Commentaries

Bridging the Week by Gary DeWaal: June 23 to 27 and 30, 2014 (SEC Cross-Border Rules; Red Flag to Broker Ripping Off NFL and NBA Players)

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Published Date: June 29, 2014

Last week, the Securities and Exchange Commission issued its first rules governing cross-border transactions involving security-based swaps. Overall these rules are parallel to guidance previously adopted by the Commodity Futures Trading Commission, but differ in some important respects. Also last week, the Financial Industry Regulatory Authority issued a red flag to a broker-dealer and its CEO for engaging in fraud against many current and former US professional football and basketball players. Talk about unsportsmanlike conduct!

As a result, the following matters are covered in this week’s Bridging the Week:

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SEC Adopts First Rules and Guidance Related to Cross-Border Security-Based Swap Activity; Describes When Registration Is Required and the Scope of the Agency’s Cross-Border Anti-Fraud Authority

The Securities and Exchange Commission last week adopted its first in a series of rules aimed at cross-border security-based swap transactions. The rules establish when a cross-border transaction must be counted to determine if a non-US person has to register as a security-based swap dealer or a major security-based swap participant, as well as the scope of the agency’s anti-fraud authority.

The SEC also adopted a rule establishing the procedure for submitting substituted compliance requests, pursuant to which, if granted, a non-US security-based swap dealer or security-based major swap participant can rely on certain of its home jurisdiction’s rules to satisfy comparable SEC obligations. The actual nature of substituted compliance will be addressed in a future SEC rule-making.

In the US, security-based swaps are swaps based on a single entity’s security or a narrow-based security index (e.g., credit default swaps based on a single entity’s security or total return swaps based on a narrow-based security index). Jurisdiction over swaps and certain persons engaging in swaps activity (except for security-based swaps) lies with the Commodity Futures Trading Commission. Jurisdiction over security-based swaps and certain persons engaging in security-based swaps activity resides with the SEC. The CFTC and SEC share jurisdiction over certain mixed swaps.

Previously, the CFTC issued interpretive guidance and an exemptive order to govern cross-border swaps transactions.  A lawsuit is pending against the CFTC for its issuance of requirements as guidance as opposed to as rules. (For details regarding the CFTC’s interpretive guidance, click here to see the July 16, 2013 article on this website, “CFTC Enacts Interpretive Guidance and Passes Exemptive Order Regarding Cross Border Swaps Transactions.” For details regarding the lawsuit against the CFTC, click here to see the article “Three Industry Organizations File Lawsuit Against the CFTC Over Its Cross Border Guidance” in the December 2 to 6 and 9, 2013 edition of Bridging the Week.

Under the SEC’s new rules, for purposes of assessing its obligation to register as a security-based swap dealer, a non-US person must count towards a de minimis threshold all security-based swaps transactions with counterparties that (1) are US persons (including foreign branches or offices of US banks that are not registered as security-based swap dealers); (2) have rights of recourse against a US person affiliate for a non-US person’s obligations under a security-based swap transaction; and (3) are so-called “conduit affiliates” (e.g., where through internal group transactions, the risks and benefits of a security-based swap with a non-US person are transferred to a US person).

These requirements are parallel to but different from CFTC requirements in some respects. For example, whereas the CFTC’s guidance takes the view that a non-US person which receives any express guarantee from a US affiliate should count all its dealing activity against the de minimis threshold, the SEC requires inclusion only where a counterparty has recourse against a US person that is affiliated with the non-US person. The SEC says it has adopted a “more targeted” approach.

The de minimis threshold, however, is similar under both the CFTC’s and SEC’s methodologies for potential swap dealers and security-based swap dealers (i.e., for a potential security-based swap dealer, $8 billion of gross notional CDS activity over the prior 12 months decreased to $3 billion after a phase-in period will trigger a registration obligation).

Likewise, the definition of US person includes (1) natural persons who reside in the US; (2) any legal entity or vehicle that is established under US laws or has its principal place of business in the US; (3) any discretionary or non-discretionary account of a US person; and (4) any estate of a decedent who was a US person at the time of death. The SEC’s final rules define place of business as “the location from which the officers, partners or managers of the legal person primarily direct, control and coordinate the activities of the legal person.” This definition of place of business will capture many externally managed investment vehicles organized outside the US that are active participants in the security-based swap markets, acknowledges the SEC.

The SEC definition of US person differs from the CFTC's definition, particularly as it relates to investment vehicles.  The SEC, for example, expressly declined to include within its definition of US person the CFTC’s inclusion of any investment vehicle that is majority-owned by US persons.

The SEC believes its definition captures the universe of persons whose security-based swaps activity could have a significant impact within the US no matter where or with whom their activities occur:

“[T]he definition of “U.S. person” in the final rule is intended, in part, to identify those persons for whom it is reasonable to infer that a significant portion of their financial and legal relationships are likely to exist within the United States and that it is therefore reasonable to conclude that risk arising from their security-based swap activities could manifest itself within the United States, regardless of the location of their counterparties, given the ongoing nature of the obligations that result from security-based swap transactions.”

In commentary regarding its new rules, the SEC said it will later solicit comment on how it should address security-based swap transactions between two non-US persons when activity related to such swaps occurs at least partially in the US.

As part of its rulemaking, the SEC also indicated that a request for substituted compliance may be submitted by any party that potentially must comply with SEC requirements, or by a relevant foreign regulator. A request must include documentation regarding methods used by a relevant foreign regulator to enforce its applicable rules.

Finally the SEC’s final rule states that its anti-fraud authority is applicable wherever there is sufficient conduct in furtherance of an alleged fraud or sufficient effects of the alleged fraud within the US.

In enacting its rules, the SEC emphasized the global interconnectedness of security-based swap dealers. According to the Commission,

“Because dealers facilitate the great majority of security-based swap transactions, with bilateral relationships that extend to potentially hundreds of counterparties, liquidity problems or other forms of financial distress that begin in one entity or one corner of the globe can potentially spread throughout the network, with dealers as a central conduit.”

The effective date of the SEC’s new rules will be 60 days after they are published in the Federal Register.

And briefly:

And even more briefly:

For more information, see:

CFTC Extends Date of Prior No-Action Relief Related to the Receipt and Recording of Customer Funds:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-88.pdf

CFTC Extends Date of Prior Relief for Reporting Certain Identifying Information Regarding Certain OTC Swaps:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-89.pdf

ESMA Publishes Revised EMIR Q&As; Adds New Matters Related to the Reporting to Trade Repositories and of Exchange-Traded Derivatives
http://www.esma.europa.eu/system/files/2014-682.pdf

Broker-Dealer Success Trade Securities and Its President Expelled From FINRA for Ripping Off Many Former NFL and NBA Players Through a Ponzi Scheme:
http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p537675.pdf

Barclays Charged by New York State in Connection With the Marketing and Operation of Its Dark Pool:
http://www.ag.ny.gov/pdfs/Barclays_complaint_as_filed_June_25_2014.pdf

NFA Highlights Changes to CPO Form PQR and CTA Form PR That Are Effective for the Period Ending June 30: http://www.nfa.futures.org/news/documents/Changes_to_PQR.pdf

NFA Proposes to Prohibit Credit Card Use to Meet Margin Calls for Retail FX Accounts:
http://www.nfa.futures.org/news/PDF/CFTC/InterpNotice_CR2-4_2-36_Prohibit_Use_of_Certain_Funding.pdf

SEC Adopts First Rules and Guidance Related to Cross-Border Security-Based Swap Activity:
http://www.sec.gov/rules/final/2014/34-72472.pdf

SEC Orders Widened Tick Size for Certain Small Capitalization Stocks and Market Quality Impact Study:
http://www.sec.gov/rules/other/2014/34-72460.pdf

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of June 28, 2014. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP and/or Gary DeWaal may represent one or more entities mentioned in this article.

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Gary DeWaal

Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.


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