SEC Proposes Rules Related To Security-Based Swaps Requiring Public Reporting Of Large Positions, Imposing Anti-Fraud And Anti-Manipulation Requirements And Prohibiting Actions To Exert Undue Influence Over CCOs - Securities

On December 15, 2021, the Securities and Exchange Commission ("SEC") voted 3-2 to propose three rules under the Securities Exchange Act of 1934 ("Exchange Act") concerning security-based swaps.¹ Proposed Rule 10B-1 would require any person having a position in security-based swaps to file publicly a schedule disclosing information regarding the person's security-based swap positions and related positions in the referenced debt, equity or loans if the person's security-based swap holdings and other specified holdings in the referenced instrument and related instruments exceed the proposed rule's reporting thresholds. Proposed Rule 9j-1, which is re-proposed from 2010, would prohibit specified activities constituting fraud, manipulation, and deception in connection with, among other things, the purchase and sale of security-based swaps and entry into any rights thereunder. Proposed Rule 15Fh-4(c) would prohibit certain actions deemed to be exertion of undue influence over the chief compliance officer ("CCO") of a security-based swap dealer or major security-based swap participant ("SBS Entities").

The proposed rules are aimed at fulfilling the SEC's mandate to regulate security-based swaps in Title VII of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act").²

While Commissioners Caroline Crenshaw and Allison Herren Lee provided statements in support of the proposed rules,³ Commissioners Hester M. Peirce and Elad L. Roisman dissented.⁴ Commissioner Peirce stated that the reporting rules "may serve to squelch legitimate market activity" and would appear to be "premature" given that new requirements for security-based swap transaction reporting go into effect in February 2022 and the impact of that reporting is yet to be realized or analyzed.⁵ Commissioner Roisman similarly stated that it was not clear that the large amount of information to be reported under proposed Rule 10B-1 would be effective in achieving the stated goals.⁶

I. Reporting Requirements for Large Positions in Security-Based Swaps

Rule 10B-1 would require any person, or group of persons, who owns security-based swap positions above specified threshold amounts, to file promptly a statement containing the information required by Schedule 10B on EDGAR.⁷ Calculation of holdings for purposes of the threshold amounts requires inclusion of the security-based swap position, holdings of the referenced instrument, and holdings of other specified instruments providing exposure to the referenced instrument. The SEC indicated in the Proposing Release that such transparency could provide both regulators and the public with advance notice that certain market participants are building large positions, facilitate risk management, inform pricing of security-based swaps, and generally allow market participants to act in an informed manner to protect their own interests and limit potentially harmful consequences.⁸

Under the proposed rule, security-based swap counterparties who trigger the reporting requirements would be required to disclose, among other information: (i) the applicable security-based swap position (including the direction, i.e., long or short); (ii) positions in any security or loan underlying the security-based swap position; (iii) other security-based swaps on other securities of the same referenced issuer; (iv) positions in other instruments relating to the security-based swap position or the referenced security or loan or group or index of securities or loans; and (v) specified identifying information regarding the reporting person.⁹ Reportable security-based swaps are limited to security-based swaps: (i) subject to transaction reporting under Rule 908 of 17 CFR 242.900 through 242.909 ("Regulation SBSR"); or (ii) entered into by a person that also holds an interest in the securities underlying the security-based swap (or is deemed to be the beneficial owner of such securities for purposes of Section 13(d) of the Exchange Act and the rules and regulations thereunder) if (1) the issuer of referenced securities is established as an entity in the U.S. and has its principal place of business in the U.S. or (2) the referenced security is part of a class of securities registered under Section 12 or Section 15(d) of the Exchange Act. The proposed rule would apply to both cleared and uncleared security-based swaps.¹⁰

The term "security-based swap" is not defined in the proposed rule but is defined generally in Section 3(a)(68) of the Exchange Act to mean an agreement, contract or transaction that is a "swap" as defined in Section 1a of the Commodity Exchange Act and is based on: (i) a narrow-based security index, including an interest therein or on the value thereof; (ii) a single security or loan, including any interest therein or on the value thereof; or (iii) the occurrence, nonoccurrence, or extent of the occurrence of an event relating to a single issuer of a security or issuers of securities in a narrow-based security index, provided that such event directly affects the financial statements, financial condition, or financial obligations of the issuer.

The threshold amounts that would trigger reporting vary based on the type of security-based swap and are calculated based on security-based swap and, in some cases, other related holdings of the reporting person.

For security-based swaps that are credit default swaps ("CDS"), the threshold for a CDS position is the lesser of: (i) a long notional amount of $150 million, calculated by subtracting the notional amount of any long positions in a deliverable debt security underlying a security-based swap from the long notional amount of the security-based swap position; (ii) a short notional amount of $150 million; or (iii) a gross notional amount of $300 million.¹¹ As noted, to the extent that a person holds long CDS exposure, a long hedge position will reduce the notional value for purposes of determining whether the $150 million threshold is met, but will not reduce the maximum gross notional amount for purposes of the $300 million threshold.¹²

Footnotes

1 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 Rel. No. 93784 (Dec. 15, 2021) (the "Proposing Release"), available here; 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, SEC Press Release No. 2021-259 (Dec. 15, 2021) (the "Press Release"), available here

2 See Commissioner Caroline Crenshaw, Statement on Re-Proposed Prohibition Against Fraud, Manipulation, or Deception in Connection with Security-Based Swaps (Dec. 15, 2021), available here.

3 Id.; Commissioner Allisson Herren Lee, Standing Up the Security-Based Swap Regime: Statement on Proposed Rules for Antifraud, Position Reporting and CCO Support (Dec. 15, 2021), available here.

4 Commissioner Hester M. Peirce, Dissenting Statement on Proposed Security-Based Swap Rules (Dec. 15, 2021), available here; Commissioner Elad L. Roisman, Dissenting Statement on Proposed Security-Based Swaps Rules (Dec. 15, 2021), available here. On December 20, 2021, Commissioner Roisman resigned from the SEC and indicated that he expected to leave prior to the end of January 2022.

5 See Commissioner Hester M. Peirce, Dissenting Statement on Proposed Security-Based Swap Rules, supra note 4 (also expressing concern that prohibiting attempted (in addition to actual) fraudulent behavior could create uncertainty for market participants who may be concerned about how the SEC or counterparties will "assess even innocuous conduct in retrospect," and that "manufactured credit events" and other opportunistic strategies involving security-based swaps may not be serious enough to warrant regulation). Transaction reporting for security-based swaps has been required since November 8, 2021, with public dissemination to begin on February 14, 2022. See SEC Approves Registration of First Security Based Swap Data Repository; Sets the First Compliance Date for Regulation SBSR, SEC Press Release No. 2021-80 (May 7, 2021), available here.

6 Commissioner Elad L. Roisman, Dissenting Statement on Proposed Security-Based Swaps Rules, supra note 4.

7 As discussed below, certain of the thresholds are calculated by reference to holdings in the referenced security and other related instruments.

8 See Press Release.

9 See proposed Rule 10B-1(b)(3).

10 See Proposing Release at 62.

11 See proposed Rule 10B-1(b)(1)(i)

12 The SEC provides the following example of how these provisions are intended to operate: If a person held $125 million in bonds on ABC Corporation and purchased $200 million in CDS on those bonds, those two positions would offset each other, such that the net security-based swap position would be $75 million, and reporting pursuant to proposed Rule 10B-1 would not be required since the net exposure is below $150 million. However, if a person held $250 million in bonds on ABC Corporation and purchased $325 million in CDS on those bonds, the person would be required to report that position pursuant to proposed Rule 10B-1 because the gross security-based swap position exceeds $300 million, even though those two positions would offset each other to create a net $75 million exposure. See Proposing Release at 75.

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