The SEC proposed three new rules relating to security-based swaps: (1) an anti-fraud rule, (2) a rule to require reporting of large positions in security-based swaps, and (3) a rule prohibiting personnel of an SBS entity from taking any action to improperly interfere with the SBS entity's CCO in the performance of such person's duties.

  • New SEA Rule 9j-1 (being re-proposed from the 2010 version) imposes a bar on fraud, manipulation and similar conduct in connection with SBS activities.
    • The SEC noted that, in contrast to the prior proposal, the new proposal (i) contains an anti-manipulation provision akin to CFTC Rule 180.2 and (ii) includes provisions intended to clarify that persons cannot avoid liability under rules applicable to securities by transacting in SBS, and vice versa.
    • While much of the rule is modeled on SEA Rule 10b-5, aspects of the proposal, in particular Rules 9j-1(a)(3) and (4), do not require scienter, consistent with SA Section 17(a)(2) and (3).
    • The SEC cited "manufactured credit events" in CDS markets as a motivating factor for aspects of the new proposal.
  • New SEA Rule 10B-1, which would require an SBS to report SBS positions (as well as positions in related securities and derivatives) above specified thresholds, using proposed new form Schedule 10B.
    • The SEC cited "net-short debt activism" (where person with a large CDS position takes a large position in the underlying asset) as a motivating factor for the new rule.
    • The SEC also cited the enhancement of risk management and informing of pricing (noting recent events involving Archegos).
    • The SEC justified the need for Rule 10B-1 beyond existing reporting requirements under Reg. SBSR, in part, by arguing the need for large positions to be made public.
    • The proposal does not require filers to disclose the names of their counterparties, though the SEC noted they have other avenues to potentially obtain that information (i.e., through a registrant or from data filed with an SBS data repository).
  • An addition to SEA Rule 15Fh-4 to prohibit undue influence over the CCO of an SBS dealer. The proposed rule makes it illegal for the employees of an SBS dealer to attempt to mislead the firm's CCO by, for example, "submitting false documentation to the CCO."
    • The SEC noted that this provision was one that was  suggested by a commenter (Better Markets) on proposed Rule 15k-1, but the SEC declined to adopt at the time.

The SEC is seeking comments on these proposed rules within 45 days after their publication in the Federal Register.

Commissioner Statements

SEC Chair Gary Gensler supported the proposals, saying that they represent another step towards "increasing transparency in this previously opaque market." Commissioner Allison Herren Lee added that the proposed rules are aimed at protecting the independence of security-based swap dealers and their personnel by targeting unsolicited influence and encouraging clear communication. Commissioner Caroline A. Crenshaw stated that market-moving events (such as the collapse of Archegos) can reverberate throughout the entire financial system, and that there is a need for stricter oversight to prevent another similar failure.

Commissioner Hester M. Peirce opposed the proposed rules, saying that she could not "support a proposed rule that would produce so little at such great cost." While Ms. Peirce recognized that the proposal addresses key issues in the SBS market, she stated that the rules overreach and seem disproportionate to the regulatory concerns raised by the fall of Archegos. Ms. Peirce claimed that the concerns underlying these proposals are not as urgent as they are perceived to be, and that the SEC could hold off on new regulation until more data can be collected.

Commissioner Elad L. Roisman described the rulemaking as overbroad, potentially ineffective and requiring a longer comment period.

Commentary - Nihal Patel

Proposed Rules 10B-1 and 9j-1 are very significant and detailed provisions that would require large compliance undertakings and impact the functioning of markets and the methods by which market participants transact. The details of these rules also will require significant time to analyze the full impact.

The amendment to Rule 15Fh-4 is a bit of an oddity, particularly given that (1) the SBSD regime has just commenced, (2) a similar rule is not in place for other registrants, and (3) the SEC does not seem to find any conduct that the new provision prohibits that is not covered by other rules. (One example of conduct that would violate the rule in the discussion is submitting false documents to a CCO, activity that fairly obviously violates a variety of laws and applicable firm policies.)

Commentary - Steven Lofchie

In the wake of the failure of Archegos, the market was generally expecting the SEC to use its authority under SEA Section 13(d), as effectively amended by SEA Section 13(o) (which was adopted as part of Dodd-Frank) to include a requirement to count equity swap positions as constituting beneficial ownership. Instead, the SEC is proposing reporting requirements under SEA Section 10B(d) that are far broader than anticipated and would apply to swaps on debt securities on credit default swaps.

It is not clear that the SEC is acting appropriately in relying on SEA Section 10B(d). While that provision, read in isolation, could give the SEC such authority, it is seemingly intended to be read in conjunction with SEA Section 10B(a), which gives the authority to seek position limits, which the SEC is not attempting in its rule proposal. By disconnecting the two related paragraphs in Section 10B, the SEC has effectively and substantially expanded its authority to require position reporting well beyond what Congress seemingly intended or anticipated. Further, if Congress expected that Section 10B(d) would provide a broad authority for the SEC to adopt position reporting requirements as to SBS, then there was no reason for Congress to adopt SEA Section 13(o), which provides the SEC with a far more limited and specific authority to impose reporting requirements as to security-based swaps on certain equity securities where specified ownership limits were exceeded. By end-running Section 13(o), the SEC allows itself to end-run both the limits on the types of securities that were subject to position reporting and the specific ownership thresholds set by Congress. 

Commissioner Roisman criticizes the SEC's various proposals as to security-based swaps, and all of the other SEC rule proposals put forth on the same day, for allowing only 45 days for the market to comment. A 45-day comment period is very short for a major rulemaking. When that major rulemaking is issued on the same day as a number of other major rulemakings likewise subject to a short comment period, the burden on the market to comment within the specified timeframe seems overmuch. Add to that, the 45-day period will presumably begin by or around the Christmas holidays, and include New Year's and Martin Luther King Jr. Day. There does not seem to be any justification for the very short comment period. The policy behind the Administrative Procedure Act is to give those affected by a rule proposal an opportunity to consider and comment. Given the number of rules being proposed, and their complexity, 120 days or 180 days would seem much more appropriate than a 45-day comment period. In regards to obtaining and listening to public comment, just because the SEC "can" act in a certain way does not mean that it "should" act in that way.

Primary Sources

  1. SEC Press Release: SEC Proposes Rules to Prevent Fraud in Connection with Security-Based Swaps Transactions, to Prevent Undue Influence over CCOs and to Require Reporting of Large Security-Based Swap Positions
  2. SEC Proposed Rule: 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
  3. SEC Chair Gary Gensler: Statement on Exchange Act 10B and Rule 9j-1
  4. Commissioner Allison Herren Lee: Standing up the Security-Based Swap Regime: Statement on Proposed Rules for Antifraud, Position Reporting and CCO Support
  5. Commissioner Caroline A. Crenshaw: Statement on Re-Proposed Prohibition against Fraud, Manipulation or Deception in Connection with Security-Based Swaps
  6. Commissioner Elad L. Roisman: Dissenting Statement on Proposed Security-Based Swaps Rules
  7. Commissioner Hester M. Peirce: Dissenting Statement on Proposed Security-Based Swaps Rules

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