Who's In and Who's Out? CFTC and SEC Finalize the Swap Entity Definitions

by Susan I. Gault-Brown, Anthony R.G. Nolan, Lawrence B. Patent, and Daniel A. Goldstein

The Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act") contains definitions for the new terms "swap dealer," "security-based swap dealer," "major swap participant" and "major security-based swap participant" (together, "Regulated Swap Entities") and an amended definition for the term "eligible contract participant" ("ECP"). As directed by that statute, on April 18, 2012, the Commodity Futures Trading Commission ("CFTC") and the Securities and Exchange Commission ("SEC") (collectively, the "Commissions") adopted a final rule (the "Final Rule") that clarifies these Dodd-Frank Act definitions, particularly in terms of scope and applicability to market participants. The Final Rule revises proposed definitions published on December 21, 2010 (the "Proposed Rule"). In this Alert, we focus on the major differences between the Proposed Rule and the Final Rule.

The Final Rule will generally be effective July 23, 2012. However, registration of Regulated Swap Entities will not be mandatory, and the substantive regulatory provisions applicable to them will not be enforced, until after the effective date of a joint final rule of the Commissions further defining the terms "swap" and "security-based swap." That rule is commonly expected to be adopted sometime in the summer or fall of 2012.

The Final Rule is of great importance for participants in derivatives markets for several reasons. Entities that fall within the Regulated Swap Entity definitions will be required to register with, and will be regulated by, the CFTC, the SEC or both. Entities that become Regulated Swap Entities will also be subject to the panoply of substantive rules and regulations that are being proposed, or have been issued, under the Dodd-Frank Act's new swap market regulatory scheme, including capital and margin requirements, business conduct rules, conflict of interest rules, chief compliance officer requirements, reporting obligations, and recordkeeping requirements. While the number of potentially affected entities appears to be considerably smaller than many had feared during consideration of the proposed rule, it is still significant. [footnote omitted]

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Susan I. Gault-Brown is a partner in K&L Gates' Washington, D.C. office and a member of the Investment Management practice. She advises participants in the financial services industry, including commodity trading advisors, commodity pool operators, investment advisers, private funds, and registered investment companies on regulatory, transactional and counseling matters involving the securities and commodities laws. She also regularly provides advice with respect to exemptions, no-action letters, and other forms of regulatory relief.

Anthony R.G. Nolan, a partner in K&L Gates' New York City office, specializes in domestic and cross-border structured finance, structured products and derivatives.

Lawrence B. Patent joined K&L Gates in 2008 after serving more than thirty years as an attorney with the CFTC, the last five as the Deputy Director of the Division of Clearing and Intermediary Oversight. Mr. Patent regularly counsels businesses with respect to commodity interest trading compliance and the legal requirements governing trading in over-the-counter derivatives and exchange-traded futures, including both international and U.S. markets. His clients include, among others, hedge funds, currency dealers, commodity pool operators, commodity trading advisors, futures commission merchants, and introducing brokers.

Daniel A. Goldstein is an associate at K&L Gates' New York office.