United States: SEC Adopts Process For SBS Entities To Apply For Relief For Statutorily Disqualified Personnel

Last Updated: January 3 2019
Article by Nihal S. Patel

Most Read Contributor in United States, December 2018

The SEC adopted Rule of Practice 194 to establish a process for registered security-based swap dealers and major security-based swap ("SBS") participants (collectively, "SBS Entities") to apply for relief from the prohibition in Exchange Act Section 15F(b)(6) on individuals subject to a statutory disqualification from effecting SBS transactions on behalf of SBS Entity. Rule of Practice 194, which was proposed in August 2015:

  • specifies the form and content of applications for SBS Entities to claim an exemption from the statutory disqualification prohibition on behalf of their SBS personnel, and requires SBS Entities to demonstrate that it would be "consistent with the public interest" to permit individuals to effect SBS transactions despite their statutory disqualification; and
  • requires the SEC to provide an SBS Entity with notice, and an opportunity to respond, if the SEC anticipates rejecting an application on behalf of a statutorily disqualified individual.

The Rule contains two exclusions from the requirement to file an application for exemption for statutorily disqualified SBS personnel:

  • The Rule permits SBS Entities to employ a statutorily disqualified individual to effect SBS transactions if the SEC or another regulator (i.e., a self-regulatory organization, the CFTC, FINRA or the National Futures Association) previously granted relief to the individual from a statutory disqualification. In this case, the SBS Entity would be required to only file a notice with the SEC, not apply for an exemption from the statutory disqualification prohibition.
  • The Rule excludes "associated persons" of an SBS Entity that are themselves legal entities (as opposed to natural persons) from the statutory disqualification prohibition.

The final rule will become effective 60 days following publication in the Federal Register. However, the compliance date for SBS Entity registration rules, including the statutory disqualification requirements, will be the later of (i) six months after adoption of capital, margin and segregation rules for SBS Entities, or (ii) the compliance date of the SBS recordkeeping and reporting rules.

Two SEC Commissioners voted against the Rule. Commissioner Robert J. Jackson dissented on the basis that permitting individuals who received statutory disqualification relief from other regulators ceded the SEC's authority to conduct an independent review of the individual's conduct and thus "smooth[ed] bad actors' path to readmission." Commissioner Kara M. Stein objected both to relying upon relief granted by other regulators and to the exclusion for associated person entities from the statutory disqualification prohibition.

The final rule will become effective 60 days after its publication in the Federal Register.

Commentary

When Rule 194 was proposed, two Commissioners with often divergent philosophical views of securities regulation dissented. Commissioner Stein dissented, largely for the reasons articulated in her dissent as to the final rule. Commissioner Piwowar dissented on different grounds, focusing on the SEC treatment of legal entity associated persons and the fact that the SEC-proposed approach was inconsistent with the CFTC approach. See CFTC Reg. 1.3 (definition of "associated person"). The final rule comes down essentially as advocated by Mr. Piwowar.

As highlighted in a recent Cadwalader memo, the statutory disqualification rule was one of three remaining rules to be completed before firms will be required to count their SBS dealing transactions toward the SBSD de minimis threshold in SEA Rule 3a71-2. (Capital/Margin and Recordkeeping are the others.) It remains to be seen whether the SEC will adopt a longer timeline, as advocated by Commissioner Peirce, which was an issue that the SEC requested comment on in its notice re-opening the capital and margin comment period.

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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