Subject: Imact of Financial Reform Legislation on Derivatives Transactions Involving Employee Benefit Plans


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Orrick Alert

Impact of Financial Reform Legislation on Derivatives Transactions Involving Employee Benefit Plans

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Act") contains a number of provisions that may substantially affect employee benefit plans that enter into swaps and other derivative transactions. 

The Act authorizes the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) to impose responsibilities on "swap dealers," "security-based swap dealers," "major swap participants" and "major security-based swap participants" (collectively, "Swap Participants") that deal with employee benefit plans (as such term is defined in Section 3 of ERISA), governmental plans (as such term is defined in Section 3 of ERISA) as well as other "special entities."  The terms "swap" and "security-based swap" are defined broadly.

In transactions with "special entities," Swap Participants will be required to disclose in writing the capacity in which they are acting, and have a "reasonable basis" to believe that the special entity has an independent representative that fulfills the following criteria:

(1) Has sufficient knowledge to evaluate the transaction and risks;

(2) Is not subject to a statutory disqualification;

(3) Is independent of the Swap Participant;

(4) Undertakes a duty to act in the best interests of the counterparty it represents;

(5) Makes appropriate disclosures;

(6) Will provide written representations to the special entity regarding fair pricing and the appropriateness of the transaction; and

(7) In the case of employee benefit plans subject to ERISA, is a fiduciary as defined under ERISA.

Further, if a Swap Participant acts as an "advisor" to a "special entity, " then it may not defraud the entity and has a "duty to act in the best interests of the special entity."   It must also "make reasonable efforts to obtain such information as is necessary to make a reasonable determination that any swap recommended by the Swap Participant is in the best interests of the special entity," including information on the "special entity's" financial status, tax status, and investment or financing objectives.

We expect that Swap Participant counterparties to swaps (including existing swaps) with employee benefit plans and governmental plans will be requesting extensive representations from such plans covering the various provisions of the Act applicable to "special entities," including a representation that the counterparty is not serving as an "advisor" to the plan. 

We further expect that any interpretive issues relating to the definition of "special entity" will be addressed in forthcoming guidance from the relevant regulatory agencies.

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