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Rule2023-12592

Prohibition Against Fraud, Manipulation, or Deception in Connection With Security-Based Swaps; Prohibition Against Undue Influence Over Chief Compliance Officers

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Published

June 30, 2023

Effective

August 29, 2023

Issuing agencies

Securities and Exchange Commission

Abstract

The Securities and Exchange Commission ("SEC" or "Commission") is adopting a final rule, under the Securities Exchange Act of 1934 ("Exchange Act"), that is designed to prevent fraud, manipulation, and deception in connection with effecting any transaction in, or attempting to effect any transaction in, or purchasing or selling, or inducing or attempting to induce the purchase or sale of, any security-based swap. The rule takes into account the features fundamental to a security-based swap and the broad definitions of purchase and sale under the Exchange Act as they relate to security- based swaps. In addition, the Commission is adopting a final rule, under the Exchange Act, that makes it unlawful for any officer, director, supervised person, or employee of a 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"), 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 chief compliance officer ("CCO") in the performance of their duties under the Federal securities laws or the rules and regulations thereunder.

Full Text

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[Federal Register Volume 88, Number 125 (Friday, June 30, 2023)]
[Rules and Regulations]
[Pages 42546-42585]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-12592]

[[Page 42545]]

Vol. 88

Friday,

No. 125

June 30, 2023

Part III

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; Final Rule

Federal Register / Vol. 88 , No. 125 / Friday, June 30, 2023 / Rules
and Regulations

[[Page 42546]]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-97656; 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

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``SEC'' or
``Commission'') is adopting a final rule, under the Securities Exchange
Act of 1934 (``Exchange Act''), that is designed to prevent fraud,
manipulation, and deception in connection with effecting any
transaction in, or attempting to effect any transaction in, or
purchasing or selling, or inducing or attempting to induce the purchase
or sale of, any security-based swap. The rule takes into account the
features fundamental to a security-based swap and the broad definitions
of purchase and sale under the Exchange Act as they relate to security-
based swaps. In addition, the Commission is adopting a final rule,
under the Exchange Act, that makes it unlawful for any officer,
director, supervised person, or employee of a 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''), 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
chief compliance officer (``CCO'') in the performance of their duties
under the Federal securities laws or the rules and regulations
thereunder.

DATES: Effective date: August 29, 2023.

FOR FURTHER INFORMATION CONTACT: Pamela Carmody, Special Counsel, Rajal
B. Patel, Senior Special Counsel, or Carol M. McGee, Associate
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: First, the Commission is adopting 17 CFR
240.9j-1 (``Rule 9j-1'') under the Exchange Act, which is a new rule
designed to prevent fraud, manipulation, and deception in connection
with effecting transactions in, or purchasing or selling, or inducing
or attempting to induce the purchase or sale of, any security-based
swap. The Commission is also adopting 17 CFR 240.15fh-4(c) (``Rule
15fh-4(c)'') under the Exchange Act, which is a new rule making 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.

I. Introduction
A. Background
B. Overview of Security-Based Swaps
1. Security-Based Swaps Generally
2. Security-Based Swap Market Developments
C. Overview of the Final Rules
1. Rule 9j-1
2. Rule 15fh-4(c)
II. Rule 9j-1: Prohibition Against Fraud, Manipulation, and
Deception in Connection With Security-Based Swaps
A. Misconduct ``In Connection With'' ``Purchases,'' ``Sales,''
or ``Effecting Transactions''
1. Proposed Approach
2. Commission Action
a. In Connection With
b. Purchases or Sales
c. Effecting Transactions
B. Fraudulent, Manipulative, or Deceptive Conduct
1. Proposed Approach
2. Commission Action
a. Scienter and Negligence Standards
b. Attempted Conduct
C. Prohibition on Price Manipulation
1. Proposed Approach
2. Commission Action
D. Liability Under Rules 9j-1(b) and (c)
1. Proposed Approach
2. Commission Action
a. Rule 9j-1(b)
b. Rule 9j-1(c)
E. Safe Harbors and Affirmative Defenses
1. Proposed Approach
2. Commission Action
a. Affirmative Defense: Binding Contractual Obligations
b. Affirmative Defense: Policies and Procedures
c. Proposed Safe Harbor: Compression
d. Other Requested Safe Harbors and Affirmative Defenses
III. Rule 15fh-4(c): Preventing Undue Influence Over Chief
Compliance Officers; Policies and Procedures Regarding Compliance
With Rule 9j-1 and Rule 15fh-4(c)
A. Proposed Approach
B. Commission Action
IV. Paperwork Reduction Act
V. Economic Analysis
A. Introduction
B. Broad Economic Considerations
C. Baseline
1. Existing Regulatory Frameworks
2. Security-Based Swap Data, Market Participants, Dealing
Structures, and Levels of Security-Based Swap Trading Activity
D. Benefits and Costs of Rule 9j-1
1. Benefits
2. Costs
E. Benefits and Costs of Rule 15fh-4(c)
1. Benefits
2. Costs
F. Effects on Efficiency, Competition, and Capital Formation
1. Competition
2. Efficiency
3. Capital Formation
G. Reasonable Alternatives
1. Narrow the Scope of Rule 9j-1
2. Safe Harbors
a. Safe Harbor for Hedging Exposure Arising Out of Lending
Activities
b. Safe Harbors for Lender Disclosure, Centralized Market
Activities, and Legitimate Restructurings
c. Safe Harbor for Publicly Executed Strategies
d. Elimination of All Safe Harbors and Affirmative Defenses
3. Implementing a More Prescriptive Approach in Rule 9j-1
4. Separate Rules for CDS and Equity Security-Based Swaps
5. Exclude Underlying Securities
6. Limit Activities Prohibited Under Rule 15fh-4(c)
VI. Regulatory Flexibility Act Certification
VII. Other Matters
Statutory Authority

I. Introduction

A. Background

Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (``Dodd-Frank Act'') \1\ provided the Commission with
primary responsibility for regulating security-based swaps. A person
who satisfies the definitions of ``security-based swap dealer'' or
``major security-based swap participant'' is required to register with
the Commission in such capacity and is therefore subject to the
Commission's regime regarding, among other things, internal supervision
requirements and the requirement to designate an individual to serve as
the CCO.\2\ In addition to other requirements, the CCO must take
reasonable steps to ensure that the SBS Entity establishes, maintains,
and reviews written policies

[[Page 42547]]

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\
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\1\ Wall Street Transparency and Accountability Act of 2010,
Public Law 111-203, sections 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., 17 CFR 240.3a71-1 (Definition of ``security-based
swap dealer''); 17 CFR 240.3a71-2 (De minimis exception for SBSD
registration); 17 CFR 240.3a67-1 (Definition of ``major security-
based swap participant''); 17 CFR 240.15Fb2-1 (Registration of SBSDs
and MSBSPs); 17 CFR 240.15Fh-3 (Business conduct requirements for
SBSDs and MSBSPs).
\3\ See 17 CFR 240.15Fk-1; Business Conduct Standards for
Security-Based Swap Dealers and Major Security-Based Swap
Participants, Exchange Act Release No. 77617 (Apr. 14, 2016), 81 FR
29960 (May 13, 2016) (``Business Conduct Standards Adopting
Release'').
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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.\4\
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 manipulative, and such quotations as
are fictitious.'' \6\
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\4\ See 15 U.S.C. 78i(j).
\5\ See id. 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 of 1933
(``Securities Act'') to account for security-based swaps.\7\ For
example, the Dodd-Frank Act amended the definition of ``security'' in
section 3(a)(10) of the Exchange Act \8\ and section 2(a)(1) of the
Securities Act \9\ 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) and 10(b) of the Exchange Act,
and 17 CFR 240.10b-5 (``Rule 10b-5'') thereunder,\10\ and section 17(a)
of the Securities Act.\11\
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\7\ Section 3(a)(68) of the Exchange Act defines ``security-
based swap.'' 15 U.S.C. 78c(a)(68).
\8\ 15 U.S.C. 78c(a)(10).
\9\ 15 U.S.C. 77b(a)(1).
\10\ 15 U.S.C. 78j(b).
\11\ 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,\12\ the definitions of ``buy'' and ``purchase'' in section
3(a)(13) of the Exchange Act,\13\ and ``sale'' and ``sell'' in section
3(a)(14) of the Exchange Act,\14\ in the context of security-based
swaps, to include the execution, termination (prior to its scheduled
maturity date), assignment, exchange, or similar transfer or conveyance
of, or extinguishing of rights or obligations under, a security-based
swap, as the context may require. As a result of those changes,
misconduct in connection with these actions is also 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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\12\ 15 U.S.C. 77b(a)(18).
\13\ 15 U.S.C. 78c(a)(13).
\14\ 15 U.S.C. 78c(a)(14).
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On December 15, 2021, the Commission re-proposed antifraud and
anti-manipulation rules,\15\ as required by section 9(j) of the
Exchange Act. The re-proposal followed the Commission's adoption of
much of its Title VII rulemaking related to security-based swaps,\16\
as well as developments in the security-based swap market, including
manufactured credit events or other opportunistic strategies in the
credit default swap (``CDS'') market, as discussed in section I.B
below.\17\ 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, the Commission proposed an additional
measure under section 15F(h) of the Exchange Act \18\ to protect CCOs
in the furtherance of those duties.\19\ The Commission is adopting Rule
9j-1 with modifications in response to commenters,\20\ and adopting
Rule 15fh-4(c) as proposed.\21\ In developing this rulemaking we have
consulted and

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coordinated with the CFTC and the prudential regulators in accordance
with section 712(a)(2) of the Dodd-Frank Act.\22\ Nothing in Rule 9j-1
alters the application of sections 9(a) and 10(b) of the Exchange Act,
and Rule 10b-5 thereunder, and section 17(a) of the Securities Act,
including to misconduct that is in connection with the exercise of any
right or performance of any obligation under the security-based swap.
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\15\ See 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, Exchange Act Release No. 93784
(Dec. 15, 2021), 87 FR 6652 (Feb. 4, 2022) (``2021 Proposing
Release''). See also 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 refer to re-proposed Rule 9j-1 as ``proposed rule''
or ``re-proposed Rule 9j-1''and to final Rule 9j-1 as ``Rule 9j-1,''
``final rule,'' or ``final Rule 9j-1.''
\16\ As more fully described in the 2021 Proposing Release, the
Commission has now completed a majority of its rulemaking under
Title VII, SBS Entities are required to register with the Commission
(as of June 7, 2023, there are 50 conditionally registered security-
based swap dealers), and all persons are required to report their
security-based swap transactions to security-based swap data
repositories. See 2021 Proposing Release, 87 FR at 6653 nn.2-4 and
accompanying text. Further, since 2010, regulators overseeing the
world's primary over-the-counter (``OTC'') derivatives markets have
made significant progress implementing reforms for OTC derivatives
and the Commodity Futures Trading Commission (``CFTC'') has largely
completed its Title VII rulemakings related to swaps, including the
adoption of antifraud and anti-manipulation rules. See 2021
Proposing Release, 87 FR at 6654-55, 6654 n.19.
\17\ See infra section I.B.2, describing in more detail
manufactured credit events and other opportunistic strategies in the
CDS market. See also 2021 Proposing Release, 87 FR at 6654-55.
Additionally, in section II.C.2, infra, the Commission addresses
concerns raised by commenters with regard to the application of Rule
9j-1 to legitimate credit activity or other activity in connection
with security-based swap transactions, some of which may fit the
descriptions of the manufactured credit events and other
opportunistic strategies described in the 2021 Proposing Release.
\18\ See 15 U.S.C. 78o-10(h).
\19\ See 2021 Proposing Release, 87 FR at 6664-65. 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.
\20\ The comment letters are available at <a href="http://www.sec.gov/comments/s7-32-10/s73210.shtml">http://www.sec.gov/comments/s7-32-10/s73210.shtml</a>. The Commission also received
comments on topics outside the scope of the proposal that are not
addressed in this release. See, e.g., Comment from Anonymous, dated
Feb. 6, 2022, available at <a href="https://www.sec.gov/comments/s7-32-10/s73210-20114041-266299.htm">https://www.sec.gov/comments/s7-32-10/s73210-20114041-266299.htm</a> (discussing dark pools); Comment from
Anonymous, dated Dec. 16, 2021, available at <a href="https://www.sec.gov/comments/s7-32-10/s73210-20109790-264127.htm">https://www.sec.gov/comments/s7-32-10/s73210-20109790-264127.htm</a> (discussing securities
lending).
\21\ As described in greater detail below, the Commission is
making several changes to proposed Rule 9j-1 and adopting Rule 15fh-
4(c) as proposed. First, the Commission is revising paragraph (a) to
more closely track the language of section 9(j) of the Exchange Act
with regard to the conduct subject to the prohibitions of final Rule
9j-1(a), moving the prohibitions on attempted conduct from
paragraphs (a)(3) and (a)(4) to a new paragraph (a)(5), and
clarifying that the Commission believes scienter is the proper
standard to apply to violations of paragraph (a)(5). See infra
sections II.A and II.B. In addition, the Commission is moving
paragraph (b) of proposed Rule 9j-1 to a new paragraph (a)(6) to
rely on the scope of conduct subject to the prohibitions of
paragraph (a). See infra section II.C. Finally, the Commission is
adopting two affirmative defenses to violations of Rule 9j-1, one
for actions taken in connection with binding rights and obligations
under security-based swap documentation and one for appropriate
policies and procedures to ensure compliance with Rule 9j-1 such as
restrictions on access to material nonpublic information. See infra
sections II.E.2.a and II.E.2.b. The Commission is not adopting the
proposed safe harbor for portfolio compression exercises. See infra
section II.E.2.c.
\22\ In addition, in accordance with section 752 of the Dodd-
Frank Act, the Commission has consulted and coordinated with foreign
regulatory authorities through Commission staff participation in
numerous bilateral and multilateral discussions with foreign
regulatory authorities addressing the regulation of OTC derivatives
markets.
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The Commission also proposed for comment a new Rule 10B-1,\23\
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 positions. The Commission is not finalizing Rule 10B-1 in this
release as it continues to consider comments received in connection
with proposed Rule 10B-1.
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\23\ See 2021 Proposing Release, 87 FR at 6667-76.
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B. Overview of Security-Based Swaps

1. Security-Based Swaps Generally
Although the definition of security-based swap is detailed and
comprehensive,\24\ at its most basic level, a security-based swap is an
agreement, contract, or transaction in which two parties agree to the
exchange of payments or cash flows based upon the value of other assets
or upon the occurrence or non-occurrence of some event, including, for
example, a change in a stock price or the occurrence of some type of
credit event.\25\ The exchange of these payments or deliveries,
including purchases or sales upon certain events, is a fundamental
aspect or feature of a security-based swap.\26\ Moreover, this feature
of security-based swaps is in contrast to secondary market transactions
involving equity or debt securities where the completion of a purchase
or sale transaction terminates the mutual obligations of the parties.
Security-based swap counterparties, who are considered the issuers of
the security-based swaps, continue to have obligations to one another
throughout the life of the instrument, which can extend for years if
not decades.\27\
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\24\ See 15 U.S.C. 78c(a)(68) (defining ``security-based
swap''). See also Further Definition of ``Swap,'' ``Security-Based
Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps;
Security-Based Swap Agreement Recordkeeping, Exchange Act Release
No. 67453 (July 18, 2012), 77 FR 48208, 48211 (Aug. 13, 2012)
(``Product Definitions Release'') (further defining certain terms
related to the definition of ``security-based swap'').
\25\ See generally section 3(a)(68) of the Exchange Act, which
defines a ``security-based swap'' as any agreement, contract, or
transaction that is a swap as defined in section 1(a) of the
Commodity Exchange Act that is based on a narrow-based security
index, or a single security or loan, or any interest therein or on
the value thereof, or the occurrence or non-occurrence of an event
relating to a single issuer of a security or the issuers of
securities in a narrow-based security index, provided that such
event directly affects the financial instruments, financial
condition, or financial obligations of the issuer. 15 U.S.C.
78c(a)(68). See also 2010 Rule 9j-1 Proposing Release, 75 FR at
68561 (generally discussing the definition of ``security-based
swap''). This section also discusses examples of security-based
swaps and the exchange of payments or deliveries, or the purchase or
sale or other payments upon the occurrence of a specific event,
between the parties during the life of a security-based swap.
\26\ The definition of security-based swap requires that the
instrument first meet the definition of swap in section 1a(47) of
the Commodity Exchange Act. See 15 U.S.C. 78c(a)(68); supra note 25.
That definition provides, inter alia, that a swap is an agreement,
contract, or transaction that provides for any purchase, sale,
payment, or delivery upon the occurrence or nonoccurrence of certain
events or that provides on an executory basis for an exchange on a
fixed or contingent basis, of one or more payments that meet certain
conditions. See 7 U.S.C. 1a(47)(ii) and (iii).
\27\ See Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based
Swap Participant'' and ``Eligible Contract Participant,'' Exchange
Act Release No. 66868 (Apr. 27, 2012), 77 FR 30596, 30616-17 (May
23, 2012) (``In contrast to a secondary market transaction involving
equity or debt securities, in which the completion of a purchase or
sale transaction can be expected to terminate the mutual obligations
of the parties to the transaction, the parties to a security-based
swap often will have an ongoing obligation to exchange cash flows
over the life of the agreement.'').
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Parties may enter into a security-based swap for a multitude of
reasons, but often, the parties to the contract seek to gain exposure
to an asset without owning it or to manage or transfer risks in their
asset and liability portfolios (e.g., credit or equity risks). Typical
participants in the security-based swap market include, among others,
lenders transferring credit risk,\28\ insurance companies managing
asset and liability risk specific to the insurance industry,\29\
activists or hedge funds obtaining exposure to the price movement and
dividend payments of a stock without the costs and burdens of stock
ownership,\30\ and financial institutions that engage in market-making
and dealing in security-based swaps.\31\ The terms of the contract
between the counterparties determine the specific rights and
obligations of the parties throughout the life of the security-based
swap, including, for example, the amount and timing of periodic
payments due under the instrument, the maturity of the instrument, and
terms of settlement. Counterparties to a security-based swap typically
use a standardized agreement published by ISDA, first in 1992 and
updated in 2002, which is the most widely used contract setting forth
the terms of security-based swap transactions (the ``ISDA Master
Agreement''). Unlike other types of securities where settlement occurs
when the buyer receives the security purchased and the seller receives
cash equaling the value of the security sold, for security-based swaps,
a final net payment is paid by one party to the other at a future point
in time to which the parties have contractually agreed.\32\
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\28\ See, e.g., Letter from Elliot Ganz, Loan Syndications and
Trading Association (``LSTA''), dated Mar. 17, 2022 (``LSTA
Letter''), at 2-3.
\29\ See Letter from Michael Lovendusky, American Council of
Life Insurers (``ACLI''), dated Mar. 21, 2022 (``ACLI Letter'').
\30\ See Letter from Richard B. Zabel, Elliott Investment
Management L.P., dated Mar. 21, 2022 (addressing concerns related to
proposed Rule 10B-1 but also describing the security-based swap
activity of activists and hedge funds).
\31\ See Letter from Bridget Polichene, Institute of
International Bankers (``IIB''), Scott O'Malia, International Swaps
and Derivatives Association (``ISDA''), and Kenneth E. Bensten, Jr.,
Securities Industry and Financial Markets Association (``SIFMA''),
dated Mar. 21, 2022 (``IIB-ISDA-SIFMA Letter'').
\32\ See, e.g., Shortening the Securities Transaction Settlement
Cycle, Exchange Act Release No. 96939 (Feb. 15, 2023), 88 FR 13872,
13878 (Mar. 6, 2023) (``T+1 Adopting Release'') (citing letter from
Thomas Price, Managing Director, and Lindsey Weber Keljo, Head--
Asset Management Group, Securities Industry and Financial Markets
Association re: File No. S7-05-22 (Apr. 13, 2022), at 11).
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Two common examples of security-based swaps--credit default swaps
(``CDS'') and total return swaps (``TRS'')--are described in more
detail below.\33\
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\33\ The definition of security-based swap in the Exchange Act
and the rules thereunder is broad. See supra notes 25-26 and related
discussion. The application of the rules we adopt in this document
is not limited to CDS and TRS or to transactions between particular
types of counterparties.
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Generally, a CDS is a contract in which a party (the ``protection
buyer''), such as a lender, agrees to make periodic payments (the
``premium'') over an agreed upon time period to another party (the
``protection seller'') in exchange for a payment from the protection
seller in the event of default by an issuer (or group of issuers) of
securities (the ``reference entity'').\34\ The

[[Page 42549]]

CDS contract states whether the CDS is settled physically or in cash in
the event of default by the reference entity. Generally, the protection
buyer is using the CDS to manage risk and the protection seller is
using the CDS to take on risk in return for a premium. A cash-settled
CDS contract relying on ISDA documentation is subject to determinations
by a committee with respect to whether a defined default event (a
``credit event'') has occurred and, if so, to hold an auction to
determine the settlement price of the CDS. The auction process includes
the determination and publication of a list of deliverable obligations
that a CDS protection buyer can deliver to the CDS protection seller
after the auction settlement. A CDS protection buyer can deliver any of
the obligations on the list, with delivery of the cheapest deliverable
obligation maximizing recovery.\35\ This feature of CDS contracts is an
aspect of some of the manufactured or opportunistic strategies
discussed in section I.B.2.
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\34\ A CDS generally falls within the second prong of the
definition of a swap under section 1(a) of the Commodity Exchange
Act as a contract ``that provides for any purchase, sale, payment,
or delivery (other than a dividend on an equity security) that is
dependent on the occurrence, nonoccurrence, or the extent of the
occurrence of an event or contingency associated with a potential
financial, economic, or commercial consequence.'' See 7 U.S.C.
1a(47)(a)(ii). If the CDS falls within any of the prongs of the
definition of security-based swap in Exchange Act section
3(a)(68)(A)(ii), the CDS would be a security-based swap. See Product
Definitions Release, 77 FR at 48267, and the broader discussion of
CDS therein.
\35\ See 2021 Proposing Release, 87 FR at 6655 n.23. As
described in the 2021 Proposing Release, in order to cash settle any
CDS contract that relies on the ISDA standard documentation, a
Credit Derivatives Determinations Committee (``DC'') must make a
determination that 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. As noted,
protection buyers are incentivized to deliver into the auction the
cheapest deliverable obligation, as it maximizes their recovery; 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, 5 (Jan. 11, 2012),
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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In contrast, a TRS may obligate one of the parties (i.e., the total
return payer) to transfer the total economic performance (e.g., income
from interest and fees, gains or losses from market movements, and
credit losses) of a reference asset (e.g., a debt or equity security)
(the ``reference underlying''), in exchange for a specified or fixed or
floating cash flow (including payments for any principal losses on the
reference asset) from the other party (i.e., the total return
receiver).\36\ If the TRS is negotiated over-the-counter, the terms of
the TRS can be individually negotiated and could include one payment at
the expiration of the TRS or might include a series of payments on
periodic interim settlement dates over the tenor of the TRS. For TRS
with periodic interim settlement dates counterparties could agree to
reset the price of the reference underlying on the periodic interim
settlement date based on current market prices of the reference
underlying (``reference price''). Accordingly, throughout the life of a
TRS, depending on the terms of the TRS, the reference price that
determines that payment on periodic interim settlement dates might be
reset based on current market prices of the reference underlying.
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\36\ See 2010 Rule 9j-1 Proposing Release, 75 FR at 68562. See
also infra section V.B, discussing broad economic considerations of
security-based swaps and specifically TRS.
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2. Security-Based Swap Market Developments
In 2010, following the 2008 financial crisis, Congress enacted the
Dodd-Frank Act ``to promote the financial stability of the United
States by improving accountability and transparency in the financial
system.'' \37\ Title VII of the Dodd-Frank Act addressed significant
issues and risks in the swap and security-based swap markets, which had
experienced dramatic growth leading up to the 2008 financial crisis and
were shown to be capable of affecting significant sectors of the U.S.
economy.\38\ In testimony before Congress introducing the first draft
of the Dodd-Frank Act, Treasury Secretary Timothy Geithner highlighted
the risks posed by an unregulated OTC derivatives market, which had
been operating without the ``basic protections and oversight'' existing
in the rest of the financial systems, including a ``limited ability to
police fraud and manipulation.'' \39\ In his written testimony,
Secretary Geithner listed four broad objectives of the proposed reforms
which were eventually enacted as Title VII of the Dodd-Frank Act: (1)
preventing activities in the OTC derivatives markets from posing risk
to the stability of the financial system; (2) promoting efficiency and
transparency of the OTC derivatives markets; (3) preventing market
manipulation, fraud, and other abuses; and (4) protecting consumers and
investors by ensuring that OTC derivatives are not marketed
inappropriately to unsophisticated parties.\40\ Secretary Geithner also
stressed that the CFTC and the SEC should be provided with strong
authority for civil enforcement and regulation of fraud, market
manipulation, and other abuses in the OTC derivative markets.\41\ The
authority enacted in Title VII of the Dodd-Frank Act includes, but is
not limited to, Exchange Act section 9(j). Ensuring that the Commission
has the necessary tools to police the security-based swap markets is a
key component to ensure that Title VII's reforms are not undermined.
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\37\ Dodd-Frank Act, Public Law 111-203, Preamble. See also
Business Conduct Standards Adopting Release, 81 FR at 29961.
\38\ Business Conduct Standards Adopting Release, 81 FR at
29961. See also Cross-Border Security-Based Swap Activities; Re-
Proposal of Regulation SBSR and Certain Rules and Forms Relating to
the Registration of Security-Based Swap Dealers and Major Security-
Based Swap Participants, Exchange Act Release No. 69490 (May 1,
2013), 78 FR 30967, 30980 (May 23, 2013) (``Cross-Border Release'')
(discussing the spillover and contagion effects arising from
security-based swap transactions in the context of American
International Group, Inc., and its subsidiary AIG Financial Products
Corp.).
\39\ Senate Hearing on Over the Counter Derivatives Reform and
Addressing Systemic Risks, S. Hrg. 1111-803 (Dec. 2, 2009),
available at <a href="https://www.govinfo.gov/content/pkg/CHRG-111shrg62722/pdf/CHRG-111shrg62722.pdf">https://www.govinfo.gov/content/pkg/CHRG-111shrg62722/pdf/CHRG-111shrg62722.pdf</a>.
\40\ Id. (including testimony noting that enacted reforms will
result in ``very consequential changes'' to OTC derivatives
markets).
\41\ Id.
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The security-based swap market remains large. Based on information
reported pursuant to 17 CFR 242.900 to 242.909 (``Regulation SBSR''),
as of November 25, 2022, the gross notional amount outstanding in the
security-based swap market is approximately $8.5 trillion across the
credit, equity, and interest rate asset classes.\42\ The credit
security-based swap asset class is large, with a gross notional amount
of approximately $4.7 trillion, of which single-name CDS (including
corporate and sovereign) account for the largest category at $4.3
trillion.\43\ Additionally, as indicated by data submitted pursuant to
Regulation SBSR, the size of the equity security-based swap market is
also significant--with approximately $3.6 trillion of equity security-
based swaps outstanding as of November 25, 2022.\44\
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\42\ See Report on Security-Based Swaps, Mar. 20, 2023,
available at <a href="https://www.sec.gov/files/report-security-based-swaps-032023.pdf">https://www.sec.gov/files/report-security-based-swaps-032023.pdf</a> (``SBS Report''). For further discussion of the
Regulation SBSR data, see infra section V.C.2.
\43\ See id.
\44\ See id.
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In general, the ongoing payments of a security-based swap depend,
in part, on

[[Page 42550]]

its gross notional amount outstanding.\45\ The particular aspects and
characteristics of security-based swaps (described above in section
I.B.1) provide opportunities and incentives for misconduct. In general,
parties to a security-based swap may engage in misconduct in connection
with the security-based swap (including in the reference underlying of
such security-based swap) to trigger, avoid, or affect the value of
ongoing payments or deliveries. For instance, a party faced with
significant risk exposure may engage or attempt to engage in
manipulative or deceptive conduct that increases or decreases the value
of payments or cash flow under a security-based swap relative to the
value of the reference underlying, including the price or value of a
deliverable obligation under a security-based swap. Moreover, fraud and
manipulation in connection with a security-based swap can affect not
just a direct counterparty, but also counterparties to that
counterparty. For example, if fraud or manipulation leads to a large
change in variation margin, the defrauded counterparty could default on
its obligations to its other counterparties. In addition, other
counterparties to the same security-based swaps could be affected by
fraud or manipulation that affects the reference underlying assets, as
could investors in those underlying assets. Given the global and
interconnected nature of the security-based swap markets, it is
critical that the Commission has appropriate tools to fight fraud and
manipulation in these markets.\46\ Recent developments in the security-
based swap market highlight these concerns. For example, in the 2021
Proposing Release, the Commission discussed certain manufactured or
other opportunistic CDS strategies that had been reported by academics
and the press: \47\
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\45\ See, e.g., Bloomberg L.P. v. Commodity Futures Trading
Com'n, 949 F. Supp. 2d 91, 96 (D.D.C. 2013) (stating that a swap
``is a contract that typically involves an exchange of one or more
payments based on the underlying value of a notional amount of one
or more commodities, or other financial or economic interest . . .
.'' (emphasis added)).
\46\ See Application of ``Security-Based Swap Dealer'' and
``Major Security-Based Swap Participant'' Definitions to Cross-
Border Security-Based Swap Activities, Exchange Act Release No.
72472 (June 25, 2014), 79 FR 47278, 47283 (Aug. 12, 2014)
(discussing the global nature and interconnectedness of the
security-based swap market and the potential for risk transmission).
\47\ 2021 Proposing Release, 87 FR at 6655. See also supra note
35 and related discussion regarding the operation of CDS auctions.
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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).\48\
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\48\ See 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. 5-32, at 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>.
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<bullet> Alone or in combination with the above or other
strategies, 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).\49\
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\49\ 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/divisionsstatement042418">https://www.cftc.gov/PressRoom/SpeechesTestimony/divisionsstatement042418</a>.
---------------------------------------------------------------------------

<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.\50\
---------------------------------------------------------------------------

\50\ See Hu, supra note 48 at 22-26.
---------------------------------------------------------------------------

<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.\51\
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\51\ See Gina-Gail S. Fletcher, Engineered Credit Default Swaps:
Innovative or Manipulative?, 94 N.Y.U. L. Rev. 1073, 1101 (2019).
---------------------------------------------------------------------------

<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.\52\
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\52\ See Fletcher, supra note 51 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>?.
---------------------------------------------------------------------------

The 2021 Proposing Release also discussed the fact that in 2019,
the former SEC Chairman issued a joint public statement with the
principals of the CFTC and the U.K. Financial Conduct Authority at the
time stating that the ``continued pursuit of various opportunistic
strategies in the credit derivatives markets . . . may adversely affect
the integrity, confidence and reputation of the credit derivatives
markets, as well as markets more generally.'' \53\
---------------------------------------------------------------------------

\53\ 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> (``2019 Joint Statement'');
2021 Proposing Release, 87 FR at 6655.
---------------------------------------------------------------------------

Taking into consideration all of the above, Rule 9j-1 will be an
important additional tool to augment the Commission's oversight of the
security-based swap markets including, but not limited to, the markets
for CDS and TRS.

B. Overview of the Final Rules

1. Rule 9j-1
As described in detail below, final Rule 9j-1 includes prohibitions
on categories of misconduct prohibited by section 10(b) of the Exchange
Act, and Rule 10b-5 thereunder, and section 17(a) of the Securities
Act, when effecting any transaction in, or attempting to effect any
transaction in, any security-based swap, or when purchasing or selling,
or inducing or attempting to induce the purchase or sale of, any
security-based swap (including but not limited to, in whole or in part,
the execution, termination (prior to its scheduled maturity date),
assignment, exchange, or similar transfer or conveyance of, or
extinguishing of any rights or obligations under, any security based-
swap).\54\ The final rule also includes a provision prohibiting the
manipulation or attempted manipulation of the price or valuation of any
security-based swap, including any payment or delivery related thereto.
This provision has been moved to paragraph (a)(6) of Rule 9j-1 (from
paragraph (b) as proposed) to clarify that these provisions apply to
conduct that is undertaken in connection with directly or indirectly
effecting, or attempting to effect, any transaction in any security-
based swap, or purchasing or selling, or inducing or attempting to
induce the purchase or sale of, any security-based swap.\55\ Further,
final Rule 9j-1 provides that: (1) a person with material nonpublic
information about a security cannot avoid liability under the
securities laws by communicating about or making purchases or sales in
the security-based swap (as opposed to communicating about or
purchasing or selling the underlying security); and (2) a person cannot
avoid liability under section 9(j) or Rule 9j-1 in connection with a
fraudulent scheme involving a security-based swap by instead making
purchases or sales in the underlying

[[Page 42551]]

security (as opposed to purchases or sales in the security-based
swap).\56\ In addition, final Rule 9j-1 includes two affirmative
defenses from the liability under paragraphs (a)(1) through (5) of Rule
9j-1: (1) where the action otherwise prohibited by Rule 9j-1 was taken
pursuant to binding rights and obligations in written security-based
swap documentation so long as the security-based swap was entered into,
or the amendment was made, before the person became aware of the
material nonpublic information, and in good faith and not as part of a
plan or scheme to evade the prohibitions of Rule 9j-1; and (2) with
respect to entities, if the entity demonstrates that the individual at
the entity making the investment decision was not aware of material
nonpublic information and the entity had implemented reasonable
policies and procedures to prevent violations of Rules 9j-1(a)(1)
through(5).\57\
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\54\ See Rules 9j-1(a), (a)(1) through (a)(5), and (d).
\55\ See Rule 9j-1(a)(6).
\56\ See Rules 9j-1(b) and (c).
\57\ See Rule 9j-1(e).
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2. Rule 15fh-4(c)
The Commission also is adopting 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 adopting Rule 15fh-
4(copyright), which makes 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.\58\
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\58\ The Commission also amends the CFR designation of Rule
15Fh-4 in order to ensure the regulatory text conforms more
consistently with section 2.13 of the Document Drafting Handbook.
See Office of the Federal Register, Document Drafting Handbook (Aug.
2018 Edition, Revision 1.4, dated Jan. 7, 2022), available at
<a href="https://www.archives.gov/files/federal-register/write/handbook/ddh.pdf">https://www.archives.gov/files/federal-register/write/handbook/ddh.pdf</a>. In particular, the Commission amends the CFR section
designation for 17 CFR 240.15Fh-4 (Rule 15Fh-4) to replace the
uppercase letter with the corresponding lowercase letter, such that
the rule is redesignated as 17 CFR 240.15fh-4 (Rule 15fh-4).
---------------------------------------------------------------------------

II. Rule 9j-1: Prohibition Against Fraud, Manipulation, and Deception
in Connection With Security-Based Swaps

Final Rule 9j-1 will aid the Commission in its pursuit of actions
that directly target misconduct that reaches security-based swaps. The
rule takes into account the features of a security-based swap and the
broad definitions of ``purchase'' and ``sale'' in the Securities
Act,\59\ and of ``buy,'' ``purchase,'' ``sale,'' and ``sell'' in the
Exchange Act,\60\ to include the execution, termination (prior to its
scheduled maturity date), assignment, exchange, or similar transfer or
conveyance of, or extinguishing of any rights or obligations under, a
security-based swap, as the context may require. Final Rule 9j-1
applies to fraudulent, deceptive, or manipulative misconduct related to
the exercise of any right or performance of any obligation under a
security-based swap if such misconduct occurs in connection with
effecting or attempting to effect a transaction in, or purchasing or
selling, or inducing or attempting to induce the purchase or sale of, a
security-based swap.\61\ For example, to the extent that such
misconduct results in the execution, termination (prior to its
scheduled maturity date), assignment, exchange, or similar transfer or
conveyance of, or extinguishing of any rights or obligations under, a
security-based swap, as the context may require, Rule 9j-1 would apply.
In adopting Rule 9j-1, the Commission continues to recognize the
regulatory and market developments that supported the proposal of an
antifraud and anti-manipulation provision.\62\
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\59\ 15 U.S.C. 77b(a)(18).
\60\ 15 U.S.C. 78c(a)(13) and (14).
\61\ See supra section I.B.1 for a discussion regarding ongoing
payments and deliveries that are typical for a security-based swap.
\62\ See supra section I.B.2.
---------------------------------------------------------------------------

In general, 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 security-based swaps, including CDS, equity security-based swaps,
and non-CDS debt security-based swaps. Manipulation of the reference
underlying security can affect the pricing of an equity or debt
security-based swap, 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 swap
transactions that are effected over the internet, there is a potential
for trading software to distort pricing and payouts on security-based
swaps.\63\ Finally, to the extent a CDS-related opportunistic strategy
alters the operations of a reference entity, shareholders in reference
underlying entities and counterparties to any security-based swap based
on that reference entity could be impacted; the potential harm is not
limited to CDS holders or to the counterparties of bad actors.
---------------------------------------------------------------------------

\63\ 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> (``SEC Binary Options Fraud
Alert'') (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 Binary Options Fraud 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 Binary Options Fraud 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.
---------------------------------------------------------------------------

A. Misconduct ``In Connection With'' ``Purchases,'' ``Sales,'' or
``Effecting Transactions''

1. Proposed Approach
As proposed, Rule 9j-1 would have prohibited the same categories of
misconduct addressed by section 10(b) of the Exchange Act,\64\ and Rule
10b-5 thereunder,\65\ as well as section 17(a) of the Securities
Act.\66\ The proposed rule imposed liability for misconduct related to
any ongoing payments and deliveries that are typical of security-based
swaps and which occur throughout the life of the security-based
swap.\67\ Specifically, proposed Rule 9j-1(a) would have made it
unlawful for any person, directly or indirectly, to purchase or sell,
or attempt to induce the purchase or sale of, any security-based swap;
to effect any transaction in, or attempt to effect any transaction in,
any security-based swap; 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 to terminate (other than on its scheduled maturity date)
or settle any security-based swap, in connection with which such
person: (1) employs or attempts to employ any device, scheme,

[[Page 42552]]

or artifice to defraud or manipulate; (2) makes or attempts 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 the light of
the circumstances under which they were made, not misleading; (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.\68\ Additionally, proposed Rule 9j-1(e) provided 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.\69\
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\64\ 15 U.S.C. 78j(b).
\65\ 17 CFR 240.10b-5.
\66\ 15 U.S.C. 77q(a).
\67\ See 2021 Proposing Release, 87 FR at 6661-62.
\68\ See 2021 Proposing Release, 87 FR at 6703.
\69\ See 15 U.S.C. 78c(a)(13) and (14).
---------------------------------------------------------------------------

2. Commission Action
The Commission is adopting final Rule 9j-1(a), but has revised the
rule to more closely follow the language used in the definitions of
``purchase'' and ``sale,'' and ``buy'' and ``sell'' in the Exchange
Act, as amended by the Dodd-Frank Act, and to respond to commenter
concerns.\70\ Specifically, the rule makes it unlawful for any person,
directly or indirectly, to effect any transaction in, or attempt to
effect any transaction in, any security-based swap, or to purchase or
sell, or induce or attempt to induce the purchase or sale of, any
security-based swap (including but not limited to, in whole or in part,
the execution, termination (prior to its scheduled maturity date),
assignment, exchange, or similar transfer or conveyance of, or
extinguishing of any rights or obligations under, a security based-
swap, as the context may require), in connection with which such person
engages in the activities specified in Rules 9j-1(a)(1) through
(6).\71\ Final Rule 9j-1(a) prohibits fraudulent, deceptive, or
manipulative misconduct related to the payments, deliveries, rights, or
obligations under a security-based swap if that misconduct occurs in
connection with effecting or attempting to effect a transaction in, or
purchasing or selling, or inducing or attempting to induce the purchase
or sale of, a security-based swap.\72\ Further, the Commission is
adopting Rule 9j-1(e) as proposed but now renumbered as final Rule 9j-
1(d).
---------------------------------------------------------------------------

\70\ See 15 U.S.C. 78c(a)(13) and (14).
\71\ See supra sections II.B and II.C.
\72\ See final Rule 9j-1(a).
---------------------------------------------------------------------------

Several commenters supported the application of Rule 9j-1(a) to the
exercise of rights and performance of obligations under a security-
based swap.\73\ One commenter recognized that the proposed rule
``appropriately recognizes that [security-based swaps] have unique
characteristics in the form of `ongoing payments or deliveries between
the parties throughout the life of the security-based swap pursuant to
their rights and obligations,' '' which creates additional
opportunities for fraud and manipulation, as compared to other types of
securities, therefore warranting ``their own unique anti-fraud rule.''
\74\
---------------------------------------------------------------------------

\73\ See Letter from Andrew Park, Americans for Financial Reform
Education Fund (``AFRED''), dated Mar. 21, 2022 (``AFRED Letter'');
Letter from Stephen W. Hall and Jason Grimes, Better Markets, Inc.,
dated Mar. 21, 2022 (``Better Markets Letter''); Letter from Gina-
Gail S. Fletcher, Duke University School of Law, dated Mar. 21, 2022
(``Fletcher Letter'').
\74\ Better Markets Letter at 9. Another commenter also noted
the ``unique risks and long duration, with a potentially complex
stream of payments and obligations'' of security-based swaps in
their support of the scope of the proposed rule. Fletcher Letter at
2.
---------------------------------------------------------------------------

Two commenters argued that the Commission exceeded its statutory
authority by applying proposed Rule 9j-1(a) ``to every interim
performance obligation'' and every exercise of a right under a
security-based swap.\75\ One commenter asserted that ``[h]ad Congress
intended'' for Exchange Act section 9(j) to cover ``actions related to
the ongoing performance of obligations under a security-based swap
agreement, it would have expressly done so in the Dodd-Frank Act or
subsequent legislation, particularly given that it amended the
definitions of `purchase' and `sale' to reflect security-based swaps.''
\76\ The commenter stated that ``[i]n so doing, Congress made a
determination to limit the covered actions to `execution,'
`termination,' `exchange,' or `extinguishing' of rights or obligations
under a security-based swap.'' \77\ The commenter also stated that
``[t]here is also no precedent or support for the Commission to adopt a
broad interpretation of the phrase `to effect any transaction in' . . .
as a basis for including interim performance obligations within the
scope of proposed Rule 9j-1, as this has not been the traditional and
longstanding understanding of that statutory phrase.'' \78\ Another
commenter asserted that the Commission could not use its prophylactic
authority under section 9(j) as a means to ``extend Proposed Rule 9j-
1(a) beyond'' what the commenter stated was ``any natural reading of
the terms `purchase' or `sale.' '' \79\
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\75\ Letter from Jennifer W. Han, Managed Funds Association
(``MFA''), dated Mar. 21, 2022 (``MFA Letter''), at 4. See id. at 3-
8; IIB-ISDA-SIFMA Letter at 6-8.
\76\ MFA Letter at 5. See IIB-ISDA-SIFMA Letter at 6.
\77\ MFA Letter at 5.
\78\ Id. at 7.
\79\ IIB-ISDA-SIFMA Letter at 8.
---------------------------------------------------------------------------

The same two commenters also raised practical concerns about
applying Rule 9j-1(a) to every exercise of a right or performance of an
obligation under a security-based swap. One commenter stated that ``if
the proposed antifraud rule can be applied to any action or omission
`related to performance of any obligation,' market participants will
undoubtedly seek to limit the scope of their transactions, and the
terms of such transactions, in order to mitigate their exposure to
liability under the rule'' and some market participants would
``terminate their involvement in the security-based swap market
entirely.'' \80\ The commenter asserted that this result would ``reduce
liquidity in security-based swap markets and, by restricting hedging
opportunities, have a material adverse effect on the availability and
cost of capital for issuers.'' \81\ The other commenter asserted that
``Proposed Rule 9j-1(a)'s application to non-volitional conduct under
[a security-based swap] would not be appropriate because it would cast
uncertainty on a wide range of bona fide conduct necessary to the
operation of the capital markets'' and ``risks chilling legitimate
market conduct as market participants try to determine whether conduct
unrelated to an affirmative investment decision could be judged after
the fact to be prohibited.'' \82\
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\80\ MFA Letter at 7-8 (emphasis in original).
\81\ MFA Letter at 8.
\82\ IIB-ISDA-SIFMA Letter at 8-9.
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The Commission has carefully considered the comments and, as
discussed below in sections II.A.2.a through II.A.2.c, is revising Rule
9j-1 to specify that it applies to misconduct that occurs in connection
with effecting any transaction in, or attempting to effect any
transaction in, any security-based swap, or purchasing or selling, or
inducing or attempting to induce the purchase or sale of, any security-
based swap (including but not limited to, in whole or in part, the
execution, termination (prior to its scheduled maturity date),
assignment, exchange, or similar transfer or conveyance of, or
extinguishing of any rights or obligations under, a security based-
swap). The language in final Rule 9j-1(a) is based on section 9(j) of
the

[[Page 42553]]

Exchange Act and the definitions of ``purchase'' and ``sale,'' and
``buy'' and ``sell,'' which were amended by the Dodd-Frank Act to take
into account the unique characteristics of security-based swaps.\83\
The final rule text also is revised to make it unlawful to ``induce . .
. the purchase or sale'' of any security-based swap, in addition to
``purchase or sell,'' and ``attempt to induce the purchase or sale
of,'' any security-based swap. This addition is made to track the
statutory language of section 9(j) of the Exchange Act.\84\ In addition
to the changes to Rule 9j-1(a), in response to commenters' practical
concerns, as discussed in section II.E.2, the Commission is adopting
affirmative defenses.
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\83\ The Dodd-Frank Act amended the definitions of ``purchase''
and ``sale'' in section 2(a)(18) of the Securities Act, 15 U.S.C.
77b(a)(18), the definitions of ``buy'' and ``purchase'' in section
3(a)(13) of the Exchange Act, 15 U.S.C. 78c(a)(13), and ``sale'' and
``sell'' in section 3(a)(14) of the Exchange Act, 15 U.S.C.
78c(a)(14), in the context of security-based swaps, to include ``the
execution, termination (prior to its scheduled maturity date),
assignment, exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a security-based swap,
as the context may require.'' Final Rule 9j-1(d) makes clear that
``[f]or purposes of this section, the terms `purchase' and `sale'
shall have the same meanings as set forth in Sections 3(a)(13) (15
U.S.C. 78c(a)(13)) and 3(a)(14) (15 U.S.C. 78c(a)(14)) of the Act.''
\84\ See 15 U.S.C. 78i(j).
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Depending on the facts and circumstances of a particular situation,
as discussed in sections II.A.2.a through II.A.2.c below, final Rule
9j-1 may reach misconduct that affects the payments and deliveries that
typically occur throughout the life of a security-based swap, if that
misconduct occurs in connection with effecting or attempting to effect
any transaction in, or purchasing or selling, or inducing or attempting
to induce the purchase or sale of, any security-based swap. Consistent
with the operation of other antifraud provisions in the securities
laws, whether that connection exists will be determined on a case-by-
case basis.\85\ Sections II.A.2.a through II.A.2.c below discuss the
scope of ``in connection with,'' ``purchases or sales,'' and
``effecting transactions'' in the context of final Rule 9j-1(a).
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\85\ One commenter asserted that the Commission's rulemaking
authority under section 9(j) is limited to ``identify[ing] specific
transactions, acts, practices and courses of business'' that are
fraudulent, deceptive, or manipulative. IIB-ISDA-SIFMA Letter at 8.
The text of section 9(j), which authorizes the Commission to
``define, and prescribe means reasonably designed to prevent, such
transactions, acts, practices, and courses of business as are
fraudulent, deceptive, or manipulative,'' does not require the
Commission to identify ``specific transactions, acts, practices and
courses of business.'' Because security-based swaps are complex, and
related strategies are constantly evolving, new opportunities for
misconduct likewise constantly arise. Rule 9j-1 must be flexible to
enable the Commission to prevent such misconduct.
---------------------------------------------------------------------------

a. In Connection With
Final Rule 9j-1 prohibits misconduct ``in connection with''
effecting any transaction in, or attempting to effect any transaction
in, any security-based swap, or when purchasing or selling, or inducing
or attempting to induce the purchase or sale of, any security-based
swap. Even if taking an action related to payments and deliveries under
any security-based swap would not itself constitute a purchase or sale,
or effecting a transaction, conduct that affects payments and
deliveries may occur ``in connection with'' purchases or sales, or
effecting a transaction. The Supreme Court has ``espoused a broad
interpretation'' of ``in connection with,'' \86\ holding that the
phrase ``should be `construed not technically and restrictively, but
flexibly to effectuate its remedial purposes.' '' \87\ Accordingly, the
Court has held that ``it is enough that the fraud alleged `coincide'
with a securities transaction.'' \88\ As one commenter who was critical
of the breadth of proposed Rule 9j-1(a) acknowledged, ``much of the
illegitimate conduct described in the [proposing] release''--and in
section I.B.2, supra--``involves a purchase or sale of securities.''
\89\
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\86\ Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547
U.S. 71, 85 (2006).
\87\ SEC v. Zandford, 535 U.S. 813, 819 (2002) (citations
omitted).
\88\ Dabit, 547 U.S. at 85 (citation omitted). See
Superintendent of Ins. of State of N.Y. v. Bankers Life & Cas. Co.,
404 U.S. 6, 12 (1971) (``deceptive practices touching [a] sale'' are
actionable); Chadbourne & Parke LLP v. Troice, 571 U.S. 377, 387
(2014) (fraud occurred ``in connection with'' a purchase or sale if
it was ``material to and `coincided with' third-party securities
transactions'' (quoting Dabit, 547 U.S. at 85)).
\89\ IIB-ISDA-SIFMA Letter at 9. As an example, the commenter
stated, ``the credit event under a credit default swap . . .
typically settles through an auction process that involves purchases
and sales of securities [and] many of the transactions with
reference entities identified by the Commission are securities
transactions.'' Id. As discussed below, see infra section II.A.2.c,
settlement also is part of effecting a securities transaction. See
15 U.S.C. 78bb(e)(3)(C).
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Moreover, the Supreme Court has held that the requirement that
``deception occur `in connection with the purchase or sale of any
security''' does not require ``deception of an identifiable purchaser
or seller'' because ``[t]he Exchange Act was enacted in part `to insure
the maintenance of fair and honest markets''' generally.\90\ The ``in
connection with'' requirement accordingly can be satisfied ``even
though the person or entity defrauded is not the other party to the
trade''--or here, the counterparty to the relevant security-based
swap.\91\ For that reason, misconduct that affects the payments and
deliveries under one security-based swap could be prohibited by final
Rule 9j-1 if that misconduct occurs in connection with effecting or
attempting to effect transactions or purchasing or selling or
attempting to induce the purchase or sale of any security-based swap,
and not just the security-based swap that was the subject of the
misconduct.
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\90\ United States v. O'Hagan, 521 U.S. 642, 657-58 (1997)
(quoting 15 U.S.C. 78b).
\91\ Id. at 656.
---------------------------------------------------------------------------

b. Purchases or Sales
Not only is ``in connection with'' construed broadly, Congress also
has broadly defined what constitutes a ``purchase'' and ``sale.''
Generally, purchases and sales of securities include ``contracts to
buy, purchase or otherwise acquire'' or ``contracts to sell or
otherwise dispose of'' the security, respectively.\92\ For security-
based swaps, as part of the provisions of the Dodd Frank Act that gave
the Commission new authority over that market, Congress added that
purchases and sales also include ``the execution, termination (prior to
its scheduled maturity date), assignment, exchange, or similar transfer
or conveyance of, or extinguishing of rights or obligations under, a
security-based swap, as the context may require.'' \93\ Final Rule 9j-
1(a) accordingly prohibits fraudulent, deceptive, or manipulative
conduct that affects ongoing payments and deliveries under a security-
based swap if that misconduct occurs in connection with any activity
that falls within those broad definitions.\94\
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\92\ 15 U.S.C. 78c(a)(13) and 78c(a)(14).
\93\ 15 U.S.C. 77b(a)(18), 78c(a)(13), and 78c(a)(14).
\94\ One commenter expressed concern that the term ``terminate
(other than on its scheduled maturity date)'' in proposed Rule 9j-
1(a) was ``simultaneously too broad and too narrow.'' Fletcher
Letter at 2. The commenter stated that the term ``would appear to
exempt terminations at maturity from the scope of the rule'' even if
``an opportunistic scheme could be executed in line with the
scheduled maturity date,'' while applying to ``contractually
permitted terminations'' prior to maturity that are ``not conducted
to intentionally distort the swap transaction.'' Id. Consistent with
Exchange Act sections 3(a)(13) and (14), the Commission has revised
final Rule 9j-1(a) to state that a purchase or sale of a security-
based swap includes, but is not limited to, a ``termination (prior
to its scheduled maturity date) . . . of . . . a security-based
swap,'' and includes any ``similar transfer or conveyance of, or
extinguishing of any rights or obligations under, a security-based
swap, as the context may require.'' Depending on the context, the
termination of a security-based swap on the scheduled maturity date
could constitute such a ``similar transfer or conveyance'' or
``extinguish[ment] of any rights or obligations.'' And while a
contractually permitted termination of a security-based swap prior
to maturity constitutes a purchase or sale under the terms of both
section 3(a) and Rule 9j-1(a), Rule 9j-1(a) prohibits only
fraudulent, deceptive, or manipulative conduct in connection with a
termination.

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[[Page 42554]]

Those definitions are not limited to executions, terminations,
assignments, exchanges, or similar transfer or conveyance of, or
extinguishing of all the rights or obligations under, a security-based
swap. Therefore, the Commission also has revised final Rule 9j-1(a) to
add the words ``including but not limited to, in whole or in part''
before listing the activities enumerated in Exchange Act sections
3(a)(13) and (14).\95\ In addition, the final rule includes the word
``any'' before ``rights or obligations.'' These modifications clarify
that, for purposes of the antifraud and anti-manipulation provisions of
paragraph (a), the definitions of purchase and sale encompass, among
other things, partial executions, terminations, assignments, exchanges,
transfers or conveyances of, or extinguishing of any rights or
obligations under, a security-based swap, as the context may
require.\96\ The Commission stated in the 2021 Proposing Release that
the Exchange Act's definitions of purchase and sale in the context of
security-based swaps ``incorporate actions that have an impact on some,
but not all, rights and obligations'' under a security-based swap,
including ``partial executions, terminations, assignments, exchanges,
transfers, or extinguishments of rights or obligations.'' \97\
Commenters did not disagree.\98\
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\95\ The phrase ``but not limited to'' reflects the fact that
Exchange Act sections 3(a)(13) and (14) do not limit the definition
of purchase or sale to the enumerated activities, contrary to the
assertion of one commenter. See MFA Letter at 5; supra notes 76 and
77, and related discussion.
\96\ See Rule 9j-1(a) (``to purchase or sell, or induce or
attempt to induce the purchase or sale of, any security-based swap
(including but not limited to, in whole or in part, the execution,
termination (prior to its scheduled maturity date), assignment,
exchange, or similar transfer or conveyance of, or extinguishing of
any rights or obligations under, a security based-swap, as the
context may require'').
\97\ 2021 Proposing Release, 87 FR at 6661.
\98\ See, e.g., IIB-ISDA-SIFMA Letter at 7 (``We concur with
this reading, insofar as it would extend Proposed Rule 9j-1(a) to an
affirmative action relating to an investment decision and affecting
a material term of [a security-based swap], for example a partial
termination or assignment.'').
---------------------------------------------------------------------------

It also is reasonable to include partial executions, terminations,
assignments, exchanges, or similar transfers or conveyances of, or
extinguishing of rights or obligations under, a security-based swap
within the scope of the rule because those actions could result in
amendments to the material terms of the security-based swap and,
therefore, result in a new security-based swap (that is, a ``purchase''
or ``sale'').\99\ Security-based swaps take many different forms and
are used for many different purposes, but often are used to hedge
risks. Even a partial change in any of the rights and obligations
underlying the security-based swap--particularly those related to
ongoing payments and deliveries--could affect the alignment of that
hedge with the attendant risk and, under a facts and circumstances
analysis, could constitute a purchase or sale of a security-based swap.
A different approach--one that only prohibited misconduct in connection
with the extinguishment of all of the rights and obligations under a
security-based swap--would leave market participants vulnerable to the
risks that the security-based swap was entered into to address (as well
as decrease the alignment of any hedge entered into to address the risk
of the security-based swap itself). These revisions to the text of
final Rule 9j-1 also ensure that market participants cannot evade
liability under Rule 9j-1 by, for example, structuring fraudulent,
deceptive, or manipulative conduct so that some portion of a
counterparty's rights and obligations under a security-based swap
remain in place.
---------------------------------------------------------------------------

\99\ See infra note 100, and related discussion of amendments of
material terms.
---------------------------------------------------------------------------

Relatedly, the Commission reiterates that ``[i]f the material terms
of a'' security-based swap ``are amended or modified during its life
based on an exercise of discretion and not through predetermined
criteria or a predetermined self-executing formula,'' then ``the
amended or modified'' security-based swap is a ``new'' security-based
swap.\100\ For example, contrary to one commenter's assertion,\101\
amendments to terms regarding ongoing rights and obligations under a
security-based swap, including those related to ongoing payments and
deliveries, could result in a new transaction.\102\ When an amendment
or modification constitutes a purchase or sale of a security-based
swap, Rule 9j-1(a) prohibits any fraudulent, deceptive, or manipulative
conduct that occurs in connection with it.
---------------------------------------------------------------------------

\100\ Product Definitions Release, 77 FR at 48286; see 17 CFR
230.145(a) Preliminary Note (``Changing the nature and terms of an
investor's relationship to the issuer may represent the offer or
sale of a new security for value.''); 2021 Proposing Release, 87 FR
at 6661. Similarly, courts have found that if an amendment or
modification to the terms of a security results in `` `a significant
change in the nature of the investment or risk' '' related to that
security, a new security results. Department of Economic Development
v. Arthur Anderson & Co. (U.S.A.), 924 F. Supp. 449, 478 (S.D.N.Y.
1996) (citation omitted). See also, e.g., Ingenito v. Bermac Corp.,
376 F. Supp. 1154, 1181 (S.D.N.Y. 1974) (considering claims of
Section 10(b) and finding that ``a purchase or a sale arises when
the nature and terms of an investor's involvement in a business
enterprise are substantially altered by the creation of new rights
or obligations''); Louis Loss, et al., Securities Regulation Sec.
3.A.2 (2023) (citing to N. Natural Gas Co., 14 SEC 506, 509 (1943)
(noting that ``for example, a change in interest or dividend rate or
a liquidation preference or underlying security, or a change in the
identity of the issuer, would seem clearly to result in a new
security'')). Changes are more likely to be considered
``significant'' if they are adverse to the security holders
affected. See, e.g., SEC v. Associated Gas & Electric Co., 99 F.2d
795, 797-98 (2nd Cir. 1938) (holding that under the Public Utility
Holding Company Act of 1935, the extension of the maturity date of a
debt security increased the risk to the holder and therefore
constituted the sale of a new security). See also Rathborne v.
Rathborne, 683 F.2d 914, 920 (5th Cir. 1982) (``In determining
whether a party to a securities transaction is a `purchaser' or
`seller,' we must ask whether the transaction has wrought a
fundamental change in the nature of the plaintiff's investment . . .
. [T]he core issue is whether the transaction has transformed the
plaintiff into the functional equivalent of a purchaser or seller--
has the plaintiff been forced to exchange his stock for shares
representing a participation in a substantially different
enterprise? We must focus upon the economic reality of the
transaction, and determine whether the transaction has `transformed'
the plaintiff's interests `in any real sense.' '' (citations
omitted)); Keys v. Wolfe, 709 F.2d 413, 417 (5th Cir. 1983) (holding
that ``the determination of whether'' there has been ``a significant
change in the nature of the investment or in the investment risks .
. . hinges on the economic reality of the transaction rather than on
formal changes in the rights and obligations of the parties'').
\101\ MFA Letter at 6.
\102\ See Loss, supra note 100 (noting that ``a change in
interest or dividend rate''--which is an ongoing right or
obligation--``would seem clearly to result in a new security'').
---------------------------------------------------------------------------

Two commenters agreed that ``Rule 9j-1 should be applicable . . .
if the parties to a security-based swap transaction make changes to
material terms that result in the creation of a new transaction.''
\103\ But these commenters disagreed with the Commission's assertion in
the 2021 Proposing Release that such a modification or amendment--and
thus a purchase or sale--occurs when a party engages in conduct that
``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.'' \104\ Under final Rule 9j-1(a), whether a purchase or sale
of a security-based swap has occurred will depend on the facts and
circumstances and therefore the operation of the rule, as revised, is
not dependent on the language in the 2021 Proposing Release

[[Page 42555]]

quoted by the commenters.\105\ Applying a facts and circumstances
analysis, if conduct that affects ongoing payments or deliveries
results in the extinguishment of a right or obligation under a
security-based swap, such as the right to such a payment or delivery,
or otherwise results in a new transaction, then a purchase or sale will
have occurred, and any related fraudulent, deceptive, or manipulative
misconduct will fall within Rule 9j-1's prohibitions.
---------------------------------------------------------------------------

\103\ MFA Letter at 4. See IIB-ISDA-SIFMA Letter at 7
(``[M]arket participants have arranged their affairs to treat such
an exercise of discretion to amend a material term of [a security-
based swap] as tantamount to the `purchase' or `sale' of [a
security-based swap], including for anti-fraud purposes.'').
\104\ 2021 Proposing Release, 87 FR at 6661. See IIB-ISDA-SIFMA
Letter at 7-8; MFA Letter at 4.
\105\ See supra note 96. The language ``as the context may
require,'' which is included in Rule 9j-1, comes from the
definitions of purchase and sale in Exchange Act sections 3(a)(13)
and 3(a)(14), and recognizes the need to consider the facts of a
particular situation to determine whether a purchase or sale has
occurred.
---------------------------------------------------------------------------

c. Effecting Transactions
Exchange Act section 9(j), and accordingly final Rule 9j-1(a), also
is not limited to prohibitions on fraud, manipulation, or deception in
connection with the purchase or sale of a security-based swap, but also
encompasses misconduct in connection with effecting a transaction in
any security-based swap. While the term ``transaction'' ``is not
defined in the Act, its broad meaning in everyday usage'' and ``the
context in which it is used in the various sections of the Act''
demonstrate that ``it has a broader meaning than purchases or sales.''
\106\ The Commission accordingly has construed the term ``to effect any
transaction in'' a security, variations of which appear in numerous
provisions of the securities laws, to include activity such as placing
bids or orders, and clearance and settlement of a securities
transaction.\107\ The Commission also has stated that ``key aspects of
the overall process of effecting security-based swap transactions''
include ``sales, booking and cash and collateral management
activities.'' \108\
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\106\ In re Kidder Peabody & Co., 18 S.E.C. 559, 1945 WL 332559,
at *8 (Apr. 2, 1945) (interpreting Exchange Act section 9(a)(2) and
finding that Congress intended to extend its ``prohibition against
manipulation . . . beyond the actual consummation of purchases or
sales,'' to include ``affecting the market artificially by raising
or depressing security prices, or creating actual or apparent
activity, whether or not accomplished by actual purchases or
sales''). See SEC v. Lek Sec. Corp., 276 F. Supp. 3d 49, 62
(S.D.N.Y. 2017) (``Courts have held that a `series of transactions'
includes not only completed purchases or sales but also bids and
orders to purchase or sell securities.'').
\107\ Kidder Peabody, 1945 WL 332559, at *8. See 15 U.S.C. 78bb
(identifying ``clearance, settlement, and custody'' as ``functions
incidental'' to ``effect[ing] securities transactions''). Settlement
of security-based swaps occurs over time in accordance with
contractually agreed upon terms (in contrast to other securities
such as debt or equity, where settlement occurs when the parties
exchange securities for cash equal to the full value of the
securities sold). See T+1 Adopting Release, 88 FR at 13878, 13883
(quoting SIFMA who noted that, that for security-based swaps,
settlement occurs when a ``final net payment is paid by one party to
the other at a future point in time to which the parties have
contractually agreed'' (citation omitted)). See also supra note 32.
\108\ Registration Process for Security-Based Swap Dealers and
Major Security-Based Swap Participants, Exchange Act Release No.
75611 (Aug. 5, 2015), 80 FR 48964, 48976 n.99 (Aug. 14, 2015)
(``SBSD/MSBSP Registration Process Release''). In the SBSD/MSBSP
Registration Process Release, in the context of determining who has
to register as a security-based swap dealer, the Commission
identified some activities that would fall within the definition of
``involved in effecting security-based swap transactions''--for
example, pricing security-based swap positions and managing
collateral. The identification of these activities as part of ``the
overall process of effecting'' a transaction'' also serves to
demonstrate that not all activities in that process take place prior
to the execution of the security-based swap. See MFA Letter at 7
(asserting ``[i]nterpretations of `effect[ing] a transaction,' . . .
have been limited to the process leading to the purchase or sale of
a security'' (emphasis added)). In addition, as the Commission has
previously explained in the context of broker-dealers, ``effecting''
transactions in securities has been construed broadly to encompass a
wide range of activities, including: (1) transmission of an order
for execution, order execution, clearance and settlement, and
arranging for the performance of any such function, see 17 CFR
240.11a2-2(T); 2014 Temp Rule 11a2-2(T); and (2) screening potential
transaction participants for creditworthiness, soliciting securities
transactions, routing or matching orders or facilitating the
execution of a transaction, handling customer funds and securities,
and preparing and sending transaction confirmations, 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)). Critically,
several of these activities are not limited to pre-trade actions
(e.g., clearance, settlement, and handling counterparty funds).
---------------------------------------------------------------------------

Final Rule 9j-1(a) therefore prohibits fraudulent, manipulative, or
deceptive conduct related to the exercise of rights or performance of
obligations--including ongoing payments and deliveries--under a
security-based swap if that misconduct occurs in connection with a
broad range of activities ``beyond the actual consummation of purchases
or sales.'' \109\ For example, as discussed in section II.C below, a
manipulation of the ongoing payments and deliveries under a security-
based swap could be used to ``affect[ ] the market artificially by
raising or depressing securities prices,'' and that conduct would be
connected to effecting transactions in security-based swaps.\110\
Similarly, as one commenter noted, a ``misappropriation of customer
margin'' would be connected to effecting a security-based swap
transaction.\111\
---------------------------------------------------------------------------

\109\ Kidder Peabody, 1945 WL 332559, at *8. See 15 U.S.C. 78bb
(identifying ``clearance, settlement, and custody'' as ``functions
incidental'' to ``effect[ing] securities transactions'').
\110\ Id. For example, a platform that effects transactions in
security-based swaps, such as binary options or other event
contracts, could fraudulently extinguish a holder's right to
payment. Such conduct could also affect the market price for similar
binary options or event contracts.
\111\ IIB-ISDA-SIFMA Letter at 9.
---------------------------------------------------------------------------

In addition, the Commission is extending the application of final
Rule 9j-1(a) to fraudulent, deceptive, or manipulative misconduct that
occurs in connection with an ``attempt'' to effect a transaction in any
security-based swap. This application is consistent with section 9(j)'s
prohibition of fraud, deception, and manipulation in connection with an
``attempt to induce the purchase or sale of'' any security-based swap
and is supported by case law that recognizes that fraudulent,
deceptive, or manipulative conduct need not be successful to violate
the securities laws.\112\ It is also a ``means reasonably designed to
prevent'' misconduct that results in completed transactions, which the
statute explicitly prohibits.\113\
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\112\ See, e.g., Koch v. SEC, 793 F.3d 147, 153-54 (D.C. Cir.
2015) (``[I]ntent--not success--is all that must accompany
manipulative conduct to prove a violation of the Exchange Act and
its implementing regulations.'' (citation omitted)); Kuehnert v.
Texstar Corp., 412 F.2d 700, 704 (5th Cir. 1969) (``[W]e are not
convinced of any difference in substance between a successful fraud
and an attempt. The statutory phrase `any manipulative or deceptive
device,' 15 U.S.C. 78j(b), seems broad enough to encompass conduct
irrespective of its outcome.''); Lek, 276 F. Supp. at 60 (S.D.N.Y.
2017) (``manipulative conduct need [not] be successful in order to
violate the securities laws''); SEC v. Martino, 255 F. Supp. 2d 268,
287 (S.D.N.Y. 2003) (``an attempted manipulation is as actionable as
a successful one''). See also Lorenzo v. SEC, 139 S. Ct. 1094, 1104
(2019) (``The Commission . . . need not show reliance in its
enforcement actions.'').
\113\ 15 U.S.C. 78i(j).
---------------------------------------------------------------------------

B. Fraudulent, Manipulative, or Deceptive Conduct

1. Proposed Approach
Proposed Rules 9j-1(a)(1) through (4), describing the prohibited
fraudulent, manipulative, or deceptive conduct, was structured to
include the antifraud and anti-manipulation provisions--in section
10(b) of the Exchange Act, and Rule 10b-5 thereunder, and section 17(a)
of the Securities Act--that apply to all securities (including
security-based swaps), and the additional antifraud and anti-
manipulative authority specific to security-based swaps provided to the
Commission in section 9(j) of the Exchange Act. Specifically, the
proposed rule would have prohibited: (1) employing or attempting to
employ any device, scheme, or artifice to defraud or manipulate; (2)
making or attempting to make any untrue statement of a material fact,
or omitting to state a material fact necessary in order to make the
statements made, in the light of the circumstances under which they
were

[[Page 42556]]

made, not misleading; (3) 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; or (4) 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.\114\
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\114\ 2021 Proposing Release, 87 FR at 6658-60.
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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, would have required scienter. In contrast, proposed
Rules 9j-1(a)(3) and (4) would not have required scienter and would
have extended to conduct that is at least negligent, consistent with
sections 17(a)(2) and (3) of the Securities Act.
2. Commission Action
After considering the comments, the Commission is revising proposed
Rule 9j-1(a) as discussed below in sections II.B.2.a and II.B.2.b.\115\
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\115\ Final Rule 9j-1(a)(6), which is a revision of proposed
Rule 9j-1(b), is discussed in section II.C below.
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Final Rule 9j-1(a)(1) is being adopted as proposed, and will
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) of the Exchange Act,\116\ Rule 10b-5
thereunder,\117\ and section 17(a)(1) of the Securities Act,\118\ the
inclusion of ``manipulate'' also comes from the text of section 9(j)).
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\116\ 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.'' 15 U.S.C. 78j(b).
\117\ 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.'' 17 CFR 240.10b-5.
\118\ 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.'' 15 U.S.C. 77q(a).
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Final Rule 9j-1(a)(2), which is based on section 9(j) and Rule 10b-
5, will prohibit making or attempting to make any untrue statement of a
material fact, or omitting 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.
Proposed paragraphs (a)(3) and (4) are revised to separate
attempted conduct into a new paragraph (a)(5) (to which a scienter
standard is applicable, as discussed in section II.B.2.b below).
Paragraph (a)(3) will prohibit obtaining 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.
Paragraph (a)(4) will prohibit engaging in any act, practice, or course
of business which operates or would operate as a fraud or deceit upon
any person. Paragraphs (a)(3) and (4) are based on sections 17(a)(2)
and (3) of the Securities Act, as well as Exchange Act section 9(j),
which similarly prohibits ``engag[ing] in any transaction, practice, or
course of business which operates as a fraud or deceit upon any
person.'' \119\
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\119\ See supra notes 5 and 118.
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Paragraph (a)(5) will prohibit 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 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. As discussed in section II.B.2.b below, the
prohibition on attempted conduct in paragraphs (a)(1), (a)(2), and
(a)(5) is premised on the text of section 9(j), including the
Commission's prophylactic authority to ``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.''
The provisions described above generally prohibit a range of
fraudulent, manipulative, and deceptive conduct in the security-based
swap market.\120\ Case law related to section 10(b) of the Exchange
Act, Rule 10b-5 thereunder, and section 17(a) of the Securities Act
provides guidance as to what conduct violates section 9(j) of the
Exchange Act and Rule 9j-1 thereunder.
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\120\ See 2021 Proposing Release, 87 FR at 6659.
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a. Scienter and Negligence Standards
Findings of misconduct under final Rules 9j-1(a)(1) and (2) require
scienter while final Rules 9j-1(a)(3) and (4) do not require scienter
and extend to conduct that is at least negligent.\121\ While both Rules
9j-1(a)(2) and (3) prohibit material misstatements and omissions,\122\
they address different levels of culpability.\123\ Specifically, Rule
9j-1(a)(2) will 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, Rule 9j-1(a)(3) extends 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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\121\ In addition, findings of misconduct under paragraphs
(a)(5) and (a)(6) will require scienter. See infra section II.B.2.b
(paragraph (a)(5)) and section II.C.2 (paragraph (a)(6)).
\122\ 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).
\123\ In addition to differences in the standard, there are
additional deviations between 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)'').
---------------------------------------------------------------------------

Several commenters argued for a scienter standard, rather than the
proposed negligence standard, with respect to paragraphs (3) and (4) of
Rule 9j-1(a).\124\ Specifically, one commenter

[[Page 42557]]

argued that applying a negligence standard ``is inconsistent with the
concept of fraud'' and that ``mere human error--which often occurs from
the high volume of the [security-based swaps] business/frequent
settlement activities--could result in liability.'' \125\ Another
commenter stated that, at a minimum, ``any liability for interim
actions taken during the term of the security-based swap should be
subject to a scienter standard.'' \126\ In addition, other commenters
believed that a negligence based standard would be ``disruptive to'' or
``chill'' the security-based swap market \127\ and interfere with the
legitimate actions taken by lenders engaged in security-based swap
transactions.\128\
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\124\ See IIB-ISDA-SIFMA Letter at 13 (arguing against applying
a negligence standard for attempted conduct); LSTA Letter, at 5-7;
MFA Letter at 12; Letter from John R. Williams, Milbank LLP, dated
Mar. 22, 2022 (``Milbank Letter''), at 5. The European Banking
Federation (``EBF'') supports the arguments in the IIB-ISDA-SIFMA
Letter regarding proposed Rule 9j-1. See Letter from EBF, dated Apr.
1, 2022, at 1. As proposed, paragraphs (3) and (4) of Rule 9j-1(a)
would have prohibited actions related to security-based swaps in
which a person 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 in which a person 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.
\125\ See Milbank Letter at 5.
\126\ MFA Letter at 12-13 (arguing that liability under Rule 9j-
1(a)(3) and (4) should be subject to scienter because security-based
swap transactions are between ``sophisticated counterparties dealing
directly with each other on negotiated terms'' rather than
``impersonal transactions'' where there is a stronger argument for
imposing liability under section 17(a) without scienter because it
is harder to form a specific intent absent a relationship between
the purchaser and the seller). Actions by the Commission demonstrate
that security-based swap transactions are not always between
sophisticated counterparties with ongoing relationships. See, e.g.,
In the Matter of Plutus Financial Inc. d/b/a Abra and Plutus
Technologies Philippines Corp., Exchange Act Release No. 89296 (July
13, 2020) (offering security-based swaps to retail investors via a
phone application); In the Matter of Forcerank LLC, Exchange Act
Release No. 79093 (Oct. 13, 2016) (illegally offering complex
security-based swaps to retail investors). See also SEC Binary
Options Fraud Alert, supra note 63 (alerting investors of fraudulent
binary options internet-based trading platforms).
\127\ See, e.g., MFA Letter at 12; Milbank Letter at 5. See also
ACLI Letter at 6 (arguing that ``a negligence standard . . . could
impact detrimentally other market participants that are involved in
private credit markets and originations'').
\128\ See LSTA Letter at 5-6 (supporting a scienter standard to
``address the concern that a lender could be subject to negligence
claims as a result of the often-fluid nature of security-based swap
or loan transactions that may be subject to private negotiations,
restructuring, or amendment at any given time'').
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Although the Commission has considered the concerns raised by these
commenters, it is adopting Rules 9j-1(a)(1) through (4) using the same
standards as proposed, with the exception of the attempted misconduct
addressed in paragraph (a)(5), as discussed below. Each of these four
provisions is based on an existing statutory and regulatory provision
that is supported by a large body of case law. Final Rules 9j-1(a)(1)
and (2), consistent with section 10(b) of the Exchange Act, and Rule
10b-5 thereunder,\129\ and section 17(a)(1) of the Securities Act,\130\
require scienter. In contrast, final Rules 9j-1(a)(3) and (4) do not
require scienter and extend to conduct that is at least negligent,
consistent with sections 17(a)(2) and (3) of the Securities Act.\131\
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\129\ To state a claim under section 10(b) of the Exchange Act,
and Rule 10b-5 thereunder, 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).
\130\ 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).
\131\ 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.
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Although, as noted above, certain commenters argued that a
negligence standard would be inconsistent with a fraud rule,\132\ the
Supreme Court has determined that a negligence standard applies to the
fraud rule upon which the provisions in Rules 9j-1(a)(3) and (4) are
based--Securities Act sections 17(a)(2) and (3).\133\ In Aaron v. SEC,
the Supreme Court stated that violations of these provisions could be
satisfied by a finding of a mental state lower than scienter.\134\
Specifically, the Court determined that the ``language of [section] 17
(a)(2), which prohibits any person from obtaining money or property `by
means of any untrue statement of a material fact or any omission to
state a material fact,' is devoid of any suggestion whatsoever of a
scienter requirement'' \135\ and ``the language of [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,' (emphasis added) quite plainly focuses
upon the effect of particular conduct on members of the investing
public, rather

[[Page 42558]]

than upon the culpability of the person responsible.'' \136\ It would
be incongruous to provide different standards in Rules 9j-1(a)(3) and
(4), which use language identical to the language in sections 17(a)(2)
and (3) of the Securities Act that was interpreted by the Supreme
Court.
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\132\ See MFA Letter at 12 (arguing that a negligence standard
could extend liability ``to conduct that is merely negligent or
inadvertent, without requiring any intent by the party to mislead or
defraud''); Milbank Letter at 5 (arguing in addition that the
negligence standard is inconsistent with the concept of fraud which
requires intent or recklessness and that human error could result in
liability). Courts have found, for example, that the negligence
standard in 17(a) requires a defendant to act in the manner that a
reasonably prudent person in its position would have acted under the
circumstances. SEC v. Shanahan, 646 F.3d 536, 545-46 (8th Cir.
2011).
\133\ Moreover, these provisions are consistent with the
antifraud and anti-manipulation authority that the Commission had
under the Commodity Futures Modernization Act over security-based
swap agreements as then defined in section 206B of the Gramm-Leach-
Bliley Act. Commodity Futures Modernization Act of 2000, Public Law
106-554, section 1(a)(5), 114 Stat. 2763 (Dec. 21, 2000) (codified
at 15 U.S.C. 78j(b)). Prior to the passage of the Dodd-Frank Act,
section 206B of the Gramm-Leach-Bliley Act defined a ``security-
based swap agreement'' as a ``swap agreement . . . of which a
material term is based on the price, yield, value, or volatility of
any security or any group or index of securities, or any interest
therein.'' Gramm-Leach-Bliley Act, Public Law 106-102 section 206B,
113 Stat 1338 (Nov. 12, 1999) (set out as a note under 15 U.S.C.
78(c). Given that many security-based swaps would have been
security-based swap agreements before the passage of the Dodd-Frank
Act, it is contrary to the purposes of the Dodd-Frank Act to create
a scienter standard under Rule 9j-1 for actions that would have been
covered by a negligence standard under section 17(a) of the
Securities Act pre-Dodd-Frank.
\134\ See Aaron, 446 U.S. at 696-97 (discussing the standard
under sections 17(a)(2) and (3) of the Securities Act).
\135\ Id. at 696.
\136\ Id. at 696-97.
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In addition, the Commission disagrees with commenters who argued
that scienter must apply because of the ongoing and ``fluid nature'' of
security-based swap transactions.\137\ The Commission agrees, as stated
previously, that a fundamental aspect of a security-based swap is the
ongoing payments or deliveries between the parties through the life of
the security-based swap. That characteristic creates additional
opportunities for misconduct after the parties enter into the security-
based swap contract and during the term of the security-based
swap.\138\ The Commission disagrees, however, that the nature of
security-based swaps--and the additional opportunities for harm--
warrants applying a scienter standard rather than following the
precedent applicable to sections 17(a)(2) and (3) of the Securities
Act. Following the Court's ruling in Aaron v. SEC, Rules 9j-1(a)(3) and
(4) focus on the ``effect'' of the particular misconduct, and
therefore, a negligence standard is appropriate.
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\137\ See, e.g., LSTA Letter at 6 (arguing that a scienter
standard would address concerns that a lender would be subject to
negligence claims as a result of the ``fluid nature'' of security-
based swap or loan transactions that may be subject to private
negotiations, restructuring, or amendment at any given time); MFA
Letter at 12-13 (arguing that sections 17(a)(2) and (3) of the
Securities Act apply only to purchases or sales of securities and
not to the performance of interim obligations, and also to
impersonal transactions with no relationship between parties, all of
which suit a negligence standard as compared to security-based swap
transactions). Commenters were also concerned that a negligence
standard would chill or be disruptive to the market. See MFA Letter
at 13.
\138\ See supra section I.B.
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Similarly, the Commission does not agree with the commenters who
suggested that the sophistication of, or the extent of the relationship
between, counterparties to a security-based swap negates the need to
prohibit certain misconduct, such as the acquisition of money or
property by means of an untrue statement or acts that operate as a
fraud, absent a showing of scienter, as provided in Rules 9j-1(a)(3)
and (4).\139\ Although the courts and Commission have, for example,
recognized that certain investors, based on qualities such as wealth or
asset size,\140\ do not always need the same disclosure and similar
investor protections as retail investors because they can ``fend for
themselves,'' \141\ the Commission and courts have also stated that
sophisticated investors are entitled to protections of the general
antifraud or anti-manipulation provisions of the Federal securities
laws.\142\ Nothing in section 9(j) suggests that it should only apply
to a limited subset of market participants.
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\139\ See, e.g., MFA Letter at 13 (arguing that the
sophistication of and personal relationships of counterparties to
security-based swap transactions supported a scienter standard).
\140\ See 17 CFR 230.500 et seq. (``Reg D'') (providing an
exemption from registration under section 5 of the Securities Act
for securities offered or sold by an issuer to accredited
investors). See also 17 CFR 230.501(a) (defining accredited
investors to include, among other things, organizations with assets
in access of $5,000,000 and natural persons with a net worth in
excess of $1,000,000).
\141\ See, e.g., SEC v. Ralston Purina Co., 346 U.S. 119 (1953)
(indicating that the application of the nonpublic offering exemption
under Securities Act section 4(a)(2) (at the time, section 4(1))
depended on whether the offerees were able to fend for themselves
and had access to the same kind of information that would be
disclosed in registration). The Court noted that such persons, by
virtue of their knowledge, would not need to rely on the protections
afforded by registration.
\142\ See Brian A. Schmidt et al., Exchange Act Release No.
45330 (Jan. 24, 2002) (citing Adena Exploration Inc. v. Sylvan, 860
F.2d 1242, 1251 (5th Cir. 1988) (citing Nor-Tex Agencies Inc. v.
Jones, 482 F.2d 1093 (5th Cir. 1973)); Stier v. Smith, 473 F.2d
1205, 1207 (5th Cir. 1973) (sophisticated investors, like all
others, are entitled to the truth); Jay Houston Meadows, 52 SEC.
778, 785 (1996), aff'd, 119 F.3d 1219 (5th Cir. 1997) (rejecting
arguments that the antifraud provisions do not apply to customers
who are experienced or sophisticated).
---------------------------------------------------------------------------

To the extent that there is overlap between Rules 9j-1(a)(3) and
(4) and sections 17(a)(2) and (3) of the Securities Act, introducing a
different standard would be counter to the position the Supreme Court
took with regard to identical language used in section 17(a) of the
Securities Act.\143\ A different standard could also 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 cannot be rationalized by the
differences in the underlying instruments.
---------------------------------------------------------------------------

\143\ The same is true with respect to Rules 9j-1(a)(1) and (2)
and section 10(b) of the Exchange Act, and Rule 10b-5 thereunder,
which the Supreme Court also addressed in Aaron.
---------------------------------------------------------------------------

Commenters also argued that the negligence standard of Rules 9j-
1(a)(3) and (4) would chill or disrupt the security-based swap market
and would capture actions, including errors, taken in connection with
normal and legitimate business activity due to the nature of security-
based swap transactions.\144\ However, as discussed, courts have
recognized that sections 17(a)(2) and (3) of the Securities Act, on
which Rules 9j-1(a)(3) and (4) are based, focus on the person's conduct
and the effect of that conduct, rather than the ``culpability of the
persons responsible.'' \145\ Like Securities Act sections 17(a)(2) and
(3), final Rules 9j-1(a)(3) and (4) will not capture normal and
legitimate business activity. Courts have found, for example, that the
negligence standard requires that to be deemed in violation of these
provisions, a defendant must act in a manner contrary to the manner in
which a reasonably prudent person in the defendant's position would
have acted under the circumstances.\146\ Accordingly, a violation of
Rules 9j-1(a)(3) and (4) would require more than a mere mistake.\147\
---------------------------------------------------------------------------

\144\ See MFA Letter at 12 (addressing the sophistication of and
personal relationships of counterparties to security-based swap
transactions as compared to the ``impersonal transactions''
underlying other types of security transactions); Milbank Letter at
5 (asserting that in light of the pace of activity involved in
security-based swap transactions ``mere human error'' could lead to
liability).
\145\ Aaron, 446 U.S. at 696-97.
\146\ SEC v. Shanahan, 646 F.3d 536, 545-46 (8th Cir. 2011).
\147\ In addition, the affirmative defenses in Rule 9j-1(e)
address some of the concerns commenters have with regard to
disruption to the security-based swap and loan markets. See infra
section II.E.
---------------------------------------------------------------------------

b. Attempted Conduct
Finally, as proposed, the Rule 9j-1(a) prohibitions would have
extended to the attempted fraudulent, manipulative or deceptive conduct
described in paragraphs (a)(1) through (4) of the rule. The Commission
largely adopts Rule 9j-1(a) as proposed as it relates to attempted
conduct, except to address the mental state applicable to attempted
conduct by placing the attempted conduct described in paragraphs (3)
and (4) of proposed Rule 9j-1 into a standalone paragraph (5) in the
final rule.\148\
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\148\ See Rules 9j-1(a)(1) through (5). In addition, final Rule
9j-1(a) has been revised to include the prohibitions on manipulation
and attempted manipulation proposed in Rule 9j-1(b) in a new
paragraph (a)(6) with some revision. See infra section II.C. The
CFTC's antifraud and anti-manipulation rule regarding swaps
similarly prohibits attempted conduct. 17 CFR 180.1.
---------------------------------------------------------------------------

The inclusion of attempted conduct in Rules 9j-1(a)(1), (2), and
(5) is premised on the text of section 9(j). First, the statute
expressly prohibits ``engag[ing] in any fraudulent, deceptive, or
manipulative act or practice, mak[ing] any fictitious quotation, or
engag[ing] in any transaction, practice, or course of business which
operates as a fraud or deceit upon any person'' in an ``attempt to
induce the purchase or sale of, any security-based swap.'' \149\
Moreover, as

[[Page 42559]]

discussed above, courts have determined that an act, practice,
transaction, or course of business can be fraudulent, deceptive, or
manipulative, or operate as a fraud or deceit--and thus violate
antifraud provisions of the securities laws--regardless of whether it
succeeds in its aims.\150\
---------------------------------------------------------------------------

\149\ 15 U.S.C. 78i(j).
\150\ See supra note 112.
---------------------------------------------------------------------------

Second, section 9(j) authorizes the Commission to ``prescribe means
reasonably designed to prevent'' the fraudulent, deceptive, or
manipulative conduct that the statute expressly prohibits. The Supreme
Court has held that this language allows the Commission to ``prohibit
acts not themselves fraudulent . . . if the prohibition is `reasonably
designed to prevent . . . acts and practices [that] are fraudulent.' ''
\151\ The Commission is exercising that authority in Rules 9j-1(a)(1),
(2), and (5) to prohibit attempts to engage in fraudulent, deceptive,
or manipulative acts, practices, transactions, or courses of business.
The prohibition applies where a person, with scienter, takes a step in
furtherance of a fraudulent, deceptive, or manipulative act, practice,
transaction, or course of business but for some reason--including
``pure fortuity'' \152\--that act, practice, transaction, or course of
business is not completed. For example, and without limitation, the
prohibition would apply where a supervisor, with scienter, directs a
subordinate to make a fraudulent material misstatement or omission, but
the subordinate refuses to do so.
---------------------------------------------------------------------------

\151\ O'Hagan, 521 U.S. at 673 (quoting a similar provision in
Exchange Act section 14(e), 15 U.S.C. 78n(e)). See also id. at 672-
73 (``A prophylactic measure, because its mission is to prevent,
typically encompasses more than the core activity prohibited.'').
\152\ Kuehnert, 412 F.2d at 704.
---------------------------------------------------------------------------

Rule 9j-1(a)'s prohibition on such attempted misconduct recognizes
that fraud, deception, and manipulation in the security-based swaps
market can involve complex strategies implemented over multiple stages,
as discussed above in section I.B.2. The prohibition is consistent with
other provisions of the securities laws that recognize the importance
of Commission intervention before the completion of a fraudulent,
deceptive, or manipulative act, practice, transaction, or course of
business. The Commission has the authority to seek an injunction
whenever ``any person is engaged or is about to engage in acts or
practices constituting a violation of'' the Exchange Act or Securities
Act.\153\ Rule 9j-1(a)'s prohibition of attempts provides the
Commission with an additional tool to prevent such misconduct before
any harm comes to the security-based swap market or market
participants.
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\153\ 15 U.S.C. 78u(d) (emphasis added) (Exchange Act); 15
U.S.C. 77t(b) (Securities Act). See, e.g., Kuehnert, 412 F.2d at 704
(``The Commission may act . . . to enjoin a potential fraud or
prosecute a fraud that failed, without proof of actual loss to any
victim.'').
---------------------------------------------------------------------------

One commenter argued against applying the negligence standard
applicable to the misconduct prohibited by Rules 9j-1(a)(3) and (4) to
attempts to engage in that misconduct because it ``may capture conduct
that is not itself fraudulent or manipulative'' but rather ``legitimate
business activities'' and would have a ``chilling effect on the market
for security-based swaps.'' \154\ Another commenter noted that sections
17(a)(2) and (3) of the Securities Act do not prohibit ``attempts'' and
that ``the Commission should either eliminate the reference to attempts
in Rules 9j-1(a)(3) and (4)'' or clarify the standard required for
liability for attempted conduct prohibited under those paragraphs of
Rule 9j-1.\155\ Similarly, one commenter believed that including
attempts within the scope of conduct covered by Rule 9j-1 was broader
than the scope of conduct covered by section 17(a) of the Securities
Act and warranted the application of an intent standard.\156\
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\154\ LSTA Letter at 7.
\155\ See IIB-ISDA-SIFMA Letter at 13 (arguing that ``[p]arties
cannot be held to a standard of strict liability with regards to
fluid discussions in the course of negotiating complex
transactions--not to mention the potential for good faith mistakes
to arise in connection with ongoing payment and delivery
obligations'').
\156\ See MFA Letter at 12. See also IIB-ISDA-SIFMA Letter at 13
(arguing for a different standard for attempted conduct).
---------------------------------------------------------------------------

Although, as discussed above, the Commission disagrees with
assertions that a different standard would capture legitimate business
decisions,\157\ we nevertheless agree that scienter is the proper
standard for attempts at conduct that would violate paragraphs (a)(3)
or (a)(4) of final Rule 9j-1.\158\ Therefore, while final Rule 9j-1
retains the non-scienter-based standard for the underlying conduct
described in paragraphs (a)(3) and (4), the Commission is revising the
final rule in order to separate the attempted conduct from paragraphs
(a)(3) and (4) of proposed Rule 9j-1 into a new paragraph (a)(5).
Scienter is the standard that will apply to Rule 9j-1(a)(5).
---------------------------------------------------------------------------

\157\ See supra notes 144-147 and accompanying text.
\158\ In other contexts, courts have recognized that a scienter
standard may be appropriate for attempts even when it is not
required for the violation attempted. See, e.g., United States v.
Cote, 504 F.3d 682, 687 (7th Cir. 2007). See also United States v.
Gracidas-Ulibarry, 231 F.3d 1188, 1192 (9th Cir. 2000) (recognizing
``the doctrine that the crime of attempt requires a showing of
specific intent even if the crime attempted does not'' (internal
quotation marks omitted)).
---------------------------------------------------------------------------

B. Prohibition on Price Manipulation

1. Proposed Approach
Partly in response to manufactured credit events and other
opportunistic CDS strategies observed over the last decade,\159\
paragraph (b) of proposed Rule 9j-1 was designed to address price
manipulation and attempted price manipulation, similar to 17 CFR 180.2
(``CFTC Rule 180.2'').\160\ Paragraph (b) of proposed Rule 9j-1 would
have made 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.
---------------------------------------------------------------------------

\159\ See supra section I.B.2. See also 2021 Proposing Release,
87 FR at 6654-55 (discussing the manufactured credit events and
other opportunistic strategies in the CDS market identified by the
Commission that ``may adversely affect the integrity, confidence,
and reputation of the credit derivatives markets) (quoting the 2019
Joint Statement). To be clear, Rule 9j-1, including Rule 9j-1(b),
applies to all security-based swaps and is not limited to CDS.
\160\ See 17 CFR 180.2.
---------------------------------------------------------------------------

Proposed Rule 9j-1(b) was designed to capture misconduct such as
situations in which a payment under the security-based swap is
intentionally or recklessly distorted for the benefit of one of the
security-based swap counterparties or situations in which a person
intentionally or recklessly causes or avoids the purchase or sale of a
security-based swap for the benefit of one counterparty. The proposed
rule was not designed to capture affirmative actions taken in the
ordinary course of a security-based swap transaction or the reference
underlying security.\161\ In this regard, the 2021 Proposing Release
stated that a determination as to whether manipulation or attempted
manipulation under Rule 9j-1(b) occurred would largely depend on the
facts and circumstances of each particular situation. However, as a
general matter the Commission would expect to use its authority to
bring an enforcement action under Rule 9j-1(b) when a party took 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, or when an action appeared to be
designed almost exclusively to harm a counterparty.\162\ The Commission
specifically stated in the 2021 Proposing Release that its intent was
not to discourage lenders and prospective lenders from discussing or

[[Page 42560]]

providing financing or other forms of relief to reference entities to
avoid defaulting on their debt.
---------------------------------------------------------------------------

\161\ See 2021 Proposing Release, 87 FR at 6663.
\162\ Id.
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2. Commission Action
The Commission is adopting a price manipulation rule as proposed in
Rule 9j-1(b), but as a new paragraph (6) to Rule 9j-1(a). Consistent
with the revisions to Rule 9j-1(a) discussed above in section II.A, the
placement of the price manipulation rule in a new paragraph to Rule 9j-
1(a), rather than in standalone paragraph 9j-1(b) as proposed,
clarifies that the prohibited manipulative conduct must occur in
connection with effecting, or attempting to effect a transaction in any
security-based swap or in connection with purchasing or selling, or
inducing or attempting to induce the purchase or sale, of any security-
based swap.\163\ We discuss this change in more detail below.
---------------------------------------------------------------------------

\163\ See Rule 9j-1(a)(6).
---------------------------------------------------------------------------

The Commission received multiple comment letters specifically
addressing paragraph (b) of proposed Rule 9j-1. One commenter was
supportive of proposed Rule 9j-1(b) and the application of a ``facts
and circumstances'' analysis to determine whether conduct in connection
with a security-based swap is manipulative.\164\ Another commenter
supported the Commission's addition of paragraph (b) to ``better
protect the fairness of markets, and better enable appropriate
enforcement to police abuses in the swaps markets.'' \165\
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\164\ See Fletcher Letter at 2 (stating that a facts and
circumstances ``approach avoids bright-line rules that potentially
create opportunities to engage in manipulative behavior within the
letter but not the spirit of the law, and provides the staff of the
Commission with the flexibility it needs to evaluate transactions in
an ever-evolving marketplace'').
\165\ AFRED Letter at 4-5 (stating specifically that Rule 9j-1
would enable the Commission ``to crack down on fraudulent conduct in
the [CDS] market that unnecessarily triggers a counterparty to post
collateral related to a default for the CDS buyers' benefit'').
---------------------------------------------------------------------------

However, most of the comments addressing paragraph (b) of proposed
Rule 9j-1 argued against the new provision or asked for added
clarity.\166\ One commenter argued that the Commission's guidance with
regard to the standard to be applied to determine liability under the
proposed rule was insufficient and that it was unclear how courts would
apply the standard absent a ``deceptive intent'' requirement.\167\
---------------------------------------------------------------------------

\166\ See Milbank Letter at 2-5; MFA Letter at 17-18; LSTA
Letter at 6; IIB-ISDA-SIFMA Letter at 13-15.
\167\ Milbank Letter at 3 (citing case law in which ``anti-
manipulation provisions of existing securities laws are generally
interpreted . . . to prohibit conduct that is intended to deceive
investors by artificially affecting market activity or prices, with
deceptive intent being an essential element for conduct to be
considered `manipulative''').
---------------------------------------------------------------------------

The Commission has carefully considered the comments. The
Commission is adopting final Rule 9j-1(a)(6) to prohibit manipulation
and attempted manipulation of the price or valuation of any security-
based swap, including any payment or delivery related thereto, in
connection with effecting or attempting to effect a transaction in, or
purchasing or selling, or inducing or attempting to induce the purchase
or sale of, any security-based swap. The Commission will apply a
scienter standard--which includes intentional or reckless misconduct--
to determine whether conduct is in violation of final Rule 9j-
1(a)(6).\168\
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\168\ Courts have found that use of the term ``manipulative'' in
the statute would evidence a Congressional intent to proscribe only
knowing or intentional misconduct and that, accordingly, the
Commission must establish that the misconduct was 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. In
addition, scienter may also be established by a finding of
recklessness. See, e.g., Sunstrand Corp. v. Sun Chemical Corp., 553
F.2d 1033, 1045 (7th Cir. 1977).
---------------------------------------------------------------------------

Many of the commenters critical of proposed Rule 9j-1(b) believed
that it was too broad and would lack clarity in application, thereby
leading to a chilling effect on the security-based swap market and the
credit market.\169\ Several commenters focused on the ``facts and
circumstances analysis'' described by the Commission in proposing Rule
9j-1(b) for determining whether a violation of the rule has occurred.
In general, these commenters believed that the facts and circumstances
test was not an adequate standard to determine when manipulation or
attempted manipulation prohibited by proposed Rule 9j-1(b) occurred.
One commenter pointed to the standard articulated by the CFTC in the
enforcement of CFTC Rule 180.2 to argue for a clearer standard
regarding manipulative conduct.\170\ When adopting CFTC Rule 180.2, the
CFTC reiterated that it would be guided by a four-part test for
manipulation that it had developed in case law under sections 6(c)
\171\ and 9(a)(2) \172\ of the Commodity Exchange Act to determine
whether to apply CFTC Rule 180.2. Under this four-part test, to bring
action, the CFTC would consider ``(1) [t]hat the accused had the
ability to influence market prices; (2) that the accused specifically
intended to create or effect a price or price trend that does not
reflect legitimate forces of supply and demand; (3) that artificial
prices existed; and (4) that the accused caused the artificial
prices.'' \173\ Another commenter pointed to the amended definition of
``Failure to Pay'' in the ISDA Credit Derivatives Definition as an
example of the type of guidance the commenter believed would be helpful
to market participants in determining what actions may be construed as
misconduct or manipulation.\174\
---------------------------------------------------------------------------

\169\ See, e.g., Milbank Letter at 2 (arguing that the provision
is overbroad and ambiguous and that the Commission should provide
``additional clarity as to the standard that would apply to claims
brought under proposed Rule 9j-1(b)''); MFA Letter at 17-18
(positing that the scope of the provision is overly broad and that
``market participants will reduce their lending activity as well as
their security-based swap and securities market activity, or avoid
certain markets altogether''); LSTA Letter at 6 (finding that the
provision introduces additional uncertainty for lenders).
\170\ See MFA Letter at 18 (``The CFTC's anti-manipulation rules
applicable to swap transactions, which are similar and analogous to
security-based swaps in many respects, set out a much clearer
standard regarding manipulative conduct.''). CFTC Rule 180.2
addresses price manipulation and 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.'' Prohibition on the Employment, or
Attempted Employment, of Manipulative and Deceptive Devices and
Prohibition on Price Manipulation, 76 FR 41398, 41707 (July 14,
2011) (``CFTC Rule 180.2 Adopting Release'').
\171\ 7 U.S.C. 6c.
\172\ 7 U.S.C. 13(a)(2).
\173\ See CFTC Rule 180.2 Adopting Release, 76 FR at 41407. In
addition, a violation of CFTC Rule 180.2 requires a showing of
``specific intent.'' Id. (``[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.''). In contrast,
for purposes of liability under Rule 9j-1, scienter includes
recklessness as established by a long line of case law. See supra
note 129.
\174\ Letter from Jennifer Han, Managed Funds Association, dated
July 8, 2022 (``July 2022 MFA Letter''), at 5-7. In 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''). See 2019 Narrowly Tailored Credit Event Supplement to
the 2014 ISDA Credit Derivatives Definition (July 15, 2019),
available at <a href="https://www.isda.org/a/KDqME/Final-NTCE-Supplement.pdf">https://www.isda.org/a/KDqME/Final-NTCE-Supplement.pdf</a>.
---------------------------------------------------------------------------

Similarly, one commenter believed that proposed Rule 9j-1(b)
included a ``manipulation standard that is new to securities markets''
and requested further guidance or definition to avoid ``the chilling
effect that a poorly-understood standard could have on legitimate
conduct.'' \175\ In the commenter's view, ``the Commission should
articulate as precisely as possible (a) what potential conduct or
activity is targeted, (b) which market participants would be harmed by
it, and (c) why it is that the existing market infrastructure (whether
the existing anti-

[[Page 42561]]

fraud rules or the provisions of the relevant contracts) does not
already provide sufficient protection.'' \176\ A significant concern
for the commenter was whether market participants would be able to
determine that their actions were manipulative and in violation of
proposed Rule 9j-1(b). Absent a clear standard, they argued that market
participants may determine to reduce their activity, which would have
broad negative impacts on liquidity in the security-based swap market
and broader economy.\177\ Finally, the commenter requested that the
Commission provide guidance with regard to the types of conduct or
activities that would violate proposed Rule 9j-1(b) and those that
would not violate proposed Rule 9j-1(b) under any implemented ``facts
and circumstances'' test.\178\ A separate commenter requested that the
Commission ``tailor'' proposed Rule 9j-1(b) so that it includes a
specific description of what constitutes manipulative conduct.\179\
---------------------------------------------------------------------------

\175\ IIB-ISDA-SIFMA Letter at 13.
\176\ Id. at 14 (stating that care should be taken to correctly
analyze the potential impact of new manipulation standards such as
that in Rule 9j-1(b)).
\177\ Id. at 13-14.
\178\ Id. at 16.
\179\ See MFA July 2022 Letter at 10. The commenter also
believed that the Commission should re-propose Rule 9j-1(b) for
public comment to allow market participants ``to adequately assess
the potential impact of [proposed Rule 9j-1(b)] on the security-
based swap markets and . . . on the broader market for corporate
debt.'' Id.
---------------------------------------------------------------------------

The Commission is revising the price manipulation provision,
originally proposed as Rule 9j-1(b) and adopted as final Rule 9j-
1(a)(6), in response to the comments above. Consistent with the
revisions to final Rule 9j-1(a) discussed above in section II.A, Rule
9j-1(a)(6) will apply to conduct undertaken in connection with
effecting or attempting to effect a transaction in any security-based
swap, and to purchasing or selling, or inducing or attempting to induce
the purchase or sale of, any security-based swap (including but not
limited to, in whole or in part, the execution, termination (prior to
its scheduled maturity date), assignment, exchange, or similar transfer
or conveyance of, or extinguishing of any rights or obligations under,
a security based-swap).\180\ As the Supreme Court has stated,
``fraudulent manipulation of [securities] prices . . . unquestionably
qualifies as a fraud `in connection with the purchase or sale' of
securities.'' \181\ Rule 9j-1(a)(6) also prohibits the manipulation (or
attempted manipulation) of the valuation of any security-based swap, or
any payment or delivery related thereto, to the extent such misconduct
is in connection with effecting or attempting to effect a transaction
in, or purchasing or selling, or inducing or attempting to induce the
purchase or sale of, any security-based swap.\182\
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\180\ See supra section II.A.
\181\ Dabit, 547 U.S. at 89.
\182\ The Commission has the authority to prohibit attempted
manipulation based on section 9(j)'s application to ``attempt[s] to
induce the purchase or sale of'' any security-based swap, as well as
case law establishing that manipulative conduct need not be
successful to violate the securities laws. See supra note 112.
---------------------------------------------------------------------------

A determination as to whether a person has violated final Rule 9j-
1(a)(6) will depend on the facts and circumstances of each particular
situation. The assessment of facts and circumstances is an objective
evaluation that considers all relevant information surrounding the
alleged misconduct, including both quantitative and qualitative
factors, to determine whether prohibited manipulation is present. A
``facts and circumstances'' analysis will provide the Commission with
the flexibility it needs to address an evolving security-based swap
market, including the ever-changing CDS market, and potential
misconduct in those markets. Bright line rules or tests, on the other
hand, may artificially exclude manipulative and attempted manipulative
conduct and could create a roadmap for market participants to avoid
liability for manipulative actions. A substantial body of case law
regarding manipulative behavior exists with regard to other antifraud
and anti-manipulation provisions in the Securities Act and Exchange Act
to which the Commission will look to assess whether a violation of Rule
9j-1(a)(6) has occurred.\183\ In addition, the Commission reiterates
that case law requires a showing of scienter to bring an action for
manipulation or attempted manipulation and that it will apply a
scienter standard to determine whether conduct is in violation of Rule
9j-1(a)(6).
---------------------------------------------------------------------------

\183\ See, e.g., Ernst & Ernst v. Hochfelder, 425 U.S. 185
(1976); Markowski v. SEC, 274 F.3d 525 (D.C. Cir. 2001); United
States v. Mulheren, 938 F.2d 364 (2d Cir. 1991); SEC v. Malenfant,
784 F. Supp. 141, 144 (S.D.N.Y. 1992); SEC v. Markusen, 2016 U.S.
Dist. LEXIS 55419 (D. Minn. Apr. 25, 2016); Sharette v. Credit
Suisse Intern, 127 F. Supp. 3d 60 (S.D.N.Y. 2015); ATSI
Communications, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (2d Cir.
2007); Wilson v. Merrill Lynch & Co., 671 F.3d 120 (2d Cir. 2011);
SEC v. Schiffer, 1998 U.S. Dist. LEXIS 8579 (S.D.N.Y. June 10,
1998).
---------------------------------------------------------------------------

Also, as noted, commenters encouraged the Commission to explicitly
recognize certain market activities as legitimate.\184\ The Commission
declines to carve out from the application of Rule 9j-1(a)(6)
categories of market activities based on hypothetical fact patterns as
requested by commenters. Liability under Rule 9j-1(a)(6) will depend
upon an analysis of all relevant information. A different approach
could artificially exclude manipulative conduct, particularly given the
complex fact patterns generally at issue in many security-based swap
transactions. As discussed in the 2021 Proposing Release, Rule 9j-
1(a)(6) applies to actions taken outside the ordinary course of a
typical lender-borrower relationship, such as an action taken 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, or when an action appears to be designed almost
exclusively to harm counterparties, and is not intended to discourage
lenders from discussing or providing financing or relief to avoid
default.\185\ Moreover, the fact that the Commission will apply a
scienter standard for liability under Rule 9j-1(a)(6) should lessen
concerns regarding any ``chilling effects'' of the new rule.\186\
Further, as discussed in section II.E.2, the affirmative defenses of
final Rule 9j-1(e) do not apply to the anti-manipulation provision in
Rule 9j-1(a)(6) because paragraph (a)(6) does not apply to affirmative
actions taken in the ordinary course of a security-based swap
transaction or the reference underlying security while aware of
material nonpublic information. To be clear, Rule 9j-1(a)(6) will
require that security-based swap market participants take care that
their legitimate market activities remain within the scope of the
typical lender-borrower relationship and do not cross the line into
prohibited manipulation. However, the use of a facts and circumstances
analysis, along with the use of a scienter standard, to identify
manipulative conduct addresses commenters concerns that legitimate
market activities would be captured by the prohibitions of Rule 9j-
1(a)(6) or otherwise chilled.
---------------------------------------------------------------------------

\184\ See IIB-ISDA-SIFMA Letter at 15-23.
\185\ See 2021 Proposing Release, 87 FR at 6663. As discussed
above, the text of revised Rule 9j-1(a) also specifies that such
actions must occur in connection with effecting or attempting to
effect a transaction in, or purchasing or selling, or inducing or
attempting to induce the purchase or sale of, any security-based
swap.
\186\ See Letter from Som-lok Leung, International Association
of Credit Portfolio Managers (``IACPM''), dated Mar. 21, 2022
(``IACPM Letter''), at 4; MFA Letter at 8-10; LSTA Letter at 5, 7-
10; IIB-ISDA-SIFMA Letter at 13-22.
---------------------------------------------------------------------------

However, to further address commenter concerns, the Commission
reiterates that Rule 9j-1(a)(6) prohibits, among other things, a
situation where a person (or group of persons) intentionally or
recklessly causes or

[[Page 42562]]

avoids the purchase or sale of a security-based swap for the benefit of
a counterparty, or to harm a counterparty, to a security-based swap.
This may include, for example, orphaning a CDS,\187\ avoiding
termination of a CDS for a period of time, or causing the termination
of a CDS. But 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 Rule 9j-1(a)(6).
---------------------------------------------------------------------------

\187\ ``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. 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.
---------------------------------------------------------------------------

The Commission also recognizes that reference entities often rely
on financing and other forms of relief to avoid defaulting on their
debt. We 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 final 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
adopting Rule 9j-1(a)(6) to account for actions taken outside the
ordinary course of a typical lender-borrower relationship (or a
prospective lender-borrower relationship). Although, as discussed, any
such determination would need to be based on the facts and
circumstances of a particular situation, as a general matter an action
that appears to be designed almost exclusively to harm one or more CDS
counterparties would likely fall within the prohibition in Rule 9j-
1(a)(6). Security-based swap market participants should and can take
care that their legitimate market activities remain within the scope of
the typical lender-borrower relationship and do not cross the line into
prohibited manipulation. Using a ``facts and circumstances'' analysis
to identify conduct that is prohibited by Rule 9j-1(a)(6), the
Commission will consider all relevant facts in any attempt to determine
whether prohibited manipulation or attempted manipulation has occurred.
Further, the Commission will apply a scienter standard, which will work
to eliminate legitimate conduct from the scope of Rule 9j-1(a)(6). As
discussed above, the adoption of a ``facts and circumstances'' analysis
is appropriate given the complex fact patterns in many security-based
swap transactions.
Proposed Rule 9j-1(b) was intended to address, among other things,
a number of the manufactured credit events or other opportunistic
strategies in the CDS market observed over the last decade.\188\ In re-
proposing Rule 9j-1, the Commission provided specific examples of
manufactured or other opportunistic CDS strategies that had been
reported by academics and the press.\189\ Commenters raised concerns
both that industry efforts, such as the ISDA Amendments and anti-net
short provisions, have successfully addressed opportunistic strategies
such as those described in the 2021 Proposing Release,\190\ and that
the description of the manufactured credit events or opportunistic
strategies identified by the Commission were ``overly-broad and capture
legitimate market activities.'' \191\ One commenter asked the
Commission to ``refine the descriptions of'' manufactured credit events
or opportunistic strategies that they believe are too broad and have
been addressed by industry efforts.\192\ With regard to industry
efforts, the anti-net short provisions and ISDA Amendments are narrowly
focused and have limited ability to reduce fraudulent and manipulative
activity in the security-based swap market. The ISDA Amendments do 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.\193\ Anti-net short
provisions are limited to syndicated bank loans and would not apply to
fraudulent activity in the security-based swap market that does not
involve such loans. Thus, even if these industry efforts were
successful in reducing fraudulent activity, their impact likely would
be limited by their narrow scope. In response to requests to refine the
descriptions of manufactured credit events in the 2021 Proposing
Release, the Commission agrees that there may be circumstances in which
the types of conduct described may not be the result of manipulation or
attempted manipulation; however, the facts and circumstances analysis
and scienter standard sufficiently tailor final Rule 9j-1(a)(6) to
properly capture manipulative conduct. Therefore, the Commission
declines to revise the descriptions.
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\188\ See 2021 Proposing Release, 87 FR at 6663.
\189\ See supra section I.B.2. See also 2021 Proposing Release,
87 FR at 6654-55 (describing in more detail examples of manufactured
credit events and other opportunistic strategies in the CDS market
reported by academics and the press).
\190\ See IIB-ISDA-SIFMA Letter at 19-20; LSTA Letter at 4; MFA
July 2022 Letter at 4-10; Milbank Letter at 6.
\191\ IIB-ISDA-SIFMA Letter at 20-23.
\192\ See IIB-ISDA-SIFMA Letter at 19.
\193\ See 2021 Proposing Release, 87 FR at 6655 n.31.
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One commenter requested that the ``valuation'' prong of proposed
Rule 9j-1(b) be removed because ``a prohibition on manipulation of the
`valuation' of an asset does not exist in any U.S. regulatory context
and would require a new body of case law to be formed to determine how
any such new prohibition should be interpreted.'' \194\ The commenter
argued that case law focuses on divergences between price and value and
that ``no analogy can be drawn in cases where it is the change in value
that is prohibited.'' \195\ The Commission declines to remove the
manipulation of a security-based swap's valuation from the scope of
Rule 9j-1(a)(6) because the pricing and valuation of security-based
swaps are intrinsically connected. For example, although CDS pricing
can be complex, ``[t]he basic idea of CDS pricing is that the present
value of all the CDS premium payments should equal to the present value
of the expected payoff from the CDS for the [net present value] to be 0
for both parties of the contract (resulting in each party being equally
well off).'' \196\ In other words, a CDS typically is priced to allow
the protection seller to recover its potential cash outflows upon a
credit event and termination of the CDS, or its ``expected loss.'' The
protection seller will determine the value of the expected loss based
on several factors, including the likelihood of default and cost of
capital. The value of the expected loss drives the price of the CDS and
the payout upon termination of the CDS. Similarly, the price of a TRS
typically is the difference between the present value of both ``legs''
of the transaction's cash flows. Therefore, actions to manipulate price
will affect valuation and vice versa. Additionally, market participants

[[Page 42563]]

may rely on models to price or value the swap.\197\ This suggests that
``valuation'' of a security-based swap has a role in the market and
should be included in the anti-manipulation provisions of Rule 9j-
1(a)(6). Further, by prohibiting the manipulation of a security-based
swap's valuation, Rule 9j-1(a)(6) will help to prevent manipulation of
payments and deliveries under a security-based swap ``from distorting
the price and market for such security-based swaps, as well as for the
reference underlying, and improperly interfering with the independent
and proper functioning of the markets.'' \198\
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\194\ Milbank Letter at 3 (citing to Santa Fe Industries, Inc.
v. Green, 430 U.S. 462, 476 (1977), to argue that ``
`[m]anipulation' is `virtually a term of art when used in connection
with securities markets' . . . The term refers generally to
practices, such as wash sales, matched orders, or rigged prices,
that are intended to mislead investors by artificially affecting
market activity'').
\195\ Milbank Letter at 3.
\196\ Yuan Wen and Jacob Kinsella, Credit Default Swap--Pricing
Theory, Real Data Analysis and Classroom Applications Using
Bloomberg Terminal, available at <a href="https://data.bloomberglp.com/bat/sites/3/2016/10/WhitePaper_Wen.pdf">https://data.bloomberglp.com/bat/sites/3/2016/10/WhitePaper_Wen.pdf</a>.
\197\ The Commission has previously recognized that market
participants may rely on models for pricing and valuation of
security-based swaps. See, e.g., Business Conduct Standards Adopting
Release, 81 FR at 29988 (in the context of daily marks, stating that
``even if the mark is calculated based on internal models or such
indices, its provision by the SBS Entity will further the goal of
providing helpful transparency into the SBS Entity's pricing and
valuation of the security-based swap by providing a helpful
reference point that the SBS Entity's counterparty can take into
account when evaluating the pricing and valuation of the SBS.'').
\198\ 2010 Rule 9j-1 Proposing Release, 75 FR at 68565-66.
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Rule 9j-1(a)(6) prohibits manipulation in connection with effecting
or attempting to effect a transaction in, any security-based swap, or
purchasing or selling, or inducing or attempting to induce the purchase
or sale of, any security-based swap, which may include intentionally or
recklessly distorting payments related to a security-based swap to
benefit, or harm, one of the security-based swap counterparties, or
actions that serve little to no economic purpose other than to
artificially influence the composition of the deliverable obligations
in a CDS auction and affect the security-based swap's valuation and
price. To remove the valuation prong from final Rule 9j-1(a)(6) would
create a gap in the prohibition against the manipulation or attempted
manipulation of prices in the security-based swap market.

D. Liability Under Rules 9j-1(b) and (c)

1. Proposed Approach
The Commission included paragraphs (c) and (d) of re-proposed Rule
9j-1 to make it clear that market participants could not 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 have provided that a person
could not escape liability for trading based on possession of material
nonpublic information about a security by purchasing or selling a
security-based swap based on that security (as opposed to trading in
the security itself). The second provision would have provided that a
person could not escape liability under section 9(j) or 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).
2. Commission Action
One commenter specifically addressed these provisions and was
supportive, noting that the antifraud and anti-manipulation provisions
in proposed Rules 9j-1(a) and (b) would be enhanced by the addition of
proposed Rules 9j-1(c) and (d).\199\ In contrast, one commenter
questioned the Commission's authority to extend the prohibitions of
Rule 9j-1 to the purchase and sale of underlying securities.\200\ After
considering these comments, the Commission adopts Rules 9j-1(c) and (d)
largely as proposed but renumbered as final Rules 9j-1(b) and (c),
respectively.
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\199\ See Better Markets Letter at 9.
\200\ See MFA Letter at 8-9.
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a. Rule 9j-1(b)
The Commission is adopting Rule 9j-1(b), as proposed in paragraph
(c). Final Rule 9j-1(b) provides that wherever communicating, or
purchasing or selling a security (other than a security-based swap)
while in possession of, material nonpublic 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.\201\
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\201\ Final Rule 9j-1(b) includes non-substantive corrections to
punctuation.
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Although generally a situation where a person uses material
nonpublic information about a security in connection with the purchase
or 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, market
participants also would benefit from a clarified interpretation of that
statutory provision in this rulemaking.\202\ 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 adopting Rule 9j-1(b) to provide that a person making a purchase or
sale of a security-based swap while in possession of material nonpublic
information with respect to the security underlying such security-based
swap is subject to liability.
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\202\ Pursuant to section 20(d) of the Exchange Act, a person
with material nonpublic information about a security cannot avoid
liability under the securities laws by making purchases or 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 nonpublic information by making purchases or sales of a
security-based swap (e.g., a swap on the security itself). The
Commission does not construe that silence as an intent to exclude
security-based swaps from the scope of section 20(d) and the
Commission has the authority under section 9(j) to prescribe means
reasonably designed to prevent fraud, manipulation, or deceit with
respect to security-based swap transactions. In addition, Section
9(j) makes it unlawful for any person to directly or indirectly take
the actions described in that section.
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b. Rule 9j-1(c)
The Commission also is adopting Rule 9j-1(c) largely as it was
proposed as paragraph (d), with a clarifying edit as discussed
below.\203\ Final Rule 9j-1(c) will address a situation similar to the
one described above. Specifically, it provides that wherever taking any
of the actions set forth in Rule 9j-1(a) involving a security-based
swap would violate, or result in liability under section 9(j) of the
Exchange Act or Rule 9j-1(a), 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, loan, 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 Rule 9j-1(a). The adopted rule
text is modified from the 2021 Proposing Release to now include a
reference to ``loan.'' The addition clarifies the scope of underlying
products that apply, and is consistent with the underlying products
included in the definition of ``security-based

[[Page 42564]]

swap'' in section 3(a)(68)(A) of the Exchange Act.\204\
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\203\ In addition, final Rule 9j-1(c) includes non-substantive
corrections to punctuation and two non-substantive revisions: (1)
the word ``whenever'' at the start of the paragraph has been
replaced with the word ``wherever'' to be consistent with the
language in paragraph (b); and (2) the references to ``paragraphs
(a) or (b)'' of Rule 9j-1 have been replaced with just a reference
to ``paragraph (a)'' to reflect the placement of paragraph (b) of
proposed Rule 9j-1 into a new paragraph (a)(6) of final Rule 9j-1.
\204\ See 15 U.S.C. 78c(68)(A).
---------------------------------------------------------------------------

This provision prevents a person from escaping liability under
section 9(j) or Rule 9j-1(a) with respect to a security-based swap by
limiting all of its actions to purchases or sales of the security,
loan, 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 Exchange Act section 9(j) and Rule 9j-1
regardless of the fact the manipulation was conducted through purchases
or sales of the equity securities.
In response to the commenter who questioned the Commission's
authority to extend the prohibitions of Rule 9j-1 to the purchase or
sale of underlying securities,\205\ the Commission clarifies that final
Rule 9j-1(c) does not create a separate category of prohibited activity
absent a connection to security-based swaps. Rather, this provision is
reasonably designed to prevent fraud, manipulation, or deceit with
respect to security-based swaps where that misconduct is accomplished
through transactions in the underlying security, loan, or group or
index of securities. This provision is necessary because security-based
swaps by their nature are tied intrinsically to activity in the markets
for other securities.
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\205\ MFA Letter at 9.
---------------------------------------------------------------------------

Moreover, this provision does not impose liability on a person for
violations of section 9(j) of the Exchange Act and Rule 9j-1 based
solely on the impact of that person's purchases or sales on the equity,
debt, or loan markets. The rule states 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 loan, or be an affiliate of, or a person acting in
concert with, such security-based swap counterparty in furtherance of
such prohibited activity. Accordingly, the Commission would analyze
whether transactions in the underlying equity or debt securities or
loan have been used as the mechanism to violate section 9(j) and Rule
9j-1. The Commission would also analyze the same transactions to
determine whether they independently violate other 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.

E. Safe Harbors and Affirmative Defenses

1. Proposed Approach
In response to operational concerns raised by commenters with
regard to the 2010 Proposed Rule, the Commission proposed two limited
safe harbors from re-proposed Rule 9j-1(a) to address situations when a
counterparty to a security-based swap was required to take certain
actions while in possession of material nonpublic information.\206\
First, proposed Rule 9j-1(f)(1), would have allowed a person to take
action 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 nonpublic information; and (2)
the entry into, and the terms of, the security-based swap were
themselves not a violation of any provision of proposed Rule 9j-
1(a).\207\
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\206\ See 2021 Proposing Release, 87 FR at 6662, 6662 n.87.
\207\ Id. at 6662.
---------------------------------------------------------------------------

Second, recognizing the important operational benefits and market
efficiencies related to security-based swap portfolio compression,
proposed Rule 9j-1(f)(2) would have provided a safe harbor for
transactions effected in connection with certain types of bilateral or
multilateral portfolio compression exercises.\208\ This proposed safe
harbor would have provided that a person would not be liable under re-
proposed Rule 9j-1(a) solely for reason of being aware of material
nonpublic information for ``security-based swap transactions effected
by a person pursuant to a bilateral portfolio compression exercise (as
defined in Sec. 240.15Fi-1(a)) or a multilateral portfolio compression
exercise (as defined in Sec. 240.15Fi-1(j)) so long as: (i) 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 (ii) 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.'' \209\
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\208\ See id. at 6662-63.
\209\ Re-proposed Rule 9j-1(f)(2); 2021 Proposing Release, 87 FR
at 6662.
---------------------------------------------------------------------------

2. Commission Action
As discussed above, in response to operational concerns raised in
response to the 2010 Proposed Rule, the Commission included two limited
safe harbors from re-proposed Rule 9j-1(a).\210\ After further
consideration and as described in more detail below, the Commission is
not adopting either proposed safe harbor. Instead, the Commission is
adopting two affirmative defenses from Rules 9j-1(a)(1) through (a)(5).
One affirmative defense is for actions taken in connection with the
binding contractual rights and obligations under a security-based swap
(similar to the proposed safe harbor). The other affirmative defense
takes account of reasonable policies and procedures that ensure that
individuals making investment decisions are not engaging in prohibited
conduct in final Rules 9j-1(a)(1) through (a)(5). These affirmative
defenses, while not identical to the affirmative defenses under Rule
10b5-1, are similar in that they apply to situations in which a person
can demonstrate that material nonpublic information did not factor into
their investment decision.
---------------------------------------------------------------------------

\210\ See 2021 Proposing Release, 87 FR at 6660-62.
---------------------------------------------------------------------------

Consistent with the analogous provisions of Rule 10b5-1, final Rule
9j-1 does not provide for an affirmative defense for violations of the
anti-manipulation provision in Rule 9j-1(a)(6). Paragraph (a)(6) of
Rule 9j-1 does not apply to actions that the affirmative defenses
address: those taken in the ordinary course of a security-based swap
transaction (including actions related to the reference underlying
security) while aware of material nonpublic information.\211\
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\211\ Final Rule 9j-1(a)(6) is discussed in section II.C above.
---------------------------------------------------------------------------

Several commenters urged the Commission to make the affirmative
defenses under Rule 10b5-1 available under Rule 9j-1, to address
situations in which a counterparty comes into possession of material
nonpublic information during the life of a security-based swap.\212\
Rule 10b5-1 applies to

[[Page 42565]]

insider trading cases under section 10(b) of the Exchange Act, and Rule
10b-5 thereunder, and includes affirmative defenses for: (1) purchases
or sales pursuant to a binding contract, an instruction to another
person to execute the trade for the instructing person's account, or a
written trading plan under certain conditions; \213\ and (2)
transactions by an entity if the individual making the investment
decision on behalf of the entity was not aware of the material
nonpublic information and the entity had implemented reasonable
policies and procedures to ensure that the individuals making
investment decisions would not violate insider trading laws.\214\
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\212\ See ACLI Letter at 2, 5; IIB-ISDA-SIFMA Letter at 4-5, 10;
MFA Letter at 13-16; LSTA Letter at 9; Letter from Lindsey Weber
Kiljo and William C. Thum, Asset Management Group of SIFMA (``SIFMA
AMG''), dated Mar. 21, 2022 (``SIFMA AMG Letter''), at 11-12.
\213\ See 17 CFR 240.10b5-1(c)(1) (``Rule 10b5-1(c)(1)'').
\214\ See 17 CFR 240.10b5-1(c)(2) (``Rule 10b5-1(c)(2)'').
---------------------------------------------------------------------------

Several commenters noted that most security-based swap market
participants are global financial firms that have spent considerable
resources to meet the requirements of current Rule 10b5-1(c)(2), by
separating their organizations so that individuals on the public side
can engage in dealing and market-making activity, while individuals on
the private side are allowed to possess material nonpublic
information.\215\ One commenter stated that the current policies and
procedures restrict access to material nonpublic information by those
individuals who engage in security-based swap transactions for hedging
or other purposes.\216\ Since neither of the Rule 10b5-1 defenses
explicitly applied to proposed Rule 9j-1 for security-based swaps, one
commenter noted the ``confusion and regulatory uncertainty'' that would
be created with the omission of a Rule 10b5-1(c)(2)-type defense from
Rule 9j-1 (because identical conduct in the context of a security-based
swap transaction could implicate both Rule 10b-5 and Rule 9j-1, but the
affirmative defense would only be available under Rule 10b-5).\217\
---------------------------------------------------------------------------

\215\ See IACPM Letter at 4; IIB-ISDA-SIFMA Letter at 5; MFA
Letter at 13-14.
\216\ See LSTA Letter at 9.
\217\ IIB-ISDA-SIFMA Letter at 5.
---------------------------------------------------------------------------

In addition, certain commenters expressed concern with the
operational impacts of Rule 9j-1(a) on the capital and loan markets.
One commenter argued 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 ``cast uncertainty
on a wide range of bona fide conduct necessary to the operation of the
capital markets.'' \218\ The commenter urged the Commission to
``provide an affirmative defense for actions taken by a person in
accordance with binding contractual rights and obligations under [a
security-based swap] . . . or to fulfill a regulatory obligation in
connection with [a security-based swap] . . . if the person did not act
intentionally or recklessly in connection with such action and . . .
complied in good faith with written policies and procedures reasonably
designed to meet the obligation.'' \219\ The commenter was concerned
that the negligence standard applicable to re-proposed Rules 9j-1(a)(3)
and (4), in particular, could lead to potential fraud liability for
good faith, non-volitional conduct.\220\ Another commenter addressed
operational concerns related to the credit markets and argued that the
proposed rule would ``create considerable uncertainty with respect to
the legitimate business decisions of lenders and impair the [security-
based swap] market and loan market.'' \221\ The commenter explained
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 made in
connection with each payment, delivery, obligation or right as well as
to track changes in its positions in the security-based swap and
reference underlying.'' \222\
---------------------------------------------------------------------------

\218\ Id. at 8-10.
\219\ Id. at 10-11, 11 n.18 (referencing a safe harbor adopted
by the CFTC in connection with non-scienter fraud and manipulative
prohibitions as part of its swap dealer business conduct standards).
\220\ Id. at 9. The commenter stated that it did not have the
same concerns about proposed Rule 9j-1(b) (now Rule 9j-1(a)(6)),
because the scienter standard applicable to that provision is
``sufficient to distinguish illegitimate conduct from merely
negligent acts that affect payment or delivery obligations.''
\221\ LSTA Letter at 3-10.
\222\ Id. The LSTA supported the principles underlying section
9(j) but did not see the need for a new rule in light of existing
antifraud rules and further believed that the existing antifraud
rules would address several of the manufactured credit events
described in the 2021 Proposing Release and that the adoption of
anti-net short provisions would address other concerns. Id. at 3-4.
The Commission believes that the affirmative defense provided by new
Rule 9j-1(e)(2) will address these concerns.
---------------------------------------------------------------------------

The Commission agrees with commenters that an affirmative defense
similar to those available under Rule 10b5-1 (when the investment
decision is not based on material nonpublic information) is important
given the similarity in the antifraud provisions. The Commission also
agrees that the affirmative defenses would address concerns regarding
market disruption. As a result, the Commission is adopting two
affirmative defenses similar in concept to the affirmative defenses in
Rule 10b5-1(c).\223\ However, the Commission is adapting the
affirmative defenses for the specific context of Rule 9j-1. In
particular, the Commission is not adopting an affirmative defense that
is as broad as the affirmative defenses in Rule 10b5-1(c)(1). Rather,
as discussed below, the Commission is limiting the relevant Rule 9j-1
affirmative defense to actions taken pursuant to binding contractual
rights under the documentation governing a security-based swap. The
Rule 10b5-1(c)(1) affirmative defenses relate to advance planning of
purchases or sales pursuant to a binding contract, an instruction to
another person to execute the trade for the instructing person's
account, or a written trading plan under certain conditions.\224\ Those
Rule 10b5-1(c)(1) affirmative defenses were created to ``provide
appropriate flexibility to those who would like to plan securities
transactions in advance, at a time when they are not aware of material
nonpublic information, and then carry out those pre-planned
transactions at a later time, even if they later become aware of
material nonpublic information.'' \225\ That flexibility is warranted
in the context of corporate insiders and others who periodically come
into possession of material nonpublic information but may want to
schedule orderly trading of securities of an issuer on a liquid public
market. It is not appropriate in the context of security-based swaps,
which are typically bespoke, created and

[[Page 42566]]

issued by the counterparties, and thinly traded.
---------------------------------------------------------------------------

\223\ Much of the development of insider trading law has
resulted from court cases. The Supreme Court has stated that
``[u]nder the `traditional' or `classical theory' of insider trading
liability, [section] 10(b) and Rule 10b-5 are violated when a
corporate insider trades in the securities of his corporation on the
basis of material, nonpublic information.'' O'Hagan, 521 U.S. at
651-52 (emphasis added). See also Selective Disclosure and Insider
Trading, Exchange Act Release No. 43154 (Aug. 15, 2000), 65 FR
51716, 51727 (Aug. 24, 2000) (discussing the awareness standard
required for insider trading liability and adopting the definition
of ``on the basis'' of material nonpublic information in Rule 10b5-
1(b)). In this regard, any of the actions set forth in Rule 9j-1(a)
with regard to a security-based swap are ``on the basis of''
material nonpublic information about that security-based swap, the
issuer of that security-based swap, or the security underlying that
security-based swap, if the person taking the action was aware of
the material nonpublic information when the person took the action.
\224\ See Rule 10b5-1(c)(1).
\225\ See Insider Trading Arrangements and Related Disclosures,
Exchange Act Release No. 96492 (Dec. 14, 2022), 87 FR 80362, 80363
(Dec. 29, 2022) (``Rule 10b5-1 Amendments'').
---------------------------------------------------------------------------

Accordingly, the Commission is adopting two affirmative defenses to
liability under paragraphs (a)(1) through (a)(5) of final Rule 9j-1.
a. Affirmative Defense: Binding Contractual Obligations
First, the Commission is adopting an affirmative defense that
maintains the substance of the safe harbor provision in re-proposed
Rule 9j-1(f)(1), which would have applied to actions taken pursuant to
binding rights and obligations in written documentation governing a
security-based swap that was entered into prior to the person coming
into possession of material nonpublic information. As adopted, the
provision in Rule 9j-1(e)(1) (renumbered from proposed paragraph (f))
is an affirmative defense, rather than a safe harbor, to be consistent
with the structure of current Rule 10b5-1(c)(1). The affirmative
defense in final Rule 9j-1(e)(1) provides that actions that would
otherwise violate the prohibitions of Rule 9j-1(a)(1) through (5) are
not a violation ``solely for reason of being aware of material
nonpublic information'' if such actions are ``taken by a person 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).''
\226\ Under this affirmative defense, consistent with Rule 10b5-
1(c)(1), a market participant may take action when aware of material
nonpublic information but may avoid liability: ``so long as the person
demonstrates that: (i) [t]he security-based swap was entered into, or
the amendment was made, before the person became aware of such material
nonpublic information, and (ii) [t]he security-based swap was entered
into in good faith and not as part of a plan or scheme to evade the
prohibitions of [Rule 9j-1].'' \227\
---------------------------------------------------------------------------

\226\ See final Rule 9j-1(e)(1).
\227\ See final Rule 9j-1(e)(1).
---------------------------------------------------------------------------

Framing this relief as an affirmative defense rather than as a safe
harbor, and restricting its use to circumstances in which the security-
based swap was entered into in good faith and not as part of a plan or
scheme to evade the prohibitions of the rule, is consistent with Rule
10b5-1(c)(1) treatment of the defense. As discussed above, multiple
commenters requested the Commission adopt affirmative defenses based on
the Rule 10b5-1(c) defenses.\228\ Rule 10b5-1(c)(1) provides an
affirmative defense from Rule 10b-5 liability in circumstances where it
is apparent that the trading was not made on the basis of material
nonpublic information because ``the trade was made pursuant to a
binding contract, an instruction to another person to execute the trade
for the instructing person's account, or a written plan for the trading
of securities . . . adopted at a time that the person was not aware of
material nonpublic information.'' \229\ Similarly, Rule 9j-1(e)(1)
provides an affirmative defense from Rule 9j-1(a) liability when an
action is taken not on basis of material nonpublic information, but
pursuant to binding contractual rights and obligations reflected in the
written documentation governing a security-based swap.
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\228\ See supra note 212.
\229\ See Rule 10b5-1 Amendments, 87 FR 80362, 80363 (adopting
revisions to the Rule 10b5-1(c)(1) affirmative defense to apply a
cooling-off period on persons other than the issuer of securities
subject to a plan, impose a certification requirement on directors
and officers of those issuers, limit the ability of persons other
than the issuer to use multiple-overlapping Rule 10b5-1 plans, limit
the use of single-trade plans by persons other than the issuer to
one such single-trade plan in any 12-month period, and add a
condition that all persons entering into a Rule 10b5-1 plan must act
in good faith with respect to that plan).
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If the security-based swap was entered into in good faith and not
as part of a plan or scheme to evade the prohibitions of the rule, the
new Rule 9j-1(e)(1) affirmative defense will allow counterparties to
take actions that are required by, and in accordance with, the written
agreements governing the security-based swap (i.e., actions in the
normal course of the security-based swap transaction) even when aware
of material nonpublic information. For example, the Rule 9j-1(e)(1)
affirmative defense would apply to 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 nonpublic information, so long as both
actions are required by the terms of the transaction and documented in
writing. In contrast, the affirmative defense 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. Rule
9j-1(e) provides an affirmative defense when a person's conduct would
violate Rule 9j-1(a)(1) through (5) ``solely'' because he or she is
``aware of material nonpublic information.'' But actions to
fraudulently increase or decrease payments or collateral transfer--when
taken in connection with effecting or attempting to effect a
transaction in, or purchasing or selling, or inducing or attempting to
induce the purchase or sale of, any security-based swap--would violate
Rule 9j-1(a) regardless of the possession of material nonpublic
information.
A person relying on the affirmative defense in adopted final Rule
9j-1(e)(1) must demonstrate that they entered into the security-based
swap, or amendment, before becoming ``aware of'' the material nonpublic
information rather than before they ``came into possession'' of the
information, as required in re-proposed Rule 9j-1.\230\ The change in
the rule text to an awareness standard, rather than a possession
standard, brings the Rule 9j-1(e)(1) affirmative defense in line with
the Commission's intent, as described in the 2021 Proposing Release
preamble.\231\ The change also makes Rule 9j-1(e)(1) consistent with
Rule 10b5-1(c)(1), which requires that the person entered into a
binding contract before becoming ``aware of'' the material nonpublic
information.\232\
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\230\ See 2021 Proposing Release, 87 FR at 6703.
\231\ See 2021 Proposing Release, 87 FR at 6662.
\232\ See 17 CFR 240.10b5-1(c)(1)(i)(A).
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b. Affirmative Defense: Policies and Procedures
Second, Rule 9j-1(e)(2) provides a defense from liability under
Rules 9j-1(a)(1) through (5) for actions taken by a person, other than
a natural person, who demonstrates that: (1) the individual making the
investment decision on behalf of the person was not aware of the
material nonpublic information; and (2) the person 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 be in violation of Rule 9j-1(a)(1)
through (5).\233\ These policies and procedures may include those that
restrict an individual from effecting a transaction in, or purchasing
or selling, any security, including any security-based swap, as to
which the individual possesses material nonpublic information, or those
that prevent individuals from becoming aware of such information.\234\
Rule 9j-1(e)(2) is modeled on Rule 10b5-1(c)(2) and addresses concerns
raised by commenters that the proposed rule would have a chilling
effect on the markets. Rule 9j-1(e)(2) recognizes that

[[Page 42567]]

many market participants, such as lenders and life insurance companies,
employ compliance programs which include, among other things,
information barriers that prevent access to material nonpublic
information by their employees who engage in security-based swap
transactions for hedging or other purposes.
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\233\ Final Rule 9j-1(e)(2).
\234\ See final Rule 9j-1(e)(2)(ii).
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c. Proposed Safe Harbor: Compression
Because the Commission is adopting final Rule 9j-1(e)(2), the
Commission is not adopting proposed Rule 9j-1(f)(2), which would have
provided a safe harbor for transactions made in connection with certain
portfolio compression exercises. The proposed safe harbor would have
conflicted with Rules 10b-5 and 10b5-1 by providing the same action
with protection from liability under Rule 9j-1, but not Rule 10b-5. In
proposing the portfolio compression safe harbor, the Commission
recognized the benefits provided by portfolio compression along with
the ``largely administrative nature of the portfolio compression
process.'' \235\ To be clear, the Commission continues to support
portfolio compression and its benefits.\236\ Providing the safe harbor
as proposed, however, would have sanctioned the use of material
nonpublic information under Rule 9j-1, even though that use would have
been prohibited by Rule 10b-5. Adopting Rule 9j-1(e)(2) instead will
avoid confusion that could have resulted by treating the same conduct
differently under Rules 10b-5 and 9j-1. In addition, the Rule 9j-
1(e)(2) will provide security-based swap market participants the
flexibility needed to engage in bilateral and multilateral portfolio
compression exercises. The affirmative defense should be consistent
with the manner in which Rules 10b-5 and 10b5-1(c)(2) currently apply
to compression exercises and eliminates concerns that compression
exercis

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