February 13, 2023

SEC to Enhance Its Regulation of Security-Based Swaps

As we have previously discussed, the SEC’s Fall 2022 “Reg Flex” Agenda charts the agency’s planned rulemaking through Q1 2023. Among this ambitious and wide-reaching agenda are two important final rulemakings concerning the regulation of security-based swaps (SBS) pursuant to Title VII of the Dodd-Frank Act.

Registration of SBS Execution Facilities (SBSEFs)

Among other things, Title VII of the Dodd-Frank Act amended the Exchange Act to prohibit the operation of a facility for the trading or processing of SBS absent registration of such facility as a SBSEF (or as a national securities exchange). The SEC’s Reg Flex Agenda includes potential finalization of a May 2022 proposed rulemaking that would stand up a regime for the registration and regulation of SBSEFs, with many similarities to the counterpart swap execution facility (SEF) registration regime previously adopted and implemented by the CFTC. In addition, the proposed rulemaking included measures intended to mitigate conflicts of interest at SBSEFs and national securities exchanges that trade SBSs, address the cross-border application of the Exchange Act SBS trading venue and trade execution requirements, and clarify the interaction of the SBSEF registrant category with existing SEC exchange and broker registration requirements. The SEC has received significant public comment on the proposal, and it remains to be seen what approach the SEC will ultimately take on a number of important issues, such as:

  • Whether the SEC will provide an abbreviated SBSEF registration procedure for CFTC-registered SEFs, a matter on which the SEC specifically requested public comment
  • Whether the SEC will proceed with its proposal to provide deemed broker status to SBSEFs that solely engage in SBS activities (and not other securities activities) so as to alleviate the need for dual registration as a broker-dealer and SBSEF
  • The extent to which any final rulemaking will mandate registration by foreign SBSEFs and mandatory trade execution on the basis of involvement of US personnel in arranging, negotiating, or executing transactions between non-US persons, a question that has drawn specific public comment
  • The extent to which the final SBSEF registration regime will ultimately align with the CFTC SEF registration regime (especially the CFTC “made available to trade” determination process), or whether the goals of regulatory harmonization will give way to differences and peculiarities of the SBS market identified as part of the public comment process

SBS Antifraud and Antimanipulation Rules; Large Position Reporting

The Dodd-Frank Act also extended the antifraud and antimanipulation provisions of the Exchange Act and Securities Act to encompass SBS activity. In this regard, the SEC Reg Flex Agenda includes potential finalization of the February 2022 SEC proposed rulemaking prohibiting certain forms of misconduct in the SBS market. The proposed rulemaking included antifraud and antimanipulation rules intended to take into account the unique features of SBS in comparison to traditional securities, including to address manufactured credit events and other potential misconduct in connection with the ongoing payments and deliveries that typically occur throughout the lifecycle of SBS transactions. In addition, the proposed rulemaking included express prohibitions on certain actions to coerce, manipulate, mislead, or fraudulently influence the CCO of an SBS dealer or major security-based swap participant in the performance of their duties. Perhaps most notably, the proposed rulemaking also includes proposed reporting requirements for certain large SBS positions. There are a number of issues that will warrant close examination and review under any forthcoming final rulemaking, for example:

  • Whether the SEC will clarify the availability of existing safe harbors and affirmative defenses to violations under the general antifraud and antimanipulation rules under the SBS-specific rules, such as trading plan and information wall defenses to insider trading violations
  • Whether the SEC will maintain the proposed approach of not requiring scienter for certain forms of misconduct in relation to SBS activity, including attempts to obtain property by means of material misstatements or omissions or attempts to engage in an act, practice, or course of business which operates as a fraud or deceit
  • Whether the SEC will proceed with the proposed reporting thresholds for large SBS positions, and what form the large position reporting obligation will ultimately take (including whether submission using a particular structured data language will be mandated)

With more than a decade having elapsed since the enactment of the Dodd-Frank Act, if adopted these planned final rulemakings will close some of the lingering gaps in the SEC’s SBS regulatory regime. Any such finalization is unlikely to go completely without controversy, with SEC Commissioner Hester M. Peirce having previously noted that public comment has identified aspects of these proposed rulemakings, such as the large SBS position reporting requirements, as beset by “deep flaws.” We will provide further updates upon finalization of these important rulemakings.