The SEC's New Proposed Rule To Regulate Credit Derivatives And Other Security-Based Swaps Raises Practical Concerns For The Industry And May Exceed The SEC's Authority

• Published date: 11 March 2022
• Subject Matter: Finance and Banking, Corporate/Commercial Law, Consumer Protection, Financial Services, Commodities/Derivatives/Stock Exchanges, Corporate and Company Law, Securities, Dodd-Frank, Consumer Protection Act
• Law Firm: Kramer Levin Naftalis & Frankel LLP
• Author: Mr Steven Sparling, Fabien Carruzzo and Michael Hardin

On Dec. 15, 2021, the U.S. Securities and Exchange Commission (SEC or Commission) proposed Rule 240.9j-1 (the Rule), intended "to prevent fraud, manipulation, and deception in connection with effecting transactions in, or inducing or attempting to induce the purchase or sale of, any security-based swap" (SBS).¹ The Rule purports to effectuate Section 9(j) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The Rule is still in the notice-and-comment period, with comments due on March 21.

Background

This is not the Commission's first crack at Rule 9(j). In 2010, the SEC proposed a different version of Rule 240.9j-1 (the 2010 Rule).² Critics observed that the 2010 Rule reached conduct beyond that which takes place "in connection with the 'purchase' and 'sale' of a[n SBS]" and would "unintentionally prohibit ... the legitimate exercise of rights and performance of obligations" such as those "dictated by the contract underlying the [SBS] and which bear no relation to execution, termination, assignment, exchange and transfer or extinguishment of rights."³ Ultimately, the 2010 Rule was never adopted.

The Commission is now back, and the Rule raises many of the concerns levied against the 2010 Rule. The Rule is notable for its breadth; on its face, the Rule regulates not only the purchase and sale of SBSs, but virtually any transaction under a swap contract, including periodic payments and deliveries. The Rule prohibits the following types of transactions in SBSs if done "in connection with" four types of fraudulent conduct:

• Purchasing or selling or attempting to induce the purchase or sale of an SBS.
• Effecting or attempting to effect any transaction in an SBS.
• Taking any action to exercise any right, or any action related to the performance of any obligation, under any SBS, including in connection with any payments, deliveries, rights, or obligations or alterations of any rights thereunder; or terminating (other than on its scheduled maturity date) or settling any SBS.⁴

Such transactions are prohibited if done in connection with one of four types of fraudulent conduct:

• Employing or attempting to employ any device, scheme or artifice to defraud or manipulate.
• 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 light of the circumstances under which they were made, not misleading.
• 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.
• Engaging or attempting to engage in any act, practice or course of business that operates or would operate as a fraud or deceit upon any person.⁵

According to the Commission, the Rule "combine[s] the antifraud and anti-manipulation provisions in Rule 10b-5 that apply to all securities ... with the additional antifraud and anti-manipulative authority specific to [SBSs]" authorized by Dodd-Frank.⁶ The first two types of fraudulent conduct are patterned on Rule 10b-5 and would thus require proof that they were done knowingly or recklessly. By contrast, the third and fourth types of fraudulent conduct are based on Section 17(a) of the Securities Act and thus would only require proof of negligence.⁷

In addition, the Rule prohibits any person from manipulating or attempting to manipulate "the price or valuation of any [SBS], or any...