Sullivan & Cromwell discusses Proposed SEC Rule Regarding Security-Based Swaps

SUMMARY

On September 8, 2014, the Securities and Exchange Commission proposed a rule under the Securities Act of 1933 to provide that the publication or distribution of price quotes relating to security-based swaps that may be purchased only by eligible contract participants and are traded or processed through a national securities exchange or a security-based swap execution facility will not be deemed to constitute offers of such security-based swaps (or any guarantees of such security-based swaps), for the purposes of the registration requirements of the Securities Act. Comments on the proposed rule are due on or before 60 days from the date of its publication in the Federal Register.

BACKGROUND

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) gives the SEC and the CFTC extensive authority to regulate over-the-counter derivative products, markets and market participants. Under Title VII of Dodd-Frank, the SEC has authority over security-based swap (“SBS”) transactions and participants in the SBS market and the CFTC has authority over swap transactions, swap markets and swap market participants.

Among other matters, Title VII includes SBSs in the definition of “security” for the purposes of the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”). Title VII also amended Section 5 of the Securities Act to make it unlawful, unless a registration statement is in effect, to offer to sell, offer to buy or purchase or sell[1] an SBS to any person who is not an “eligible contract participant” (“ECP”).[2] Any offer and sale of an SBS between ECPs may either be registered under the Securities Act or be made pursuant to an exemption from the registration requirements of the Securities Act. Many SBS transactions today are entered into in reliance on the private placement exemption from the registration requirements of the Securities Act provided by Section 4(a)(2) thereunder. Compliance with the Section 4(a)(2) exemption has been interpreted by the SEC and the courts to require that any offer or sale of the security made thereunder not be made by means of general solicitation or advertising.

Title VII also amends the Exchange Act to govern the regulation of SBS execution facilities (“SBSEFs”), including by adding provisions relating to access to SBSEFs and the availability of bid, offer or other price information relating to SBSs. Proposed rules by the SEC with respect to SBSEFs and national securities exchanges generally require these trading platforms to make price quotes involving SBSs (“SBS price quotes”) available to all market participants. However, unrestricted publication or distribution of SBS price quotes could potentially be considered a general solicitation for the SBS transaction for purposes of Section 4(a)(2) and thereby render the Section 4(a)(2) exemption unavailable. The SEC has issued the proposed rule (the “Proposed Rule”) to address this potential issue.[3]

THE PROPOSED RULE

Under the Proposed Rule, the publication or distribution of SBS price quotes would not be deemed to constitute an offer, an offer to sell, or a solicitation of an offer to buy or purchase such SBSs (or any guarantees of such SBSs[4]), for the purposes of the registration requirements of the Securities Act, if:

  • the SBSs may be purchased only by ECPs; and
  • the SBSs are traded or processed on or through a trading system or platform that is registered as either a national securities exchange or as an SBSEF, or is exempt from registration as an SBSEF pursuant to a rule, regulation, or order of the SEC (an “eligible trading platform”).

The Proposed Rule would apply to the initial publication or distribution of the SBS price quotes on eligible trading platforms and to any subsequent republication or redistribution of the SBS price quotes on or through other media, such as on-line information services. The exemption provided by the Proposed Rule would apply whether or not the SBS transaction is cleared through an eligible clearing agency.

The SEC noted that the SBS price quotes covered by the Proposed Rule could take a number of forms, such as indicative quotes, executable quotes, bids and offers and other pricing information. The SEC expressly declined to define the specific types of SBS price quotes covered by the Proposed Rule in order to maintain flexibility as organized markets for SBS trading continue to develop through the ongoing implementation of Title VII.[5]

According to the SEC, the Proposed Rule is designed to permit SBS transactions between ECPs to continue to be able to rely on available exemptions from the registration requirements of the Securities Act, without unintended consequences from the unrestricted public dissemination of SBS price quotes by SBSEFs and national securities exchanges that trade or process SBS transactions. The unrestricted access to such SBS price quotes on eligible trading platforms would, according to the SEC, provide increased market transparency by providing all investors with the same information on the pricing of SBS transactions.

According to the SEC, other than excluding the publication or distribution of SBS price quotes from the definition of an “offer” under Section 5 of the Securities Act, the Proposed Rule does not affect the availability of any exemption from the registration requirements of the Securities Act. Market participants would therefore still need to determine whether an exemption from the registration requirements of the Securities Act is available with respect to an SBS transaction. The SEC also stressed that the Proposed Rule does not limit the scope or applicability of antifraud provisions of the federal securities laws relating to oral or written material misstatements and omissions in the offer and sale of securities, including SBSs.

The SEC had received comments that the Proposed Rule should also extend to SBS communications that could be characterized as “research.” The SEC, citing a lack of information on the types of communications that could constitute “research,” declined to so extend the Proposed Rule. However, the SEC has requested comment on this topic.

The SEC also declined to adopt:

  • a broad-based exemption from registration under Section 12(g) of the Exchange Act for types of SBS transactions that could be deemed to be of the same class on the basis that it was not clear how the SBS market would develop once Title VII was fully implemented; and
  • a broad-based exemption from the Trust Indenture Act of 1939 for SBS transactions on the basis that the Trust Indenture Act already has an exclusion from registration for transactions exempt under Section 4(a)(2).

The SEC, however, requests comments on both topics.

[1] The “purchase” or “sale” of a SBS would include entry into the SBS.

[2] For the SEC’s and CFTC’s joint final rules regarding the classification of ECPs, see “Further Definition of ‘Swap Dealer,’ ‘Security-Based Swap Dealer,’ ‘Major Swap Participant,’ ‘Major Security-Based Swap Participant’ and ‘Eligible Contract Participant,’” 77 FR 30596 (May 23, 2012). For more information regarding the classification of entities as ECPs, see our Memorandum to Clients, dated June 8, 2012, entitled “CFTC and SEC Issue Final Swap-Related Rules Under Title VII of Dodd-Frank: CFTC and SEC Issue Final Rules and Guidance to Further Define the Terms “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant”

[3] See “Treatment of Certain Communications Involving Security-Based Swaps That May Be Purchased Only By Eligible Contract Participants” (September 8, 2014), available at http:// www.sec.gov/rules/proposed/2014/33-9643.pdf.

[4] The Proposed Rule would also extend to guarantees of SBS transactions since the guarantee of an SBS transaction is itself a security under the Securities Act.

[5] The SEC indicates that there are at least five types of eligible trading platforms – single dealer request for quotes, aggregators, multi-dealer request for quotes, limit order book systems, and electronic brokering.

The full and original memorandum was published by Sullivan & Cromwell LLP on September 10, 2014, and is available here.