Tuesday, November 21, 2023

New SEC rule aims to reduce conflicts on clearinghouse boards

By Anne Sherry, J.D.

The SEC adopted new rules regarding the governance of registered clearing agencies. New Exchange Act Rule 17ad-25 fulfills a Dodd-Frank mandate to mitigate conflicts of interest for security-based-swap clearing agencies. The rules establish new requirements for board and committee composition, independent directors and committees, management of conflicts, and board oversight. Clearinghouses must abide by most of the rules starting a year from publication in the Federal Register, with an extra year for the board independence requirements (Clearing Agency Governance and Conflicts of Interest, Release No. 34-98959, November 16, 2023).

In a statement, SEC Chair Gary Gensler said the rule is meant to promote board independence, consider the views of relevant stakeholders, and reduce the potential for conflicts of interest within the board and senior management. The SEC first proposed the new regulation last August.

Independence requirements. Under the new rule, a majority of the board of a registered clearing agency must be independent directors (unless a majority of voting rights are held by participants, in which case the independence requirement is 34 percent of the board). An independent director is one who has no material relationship (either currently or looking back one year) with the clearinghouse or an affiliate. It is up to the clearinghouse to make an affirmative determination that a director is not precluded from being an independent director.

In addition to these definitions, the rule sets out some circumstances that preclude a director from being independent, again subject to a one-year lookback period. For example, a director is not independent if they are subject to rules that undermine their ability to act unimpeded, such as removal by less than a majority of shares. A director is not independent if they or a family member are employees of or receive payments from the registered clearing agency or an affiliate (other than compensation as a director). A director cannot be independent if they are an executive of another entity whose compensation committee includes executive officers of the clearing agency, or if they or a family member is a partner of the clearing agency’s outside auditor or an employee working on an audit of the clearing agency.

Committees. Each registered clearing agency must establish a nominating committee with a written process for evaluating director nominees. A majority of directors on the committee, and its chair, must be independent. A clearinghouse must also establish at least one risk management committee that includes representatives from the owners and participants of the clearinghouse.

If any committee has authority to act on behalf of the board, the committee must meet the same independence threshold as is required for the board.

Policies and procedures. The rule also requires clearinghouses to establish written policies and procedures to identify and mitigate conflicts of interest. Policies and procedures must require a director to document and inform the clearinghouse of a conflict of interest. Policies must also account for risks from relationships with third-party providers of core services. Finally, the clearinghouse must establish policies and procedures to require the board to “solicit, consider, and document its consideration of the views of participants and other relevant stakeholders of the registered clearing agency regarding material developments in its risk management and operations on a recurring basis.”

This is Release No. 34-98959.