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From Securities Regulation Daily, April 13, 2016

SEC adopts business conduct rules, approves concept release on Reg. S-K

By Jacquelyn Lumb

The Commission voted two-to-one to adopt business conduct standards for security-based swap dealers and major security-based swap participants. Commissioner Michael Piwowar voted against the business conduct rules because of their lack of harmonization with the CFTC’s rules, with which he noted many swaps participants already comply. The SEC commissioners also voted unanimously to approve the issuance of a concept release under its disclosure effectiveness project to seek views on the business and financial information that companies provide under Regulation S-K.

Business conduct rules. The adoption of the business conduct rules for security-based swap entities implements provisions in Title VII of the Dodd-Frank Act. White noted that the security-based swap market is an established market and many swap entities already comply with the CFTC’s business conduct rules. She said the SEC’s rules are consistent with those rules to the extent it is practicable. Division of Trading and Markets Director Steve Luparello advised that the staff worked closely with the CFTC in drafting the final rules.

The rules require security-based swap dealers and major security-based swap participants to verify that counterparties are eligible contract participants and determine whether they are special entities. These swap dealers and participants must disclose to counterparties material information about the swap, including risks, incentives, and conflicts of interest. They also must establish a supervisory and compliance infrastructure and appoint a chief compliance officer who will be responsible for preparing an annual compliance report.

Special entities. Swap dealers’ recommendations must be suitable for the counterparties. When acting as an adviser to a special entity, such as a municipality or an endowment, a dealer must make a reasonable determination that the swap or trading strategy is in the entities’ best interest. Commissioner Kara Stein said this provision goes to the heart of the abuses that affected the residents of Jefferson County and a school district in Philadelphia, both of which suffered significant losses in complex swap deals.

As additional protections for special entities, the rules require swap participants to reasonably believe that the special entities have an independent representative with sufficient knowledge to evaluate the transaction and risks; that the representative is not subject to a statutory disqualification; is independent from the swap participant; acts in the entities’ best interests; makes timely and appropriate disclosure of material information about the swap; evaluates the fair pricing of the swap; and is subject to pay-to-play regulations. Swap dealers also must comply with pay-to-play rules in transactions with municipal entities.

Cross-border issues. The rules require U.S. security-based swap dealers to comply with the transaction-level business conduct requirements for all transactions except for those conducted through the dealer’s foreign branch. Foreign security-based swap dealers must comply with transaction-level business conduct requirements in any transactions with a U.S. person, except those conducted through the foreign branch of a U.S. person and in any transaction that the dealer arranges, negotiates, or executes using personnel located in the U.S., even if the counterparty is a non-U.S. person.

The rules may allow for substituted compliance if the Commission determines that the foreign requirements for the non-U.S. dealers and participants are comparable to its business conduct rules.

The rules become effective 60 days after publication in the Federal Register, with separate compliance dates for some of the provisions.

Regulation S-K. Commenters will be asked for their views on what to keep, what to modify, what to eliminate, and what to add to Regulation S-K, according to Chair Mary Jo White. The release seeks input in three key areas—the overall disclosure framework, specific line item presentations, and changes in the regulatory landscape since Regulation S-K was adopted in 1977. The SEC also wants to hear from commenters about the use of cross-references, incorporation by reference, hyperlinks, and public company websites as a source for information.

Commissioner Stein, while voting in favor of the release, said there were many more questions that should have been asked, including those relating to topics such as the use of non-GAAP measures and environmental, social, and corporate governance issues. She encouraged commenters to address the whole range of topics that may arise under Regulation S-K.

Commissioner Michael Piwowar emphasized the importance of focusing on materiality when it comes to disclosure. He said any reforms should reflect the provision in the FAST Act, which said the SEC should explore methods for discouraging repetition and the disclosure of immaterial information. The comment period on the concept release will be open for 90 days.

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