stroock & stroock & lavan llp Arrange, Negotiate or Execute Guidance in SEC Final Rule on De Minimis Exception February 24, 2016 On February 10, 2016, the Securities and Exchange Commission ( SEC ) released its final rule governing the cross-border application of the de minimis exception from designation as a securitybased swap dealer. 1 Under the final rule, a non- U.S. person will be required to include, in its calculations of whether it qualifies for such de minimis exception, security-based swaps that are arranged, negotiated or executed by personnel (or personnel of an agent) located in a U.S branch or office. 2 1 2 Security-Based Swap Transactions Connected With a Non-U.S. Person s Dealing Activity That Are Arranged, Negotiated, or Executed by Personnel Located in a U.S. Branch or Office or in a U.S. Branch or Office of an Agent; Security-Based Swap Dealer De Minimis Exception, SEC Release No. 34-77104 ( Feb. 10, 2016), 81 Fed. Reg. 8597 (Feb. 19, 2016), available at https://www.gpo.gov/fdsys/pkg/fr-2016-02- 19/pdf/2016-03178.pdf. The compliance date for the final rule is the later of (a) February 21, 2017 or (b) two months prior to the Registration Compliance Date set forth in the final rule governing the Registration Process for Security- This Stroock Special Bulletin focuses on the SEC s test for such arrangement, negotiation or execution. Personnel Subject to Arrange, Negotiate or Execute Test The arrange, negotiate or execute test in the final rule applies to the actions of a non-u.s. person s personnel or the personnel of an agent of such non-u.s. person. For these purposes, the word personnel will be interpreted similarly to the associated person definitions in sections 3(a)(70) and 3(a)(18) of the Securities Exchange Act of 1934 (the Exchange Act ), so that it encompass[es] a broad range of relationships that can be used by firms to engage in and effect securities transactions, and is not dependent solely on whether a natural person is technically an employee of the entity in Based Swap Dealers and Major Security-Based Swap Participants. See SEC Release No. 34-75611 (Aug. 5, 2015), 80 Fed. Reg. 48963 (Aug. 14, 2015). stroock & stroock & lavan llp new york los angeles miami washington, dc 180 maiden lane, new york, ny 10038-4982 tel 212.806.5400 fax 212.806.6006 www.stroock.com
question. 3 Instead, the SEC expect[s] to consider whether a particular entity is able to control or supervise the actions of an individual when determining whether the individual is considered to be personnel of a U.S. branch, office, or agent of a security-based swap dealer. The SEC noted that this definition of personnel is particularly relevant for bank holding companies and other financial groups, because personnel of one affiliate may operate under the direction of, or in some cases, report to personnel of another affiliate within the group. The term agent would include both unaffiliated agents (e.g., a broker with personnel located in the United States) and agents that are affiliates of a non-u.s. person (e.g., an entity within a financial group that perform[s] the sales and trading functions associated with the dealing business of an affiliated non-u.s. entity that books the resulting transactions). Where Personnel Are Located The arrange, negotiate or execute test in the final rule applies only to personnel (or personnel of an agent) that are located in a U.S. branch or office. The SEC explained that it would generally view personnel as being located in the United States if such personnel were assigned to, on an ongoing or temporary basis, or regularly working in a U.S. branch or office. However, personnel would not be located in the United States if such personnel are only incidentally in the United States[,] which the SEC clarified to mean that the final rule does not require a non-u.s. person to include transactions that such personnel arrange, 3 Section 3(a)(70) of the Exchange Act, 15 U.S.C. 78c(a)(70), contains a definition for the term associated person of a security-based swap dealer or major security-based swap participant. Section 3(a)(18) of the Exchange Act, 15 U.S.C. 78c(a)(18), contains a definition for the term associated person of a broker or dealer. negotiate, or execute while traveling in the United States to attend an educational or industry conference. The test applies to any transaction arranged, negotiated or executed by personnel located in a U.S. branch or office, even if the transaction was arranged, negotiated or executed in response to inquiries from a non-u.s.-person counterparty outside business hours in the counterparty s jurisdiction. The SEC noted that it is not relevant if the U.S. nexus to the transaction occurred only due to the time that the counterparty desired to trade, or if product, credit and market risk parameters were set by management personnel located outside of the United States. What Constitutes Arrangement, Negotiation or Execution Under the final rule, the terms arrange, negotiate or execute refer to market-facing activity with respect to a transaction and do not encompass internal functions performed by personnel located in a U.S. branch or office. The SEC explained that the terms: also include directing other personnel to arrange, negotiate, or execute a particular security-based swap. In other words, sales and trading personnel of a non-u.s. person who are located in the United States cannot avoid application of this rule by simply directing other personnel to carry out dealing activity, and we would view personnel located in a U.S. branch or office who direct personnel not located in the United States to arrange, negotiate, or execute a securitybased swap transaction as themselves arranging, negotiating, or executing the transaction. 4 The SEC noted that sales or trading personnel will generally be responsible for arranging, 4 81 Fed. Reg. 8623. 2
negotiating and executing a transaction, but that to the extent that personnel located in a U.S. branch or office engage in market-facing activity normally associated with sales and trading, the location of those personnel would be relevant, even if the personnel are not formally designated as sales persons or traders. Arrangement and Negotiation Under the final rule, the terms arrange and negotiate refer to market-facing activity of sales or trading personnel in connection with a particular transaction, including interactions with counterparties or their agents[,] such as negotiating with the counterparty the specific economic terms of a particular security-based swap transaction. The term arrange encompasses respond[ing] to requests by counterparties to enter into dealing transactions, as well as actively seeking out counterparties to such transactions. The terms arrange and negotiate do not include internal activities, such as: a person who designs the security-based swap but does not communicate with the counterparty regarding the contract in connection with a specific transaction[;] the preparation of underlying documentation for the transaction, including negotiation of a master agreement and related documentation[;] and performing ministerial or clerical tasks in connection with the transaction[,] including the ministerial task of entering transactions on a non-u.s. person s books once the transaction has been executed by marketfacing personnel[.] The term negotiate also does not include the actions of a U.S.-based attorney... involved in negotiations regarding the terms of the transaction. Execution The term execute refers to the market-facing act that, in connection with a particular transaction, causes the person to become irrevocably bound under the security-based swap under applicable law. The term execute does not encompass internal functions (such as the processing of trades or other back-office activities)[.] Furthermore, transactions will not be considered to have been executed by personnel located in a U.S. branch or office solely on the basis that they were submitted for clearing in the United States, reported to a security-based swap data repository in the United States, or because activities related to collateral management of the transaction, such as the exchange of margin, occurred within the United States. Application to Electronic Trading There is no general exclusion from the arrange, negotiate or execute test for transactions entered into via algorithmic trading and electronic execution. Personnel located in a U.S. branch or office will be deemed to have directed the arrangement, negotiation or execution of transactions if such personnel specify the trading strategy or techniques carried out through algorithmic trading or automated electronic execution of security-based swaps, even if the related server is located outside the United States. However, the SEC explained that it would not view personnel responsible solely for coding the algorithm as specifying the trading strategy or techniques carried out through such trading or execution. Other Arrange, Negotiate or Execute Tests The SEC previously proposed application of the arrange, negotiate or execute test to determine cross-border application of the external business 3
New York 180 Maiden Lane New York, NY 10038-4982 Tel: 212.806.5400 Fax: 212.806.6006 Los Angeles 2029 Century Park East Los Angeles, CA 90067-3086 Tel: 310.556.5800 Fax: 310.556.5959 Miami Southeast Financial Center 200 South Biscayne Boulevard, Suite 3100 Miami, FL 33131-5323 Tel: 305.789.9300 Fax: 305.789.9302 Washington, DC 1875 K Street NW, Suite 800 Washington, DC 20006-1253 Tel: 202.739.2800 Fax: 202.739.2895 www.stroock.com This Stroock Special Bulletin is a publication of Stroock & Stroock & Lavan LLP 2016 Stroock & Stroock & Lavan LLP. All rights reserved. Quotation with attribution is permitted. This Stroock publication offers general information and should not be taken or used as legal advice for specific situations, which depend on the evaluation of precise factual circumstances. Please note that Stroock does not undertake to update its publications after their publication date to reflect subsequent developments. This Stroock publication may contain attorney advertising. Prior results do not guarantee a similar outcome. Stroock & Stroock & Lavan LLP, with more than 300 attorneys in New York, Los Angeles, Miami and Washington, DC, is a law firm providing transactional, regulatory and litigation guidance to leading financial institutions, multinational corporations, investment funds and entrepreneurs in the U.S. and abroad. Our emphasis on excellence and innovation has enabled us to maintain long-term relationships with our clients and made us one of the nation s leading law firms for almost 140 years. For further information about Stroock Special Bulletins, or other Stroock publications, please contact Richard Fortmann, Senior Director-Legal Publications, at 212.806.5522.