United States: SEC Adopts Recordkeeping And Reporting Requirements For Security-Based Swaps Dealers

The SEC adopted a final rule under the Dodd-Frank Act, establishing recordkeeping and financial reporting requirements applicable to (i) broker-dealers, (ii) SBSDs that are primarily regulated by a "prudential regulator" ("bank SBSDs"), and (iii) SBSDs that are neither broker-dealers nor bank SBSDs ("standalone SBSDS").

Broker-dealers generally will be subject to existing Rules adopted under Section 17(a) of the Exchange Act as amended to account for SBS transactions. Bank SBSDs and standalone SBSDs will be subject to newly adopted Rules 18a-5 through 18a-10. Although the newly adopted rules significantly parallel the existing amended rules, there are some meaningful differences reflecting the fact that (i) bank SBSDs and standalone SBSDs can engage in a lesser range of activities than broker-dealers, and (ii) the SEC's authority over bank SBSDs is materially less than its authority over the types of firms. That is, as to bank SBSDs, the SEC's authority is limited to their activities as SBSDs (not their general banking activities) and, even as to the SBSD activities, the SEC does not regulate their capital or their imposition of margin requirements.

The rule amendments and new rules will establish, for broker-dealers and SBSDs, the following types of requirements (though not applied in the same manner as to all types of registrants):

  • record creation and preservation;

  • periodic financial reporting and annual auditing;

  • early warning notifications;

  • security counts; and

  • risk management procedures.

In addition, the SEC adopted:

  • Securities Exchange Act Rule 18a-10 (alternative compliance mechanism) to allow SBSDs that are registered as swap dealers and predominantly engage in a swaps business to comply with the recordkeeping and reporting requirements of the Commodity Exchange Act and the CFTC's rules in place of complying with the relevant SEC recordkeeping and reporting rules.

The SEC did not impose any liquidity requirements, though it is likely to take up that issue at a later date.

The SEC indicated that it will issue further rule-making as to the application of these requirements to non-U.S. firms and non-U.S. activities. Likewise, the SEC indicated that it is open to revisiting some of the existing record retention requirements that apply to registered broker-dealers, particularly the so-called "WORM" (write once, read many) retention requirement, and the third-party access requirement.

The final rules and amendments will go into effect 60 days after publication in the Federal Register and the compliance date for these rules is 18 months after the effective date of final rules addressing the cross-border application of certain security-based swap requirements.


Steven Lofchie

While the SEC's rulemaking largely sticks very closely to the existing broker-dealer framework, the SEC did make a good faith effort to tailor the application of its requirements to the scope of its authority. For example, the SEC did not impose heavy new financial reporting requirements on bank SBSDs, which makes sense as the SEC does not regulate the capital of these entities. Likewise, the SEC did not apply WORM record retention requirements as to the entities that will be newly registered as bank SBSDs and standalone SBSDs.

One place where the SEC could have exercised greater discretion is with the retention of telephone communications. Although the SEC does not require that phone calls be recorded, if a firm elects to record them, the firm will be required to save the recordings for three years. By contrast, the CFTC requires that phone calls be recorded, but only requires that they be saved for a year. The upshot of this is that firms that are both swap dealers and SBSDs will likely, as a practical matter, have to record all phone calls (to satisfy the CFTC) and save the recordings for three years (to satisfy the SEC).

Bank SBSDs will have some challenging determinations to make as to the scope of the application of the record keeping requirements to their activities. For a bank, many of the requirements only apply as to its activities relating to SBS dealings. But drawing the line as to where any activity falls will involve some degree of arbitrary judgment. Are there operational or technological builds, and bills for builds, that will become subject to the SEC's record keeping rules?

It is notable that the SEC conceded in the adopting release that its existing broker-dealer record retention requirements are not only obsolete, but also that their obsolescence creates problems for registrants. The industry should push aggressively for a rewrite of these requirements.


Conor Almquist

Tucked within this nearly 500 page release are rule changes and clarifications that provide much needed technology updates. As Commissioner Peirce explained last December, SEC rules reflect significant technological obsolescence, particularly the rules that require notices to be sent by facsimile and the use of microfiche storage. This release removes many of these outdated requirements while adding the ability to provide notice by email.

The amendment to 17a-11 notice requirements will likely be welcome news to firms, who might now be able to throw away the last of their fax machines. The clarification to 17a-4(f) regarding the "WORM" requirements is notable, as the SEC's 2003 guidance on use of electronic storage media referred to WORM being satisfied by use of "integrated hardware and software control codes," which seemed to indicate specific hardware requirements, such as optical disk, CD-ROM and magnetic tape. This release states that compliance could be achieved through an electronic storage system that relies exclusively on software coding to prevent overwriting, erasing, or alteration of records. As such, this clarification has significant implications for the use of modern technology like cloud storage and perhaps blockchain.

While the SEC does not go as far as it might in modernizing technology related to recordkeeping requirements (or as the CFTC did in 2017 - generally requiring that trustworthiness of documents is ensured and eliminating prescriptive requirements, including the use of WORM format), the SEC acknowledges that changes should be made to the electronic storage requirements in 17a-4, and that these are intended to be addressed in a separate regulatory initiative. Notably, the SEC did not apply the WORM record retention requirements to bank SBSDs and standalone SBSDs, conceding that this would place a needless burden on them.

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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