Proposed Rule2021-27531
Prohibition Against Fraud, Manipulation, or Deception in Connection With Security-Based Swaps; Prohibition Against Undue Influence Over Chief Compliance Officers; Position Reporting of Large Security-Based Swap Positions
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Published
February 4, 2022
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("SEC" or "Commission") is re-proposing for comment a rule under the Securities Exchange Act of 1934 ("Exchange Act"), which would be a new rule designed to prevent fraud, manipulation, and deception in connection with effecting transactions in, or inducing or attempting to induce the purchase or sale of, any security-based swap. The rule is designed specifically to take into account the unique features of a security- based swap and would explicitly reach misconduct in connection with the ongoing payments and deliveries that typically occur throughout the life of a security-based swap. The Commission also is proposing a new rule, which would make it unlawful for any officer, director, supervised person, or employee of a security-based swap dealer or major security-based swap participant, or any person acting under such person's direction, to directly or indirectly take any action to coerce, manipulate, mislead, or fraudulently influence the security- based swap dealer's or major security-based swap participant's chief compliance officer ("CCO") in the performance of their duties under the federal securities laws or the rules and regulations thereunder. Finally, the Commission is using its authority under the Exchange Act to propose for comment a new rule, which would require any person with a security-based swap position that exceeds a certain threshold to promptly file with the Commission a schedule disclosing certain information related to its security-based swap position.
Full Text
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[Federal Register Volume 87, Number 24 (Friday, February 4, 2022)]
[Proposed Rules]
[Pages 6652-6706]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2021-27531]
[[Page 6651]]
Vol. 87
Friday,
No. 24
February 4, 2022
Part II
Securities and Exchange Commission
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17 CFR Part 240
Prohibition Against Fraud, Manipulation, or Deception in Connection
With Security-Based Swaps; Prohibition Against Undue Influence Over
Chief Compliance Officers; Position Reporting of Large Security-Based
Swap Positions; Proposed Rule
Federal Register / Vol. 87, No. 24 / Friday, February 4, 2022 /
Proposed Rules
[[Page 6652]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-93784; File No. S7-32-10]
RIN 3235-AK77
Prohibition Against Fraud, Manipulation, or Deception in
Connection With Security-Based Swaps; Prohibition Against Undue
Influence Over Chief Compliance Officers; Position Reporting of Large
Security-Based Swap Positions
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rules.
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SUMMARY: The Securities and Exchange Commission (``SEC'' or
``Commission'') is re-proposing for comment a rule under the Securities
Exchange Act of 1934 (``Exchange Act''), which would be a new rule
designed to prevent fraud, manipulation, and deception in connection
with effecting transactions in, or inducing or attempting to induce the
purchase or sale of, any security-based swap. The rule is designed
specifically to take into account the unique features of a security-
based swap and would explicitly reach misconduct in connection with the
ongoing payments and deliveries that typically occur throughout the
life of a security-based swap. The Commission also is proposing a new
rule, which would make it unlawful for any officer, director,
supervised person, or employee of a security-based swap dealer or major
security-based swap participant, or any person acting under such
person's direction, to directly or indirectly take any action to
coerce, manipulate, mislead, or fraudulently influence the security-
based swap dealer's or major security-based swap participant's chief
compliance officer (``CCO'') in the performance of their duties under
the federal securities laws or the rules and regulations thereunder.
Finally, the Commission is using its authority under the Exchange Act
to propose for comment a new rule, which would require any person with
a security-based swap position that exceeds a certain threshold to
promptly file with the Commission a schedule disclosing certain
information related to its security-based swap position.
DATES: Comments should be received on or before March 21, 2022.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="https://www.sec.gov/rules/regulatory-actions/how-to-submit-comments">https://www.sec.gov/rules/regulatory-actions/how-to-submit-comments</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#c2b0b7aea7efa1adafafa7acb6b182b1a7a1eca5adb4"><span class="__cf_email__" data-cfemail="ed9f988188c08e8280808883999ead9e888ec38a829b">[email protected]</span></a>. Please include
File Number S7-32-10 on the subject line; or
Paper Comments
<bullet> Send paper comments to Vanessa A. Countryman, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.
All submissions should refer to File Number S7-32-10. This file number
should be included on the subject line if email is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
internet website (<a href="http://www.sec.gov/rules/proposed.shtml">http://www.sec.gov/rules/proposed.shtml</a>). Comments
are also available for website viewing and printing in the Commission's
Public Reference Room, 100 F Street NE, Room 1580, Washington, DC
20549, on official business days between the hours of 10 a.m. and 3
p.m. Operating conditions may limit access to the Commission's public
reference room. All comments received will be posted without change.
Persons submitting comments are cautioned that the Commission does not
redact or edit personal identifying information from comment
submissions. You should submit only information that you wish to make
publicly available.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the SEC's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at <a href="http://www.sec.gov">www.sec.gov</a> to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Carol M. McGee, Assistant Director, at
(202) 551-5870, Office of Derivatives Policy, Division of Trading and
Markets, Securities and Exchange Commission, 100 F Street NE,
Washington, DC 20549-8010.
SUPPLEMENTARY INFORMATION: The Commission is re-proposing for comment
17 CFR 240.9j-1 (``Rule 9j-1'') under the Exchange Act, which would be
a new rule designed to prevent fraud, manipulation, and deception in
connection with effecting transactions in, or inducing or attempting to
induce the purchase or sale of, any security-based swap. The Commission
also is proposing new 17 CFR 240.15Fh-4(c) (``Rule 15Fh-4(c)'') under
the Exchange Act, which would make it unlawful for any officer,
director, supervised person, or employee of a security-based swap
dealer or major security-based swap participant, or any person acting
under such person's direction, to directly or indirectly take any
action to coerce, manipulate, mislead, or fraudulently influence the
security-based swap dealer's or major security-based swap participant's
CCO in the performance of their duties under the Federal securities
laws or the rules and regulations thereunder. Finally, the Commission
is using its authority under Section 10B(d) of the Exchange Act to
propose for comment new 17 CFR 240.10B-1 (``Rule 10B-1''), which would
require any person with a security-based swap position that exceeds a
certain threshold to promptly file with the Commission a schedule
disclosing among other things: (1) The applicable security-based swap
position; (2) positions in any security or loan underlying the
security-based swap position; and (3) any other instrument relating to
the underlying security or loan, or group or index of securities or
loans. Proposed Rule 10B-1 includes different reporting thresholds for
security-based swaps tied to debt securities and security-based swaps
tied to equity securities. The Commission would make all filings
received pursuant to proposed Rule 10B-1 available to the public, with
the goal of increasing transparency and oversight in the security-based
swap market.
I. Introduction
A. Background
B. Observations in the Credit Default Swap Market
C. Overview of the Proposal
1. Re-Proposed Rule 9j-1
2. Proposed Rule 15Fh-4(c)
3. Proposed Rule 10B-1 20
II. Re-Proposed Rule 9j-1: Prohibition Against Fraud, Manipulation,
and Deception in Connection With Security-Based Swaps
A. Prior Commission Action
B. Scope of Re-Proposed Rule 9j-1
1. General Antifraud and Anti-Manipulation Provisions
2. ``Purchases'' and ``Sales'' in the Context of Security-Based
Swaps and Limited Safe Harbor for Certain Limited Actions
3. Prohibition on Price Manipulation
C. Liability Under Proposed Rule 9j-1 in Connection With the
Purchase or Sale of a Security
D. Preventing Undue Influence Over Chief Compliance Officers;
Policies and Procedures Regarding Compliance With Re-Proposed Rule
9j-1, Proposed Rule 10B-1 and Proposed Rule 15Fh-4(c)
E. Request for Comment
III. Proposed Rule 10B-1: Position Reporting of Large Security-Based
Swap Positions
A. Proposed Definitions and Thresholds
[[Page 6653]]
1. Reporting Thresholds for Debt Security-Based Swaps (Including
CDS)
2. Reporting Threshold for Security-Based Swaps on Equity
3. Amendments to a Previously Filed Schedule 10B
B. Information Required To Be Included in Schedule 10B
C. Cross-Border Issues
D. Structured Data Requirement for Schedule 10B
E. Request for Comment
IV. General Request for Comment
V. Paperwork Reduction Act
A. Summary of Collections of Information
B. Proposed Use of Information
C. Respondents
D. Total Annual Recordkeeping Burden
1. Initial Costs and Burdens
2. Ongoing Costs and Burdens
E. Collection of Information Is Mandatory
F. Confidentiality
G. Request for Comment
VI. Economic Analysis
A. Introduction
B. Broad Economic Considerations
C. Baseline
1. Existing Regulatory Frameworks
2. Security-Based Swap Data, Market Participants, Dealing
Structures, Levels of Security-Based Swap Trading Activity, and
Position Concentration
D. Consideration of Costs and Benefits; Consideration of Burden
on Competition and Promotion of Efficiency, Competition and Capital
Formation
1. Re-Proposed Rule 9j-1 and Proposed Rule 15Fh-4(c)
i. Benefits
ii. Costs
2. Proposed Rule 10B-1
i. Benefits
ii. Costs
iii. Reporting Thresholds
(A) Thresholds for Credit Default Swaps
(B) Thresholds for Non-CDS Debt Security-Based Swaps and
Security-Based Swaps on Equity
E. Reasonable Alternatives
1. Implementing a More Prescriptive Approach in Re-Proposed Rule
9j-1
2. Safe Harbor for Hedging Exposure Arising Out of Lending
Activities
3. Mandating That Security-Based Swap Data Repositories Report
or Publicly Disclose Positions
4. Adopting Position Limits
5. Threshold Alternatives for Security-Based Swaps Based on
Equity and Non-CDS Debt 173
6. Threshold Alternatives for Credit Default Swaps
7. Information Required To Be Reported on Schedule 10B
F. Request for Comment
VII. Consideration of Impact on the Economy
VIII. Regulatory Flexibility Act Certification
IX. Statutory Authority
I. Introduction
A. Background
Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (``Dodd-Frank Act''),\1\ which established a regulatory
framework for the over-the-counter (``OTC'') derivatives market,
provides that the Commission is primarily responsible for regulating
security-based swaps, while the Commodity Futures Trading Commission
(``CFTC'') is primarily responsible for regulating swaps. The
Commission has now finalized a majority of its Title VII rules related
to security-based swaps.\2\ In accordance with those rules, a person
who satisfies the definitions of ``security-based swap dealer''
(``SBSD'') or ``major security-based swap participant'' (``MSBSP'')
(each SBSD and each MSBSP also referred to as an ``SBS Entity'' and
together referred to as ``SBS Entities'') is now required to register
with the Commission in such capacity and is therefore subject to the
Commission's regime regarding margin, capital, segregation,
recordkeeping and reporting, trade acknowledgment and verification
requirements, risk mitigation techniques for uncleared security-based
swaps, business conduct standards for security-based swap activity,
including internal supervision requirements and the requirement to
designate an individual to serve as the CCO who must take reasonable
steps to ensure that the SBS Entity establishes, maintains, and reviews
written policies and procedures reasonably designed to achieve
compliance with the Exchange Act and the rules and regulations
thereunder relating to its business as an SBS Entity.\3\ Transaction
reporting for security-based swaps has been required since November 8,
2021, with public dissemination to begin on February 14, 2022.\4\
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\1\ Wall Street Transparency and Accountability Act of 2010,
Public Law. 111-203, Sec. 761-774, 124 Stat. 1376, 1754-1802(2010).
Unless otherwise indicated, references to ``Title VII'' in this
release are to Subtitle B of Title VII of the Dodd-Frank Act.
\2\ See, e.g., Regulation SBSR--Reporting and Dissemination of
Security-Based Swap Information, Exchange Act Release No. 74244
(Feb. 11, 2015), 80 FR 14563 (Mar. 19, 2015) (``2015 Regulation SBSR
Adopting Release''); Security-Based Swap Data Repository
Registration, Duties, and Core Principles, Exchange Act Release No.
74246 (Feb. 11, 2015), 80 FR 14437 (Mar. 19, 2015); Registration
Process for Security-Based Swap Dealers and Major Security-Based
Swap Participants, Exchange Act Release No. 75611 (Aug. 5, 2015), 80
FR 48963 (Aug. 14, 2015); Regulation SBSR--Reporting and
Dissemination of Security-Based Swap Information, Exchange Act
Release No. 78321 (July 14, 2016), 81 FR 53545 (Aug. 12, 2016)
(``2016 Regulation SBSR Adopting Release''); Applications by
Security-Based Swap Dealers or Major Security-Based Swap
Participants for Statutorily Disqualified Associated Person To
Effect or Be Involved in Effecting Security-Based Swaps, Exchange
Act Release No. 84858 (Dec. 19, 2018), 84 FR 4906 (Feb. 19, 2019);
Capital, Margin, and Segregation Requirements for Security-Based
Swap Dealers and Major Security-Based Swap Participants and Capital
and Segregation Requirements for Broker-Dealers, Exchange Act
Release No. 86175 (June 21, 2019), 84 FR 43872 (Aug. 22, 2019)
(``Capital, Margin, and Segregation Adopting Release'');
Recordkeeping and Reporting Requirements for Security-Based Swap
Dealers, Major Security-Based Swap Participants, and Broker-Dealers,
Exchange Act Release No. 87005 (Sept. 19, 2019), 84 FR 68550 (Dec.
16, 2019) (``Recordkeeping and Reporting Adopting Release''); Rule
Amendments and Guidance Addressing Cross-Border Application of
Certain Security-Based Swap Requirements, Exchange Act Release No.
87780 (Dec. 18, 2019), 85 FR 6270 (Feb. 4, 2020) (``Cross-Border
Amendments Release'').
\3\ See Cross-Border Amendments Release, 85 FR at 6345-46. The
first SBSDs were required to be conditionally registered with the
Commission by November 1, 2021.
\4\ See SEC Approves Registration of First Security-Based Swap
Data Repository; Sets the First Compliance Date for Regulation SBSR
(available at: <a href="https://www.sec.gov/news/press-release/2021-80">https://www.sec.gov/news/press-release/2021-80</a>). In
addition, each registered security-based swap data repository
(``SBSDR'') will be required to begin publicly disseminating
security-based swap data as of February 14, 2022, which is the first
Monday that is three months after the date that reporting began. See
2016 Regulation SBSR Adopting Release, 81 FR at 53608. Finally, the
deadline for reporting certain historical security-based swaps to an
SBSDR is two months after the date that public dissemination is
required to begin (i.e., April 14, 2022). See 2016 Regulation SBSR
Adopting Release, 81 FR at 53610.
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In addition to the operational rules for SBS Entities and security-
based swap data reporting and public dissemination, the Dodd-Frank Act
also amended the Exchange Act in a number of important ways to prohibit
fraud, manipulation, and deception in connection with security-based
swaps. In particular, Section 763(g) of the Dodd-Frank Act expanded the
anti-manipulation provisions of Section 9 of the Exchange Act to
encompass purchases or sales of security-based swaps and requires the
Commission to adopt rules to prevent fraud, manipulation, and deception
in connection with security-based swaps. Specifically, paragraph (j) of
Section 9 makes it unlawful for ``any person, directly or indirectly,
by the use of any means or instrumentality of interstate commerce or of
the mails, or of any facility of any national securities exchange, to
effect any transaction in, or to induce or attempt to induce the
purchase or sale of, any security-based swap, in connection with which
such person engages in any fraudulent, deceptive, or manipulative act
or practice, makes any fictitious quotation, or engages in any
transaction, practice, or course of business which operates as a fraud
or deceit upon any person.'' \5\ It also provides that the Commission
``shall . . . by rules and regulations define, and prescribe means
reasonably designed to prevent, such transactions, acts, practices, and
courses of business as are fraudulent, deceptive, or
[[Page 6654]]
manipulative, and such quotations as are fictitious.'' \6\
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\5\ See 15 U.S.C. 78i(j). Note that Section 9 of the Exchange
Act erroneously contains two subsection (j)s.
\6\ See id.
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Additionally, Section 761 of the Dodd-Frank Act modified several
definitions in both the Exchange Act and the Securities Act to account
for security-based swaps. For example, the Dodd-Frank Act amended the
definition of ``security'' in Section 3(a)(10) of the Exchange Act \7\
and Section 2(a)(1) of the Securities Act \8\ to include security-based
swaps. As a result, security-based swaps, because they are securities,
are subject to the general antifraud and anti-manipulation provisions
of the Federal securities laws, including Sections 9(a), 10(b) and 17
CFR 240.10b-5 (``Rule 10b-5'') under the Exchange Act,\9\ and Section
17(a) of the Securities Act.\10\
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\7\ 15 U.S.C. 78c(a)(10).
\8\ 15 U.S.C. 77b(a)(1).
\9\ 15 U.S.C. 78j(b).
\10\ 15 U.S.C. 77q(a).
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Moreover, the Dodd-Frank Act amended the definitions of
``purchase'' and ``sale'' in Section 2(a)(18) of the Securities
Act,\11\ the definitions of ``buy'' and ``purchase'' in Section
3(a)(13) of the Exchange Act,\12\ and ``sale'' and ``sell'' in Section
3(a)(14) of the Exchange Act,\13\ in the context of security-based
swaps, to include the execution, termination, assignment, exchange,
transfer, or extinguishment of rights or obligations. As a result of
those changes, misconduct in connection with these actions will also be
prohibited under Sections 9 and 10(b) of the Exchange Act and Rule 10b-
5 thereunder, and Section 17(a) of the Securities Act.
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\11\ 15 U.S.C. 77b(a)(18).
\12\ 15 U.S.C. 78c(a)(13).
\13\ 15 U.S.C. 78c(a)(14).
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Finally, the Dodd-Frank Act also amended the Exchange Act to
explicitly authorize the Commission to require reporting of large
security-based swap positions. Section 763(h) of the Dodd-Frank Act,
entitled ``Position limits and position accountability for security-
based swaps and large trader reporting,'' added Section 10B to the
Exchange Act. In addition to providing the Commission with authority to
establish position limits for security-based swaps, Section 10B(d) also
provides the Commission with rulemaking authority to require reporting
of large security-based swap positions. Specifically, Section 10B(d)
authorizes the Commission to:
. . . require any person that effects transactions for such person's
own account or the account of others in any securities-based swap or
uncleared security-based swap and any security or loan or group or
narrow-based security index of securities or loans . . . to report
such information as the Commission may prescribe regarding any
position or positions in any security-based swap or uncleared
security-based swap and any security or loan or group or narrow-
based security index of securities or loans and any other instrument
relating to such security or loan or group or narrow-based security
index of securities or loans . . .\14\
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\14\ See 15 U.S.C. 78j-2(d).
On November 3, 2010, the Commission proposed for comment new Rule
9j-1, which would have prohibited the same categories of misconduct as
Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and
Section 17(a) of the Securities Act of 1933, in the context of
security-based swaps, but would also have explicitly addressed
misconduct that is in connection with the ``exercise of any right or
performance of any obligation under'' a security-based swap.\15\ In
other words, the 2010 proposed rule would have applied to offers,
purchases, and sales of security-based swaps in the same way that the
general antifraud provisions apply to all securities, but also would
have explicitly applied to the cash flows, payments, deliveries, and
other ongoing obligations and rights that are specific to security-
based swaps.\16\
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\15\ See Prohibition Against Fraud, Manipulation, and Deception
in Connection with Security-Based Swaps, Exchange Act Release No.
63236 (Nov. 3, 2010), 75 FR 68560 (Nov. 8, 2010) (``2010 Rule 9j-1
Proposing Release''). For purposes of this release, we will refer to
the version of Rule 9j-1 that the Commission proposed in the 2010
Rule 9j-1 Proposing Release as the ``2010 proposed rule.'' We will
generally refer to Rule 9j-1 as we propose it here as the ``proposed
rule'' or ``re-proposed Rule 9j-1.''
\16\ See 2010 Rule 9j-1 Proposing Release, 75 FR at 68561-62.
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The Commission has not yet finalized rules mandated by Section
9(j), nor has it proposed any reporting requirements pursuant to
Section 10B(d) of the Exchange Act. The regulatory landscape for
security-based swaps has changed since the Commission first proposed
Rule 9j-1 in 2010. At the time, efforts to reform the global OTC
derivatives markets, which had been set in motion in response to the
2008 financial crisis, had only begun, such that these markets were not
yet subject to a comprehensive regulatory framework.\17\ Since that
time, however, regulators overseeing the world's primary OTC
derivatives markets have made significant progress implementing reforms
for OTC derivatives.\18\ In addition to the progress made by the
Commission in finalizing its Title VII rulemakings related to security-
based swaps, the CFTC has largely completed its Title VII rulemakings
related to swaps, including by adopting antifraud and anti-manipulation
rules under the Commodity Exchange Act (``CEA'') to implement the Dodd-
Frank Act's amendments to Section 6(c) of the CEA.\19\ In light of the
above, the Commission believes that now is an opportune time to move
forward with the antifraud and manipulation rules required by Section
9(j) as well the rules contemplated by Section 10B(d). In addition, in
recognition of the fact that CCOs of SBS Entities play an important
role in preventing fraud and manipulation by SBS Entities and their
personnel, in that they are tasked with designing and maintaining
effective compliance systems, the Commission also is proposing an
additional measure under Section 15F(h) of the Exchange Act to protect
CCOs in the furtherance of those duties.\20\
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\17\ Commodity Futures Trading Commission and SEC Joint Report
on International Swap Regulation, Jan. 31, 2012 (available at:
<a href="https://www.sec.gov/files/sec-cftc-intlswapreg.pdf">https://www.sec.gov/files/sec-cftc-intlswapreg.pdf</a>).
\18\ See Financial Stability Board, OTC Derivatives Market
Reforms: Note on implementation progress for 2010, Nov. 25, 2020
(available at: <a href="https://www.fsb.org/wp-content/uploads/P251120.pdf">https://www.fsb.org/wp-content/uploads/P251120.pdf</a>).
\19\ 17 CFR 180.1 (``CFTC Rule 180.1'') implements the
provisions of Section 6(c)(1) of the CEA by prohibiting, among other
things, manipulative and deceptive devices employed intentionally or
recklessly, regardless of whether the conduct in question was
intended to create or did create an artificial price. CFTC Rule
180.1 also prohibits trading on the basis of material non-public
information in breach of a pre-existing duty (established by another
law or rule, agreement, understanding, or some other source) and
trading on the basis of material non-public information that was
obtained through fraud or deception. See 17 CFR 180.1. CFTC Rule
180.1(a) is modeled after Rule 10b-5 of the Exchange Act, although
it contains some notable differences, such as its application to
attempted fraud and manipulation. Id. 17 CFR 180.2 (``CFTC Rule
180.2''), promulgated pursuant to Section 6(c)(3) of the CEA and
CFTC's general rulemaking authority, addresses price manipulation
and, in line with Section 6(c)(3) of the CEA, provides that ``[i]t
shall be unlawful for any person, directly or indirectly, to
manipulate or attempt to manipulate the price of any swap, or of any
commodity in interstate commerce, or for future delivery on or
subject to the rules of any registered entity.'' A violation of CFTC
Rule 180.2 requires a showing of ``specific intent.'' See
Prohibition on the Employment, or Attempted Employment, of
Manipulative and Deceptive Devices and Prohibition on Price
Manipulation, 76 FR 41398, 41707 (Jul. 14, 2011) (``[the CFTC]
reaffirms the requirement under final Rule 180.2 that a person must
act with the requisite specific intent. In other words, recklessness
will not suffice under final Rule 180.2 as it will under final Rule
180.1.'').
\20\ To be clear, the ultimate responsibility for compliance by
the SBS Entity with the federal securities laws, including the
requirement to have adequate compliance systems and to avoid
violations generally, rests with the SBS Entity itself.
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B. Observations in the Credit Default Swap Market
In addition to the regulatory developments, there have been market
developments. A number of press reports and academic articles since
2010
[[Page 6655]]
have discussed manufactured credit events or other opportunistic
strategies in the credit default swap (``CDS'') market.\21\
Manufactured or other opportunistic CDS strategies can take a number of
different forms but generally involve CDS buyers or sellers taking
steps, with or without the participation of a company whose securities
underlie, or are referenced by, a CDS (a ``reference entity''),\22\ to
avoid, trigger, delay, accelerate, decrease, and/or increase payouts on
CDS.\23\ Some examples reported by academics and the press include:
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\21\ See, e.g., Gina-Gail S. Fletcher, Engineered Credit Default
Swaps: Innovative or Manipulative? 94 N.Y.U. L. Rev. 1073 (2019);
see also Andras Danis & Andrea Gamba, Dark Knights: The Rise in Firm
Intervention by CDS Investors, Ga. Inst. Of Tech. Scheller Coll. of
Bus. Working Paper, Paper No. 3479635 & WBS Fin. Grp. Working Paper,
Paper No. 265 (Nov. 2019) (available at: <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3479635">https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3479635</a>); see also Henry T.C. Hu,
Corporate Distress, Credit Default Swaps, and Defaults: Information
and Traditional, Contingent, and Empty Creditors, 13 Brook. J. Corp.
Fin. & Com. L. 26-27 (Nov. 2018) (available at: <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3302816">https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3302816</a>).
\22\ A security-based swap, including a CDS contract, may
reference a number of different types of securities, including
instruments of indebtedness, indices, interest rates, quantitative
measures, or other financial or economic interests (each a
``reference obligation'').
\23\ In order to cash settle any CDS contract that relies on the
International Swaps and Derivatives Association (``ISDA'') standard
documentation, a Credit Derivatives Determinations Committee
(``DC'') must make a determination that a defined default event (a
``credit event'') occurred and vote to hold an auction to determine
the settlement price of the CDS. A DC is generally composed of nine
or ten dealers and five buy-side members. Once a DC determines that
a credit event has occurred and that an auction should be held, the
DC Secretary publishes auction terms, which include a list of
obligations that a CDS protection buyer can deliver to the CDS
protection seller after the auction settlement (each a ``deliverable
obligation''). Each auction consists of two parts: (1) The first
part of the auction, which involves submission of physical
settlement requests by participating dealers, aims at determining
the initial market mid-point, the net open interests, and adjustment
amounts; and (2) the second part of the auction consists of
calculating the final settlement price. Since a protection buyer has
the right to deliver any of the deliverable obligations specified on
the list, it is in the protection buyers' interest to deliver into
the auction the cheapest deliverable obligation; as a result, the
value of this ``cheapest to deliver'' deliverable obligation drives
the final settlement price. See Markit and Creditex Credit Event
Auction Primer, 1 (Feb. 2010) (available at: <a href="http://www.creditfixings.com/information/affiliations/fixings/auctions/docs/credit_event_auction_primer.pdf">http://www.creditfixings.com/information/affiliations/fixings/auctions/docs/credit_event_auction_primer.pdf</a>); see also Credit Suisse, A
Guide to Credit Events and Auctions, Jan. 11, 2012, 5 (available at:
<a href="https://doc.research-andanalytics.csfb.com/docView?language=ENG&source=emfromsendlink&format=PDF&document_id=803733390&serialid=FWHCx3yCrSE3FoEvAbEKa6fRKhqLoKs0jL1gR5W2Dfs%3D">https://doc.research-andanalytics.csfb.com/docView?language=ENG&source=emfromsendlink&format=PDF&document_id=803733390&serialid=FWHCx3yCrSE3FoEvAbEKa6fRKhqLoKs0jL1gR5W2Dfs%3D</a>).
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<bullet> A CDS buyer working with a reference entity to create an
artificial, technical, or temporary failure-to-pay credit event in
order to trigger a payment on a CDS to the buyer (and to the detriment
of the CDS seller).\24\
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\24\ See Hu, supra note 21 at 26-27.
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<bullet> The strategy above (as well as other strategies) can be
combined with causing the reference entity to issue a below-market debt
instrument in order to artificially increase the auction settlement
price for the CDS (i.e., by creating a new ``cheapest to deliver''
deliverable obligation).\25\
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\25\ See Statement on Manufactured Credit Events by CFTC
Divisions of Clearing and Risk, Market Oversight, and Swap Dealer
and Intermediary Oversight (Apr. 24, 2018) (available at: <a href="https://www.cftc.gov/PressRoom/SpeechesTestimony/divisionsstatement">https://www.cftc.gov/PressRoom/SpeechesTestimony/divisionsstatement</a> 042418).
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<bullet> CDS buyers endeavoring to influence the timing of a credit
event in order to ensure a payment (upon the triggering of the CDS)
before expiration of a CDS, or a CDS seller taking similar actions to
avoid the obligation to pay by ensuring a credit event occurs after the
expiration of the CDS, or taking actions to limit or expand the number
and/or kind of deliverable obligations in order to impact the recovery
rate.\26\
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\26\ See Hu, supra note 21 at 22-26.
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<bullet> CDS sellers offering financing to restructure a reference
entity in such a way that ``orphans'' the CDS--eliminating or reducing
the likelihood of a credit event by moving the debts off the balance
sheets of the reference entity and onto the balance sheets of a
subsidiary or an affiliate that is not referenced by the CDS.\27\
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\27\ See Fletcher, supra note 21 at 1101.
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<bullet> Taking actions, including as part of a larger
restructuring, to increase (or decrease) the supply of deliverable
obligations by, for example, adding (or removing) a co-borrower to
existing debt of a reference entity, thereby increasing (or decreasing)
the likelihood of a credit event and the cost of CDS.\28\
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\28\ See Fletcher, supra note 21 at 1098. See also CFTC Talks
Podcast, Credit Derivatives, (Jul. 10, 2019) (available at: <a href="https://www.cftc.gov/Exit/index.htm?https://youtu.be/Qqo9KR6JXaM">https://www.cftc.gov/Exit/index.htm?https://youtu.be/Qqo9KR6JXaM</a>?).
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In June 2019, the former SEC Chairman, together with the principals
of the CFTC and the U.K. Financial Conduct Authority at the time,
issued a public statement stating that the ``continued pursuit of
various opportunistic strategies in the credit derivatives markets,
including but not limited to those that have been referred to as
`manufactured credit events,' may adversely affect the integrity,
confidence and reputation of the credit derivatives markets, as well as
markets more generally'' (``2019 Joint Statement'').\29\ Additionally,
in April 2018 the Board of Directors of ISDA stated their belief that
``narrowly tailored defaults . . . could negatively impact the
efficiency, reliability and fairness of the overall CDS market.'' \30\
Following this statement, in March 2019, ISDA introduced amendments to
its Credit Derivatives Definitions designed to address certain issues
related to manufactured credit events, which ISDA termed ``narrowly
tailored credit events'' (``ISDA Amendments'').\31\
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\29\ See Joint Statement on Opportunistic Strategies in the
Credit Derivatives Market (June 24, 2019) (available at: <a href="https://www.sec.gov/news/press-release/2019-106">https://www.sec.gov/news/press-release/2019-106</a>).
\30\ See ISDA Board Statement on Narrowly Tailored Credit Events
(April 11, 2018) (available at: ISDA Board Statement on Narrowly
Tailored Credit Events--International Swaps and Derivatives
Association).
\31\ See Proposed Amendments to the 2014 ISDA Credit Derivatives
Definitions Relating to Narrowly Tailored Credit Event (Mar. 6,
2019) (available at: <a href="https://www.isda.org/2019/03/06/proposed-amendments-to-the-2014-isda-credit-derivatives-definitions-relating-to-narrowly-tailored-credit-events/">https://www.isda.org/2019/03/06/proposed-amendments-to-the-2014-isda-credit-derivatives-definitions-relating-to-narrowly-tailored-credit-events/</a>). On September 19, 2019, an
update to the 2019 Joint Statement was issued. See Update to Joint
Statement (Sept. 19, 2019) (available at: <a href="https://www.sec.gov/news/public-statement/update-june-2019-joint-statement-opportunistic-strategies-credit-derivatives">https://www.sec.gov/news/public-statement/update-june-2019-joint-statement-opportunistic-strategies-credit-derivatives</a>). The updated statement welcomed
ISDA's efforts, but also noted that the ISDA Amendments would not
address all of the concerns identified in the 2019 Joint Statement,
including but not limited to addressing opportunistic strategies
that do not involve narrowly tailored credit events.
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C. Overview of the Proposal
1. Re-Proposed Rule 9j-1
The Commission has decided to re-propose Rule 9j-1. As described in
detail below, re-proposed Rule 9j-1 follows the same general approach
as the 2010 proposed rule in that it would prohibit the same categories
of misconduct as Section 10(b) of the Exchange Act and Rule 10b-5
thereunder, and Section 17(a) of the Securities Act of 1933 in the
context of security-based swaps, including misconduct that is in
connection with the exercise of any right or performance of any
obligation under a security-based swap.\32\ Unlike the 2010 proposed
rule, however, this new proposal also includes an anti-manipulation
provision similar to 17 CFR 108.2 (``CFTC Rule 180.2'').\33\ Further,
re-proposed Rule 9j-1 would provide that: (1) A person with material
non-public information about a security cannot avoid liability under
the securities laws by making purchases or sales in the security-based
swap (as opposed to purchasing or selling the underlying security), and
(2) a person cannot avoid liability under Section 9(j) or re-proposed
Rule 9j-1 in connection with a fraudulent scheme involving a security-
based swap by instead making purchases or sales in the underlying
[[Page 6656]]
security (as opposed to purchases or sales in -the security-based
swap).\34\
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\32\ See re-proposed Rule 9j-1(a) and (e).
\33\ See re-proposed Rule 9j-1(b).
\34\ See re-proposed Rule 9j-1(c) and (d).
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The Commission recognizes that CDS buyers and sellers regularly
engage in legitimate interactions with reference entities, and often
offer critical means of restructuring and funding for reference
entities. Moreover, we also understand that CDS transactions are an
important means by which debt holders hedge their underlying debt
instruments, and that the absence of such hedging opportunities could
impact prospective investors' willingness and ability to invest in that
underlying market. The Commission preliminarily believes the proposal
is sufficiently tailored to balance these concerns but, in section II.E
below, is also soliciting comment on how it can address manufactured or
other opportunistic strategies that involve fraudulent, deceptive, or
manipulative activity, or that involve such quotations as are
fictitious, without impairing the proper functioning of the security-
based swap markets or other securities markets.
Further, the scope of re-proposed Rule 9j-1 is not limited to CDS.
Fraudulent, deceptive, or manipulative conduct, such as providing false
or incomplete information to a counterparty to secure better terms or
pricing or to alter the performance of ongoing rights and obligations,
has the potential to harm counterparties to all forms of swaps,
including equity and non-CDS debt security-based swaps. Manipulation of
the underlying reference security can affect the pricing of an equity
or debt security-based swaps, as well as the ongoing payments and
obligations that are based on the value of that reference security.
Further, in some cases, particularly in instances involving security-
based swaps transactions that are effected over the internet, there is
a potential for trading software to distort pricing and payouts on
security-based swaps.\35\ Finally, to the extent an opportunistic
strategy alters the operations of a reference entity, counterparties to
any security-based swap based on that reference entity could be
impacted; the potential harm is not limited to CDS holders. As a
result, re-proposed Rule 9j-1 applies to all transactions in security-
based swaps, consistent with the 2010 proposed rule.
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\35\ See e.g., SEC Investor Alert: Binary Options Fraud
available at: <a href="https://www.investor.gov/protect-your-investments/fraud/types-fraud/binary-options-fraud">https://www.investor.gov/protect-your-investments/fraud/types-fraud/binary-options-fraud</a>. (stating that the SEC has
received numerous complaints alleging that certain ``internet-based
binary options trading platforms manipulate the trading software to
distort binary options prices and payouts.''). The SEC Investor
Alert represents the views of the staff of the Office Investor
Education and Advocacy. It is not a rule, regulation, or statement
of the Commission. The Commission has neither approved nor
disapproved its content. The SEC Investor Alert, like all staff
statements, has no legal force or effect: It does not alter or amend
applicable law, and it creates no new or additional obligations for
any person. Depending on the facts and circumstances, binary options
based on securities may be security-based swaps.
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2. Proposed Rule 15Fh-4(c)
The Commission also is proposing a rule aimed at protecting the
independence and objectivity of an SBS Entity's CCO by preventing the
personnel of an SBS Entity from taking actions to coerce, mislead, or
otherwise interfere with the CCO. The Commission recognizes that SBS
Entities dominate the security-based swap market and also recognizes
the important role that CCOs of SBS Entities play in ensuring
compliance by SBS Entities and their personnel with the federal
securities laws. As a result, the Commission is proposing Rule15Fh-4(c)
which would make it unlawful for any officer, director, supervised
person, or employee of an SBS Entity, or any person acting under such
person's direction, to directly or indirectly take any action to
coerce, manipulate, mislead, or fraudulently influence the SBS Entity's
CCO in the performance of their duties under the Federal securities
laws or the rules and regulations thereunder.
3. Proposed Rule 10B-1
Finally, the Commission also recognizes that transparency can be
beneficial to market participants so that they can act in an informed
manner to protect their own interests. One example involves what some
legal observers refer to as ``net-short debt activism''--where a market
participant with a large CDS position and a controlling voting interest
in the debt of a reference entity votes against its interest as a debt
holder to ensure that a credit event occurs (such as by blocking a
restructuring or voting against curing a technical default under the
terms of a loan).\36\ In such instances, both the Commission and
relevant market participants--particularly issuers of the underlying
debt securities--could benefit from having access to information that
may indicate that one or more market participants has a financial
incentive to take an action that would be harmful to the issuer, which
in turn could impact the issuer's other security holders.\37\ In
particular, such notice would provide the relevant parties with the
ability to take appropriate action to limit any potential harmful
consequences. Given such benefits to the market, which may accrue even
where the facts and circumstances of a particular situation are not
indicative of potentially fraudulent, manipulative, or deceptive
conduct, the Commission believes that public reporting of large CDS
positions would help to provide such advance notice.
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\36\ See Joshua A. Feltman, Emil A. Kleinhaus, and John R.
Sobolewski, Wachtell, Lipton, Rosen & Katz, The Rise of Net-Short
Debt Activism, Harvard Law School Forum on Corporate Governance and
Financial Regulation (Aug. 7, 2018) (available at: <a href="https://corpgov.law.harvard.edu/2018/08/07/the-rise-of-the-net-short-debt-activist/">https://corpgov.law.harvard.edu/2018/08/07/the-rise-of-the-net-short-debt-activist/</a>). See also Matt Levine, Aurelius Broke Windstream's Bonds
to Save Them, Bloomberg View (Feb. 27, 2019).
\37\ Harm to the issuer could lead to harm to its employees,
customers, and business partners, among others. Any one of these
indirect effects could create further harm to the issuer and its
security holders.
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Additional transparency regarding large security-based swap
positions also could alert market participants, including
counterparties, as well as issuers of securities and their security
holders, to the risk posed by the concentrated exposure of a
counterparty. Such transparency also could enhance risk management by
security-based swap counterparties and inform pricing of the security-
based swaps. For example, if a single counterparty has a $5 billion
security-based swap position distributed equally among five different
dealers on the same underlying equity security, public reporting of
that security-based swap position would alert each dealer to the total
exposure of the reporting counterparty. In the event of an issue
involving the underlying security or the counterparty's ability to make
a payment on the security-based swaps composing the large position,
some or all of those dealers could then take actions to protect their
positions, such as increasing their hedges against the relevant
security-based swaps or calling for additional margin, if permitted.
Knowledge of the total position of a counterparty also may inform a
dealer's actions in the event that the counterparty defaults on its
obligations under the security-based swap.
Finally, transparency about security-based swap positions could
play an important role in protecting market integrity, including by
providing the Commission and other regulators with access to
information that may indicate that a person (or a group of persons) is
building up a large security-based swap position, which may be relevant
for a number of reasons, as discussed in greater detail in section III.
As previously discussed, the manufactured or other opportunistic
strategies that have been reported to have taken place in the CDS
markets take on a variety of
[[Page 6657]]
forms. Although some of those strategies may have involved fraudulent
or manipulative conduct, including those that involve parties acting to
artificially inflate CDS payments, others do not necessarily constitute
prohibited activity. The common thread to all of those strategies,
however, is one or more parties taking affirmative steps to avoid,
trigger, delay, accelerate, decrease, and/or increase payouts on
CDS.\38\ Given the importance of the CDS market and its
interconnectedness with the underlying debt securities that CDS may be
used to hedge, the Commission believes that additional transparency in
the CDS market can help to ensure that it remains fair, orderly, and
efficient. For similar reasons, such transparency also should benefit
the market for other types of security-based swaps.
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\38\ See Fletcher, supra note 21 at 1098 (``[I]t is evident that
engineered CDS transactions are unfair, create the perception of the
market being rigged, and undermine the integrity of the market. . .
. Fundamentally, parties enter into CDS expecting that the ultimate
determination of whether the contract pays off rests with market
forces, over which neither party has control. However, when a
counterparty interferes and skews the outcome of the CDS contract to
her benefit, she undercuts her counterparties' reasonable
expectations and unjustly transfers wealth from her counterparty to
herself.'').
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Accordingly, the Commission has decided to utilize its rulemaking
authority under Section 10B of the Exchange Act to propose new Rule
10B-1, which would be a large trader position reporting rule for
security-based swaps. Specifically, proposed Rule 10B-1 would require
public reporting of, among other things: (1) Certain large positions in
security-based swaps; (2) positions in any security or loan underlying
the security-based swap position; and (3) positions in any other
instrument relating to the underlying security or loan or group or
index of securities or loans. As described in detail below, proposed
Rule 10B-1 would, among other things, include a specific quantitative
threshold for when public reporting is required.
The Commission recognizes that market participants are already
subject to the requirements of 17 CFR 242.900 through 242.909
(``Regulation SBSR''), which governs regulatory reporting of security-
based swap transactions to security-based swap data repositories
(``SBSDRs'') and public dissemination of some of that transaction data
pursuant to Section 13(m) of the Exchange Act.\39\ Although both sets
of requirements are intended to provide greater transparency in the
security-based swap market, certain differences between the two
highlight the need to propose Rule 10B-1. For example, pursuant to the
statutory authority in Section 13(m)(1), Regulation SBSR requires real-
time public reporting to SBSDRs and public dissemination of security-
based swap transaction data but not of position data as is contemplated
by Section 10B and proposed Rule 10B-1.\40\ Although registered SBSDRs
are required to establish, maintain, and enforce written policies and
procedures reasonably designed to calculate positions for all persons
with open security-based swaps for which the SBSDR maintains
records,\41\ they are not required to make those reports public.\42\ As
a result, any public position reporting pursuant to Regulation SBSR
would need to be completely anonymous with respect to both the person
building up large, concentrated security-based swap positions, and each
of its counterparties. Finally, Regulation SBSR only requires reporting
and public dissemination of security-based swaps, in contrast to
Section 10B, which authorizes the Commission to require reporting of
positions in both security-based swaps and related securities.\43\ The
Commission believes that requiring reporting of related securities
serves an important function in allowing both the Commission and the
public to develop a greater understanding of the impact that a large
security-based swap position can have on the broader securities
markets.
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\39\ See supra note 4 and accompanying text (explaining that
transaction reporting for security-based swaps has been required
since November 8, 2021, with public dissemination to begin on
February 14, 2022).
\40\ See, e.g., Section 13(m)(1)(C) of the Exchange Act, which
provides that ``[t]he Commission is authorized to provide by rule
for the public availability of security-based swap transaction,
volume, and pricing data'' subject to certain conditions and
requirements. 15 U.S.C. 78m(m)(1)(C).
\41\ See 17 CFR 240.13n-5(b)(2).
\42\ In fact, Section 13(m)(1)(C)(iii) of the Exchange Act
provides that any Commission rulemaking pursuant to Section 13(m)
(i.e., Regulation SBSR) ``shall require real-time public reporting
for [security-based swap] transactions, in a manner that does not
disclose the business transactions and market positions of any
person.'' See 15 U.S.C. 78m(m)(1)(C)(iii). By contrast, Section
10B(d), which is titled ``Large Trader Reporting,'' does not contain
a limitation on disclosing the identity of security-based swap
counterparties in connection with security-based swap position
reporting. As discussed in section III, however, a person subject to
the reporting requirements of proposed Rule 10B-1 would have to
report its own identity and the size of its aggregate security-based
swap position, but the person would not be required to report any
information about its counterparties, including their identities.
\43\ See supra note 14 and accompanying text.
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II. Re-Proposed Rule 9j-1: Prohibition Against Fraud, Manipulation, and
Deception in Connection With Security-Based Swaps
A. Prior Commission Action
As initially proposed in 2010, Rule 9j-1 would have prohibited the
same categories of misconduct addressed by Section 10(b) of the
Exchange Act \44\ and Rule 10b-5 thereunder,\45\ as well as Section
17(a) of the Securities Act,\46\ but specifically in the context of
security-based swaps. The 2010 proposed rule explicitly reached
misconduct in connection with the ongoing payments and deliveries that
are typical of security-based swaps, which occur throughout the life of
the security-based swap.\47\ Specifically, the 2010 proposed rule would
have made it unlawful for any person, directly or indirectly, in
connection with the offer, purchase or sale of any security-based swap,
in the exercise of any right or performance of any obligation under a
security-based swap, or the avoidance of such exercise or performance:
(a) To employ any device, scheme, or artifice to defraud or manipulate;
(b) to knowingly or recklessly make any untrue statement of a material
fact, or to knowingly or recklessly omit to state a material fact
necessary in order to make the statements made, in the light of the
circumstances under which they were made, not misleading; (c) to obtain
money or property by means of any untrue statement of a material fact
or any omission to state a material fact necessary in order to make the
statements made, in light of the circumstances under which they were
made, not misleading; or (d) to engage in any act, practice, or course
of business which operates or would operate as a fraud or deceit upon
any person.\48\
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\44\ 15 U.S.C. 78j(b).
\45\ 17 CFR 240.10b-5.
\46\ 15 U.S.C. 77q(a).
\47\ 2010 Rule 9j-1 Proposing Release, 75 FR at 68561.
\48\ 2010 Rule 9j-1 Proposing Release, 75 FR at 68568.
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Most commenters on the 2010 proposed rule generally supported the
Commission's goal of adopting antifraud standards to ensure the
integrity of the security-based swap market.\49\ Some commenters
expressed strong support for the 2010 proposed rule, stating that the
rule would encourage investor confidence in the security-based swap
market and would help ensure that the Commission has the ability to
respond through enforcement mechanisms to
[[Page 6658]]
misconduct interfering with the independence and proper functioning of
the market.\50\ In addition, one commenter specifically requested that
the Commission require disclosure of debt security-based swap
positions.\51\
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\49\ The comment letters can be found at: <a href="http://www.sec.gov/comments/s7-32-10/s73210.shtml">http://www.sec.gov/comments/s7-32-10/s73210.shtml</a>.
\50\ See, e.g., Letter from Laurel Leitner, Council for
Institutional Investors, dated Dec. 16, 2010, at 1-2; Letter from
Dennis Kelleher and Wallace Turbeville, Better Markets, dated Dec.
23, 2010, at 1-2; Letter from Chris Bernard, dated Nov. 21, 2010, at
1.
\51\ See Letter from Suzanne H. Shatto, dated Jan. 27, 2011.
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However, some commenters stated that the 2010 proposed rule
exceeded the Commission's authority by addressing activities involving
the exercise of any rights and performance of any obligations during
the life of a security-based swap, as opposed to addressing only
misconduct taking place in connection with the ``purchase'' and
``sale'' of a security-based swap.\52\ Those commenters all generally
argued that unless modified, the 2010 proposed rule would have a
negative impact or chilling effect on the security-based swap market by
unintentionally prohibiting the legitimate exercise of rights and
performance of obligations under a security-based swap and by leading
to costly unintended consequences. Section II.B.2. includes a
discussion of the concerns raised by these commenters.
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\52\ See Letter from Stuart J. Kaswell, Managed Funds
Association (``MFA''), dated Dec. 23, 2010 (``December 2010 MFA
Comment Letter'') at 2-10; Letter from Stuart J. Kaswell, MFA, dated
Mar. 29, 2011 (``March 2011 MFA Comment Letter'') at 3-9; Letter
from Kenneth E. Bentsen, Jr., Securities Industry and Financial
Markets Association (``SIFMA'') and Robert G. Pickel, ISDA, dated
Dec. 23, 2010 (``SIFMA/ISDA Joint Comment Letter'') at 9-10, 13;
Letter from Kenneth E. Bentsen, Jr., SIFMA, dated July 8, 2011
(``July 2011 SIFMA Comment Letter'') at 2-8; and Letter from R. Bram
Smith, Loan Syndications and Trading Association (``LSTA''), dated
Dec. 23, 2010 (``LSTA Comment Letter'') at 2-10.
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B. Scope of Re-Proposed Rule 9j-1
1. General Antifraud and Anti-Manipulation Provisions
The general antifraud and anti-manipulation provisions in re-
proposed Rule 9j-1(a) would make it unlawful for any person, directly
or indirectly, (i) to purchase or sell, or attempt to induce the
purchase or sale of, any security-based swap; \53\ (ii) to effect any
transaction in, or attempt to effect any transaction in, any security-
based swap; (iii) to take any action to exercise any right, or any
action related to performance of any obligation, under any security-
based swap, including in connection with any payments, deliveries,
rights, or obligations or alterations of any rights thereunder; or (iv)
to terminate (other than on its scheduled maturity date) or settle any
security-based swap, in connection with which such person:
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\53\ See proposed Rule 9j-1(e), which provides that the terms
``purchase'' and ``sale'' would have the same meaning as set forth
in Sections 3(a)(13) and (14) of the Exchange Act. 15 U.S.C.
78c(a)(13) and (14).
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(1) Employs or attempts to employ any device, scheme, or artifice
to defraud or manipulate; or
(2) Makes or attempts to make any untrue statement of a material
fact, or omits to state a material fact necessary in order to make the
statements made, in the light of the circumstances under which they
were made, not misleading; or
(3) Obtains or attempts to obtain money or property by means of any
untrue statement of a material fact or any omission to state a material
fact necessary in order to make the statements made, in light of the
circumstances under which they were made, not misleading; or
(4) Engages or attempts to engage in any act, practice, or course
of business which operates or would operate as a fraud or deceit upon
any person.
Like the 2010 proposed rule, the current proposal generally relies
on language from Section 10(b) of the Exchange Act \54\ and Rule 10b-5
thereunder,\55\ and Section 17(a) of the Securities Act,\56\ as it
relates to the specific types of fraudulent, manipulative, or deceptive
conduct that re-proposed Rule 9j-1(a) is designed to address. In
addition, re-proposed Rule 9j-1(a) describes the particular types of
activity that would be covered by the rule, to the extent that a person
engages in specified types of fraudulent, manipulative, or deceptive
conduct in connection with such activities.\57\ Specifically, the
proposed rule would apply not only to the ``purchase'' or ``sale'' of
security-based swaps, as such terms are defined in the Exchange
Act,\58\ but also to: (1) Effecting transactions, or attempts to effect
transactions in, security-based swaps, (2) taking actions to exercise
any right or actions related to performance of any obligation pursuant
to any security-based swap including any payments, deliveries, rights,
or obligations or alterations of any rights thereunder, or (3)
terminating (other than on its scheduled maturity date) or settling any
security-based swap, in connection with which such person engages in
the specified fraudulent, manipulative, or deceptive conduct.
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\54\ Section 10(b) of the Exchange Act provides that ``[i]t
shall be unlawful for any person, directly or indirectly . . . (b)
to use or employ, in connection with the purchase or sale of any
security . . . any manipulative or deceptive device or contrivance
in contravention of such rules and regulations as the Commission may
prescribe as necessary or appropriate in the public interest or for
the protection of investors.'' See 15 U.S.C. 78j(b).
\55\ Rule 10b-5 under the Exchange Act provides that ``[i]t
shall be unlawful for any person, directly or indirectly . . . (a)
to employ any device, scheme, or artifice to defraud, (b) to make
any untrue statement of a material fact or to omit to state a
material fact necessary in order to make the statements made, in
light of the circumstances under which they are made, not
misleading, or (c) to engage in any act, practice, or course of
business which operates or would operate as a fraud or deceit upon
any person, in connection with the purchase or sale of any
security.'' See 17 CFR 240.10b-5.
\56\ Section 17(a) of the Securities Act provides that ``[i]t
shall be unlawful for any person in the offer or sale of securities
. . . directly or indirectly--(1) to employ any device, scheme, or
artifice to defraud, or (2) to obtain money or property by means of
any untrue statement of a material fact or any omission to state a
material fact necessary in order to make the statements made, in
light of the circumstances under which they are made, not
misleading, or (3) to engage in any transaction, practice, or course
of business which operates or would operate as a fraud or deceit
upon the purchaser.'' See 15 U.S.C. 77q(a). In contrast to the 2010
proposed rule, the current proposal does not contain a provision
based on Section 17(a)(2) of the Securities Act. Given that the
current proposal itself relies on the statutory authority in Section
9(j) of the Exchange Act, the Commission has determined to retain
the language from the 2010 proposed rule that is based on an
existing Exchange Act rule.
\57\ See proposed Rule 9j-1(a). The introductory language in
paragraph (a) follows Section 9(j) of the Exchange Act, in that it
would prohibit specified activities in connection with which any
person engages in the prohibited conduct set forth in paragraphs (1)
through (4). By contrast, the corresponding language in the 2010
proposed rule followed the format used in Section 10(b) and applied
solely to conduct that is in connection with the offer, purchase or
sale of any security-based swap, the exercise of any right or
performance of any obligation under a security-based swap, or the
avoidance of such exercise or performance. The re-proposed language
is intended to more closely track the authorizing statutory language
in Section 9(j), and to make clear that under the proposed rule an
activity would only be unlawful when done in connection with
fraudulent, manipulative, or deceptive conduct.
\58\ See proposed Rule 9j-1(e).
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With respect to the operative paragraphs in re-proposed Rule 9j-
1(a) describing the fraudulent, manipulative or deceptive conduct that
the rule prohibits, those provisions have been structured to combine
the antifraud and anti-manipulation provisions in Rule 10b-5 that apply
to all securities (including security-based swaps) with the additional
antifraud and anti-manipulative authority specific to security-based
swaps provided to the Commission in Section 9(j). For example, re-
proposed Rule 9j-1(a)(1) would explicitly prohibit employing or
attempting to employ any device, scheme, or artifice to defraud or
manipulate. Although most of that language is derived from Section
10(b)
[[Page 6659]]
of the Exchange Act,\59\ Rule 10b-5 thereunder,\60\ and Section
17(a)(1) of the Securities Act,\61\ the inclusion of ``manipulate'' and
the extension of the prohibition to include an ``attempt'' to employ
any device, scheme, or artifice to defraud or manipulate comes directly
from the statutory authority in Section 9(j).\62\ Paragraph (a)(2) of
re-proposed Rule 9j-1, which prohibits the making of material
misstatements or omissions, also is based on Rule 10b-5 and also
contemplates an attempt to make a material misstatement or omission.
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\59\ See supra note 54.
\60\ See supra note 55.
\61\ See supra note 56.
\62\ See supra note 5 and accompanying text. The application to
attempted conduct also appears in other places in the Exchange Act
and the rules and regulations thereunder. For example, Section
15(c)(1)(A) of the Exchange Act makes it unlawful for any broker-
dealer ``to effect any transaction in, or to induce or attempt to
induce the purchase or sale of, any security (other than commercial
paper, bankers' acceptances, or commercial bills), or any security-
based swap agreement by means of any manipulative, deceptive, or
other fraudulent device or contrivance.'' 15 U.S.C. 78o(c)(1)(A).
See also Commission Guidance Regarding Prohibited Conduct in
Connection with IPO Allocations, Exchange Release No. 51500 (Apr. 7,
2005), 70 FR 19672, 19673 (Apr. 13, 2005) (``Regulation M applies to
`attempts,' thus proscribing a distribution participant's conduct
irrespective of whether it actually results in market activity by
others. It is the inducement or the attempt to induce during the
restricted period that Regulation M prohibits.'') (internal
citations omitted).
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Finally, paragraphs (a)(3) and (4) of re-proposed Rule 9j-1 are
based on Sections 17(a)(2) and (3) of the Securities Act.\63\ Again,
however, the re-proposed rule would now extend those provisions to
attempted conduct, such that they would prohibit a person from (i)
obtaining or attempting to obtain money or property by means of any
untrue statement of a material fact or any omission to state a material
fact necessary in order to make the statements made, in light of the
circumstances under which they were made, not misleading; and (ii)
engaging or attempting to engage in any act, practice, or course of
business which operates or would operate as a fraud or deceit upon any
person.
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\63\ See supra note 56.
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As the Commission explained in the 2010 Rule 9j-1 Proposing
Release, the provisions described above have been designed generally to
prohibit a range of fraudulent, manipulative and deceptive conduct in
the security-based swap market, such as, among other things, ``engaging
in fraudulent and deceptive schemes in order to increase or decrease
the price or value of a security-based swap, or disseminating false or
misleading statements that affect or otherwise manipulate the price or
value of the reference underlying of a security-based swap for the
purpose of benefiting such person's position in the security-based
swap.'' \64\ Re-proposed Rule 9j-1(a) also would prohibit, for example,
disseminating false financial information or data in connection with
the sale of a security-based swap or insider trading in a security-
based swap. It also would prevent misconduct that affects the market
value of the security-based swap for purposes of posting collateral or
making payments or deliveries under such security-based swap.\65\
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\64\ See 2010 Rule 9j-1 Proposing Release, 75 FR at 68569.
\65\ See id.
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Re-proposed Rule 9j-1(a) also would prohibit fraudulent conduct in
connection with a security-based swap that affects the value of cash
flow, payments, or deliveries, such as by triggering the obligation of
a counterparty to make a large payment or to post additional
collateral. It would also prohibit a person from taking fraudulent or
manipulative action with respect to the reference entity or asset of
the security-based swap that triggers the exercise of a right or
performance of an obligation or affects the payments to be made.\66\
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\66\ See id.
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Re-proposed Rules 9j-1(a)(1) and (2), consistent with Section 10(b)
of the Exchange Act and Rule 10b-5 thereunder,\67\ and Section 17(a)(1)
of the Securities Act,\68\ would require scienter.\69\ In contrast, re-
proposed Rules 9j-1(a)(3) and (4) would not require scienter consistent
with Sections 17(a)(2) and (3) of the Securities Act.\70\
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\67\ To state a claim under Section 10(b) of the Exchange Act
and Rule 10b-5, the Commission must establish that the misstatements
or omissions were made with scienter. See, e.g., Ernst & Ernst v.
Hochfelder, 425 U.S. 185, 193 (1976). The Supreme Court has defined
scienter as ``a mental state embracing intent to deceive, manipulate
or defraud.'' Id. Recklessness will generally satisfy the scienter
requirement. See, e.g., Sunstrand Corp. v. Sun Chemical Corp., 553
F.2d 1033, 1045 (7th Cir. 1977). See also Greebel v. FTP Software,
Inc., 194 F.3d 185, 198 (1st Cir. 1999); SEC v. Environmental, Inc.,
155 F.3d 107, 111 (2d Cir. 1998).
\68\ Establishing violations of Securities Act Section 17(a)(1)
requires a showing of scienter. See, e.g., Aaron v. SEC, 446 U.S.
680, 701-02 (1980). Scienter is the ``mental state embracing intent
to deceive, manipulate or defraud.'' Ernst & Ernst v. Hochfelder,
425 U.S. 185, 193 (1976). See also Section 206(1) of the Investment
Advisers Act of 1940 (``Advisers Act'), which makes it unlawful for
an investment adviser to employ any device, scheme, or artifice to
defraud any client or prospective client. 15 U.S.C. 80b-6(1). Claims
arising under Section 206(1) of the Advisers Act require scienter.
See, e.g., Robare Grp. LTD v. SEC, 922 F.3d 468, 472 (D.C. Cir.
2019); SEC v. Moran, 922 F. Supp. 867, 896 (S.D.N.Y. 1996); Carroll
v. Bear, Stearns & Co., 416 F. Supp. 998, 1001 (S.D.N.Y. 1976).
\69\ The language in the 2010 proposed rule that corresponds to
re-proposed Rule 9j-1(a)(2) included the phrase ``knowingly or
recklessly'' when describing the prohibited conduct. The Commission
has not included such phrase in the current proposal to remain
consistent with similar language in Rule 10b-5. See 17 CFR 240.10b-
5(b).
\70\ Actions pursuant to Sections 17(a)(2) and 17(a)(3) of the
Securities Act do not require a showing of scienter. See, e.g.,
Aaron, 446 U.S. at 701-02. In Aaron, the Supreme Court sought to
determine whether scienter was required in a Commission injunctive
proceeding pursuant to the antifraud provisions of Section 10(b) of
the Exchange Act and Section 17(a) of the Securities Act. The Court
examined the language of both sections and determined that scienter
was required under Section 10(b) because the words ``manipulative,''
``device,'' and ``contrivance,'' which are used in the statute,
evidenced a Congressional intent to proscribe only knowing or
intentional misconduct. Similarly, the Court concluded that
subsection (1) of Section 17(a) required proof of scienter because
Congress used such words as ``device,'' ``scheme,'' and ``artifice
to defraud.'' Aaron, 446 U.S. at 696. In contrast, the Court
concluded that the absence of such words under subsections (2) and
(3) of Section 17(a) demonstrated that no scienter was required.
Section 17(a)(2) prohibits any person from obtaining money or
property ``by means of any untrue statement of a material fact or
omission to state a material fact,'' which the Court found to be
``devoid of any suggestion whatsoever of a scienter requirement.''
Aaron, 446 U.S. at 696. Similarly, the Court found, in construing
Section 17(a)(3), under which it is unlawful for any person ``to
engage in any transaction, practice, or course of business which
operates or would operate as a fraud or deceit,'' that scienter was
not required because it ``quite plainly focuses upon the effect of
particular conduct on members of the investing public, rather than
upon the culpability of the person responsible.'' Aaron, 446 U.S. at
697. See also Section 206(2) of the Advisers Act, which makes it
unlawful for an investment adviser to engage in any transaction,
practice or course of business which operates as a fraud or deceit
upon any client or prospective client. 15 U.S.C. 80b-6(2). The
Commission is not required to demonstrate that an adviser acted with
scienter in order to prove a Section 206(2) violation. SEC v.
Steadman, 967 F.2d 636, 643 (D.C. Cir. 1992) (citing SEC v. Capital
Gains Research Bureau, Inc., 375 U.S. 180, 191-92 (1963)).
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While both re-proposed Rules 9j-1(a)(2) and (3) would prohibit
material misstatements and omissions,\71\ they would address different
levels of culpability.\72\ Specifically, re-proposed
[[Page 6660]]
Rule 9j-1(a)(2) would apply when there is evidence of scienter (e.g.,
when a party to a security-based swap knowingly or recklessly makes a
false statement even though the party may not receive any money or
property as a result). In contrast, re-proposed Rule 9j-1(a)(3) would
extend to conduct that is at least negligent (e.g., when a party to a
security-based swap knows or reasonably should know that a statement
was false or misleading and directly or indirectly obtains money or
property by means of such statement).
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\71\ Consistent with Section 10(b) of the Exchange Act, such
misstatements and omissions must be material to be actionable. ``The
question of materiality, it is universally agreed, is an objective
one, involving the significance of an omitted or misrepresented fact
to a reasonable investor . . . there must be a substantial
likelihood that the disclosure of the omitted fact would have been
viewed by the reasonable investor as having significantly altered
the ``total mix'' of information made available.'' TSC Indus., Inc.
v. Northway, Inc., 426 U.S. 438, 445, 449 (1976). See also Basic v.
Levinson, 485 U.S. 224, 233 (1988).
\72\ In addition to differences in the standard of care, there
are additional deviations between re-proposed Rules 9j-1(a)(2) and
(3), notwithstanding the significant overlap in the rule text. For
example, while paragraph (a)(2), like Rule 10b-5(b), makes it
unlawful to make any untrue statement of a material fact, paragraph
(a)(3), like Section 17(a)(2) of the Securities Act does not use the
word ``make.'' Based on that difference courts have contrasted the
application of Rule 10b-5(b) from the application of Section
17(a)(2) of the Securities Act as it relates to determining who is
the maker of a material misstatement. See, e.g., SEC v. Big Apple
Consulting USA, Inc., 783 F.3d 786, 797 (11th Cir. 2015) (``[W]e . .
. agree with the Securities and Exchange Commission's recent
opinion, which held `Janus's limitation on primary liability under
Rule 10b-5(b) does not apply to claims arising under Section
17(a)(2).' ''); SEC v. Tambone, 597 F.3d 436, 444 (1st Cir. 2010)
(en banc) (contrasting the language of Rule 10b-5(b) with ``the
expansive language of section 17(a)(2),'' which covers ``the `use'
of an untrue statement of material fact (regardless of who created
or composed the statement)'').
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The Commission recognizes that two commenters to the 2010 proposed
rule opposed not requiring scienter with respect to paragraphs (3) and
(4) of re-proposed Rule 9j-1(a) (which were paragraphs (c) and (d) in
the 2010 proposed rule). Specifically, SIFMA and ISDA argued that
applying a negligence standard to those provisions did not account for
the unique aspects of the security-based swap market and, when
``coupled with the rights and responsibilities provision and
enforcement exposure for omissions of disclosure, potentially would
make illegal a wide range of ordinary course activities that may relate
to an SBS transaction.'' \73\ Those commenters explained that
``[s]ubjecting every trading decision or payment under an SBS to an
enforcement claim that someone knew or should have known that the
action would operate as a fraud or deceit on a person could potentially
deter many parties from entering into SBS, increase their cost and have
other distorting effects on the markets.'' \74\
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\73\ See SIFMA/ISDA Joint Comment Letter at 12.
\74\ See SIFMA/ISDA Joint Comment Letter at 3.
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Although the Commission recognizes the concerns raised by these
commenters, we have determined to re-propose Rule 9j-1(a) using the
same standards of care as proposed in 2010. As previously noted, each
of those provisions is based on an existing statutory and regulatory
provision that is supported by a large body of case law.\75\ In that
respect, the Commission does not believe it is appropriate to treat
negligent conduct that would have been deemed a violation under the
existing antifraud and anti-manipulation provisions of the Federal
securities laws and the rules and regulations thereunder as not
violative under proposed Rule 9j-1(a) solely because security-based
swaps contracts by their nature may require the counterparties to take
ongoing actions to satisfy their rights and obligations. Such an
approach would be particularly untenable in light of the fact that
security-based swaps are included in the definition of ``security'',
and therefore are also subject to such general antifraud and anti-
manipulation provisions, including the relevant non-scienter-based
prohibitions. To the extent that there is any overlap between re-
proposed Rule 9j-1(a) and those existing provisions, introducing a
different standard of care would create unnecessary confusion.
---------------------------------------------------------------------------
\75\ See supra notes 67-71 and accompanying text.
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Moreover, having two nearly identical antifraud and anti-
manipulation rules (e.g., re-proposed Rule 9j-1(a)(1) and Rule 10b-
5(b)) that are subject to two different standards of care--one for
security-based swaps and one for other types of securities--is likely
to lead to confusion among market participants and could potentially
undermine the effectiveness of both provisions in certain
circumstances, such as when the case law applicable to one provision
contradicts the other in a way that is not able to be rationalized by
the differences in the underlying instruments. Although the Commission
preliminarily believes the re-proposed rule is not overly broad, in
section II.E below, the Commission is requesting comment on whether
there are potential ways to minimize the impact of the rule on non-
fraudulent and non-manipulative ordinary course activities in
connection with security-based swap transactions.
2. ``Purchases'' and ``Sales'' in the Context of Security-Based Swaps
and Limited Safe Harbor for Certain Limited Actions
As previously noted, a number of commenters on the 2010 proposed
rule argued that the Commission exceeded its statutory authority in the
course of proposing Rule 9j-1 by explicitly applying the rule to
activities involving the exercise of any rights and performance of any
obligations during the life of a security-based swap, as opposed to
limiting the proposed rule to misconduct taking place in connection
with the ``purchase'' and ``sale'' of a security-based swap.\76\ For
example, MFA argued that the Commission exceeded delegated authority in
proposing that the prohibitions in Rule 9j-1 extend ``beyond purchases
and sales to acts and omissions occurring during the term of a
security-based swap,'' explaining that ``[i]n clarifying the terms
`purchase' and `sale' in the security-based swap context, Congress
chose specifically not to include ongoing obligations, which are
dictated by the contract between the two parties underlying the
security-based swap and which bear no relation to execution,
termination, assignment, exchange and transfer or extinguishment of
rights.'' \77\ MFA also expressed its view that ``Section 763(g) of
Dodd-Frank is aimed at preventing fraudulent, deceptive, or
manipulative acts in connection with: (i) The entry into a securit[y]-
based swap; (ii) the novation or assignment of a securit[y]-based swap;
and (iii) the unwind of a securit[y]-based swap,'' and that the statute
should not be read to encompass the settlement of a security-based
swap, or the ongoing payments or collateral postings that take place
throughout the life of the transaction.\78\
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\76\ See supra note 52 and accompanying text.
\77\ See December 2010 MFA Letter at 2-3. MFA provided examples
of the types of ongoing obligations that it believed should not be
covered by the rule, which included, among other things, certain
periodic or other types of payments under the terms of the security-
based swap as well as many forms of collateral or margin payments,
and related obligations.
\78\ See March 2011 MFA Comment Letter at 3-6.
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Similarly, SIFMA and ISDA expressed the view that ``[t]he
rulemaking authority provided by Section 763(g) only extends to
transactions, acts, practices, or courses of business in connection
with (i) effecting any transaction in [a security-based swap] and (ii)
inducing or attempting to induce the purchase or sale of [a security-
based swap].'' \79\ SIFMA also separately shared its concerns that the
application of proposed Rule 9j-1 to the ongoing, ``non-volitional''
rights and obligations that occur throughout the life of a security-
based swap could be particularly problematic in the event that a
counterparty came into possession of material non-public information
relating to the underlying security, even if such information had no
bearing on such non-volitional actions.\80\ Further, the LSTA argued
that
[[Page 6661]]
the 2010 proposed rule would ``create uncertainty that undermines
investors' willingness to enter [the security-based swap] market,''
explaining that if the rule were to apply to any activity that
potentially affects the stream of payments, deliveries or other ongoing
obligations or rights between parties to a security-based swap, ``each
party will have to implement controls and mechanisms to track decisions
it may take that could affect each such payment, delivery, obligation
or right as well as to track changes in its positions in the security-
based swap and reference underlying.'' \81\
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\79\ See SIFMA/ISDA Joint Comment Letter at 13.
\80\ See July 2011 SIFMA Comment Letter at 2-7. SIFMA also
requested that proposed Rule 9j-1 be modified to include a safe
harbor, such as one that is similar to Rule 10b5-1(c)(2), which
provides that an entity may demonstrate that a purchase or sale of
securities is not ``on the basis of'' material non-public
information if the person demonstrates that: (i) The individual
making the investment decision on behalf of the person to purchase
or sell the securities was not aware of the information; and (ii)
the entity had implemented reasonable policies and procedures,
taking into consideration the nature of the person's business, to
ensure that individuals making investment decisions would not
violate the laws prohibiting trading on the basis of material non-
public information. Such policies and procedures may include those
that restrict any purchase, sale, and causing any purchase or sale
of any security as to which the person has material non-public
information, or those that prevent such individuals from becoming
aware of such information. See 17 CFR 240.10b5-1(c)(2).
\81\ See LSTA Comment Letter at 2-8. As an example, the LSTA
noted its concern that a decision to allow a borrower to avoid a
bankruptcy filing or payment default could be construed as
manipulation in connection with the subsequent exercise of a right
or performance of an obligation (whether such action is volitional
or non-volitional).
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The Commission has carefully considered these comments, but
disagrees with the narrow interpretation of the terms ``purchase'' and
``sale'' when used in the context of security-based swaps, as espoused
by commenters. Specifically, the Commission does not believe that the
definitions of ``purchase'' and ``sale'' in Section 2(a)(18) of the
Securities Act, the definitions of ``buy'' and ``purchase'' in Section
3(a)(13) of the Exchange Act, and the definitions of ``sale'' and
``sell'' in Section 3(a)(14) of the Exchange Act are limited to actions
involving all of the rights and obligations under a security-based
swap. Rather, the Commission believes that those definitions
incorporate partial executions, terminations, assignments, exchanges,
transfers, or extinguishments of rights or obligations. Put another
way, those definitions incorporate actions that have an impact on some,
but not all, rights and obligations, such as a margin payment that
represents only part of what one counterparty owes the other.
In addition, Congress could have specifically limited the statutory
definitions of ``purchase'' or ``sale'' to actions involving all of the
rights and obligations under a security-based swap, and the Commission,
therefore, does not believe it necessary to apply limitations to those
definitions that do not appear in the statute given that even partial
payments or deliveries over the course of a security-based swap are
likely to be meaningful to most security-based swap transactions.
Accordingly, we continue to believe the statute provides the Commission
with authority to make explicit the liability of persons that engage in
misconduct to trigger, avoid, or affect the value of ongoing payments
or deliveries as a means reasonably designed to prevent fraud,
manipulation, and deception in connection with security-based swap
transactions.
To be clear, the Commission is not taking the position that every
payment or delivery made during the course of a security-based swap
transaction is itself a purchase or sale of a security-based swap under
the applicable statutory authority. Rather, fraudulent or manipulative
conduct would be in connection with the purchase or sale of a security-
based swap if it either alters any material terms of the security-based
swap (as set forth in the applicable trading relationship
documentation) or has a material impact on any payment or delivery
under the security-based swap, such that it would not be consistent
with what a reasonable person would have expected to pay, deliver, or
receive absent such conduct. The Commission took a similar position
when it defined certain Title VII terms, including ``swap'' and
``security-based swap,'' in a joint release with the CFTC, explaining
that ``[i]f the material terms of a Title VII instrument are amended or
modified during its life based on an exercise of discretion and not
through predetermined criteria or a predetermined self-executing
formula, the Commissions view the amended or modified Title VII
instrument as a new Title VII instrument.'' \82\ If a party engages in
fraudulent or manipulative conduct that impacts the amount of payment
or delivery in a way that is materially different from the amount a
reasonable person would have expected to pay, deliver, or receive (or
where such person would not have expected a payment or delivery to be
required at all), such actions would be a new purchase or sale of the
security-based swap. For example, and without limitation, such a
scenario could involve a counterparty misstating certain information
about a transaction (or any related transactions) resulting in a missed
or late payment or loss of an opportunity to request additional
collateral under a security-based swap.
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\82\ See Further Definition of ``Swap,'' ``Security-Based
Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps;
Security-Based Swap Agreement Recordkeeping, 77 FR 48208, 48286
(Aug. 13, 2012) (``Products Release'').
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Moreover, even if those statutory definitions were interpreted
narrowly, the Commission's rulemaking authority under Section 9(j) of
the Exchange Act to adopt prophylactic rules is not limited solely to
purchases and sales of security-based swaps.\83\ Section 9(j) of the
Exchange Act provides that the Commission ``shall . . . by rules and
regulations define, and prescribe means reasonably designed to prevent,
such transactions, acts, practices, and courses of business as are
fraudulent, deceptive, or manipulative, and such quotations as are
fictitious.'' \84\ Without limiting what is already covered by Section
9(j), the Commission is using that statutory authority to prohibit
actions to exercise any right, or any action related to performance of
any obligation, under any security-based swap, including in connection
with any payments, deliveries, rights, or obligations or alterations of
any rights thereunder; or to terminate (other than on its scheduled
maturity date) or settle any security-based swap, in each case so long
as those actions are taken in connection with fraud, manipulation, or
deception. The Commission believes that by prohibiting actions that
directly impact a counterparty's rights and obligations under a
security-based swap--when such actions are in connection with specified
fraudulent, manipulative, or deceptive conduct--re-proposed Rule 9j-1
represents a means reasonably designed to prevent fraud, manipulation,
and deception in the security-based swap market.
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\83\ See, e.g., U.S. v. O'Hagan, 521 U.S. 642 (1997) (``[a]
prophylactic measure, because its mission is to prevent, typically
encompasses more than the core activity prohibited''). In O'Hagan,
the Supreme Court held that under Section 14(e) of the Exchange Act
(which includes the same ``reasonably designed to prevent fraudulent
activity'' rulemaking language as Section 763(g) of the Dodd-Frank
Act) the Commission may prohibit acts not themselves fraudulent
under the common law or Section 10(b), provided that the prohibition
is ``reasonably designed to prevent . . . acts and practices [that]
are fraudulent.''
\84\ See 15 U.S.C. 78i(j).
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Furthermore, in the course of using its rulemaking authority under
Section 9(j), the Commission looked not only to the antifraud and anti-
manipulation provisions in Section 10(b) of the Exchange Act, Rule 10b-
5 thereunder, and Section 17(a) of the Securities Act, but also to the
operative provisions of Section 9(j) itself, which makes it unlawful
``to effect any transaction in, or to induce or attempt to induce the
purchase or sale of, any security-based swap, in connection with which
such person engages in any fraudulent, deceptive, or manipulative act
or practice, makes any fictitious quotation, or engages in any
transaction, practice, or course of business which operates as
[[Page 6662]]
a fraud or deceit upon any person.'' At a minimum, that provision
prohibits fraud, manipulation, or deception in the context of both
inducements or attempts to induce the purchase or sale of a security-
based swap, and effecting security-based swap transactions. As the
Commission has previously explained in other contexts, ``effecting''
transactions in securities has been interpreted broadly and includes
more than just executing trades or forwarding orders for execution.\85\
Generally, effecting securities transactions also can include, for
example, participating in the transactions through a number of
activities such as screening potential participants in a transaction
for creditworthiness, facilitating the execution of a transaction, and
handling customer funds and securities.\86\
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\85\ See Registration Adopting Release, 80 FR at 48976, n. 99
(citing, for example, Definition of Terms in and Specific Exemptions
for Banks, Savings Associations, and Savings Banks Under Sections
3(a)(4) and 3(a)(5) of the Securities Exchange Act of 1934, Exchange
Act Release No. 44291 (May 11, 2001), 66 FR 27760, 27772-73 (May 18,
2001)).
\86\ See id.
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As discussed above, we disagree with the narrow interpretation of
the statutory changes to the definitions of ``purchase'' and ``sale''
in the context of a security-based swap, as suggested by some
commenters. That said, the Commission is sensitive to the operational
concerns raised by commenters in response to the 2010 proposed rule and
is therefore proposing two limited safe harbors from re-proposed Rule
9j-1(a) to address situations when a counterparty to a security-based
swap is required to take certain actions while in possession of
material non-public information.\87\
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\87\ Specifically, in its comment letter on the 2010 proposed
rule, SIFMA explained that ``[u]nder the proposed rule, the
counterparty would be required to disclose the [material non-public
information] or abstain from performing its obligations under the
contract, even though the [material non-public information] plays no
role in its obligation to make payment. Requiring parties to
``disclose or abstain'' [material non-public information], as in the
securities context, would leave market participants in the position
of choosing among: Disclosing information to counterparties who may
not want to know it because of the effect on their trading activity,
violating the antifraud rule by performing their obligations under
the SBS contract while in possession of [material non-public
information] or abstaining from performance and defaulting on the
contract.'' See July 2011 SIFMA Comment Letter at 3.
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Specifically, re-proposed Rule 9j-1(f)(1) would provide that a
person would not be liable under re-proposed Rule 9j-1(a) solely for
reason of being aware of material non-public information while taking
certain actions, the first of which includes actions taken in
accordance with binding contractual rights and obligations under a
security-based swap (as reflected in the written security-based swap
documentation governing such transaction or any amendment thereto) so
long as the person could demonstrate that: (1) The security-based swap
was entered into, or the amendment was made, before the person became
aware of such material non-public information; and (2) that the entry
into, and the terms of, the security-based swap are themselves not a
violation of any provision of re-proposed Rule 9j-1(a).\88\ The
Commission believes that limiting the safe harbor to circumstances
where the activity is taken in accordance with the written agreements
governing the security-based swap would help to ensure that such action
is taken in the ordinary course of the transaction. Further, the safe
harbor would apply only so long as the entry into, and the terms of,
the security-based swap do not otherwise violate re-proposed Rule 9j-1.
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\88\ See re-proposed Rule 9j-1(f)(1). In general, for uncleared
security-based swap transactions, the relevant documentation should
include the written security-based swap trading relationship
documentation executed by the counterparties. For cleared security-
based swap transactions, the relevant documentation should include
the written agreement between the applicable counterparty and the
clearing agency. For SBS Entities, existing 17 CFR 240.15Fi-5
(``Rule 15Fi-5'') requires each SBS Entity to establish, maintain,
and follow written policies and procedures reasonably designed to
ensure that it executes written trading relationship documentation
with each of its counterparties, subject to certain exceptions,
prior to, or contemporaneously with, executing a security-based swap
transaction, in each case in the manner as provided for in the rule.
That documentation is also subject to the Commission's recordkeeping
requirements in 17 CFR 240.17a-4 or 17 CFR 240.18a-6, as applicable.
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As a result, the proposed safe harbor would generally apply to, for
example, making a standardized coupon payment or delivering collateral
to a counterparty (and would also permit the counterparty to receive
the coupon payment or collateral), while such person is aware of
material non-public information, so long as both actions are explicitly
required by the terms of the transaction and documented in writing.
However, the safe harbor would not apply if a counterparty took some
action to fraudulently increase (in the case of the receiving
counterparty) or decrease (in the case of the delivering counterparty)
the amount of such payment or collateral transfer.
The second proposed safe harbor would apply to transactions
effected pursuant to certain types of compression exercises.
Specifically, proposed Rule 9j-1(f)(2) would provide that a person
would not be liable under re-proposed Rule 9j-1(a) solely for reason of
being aware of material non-public information when effecting security-
based swap transactions pursuant to a bilateral portfolio compression
exercise (as defined in 17 CFR 240.15Fi-1(a) (``Rule 15Fi-1(a)'') of
the Exchange Act) or a multilateral portfolio compression exercise (as
defined Rule 15Fi-1(j)) so long as: (1) Any such transactions are
consistent with all of the terms of a bilateral portfolio compression
exercise or multilateral portfolio compression exercise, including as
it relates to, without limitation, the transactions to be included in
the exercise, the risk tolerances of the persons participating in the
exercise, and the methodology used in the exercise, and (2) all such
terms were agreed to by all participants of the bilateral portfolio
compression exercise or multilateral portfolio compression exercise
prior to the commencement of the applicable exercise.\89\
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\89\ See re-proposed Rule 9j-1(f)(2). Rule 15Fi-1(a) defines the
term ``bilateral portfolio compression exercise'' to mean ``an
exercise by which two security-based swap counterparties wholly
terminate or change the notional value of some or all of the
security-based swaps submitted by the counterparties for inclusion
in the portfolio compression exercise and, depending on the
methodology employed, replace the terminated security-based swaps
with other security-based swaps whose combined notional value (or
some other measure of risk) is less than the combined notional value
(or some other measure of risk) of the terminated security-based
swaps in the exercise.'' 17 CFR 240.15Fi-1(a). Rule 15Fi-1(j)
defines the term ``multilateral portfolio compression exercise'' to
mean ``an exercise by which multiple security-based swap
counterparties wholly terminate or change the notional value of some
or all of the security-based swaps submitted by the counterparties
for inclusion in the portfolio compression exercise and, depending
on the methodology employed, replace the terminated security-based
swaps with other security-based swaps whose combined notional value
(or some other measure of risk) is less than the combined notional
value (or some other measure of risk) of the terminated security-
based swaps in the exercise.'' 17 CFR 240.15Fi-1(j).
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As the Commission explained when it adopted portfolio compression
requirements for SBS Entities, portfolio compression generally refers
to a post-trade processing exercise that allows two or more market
participants to eliminate redundant derivatives transactions within
their portfolios in a manner that does not change their net exposure,
and is intended to help market participants manage their post-traded
risk.\90\ For example, reducing the number of outstanding contracts
provides important operational benefits and efficiencies for market
participants in that there are fewer open contracts to
[[Page 6663]]
manage, maintain, and settle, resulting in fewer opportunities for
processing errors, failures, or other problems that could develop
throughout the lifecycle of a transaction.\91\ Given these important
benefits, as well as the largely administrative nature of the portfolio
compression process, the Commission believes it to be appropriate to
provide a safe harbor for this activity in circumstances where the
security-based swap counterparty is in possession of material non-
public information with respect to a reference entity underlying an
applicable security-based swap.
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\90\ See Risk Mitigation Techniques for Uncleared Security-Based
Swaps, Exchange Act Release No. 87762 (Dec. 18, 2019), 85 FR 6359 at
6391 (Feb. 4, 2020) (``Risk Mitigation Adopting Release'').
\91\ See id.
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However, the proposed safe harbor would apply only so long as: (1)
Any such transactions are consistent with all of the terms of a
bilateral portfolio compression exercise or multilateral portfolio
compression exercise, including as it relates to, without limitation,
the transactions to be included in the exercise, the risk tolerances of
the persons participating in the exercise, and the methodology used in
the exercise, and (2) all such terms were agreed to by all participants
of the bilateral portfolio compression exercise or multilateral
portfolio compression exercise prior to the commencement of the
applicable exercise. This condition, which the Commission believes is
consistent with how portfolio compression exercises typically operate,
is intended to help ensure that most, if not all, of the opportunities
to take a discretionary action to impact the outcome of the compression
exercise occur before the process begins, and therefore before specific
security-based swap transactions are identified to be added or
eliminated. Finally, this safe harbor, which is limited to
circumstances involving the misuse of material non-public information,
would not apply where the portfolio compression exercise itself was
part of a fraudulent or manipulative scheme to increase (in the case of
the receiving counterparty) or decrease (in the case of the delivering
counterparty) the amount of any payment made or received in connection
with a terminated or replacement security-based swap transaction
resulting from the portfolio compression exercise, as applicable.
3. Prohibition on Price Manipulation
In addition to the general antifraud and anti-manipulation
provisions discussed above, re-proposed Rule 9j-1 also contains
provisions designed to address price manipulation similar to CFTC Rule
180.2.\92\ Specifically, re-proposed Rule 9j-1 includes a prohibition
on attempted manipulation. Re-proposed Rule 9j-1(b) would make it
unlawful for any person to, directly or indirectly, manipulate or
attempt to manipulate the price or valuation of any security-based
swap, or any payment or delivery related thereto. Among other things,
this language is intended to address a number of the manufactured or
other opportunistic CDS strategies observed over the last decade, and
summarized above in section I.B, including situations where a party
intentionally distorts any payment related to a security-based swap for
the benefit of one of the security-based swap counterparties, such as
actions that serve little to no economic purpose other than to
artificially influence the composition of the deliverable obligations
in a CDS auction.\93\
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\92\ See 17 CFR 180.2.
\93\ See Fletcher, supra note 21 at 1096-98.
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Re-proposed Rule 9j-1(b) also is intended to prohibit, among other
things, a situation where a person (or group of persons) improperly and
intentionally causes or avoids the purchase or sale of a security-based
swap for the benefit of a counterparty to an SBS, such as intentionally
and improperly orphaning a CDS, avoiding termination of a CDS for a
period of time, or causing the termination of a CDS. As previously
noted, ``orphaning'' a CDS refers to a situation where the debt of a
reference entity is eliminated or reduced for the purposes of moving
the price of CDS.\94\ The end result of such activity is that CDS
buyers continue to pay (and CDS sellers continue to receive) premiums
on CDS that will never default. Similarly, a CDS protection seller
could offer financing to the company to avoid a credit event and
subsequent CDS payout, with the financing timed so that the company's
bankruptcy is merely delayed until after the CDS expires.\95\ To be
clear, a person simply profiting from a CDS position after a company's
bankruptcy, which such person could have prevented by participating in
a financing to the company, without more is not in and of itself
improper conduct for purposes of re-proposed Rule 9j-1(b).
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\94\ See supra note 27 and accompanying text.
\95\ See Fletcher, supra note 21 at 1101.
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Moreover, the Commission does not intend for re-proposed Rule 9j-
1(b) to apply to taking affirmative actions in the ordinary course of a
security-based swap transaction or the underlying referenced security.
Specifically, re-proposed Rule 9j-1(b) is designed to capture
situations when a payment under the security-based swap is
intentionally distorted. A determination as to whether a payment is
intentionally distorted will largely depend on the facts and
circumstances of each particular situation, but as a general matter the
Commission would expect to use its authority to bring an enforcement
action under re-proposed Rule 9j-1(b) when a party takes action for the
purposes of avoiding or causing, or increasing or decreasing, a payment
under a security-based swap in a manner that would not have occurred,
but for such actions.
The Commission recognizes that reference entities often rely on
financing and other forms of relief to avoid defaulting on their debt,
and the proposed rule is not intended to discourage lenders and
prospective lenders from discussing or providing such financing or
relief, even when those persons also hold CDS positions. Rather, the
Commission is proposing Rule 9j-1(b) to account for actions taken
outside the ordinary course of a typical lender-borrower relationship
(or a prospective lender-borrower relationship). Although any such
determination would need to be based on the facts and circumstances of
a particular situation, as a general matter the Commission believes
that an action that appears to be designed almost exclusively to harm
one or more CDS counterparties would likely fall within the prohibition
in re-proposed Rule 9j-1(b).
C. Liability Under Proposed Rule 9j-1 in Connection With the Purchase
or Sale of a Security
Finally, and consistent with the long-standing principle that
parties cannot do indirectly what they are prohibited from doing
directly, paragraphs (c) and (d) of re-proposed Rule 9j-1 would make it
clear that market participants cannot avoid liability under the rule by
effecting a fraudulent scheme through the purchase or sale of an
underlying security, rather than the purchase or sale of the security-
based swap on which it is based, and vice versa. The first of those two
provisions would provide that a person could not escape liability for
trading based on possession of material non-public information about a
security by purchasing or selling a security-based swap based on that
security (as opposed to trading in the security itself) and the second
provision provides that a person could not escape liability under
Section 9(j) or re-proposed Rule 9j-1 by purchasing or selling the
underlying security (as opposed to purchasing or selling a security-
based swap that is based on that security).
[[Page 6664]]
Specifically, re-proposed Rule 9j-1(c) would provide that wherever
communicating, or purchasing or selling a security (other than a
security-based swap) while in possession of, material non-public
information would violate, or result in liability to any purchaser or
seller of the security, under either the Exchange Act or the Securities
Act, or any rule or regulation thereunder, such conduct in connection
with a purchase or sale of a security-based swap with respect to such
security or with respect to a group or index of securities including
such security shall also violate, and result in comparable liability to
any purchaser or seller of that security under, such provision, rule,
or regulation. Rule 9j-1(c) would be modeled after Section 20(d) of the
Exchange Act, which is substantially similar to the proposal, except
that the statutory provision applies to ``a put, call, straddle,
option, privilege or security-based swap agreement''--i.e., it does not
expressly include the term security-based swap.\96\
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\96\ See 15 U.S.C. 78t(d). Re-proposed Rule 9j-1(c) also differs
from Section 20(d) in two other ways. First, the statutory provision
refers to insider trading violations under the entirety of Title 15
of the U.S.C., the proposed rule refers only to the Exchange Act and
the Securities Act, which are the two most common bases for
asserting the Commission's authority for insider trading violations.
Second, re-proposed Rule 9j-1(c) makes clear that the reference to a
``security'' does not include a security-based swap. This is
intended solely to avoid confusion given that a security-based swap
is included in the definition of ``security'' in Section 3(a)(10) of
the Exchange Act [15 U.S.C. 78c(a)(10)] and Section 2(a)(1) of the
Securities Act [15 U.S.C. 77b(a)(1)].
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Although the Commission generally believes that a situation where a
person uses material non-public information in a security in connection
with the purchase and sale of a security-based swap would be subject to
the existing antifraud authority under the Federal securities laws,
particularly Section 10(b) of the Exchange Act and Rule 10b-5
thereunder, the Commission also believes that market participants would
benefit from a clarified interpretation of that statutory provision in
this rulemaking.\97\ This is particularly true given that the issuer of
a security-based swap (i.e., each counterparty to the transaction) is
different from the issuer of the underlying security (i.e., the
reference entity). Accordingly, the Commission is now proposing new
Rule 9j-1(c) to provide that a person making a purchase or sale of a
security-based swap while in possession of material non-public
information with respect to the security underlying such security-based
swap is subject to liability.
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\97\ Pursuant to Section 20(d), a person with material non-
public information about a security cannot avoid liability under the
securities laws by making purchases and sales in a swap on a broad-
based index containing the security (e.g., the S&P 500), which would
be a security-based swap agreement, whereas the statute is silent as
to the permissibility of trading on such material non-public
information by making purchases and sales of a security-based swap
(e.g., a swap on the security itself).
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Lastly, the Commission also is proposing new Rule 9j-1(d), which is
intended to address a situation similar to the one described above, but
in the other direction. Specifically, re-proposed Rule 9j-1(d) would
provide that whenever purchasing or selling a security-based swap would
violate, or result in liability under Section 9(j) of the Exchange Act
or re-proposed Rule 9j-1(a) or (b), such conduct, when taken by a
counterparty to such security-based swap (or any affiliate of, or a
person acting in concert with, such security-based swap counterparty in
furtherance of such prohibited activity), in connection with a purchase
or sale of a security or group or index of securities on which such
security-based swap is based shall also violate, and shall be deemed a
violation of, Section 9(j) or re-proposed Rule 9j-1(a) or (b).
This provision is designed so that a person cannot escape liability
under Section 9(j) or re-proposed Rule 9j-1(a) or (b) with respect to a
security-based swap by limiting all of its actions to purchases and
sales of the security or narrow-based security index underlying that
security-based swap. For example, if a person with an existing total
return swap on equity securities issued by XYZ Corporation subsequently
engages in a number of wash trades to artificially inflate the price of
the equity securities in order to benefit from the manipulated price by
way of their existing security-based swap position, such person would
be liable for violations of Section 9(j) and re-proposed Rule 9j-1
regardless of the fact the manipulation was conducted through purchases
and sales of the equity securities.
To be clear, re-proposed Rule 9j-1(d) is not intended to create a
separate category of prohibited activity. Rather, this provision is
designed to specify that many of the activities that would be
considered fraud, manipulation, or deceit with respect to a security-
based swap are typically effected through transactions in the
underlying reference entity, security, loan, or group or index of
securities or loans. The Commission believes that this provision is
important to include in the rule because security-based swaps by their
nature are tied intrinsically to activity in other securities markets.
Moreover, this provision is not intended to suggest that a person
could be liable for violations of Section 9(j) and re-proposed Rule 9j-
1 based solely on the impact of its transactions on the equity, debt,
or loan markets. In that regard, the rule would state that the person
engaged in prohibited activities in the equity, debt, or loan markets
must be a counterparty to a security-based swap that references such
equity or debt securities or loans, or be an affiliate of, or a person
acting in concert with, such security-based swap counterparty in
furtherance of such prohibited activity. Finally, and in addition to
analyzing whether transactions in the underlying equity or debt
securities or loans have been used as the mechanism for violations of
Section 9(j) and re-proposed Rule 9j-1, the Commission also would
expect to analyze the same activities to determine whether they
independently would also constitute violations under the existing
antifraud and anti-manipulation provisions of the securities laws,
including Sections 9 and 10(b) of the Exchange Act and Rule 10b-5
thereunder, as well as Section 17(a) of the Securities Act, as it
relates the market for those underlying equity or debt securities or
loans.
D. Preventing Undue Influence Over Chief Compliance Officers; Policies
and Procedures Regarding Compliance With Re-Proposed Rule 9j-1,
Proposed Rule 10B-1 and Proposed Rule 15Fh-4(c)
In addition to proposing rules to prevent fraudulent, manipulative,
or deceptive conduct in connection with security-based swaps, the
Commission also is proposing a rule aimed at protecting the
independence and objectivity of an SBS Entity's CCO by preventing the
personnel of an SBS Entity from taking actions to coerce, mislead, or
otherwise interfere with the CCO. Specifically, new Rule 15Fh-4(c)
would make it unlawful for any officer, director, supervised person, or
employee of an SBS Entity, or any person acting under such person's
direction, to directly or indirectly take any action to coerce,
manipulate, mislead, or fraudulently influence the SBS Entity's CCO in
the performance of their duties under the Federal securities laws or
the rules and regulations thereunder.
The Commission previously considered whether to adopt a similar
requirement when it adopted business conduct standards for SBS Entities
in 2016.\98\ That rulemaking included, among other things, 17 CFR
240.15Fk-1 (``Rule 15Fk-1''), which requires an
[[Page 6665]]
SBS Entity to designate a CCO and imposes certain duties and
responsibilities on that CCO,\99\ and Rule 15Fh-4(a), which makes it
unlawful for an SBS Entity to: (i) Employ any device, scheme, or
artifice to defraud any special entity or prospective customer who is a
special entity; (ii) engage in any transaction, practice, or course of
business that operates as a fraud or deceit on any special entity or
prospective customer who is a special entity; or (iii) engage in any
act, practice, or course of business that is fraudulent, deceptive, or
manipulative.\100\ In the course of that rulemaking, one commenter
requested that the Commission adopt a rule prohibiting attempts by
officers, directors, or employees to coerce, mislead, or otherwise
interfere with the CCO.\101\ The Commission considered that request,
but ultimately concluded not to adopt such a rule, explaining that
``requiring a majority of the board to approve the compensation and
removal of the CCO is appropriate to promote the CCO's independence and
effectiveness. . . .'' \102\
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\98\ See Business Conduct Standards for Security-Based Swap
Dealers and Major Security-Based Swap Participants, Release No.
77617 (Apr. 14, 2016), 81 FR 29960 (``Business Conduct Standards
Adopting Release'').
\99\ See 17 CFR 240.15Fk-1.
\100\ See 17 CFR 240.15Fh-4(a).
\101\ See Business Conduct Standards Adopting Release, 81 FR at
30053, n. 1166 and accompanying text.
\102\ See id. at 30054-55.
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Moreover, at the time the Commission declined to include a rule
regarding undue influence over the CCO, the Commission had not yet
finalized most of the requirements for which the CCO of an SBS Entity
would be responsible and had not yet proposed rules relating to trading
relationship documentation, dispute resolution, portfolio
reconciliation or portfolio compression (``Risk Mitigation
Rules'').\103\ As the Commission explained when adopting the Risk
Mitigation Rules, those rules were designed to further effective risk
management by requiring the existence of sound documentation, periodic
reconciliation of portfolios, rigorously tested valuation
methodologies, and sound collateralization practices.\104\ Attempts by
officers, directors or employees to hide transactions, submit false
valuations or manipulate or fraudulently influence the CCO in the
performance of their duties related to the Risk Mitigation Rules would
undermine the SBS Entity's risk management and could pose risk to the
market.
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\103\ See supra note 2. The Commission first proposed the Risk
Mitigation Rules in December 2018. See Risk Mitigation Techniques
for Uncleared Security-Security-Based Swaps, Exchange Act Release
No. 87782 (Dec. 19, 2018), 84 FR 4614 (Feb. 15, 2019).
\104\ See Risk Mitigation Adopting Release, 85 FR at 6390.
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In light of the re-proposal of Rule 9j-1 and the proposal of 10B-1
as well as the rules finalized subsequent to the CCO rules, the
Commission believes it is appropriate to reconsider the need for a rule
expressly prohibiting interference with the performance of a CCO's
duties, even if not directly related to compensation or the threat of
removal of the CCO to help ensure the independence and effectiveness of
the CCO function.\105\ In connection with re-proposed Rule 9j-1 and
proposed Rule 10B-1, as well as other rules for which the CCO is
responsible, undue influence could arise from many actors (and many
actions), and not merely from those actors with the power to set
compensation or with hiring and firing authority over the CCO. For
example, an employee at an SBS Entity planning an opportunistic
strategy could attempt to mislead the CCO by submitting false
documentation to the CCO in order to avoid disclosing the build-up of a
large position that would require public reporting and thwart the plans
of the employee.
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\105\ As the Commission explained when adopting similar rules
prohibiting persons from unduly influencing auditors pursuant to
Section 303(a) of the Sarbanes Oxley Act of 2002 (``Sarbanes-Oxley
Act), activities by persons acting ``under the direction'' of
officers and directors of the issuer ``currently may constitute
violations of the antifraud or other provisions of the securities
laws or aiding or abetting or causing an issuer's violations of the
securities laws.'' See Improper Influence on Conduct of Audits,
Exchange Act Release No. 47890 (May 20, 2003), 68 FR 31820, 31821
(May 28, 2003) (internal citations omitted). Nevertheless, like the
rule implementing Section 303(a) of the Sarbanes-Oxley Act, proposed
Rule 15Fh-4(c) would provide the Commission with an additional means
of addressing efforts by persons acting under the direction of an
officer or director to thwart the responsibilities of the CCO. See
also Compliance Programs of Investment Companies and Investment
Advisers, Investment Advisers Act Release No. 2204 (Dec. 17, 2003),
68 FR 74714 at 74721-22 (Dec. 24, 2003).
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Although re-proposed Rule 9j-1 and proposed Rule 10B-1 apply to any
person, without exception, and not just SBS Entities, as discussed in
the Economic Analysis, the security-based swap market is dominated by
dealers. The Commission estimates that dealing activity in security-
based swap markets is highly concentrated among a small number of firms
who are or will be registered with the Commission as SBS Entities.\106\
Because of the concentration of security-based swap activities in a
small number of firms that are SBS Entities, their compliance with the
Federal securities laws, including those adopted since 2016 and any
rules adopted as a result of this proposal, is critically important to
fostering integrity in the security-based swap market.
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\106\ See infra section VI.C.2. See also Applications by
Security-Based Swap Dealers or Major Security-Based Swap
Participants for Statutory Disqualified Associated Persons to Effect
or Be Involved in Effecting Security-Based Swaps, Exchange Act
Release No. 84858 (Dec. 19, 2018), 84 FR 4906, 4923 (Feb. 19, 2019)
(``[t]he Commission estimates that dealing activity in security-
based swap markets is highly concentrated among a small number of
dealers, with the top five dealer accounts intermediating
approximately 55 percent of all SBS Entity transactions, and
reaching hundreds and even thousands of counterparties.'') (internal
citations omitted).
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Moreover, existing 17 CFR 240.15Fh-3(h) (``Rule 15Fh-3(h)'')
requires an SBS Entity to establish and maintain a system to supervise
its business and the activities of its associated persons which must be
reasonably designed to prevent violations of the provisions of
applicable Federal securities laws and the rules and regulations
thereunder.\107\ In addition, existing Rule 15Fk-1 requires an SBS
Entity to designate a CCO, who must comply with certain duties,
including to ``[t]ake reasonable steps to ensure that the [SBS Entity]
establishes, maintains and reviews written policies and procedures
reasonably designed to achieve compliance with the [Exchange Act] and
the rules and regulations thereunder relating to its business as [an
SBS Entity].'' \108\ Failure to establish, maintain, and review written
policies and procedures reasonably designed to achieve compliance with
the Exchange Act and the rules and regulations thereunder (including
re-proposed Rule 9j-1, and proposed rules 10B-1 and 15Fh-4(c) if
adopted), may result in violations by the SBS Entity of Rule 15Fh-3(h),
as well as Rule 15Fk-1.\109\ Proposed Rule 15Fh-4(c) is designed to
protect investors and promote the fairness of the markets by supporting
the ability of the CCO to meet the CCO's important obligations to
foster compliance without undue influence, which should ultimately
support the integrity of SBS Entities and the markets.
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\107\ See 17 CFR 240.15Fh-3(h).
\108\ See 17 CFR 240.15k-1. Additionally, in its application for
registration, an SBS Entity is required to include a senior
officer's certification that the SBS Entity has developed and
implemented written policies and procedures reasonably designed to
prevent violation of federal securities laws and the rules
thereunder. See 17 CFR 240.15Fb2-1(b) (``Rule 15Fb2-1(b)'').
\109\ The SBS Entity could also face liability under Rules
15Fb2-1(b) and (h) under such circumstances.
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E. Request for Comment
The Commission generally requests comments on all aspects of re-
proposed Rule 9j-1. In addition, the Commission requests comments on
the following specific issues:
[[Page 6666]]
<bullet> Do commenters agree or disagree with any particular
aspects of re-proposed Rule 9j-1? If so, which ones and why? If
commenters disagree with any provision of the re-proposed rule, how
should such provision be modified and why?
<bullet> As noted in section I.A, the existing antifraud and anti-
manipulation provisions of the securities laws, including Sections 9
and 10(b) of the Exchange Act and Rule 10b-5 thereunder, as well as
Section 17(a) of the Securities Act, already apply to security-based
swaps because they fall within the definition of ``security'' in each
of those statutes. Are there particular aspects of security-based swap
transactions and the security-based swap markets that the Commission
should specifically address? If so, does re-proposed Rule 9j-1 address
those areas? If not, what types of fraudulent or manipulative activity,
if any, might not be captured by the existing antifraud or anti-
manipulation provisions or re-proposed Rule 9j-1, and how might new
rules be drafted to address such activity?
<bullet> Do commenters agree with the inclusion and scope of the
proposed safe harbors in re-proposed Rule 9j-1(f)? Why or why not?
Should the actions permitted under the proposed safe harbor be limited
solely to circumstances involving actions taken when a person is aware
of material nonpublic information? Why or why not? Should the
Commission include additional safe harbors in re-proposed Rule 9j-1 to
address other types of ordinary course business activities, both in
relation to a security-based swap transaction or any reference
obligation? If so, how should the Commission define such activities?
<bullet> As discussed above, in response to operational concerns
raised by commenters on the 2010 proposed rule, the Commission is
proposing two limited safe harbors from re-proposed Rule 9j-1(a) to
address situations when a counterparty to a security-based swap is
required to take certain actions while in possession of material non-
public information. Should the Commission also create a safe harbor for
entering into security-based swap transactions for purposes of hedging
some or all of their exposure arising out of lending activities with a
reference entity or the syndication of such lending activities? Why or
why not? If such a safe harbor is necessary, should ``hedging'' be
defined and if so, how should it be defined? What types of activities
should be included and/or excluded in such a safe harbor? What
conditions should be included to protect other market participants and
to ensure that any such safe harbor is not overly broad? For example,
should the safe harbor require that a person using a security-based
swap to hedge their interest in a loan while in possession of material
nonpublic information provide certain information to their counterparty
about the underlying borrower/reference entity? If so, what information
should be required to be provided, and why? Should the safe harbor be
conditioned on the person using a security-based swap to hedge their
interest in a loan being a particular type of financial institution,
such as a bank? Why or why not? Should the safe harbor be time limited,
for example by requiring that the security-based swap be executed
contemporaneously with the execution of the loan or the syndication of
the loan? If so, how should such condition be structured? Could a safe
harbor for hedging be constructed in a way to always distinguish
legitimate hedging activity from other types of transactions? If so,
how?
<bullet> As previously noted, re-proposed Rules 9j-1(a)(1) and (2),
consistent with Section 10(b) of the Exchange Act and Rule 10b-5
thereunder, and Section 17(a)(1) of the Securities Act, require
scienter. In contrast, re-proposed Rules 9j-1(a)(3) and (4) would not
require scienter, consistent with Sections 17(a)(2) and (a)(3) of the
Securities Act. Do commenters agree with the proposed standards of care
in re-proposed Rule 9j-1(a)? Why or why not? If not, what should be the
standard of care for each aspect of re-proposed Rule 9j-1(a) and why?
Also, should the standard of care be different from the existing
provision on which it was based, and if so, how and why? For example,
if re-proposed Rules 9j-1(a)(1) and (2) continue to be based on Section
10(b) of the Exchange Act and Rule 10b-5 thereunder, and Section
17(a)(1) of the Securities Act, which require scienter, why should the
proposed provisions rely on a different standard of care?
<bullet> One difference between re-proposed Rule 9j-1(a) and the
2010 proposed rule is that the four provisions based on Section 10(b)
of the Exchange Act and Rule 10b-5 thereunder, and Section 17(a) of the
Securities Act now refer to both actual conduct and attempted conduct.
Do commenters agree with the change, as compared to the 2010 proposed
rule, to extend those provisions in this manner? Why or why not?
<bullet> Do commenters agree with the application of re-proposed
Rule 9j-1(a) to actions to exercise or any action related to
performance pursuant to any security-based swap including any payments,
deliveries, rights, or obligations or alterations of any rights
thereunder; or to terminate (other than on its scheduled maturity date)
or settle any security-based swap (in addition to, among other things,
purchases or sales of, or actions to effect transactions in, security
based swaps)? Why or why not?
<bullet> Re-proposed Rule 9j-1(a) differs from the 2010 proposed
rule in that the current proposal is structured such that that the
exercise of authority under the rule applies to certain specified
actions being taken ``in connection'' with the fraudulent or
manipulative conduct specified in paragraphs (1) through (4) of the re-
proposed rule. By contrast, the 2010 proposed rule required that the
fraudulent or manipulative conduct be ``in connection'' with the offer,
purchase or sale of any security-based swap, the exercise of any right
or performance of any obligation under a security-based swap, or the
avoidance of such exercise or performance. The Commission is proposing
the change to more closely track the language of Section 9(j) of the
Exchange Act. Do commenters believe that this change better delineates
the actions that would be subject to the rule or does it create
confusion?
<bullet> Do commenters agree with the inclusion of re-proposed Rule
9j-1(b), which makes it unlawful for any person to, directly or
indirectly, manipulate or attempt to manipulate the price or valuation
of any security-based swap, or any payment or delivery related thereto?
Why or why not? Should the Commission modify the proposed rule to
expressly apply to the types of manufactured or other opportunistic
behavior that have been occurring in the credit derivatives market and
that are discussed in section II.B.3? If so, which ones and why? Are
there additional types of manufactured or other opportunistic behavior
that have been observed in the credit derivatives market that may be
considered transactions, acts, practices, and courses of business that
are fraudulent, deceptive, or manipulative, or involve such quotations
as are fictitious? If so, which activities should be expressly
prohibited and why?
<bullet> Re-proposed Rule 9j-1(c) would generally provide that a
person could not avoid liability for insider trading by purchasing or
selling a security-based swap while in possession of material non-
public information with respect to a security or group or index of
securities underlying such security-based swap if the person would
otherwise have been liable had they purchased or sold the relevant
securities. Do commenters agree with the inclusion of this provision?
Why or why not? If not, how
[[Page 6667]]
should this provision be modified and why?
<bullet> Re-proposed Rule 9j-1(d) would generally provide that a
person could not avoid liability under Section 9(j) of the Exchange Act
or re-proposed Rule 9j-1 by purchasing or selling one or more
securities underlying a security-based swap, as opposed to purchasing
or selling the security-based swap itself if the person would otherwise
have been liable under Section 9(j) of the Exchange Act or re-proposed
Rule 9j-1 had they purchased or sold the security-based swap. Do
commenters agree with the inclusion of this provision? Why or why not?
If not, how should this provision be modified and why?
<bullet> Should the Commission adopt proposed Rule 15Fh-4(c), which
would make it unlawful for any officer, director, supervised person, or
employee of a security-based swap dealer or major security-based swap
participant, or any person acting under such person's direction, to
directly or indirectly take any action to coerce, manipulate, mislead,
or fraudulently influence the security-based swap dealer's or major
security-based swap participant's chief compliance officer in the
performance of their duties under the Federal securities laws or the
rules and regulations thereunder? Why or why not?
<bullet> Should proposed Rule 15Fh-4(c) only apply to officers or
directors? Why or why not?
<bullet> Should proposed Rule 15Fh-4(c) apply to any person? Why or
why not?
<bullet> Should proposed Rule 15Fh-4(c) be limited to actions to
coerce, manipulate, or fraudulently influence the CCO? Should the
proposed rule be limited to actions to mislead? Should the types of
actions explicitly prohibited be expanded? If so, how and why?
<bullet> Should the Commission consider other means to protect the
CCO in the performance of their duties?
<bullet> Should the Commission consider expanding proposed Rule
15Fh-4(c) to protect other officers of an SBS Entity in the performance
of their duties? If so, which officers and why?
III. Proposed Rule 10B-1: Position Reporting of Large Security-Based
Swap Positions
As previously noted, Section 10B of the Exchange Act, which
provides the Commission with authority to establish position limits for
security-based swaps, also provides the Commission with rulemaking
authority to require reporting of large security-based swap positions.
Specifically, Section 10B(d) authorizes the Commission to:
``. . . require any person that effects transactions for such
person's own account or the account of others in any securities-
based swap or uncleared security-based swap and any security or loan
or group or narrow-based security index of securities or loans . . .
to report such information as the Commission may prescribe regarding
any position or positions in any security-based swap or uncleared
security-based swap and any security or loan or group or narrow-
based security index of securities or loans and any other instrument
relating to such security or loan or group or narrow-based security
index of securities or loans . . .'' \110\
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\110\ See 15 U.S.C. 78j-2.
The Commission has not previously proposed rules using its
authority under Section 10B with respect to either position limits or
reporting of large positions in security-based swaps. However, the
Commission's observations of the security-based swap market suggest a
number of potential benefits of requiring reporting. Those benefits,
which are described in greater detail above in section I.C. include:
(1) Providing market participants (including counterparties, issuers
and issuers' stakeholders) and regulators with access to information
that may indicate that a person (or a group of persons) is building up
a large security-based swap position, which in some cases could be
indicative of potentially fraudulent or manipulative purposes; (2)
alerting market participants and regulators to the existence of
concentrated exposures to a limited number of counterparties, which
should inform those market participants and regulators of the attendant
risks, allow counterparties to risk manage and lead to better pricing
of the security-based swaps with respect to transactions with persons
holding large positions in those security-based swaps; and (3) in the
case of manufactured or other opportunistic strategies in the CDS
market, providing market participants and regulators with advance
notice that a person (or a group of persons) is building up a large CDS
position which could create an incentive to vote against their
interests as a debt holder, possibly with an intent to harm the
company, even if such conduct is not inherently fraudulent.
Moreover, given that a number of these benefits accrue not only to
the Commission, as the primary regulator of the security-based swap
market (and potentially other regulators), but also to market
participants (including reference entities), the Commission also
believes that such reports should be made publicly available.\111\ At
the same time, however, the Commission understands that certain aspects
of a security-based swap transaction may be sensitive or proprietary,
particularly as they relate to a market participant's relationship with
its counterparties, and accordingly we are not proposing to require
reporting persons to publicly disclose any information about their
counterparties, including their identities. Rather, under the proposed
rule persons subject to the reporting requirement would only need to
report the amount of their aggregated positions in a security-based
swap on a single reference underlier, as well as any underlying or
related positions.\112\ However, to the extent that Commission staff
believes it important to obtain counterparty information as part of our
regulatory mission as it relates to one or more particular filings,
staff would endeavor to obtain such information either directly from
the filer (if so registered with the Commission) or from a registered
SBSDR pursuant to Regulation SBSR.
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\111\ See supra section I.C. Several academics discuss
disclosure as a potential solution to some of the manufactured or
other opportunistic CDS strategies described in section I.C. See
Fletcher, supra note 21 at 1139-40 (``By requiring disclosure of
plans to engage in an engineered CDS transaction, traders are able
to reject counterparties that have indicated their intentions to
intervene in the market. Alternatively, it allows CDS traders to
decide if they want to charge or demand a higher price from the
counterparty to offset the risk of loss. Disclosure, therefore,
minimizes informational asymmetry between the counterparties, which
would increase the cost of engineered transactions and in turn lower
their profitability and their occurrence. Additionally, this
disclosure requirement may also enhance market discipline, enabling
CDS traders to avoid counterparties that might engage in engineered
transactions or have done so in the past.''). Other academics have
made similar points in the broader context, some as far back as
2008. See Henry T.C. Hu and Bernard S. Black, Debt, Equity, and
Hybrid Decoupling: Governance and Systemic Risk Implications, U of
Texas Law, Law and Econ Research Paper No. 120, 31 (June 1, 2008)
(``. . . to address debt . . . decoupling, we propose . . .
disclosure of their aggregate holdings of debt and debt
derivatives''); see also Patrick Bolton and Martin Oehmke, Credit
Default Swaps and the Empty Creditor Problem 24:8 Rev. Fin. Stud., 7
(Jan. 4, 2011) (``. . . disclosure of CDS positions may mitigate the
inefficiencies resulting from the empty creditor problem, without
undermining the ex ante commitment effect of CDS. In particular, if
public disclosure allows borrowers and lenders to contract on CDS
positions, they may allow the lender to commit not to over-insure
once he has acquired the bond. More generally, public disclosure of
positions may also be beneficial by giving investors a more complete
picture of creditors' incentives in restructuring.''); see also
Danis and Gamba, supra note 21 at 33 (``The CDS market is very
opaque, and no regular investor knows how many protection sellers
there are, how much protection they have sold, and whether they have
deep pockets to inject cash into the underlying firm. Therefore, we
argue that it is possible that regulation that improves the
transparency of the CDS market can increase firm value. Other
authors have proposed disclosure requirements in the CDS market as
well . . . , although for different reasons.'')
\112\ See infra section III.B.
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Accordingly, the Commission is proposing to use its rulemaking
[[Page 6668]]
authority under Section 10B of the Exchange Act to propose a large
trader position reporting rule for security-based swaps. That proposal
is described in detail below.
A. Proposed Definitions and Thresholds
Proposed Rule 10B-1(a)(1) would require any person (and any entity
controlling, controlled by or under common control with such person),
or group of persons, who through any contract, arrangement,
understanding or relationship, after acquiring or selling directly or
indirectly, any security-based swap, is directly or indirectly the
owner or seller of a Security-Based Swap Position that exceeds the
Reporting Threshold Amount, to promptly file with the Commission a
statement containing the information required by 17 CFR 240.10B-101
(``Schedule 10B'') on the Commission's Electronic Data Gathering,
Analysis, and Retrieval system (``EDGAR'').\113\ These reports would be
made publicly available immediately upon filing.
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\113\ See proposed Rule 10B-1(a). Because these position reports
on proposed Schedule 10B would be made publicly available, the
Commission is proposing to require them to be filed on EDGAR,
similar to the way that beneficial ownership reports are filed
pursuant to Sections 13(d) and (g) of the Exchange Act. See Rule
101(a)(1)(iii) of Regulation S-T (17 CFR 232.101(a)(1)(iii))
(requiring all statements, reports, and schedules filed with the
Commission pursuant to Section 13 of the Exchange Act, among other
provisions, to be submitted to the Commission in electronic form).
If commenters believe that an alternate means of submission would be
more appropriate, the Commission welcomes such feedback and
encourages commenters to be as detailed as possible when specifying
how such an alternative process would work, either in addition to or
in lieu of the requirement to file proposed Schedule 10B on EDGAR.
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Additionally, a person owns a Security-Based Swap Position by
virtue of participation in a group of persons pursuant to any contract,
arrangement, understanding or relationship, the proposed rule would
provide that the group's filing obligation may be satisfied either by a
single joint filing or by each of the group members making an
individual filing.\114\ If the group's members elect to make their own
filings, each filing would be required to identify all members of the
group, but the information provided concerning the other persons making
the filing would need only to reflect information which the filing
person knows or has reason to know.\115\
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\114\ See proposed Rule 10B-1(a)(3).
\115\ See id. The requirements related to the process for
satisfying a group's filing obligations are similar to how the issue
is addressed in 17 CFR 240.13d-1 (``Rule 13d-1''), which relates to
the filing of Schedules 13D and 13G. Specifically, Rule 13d-1(k)(2)
provides that ``[a] group's filing obligation may be satisfied
either by a single joint filing or by each of the group's members
making an individual filing. If the group's members elect to make
their own filings, each such filing should identify all members of
the group but the information provided concerning the other persons
making the filing need only reflect information which the filing
person knows or has reason to know.'' 17 CFR 240.13d-1(k)(2).
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Moreover, the proposed rule also contains a provision intended to
prevent evasion of the reporting requirement. Specifically, proposed
Rule 10B-1(b)(4) provides that any person who, directly or indirectly,
creates or uses a trust, proxy, power of attorney, pooling arrangement
or any other contract, arrangement, or device as part of a plan or
scheme to evade the reporting requirements of paragraph (a)(1) of this
section with respect to a Security-Based Swap Position shall be deemed
for purposes of this section to be the owner of such Security-Based
Swap Position.\116\ For example, if a number of entities agreed to
acquire separate Security-Based Swap Positions that each fell below the
relevant threshold in order to evade the requirement to report the
larger, aggregated Security-Based Swap Position that exceeded the
relevant threshold), proposed Rule 10B-1(a)(4) would deem each entity
that was party to the arrangement to be the owner of the aggregated
Security-Based Swap Position.
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\116\ See proposed Rule 10B-1(a)(4).
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With respect to the scope of persons subject to this proposal,
Section 10B provides the Commission with authority to require reporting
by ``any person that effects transactions for such person's own account
or the account of others [in security-based swaps and related financial
instruments].'' \117\ The Commission considered whether to limit this
reporting requirement to certain types of persons, such as SBS
Entities. However, and as described above, proposed Rule 10B-1 is
ultimately intended to provide both the Commission and the market with
information about any large positions in security-based swaps and any
related securities that, in the event of a default, could have an
impact on the markets, counterparties, or other market participants.
This includes those positions that could adversely impact issuers of
reference entities and their stakeholders, and those that could
influence counterparties' risk management decisions or pricing of
security-based swaps. Accordingly, the requirements in proposed Rule
10B-1 apply to ``any person,'' regardless of whether they are
registered with the Commission in any capacity.
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\117\ See 15 U.S.C. 78j-2.
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In terms of timing, proposed Rule 10B-1(a)(2) would provide that
any Schedule 10B required by the rule shall be filed promptly, but in
no event later than the end of the first business day following the day
of execution of the security-based swap transaction that results in the
Security-Based Swap Position first exceeding the Reporting Threshold
Amount. That timing is consistent with the requirement in existing 17
CFR 240.15Fi-2(b) (``Rule 15Fi-2(b)''), which governs the timeframe for
when an SBS Entity is required to provide a trade acknowledgment to its
counterparty after executing a security-based swap transaction.\118\
The Commission believes using a similar approach in proposed Rule 10B-1
is appropriate given that once a security-based swap transaction
reaches the point when an SBS Entity is required to deliver a trade
acknowledgment of a security-based swap to its counterparty, both sides
to the transaction should then have the information about the size of
the transaction so that each can determine whether any applicable
Security-Based Swap Position has exceeded the Reporting Threshold
Amount.\119\
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\118\ See 17 CFR 240.15Fi-2(b).
\119\ Rule 15Fi-2 also contains a second step once the
applicable SBS Entity provides its counterparty with the required
trade acknowledgment. Specifically, the rule also requires that the
SBS Entity: (i) Establish, maintain, and enforce written policies
and procedures that are reasonably designed to obtain prompt
verification of the terms of a trade acknowledgment; and (ii)
promptly verify the accuracy of, or dispute with its counterparty,
the terms of a trade acknowledgment that it receives. See 17 CFR
240.15Fi-2(d). The Commission has determined to base the timing
requirement in proposed Rule 10B-1 on the requirement to deliver a
trade acknowledgment of a security-based swap, as opposed to the
requirement to verify the trade acknowledgment due to the fact the
rule does not require a counterparty that is not an SBS Entity to
verify the trade acknowledgment. Rather, the regulatory obligation
runs only to the SBS Entity, which is required to establish,
maintain, and enforce written policies and procedures that are
reasonably designed to obtain prompt verification of the terms of a
trade acknowledgment. Moreover, while the Commission recognizes that
the amount of the security-based swap transaction is clearly a term
that would need to be resolved during the trade verification process
if there is a dispute as to such value, the Commission believes that
in most cases any such dispute would be resolved on a near real-time
basis given the importance of that term as it relates to all of the
other terms of the transaction.
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Proposed Rule 10B-1 also contains key definitions for determining
the scope of the position to be disclosed. In particular, the term
``Security-Based Swap Position'' would be defined to mean all security-
based swaps based on: (a) A single security or loan, or a narrow-based
security index, or any interest therein or based on the value thereof;
(b) any securities issued by the
[[Page 6669]]
same issuer (each, an ``issuing entity'') of the securities, loans, or
securities included in the narrow-based index (including any interest
therein or based on the value thereof) described in (a); or (c) any
narrow-based security index that includes any of those issuing entities
or their securities (including any interest therein or based on the
value thereof), in each case as applicable.\120\ To the extent that a
Security-Based Swap Position is based on a single security or loan that
is included in a narrow-based security index, the calculation of the
Security-Based Swap Position with respect to a particular component of
the index would be based on the weighting of the reference entity or
securities as a component of the index. With respect to security-based
swaps based on equity securities, a Security-Based Swap Position shall
include all security-based swaps based on a single class of equity
securities.\121\
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\120\ See proposed Rule 10B-1(b)(3).
\121\ See id.
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Under this definition, a security-based swap that is based on a
narrow-based security-index could trigger a reporting obligation under
proposed Rule 10B-1 in two different ways. First, reporting under
proposed Rule 10B-1 would be required if a person had a Security-Based
Swap Position composed of security-based swaps based on a narrow-based
security index that itself exceeded the relevant Reporting Threshold
Amount. Second, if a person had a Security-Based Swap Position composed
of security-based swaps based on a single security or loan, that person
would need to include in the calculation of that position all security-
based swaps based on the applicable single security or loan, in an
amount proportionate to the weighting of the security or loan in the
narrow-based security index. As a hypothetical example, if a person is
a counterparty to a security-based swap on a narrow-based security
index composed of equity securities with a notional amount of $100
million, the Security-Based Swap Position on the index itself would
also be $100 million. In addition, if one security makes up 40% of that
index by weight, that person would also be considered to have a
Security-Based Swap Position of $40,000,000 attributable to such
security for purposes of that transaction (which would need to be added
to any other security-based swaps based on the same security in
calculating the entire Security-Based Swap Position with respect such
security).\122\
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\122\ As discussed below, for equity-based Security-Based Swap
Positions the proposed rule would include both a notional threshold
and a threshold based on the number of shares attributable to the
Security-Based Swap Position. As a result, a person would need to
convert the proportionate notional amount of a component security of
a narrow-based security-index into a share count. In the above
example, the notional amount of $40,000,000 would need to be
converted into a share count using the methodologies set forth in
proposed Rule 10B-1(b)(4). See infra section III.A.2.
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The Commission believes that the reporting requirement in proposed
Rule 10B-1 should represent a person's gross position in a security-
based swap \123\ due to the fact that the proposed rule is intended to,
among other things, identify circumstances when a market participant
has a large, concentrated position in a security-based swap on a single
issuer, which has the potential to impact not only the market for other
security-based swaps on the same issuer, but also the applicable
reference securities, even if that gross position consists of smaller
positions that offset each other.\124\ In such an instance, the gross
position would be particularly informative where the offsetting
positions are not with the same counterparty, where it may not be
possible to net out any payment obligations between any two
counterparties. For example, if a reporting person was long a total
return swap with one counterparty and short a total return swap with a
second counterparty (on the same reference equity security), a large
decline in the price of the underlying security could trigger large
payment obligations under both transactions, which could require one or
more persons to liquidate some or all of the securities held to hedge
the applicable total return swap. Under those circumstances, reporting
the gross position would alert each of the two counterparties to the
reporting person's overall exposure, which may be relevant to the
extent that the counterparty to the other transaction is unable to
satisfy its payment or delivery obligations.
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\123\ For purposes of this release, the term ``gross'' means the
sum of the absolute values of notional amounts outstanding of all of
the security-based swaps included in a Security-Based Swap Position.
For example, if a person has a $75 million long CDS position and a
$75 million short CDS position on the same reference entity or
security, the person will have a Security-Based Swap Position of
$150 million.
\124\ As a hypothetical, if a person has a large, hedged
position in an equity swap and is required to quickly liquidate its
hedged positions in the reference securities in order to close out
the security-based swap position, the transactions made to liquidate
the reference securities could potentially impact the price of those
securities depending on the size of the hedged position.
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The Commission also believes that requiring reporting of a person's
aggregate Security-Based Swap Position (i.e., all security-based swaps
on the same reference entity, security, loan, or group or index of
securities or loans that a person has with all their counterparties) is
important for identifying positions that may have a significant impact
on the person's counterparties, companies whose securities are
referenced by a security-based swap, and the market as a whole, as
discussed above in section I.C. For example, if a person has a large
Security-Based Swap Position that is broken up between a number of
different counterparties, reporting of the aggregated position could
alert each individual counterparty to the fact that the reporting
person also has significant exposure to other individual counterparties
with respect to the same security-based swap.
For purposes of the definition of ``Security-Based Swap Position,''
security-based swaps based on a single class of equity securities
issued by a reference entity would constitute a separate Security-Based
Swap Position than security-based swaps based on debt securities of the
same reference entity. A Security-Based Swap Position based on CDS also
would constitute a separate Security-Based Swap Position.\125\ As a
result, there is a separate definition of ``Reporting Threshold
Amount'' (as discussed in detail below) for Security-Based Swap
Positions in each of: (i) CDS, (ii) debt security-based swaps
(excluding CDS), and (iii) equity security-based swaps. For example,
under that definition, a Security-Based Swap Position would include all
security-based swaps on equity securities issued by XYZ Corporation,
regardless of the fact that the position may be split among a number of
counterparties. If the same reporting person also had CDS positions
based on debt securities issued by XYZ Corporation, those CDS positions
would constitute a separate Security-Based Swap Position. Lastly, if
the same reporting person was also party to security-based swaps based
on debt securities issued by XYZ Corporation that were not CDS, those
transactions would constitute yet another separate Security-Based Swap
Position.
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\125\ See id.
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However, proposed Schedule 10B would require the reporting party to
report other securities (including other security-based swaps) that are
related to the applicable Security-Based Swap Position.\126\ Thus, if a
reporting party has a Security-Based Swap Position composed of non-CDS
security-based swaps on debt securities of XYZ Corporation that exceeds
the relevant
[[Page 6670]]
threshold, as well as a Security-Based Swap Position composed of
security-based swaps on equity securities of XYZ Corporation that does
not exceed the threshold for reporting, such person would be required
to report the debt-based Security-Based Swap Position on proposed
Schedule 10B on which the person would need to report the equity-based
security-based swaps as related securities.\127\ If both the debt-based
Security-Based Swap Position and the equity-based Security-Based Swap
Position exceeded the applicable threshold, the reporting party would
need to file a separate Schedule 10B for each position, which could
cross-reference to the other filing for purposes of disclosing related
securities.
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\126\ Section III.B. below discussed the information required to
be included in proposed Schedule 10B.
\127\ As previously noted, Section 10B(d) provides the
Commission with the authority to require ``any person that effects
transactions for such person's own account or the account of others
in any securities-based swap or uncleared security-based swap and
any security or loan or group or narrow-based security index of
securities or loans . . . to report such information as the
Commission may prescribe regarding any position or positions in any
security-based swap or uncleared security-based swap and any
security or loan or group or narrow-based security index of
securities or loans and any other instrument relating to such
security or loan or group or narrow-based security index of
securities or loans . . .'' See 15 U.S.C. 78j-2(d) (emphasis added).
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1. Reporting Thresholds for Debt Security-Based Swaps (Including CDS)
Proposed Rule 10B-1(b)(1) sets forth the definition of ``Reporting
Threshold Amount.'' That definition is bifurcated depending on whether
the security-based swap is based on equity or debt, with a further
delineation for CDS. For CDS (including CDS where the underlying
reference is a group or index of entities or obligations of entities
that is a narrow-based security index), the threshold is the lesser of:
(i) A long notional amount of $150 million, calculated by subtracting
the notional amount of any long positions in a deliverable debt
security underlying a security-based swap included in the Security-
Based Swap Position from the long notional amount of the Security-Based
Swap Position; (ii) a short notional amount of $150 million; or (iii) a
gross notional amount of $300 million.\128\
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\128\ See proposed Rule 10B-1(b)(1)(i). These proposed
thresholds are based, at least in part, on individual CDS exposure
data from the Depository Trust and Clearing Corporation (``DTCC'')
Trade Information Warehouse (``TIW''). This information is made
available to the Commission voluntarily in accordance with an
agreement between the DTCC-TIW and the OTC Derivatives Regulators'
Forum, of which the Commission is a member. In reviewing the DTCC-
TIW data, Commission staff attempted to identify notional amounts
that would be low enough to capture any positions that could
potentially have an effect on either the reference entity and/or the
CDS or bond market (or both), yet also high enough to avoid over-
reporting, which could limit the effectiveness of the rule. See
infra section VI.D.2.iii. In developing these thresholds, staff also
considered the opportunistic CDS strategies described in the
relevant academic literature, and summarized in section I.C.
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With respect to the $150 million long notional threshold for CDS
positions, the Commission believes that a threshold that identifies
parties with a significant naked CDS long exposure (or a CDS exposure
that significantly exceeds its position in deliverable bonds) could
help to more accurately identify situations where a CDS counterparty
may be incentivized to act against their own interest as a debt holder
(i.e., because they stand more to gain from their CDS than they would
lose on their bonds) which, as described above, is a possible indicator
of an incentive to create a manufactured or other opportunistic credit
event.\129\ Put another way, if a bondholder uses long CDS positions
solely to hedge their underlying bonds, payments received in connection
with the CDS (upon a trigger) generally would be offset by losses on
the bonds, leaving the person flat, and therefore not required to
report under proposed Rule 10B-1. The Commission believes that $150
million, which again was based on staff's review of the available DTCC-
TIW data,\130\ appropriately captures naked CDS positions that carry
the potential to be used in connection with a manufactured or other
opportunistic credit event, even if such an activity would be unlikely
to result in a broader impact on the CDS and bond markets.
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\129\ See supra section I.C. Proposed Rule 10B-1(b)(1)(iv)
provides that for purposes of the rule, a ``debt security underlying
a security-based swap included in the Security-Based Swap Position''
means any security that could potentially be deliverable into a CDS
auction in the event of a default.
\130\ See infra section VI.D.2.iii.
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The Commission also is proposing to use a $150 million notional
threshold for short CDS positions. In particular, we believe that this
threshold should capture situations where a CDS seller has a large
enough position to potentially utilize an opportunistic strategy to
avoid or delay a credit event, such as by ensuring a credit event
occurs after the expiration of the CDS, or taking actions to limit the
number and/or kind of deliverable obligations in order to impact the
recovery rate following a credit event.\131\ However, because the same
dynamic described in the previous paragraph--vis-[agrave]-vis the
potential motivations of a person with a significant naked CDS long
exposure to vote against their own interests as a bondholder--may not
exist in the case of a CDS seller, the $150 million notional threshold
for short CDS positions does not include a provision allowing the
reporting person to net out any deliverable bonds from the calculation.
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\131\ See supra note 26 and accompanying text.
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Accordingly, the Commission is proposing a third threshold to
capture the positions of market participants with significant gross CDS
positions, notwithstanding the direction of the person's CDS positions
or their positions in deliverable bonds. Specifically, the Commission
believes that a gross CDS position that equals or exceeds $300 million
would likely create enough counterparty concentration risk to
potentially have other impacts on the market, even in the absence of a
manufactured or other opportunistic credit event. As an example, if a
person held $125 million in bonds on ABC Corporation and purchased $200
million in CDS on those bonds (or any other obligations that could be
deliverable into an auction after a Credit Event), those two positions
would offset each other, such that the net Security-Based Swap Position
would be $75 million, and reporting pursuant to proposed Rule 10B-1
would not be required given that the net exposure falls below $150
million. By contrast, if a person held $250 million in bonds on ABC
Corporation and purchased $325 million in CDS on those bonds, the
person would be required to report that position pursuant to proposed
Rule 10B-1 given that the gross Security-Based Swap Position exceeds
$300 million, even though those two positions would offset each other
to create a net $75 million exposure.
With respect to all other Security-Based Swap Positions based on
debt securities (i.e., not CDS), the Commission is proposing that the
threshold be a gross notional amount of $300 million, without regard to
direction of the person's CDS positions and without excluding any debt
securities underlying a security-based swap included in the Security-
Based Swap Position.\132\ The Commission does not believe it to be
appropriate to allow these positions to be netted against any
underlying debt securities given that these types of security-based
swap transactions operate differently than CDS transactions. For
example, a CDS buyer whose security-based swaps are used to hedge some
or all of their positions in an underlying bond will likely be less
inclined to take actions that would result in a CDS default,
[[Page 6671]]
given that the payment received should correspond to their losses from
the bond. By contrast, a CDS buyer who does not hold the underlying
bond may be incentivized to take actions that would result in a CDS
default given that the resulting payment would not be offset by the
buyer's losses from the bond. Such a dynamic--i.e., where there are
conflicting motivations as between the CDS transaction and any debt
securities underlying that CDS transaction--is less likely to occur in
connection with other types of security-based swaps.\133\ For similar
reasons, the threshold for these types of security-based swaps also
does not include a lower threshold for long and short positions.
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\132\ See proposed Rule 10B-1(b)(1)(ii).
\133\ See supra note 129 and accompanying text.
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2. Reporting Threshold for Security-Based Swaps on Equity
For Security-Based Swap Positions based on equity securities, the
Commission is proposing that the ``Reporting Threshold Amount'' in
proposed Rule 10B-1(b)(1) be bifurcated, such that it would be defined
to include both a threshold based on the notional amount of the
Security-Based Swap Position, and a threshold based on the total number
of shares attributable to the Security-Based Swap Position as a
percentage of the outstanding number of shares of that class of equity
securities. Those thresholds, which are specified below, are based on a
review of all available information, including the data the Commission
collects from Form N-PORT, which requires certain registered investment
companies to report information about their monthly portfolio holdings
to the Commission.\134\ As with the threshold for Security-Based Swap
Positions based on CDS, these thresholds were constructed to be low
enough to capture any positions that could potentially have a
significant effect on the equities markets, and potentially issuers of
equity securities and their security holders, yet also high enough to
avoid over-reporting, which could limit the effectiveness of the rule.
In other words, the Commission has endeavored to set these thresholds
at a level that should limit the reporting burden to include only those
positions that are most likely to achieve the underlying purposes of
the rule.
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\134\ See infra section VI.D.2.iii.
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As of November 8, 2021, the Commission now has access to additional
equity security-based swap transaction data from registered SBSDRs
pursuant to Regulation SBSR.\135\ In addition, equity securities are
more widely traded in the secondary markets than debt securities, such
that trading volume could be a key metric for measuring the potential
market impact of a large equity swap position but not as relevant a
metric for measuring the potential market impact of a large CDS
position. The Commission intends to consider this newly available data
in determining thresholds to use in connection with Security-Based Swap
Positions based on equity securities when adopting a final rule.
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\135\ See supra note 4. By contrast, CDS data has been
voluntarily reported and available to the Commission for more than a
decade.
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Notional Threshold
Pursuant to proposed Rule 10B-1(b)(1)(iii), the term ``Reporting
Threshold Amount'' with respect to Security-Based Swap Positions on
equity securities is defined to mean the lesser of two different
thresholds, one based on the notional amount of the position and one
based on the percentage of outstanding of shares attributable to the
position. With respect to the notional amount, a person would be
required to file a Schedule 10B once a Security-Based Swap Position
based on equity meets or exceeds $300 million, calculated on a gross
basis (i.e., including both long and short positions). However, the
Commission also recognizes that people may attempt to evade the
reporting requirements in proposed Rule 10B-1 by making efforts to keep
a Security-Based Swap Position below the $300 million gross notional
threshold, while also building up a position in the underlying equity
securities and/or other types of non-security-based swap derivatives on
such underlying security. Accordingly, proposed Rule 10B-
1(b)(1)(iii)(A) would provide that once a Security-Based Swap Position
exceeds a gross notional amount of $150 million, the calculation of the
Security-Based Swap Position shall also include the value of all of the
underlying equity securities owned by the holder of the Security-Based
Swap Position (based on the most recent closing price of shares), as
well as the delta-adjusted notional amount of any options, security
futures, or any other derivative instruments based on the same class of
equity securities.\136\ The Commission believes that the proposed
approach would provide greater transparency with respect to a person
with significant exposure to a particular equity security, which
includes a large Security-Based Swap Position, even if that position by
itself would not be large enough to require the person to file a
Schedule 10B.\137\ In such instance, the total exposure could carry the
same risks in terms of potential effects on the securities markets
(including the market for security-based swaps) and to security-based
swap counterparties as a Security-Based Swap Position that meets or
exceeds the $300 million gross notional threshold.
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\136\ Proposed Rule 10B-1(b)(6) defines the term ``delta'' to
mean the ratio that that is obtained by comparing (x) the change in
the value of a derivative instrument to (y) the change in the value
of the reference equity security. If a derivative instrument does
not have a fixed delta, then generally the delta should be
calculated on a daily basis, based on the most recent closing price
of shares of the reference equity security. The Commission is not
proposing a specific definition of ``delta-adjusted notional
amount'' in order to allow for flexibility in how it is computed,
but as a general matter the calculation should involve multiplying
the notional amount of the derivative by the delta adjustment.
\137\ The Commission recognizes, however, the limited value that
would be obtained by including in the calculation equity securities
held by an intermediary, such as a broker-dealer or a bank, in
street name for the benefit of the person with the actual economic
or beneficial ownership of such securities. Accordingly, proposed
Rule 10B-1(b)(7) provides that for purposes of the $300 million
gross notional threshold (and the 5% threshold discussed below), a
person that is a member of a national securities exchange shall not
be deemed to be the owner of any equity securities that they hold
directly or indirectly on behalf of another person solely because
such person is the record holder of such securities and, pursuant to
the rules of such exchange, may direct the vote of such securities,
without instruction, on other than contested matters or matters that
may affect substantially the rights or privileges of the holders of
the securities to be voted, but is otherwise precluded by the rules
of such exchange from voting without instruction. Proposed Rule 10B-
1(b)(7) is similar to existing Rule 13d-3(d)(2) under the Exchange
Act, which provides a similar exclusion for purposes the beneficial
ownership requirements in Sections 13(d) and (g) of the Exchange
Act. See 17 CFR 240.13d-3(d)(2).
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Percentage Threshold
The Commission believes that including a second test that is based
on the number of applicable shares represented by the Security-Based
Swap Position is likely important for a number of reasons, particularly
as it relates to security-based swaps based on equity securities issued
by companies with a smaller market capitalization. Under those
circumstances, the notional amount of such security-based swaps may not
trigger either the $150 million or $300 million gross notional
thresholds, and may not be likely to have a broad impact on the
securities markets, but may represent a significant number of shares of
the issuer and therefore carry the potential to impact the issuer.
A person would be required to file a Schedule 10B once the
``Security-Based Swap Equivalent Position'' (discussed
[[Page 6672]]
below) represents more than 5% of a class of equity securities.\138\
People may attempt to evade the reporting requirements in proposed Rule
10B-1 by keeping a Security-Based Swap Equivalent Position below the
threshold, while also building up a position in the underlying equity
securities and/or other types of non-security-based swap derivatives on
such underlying security. Accordingly, proposed Rule 10B-
1(b)(1)(iii)(B) would provide that once a Security-Based Swap
Equivalent Position represents more than 2.5% of a class of equity
securities, the calculation of the Security-Based Swap Equivalent
Position shall also include in the numerator all of the underlying
equity securities owned by the holder of the Security-Based Swap
Position, as well as the number of shares attributable to any options,
security futures, or any other derivative instruments based on the same
class of equity securities.
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\138\ Because the definition of ``Reporting Threshold Amount''
with respect to Security-Based Swap Positions on equity securities
is defined in proposed Rule 10B-1(b)(1)(iii) to mean the lesser of
two different thresholds, one based on the notional amount of the
position and one based on the percentage of outstanding shares
attributable to the position, the applicable Security-Based Swap
Position may have already exceeded the notional threshold. To the
extent that the holder of such Security-Based Swap Position has
already filed the applicable Schedule 10B with the Commission, such
person would not need to file a new or amended Schedule 10B if the
position subsequently exceeds the percentage threshold (or vice
versa), unless an amendment to the previously-filed Schedule 10B is
required pursuant to proposed Rule 10B-1(c). See infra section
III.A.iii.
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For purposes of this threshold, proposed Rule 10B-1(b)(2) would
define the term ``Security-Based Swap Equivalent Position'' to mean the
number of shares attributable to all of the security-based swaps
composing a Security-Based Swap Position, as determined in accordance
with proposed Rule 10B-1(b)(4). That rule defines the phrase ``number
of shares attributable'' to a derivative instrument (including a
security-based swap) to mean the larger of (in each case as
applicable):
(i) The number of shares of the reference equity security that may
be delivered upon on the exercise of the rights under the derivative
instrument, as determined in accordance with the terms of the
applicable documentation;
(ii) The number of shares of the reference equity security
determined by multiplying (x) the number of shares by reference to
which the amount payable under the derivative instrument is determined
by (y) the delta of the applicable derivative instrument; and
(iii) The number of shares of the reference equity security
determined by (x) dividing the notional amount of such derivative
instrument by the most recent closing price of shares of the reference
equity security, and then (y) multiplying such quotient by the delta of
the applicable derivative instrument.\139\
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\139\ Proposed Rule 10B-1(b)(4) defines the phrase ``number of
shares attributable to'' for purposes of proposed Rule 10B-1(b)(2),
which relates to determining the number for shares attributable to
the Security-Based Swap Position when calculating the ``Security-
Based Swap Equivalent Position'' and for purposes of proposed Rule
10B-1(b)(1)(iii)(B), which relates to determining the number of
shares attributable to other derivatives that would be required to
be added to a Security-Based Swap Equivalent Position that
represents more than 2.5% of a class of equity securities.
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The first prong of the definition is intended to apply primarily to
physically settled instruments. Thus, if the applicable documentation
refers to a specific number of shares of the reference security or
provides a formula to determine the number of shares to be delivered,
that number would be used for purposes of this prong. The second prong
of the definition is intended to apply primarily to a cash-settled
instruments that provide for a way to calculate the number of shares of
the reference security based on the amount payable, with an adjustment
to account for derivative instruments with a delta that is not equal to
one. Finally, the third prong is intended to apply primarily to a cash-
settled instrument where no such methodology exists. In that case, the
number of shares attributable to the instrument would be calculated by
dividing the notional amount of the instrument by the most recent
closing price of the reference equity security, and multiplying the
quotient by the delta of the instrument.
The above calculations would apply not only to all security-based
swaps based on a single equity security, but also to security-based
swaps based on a narrow-based security index containing that reference
security. As an example, if a person has a Security-Based Swap Position
consisting of security-based swaps on the common shares of XYZ
Corporation and security-based swaps on a narrow-based security index
that contains XYZ Corporation, the number of shares attributable to the
index-based security-based swaps would need to be added to the number
of shares attributable to the single-name security based swaps for
purposes of calculating the percentage of those shares by reference to
the number of outstanding shares. With respect to the index-based
security-based swaps, if the documentation contained no methodology for
calculating the number of shares of the reference equity security by
reference to which the amount payable under the derivative instrument
is determined, the third prong of proposed Rule 10B-1(b)(4) would
apply. Thus, if the notional amount of security-based swaps based on
the index was $100 million, and XYZ Corporation common stock
constituted 40% of the index, the notional amount for these purposes
would be $40 million, which would then be divided by the most recent
closing price of XYZ Corporation common stock to determine the number
of shares attributable to the index-based security-based swaps.\140\
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\140\ This assumes that the delta of the applicable security-
based swaps was one. If not, or if the relevant instrument was one
that is generally not a delta one derivative (e.g., an option), the
number of shares resulting from the calculation would then need to
be multiplied by the delta.
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3. Amendments to a Previously Filed Schedule 10B
Proposed Rule 10B-1(c) would require a person who has previously
filed a Schedule 10B with the Commission to file an amendment if any
material change occurs in the facts set forth in a previously filed
Schedule 10B including, but not limited to, any material increase in
the Security-Based Swap Positions or if a Security-Based Swap Position
falls back below the applicable Reporting Threshold Amount. Any such
amendment would be required to be filed on EDGAR promptly, but in no
event later than the end of the first business day following the
material change.
For purposes of the proposed rule, an acquisition or disposition in
an amount equal to 10% or more of the position previously disclosed in
Schedule 10B would be deemed ``material'' for purposes of this
requirement. The Commission believes that this requirement will help
ensure that regulators and market participants continue to have updated
information about reportable Security-Based Swap Positions, but only so
far as the updated information is material. Accordingly, proposed Rule
10B-1(c) would require a person who has previously filed a Schedule 10B
to file an amendment if the amount of the Security-Based Swap Position
that was previously reported increases or decreases by 10% or more. The
Commission welcomes and encourages comments as to when commenters
believe that an amendment should be required to be filed, any
thresholds used to make such a determination, and the timeframe for
making such submission.
[[Page 6673]]
B. Information Required To Be Included in Schedule 10B
Pursuant to proposed Schedule 10B, persons subject to the proposed
rule would be required to report the following information:
(1) Name of reporting person (or names of reporting persons if
making a joint filing as a group), whether reporting person is a
member of a group and names of the members of the group if the
members of the group are satisfying the group's Rule 10B-1(a)(1)
filing obligation by making individual filings.
(2) Residency or place of organization of the reporting
person(s).
(3) Type of reporting person(s).
(4) For reporting persons that are legal entities, the Legal
Entity Identifier (``LEI'') of the reporting person, if such person
has an LEI.
(5) Notional amount of the applicable Security-Based Swap
Position(s) of the reporting person, along with summary information
about the composition of the position as it relates to the direction
(i.e., long or short) and the tenor/expiration of the underlying
security-based swap transactions and the product ID (such as the
Unique Product Identifier, or ``UPI'') of the security-based swap(s)
included in the Security-Based Swap Position, if applicable.
(6) In the case of a Security-Based Swap Position based on debt
securities (including credit default swaps), ownership of: (i) All
debt securities underlying a security-based swap included in the
Security-Based Swap Position, including the Financial Instrument
Global Identifier (``FIGI'') of each underlying debt security, if
applicable, and the LEI of the issuer of each underlying debt
security, if the issuer has an LEI; and (ii) all security-based
swaps based on equity securities issued by the same reference
entity, including the FIGI of each underlying equity security, if
applicable. In addition to the FIGI, other unique security
identifier(s) may be included at the filer's option.
(7) In the case of a Security-Based Swap Position based on
equity securities, ownership of: (i) All equity securities
underlying a security-based swap included in the Security-Based Swap
Position, including the FIGI of each underlying equity security and
the LEI of the issuer of each underlying equity security, if the
issuer has an LEI; and (ii) all security-based swaps based on debt
securities issued by the same reference entity (including credit
default swaps), including the FIGI of each underlying debt security,
if applicable. In addition to the FIGI, other unique security
identifier(s) may be included at the filer's option.
(8) Ownership of any other instrument relating to the Security-
Based Swap Position and/or any underlying security or loan or group
or index of securities or loans, or any security or group or index
of securities, the price, yield, value, or volatility of which, or
of which any interest therein, is the basis for a material term of a
security-based swap included in the Security-Based Swap Position, if
not otherwise disclosed pursuant to Items 6 or 7 of this form. For
any underlying security disclosed pursuant to this Item, disclose
the FIGI of the security, if applicable, and the LEI of the issuer
of the security, if the issuer has an LEI. In addition to the FIGI,
other unique security identifier(s) may be included at the filer's
option.
(9) To the extent that the Reporting Threshold Amount is based
on the number of shares corresponding to a Security-Based Swap
Position based on equity securities, the number of shares
attributable to the Security-Based Swap Position, along with the
closing price used in the calculation and the date of such closing
price.
The first four items relate to the identity of the reporting
person. With respect to item (3), the reference to ``type'' of
reporting person would include the following categories: (i) Broker-
dealer; (ii) security-based swap dealer or major security-based swap
participant; (iii) bank; (iv) insurance company; (v) investment
company; (vi) investment adviser; (vii) employee benefit plan or
endowment fund; (viii) parent holding company/control person; (ix)
savings association; (x) church plan; (xi) corporation; (xii)
partnership; (xiii) individual; and (xiv) other. These categories are
identical to those included in Schedule 13D, other than the addition of
SBS Entities in item (ii).\141\
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\141\ See 17 CFR 240.13d-101.
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Items (5) through (8) require reporting of the Security-Based Swap
Position, the loans or securities underlying that position, any related
securities and loans, and other security-based swaps related to the
applicable Security-Based Swap Position.\142\ Item (9) applies only to
Security-Based Swap Positions based on equity securities where the
Reporting Threshold Amount is based on the number of shares
corresponding to a Security-Based Swap Position and is intended to
provide basic information as to how the number of shares was
calculated.
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\142\ As previously explained, for purposes of the definition of
``Security-Based Swap Position,'' security-based swaps based on
equity securities issued by a reference entity would constitute a
separate Security-Based Swap Position as compared to security-based
swaps based on debt securities of the same reference entity. See
supra note 125 and accompanying text. As a result, if a reporting
party had a Security-Based Swap Position composed of security-based
swaps based on equity securities and separate security-based swaps
based on debt securities of the same issuer, the Security-Based
Position would be disclosed pursuant to Item (5), and the debt
security-based swaps would be disclosed pursuant to Item (6). In the
reverse scenario, a Security-Based Position composed of security-
based swaps based on debt securities would be disclosed pursuant to
Item (5), and the equity security-based swaps would be disclosed
pursuant to Item (7). Item (8) would include any other instrument
relating to the Security-Based Swap Position and/or any underlying
security or loan or group or index of securities or loans.
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At the same time, however, the Commission also understands that
certain aspects of a security-based swap transaction may be sensitive
or proprietary information. As previously noted, the intent of proposed
Rule 10B-1 is to alert regulators and the market, including
counterparties to security-based swap trades and the companies whose
securities underlie security-based swaps, that one or more market
participants are amassing a large position in security-based swaps. The
items listed above are intended to achieve that objective without
requiring market participants to publicly disclose sensitive or
proprietary information about their Security-Based Swap Positions. In
particular, Schedule 10B does not require reporting persons to disclose
any information about their counterparties, including their identities,
to any security-based swap or other related derivatives; only the
aggregated positions would need to be disclosed. Moreover, Schedule 10B
only requires reporting persons to include a ``brief description'' of
any contracts, arrangements, understandings or relationships with
respect to any security-based swaps included in the Security-Based Swap
Position or any underlying or related securities (including security-
based swaps) or loans required to be disclosed pursuant the form; the
agreements themselves would not need to be disclosed. The Commission
believes that structuring Schedule 10B in such a manner would help to
alleviate concerns regarding the potential public disclosure of
sensitive or proprietary information, and we encourage commenters to
provide information as to whether the Commission should take any
additional measures to accomplish that goal, consistent with the
underlying objectives of proposed Rule 10B-1.
Finally, proposed Rule 10B-1(e) would provide that if some or all
of the information required to be disclosed on proposed Schedule 10B is
publicly available on EDGAR at the time the Schedule 10B is required to
be filed, such information may be incorporated by reference in answer,
or partial answer, to any item of Schedule 10B. This provision is
intended to make the proposed rule more efficient in cases where any
required information is publicly available on EDGAR. In such cases, the
Schedule 10B need only cite to the filing where the information can be
found.\143\
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\143\ The Commission has previously allowed people subject to
reporting and other disclosure obligations to i
[…truncated; see source link]Indexed from Federal Register on February 4, 2022.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.