On June 29, 2011, the SEC issued a set of proposed rules promulgating certain business conduct standards for security-based swap (“SBS”) dealers and major SBS participants (together, “SBS Entities”).
Summary of the Proposed Rules
Verification. SBS Entities would be required to verify, through reasonable means, that their counterparties meet the definition of an eligible contract participant (an “ECP”) before entering into the swap, unless the transaction is entered into on a registered securities exchange.
Disclosure. Prior to entering into an SBS transaction, SBS Entities would be required to disclose to their counterparties (i) information about the material risks and characteristics of the swap and material incentives or conflicts of interest with respect to the swap, and (ii) the counterparty’s rights to clear the swap and select the clearinghouse. SBS Entities must also provide to counterparties the “daily mark” of the swap, which the SEC proposes would have an analogous meaning for both cleared and uncleared security-based swaps. For cleared swaps, this daily mark would be the end-of-day settlement price; for uncleared swaps, the daily mark would be the midpoint between the bid and offer prices for the particular uncleared swap as of close of business on the given day.
Recommendations and Fair Dealing. SBS dealers would be required to have a reasonable basis for believing that any recommendation of a swap to a counterparty is suitable for such counterparty. This requirement is analogous to the FINRA rule on suitability and is only triggered when a “recommendation” is being made by the SBS dealer, which requires a “facts and circumstances” analysis. The proposed rule also requires that SBS Entities communicate with their counterparties in a fair and balanced manner with principles of good faith and fair dealing, both prior to entering into the transaction and throughout the term of the swap.
Special Entities. The proposed rule affords special protections to “special entities,” which include municipalities, pension plans, endowments and similar entities. If an SBS dealer “acts as an advisor” to a special entity, the dealer is charged with the duty to use reasonable efforts to determine whether the swap is in the best interests of the special entity. SBS Entities acting as counterparties to special entities would be required to have a reasonable basis for their belief that the special entity has an independent representative working in the special entity’s best interests. Such an independent representative may be an employee of the special entity.
The proposed rules are available here. Comments to the proposed rules must be received on or before August 29, 2011.