Proposed CFTC Regulations Under Dodd-Frank Could Jeopardize Swaps with ERISA Plans


The Commodity Futures Trading Commission ("CFTC") recently proposed rules[1] (the "Proposed Regulations") under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank") that create significant uncertainty for employee benefit plans subject to the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and other "Special Entities" (as defined in Dodd-Frank and explained further below) entering into swap transactions.  Employee benefit plans subject to ERISA (and investment vehicles into which such plans invest) regularly engage in swap transactions to hedge against market risks.  Swaps also help defined benefit pension plan sponsors reduce volatility and make funding obligations more predictable.  

The concerns revised by the Proposed Regulations fall into two main areas:

  • ERISA Fiduciary Issues.    The Proposed Regulations resurrect the issue (that many practitioners had hoped was resolved with the passage of Dodd-Frank) that swap dealers engaging in typical business activities with respect to Special Entities could be treated as an ERISA fiduciaries.  ERISA provides that, generally, any transaction between a fiduciary and the ERISA-subject plan assets with respect to which it owes fiduciary duties is prohibited.  Therefore, in effect, the Proposed Regulations may preclude swap dealers from entering into swap transactions with Special Entities subject to ERISA.
  • Issues Regarding the Definition of Special Entity.  The Proposed Regulations further articulate an interpretive issue in Dodd-Frank with respect to the definition of Special Entity.  The text of Dodd-Frank provides that a Special Entity includes "employee benefit plans," as such term is defined in ERISA, and does not indicate whether certain investment vehicles, such as a fund in which 25 percent of more of its equity interests are held by "benefit plan investors" (a term that includes ERISA-subject plans and investment vehicles), are also included in the definition of Special Entity.  The Proposed Regulations invite comment on this unresolved issue.  If the definition of Special Entity includes investment vehicles into which employee benefit plans invest in addition to employee benefit plans themselves, such investment vehicles could also be prohibited from entering into swap transactions. 


Proposed legislation prior to the passage of Dodd-Frank contained provisions that would have explicitly imposed fiduciary duties on swap dealers transacting with employee benefit plans subject to ERISA.  Amid outcry from various pension industry executives and dealer representatives, the provisions were dropped from the final version of Dodd-Frank.  Dodd-Frank in its final form provided for certain "business conduct" standards to which swap dealers must adhere with respect to Special Entities.  Unfortunately for dealers and plans engaged in swap transactions, the Proposed Regulations implementing these business conduct standards, together with recently proposed U.S. Department of Labor ("DOL") regulations (the "Fiduciary Regulations") that purport to expand the definition of fiduciary conduct under ERISA, effectively resurrect the fiduciary standard.  As a result, a swap dealer who complies with the Proposed Regulations may be treated as a fiduciary under ERISA.  Such a potential result would effectively preclude swap dealers from entering into swaps with ERISA-subject plans.  

Business Conduct Standards – "Advisors" to Special Entities

Under the Dodd-Frank business conduct standards, a swap dealer that acts as an "advisor" to a Special Entity has a duty to act in the "best interests" of the Special Entity.  The dealer must make reasonable efforts to obtain such information as is necessary to make a reasonable determination that any swap recommended by the swap dealer is in the best interests of the Special Entity, including information relating to:

  • the financial status of the Special Entity;
  • the tax status of the Special Entity;
  • the investment or financing objectives of the Special Entity; and
  • any other information that the CFTC may prescribe by rule or regulation.

Under ERISA, a fiduciary is defined to include who exercises any control over the management of plan assets or anyone who renders investment advice with respect to plan assets (or has any authority or responsibility to do so) for a fee or other compensation.  After the passage of Dodd-Frank, it was expected that swap dealers would take steps to avoid advisor status with respect to plan assets by obtaining representations from plan counterparties that the swap dealer was not acting as an advisor.

Effect of Proposed Regulations and Fiduciary Regulations

However, the definition of advisor in the Proposed Regulations is broad, and may encompass swap dealers who otherwise would not consider themselves as providers of advice, regardless of the representations they receive from plan counterparties.  The Proposed Regulations include as advisors swap dealers who recommend a swap or a trading strategy involving the use of swaps.  Significantly, the definition of "recommendation" is also broad, and is defined as "any communication by which a swap dealer provides information to a counterparty about a particular swap or trading strategy that is tailored to the needs or characteristics of the counterparty."  Information that is general transaction, financial or market information, or swap terms in response to a competitive bid request from the counterparty, is not a recommendation.  "Recommendations" of the type described in the Proposed Regulations are commonly provided by swap dealers to their counterparties.  It appears that mere customized information may constitute a recommendation, and a dealer does not have to encourage a trade or position based on such information for the information to constitute a recommendation.

Further, the term "best interests" is not defined under the Proposed Regulations.  The Proposed Regulations state generally that best interest principles would "impose affirmative duties to act in good faith and make full and fair disclosure of all material facts and conflicts of interest, and to employ reasonable care that any recommendation given to a Special Entity is designed to further the purposes of the Special Entity."  While the Proposed Regulations further state that they are "not intended to preclude, per se, a swap dealer from both recommending a swap to a Special Entity and entering into that swap with the same Special Entity where the parties abide by the requirements of the [Proposed Regulations]," swap dealers who comply with the duties imposed run the risk of exercising a such a degree of control over plan assets that they engage in fiduciary conduct as defined in ERISA.

Moreover, swap dealers who act as advisors run the risk of being treated as an ERISA fiduciary by reason of providing "investment advice" under ERISA. Currently, regulations under ERISA provide a five-part test for determining whether providing a recommendation would constitute providing "investment advice" and result in fiduciary status.  Under this test, among other factors, in order to constitute "investment advice", and confer fiduciary status, a recommendation must be provided pursuant to a mutual agreement, arrangement or understanding, must be part of advice provided on a regular basis, and must serve as the primary basis for investment decisions with respect to plan assets.  Under the Fiduciary Regulations, however, the test for providing "investment advice" has been relaxed considerably.  Under these proposed rules, a counterparty providing a recommendation, as defined in the Proposed Regulations, would be an ERISA fiduciary if the recommendation was part of advice that may be considered in making investment or management decisions with respect to the plan.  Therefore, if the Fiduciary Regulations are finalized in substantially their current form, it is likely that a swap dealer that provides recommendations and complies with the business conduct requirements will be treated as an ERISA fiduciary, regardless of the representations obtained from a plan counterparty.

While the Proposed Regulations indicate that the DOL has been consulted with respect to ERISA fiduciary concerns arising from the Proposed Regulations, the text is hardly reassuring to swap dealers and ERISA-subject plans.  A footnote to the Proposed Regulations states that "[t]he Commission staff has consulted with DOL staff, who has advised that any determination of status under the Dodd-Frank Act is separate and distinct from the determination of whether an entity is a fiduciary under ERISA."  Ominously, this statement does not preclude the possibility that advisors who comply with the business conduct requirements under the Proposed Regulations could also be ERISA fiduciaries, notwithstanding that the determinations of "advisor" and "fiduciary" require separate analyses under separate statutes.  Further, the Proposed Regulations request comments on whether an advisor should be subject to an explicit fiduciary duty when making a recommendation to a Special Entity.  As a result of the troubling nature of the Proposed Regulations, swap dealers may cease transacting with ERISA-subject plans altogether, in order to avoid the risk of entering into prohibited transactions under ERISA and potentially incurring substantial excise taxes and penalties.

Definition of Special Entity

The definition of Special Entity under Dodd-Frank includes any employee benefit plan, as defined in section 3 of ERISA.  The Proposed Regulations indicate that this definition may be ambiguous and invite comment on the issue.  Therefore, until this interpretive issue is resolved, managers of investment vehicles such as hedge funds, private equity funds and structured finance vehicles into which employee benefit plans invest may be concerned with the effect of the Proposed Regulations on their swap transactions. 

The Proposed Regulations raise a number of questions on the clarification of the definition of Special Entity, including the following:

  • Should the definition "employee benefit plans," as defined in Section 3 of ERISA, be clarified in any way?
  • Should the Commission "look through" an entity to determine whether it is a Special Entity for the purposes of these rules?  If so, why?  If not, why not?  If so, should the Commission clarify that master trusts, or similar entities, that hold assets of more than one pension plan from the same plan sponsor are within the definition of Special Entity?

Next Steps

Until the uncertainty with respect to fiduciary status and definition of Special Entity is resolved, the future is murky for swap transactions with employee benefit plans (and, potentially, investment vehicles in which plans invest).  Comments under the Proposed Regulations are being accepted until February 22, 2011.  Comments under the Fiduciary Regulations are now being accepted under February 3, 2011, an extension of the comment period from January 20, 2011, and a public hearing is to be held on March 1, 2011 and if necessary, March 2, 2011.

[1] 17 CFR 23 and 155 (December 22, 2010)