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

Federal RegisterJun 30, 2023

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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.

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”)

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.

In addition to other requirements, the CCO must take reasonable steps to ensure that the SBS Entity establishes, maintains, and reviews written policies

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.

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.

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).

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”).

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.

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.”

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.”

See

15 U.S.C. 78i(j).

See id.

Note that section 9 of the Exchange Act erroneously contains two subsection (j)s.

See id.

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.

For example, the Dodd-Frank Act amended the definition of “security” in section 3(a)(10) of the Exchange Act

and section 2(a)(1) of the Securities Act

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,

and section 17(a) of the Securities Act.

Section 3(a)(68) of the Exchange Act defines “security-based swap.” 15 U.S.C. 78c(a)(68).

15 U.S.C. 78c(a)(10).

15 U.S.C. 77b(a)(1).

15 U.S.C. 78j(b).

15 U.S.C. 77q(a).

Moreover, the Dodd-Frank Act amended the definitions of “purchase” and “sale” in section 2(a)(18) of the Securities Act,

the definitions of “buy” and “purchase” in section 3(a)(13) of the Exchange Act,

and “sale” and “sell” in section 3(a)(14) of the Exchange Act,

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.

15 U.S.C. 77b(a)(18).

15 U.S.C. 78c(a)(13).

15 U.S.C. 78c(a)(14).

On December 15, 2021, the Commission re-proposed antifraud and anti-manipulation rules,

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,

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.

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

to protect CCOs in the furtherance of those duties.

The Commission is adopting Rule 9j-1 with modifications in response to commenters,

and adopting Rule 15fh-4(c) as proposed.

In developing this rulemaking we have consulted and

coordinated with the CFTC and the prudential regulators in accordance with section 712(a)(2) of the Dodd-Frank Act.

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.

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.”

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.

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.

See

15 U.S.C. 78

-10(h).

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.

The comment letters are available at

http://www.sec.gov/comments/s7-32-10/s73210.shtml.

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

https://www.sec.gov/comments/s7-32-10/s73210-20114041-266299.htm

(discussing dark pools); Comment from Anonymous, dated Dec. 16, 2021, available at

https://www.sec.gov/comments/s7-32-10/s73210-20109790-264127.htm

(discussing securities lending).

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 s

ection II.E.2.c.

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.

The Commission also proposed for comment a new Rule 10B-1,

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.

See

2021 Proposing Release, 87 FR at 6667-76.

B. Overview of Security-Based Swaps

1. Security-Based Swaps Generally

Although the definition of security-based swap is detailed and comprehensive,

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.

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.

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.

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”).

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.

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).

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.”).

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,

insurance companies managing asset and liability risk specific to the insurance industry,

activists or hedge funds obtaining exposure to the price movement and dividend payments of a stock without the costs and burdens of stock ownership,

and financial institutions that engage in market-making and dealing in security-based swaps.

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.

See, e.g.,

Letter from Elliot Ganz, Loan Syndications and Trading Association (“LSTA”), dated Mar. 17, 2022 (“LSTA Letter”), at 2-3.

See

Letter from Michael Lovendusky, American Council of Life Insurers (“ACLI”), dated Mar. 21, 2022 (“ACLI Letter”).

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).

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”).

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).

Two common examples of security-based swaps—credit default swaps (“CDS”) and total return swaps (“TRS”)—are described in more detail below.

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.

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”).

The

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.

This feature of CDS contracts is an aspect of some of the manufactured or opportunistic strategies discussed in section I.B.2.

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.

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

http://www.creditfixings.com/information/affiliations/fixings/auctions/docs/credit_event_auction_primer.pdf. See also

Credit Suisse, A Guide to Credit Events and Auctions, 5 (Jan. 11, 2012), available at

https://doc.research-andanalytics.csfb.com/docView?language=ENG&source=emfromsendlink&format=PDF&document_id=803733390&serialid=FWHCx3yCrSE3FoEvAbEKa6fRKhqLoKs0jL1gR5W2Dfs%3D.

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).

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.

See

2010 Rule 9j-1 Proposing Release, 75 FR at 68562.

See also

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.).

Senate Hearing on Over the Counter Derivatives Reform and Addressing Systemic Risks, S. Hrg. 1111-803 (Dec. 2, 2009), available at

https://www.govinfo.gov/content/pkg/CHRG-111shrg62722/pdf/CHRG-111shrg62722.pdf.

Id.

(including testimony noting that enacted reforms will result in “very consequential changes” to OTC derivatives markets).

Id.

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.

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.

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.

See

Report on Security-Based Swaps, Mar. 20, 2023, available at

https://www.sec.gov/files/report-security-based-swaps-032023.pdf

(“SBS Report”). For further discussion of the Regulation SBSR data,

see infra

section V.C.2.

See id.

In general, the ongoing payments of a security-based swap depend, in part, on

its gross notional amount outstanding.

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.

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:

See, e.g., Bloomberg L.P.

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)).

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).

2021 Proposing Release, 87 FR at 6655.

See also

CFTC Talks Podcast, Credit Derivatives, (Jul. 10, 2019), available at

https://www.cftc.gov/Exit/index.htm?https://youtu.be/Qqo9KR6JXaM

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.”

See

Joint Statement on Opportunistic Strategies in the Credit Derivatives Market (June 24, 2019), available at

https://www.sec.gov/news/press-release/2019-106

(“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).

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.

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

security (as opposed to purchases or sales in the security-based swap).

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).

See

Rules 9j-1(a), (a)(1) through (a)(5), and (d).

See

Rule 9j-1(a)(6).

See

Rules 9j-1(b) and (c).

See

Rule 9j-1(e).

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©, 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.

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

https://www.archives.gov/files/federal-register/write/handbook/ddh.pdf.

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,

and of “buy,” “purchase,” “sale,” and “sell” in the Exchange Act,

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.

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.

15 U.S.C. 77b(a)(18).

15 U.S.C. 78c(a)(13) and (14).

See supra

section I.B.1 for a discussion regarding ongoing payments and deliveries that are typical for a security-based swap.

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.

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.

See, e.g.,

SEC Investor Alert: Binary Options Fraud, available at

https://www.investor.gov/protect-your-investments/fraud/types-fraud/binary-options-fraud

(“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,

and Rule 10b-5 thereunder,

as well as section 17(a) of the Securities Act.

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.

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,

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.

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.

15 U.S.C. 78j(b).

17 CFR 240.10b-5.

15 U.S.C. 77q(a).

See

2021 Proposing Release, 87 FR at 6661-62.

See

2021 Proposing Release, 87 FR at 6703.

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.

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).

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.

Further, the Commission is adopting Rule 9j-1(e) as proposed but now renumbered as final Rule 9j-1(d).

See

15 U.S.C. 78c(a)(13) and (14).

See supra

sections II.B and II.C.

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.

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.”

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”).

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.

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.”

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.”

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.”

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.' ”

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.

MFA Letter at 5.

See

IIB-ISDA-SIFMA Letter at 6.

MFA Letter at 5.

Id.

at 7.

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.”

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.”

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.”

MFA Letter at 7-8 (emphasis in original).

MFA Letter at 8.

IIB-ISDA-SIFMA Letter at 8-9.

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

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.

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.

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.

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.”

See

15 U.S.C. 78i(j).

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.

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).

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,”

holding that the phrase “should be `construed not technically and restrictively, but flexibly to effectuate its remedial purposes.' ”

Accordingly, the Court has held that “it is enough that the fraud alleged `coincide' with a securities transaction.”

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.”

Merrill Lynch, Pierce, Fenner & Smith Inc.

Dabit,

547 U.S. 71, 85 (2006).

SEC

Zandford,

535 U.S. 813, 819 (2002) (citations omitted).

Dabit,

547 U.S. at 85 (citation omitted).

See Superintendent of Ins. of State of N.Y.

Bankers Life & Cas. Co.,

404 U.S. 6, 12 (1971) (“deceptive practices touching [a] sale” are actionable);

Chadbourne & Parke LLP

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)).

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).

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.

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.

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.

United States

O'Hagan,

521 U.S. 642, 657-58 (1997) (quoting 15 U.S.C. 78b).

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.

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.”

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.

15 U.S.C. 78c(a)(13) and 78c(a)(14).

15 U.S.C. 77b(a)(18), 78c(a)(13), and 78c(a)(14).

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.

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).

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.

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.”

Commenters did not disagree.

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.

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”).

2021 Proposing Release, 87 FR at 6661.

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”).

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.

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

Arthur Anderson & Co. (U.S.A.),

924 F. Supp. 449, 478 (S.D.N.Y. 1996) (citation omitted).

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”).

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

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

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.

Sun Chemical Corp.,

553 F.2d 1033, 1045 (7th Cir. 1977).

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

SEC,

922 F.3d 468, 472 (D.C. Cir. 2019);

SEC

Moran,

922 F. Supp. 867, 896 (S.D.N.Y. 1996);

Carroll

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.

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

Aaron

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

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

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.

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

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.

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

SEC,

Rules 9j-1(a)(3) and (4) focus on the “effect” of the particular misconduct, and therefore, a negligence standard is appropriate.

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.

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.

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

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.

Sylvan,

860 F.2d 1242, 1251 (5th Cir. 1988) (citing

Nor-Tex Agencies Inc.

Jones,

482 F.2d 1093 (5th Cir. 1973));

Stier

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

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

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

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

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

Cote,

504 F.3d 682, 687 (7th Cir. 2007).

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

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.

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

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

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

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.

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

https://www.isda.org/a/KDqME/Final-NTCE-Supplement.pdf.

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-

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

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

Hochfelder,

425 U.S. 185 (1976);

Markowski

SEC,

274 F.3d 525 (D.C. Cir. 2001);

United States

Mulheren,

938 F.2d 364 (2d Cir. 1991);

SEC

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

Credit Suisse Intern,

127 F. Supp. 3d 60 (S.D.N.Y. 2015);

ATSI Communications, Inc.

Shaar Fund, Ltd.,

493 F.3d 87 (2d Cir. 2007);

Wilson

Merrill Lynch & Co.,

671 F.3d 120 (2d Cir. 2011);

SEC

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

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.

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.

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

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

194

Milbank Letter at 3 (citing to

Santa Fe Industries, Inc.

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

https://data.bloomberglp.com/bat/sites/3/2016/10/WhitePaper_Wen.pdf.

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.

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.

199

See

Better Markets Letter at 9.

200

See

MFA Letter at 8-9.

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

Final Rule 9j-1(b) includes non-substantive corrections to punctuation.

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.

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.

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

swap” in section 3(a)(68)(A) of the Exchange Act.

204

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.

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

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