CFTC Adopts Internal Business Conduct Rules - Sullivan & Cromwell

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similarly would have included personnel “involved in” clearing activities. The Commission made conforming changes to the definition of this term to exclude personnel who are not directly involved in actual clearing activities. Under the Final Rules, an SD or MSP may not interfere with or influence the decision of an affiliated clearing member, and an FCM may not permit an affiliated SD or MSP to interfere with or influence the decision of its clearing unit personnel, to provide clearing services. The SD or MSP also cannot influence or interfere with the decision to adjust the risk tolerance levels of the clearing unit of an affiliated FCM nor can the SD or MSP influence or interfere with a decision to accept certain forms of collateral from, or charge fees to, a particular customer. The Commission modified the Final Rules to clarify that “business trading unit personnel may not condition or tie the provision of trading services to the provision of clearing services or otherwise participate in clearing services by improperly incentivizing or encouraging the use of the affiliated FCM.” 16 Improper incentives include discounting clearing services in connection with trading activities. The Commission explained that the “separation of the FCM clearing unit from the interference or influence of an affiliated SD or MSP is crucial to promoting open access to clearing.” 17 The Final Rules require an FCM to erect an informational partition between its clearing unit personnel and business trading personnel at an affiliated SD or MSP. SDs and MSPs are required to erect similar informational partitions between their business trading units and the clearing personnel at an affiliated clearing member of a DCO. An SD or MSP must prohibit any business trading personnel from supervising, controlling or influencing any clearing personnel of an affiliated clearing member of a DCO. No business trading personnel of an affiliated SD or MSP may influence the compensation of clearing personnel at an affiliated clearing member of a DCO. Further, business trading personnel must not participate in any manner in the provision of clearing services by an affiliated clearing member of a DCO except to assist clearing personnel in an affiliated DCO’s default management process. The Internal Business Conduct Rules also require that IBs and FCMs disclose any material incentives and conflicts of interest regarding the customer’s decision relating to trade execution and/or clearing of a derivatives transaction prior to execution. SDs and MSPs must disclose any material incentives or conflicts of interest concerning whether a counterparty executes a swap on an SEF or DCM and whether a counterparty clears a derivative through a DCO. Separation of Research Departments; Restrictions on Research Communications FCMs, certain IBs, SDs and MSPs (“Registered Entities”) must now, under the Internal Business Conduct Rules, prohibit non-research personnel, including clearing and business trading personnel, from directing or influencing research analysts and research reports. A “research report,” under the Final Rules, is any written communication that contains analysis of the price or market and other information reasonably sufficient to allow a person to formulate a decision to enter into a derivatives transaction. Unlike the Proposed Rules, the adopted definition of research report includes neither “commentaries on economic, political, or market conditions” nor “statistical summaries of multiple companies’ financial data.” 18 The CFTC Adopts Internal Business Conduct Rules March 8, 2012 -6-
Commission excluded these two types of communications in order to harmonize this term with the identical term in NASD Rule 2711, promulgated pursuant to section 15D of the Securities Exchange Act. In general, non-research personnel at a Registered Entity cannot influence the views and opinions expressed in a research report or by research analysts or direct a research analyst to publish a research report. Unlike the Proposed Rules, non-research personnel are not completely prohibited from “influencing the content” of a research report. Such a broad prohibition, it was feared, “would impair ordinary communications between research and non-research personnel.” Under the Final Rules, therefore, for example, non-research personnel may still provide factual content for research reports but may not have the authority to review or approve research reports prior to publication. Non-research personnel may review a research report only to verify factual accuracy, and the communications with research personnel concerning such factual verification must be made through, or by, authorized legal or compliance personnel. Clearing or business trading personnel of a Registered Entity must not supervise or control any research analysts, including with respect to the compensation of research analysts. The Commission believed the changes to the definition of the terms “clearing unit” and “business trading unit” from the Proposed Rules (discussed above) sufficiently limit the scope of the terms so as to allow more senior officers or supervisors who may indirectly supervise clearing and trading personnel to have a role in setting the compensation of, and evaluating, research analysts. Finally, a Registered Entity must not consider a research analyst’s contributions to the Registered Entity’s trading or clearing business when setting the compensation for such research analyst. The Internal Business Conduct Rules also regulate the content of research reports and the manner in which they are disseminated. Any communication by research analysts with a prospective or current customer must not be misleading and must contain all material facts and qualifications necessary to ensure that it is not misleading. Unlike the Proposed Rules, the Final Rules do not impose this duty on research analysts at a Registered Entity when communicating with other employees of the Registered Entity or its affiliates. The Final Rules also prohibit Registered Entities from inducing customer business by offering a favorable research report or threatening an adverse research report. Research reports from Registered Entities must disclose the financial interest of the research analyst in any derivative of a type, class, or category the research analyst follows. The Registered Entity also must disclose this information even when distributing independent third-party research. The Commission explained that third-party research distributed by the Registered Entity may be perceived as endorsed by the Registered Entity and the Registered Entity should disclose any conflicts of interest accordingly. The Commission elected not to modify the Proposed Rules to address how the rules would apply to research reports that contain information that is subject to the Internal Business Conduct Rules as well as information that is securities-related. Any discussion of derivatives, even if securities underlie those derivatives, according to the Commission, should be subject to its conflict of interest rules. FIA, ISDA and SIFMA argued in a joint comment letter that applying the Internal Business Conduct Rules to multi- CFTC Adopts Internal Business Conduct Rules March 8, 2012 -7-
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CFTC Adopts Internal Business Conduct Rules - Sullivan & Cromwell

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