and states a full Commission view (if only as to enforcement discretion). The SEC itself characterizes the Statement as "an agency statement of general applicability with future effect designed to implement, interpret, or prescribe law or policy."

Second, the five-year period seems arbitrary. It is not clear at this time how long it will be before the SBSD registration compliance date is set. And there is no explanation provided for how the SEC settled on a five-year period. It seems possible that the SEC thinks it will take that long for it to more fully harmonize its rules with the CFTC - i.e., that it expects to address the issues by rulemaking somewhere down the line. But nothing in the Statement indicates such an expectation.

Third, the scope of the relief is somewhat limited. The SEC explicitly expressed openness to address additional differences from the CFTC business conduct rules and that "otherwise present documentation implementation difficulties." See footnote 7. But it is unclear how the SEC, having acknowledged the problems associated with the basis between the two rule sets, could have decided to address only the special entity rules and a general view as to analogous representations. What about disclosures and other onboarding matters as to counterparties generally? In addition, as to suitability for all counterparties, will the SEC take action to address the fact that their rules require, in addition to representations and disclosures, that a counterparty have total assets of at least $50 million to rely on the institutional suitability safe harbor? Given the SEC statement about listening to market participants' concerns, it seems possible these matters will be further considered by the SEC. Why not do it all at once?

*As one of the drafters of the (elegantly named) ISDA August 2012 DF Protocol, it is disappointing that the SEC did not get the name of the protocol right in the Statement (see footnote 2). They could have asked!

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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