[Federal Register Volume 88, Number 125 (Friday, June 30, 2023)]
[Rules and Regulations]
[Pages 42546-42585]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-12592]



[[Page 42545]]

Vol. 88

Friday,

No. 125

June 30, 2023

Part III





 Securities and Exchange Commission





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17 CFR Part 240





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

  Federal Register / Vol. 88 , No. 125 / Friday, June 30, 2023 / Rules 
and Regulations  

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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.

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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'') \1\ 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.\2\ In addition to other requirements, the CCO must take 
reasonable steps to ensure that the SBS Entity establishes, maintains, 
and reviews written policies

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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.\3\
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    \1\ 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.
    \2\ 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).
    \3\ 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'').
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    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.\4\ 
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.'' \5\ 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.'' \6\
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    \4\ See 15 U.S.C. 78i(j).
    \5\ See id. Note that section 9 of the Exchange Act erroneously 
contains two subsection (j)s.
    \6\ See id.
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    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.\7\ For 
example, the Dodd-Frank Act amended the definition of ``security'' in 
section 3(a)(10) of the Exchange Act \8\ and section 2(a)(1) of the 
Securities Act \9\ 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,\10\ and section 17(a) 
of the Securities Act.\11\
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    \7\ Section 3(a)(68) of the Exchange Act defines ``security-
based swap.'' 15 U.S.C. 78c(a)(68).
    \8\ 15 U.S.C. 78c(a)(10).
    \9\ 15 U.S.C. 77b(a)(1).
    \10\ 15 U.S.C. 78j(b).
    \11\ 15 U.S.C. 77q(a).
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    Moreover, the Dodd-Frank Act amended the definitions of 
``purchase'' and ``sale'' in section 2(a)(18) of the Securities 
Act,\12\ the definitions of ``buy'' and ``purchase'' in section 
3(a)(13) of the Exchange Act,\13\ and ``sale'' and ``sell'' in section 
3(a)(14) of the Exchange Act,\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. 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.
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    \12\ 15 U.S.C. 77b(a)(18).
    \13\ 15 U.S.C. 78c(a)(13).
    \14\ 15 U.S.C. 78c(a)(14).
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    On December 15, 2021, the Commission re-proposed antifraud and 
anti-manipulation rules,\15\ 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,\16\ 
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.\17\ 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 \18\ to protect CCOs 
in the furtherance of those duties.\19\ The Commission is adopting Rule 
9j-1 with modifications in response to commenters,\20\ and adopting 
Rule 15fh-4(c) as proposed.\21\ In developing this rulemaking we have 
consulted and

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coordinated with the CFTC and the prudential regulators in accordance 
with section 712(a)(2) of the Dodd-Frank Act.\22\ 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.
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    \15\ 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.''
    \16\ 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.
    \17\ 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.
    \18\ See 15 U.S.C. 78o-10(h).
    \19\ 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.
    \20\ 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).
    \21\ 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 
section II.E.2.c.
    \22\ 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.
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    The Commission also proposed for comment a new Rule 10B-1,\23\ 
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.
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    \23\ See 2021 Proposing Release, 87 FR at 6667-76.
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B. Overview of Security-Based Swaps

1. Security-Based Swaps Generally
    Although the definition of security-based swap is detailed and 
comprehensive,\24\ 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.\25\ 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.\26\ 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.\27\
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    \24\ 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'').
    \25\ 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.
    \26\ 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).
    \27\ 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.'').
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    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,\28\ insurance companies managing 
asset and liability risk specific to the insurance industry,\29\ 
activists or hedge funds obtaining exposure to the price movement and 
dividend payments of a stock without the costs and burdens of stock 
ownership,\30\ and financial institutions that engage in market-making 
and dealing in security-based swaps.\31\ 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.\32\
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    \28\ See, e.g., Letter from Elliot Ganz, Loan Syndications and 
Trading Association (``LSTA''), dated Mar. 17, 2022 (``LSTA 
Letter''), at 2-3.
    \29\ See Letter from Michael Lovendusky, American Council of 
Life Insurers (``ACLI''), dated Mar. 21, 2022 (``ACLI Letter'').
    \30\ 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).
    \31\ 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'').
    \32\ 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).
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    Two common examples of security-based swaps--credit default swaps 
(``CDS'') and total return swaps (``TRS'')--are described in more 
detail below.\33\
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    \33\ 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.
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    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'').\34\ The

[[Page 42549]]

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.\35\ This feature of CDS contracts is an 
aspect of some of the manufactured or opportunistic strategies 
discussed in section I.B.2.
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    \34\ 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.
    \35\ 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.
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    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).\36\ 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.
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    \36\ See 2010 Rule 9j-1 Proposing Release, 75 FR at 68562. See 
also infra section V.B, discussing broad economic considerations of 
security-based swaps and specifically TRS.
---------------------------------------------------------------------------

2. Security-Based Swap Market Developments
    In 2010, following the 2008 financial crisis, Congress enacted the 
Dodd-Frank Act ``to promote the financial stability of the United 
States by improving accountability and transparency in the financial 
system.'' \37\ Title VII of the Dodd-Frank Act addressed significant 
issues and risks in the swap and security-based swap markets, which had 
experienced dramatic growth leading up to the 2008 financial crisis and 
were shown to be capable of affecting significant sectors of the U.S. 
economy.\38\ In testimony before Congress introducing the first draft 
of the Dodd-Frank Act, Treasury Secretary Timothy Geithner highlighted 
the risks posed by an unregulated OTC derivatives market, which had 
been operating without the ``basic protections and oversight'' existing 
in the rest of the financial systems, including a ``limited ability to 
police fraud and manipulation.'' \39\ In his written testimony, 
Secretary Geithner listed four broad objectives of the proposed reforms 
which were eventually enacted as Title VII of the Dodd-Frank Act: (1) 
preventing activities in the OTC derivatives markets from posing risk 
to the stability of the financial system; (2) promoting efficiency and 
transparency of the OTC derivatives markets; (3) preventing market 
manipulation, fraud, and other abuses; and (4) protecting consumers and 
investors by ensuring that OTC derivatives are not marketed 
inappropriately to unsophisticated parties.\40\ Secretary Geithner also 
stressed that the CFTC and the SEC should be provided with strong 
authority for civil enforcement and regulation of fraud, market 
manipulation, and other abuses in the OTC derivative markets.\41\ The 
authority enacted in Title VII of the Dodd-Frank Act includes, but is 
not limited to, Exchange Act section 9(j). Ensuring that the Commission 
has the necessary tools to police the security-based swap markets is a 
key component to ensure that Title VII's reforms are not undermined.
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    \37\ Dodd-Frank Act, Public Law 111-203, Preamble. See also 
Business Conduct Standards Adopting Release, 81 FR at 29961.
    \38\ 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.).
    \39\ 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.
    \40\ Id. (including testimony noting that enacted reforms will 
result in ``very consequential changes'' to OTC derivatives 
markets).
    \41\ Id.
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    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.\42\ 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.\43\ 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.\44\
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    \42\ 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.
    \43\ See id.
    \44\ See id.
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    In general, the ongoing payments of a security-based swap depend, 
in part, on

[[Page 42550]]

its gross notional amount outstanding.\45\ 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.\46\ 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: \47\
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    \45\ See, e.g., Bloomberg L.P. v. 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)).
    \46\ 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).
    \47\ 2021 Proposing Release, 87 FR at 6655. See also supra note 
35 and related discussion regarding the operation of CDS auctions.
---------------------------------------------------------------------------

     A CDS buyer working with a reference entity to create an 
artificial, technical, or temporary failure-to-pay credit event in 
order to trigger a payment on a CDS to the buyer (and to the detriment 
of the CDS seller).\48\
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    \48\ See Henry T.C. Hu, Corporate Distress, Credit Default 
Swaps, and Defaults: Information and Traditional, Contingent, and 
Empty Creditors, 13 Brook. J. Corp. Fin. & Com. L. 5-32, at 26-27 
(Nov. 2018), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3302816.
---------------------------------------------------------------------------

     Alone or in combination with the above or other 
strategies, causing the reference entity to issue a below-market debt 
instrument in order to artificially increase the auction settlement 
price for the CDS (i.e., by creating a new ``cheapest to deliver'' 
deliverable obligation).\49\
---------------------------------------------------------------------------

    \49\ See Statement on Manufactured Credit Events by CFTC 
Divisions of Clearing and Risk, Market Oversight, and Swap Dealer 
and Intermediary Oversight (Apr. 24, 2018), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/divisionsstatement042418.
---------------------------------------------------------------------------

     CDS buyers endeavoring to influence the timing of a credit 
event in order to ensure a payment (upon the triggering of the CDS) 
before expiration of a CDS, or a CDS seller taking similar actions to 
avoid the obligation to pay by ensuring a credit event occurs after the 
expiration of the CDS, or taking actions to limit or expand the number 
and/or kind of deliverable obligations in order to impact the recovery 
rate.\50\
---------------------------------------------------------------------------

    \50\ See Hu, supra note 48 at 22-26.
---------------------------------------------------------------------------

     CDS sellers offering financing to restructure a reference 
entity in such a way that ``orphans'' the CDS--eliminating or reducing 
the likelihood of a credit event by moving the debts off the balance 
sheets of the reference entity and onto the balance sheets of a 
subsidiary or an affiliate that is not referenced by the CDS.\51\
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    \51\ See Gina-Gail S. Fletcher, Engineered Credit Default Swaps: 
Innovative or Manipulative?, 94 N.Y.U. L. Rev. 1073, 1101 (2019).
---------------------------------------------------------------------------

     Taking actions, including as part of a larger 
restructuring, to increase (or decrease) the supply of deliverable 
obligations by, for example, adding (or removing) a co-borrower to 
existing debt of a reference entity, thereby increasing (or decreasing) 
the likelihood of a credit event and the cost of CDS.\52\
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    \52\ See Fletcher, supra note 51 at 1098. 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.'' \53\
---------------------------------------------------------------------------

    \53\ 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).\54\ 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.\55\ 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

[[Page 42551]]

security (as opposed to purchases or sales in the security-based 
swap).\56\ 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).\57\
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    \54\ See Rules 9j-1(a), (a)(1) through (a)(5), and (d).
    \55\ See Rule 9j-1(a)(6).
    \56\ See Rules 9j-1(b) and (c).
    \57\ See Rule 9j-1(e).
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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(copyright), 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.\58\
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    \58\ 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,\59\ and of ``buy,'' ``purchase,'' ``sale,'' and ``sell'' in the 
Exchange Act,\60\ 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.\61\ 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.\62\
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    \59\ 15 U.S.C. 77b(a)(18).
    \60\ 15 U.S.C. 78c(a)(13) and (14).
    \61\ See supra section I.B.1 for a discussion regarding ongoing 
payments and deliveries that are typical for a security-based swap.
    \62\ 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.\63\ 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.
---------------------------------------------------------------------------

    \63\ 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.
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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,\64\ and Rule 
10b-5 thereunder,\65\ as well as section 17(a) of the Securities 
Act.\66\ 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.\67\ 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,

[[Page 42552]]

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.\68\ 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.\69\
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    \64\ 15 U.S.C. 78j(b).
    \65\ 17 CFR 240.10b-5.
    \66\ 15 U.S.C. 77q(a).
    \67\ See 2021 Proposing Release, 87 FR at 6661-62.
    \68\ See 2021 Proposing Release, 87 FR at 6703.
    \69\ 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.\70\ 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).\71\ 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.\72\ Further, the Commission is 
adopting Rule 9j-1(e) as proposed but now renumbered as final Rule 9j-
1(d).
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    \70\ See 15 U.S.C. 78c(a)(13) and (14).
    \71\ See supra sections II.B and II.C.
    \72\ 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.\73\ 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.'' 
\74\
---------------------------------------------------------------------------

    \73\ 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'').
    \74\ 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.\75\ 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.'' 
\76\ 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.'' \77\ 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.'' \78\ 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.' '' \79\
---------------------------------------------------------------------------

    \75\ 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.
    \76\ MFA Letter at 5. See IIB-ISDA-SIFMA Letter at 6.
    \77\ MFA Letter at 5.
    \78\ Id. at 7.
    \79\ 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.'' \80\ 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.'' \81\ 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.'' \82\
---------------------------------------------------------------------------

    \80\ MFA Letter at 7-8 (emphasis in original).
    \81\ MFA Letter at 8.
    \82\ 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

[[Page 42553]]

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.\83\ 
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.\84\ 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.
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    \83\ 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.''
    \84\ 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.\85\ 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).
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    \85\ 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,'' \86\ holding that the 
phrase ``should be `construed not technically and restrictively, but 
flexibly to effectuate its remedial purposes.' '' \87\ Accordingly, the 
Court has held that ``it is enough that the fraud alleged `coincide' 
with a securities transaction.'' \88\ 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.'' 
\89\
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    \86\ Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 
U.S. 71, 85 (2006).
    \87\ SEC v. Zandford, 535 U.S. 813, 819 (2002) (citations 
omitted).
    \88\ Dabit, 547 U.S. at 85 (citation omitted). See 
Superintendent of Ins. of State of N.Y. v. Bankers Life & Cas. Co., 
404 U.S. 6, 12 (1971) (``deceptive practices touching [a] sale'' are 
actionable); Chadbourne & Parke LLP v. 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)).
    \89\ 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.\90\ 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.\91\ 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.
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    \90\ United States v. O'Hagan, 521 U.S. 642, 657-58 (1997) 
(quoting 15 U.S.C. 78b).
    \91\ 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.\92\ 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.'' \93\ 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.\94\
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    \92\ 15 U.S.C. 78c(a)(13) and 78c(a)(14).
    \93\ 15 U.S.C. 77b(a)(18), 78c(a)(13), and 78c(a)(14).
    \94\ 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.

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[[Page 42554]]

    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).\95\ 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.\96\ 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.'' \97\ 
Commenters did not disagree.\98\
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    \95\ 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.
    \96\ 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'').
    \97\ 2021 Proposing Release, 87 FR at 6661.
    \98\ 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'').\99\ 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.
---------------------------------------------------------------------------

    \99\ 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 
v. Arthur Anderson & Co. (U.S.A.), 924 F. Supp. 449, 478 (S.D.N.Y. 
1996) (citation omitted). See also, e.g., Ingenito v. Bermac Corp., 
376 F. Supp. 1154, 1181 (S.D.N.Y. 1974) (considering claims of 
Section 10(b) and finding that ``a purchase or a sale arises when 
the nature and terms of an investor's involvement in a business 
enterprise are substantially altered by the creation of new rights 
or obligations''); Louis Loss, et al., Securities Regulation Sec.  
3.A.2 (2023) (citing to N. Natural Gas Co., 14 SEC 506, 509 (1943) 
(noting that ``for example, a change in interest or dividend rate or 
a liquidation preference or underlying security, or a change in the 
identity of the issuer, would seem clearly to result in a new 
security'')). Changes are more likely to be considered 
``significant'' if they are adverse to the security holders 
affected. See, e.g., SEC v. Associated Gas & Electric Co., 99 F.2d 
795, 797-98 (2nd Cir. 1938) (holding that under the Public Utility 
Holding Company Act of 1935, the extension of the maturity date of a 
debt security increased the risk to the holder and therefore 
constituted the sale of a new security). See also Rathborne v. 
Rathborne, 683 F.2d 914, 920 (5th Cir. 1982) (``In determining 
whether a party to a securities transaction is a `purchaser' or 
`seller,' we must ask whether the transaction has wrought a 
fundamental change in the nature of the plaintiff's investment . . . 
. [T]he core issue is whether the transaction has transformed the 
plaintiff into the functional equivalent of a purchaser or seller--
has the plaintiff been forced to exchange his stock for shares 
representing a participation in a substantially different 
enterprise? We must focus upon the economic reality of the 
transaction, and determine whether the transaction has `transformed' 
the plaintiff's interests `in any real sense.' '' (citations 
omitted)); Keys v. Wolfe, 709 F.2d 413, 417 (5th Cir. 1983) (holding 
that ``the determination of whether'' there has been ``a significant 
change in the nature of the investment or in the investment risks . 
. . hinges on the economic reality of the transaction rather than on 
formal changes in the rights and obligations of the parties'').
    \101\ MFA Letter at 6.
    \102\ See Loss, supra note 100 (noting that ``a change in 
interest or dividend rate''--which is an ongoing right or 
obligation--``would seem clearly to result in a new security'').
---------------------------------------------------------------------------

    Two commenters agreed that ``Rule 9j-1 should be applicable . . . 
if the parties to a security-based swap transaction make changes to 
material terms that result in the creation of a new transaction.'' 
\103\ But these commenters disagreed with the Commission's assertion in 
the 2021 Proposing Release that such a modification or amendment--and 
thus a purchase or sale--occurs when a party engages in conduct that 
``has a material impact on any payment or delivery under the security-
based swap, such that it would not be consistent with what a reasonable 
person would have expected to pay, deliver, or receive absent such 
conduct.'' \104\ Under final Rule 9j-1(a), whether a purchase or sale 
of a security-based swap has occurred will depend on the facts and 
circumstances and therefore the operation of the rule, as revised, is 
not dependent on the language in the 2021 Proposing Release

[[Page 42555]]

quoted by the commenters.\105\ Applying a facts and circumstances 
analysis, if conduct that affects ongoing payments or deliveries 
results in the extinguishment of a right or obligation under a 
security-based swap, such as the right to such a payment or delivery, 
or otherwise results in a new transaction, then a purchase or sale will 
have occurred, and any related fraudulent, deceptive, or manipulative 
misconduct will fall within Rule 9j-1's prohibitions.
---------------------------------------------------------------------------

    \103\ MFA Letter at 4. See IIB-ISDA-SIFMA Letter at 7 
(``[M]arket participants have arranged their affairs to treat such 
an exercise of discretion to amend a material term of [a security-
based swap] as tantamount to the `purchase' or `sale' of [a 
security-based swap], including for anti-fraud purposes.'').
    \104\ 2021 Proposing Release, 87 FR at 6661. See IIB-ISDA-SIFMA 
Letter at 7-8; MFA Letter at 4.
    \105\ See supra note 96. The language ``as the context may 
require,'' which is included in Rule 9j-1, comes from the 
definitions of purchase and sale in Exchange Act sections 3(a)(13) 
and 3(a)(14), and recognizes the need to consider the facts of a 
particular situation to determine whether a purchase or sale has 
occurred.
---------------------------------------------------------------------------

c. Effecting Transactions
    Exchange Act section 9(j), and accordingly final Rule 9j-1(a), also 
is not limited to prohibitions on fraud, manipulation, or deception in 
connection with the purchase or sale of a security-based swap, but also 
encompasses misconduct in connection with effecting a transaction in 
any security-based swap. While the term ``transaction'' ``is not 
defined in the Act, its broad meaning in everyday usage'' and ``the 
context in which it is used in the various sections of the Act'' 
demonstrate that ``it has a broader meaning than purchases or sales.'' 
\106\ The Commission accordingly has construed the term ``to effect any 
transaction in'' a security, variations of which appear in numerous 
provisions of the securities laws, to include activity such as placing 
bids or orders, and clearance and settlement of a securities 
transaction.\107\ The Commission also has stated that ``key aspects of 
the overall process of effecting security-based swap transactions'' 
include ``sales, booking and cash and collateral management 
activities.'' \108\
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    \106\ In re Kidder Peabody & Co., 18 S.E.C. 559, 1945 WL 332559, 
at *8 (Apr. 2, 1945) (interpreting Exchange Act section 9(a)(2) and 
finding that Congress intended to extend its ``prohibition against 
manipulation . . . beyond the actual consummation of purchases or 
sales,'' to include ``affecting the market artificially by raising 
or depressing security prices, or creating actual or apparent 
activity, whether or not accomplished by actual purchases or 
sales''). See SEC v. Lek Sec. Corp., 276 F. Supp. 3d 49, 62 
(S.D.N.Y. 2017) (``Courts have held that a `series of transactions' 
includes not only completed purchases or sales but also bids and 
orders to purchase or sell securities.'').
    \107\ Kidder Peabody, 1945 WL 332559, at *8. See 15 U.S.C. 78bb 
(identifying ``clearance, settlement, and custody'' as ``functions 
incidental'' to ``effect[ing] securities transactions''). Settlement 
of security-based swaps occurs over time in accordance with 
contractually agreed upon terms (in contrast to other securities 
such as debt or equity, where settlement occurs when the parties 
exchange securities for cash equal to the full value of the 
securities sold). See T+1 Adopting Release, 88 FR at 13878, 13883 
(quoting SIFMA who noted that, that for security-based swaps, 
settlement occurs when 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'' (citation omitted)). See also supra note 32.
    \108\ Registration Process for Security-Based Swap Dealers and 
Major Security-Based Swap Participants, Exchange Act Release No. 
75611 (Aug. 5, 2015), 80 FR 48964, 48976 n.99 (Aug. 14, 2015) 
(``SBSD/MSBSP Registration Process Release''). In the SBSD/MSBSP 
Registration Process Release, in the context of determining who has 
to register as a security-based swap dealer, the Commission 
identified some activities that would fall within the definition of 
``involved in effecting security-based swap transactions''--for 
example, pricing security-based swap positions and managing 
collateral. The identification of these activities as part of ``the 
overall process of effecting'' a transaction'' also serves to 
demonstrate that not all activities in that process take place prior 
to the execution of the security-based swap. See MFA Letter at 7 
(asserting ``[i]nterpretations of `effect[ing] a transaction,' . . . 
have been limited to the process leading to the purchase or sale of 
a security'' (emphasis added)). In addition, as the Commission has 
previously explained in the context of broker-dealers, ``effecting'' 
transactions in securities has been construed broadly to encompass a 
wide range of activities, including: (1) transmission of an order 
for execution, order execution, clearance and settlement, and 
arranging for the performance of any such function, see 17 CFR 
240.11a2-2(T); 2014 Temp Rule 11a2-2(T); and (2) screening potential 
transaction participants for creditworthiness, soliciting securities 
transactions, routing or matching orders or facilitating the 
execution of a transaction, handling customer funds and securities, 
and preparing and sending transaction confirmations, Definition of 
Terms in and Specific Exemptions for Banks, Savings Associations, 
and Savings Banks Under Sections 3(a)(4) and 3(a)(5) of the 
Securities Exchange Act of 1934, Exchange Act Release No. 44291 (May 
11, 2001), 66 FR 27760, 27772-73 (May 18, 2001)). Critically, 
several of these activities are not limited to pre-trade actions 
(e.g., clearance, settlement, and handling counterparty funds).
---------------------------------------------------------------------------

    Final Rule 9j-1(a) therefore prohibits fraudulent, manipulative, or 
deceptive conduct related to the exercise of rights or performance of 
obligations--including ongoing payments and deliveries--under a 
security-based swap if that misconduct occurs in connection with a 
broad range of activities ``beyond the actual consummation of purchases 
or sales.'' \109\ For example, as discussed in section II.C below, a 
manipulation of the ongoing payments and deliveries under a security-
based swap could be used to ``affect[ ] the market artificially by 
raising or depressing securities prices,'' and that conduct would be 
connected to effecting transactions in security-based swaps.\110\ 
Similarly, as one commenter noted, a ``misappropriation of customer 
margin'' would be connected to effecting a security-based swap 
transaction.\111\
---------------------------------------------------------------------------

    \109\ Kidder Peabody, 1945 WL 332559, at *8. See 15 U.S.C. 78bb 
(identifying ``clearance, settlement, and custody'' as ``functions 
incidental'' to ``effect[ing] securities transactions'').
    \110\ Id. For example, a platform that effects transactions in 
security-based swaps, such as binary options or other event 
contracts, could fraudulently extinguish a holder's right to 
payment. Such conduct could also affect the market price for similar 
binary options or event contracts.
    \111\ IIB-ISDA-SIFMA Letter at 9.
---------------------------------------------------------------------------

    In addition, the Commission is extending the application of final 
Rule 9j-1(a) to fraudulent, deceptive, or manipulative misconduct that 
occurs in connection with an ``attempt'' to effect a transaction in any 
security-based swap. This application is consistent with section 9(j)'s 
prohibition of fraud, deception, and manipulation in connection with an 
``attempt to induce the purchase or sale of'' any security-based swap 
and is supported by case law that recognizes that fraudulent, 
deceptive, or manipulative conduct need not be successful to violate 
the securities laws.\112\ It is also a ``means reasonably designed to 
prevent'' misconduct that results in completed transactions, which the 
statute explicitly prohibits.\113\
---------------------------------------------------------------------------

    \112\ See, e.g., Koch v. SEC, 793 F.3d 147, 153-54 (D.C. Cir. 
2015) (``[I]ntent--not success--is all that must accompany 
manipulative conduct to prove a violation of the Exchange Act and 
its implementing regulations.'' (citation omitted)); Kuehnert v. 
Texstar Corp., 412 F.2d 700, 704 (5th Cir. 1969) (``[W]e are not 
convinced of any difference in substance between a successful fraud 
and an attempt. The statutory phrase `any manipulative or deceptive 
device,' 15 U.S.C. 78j(b), seems broad enough to encompass conduct 
irrespective of its outcome.''); Lek, 276 F. Supp. at 60 (S.D.N.Y. 
2017) (``manipulative conduct need [not] be successful in order to 
violate the securities laws''); SEC v. Martino, 255 F. Supp. 2d 268, 
287 (S.D.N.Y. 2003) (``an attempted manipulation is as actionable as 
a successful one''). See also Lorenzo v. SEC, 139 S. Ct. 1094, 1104 
(2019) (``The Commission . . . need not show reliance in its 
enforcement actions.'').
    \113\ 15 U.S.C. 78i(j).
---------------------------------------------------------------------------

B. Fraudulent, Manipulative, or Deceptive Conduct

1. Proposed Approach
    Proposed Rules 9j-1(a)(1) through (4), describing the prohibited 
fraudulent, manipulative, or deceptive conduct, was structured to 
include the antifraud and anti-manipulation provisions--in section 
10(b) of the Exchange Act, and Rule 10b-5 thereunder, and section 17(a) 
of the Securities Act--that apply to all securities (including 
security-based swaps), and the additional antifraud and anti-
manipulative authority specific to security-based swaps provided to the 
Commission in section 9(j) of the Exchange Act. Specifically, the 
proposed rule would have prohibited: (1) employing or attempting to 
employ any device, scheme, or artifice to defraud or manipulate; (2) 
making or attempting to make any untrue statement of a material fact, 
or omitting to state a material fact necessary in order to make the 
statements made, in the light of the circumstances under which they 
were

[[Page 42556]]

made, not misleading; (3) obtaining or attempting to obtain money or 
property by means of any untrue statement of a material fact or any 
omission to state a material fact necessary in order to make the 
statements made, in light of the circumstances under which they were 
made, not misleading; or (4) engaging or attempting to engage in any 
act, practice, or course of business which operates or would operate as 
a fraud or deceit upon any person.\114\
---------------------------------------------------------------------------

    \114\ 2021 Proposing Release, 87 FR at 6658-60.
---------------------------------------------------------------------------

    Proposed Rules 9j-1(a)(1) and (2), consistent with section 10(b) of 
the Exchange Act, and Rule 10b-5 thereunder, and section 17(a)(1) of 
the Securities Act, would have required scienter. In contrast, proposed 
Rules 9j-1(a)(3) and (4) would not have required scienter and would 
have extended to conduct that is at least negligent, consistent with 
sections 17(a)(2) and (3) of the Securities Act.
2. Commission Action
    After considering the comments, the Commission is revising proposed 
Rule 9j-1(a) as discussed below in sections II.B.2.a and II.B.2.b.\115\
---------------------------------------------------------------------------

    \115\ Final Rule 9j-1(a)(6), which is a revision of proposed 
Rule 9j-1(b), is discussed in section II.C below.
---------------------------------------------------------------------------

    Final Rule 9j-1(a)(1) is being adopted as proposed, and will 
prohibit employing or attempting to employ any device, scheme, or 
artifice to defraud or manipulate. Although most of that language is 
derived from section 10(b) of the Exchange Act,\116\ Rule 10b-5 
thereunder,\117\ and section 17(a)(1) of the Securities Act,\118\ the 
inclusion of ``manipulate'' also comes from the text of section 9(j)).
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    \116\ Section 10(b) of the Exchange Act provides that ``[i]t 
shall be unlawful for any person, directly or indirectly . . . (b) 
to use or employ, in connection with the purchase or sale of any 
security . . . any manipulative or deceptive device or contrivance 
in contravention of such rules and regulations as the Commission may 
prescribe as necessary or appropriate in the public interest or for 
the protection of investors.'' 15 U.S.C. 78j(b).
    \117\ Rule 10b-5 under the Exchange Act provides that ``[i]t 
shall be unlawful for any person, directly or indirectly . . . (a) 
to employ any device, scheme, or artifice to defraud, (b) 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 
light of the circumstances under which they are made, not 
misleading, or (c) to engage in any act, practice, or course of 
business which operates or would operate as a fraud or deceit upon 
any person, in connection with the purchase or sale of any 
security.'' 17 CFR 240.10b-5.
    \118\ Section 17(a) of the Securities Act provides that ``[i]t 
shall be unlawful for any person in the offer or sale of securities 
. . . directly or indirectly--(1) to employ any device, scheme, or 
artifice to defraud, or (2) 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 are made, not 
misleading, or (3) to engage in any transaction, practice, or course 
of business which operates or would operate as a fraud or deceit 
upon the purchaser.'' 15 U.S.C. 77q(a).
---------------------------------------------------------------------------

    Final Rule 9j-1(a)(2), which is based on section 9(j) and Rule 10b-
5, will prohibit making or attempting to make any untrue statement of a 
material fact, or omitting to state a material fact necessary in order 
to make the statements made, in the light of the circumstances under 
which they were made, not misleading.
    Proposed paragraphs (a)(3) and (4) are revised to separate 
attempted conduct into a new paragraph (a)(5) (to which a scienter 
standard is applicable, as discussed in section II.B.2.b below). 
Paragraph (a)(3) will prohibit obtaining 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. 
Paragraph (a)(4) will prohibit engaging in any act, practice, or course 
of business which operates or would operate as a fraud or deceit upon 
any person. Paragraphs (a)(3) and (4) are based on sections 17(a)(2) 
and (3) of the Securities Act, as well as Exchange Act section 9(j), 
which similarly prohibits ``engag[ing] in any transaction, practice, or 
course of business which operates as a fraud or deceit upon any 
person.'' \119\
---------------------------------------------------------------------------

    \119\ See supra notes 5 and 118.
---------------------------------------------------------------------------

    Paragraph (a)(5) will prohibit attempting to obtain money or 
property by means of any untrue statement of a material fact or any 
omission to state a material fact necessary in order to make the 
statements made, in light of the circumstances under which they were 
made, not misleading 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. As discussed in section II.B.2.b below, the 
prohibition on attempted conduct in paragraphs (a)(1), (a)(2), and 
(a)(5) is premised on the text of section 9(j), including the 
Commission's prophylactic authority to ``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.''
    The provisions described above generally prohibit a range of 
fraudulent, manipulative, and deceptive conduct in the security-based 
swap market.\120\ Case law related to section 10(b) of the Exchange 
Act, Rule 10b-5 thereunder, and section 17(a) of the Securities Act 
provides guidance as to what conduct violates section 9(j) of the 
Exchange Act and Rule 9j-1 thereunder.
---------------------------------------------------------------------------

    \120\ See 2021 Proposing Release, 87 FR at 6659.
---------------------------------------------------------------------------

a. Scienter and Negligence Standards
    Findings of misconduct under final Rules 9j-1(a)(1) and (2) require 
scienter while final Rules 9j-1(a)(3) and (4) do not require scienter 
and extend to conduct that is at least negligent.\121\ While both Rules 
9j-1(a)(2) and (3) prohibit material misstatements and omissions,\122\ 
they address different levels of culpability.\123\ Specifically, Rule 
9j-1(a)(2) will apply when there is evidence of scienter (e.g., when a 
party to a security-based swap knowingly or recklessly makes a false 
statement even though the party may not receive any money or property 
as a result). In contrast, Rule 9j-1(a)(3) extends to conduct that is 
at least negligent (e.g., when a party to a security-based swap knows 
or reasonably should know that a statement was false or misleading and 
directly or indirectly obtains money or property by means of such 
statement).
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    \121\ In addition, findings of misconduct under paragraphs 
(a)(5) and (a)(6) will require scienter. See infra section II.B.2.b 
(paragraph (a)(5)) and section II.C.2 (paragraph (a)(6)).
    \122\ Consistent with section 10(b) of the Exchange Act, such 
misstatements and omissions must be material to be actionable. ``The 
question of materiality, it is universally agreed, is an objective 
one, involving the significance of an omitted or misrepresented fact 
to a reasonable investor . . . there must be a substantial 
likelihood that the disclosure of the omitted fact would have been 
viewed by the reasonable investor as having significantly altered 
the `total mix' of information made available.'' TSC Indus., Inc. v. 
Northway, Inc., 426 U.S. 438, 445, 449 (1976). See also Basic v. 
Levinson, 485 U.S. 224, 233 (1988).
    \123\ In addition to differences in the standard, there are 
additional deviations between Rules 9j-1(a)(2) and (3), 
notwithstanding the significant overlap in the rule text. For 
example, while paragraph (a)(2), like Rule 10b-5(b), makes it 
unlawful to make any untrue statement of a material fact, paragraph 
(a)(3), like section 17(a)(2) of the Securities Act does not use the 
word ``make.'' Based on that difference courts have contrasted the 
application of Rule 10b-5(b) from the application of section 
17(a)(2) of the Securities Act as it relates to determining who is 
the maker of a material misstatement. See, e.g., SEC v. Big Apple 
Consulting USA, Inc., 783 F.3d 786, 797 (11th Cir. 2015) (``[W]e . . 
. agree with the Securities and Exchange Commission's recent 
opinion, which held `Janus's limitation on primary liability under 
Rule 10b-5(b) does not apply to claims arising under Section 
17(a)(2).' ''); SEC v. Tambone, 597 F.3d 436, 444 (1st Cir. 2010) 
(en banc) (contrasting the language of Rule 10b-5(b) with ``the 
expansive language of section 17(a)(2),'' which covers ``the `use' 
of an untrue statement of material fact (regardless of who created 
or composed the statement)'').
---------------------------------------------------------------------------

    Several commenters argued for a scienter standard, rather than the 
proposed negligence standard, with respect to paragraphs (3) and (4) of 
Rule 9j-1(a).\124\ Specifically, one commenter

[[Page 42557]]

argued that applying a negligence standard ``is inconsistent with the 
concept of fraud'' and that ``mere human error--which often occurs from 
the high volume of the [security-based swaps] business/frequent 
settlement activities--could result in liability.'' \125\ Another 
commenter stated that, at a minimum, ``any liability for interim 
actions taken during the term of the security-based swap should be 
subject to a scienter standard.'' \126\ In addition, other commenters 
believed that a negligence based standard would be ``disruptive to'' or 
``chill'' the security-based swap market \127\ and interfere with the 
legitimate actions taken by lenders engaged in security-based swap 
transactions.\128\
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    \124\ See IIB-ISDA-SIFMA Letter at 13 (arguing against applying 
a negligence standard for attempted conduct); LSTA Letter, at 5-7; 
MFA Letter at 12; Letter from John R. Williams, Milbank LLP, dated 
Mar. 22, 2022 (``Milbank Letter''), at 5. The European Banking 
Federation (``EBF'') supports the arguments in the IIB-ISDA-SIFMA 
Letter regarding proposed Rule 9j-1. See Letter from EBF, dated Apr. 
1, 2022, at 1. As proposed, paragraphs (3) and (4) of Rule 9j-1(a) 
would have prohibited actions related to security-based swaps in 
which a person 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 in which a person 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.
    \125\ See Milbank Letter at 5.
    \126\ MFA Letter at 12-13 (arguing that liability under Rule 9j-
1(a)(3) and (4) should be subject to scienter because security-based 
swap transactions are between ``sophisticated counterparties dealing 
directly with each other on negotiated terms'' rather than 
``impersonal transactions'' where there is a stronger argument for 
imposing liability under section 17(a) without scienter because it 
is harder to form a specific intent absent a relationship between 
the purchaser and the seller). Actions by the Commission demonstrate 
that security-based swap transactions are not always between 
sophisticated counterparties with ongoing relationships. See, e.g., 
In the Matter of Plutus Financial Inc. d/b/a Abra and Plutus 
Technologies Philippines Corp., Exchange Act Release No. 89296 (July 
13, 2020) (offering security-based swaps to retail investors via a 
phone application); In the Matter of Forcerank LLC, Exchange Act 
Release No. 79093 (Oct. 13, 2016) (illegally offering complex 
security-based swaps to retail investors). 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 v. 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. v. Sun 
Chemical Corp., 553 F.2d 1033, 1045 (7th Cir. 1977). See also 
Greebel v. FTP Software, Inc., 194 F.3d 185, 198 (1st Cir. 1999); 
SEC v. Environmental, Inc., 155 F.3d 107, 111 (2d Cir. 1998).
    \130\ Establishing violations of Securities Act section 17(a)(1) 
requires a showing of scienter. See, e.g., Aaron v. SEC, 446 U.S. 
680, 701-02 (1980). Scienter is the ``mental state embracing intent 
to deceive, manipulate or defraud.'' Ernst & Ernst v. Hochfelder, 
425 U.S. 185, 193 (1976). 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 v. SEC, 922 F.3d 468, 472 (D.C. Cir. 
2019); SEC v. Moran, 922 F. Supp. 867, 896 (S.D.N.Y. 1996); Carroll 
v. 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\ In Aaron v. 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 or 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

[[Page 42558]]

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 v. 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 v. 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 v. 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. v. Sylvan, 860 
F.2d 1242, 1251 (5th Cir. 1988) (citing Nor-Tex Agencies Inc. v. 
Jones, 482 F.2d 1093 (5th Cir. 1973)); Stier v. 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 v. 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\
---------------------------------------------------------------------------

    \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

[[Page 42559]]

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 id. at 672-
73 (``A prophylactic measure, because its mission is to prevent, 
typically encompasses more than the core activity prohibited.'').
    \152\ Kuehnert, 412 F.2d at 704.
---------------------------------------------------------------------------

    Rule 9j-1(a)'s prohibition on such attempted misconduct recognizes 
that fraud, deception, and manipulation in the security-based swaps 
market can involve complex strategies implemented over multiple stages, 
as discussed above in section I.B.2. The prohibition is consistent with 
other provisions of the securities laws that recognize the importance 
of Commission intervention before the completion of a fraudulent, 
deceptive, or manipulative act, practice, transaction, or course of 
business. The Commission has the authority to seek an injunction 
whenever ``any person is engaged or is about to engage in acts or 
practices constituting a violation of'' the Exchange Act or Securities 
Act.\153\ Rule 9j-1(a)'s prohibition of attempts provides the 
Commission with an additional tool to prevent such misconduct before 
any harm comes to the security-based swap market or market 
participants.
---------------------------------------------------------------------------

    \153\ 15 U.S.C. 78u(d) (emphasis added) (Exchange Act); 15 
U.S.C. 77t(b) (Securities Act). See, e.g., Kuehnert, 412 F.2d at 704 
(``The Commission may act . . . to enjoin a potential fraud or 
prosecute a fraud that failed, without proof of actual loss to any 
victim.'').
---------------------------------------------------------------------------

    One commenter argued against applying the negligence standard 
applicable to the misconduct prohibited by Rules 9j-1(a)(3) and (4) to 
attempts to engage in that misconduct because it ``may capture conduct 
that is not itself fraudulent or manipulative'' but rather ``legitimate 
business activities'' and would have a ``chilling effect on the market 
for security-based swaps.'' \154\ Another commenter noted that sections 
17(a)(2) and (3) of the Securities Act do not prohibit ``attempts'' and 
that ``the Commission should either eliminate the reference to attempts 
in Rules 9j-1(a)(3) and (4)'' or clarify the standard required for 
liability for attempted conduct prohibited under those paragraphs of 
Rule 9j-1.\155\ Similarly, one commenter believed that including 
attempts within the scope of conduct covered by Rule 9j-1 was broader 
than the scope of conduct covered by section 17(a) of the Securities 
Act and warranted the application of an intent standard.\156\
---------------------------------------------------------------------------

    \154\ LSTA Letter at 7.
    \155\ See IIB-ISDA-SIFMA Letter at 13 (arguing that ``[p]arties 
cannot be held to a standard of strict liability with regards to 
fluid discussions in the course of negotiating complex 
transactions--not to mention the potential for good faith mistakes 
to arise in connection with ongoing payment and delivery 
obligations'').
    \156\ See MFA Letter at 12. 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 v. 
Cote, 504 F.3d 682, 687 (7th Cir. 2007). See also United States v. 
Gracidas-Ulibarry, 231 F.3d 1188, 1192 (9th Cir. 2000) (recognizing 
``the doctrine that the crime of attempt requires a showing of 
specific intent even if the crime attempted does not'' (internal 
quotation marks omitted)).
---------------------------------------------------------------------------

B. Prohibition on Price Manipulation

1. Proposed Approach
    Partly in response to manufactured credit events and other 
opportunistic CDS strategies observed over the last decade,\159\ 
paragraph (b) of proposed Rule 9j-1 was designed to address price 
manipulation and attempted price manipulation, similar to 17 CFR 180.2 
(``CFTC Rule 180.2'').\160\ Paragraph (b) of proposed Rule 9j-1 would 
have made it unlawful for any person to, directly or indirectly, 
manipulate or attempt to manipulate the price or valuation of any 
security-based swap, or any payment or delivery related thereto.
---------------------------------------------------------------------------

    \159\ See supra section I.B.2. 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

[[Page 42560]]

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.
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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\
---------------------------------------------------------------------------

    \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 v. 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. v. 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-

[[Page 42561]]

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 v. Hochfelder, 425 U.S. 185 
(1976); Markowski v. SEC, 274 F.3d 525 (D.C. Cir. 2001); United 
States v. Mulheren, 938 F.2d 364 (2d Cir. 1991); SEC v. 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 v. Credit 
Suisse Intern, 127 F. Supp. 3d 60 (S.D.N.Y. 2015); ATSI 
Communications, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (2d Cir. 
2007); Wilson v. Merrill Lynch & Co., 671 F.3d 120 (2d Cir. 2011); 
SEC v. 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

[[Page 42562]]

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

[[Page 42563]]

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\
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    \194\ Milbank Letter at 3 (citing to Santa Fe Industries, Inc. 
v. 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.
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    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.
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    \199\ See Better Markets Letter at 9.
    \200\ See MFA Letter at 8-9.
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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\
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    \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.
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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

[[Page 42564]]

swap'' in section 3(a)(68)(A) of the Exchange Act.\204\
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    \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 equity or 
debt securities or loan, or be an affiliate of, or a person acting in 
concert with, such security-based swap counterparty in furtherance of 
such prohibited activity. Accordingly, the Commission would analyze 
whether transactions in the underlying equity or debt securities or 
loan have been used as the mechanism to violate section 9(j) and Rule 
9j-1. The Commission would also analyze the same transactions to 
determine whether they independently violate other antifraud and anti-
manipulation provisions of the securities laws--including sections 9 
and 10(b) of the Exchange Act, and Rule 10b-5 thereunder, as well as 
section 17(a) of the Securities Act.

E. Safe Harbors and Affirmative Defenses

1. Proposed Approach
    In response to operational concerns raised by commenters with 
regard to the 2010 Proposed Rule, the Commission proposed two limited 
safe harbors from re-proposed Rule 9j-1(a) to address situations when a 
counterparty to a security-based swap was required to take certain 
actions while in possession of material nonpublic information.\206\ 
First, proposed Rule 9j-1(f)(1), would have allowed a person to take 
action in accordance with binding contractual rights and obligations 
under a security-based swap (as reflected in the written security-based 
swap documentation governing such transaction or any amendment 
thereto), so long as the person could demonstrate that: (1) the 
security-based swap was entered into, or the amendment was made, before 
the person became aware of such material nonpublic information; and (2) 
the entry into, and the terms of, the security-based swap were 
themselves not a violation of any provision of proposed Rule 9j-
1(a).\207\
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    \206\ See 2021 Proposing Release, 87 FR at 6662, 6662 n.87.
    \207\ Id. at 6662.
---------------------------------------------------------------------------

    Second, recognizing the important operational benefits and market 
efficiencies related to security-based swap portfolio compression, 
proposed Rule 9j-1(f)(2) would have provided a safe harbor for 
transactions effected in connection with certain types of bilateral or 
multilateral portfolio compression exercises.\208\ This proposed safe 
harbor would have provided that a person would not be liable under re-
proposed Rule 9j-1(a) solely for reason of being aware of material 
nonpublic information for ``security-based swap transactions effected 
by a person pursuant to a bilateral portfolio compression exercise (as 
defined in Sec.  240.15Fi-1(a)) or a multilateral portfolio compression 
exercise (as defined in Sec.  240.15Fi-1(j)) so long as: (i) any such 
transactions are consistent with all of the terms of a bilateral 
portfolio compression exercise or multilateral portfolio compression 
exercise, including as it relates to, without limitation, the 
transactions to be included in the exercise, the risk tolerances of the 
persons participating in the exercise, and the methodology used in the 
exercise; and (ii) all such terms were agreed to by all participants of 
the bilateral portfolio compression exercise or multilateral portfolio 
compression exercise prior to the commencement of the applicable 
exercise.'' \209\
---------------------------------------------------------------------------

    \208\ See id. at 6662-63.
    \209\ Re-proposed Rule 9j-1(f)(2); 2021 Proposing Release, 87 FR 
at 6662.
---------------------------------------------------------------------------

2. Commission Action
    As discussed above, in response to operational concerns raised in 
response to the 2010 Proposed Rule, the Commission included two limited 
safe harbors from re-proposed Rule 9j-1(a).\210\ After further 
consideration and as described in more detail below, the Commission is 
not adopting either proposed safe harbor. Instead, the Commission is 
adopting two affirmative defenses from Rules 9j-1(a)(1) through (a)(5). 
One affirmative defense is for actions taken in connection with the 
binding contractual rights and obligations under a security-based swap 
(similar to the proposed safe harbor). The other affirmative defense 
takes account of reasonable policies and procedures that ensure that 
individuals making investment decisions are not engaging in prohibited 
conduct in final Rules 9j-1(a)(1) through (a)(5). These affirmative 
defenses, while not identical to the affirmative defenses under Rule 
10b5-1, are similar in that they apply to situations in which a person 
can demonstrate that material nonpublic information did not factor into 
their investment decision.
---------------------------------------------------------------------------

    \210\ See 2021 Proposing Release, 87 FR at 6660-62.
---------------------------------------------------------------------------

    Consistent with the analogous provisions of Rule 10b5-1, final Rule 
9j-1 does not provide for an affirmative defense for violations of the 
anti-manipulation provision in Rule 9j-1(a)(6). Paragraph (a)(6) of 
Rule 9j-1 does not apply to actions that the affirmative defenses 
address: those taken in the ordinary course of a security-based swap 
transaction (including actions related to the reference underlying 
security) while aware of material nonpublic information.\211\
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    \211\ Final Rule 9j-1(a)(6) is discussed in section II.C above.
---------------------------------------------------------------------------

    Several commenters urged the Commission to make the affirmative 
defenses under Rule 10b5-1 available under Rule 9j-1, to address 
situations in which a counterparty comes into possession of material 
nonpublic information during the life of a security-based swap.\212\ 
Rule 10b5-1 applies to

[[Page 42565]]

insider trading cases under section 10(b) of the Exchange Act, and Rule 
10b-5 thereunder, and includes affirmative defenses for: (1) purchases 
or sales pursuant to a binding contract, an instruction to another 
person to execute the trade for the instructing person's account, or a 
written trading plan under certain conditions; \213\ and (2) 
transactions by an entity if the individual making the investment 
decision on behalf of the entity was not aware of the material 
nonpublic information and the entity had implemented reasonable 
policies and procedures to ensure that the individuals making 
investment decisions would not violate insider trading laws.\214\
---------------------------------------------------------------------------

    \212\ See ACLI Letter at 2, 5; IIB-ISDA-SIFMA Letter at 4-5, 10; 
MFA Letter at 13-16; LSTA Letter at 9; Letter from Lindsey Weber 
Kiljo and William C. Thum, Asset Management Group of SIFMA (``SIFMA 
AMG''), dated Mar. 21, 2022 (``SIFMA AMG Letter''), at 11-12.
    \213\ See 17 CFR 240.10b5-1(c)(1) (``Rule 10b5-1(c)(1)'').
    \214\ See 17 CFR 240.10b5-1(c)(2) (``Rule 10b5-1(c)(2)'').
---------------------------------------------------------------------------

    Several commenters noted that most security-based swap market 
participants are global financial firms that have spent considerable 
resources to meet the requirements of current Rule 10b5-1(c)(2), by 
separating their organizations so that individuals on the public side 
can engage in dealing and market-making activity, while individuals on 
the private side are allowed to possess material nonpublic 
information.\215\ One commenter stated that the current policies and 
procedures restrict access to material nonpublic information by those 
individuals who engage in security-based swap transactions for hedging 
or other purposes.\216\ Since neither of the Rule 10b5-1 defenses 
explicitly applied to proposed Rule 9j-1 for security-based swaps, one 
commenter noted the ``confusion and regulatory uncertainty'' that would 
be created with the omission of a Rule 10b5-1(c)(2)-type defense from 
Rule 9j-1 (because identical conduct in the context of a security-based 
swap transaction could implicate both Rule 10b-5 and Rule 9j-1, but the 
affirmative defense would only be available under Rule 10b-5).\217\
---------------------------------------------------------------------------

    \215\ See IACPM Letter at 4; IIB-ISDA-SIFMA Letter at 5; MFA 
Letter at 13-14.
    \216\ See LSTA Letter at 9.
    \217\ IIB-ISDA-SIFMA Letter at 5.
---------------------------------------------------------------------------

    In addition, certain commenters expressed concern with the 
operational impacts of Rule 9j-1(a) on the capital and loan markets. 
One commenter argued that the application of proposed Rule 9j-1 to the 
ongoing, ``non-volitional'' rights and obligations that occur 
throughout the life of a security-based swap could ``cast uncertainty 
on a wide range of bona fide conduct necessary to the operation of the 
capital markets.'' \218\ The commenter urged the Commission to 
``provide an affirmative defense for actions taken by a person in 
accordance with binding contractual rights and obligations under [a 
security-based swap] . . . or to fulfill a regulatory obligation in 
connection with [a security-based swap] . . . if the person did not act 
intentionally or recklessly in connection with such action and . . . 
complied in good faith with written policies and procedures reasonably 
designed to meet the obligation.'' \219\ The commenter was concerned 
that the negligence standard applicable to re-proposed Rules 9j-1(a)(3) 
and (4), in particular, could lead to potential fraud liability for 
good faith, non-volitional conduct.\220\ Another commenter addressed 
operational concerns related to the credit markets and argued that the 
proposed rule would ``create considerable uncertainty with respect to 
the legitimate business decisions of lenders and impair the [security-
based swap] market and loan market.'' \221\ The commenter explained 
that if the rule were to apply to any activity that potentially affects 
the stream of payments, deliveries or other ongoing obligations or 
rights between parties to a security-based swap, ``each party will have 
to implement controls and mechanisms to track decisions made in 
connection with each payment, delivery, obligation or right as well as 
to track changes in its positions in the security-based swap and 
reference underlying.'' \222\
---------------------------------------------------------------------------

    \218\ Id. at 8-10.
    \219\ Id. at 10-11, 11 n.18 (referencing a safe harbor adopted 
by the CFTC in connection with non-scienter fraud and manipulative 
prohibitions as part of its swap dealer business conduct standards).
    \220\ Id. at 9. The commenter stated that it did not have the 
same concerns about proposed Rule 9j-1(b) (now Rule 9j-1(a)(6)), 
because the scienter standard applicable to that provision is 
``sufficient to distinguish illegitimate conduct from merely 
negligent acts that affect payment or delivery obligations.''
    \221\ LSTA Letter at 3-10.
    \222\ Id. The LSTA supported the principles underlying section 
9(j) but did not see the need for a new rule in light of existing 
antifraud rules and further believed that the existing antifraud 
rules would address several of the manufactured credit events 
described in the 2021 Proposing Release and that the adoption of 
anti-net short provisions would address other concerns. Id. at 3-4. 
The Commission believes that the affirmative defense provided by new 
Rule 9j-1(e)(2) will address these concerns.
---------------------------------------------------------------------------

    The Commission agrees with commenters that an affirmative defense 
similar to those available under Rule 10b5-1 (when the investment 
decision is not based on material nonpublic information) is important 
given the similarity in the antifraud provisions. The Commission also 
agrees that the affirmative defenses would address concerns regarding 
market disruption. As a result, the Commission is adopting two 
affirmative defenses similar in concept to the affirmative defenses in 
Rule 10b5-1(c).\223\ However, the Commission is adapting the 
affirmative defenses for the specific context of Rule 9j-1. In 
particular, the Commission is not adopting an affirmative defense that 
is as broad as the affirmative defenses in Rule 10b5-1(c)(1). Rather, 
as discussed below, the Commission is limiting the relevant Rule 9j-1 
affirmative defense to actions taken pursuant to binding contractual 
rights under the documentation governing a security-based swap. The 
Rule 10b5-1(c)(1) affirmative defenses relate to advance planning of 
purchases or sales pursuant to a binding contract, an instruction to 
another person to execute the trade for the instructing person's 
account, or a written trading plan under certain conditions.\224\ Those 
Rule 10b5-1(c)(1) affirmative defenses were created to ``provide 
appropriate flexibility to those who would like to plan securities 
transactions in advance, at a time when they are not aware of material 
nonpublic information, and then carry out those pre-planned 
transactions at a later time, even if they later become aware of 
material nonpublic information.'' \225\ That flexibility is warranted 
in the context of corporate insiders and others who periodically come 
into possession of material nonpublic information but may want to 
schedule orderly trading of securities of an issuer on a liquid public 
market. It is not appropriate in the context of security-based swaps, 
which are typically bespoke, created and

[[Page 42566]]

issued by the counterparties, and thinly traded.
---------------------------------------------------------------------------

    \223\ Much of the development of insider trading law has 
resulted from court cases. The Supreme Court has stated that 
``[u]nder the `traditional' or `classical theory' of insider trading 
liability, [section] 10(b) and Rule 10b-5 are violated when a 
corporate insider trades in the securities of his corporation on the 
basis of material, nonpublic information.'' O'Hagan, 521 U.S. at 
651-52 (emphasis added). See also Selective Disclosure and Insider 
Trading, Exchange Act Release No. 43154 (Aug. 15, 2000), 65 FR 
51716, 51727 (Aug. 24, 2000) (discussing the awareness standard 
required for insider trading liability and adopting the definition 
of ``on the basis'' of material nonpublic information in Rule 10b5-
1(b)). In this regard, any of the actions set forth in Rule 9j-1(a) 
with regard to a security-based swap are ``on the basis of'' 
material nonpublic information about that security-based swap, the 
issuer of that security-based swap, or the security underlying that 
security-based swap, if the person taking the action was aware of 
the material nonpublic information when the person took the action.
    \224\ See Rule 10b5-1(c)(1).
    \225\ See Insider Trading Arrangements and Related Disclosures, 
Exchange Act Release No. 96492 (Dec. 14, 2022), 87 FR 80362, 80363 
(Dec. 29, 2022) (``Rule 10b5-1 Amendments'').
---------------------------------------------------------------------------

    Accordingly, the Commission is adopting two affirmative defenses to 
liability under paragraphs (a)(1) through (a)(5) of final Rule 9j-1.
a. Affirmative Defense: Binding Contractual Obligations
    First, the Commission is adopting an affirmative defense that 
maintains the substance of the safe harbor provision in re-proposed 
Rule 9j-1(f)(1), which would have applied to actions taken pursuant to 
binding rights and obligations in written documentation governing a 
security-based swap that was entered into prior to the person coming 
into possession of material nonpublic information. As adopted, the 
provision in Rule 9j-1(e)(1) (renumbered from proposed paragraph (f)) 
is an affirmative defense, rather than a safe harbor, to be consistent 
with the structure of current Rule 10b5-1(c)(1). The affirmative 
defense in final Rule 9j-1(e)(1) provides that actions that would 
otherwise violate the prohibitions of Rule 9j-1(a)(1) through (5) are 
not a violation ``solely for reason of being aware of material 
nonpublic information'' if such actions are ``taken by a person in 
accordance with binding contractual rights and obligations under a 
security-based swap (as reflected in the written security-based swap 
documentation governing such transaction or any amendment thereto).'' 
\226\ Under this affirmative defense, consistent with Rule 10b5-
1(c)(1), a market participant may take action when aware of material 
nonpublic information but may avoid liability: ``so long as the person 
demonstrates that: (i) [t]he security-based swap was entered into, or 
the amendment was made, before the person became aware of such material 
nonpublic information, and (ii) [t]he security-based swap was entered 
into in good faith and not as part of a plan or scheme to evade the 
prohibitions of [Rule 9j-1].'' \227\
---------------------------------------------------------------------------

    \226\ See final Rule 9j-1(e)(1).
    \227\ See final Rule 9j-1(e)(1).
---------------------------------------------------------------------------

    Framing this relief as an affirmative defense rather than as a safe 
harbor, and restricting its use to circumstances in which the security-
based swap was entered into in good faith and not as part of a plan or 
scheme to evade the prohibitions of the rule, is consistent with Rule 
10b5-1(c)(1) treatment of the defense. As discussed above, multiple 
commenters requested the Commission adopt affirmative defenses based on 
the Rule 10b5-1(c) defenses.\228\ Rule 10b5-1(c)(1) provides an 
affirmative defense from Rule 10b-5 liability in circumstances where it 
is apparent that the trading was not made on the basis of material 
nonpublic information because ``the trade was made pursuant to a 
binding contract, an instruction to another person to execute the trade 
for the instructing person's account, or a written plan for the trading 
of securities . . . adopted at a time that the person was not aware of 
material nonpublic information.'' \229\ Similarly, Rule 9j-1(e)(1) 
provides an affirmative defense from Rule 9j-1(a) liability when an 
action is taken not on basis of material nonpublic information, but 
pursuant to binding contractual rights and obligations reflected in the 
written documentation governing a security-based swap.
---------------------------------------------------------------------------

    \228\ See supra note 212.
    \229\ See Rule 10b5-1 Amendments, 87 FR 80362, 80363 (adopting 
revisions to the Rule 10b5-1(c)(1) affirmative defense to apply a 
cooling-off period on persons other than the issuer of securities 
subject to a plan, impose a certification requirement on directors 
and officers of those issuers, limit the ability of persons other 
than the issuer to use multiple-overlapping Rule 10b5-1 plans, limit 
the use of single-trade plans by persons other than the issuer to 
one such single-trade plan in any 12-month period, and add a 
condition that all persons entering into a Rule 10b5-1 plan must act 
in good faith with respect to that plan).
---------------------------------------------------------------------------

    If the security-based swap was entered into in good faith and not 
as part of a plan or scheme to evade the prohibitions of the rule, the 
new Rule 9j-1(e)(1) affirmative defense will allow counterparties to 
take actions that are required by, and in accordance with, the written 
agreements governing the security-based swap (i.e., actions in the 
normal course of the security-based swap transaction) even when aware 
of material nonpublic information. For example, the Rule 9j-1(e)(1) 
affirmative defense would apply to making a standardized coupon payment 
or delivering collateral to a counterparty (and would also permit the 
counterparty to receive the coupon payment or collateral), while such 
person is aware of material nonpublic information, so long as both 
actions are required by the terms of the transaction and documented in 
writing. In contrast, the affirmative defense would not apply if a 
counterparty took some action to fraudulently increase (in the case of 
the receiving counterparty) or decrease (in the case of the delivering 
counterparty) the amount of such payment or collateral transfer. Rule 
9j-1(e) provides an affirmative defense when a person's conduct would 
violate Rule 9j-1(a)(1) through (5) ``solely'' because he or she is 
``aware of material nonpublic information.'' But actions to 
fraudulently increase or decrease payments or collateral transfer--when 
taken 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--would violate 
Rule 9j-1(a) regardless of the possession of material nonpublic 
information.
    A person relying on the affirmative defense in adopted final Rule 
9j-1(e)(1) must demonstrate that they entered into the security-based 
swap, or amendment, before becoming ``aware of'' the material nonpublic 
information rather than before they ``came into possession'' of the 
information, as required in re-proposed Rule 9j-1.\230\ The change in 
the rule text to an awareness standard, rather than a possession 
standard, brings the Rule 9j-1(e)(1) affirmative defense in line with 
the Commission's intent, as described in the 2021 Proposing Release 
preamble.\231\ The change also makes Rule 9j-1(e)(1) consistent with 
Rule 10b5-1(c)(1), which requires that the person entered into a 
binding contract before becoming ``aware of'' the material nonpublic 
information.\232\
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    \230\ See 2021 Proposing Release, 87 FR at 6703.
    \231\ See 2021 Proposing Release, 87 FR at 6662.
    \232\ See 17 CFR 240.10b5-1(c)(1)(i)(A).
---------------------------------------------------------------------------

b. Affirmative Defense: Policies and Procedures
    Second, Rule 9j-1(e)(2) provides a defense from liability under 
Rules 9j-1(a)(1) through (5) for actions taken by a person, other than 
a natural person, who demonstrates that: (1) the individual making the 
investment decision on behalf of the person was not aware of the 
material nonpublic information; and (2) the person had implemented 
reasonable policies and procedures, taking into consideration the 
nature of the person's business, to ensure that individuals making 
investment decisions would not be in violation of Rule 9j-1(a)(1) 
through (5).\233\ These policies and procedures may include those that 
restrict an individual from effecting a transaction in, or purchasing 
or selling, any security, including any security-based swap, as to 
which the individual possesses material nonpublic information, or those 
that prevent individuals from becoming aware of such information.\234\ 
Rule 9j-1(e)(2) is modeled on Rule 10b5-1(c)(2) and addresses concerns 
raised by commenters that the proposed rule would have a chilling 
effect on the markets. Rule 9j-1(e)(2) recognizes that

[[Page 42567]]

many market participants, such as lenders and life insurance companies, 
employ compliance programs which include, among other things, 
information barriers that prevent access to material nonpublic 
information by their employees who engage in security-based swap 
transactions for hedging or other purposes.
---------------------------------------------------------------------------

    \233\ Final Rule 9j-1(e)(2).
    \234\ See final Rule 9j-1(e)(2)(ii).
---------------------------------------------------------------------------

c. Proposed Safe Harbor: Compression
    Because the Commission is adopting final Rule 9j-1(e)(2), the 
Commission is not adopting proposed Rule 9j-1(f)(2), which would have 
provided a safe harbor for transactions made in connection with certain 
portfolio compression exercises. The proposed safe harbor would have 
conflicted with Rules 10b-5 and 10b5-1 by providing the same action 
with protection from liability under Rule 9j-1, but not Rule 10b-5. In 
proposing the portfolio compression safe harbor, the Commission 
recognized the benefits provided by portfolio compression along with 
the ``largely administrative nature of the portfolio compression 
process.'' \235\ To be clear, the Commission continues to support 
portfolio compression and its benefits.\236\ Providing the safe harbor 
as proposed, however, would have sanctioned the use of material 
nonpublic information under Rule 9j-1, even though that use would have 
been prohibited by Rule 10b-5. Adopting Rule 9j-1(e)(2) instead will 
avoid confusion that could have resulted by treating the same conduct 
differently under Rules 10b-5 and 9j-1. In addition, the Rule 9j-
1(e)(2) will provide security-based swap market participants the 
flexibility needed to engage in bilateral and multilateral portfolio 
compression exercises. The affirmative defense should be consistent 
with the manner in which Rules 10b-5 and 10b5-1(c)(2) currently apply 
to compression exercises and eliminates concerns that compression 
exercises may be more than merely administrative and could be made on 
the basis of material nonpublic information.
---------------------------------------------------------------------------

    \235\ 2021 Proposing Release, 87 FR at 6662-63 (describing the 
operational benefits and efficiencies resulting from portfolio 
compression).
    \236\ As the Commission recognized when it adopted portfolio 
compression requirements for SBS Entities, there are times when 
entering into compression exercises would not be appropriate. See 
Risk Mitigation Techniques for Uncleared Security-Based Swaps, 
Exchange Act Release No. 87762 (Dec. 18, 2019), 85 FR 6359, at 6370 
(Feb. 4, 2020) (``Risk Mitigation Adopting Release''). As a result, 
17 CFR 240.15Fi-4 provides that the policies and procedures required 
under the rule will need to provide that portfolio compression 
exercises occur ``when appropriate.'' It would not be appropriate to 
enter into compression exercises when doing so would be on the basis 
of material nonpublic information in violation of Commission rules, 
including Rule 10b-5 or final Rule 9j-1.
---------------------------------------------------------------------------

d. Other Requested Safe Harbors and Affirmative Defenses
    Certain commenters were supportive of the proposed safe harbors 
\237\ but also believed that the safe harbors were too narrow and urged 
the adoption of additional Rule 9j-1 safe harbors for legitimate 
restructuring transactions, hedging activity related to lending, 
transactions with counterparty disclosure regarding status as a lender 
and access to material nonpublic information from the borrower, 
multilateral amendment exercises (including ISDA protocols) or 
bilateral equivalents, participation in determinations committee, or 
for publicly executed strategies.\238\ One commenter raised concerns 
that the proposed safe harbor only addresses situations where a lender, 
aware of material nonpublic information, exercises rights or takes 
actions with respect to security-based swaps, but not if the lender 
exercises rights or remedies under a credit, loan, or similar 
agreement, while aware of material nonpublic information.\239\ The 
Commission declines to adopt additional safe harbors. The affirmative 
defenses the Commission is adopting provide consistency with Rule 10b5-
1. Additionally, they will address concerns expressed by market 
participants advocating for additional safe harbors by permitting 
persons to enter into certain types of activity, pursuant to the 
requirements of the affirmative defenses, while also addressing 
concerns about fraud and manipulation for the entire security-based 
swap market.
---------------------------------------------------------------------------

    \237\ Only one commenter specifically addressed the compression 
safe harbor of re-proposed Rule 9j-1(f)(2). See IIB-ISDA-SIFMA 
Letter at 11. The commenter noted that ``the important operational 
benefits and efficiencies for market participants'' supporting the 
safe harbor for portfolio compression exercises would also support a 
safe harbor for ``other centralized market activities'' including 
multilateral amendment exercises (such as an ISDA protocol) and the 
use of determinations committees. Id.
    \238\ See Fletcher Letter at 4; IACPM Letter at 4; MFA Letter at 
10-12; LSTA Letter at 8-9; IIB-ISDA-SIFMA Letter at 11-12.
    \239\ See LSTA Letter at 8-9.
---------------------------------------------------------------------------

    In response to the proposed safe harbors, one commenter urged for 
the elimination of all safe harbors from proposed Rule 9j-1(a) 
liability because the Commission had ``not demonstrated that a safe 
harbor from the prohibition on fraud and manipulation is necessary or 
appropriate.'' \240\ This same commenter also argued for compliance 
with Rule 9j-1(a) rather than for the adoption of safe harbors that it 
believed would encourage unlawful behavior.\241\ Another commenter 
argued that the proposed safe harbors were overly broad and protective 
of actions that are inherently fraudulent.\242\ However, as discussed 
above, the Commission agrees with commenters that an affirmative 
defense similar to those available under Rule 10b5-1 (when the 
investment decision is not based on material nonpublic information) is 
important given the similarity in the antifraud provisions. The 
Commission also agrees that the affirmative defenses would address 
concerns regarding market disruption while also addressing concerns 
about fraud and manipulation in the security-based swap market. 
Therefore, the Commission is adopting the affirmative defenses as 
discussed above.
---------------------------------------------------------------------------

    \240\ Better Markets Letter at 9. This commenter stated that it 
``[d]oes not appear there is any need for a safe harbor such as the 
one proposed by the SEC, because it is not clear how a prohibition 
on fraud and manipulation could possibly apply to the performance of 
completely non-volitional, contractual requirements, of a contract 
that was entered into without fraudulent, deceptive, or manipulative 
intent.'' Id. at 10. See also WebForm Comments from Anonymous 
Penguin, dated Oct. 7, 2022 (``Anonymous Penguin Comments''), at 1 
(arguing for no affirmative defense from liability); WebForm 
Comments from J.T., dated Nov. 15, 2022 (``J.T. Comments''), at 1 
(arguing for no safe harbor for binding contractual rights and 
obligations under a security-based swap).
    \241\ Better Markets Letter at 12 (pointing to experience with 
Rule 10b5-1 and citing studies and Wall Street Journal reporting).
    \242\ See WebForm Comments from Michael, dated Jan. 3, 2023 
(``Michael Comments''), at 1.
---------------------------------------------------------------------------

    In addition to the request for the inclusion of additional safe 
harbors and affirmative defenses, commenters also addressed the scope 
of Rule 9j-1 as it applies to different types of security-based swap 
instruments. One commenter argued for carving out sovereign debt from 
the scope of Rule 9j-1 due to the unlikelihood that holders of 
security-based swaps on sovereign debt would be able to manufacture 
credit events or otherwise engage in opportunistic trading, especially 
life insurers which are prohibited by state law from entering into 
speculative or abusive trading.\243\ While security-based swaps related 
to sovereign debt may present fewer opportunities for manufactured 
credit events or opportunistic strategies, by regulated and non-
regulated market participants alike, such instruments are not without 
risk of fraudulent and manipulative conduct and should

[[Page 42568]]

remain within the scope of Rule 9j-1.\244\ One commenter supported 
adopting different rules for CDS as opposed to other security-based 
swaps due to ``the structure and nature of CDS instruments,'' which the 
commenter believes make CDS more susceptible to opportunistic 
strategies.\245\ However, non-CDS security-based swaps are also 
susceptible to fraud and manipulation and, therefore, the Commission 
makes no change to the scope of Rule 9j-1 to treat CDS differently from 
other security-based swaps. Additionally, Rule 9j-1 is tailored 
appropriately to address fraud and manipulation for the entire 
security-based swap market.
---------------------------------------------------------------------------

    \243\ See ACLI at 3, 13-14 (arguing that sovereign debt should 
be excluded from the scope of both final Rule 9j-1 and final Rule 
10B-1).
    \244\ As of Nov. 25, 2022, sovereign CDS have the second highest 
gross notional amount outstanding among credit security-based swaps. 
See infra section V.C.2, Table 1. The Commission further observes 
that the share of CDS written on sovereign debt has risen from less 
than four percent of the total notional amounts outstanding in the 
global CDS market in 2007 to 14 percent at the end of 2020. For 
single-name CDS during that same period, the share of the sovereign 
sector grew from six percent to close to one-third. See Antulio N. 
Bomfim, ``Credit Default Swaps,'' Finance and Economics Discussion 
Series 2022-023 at 4, Washington: Board of Governors of the Federal 
Reserve System (2022), available at https://doi.org/10.17016/FEDS.2022.023. See also Ben St. Clair, ``Pimco Loses $400m on Failed 
Russia CDS Bets,'' Risk.Net (June 20, 2022) (describing the effects 
on CDS of Russia's failure to pay additional interest due on its 
sovereign bonds in Apr. 2022).
    \245\ See Fletcher Letter at 4.
---------------------------------------------------------------------------

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

    The Commission also proposed 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. Specifically, proposed Rule 15Fh-4(c) 
(``proposed Rule 15Fh-4(c)'') would have made 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.

B. Commission Action

    After review of the comments, the Commission is adopting Rule 15fh-
4(c) as proposed. The final rule will protect 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 agrees with the two commenters who supported the 
adoption of Rule 15fh-4(c) to further protect SBS Entities' CCOs from 
undue influence.\246\ Recognizing the CCO's critical function, one 
commenter believed the new rule would serve as an important deterrent 
to improper interference with the CCO's duties.\247\ A second commenter 
supported the rule because it would reinforce existing CCO independence 
requirements and duties essential to effective risk management programs 
of SBS Entities.\248\
---------------------------------------------------------------------------

    \246\ See Better Markets Letter at 14; Letter from Patrick T. 
Campbell, New York City Bar Association, dated Mar. 21, 2022 (``NYC 
Bar Letter'').
    \247\ See Better Markets Letter at 14.
    \248\ See NYC Bar Letter at 2-5.
---------------------------------------------------------------------------

    One commenter suggested that the proposed rule was unnecessary 
because the existing requirements of 17 CFR 240.15Fk-1 (``Rule 15Fk-
1'') are sufficient to address the risks of undue influence on a 
CCO.\249\ This commenter suggested that because the CCO is required to 
report directly to the board of directors or senior officer of the SBS 
Entity, and the CCO's compensation and removal requires approval of a 
majority of the SBS Entity's board of directors, attempts by others to 
influence the CCO inappropriately should be unavailing.\250\ The 
Commission disagrees. When the Commission previously considered whether 
to adopt a similar requirement, it concluded that requiring a majority 
of the board to compensate and remove the CCO was sufficient to 
establish CCO independence.\251\ However, in light of the rules 
finalized subsequent to the CCO rules, including Rule 9j-1 (which is 
being adopted in this release) and the risk mitigation requirements for 
SBS Entities,\252\ a rule expressly prohibiting interference with the 
performance of a CCO's duties is appropriate to: (1) deter any undue 
influence even if not directly related to compensation or the threat of 
removal of the CCO; and (2) help ensure the independence and 
effectiveness of the CCO function.\253\ In connection with Rule 9j-1, 
as well as other rules for which the CCO is responsible, undue 
influence could arise from many actors (and many actions), and not 
merely from those actors with the power to set compensation or with 
hiring and firing authority over the CCO.\254\
---------------------------------------------------------------------------

    \249\ See Letter from Stephanie Webster, IIB, Chris Young, ISDA, 
and Kyle Brandon, SIFMA, dated Mar. 21, 2022 (``IIB-ISDA-SIFMA CCO 
Letter''), at 3.
    \250\ Id.
    \251\ The Commission considered and rejected a prohibition on 
attempts by officers, directors, or employees to coerce, mislead, or 
otherwise mislead the CCO when it adopted business conduct standards 
for SBS Entities in 2016. See Business Conduct Standards Adopting 
Release, 81 FR at 30054-55. That rulemaking included, among other 
things, a rule to require an SBS Entity to designate a CCO and 
impose certain duties and responsibilities on that CCO, as well as 
antifraud provisions for SBS Entities. See 17 CFR 240.15Fk-1; 
240.15Fh-4(a).
    \252\ Risk mitigation rules are designed to further effective 
risk management by requiring the existence of sound documentation, 
periodic reconciliation of portfolios, rigorously tested valuation 
methodologies, and sound collateralization practices. See Risk 
Mitigation Adopting Release, 85 FR at 6390-91.
    \253\ As the Commission explained when adopting similar rules 
prohibiting persons from unduly influencing auditors pursuant to 
section 303(a) of the Sarbanes Oxley Act of 2002 (``Sarbanes-Oxley 
Act), activities by persons acting ``under the direction'' of 
officers and directors of the issuer ``currently may constitute 
violations of the anti-fraud or other provisions of the securities 
laws or aiding or abetting or causing an issuer's violations of the 
securities laws.'' Improper Influence on Conduct of Audits, Exchange 
Act Release No. 47890 (May 20, 2003), 68 FR 31820, 31821 (May 28, 
2003) (internal citations omitted). Nevertheless, like the rule 
implementing section 303(a) of the Sarbanes-Oxley Act, Rule 15fh-
4(c) would provide the Commission with an additional means of 
addressing efforts by persons acting under the direction of an 
officer or director to thwart the responsibilities of the CCO. See 
also Compliance Programs of Investment Companies and Investment 
Advisers, Investment Advisers Act Release No. 2204 (Dec. 17, 2003), 
68 FR 74714, 74721-22 (Dec. 24, 2003).
    \254\ For example, an employee at an SBS Entity planning an 
opportunistic strategy could attempt to mislead the CCO by 
submitting false documentation to the CCO in order to avoid 
disclosing the build-up of a large position that might require 
public reporting and thwart the plans of the employee.
---------------------------------------------------------------------------

    Moreover, existing 17 CFR 240.15Fh-3(h) (``Rule 15Fh-3(h)'') 
requires an SBS Entity to establish and maintain a system to supervise 
its business and the activities of its associated persons, which must 
be reasonably designed to prevent violations of the provisions of 
applicable Federal securities laws and the rules and regulations 
thereunder.\255\ In addition, existing Rule 15Fk-1 requires an SBS 
Entity to designate a CCO, who must comply with certain duties. Such 
duties include ``[t]ak[ing] 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].'' \256\ Failure to establish, maintain, and review 
written policies and procedures reasonably designed to

[[Page 42569]]

achieve compliance with the Exchange Act and the rules and regulations 
thereunder (including Rules 9j-1 and 15fh-4(c)) may result in 
violations by the SBS Entity of Rule 15Fh-3(h), as well as Rule 15Fk-
1.\257\ Rule 15fh-4(c) protects investors and promotes the fairness of 
the markets by supporting the ability of CCOs to meet their important 
obligations to foster compliance without undue influence, which should 
ultimately support the integrity of SBS Entities and the markets.
---------------------------------------------------------------------------

    \255\ See 17 CFR 240.15Fh-3(h).
    \256\ See 17 CFR 240.15Fk-1. Additionally, in its application 
for registration, an SBS Entity is required to include a senior 
officer's certification that the SBS Entity has developed and 
implemented written policies and procedures reasonably designed to 
prevent violation of Federal securities laws and the rules 
thereunder. See 17 CFR 240.15Fb2-1(b).
    \257\ The SBS Entity could also face liability under 17 CFR 
240.15Fb2-1(b) and (h) under such circumstances.
---------------------------------------------------------------------------

    One commenter argued that the scope of proposed Rule 15Fh-4(c) was 
``unclear and could lead to confusion and uncertainty in the market as 
to which activities are prohibited.'' \258\ This commenter went on to 
suggest that, if the Commission did adopt Rule 15fh-4(c), the final 
rule should clarify which activities are prohibited by including 
materiality and intent standards that would limit the prohibited 
interference to knowingly making untrue statements or omitting material 
facts.\259\ The commenter believed that ambiguities could have a 
chilling effect on communications between the CCO and personnel of the 
SBS Entity.\260\
---------------------------------------------------------------------------

    \258\ IIB-ISDA-SIFMA CCO Letter at 1.
    \259\ See id. at 2 (stating that the rule is unclear and could 
lead to confusion and uncertainty in the market as to which 
activities are prohibited and that the rule does not provide any 
materiality or intent standards, which could allow for immaterial or 
inadvertent actions or statements to result in liability).
    \260\ Id. IIB-ISDA-SIFMA was concerned that questions could 
arise as to whether good faith disagreements or legitimate 
discussions ``involve[d] `interference' with or `undue influence' 
over a CCO.'' Id.
---------------------------------------------------------------------------

    After considering the comments, the Commission declines to revise 
Rule 15fh-4(c) and adopts the rule as proposed. Rule 15fh-4(c) protects 
the independence and objectivity of an SBS Entity's CCO by prohibiting 
undue influence by other personnel. The concerns regarding the rule 
having a chilling effect on communications are misplaced since the rule 
prohibits actions to coerce, manipulate, mislead, or fraudulently 
influence CCOs--not good faith disagreements or legitimate discussions. 
However, such influence could take many forms and is not limited to 
material misstatements or omissions. As noted, the Commission has 
adopted the majority of its Title VII rules related to security-based 
swaps,\261\ including rules relating to trading relationship 
documentation, dispute resolution, portfolio reconciliation, or 
portfolio compression (``Risk Mitigation Rules''). As the Commission 
explained when adopting the Risk Mitigation Rules, those rules were 
designed to further effective risk management by requiring the 
existence of sound documentation, periodic reconciliation of 
portfolios, rigorously tested valuation methodologies, and sound 
collateralization practices.\262\ Attempts by officers, directors, or 
employees to hide transactions, submit false valuations, or manipulate 
or fraudulently influence the CCO in the performance of their duties 
related to the Risk Mitigation Rules would undermine the SBS Entity's 
risk management and could pose risk to the market. Therefore, the 
Commission is adopting a rule that is broad enough to apply to these 
actions and any others that may undermine the independence and 
responsibilities of the CCO.
---------------------------------------------------------------------------

    \261\ See supra note 16.
    \262\ See Risk Mitigation Adopting Release, 85 FR at 6390-91.
---------------------------------------------------------------------------

    A commenter also argued for more clarity with regard to the intent 
and conduct required to be liable under Rule 15fh-4(c).\263\ The 
Commission declines to make any revisions to the proposed rule in 
response to this comment. Specifically, the acts to ``coerce, 
manipulate, mislead, or fraudulently influence'' that would be 
prohibited by Rule 15fh-4(c) imply compelling the CCO to act in a 
certain way through pressure, threats, trickery, intimidation, 
misrepresentation, or some other form of purposeful action not limited 
to untrue statements or omissions of material facts, and therefore, 
further clarity is not necessary.\264\ As noted, one of the purposes of 
Title VII security-based swap legislation is promoting the integrity of 
the security-based swap market. Such a purpose would not be served by 
imposing a scienter or materiality requirement on Rule 15fh-4(c) 
violations. Further, the Commission believes that the rule will 
encourage directors, officers, supervised persons, or employees of SBS 
Entities to exercise reasonable attention and care in their dealings 
with CCOs.
---------------------------------------------------------------------------

    \263\ See IIB-ISDA-SIFMA CCO Letter at 2.
    \264\ The Commission came to a similar conclusion when adopting 
similar rules prohibiting persons from unduly influencing auditors 
pursuant to section 303(a) of the Sarbanes Oxley Act of 2002 
(``Sarbanes-Oxley Act). See Improper Influence on Conduct of Audits, 
Exchange Act Release No. 47890 (May 20, 2003), 68 FR 31820, 31823 
(May 28, 2003).
---------------------------------------------------------------------------

    One commenter suggested expanding the scope of the rule to actions 
taken to coerce, manipulate, mislead, or fraudulently influence all 
officers and other decision-makers, and not limit the rule to actions 
taken with respect to the SBS Entity's CCO.\265\ However, activities 
taken by persons under the direction of officers and directors of an 
issuer may already constitute violations of the securities laws.\266\ 
This additional rule is appropriate given the key role that the CCO 
plays in an SBS Entity's compliance with the security-based swap 
related regulations, such as the risk mitigation requirements for SBS 
Entities. Furthermore, it provides an additional means of addressing 
efforts by persons acting under the direction of an officer or director 
to thwart the responsibilities of the CCO.
---------------------------------------------------------------------------

    \265\ Michael Comments at 1.
    \266\ See supra note 252.
---------------------------------------------------------------------------

IV. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \267\ imposes certain 
requirements on Federal agencies in connection with the conducting or 
sponsoring of any ``collection of information.'' \268\ Neither Rule 9j-
1 nor Rule 15fh-4(c) contain a collection of information requirement 
within the meaning of the PRA. Specifically, Rule 9j-1 contains 
prohibitions 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. Rule 15fh-4(c) generally makes it unlawful for certain 
specified persons to directly or indirectly take any action to coerce, 
manipulate, mislead, or fraudulently influence an SBS Entity's CCO in 
the performance of their duties under the Federal securities laws or 
the rules and regulations thereunder. Neither of those rules require a 
person to establish, maintain, and enforce written policies and 
procedures reasonably designed to ensure compliance with the applicable 
rule. However, to the extent that a person is already subject to a 
similar policies and procedures requirement, any updates to those 
policies and procedures would likely be captured by an existing 
collection of information. For example, as previously explained, Rule 
15Fh-3(h) requires an SBS Entity to establish and maintain a system to 
supervise its business and the activities of its associated persons and 
that system must be reasonably designed to prevent violations of the 
provisions of applicable Federal securities laws and the rules and 
regulations thereunder. In the PRA analysis when that rule was adopted, 
the Commission estimated that each SBS Entity would spend 60 hours per 
year to update each of the policies and procedures required by Rule 
15Fh-

[[Page 42570]]

3.\269\ Both Rule 9j-1 and Rule 15fh-4(c) are intended solely to 
identify actions that an SBS Entity is not permitted to take, and as 
such do not make substantive modifications to any existing collection 
of information or impose new information collection requirements within 
the meaning of the PRA. Accordingly, we are not revising any burden and 
cost estimates in connection with these amendments.
---------------------------------------------------------------------------

    \267\ 44 U.S.C. 3501 et seq.
    \268\ See 44 U.S.C. 3502(3).
    \269\ See Business Conduct Standards Adopting Release, 81 FR at 
30094.
---------------------------------------------------------------------------

V. Economic Analysis

A. Introduction

    The Commission is mindful of the economic effects, including the 
costs and benefits, of Rule 9j-1 and Rule 15fh-4(c). Section 3(f) of 
the Exchange Act \270\ directs the Commission, when engaging in 
rulemaking where it is required to consider or determine whether an 
action is necessary or appropriate in the public interest, to consider, 
in addition to the protection of investors, whether the action will 
promote efficiency, competition, and capital formation. In addition, 
section 23(a)(2) of the Exchange Act \271\ requires the Commission, 
when making rules under the Exchange Act, to consider the impact that 
the rules would have on competition, and prohibits the Commission from 
adopting any rule that would impose a burden on competition not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act.
---------------------------------------------------------------------------

    \270\ 15 U.S.C. 78c(f).
    \271\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The analysis below addresses the likely economic effects of Rule 
9j-1 and Rule 15fh-4(c), including the anticipated benefits and costs 
of the rules and their likely effects on efficiency, competition, and 
capital formation. Many of the benefits and costs discussed below are 
difficult to quantify. For example, the Commission cannot quantify the 
impact of litigation and litigation risk on counterparties and 
underlying entities or the overall impact on the credibility and 
reputation of the security-based swap market. The extent of some of 
these impacts will depend, in part, on events difficult to predict that 
might affect security-based swaps, such as changes in counterparty or 
reference underlying entity behavior. Reputational and credibility 
effects also are difficult to measure. Therefore, while the Commission 
attempted to quantify economic effects where possible, much of the 
discussion of the anticipated economic effects below is qualitative and 
descriptive in nature.
    The Commission received a number of comments related to various 
aspects of the economic analysis of re-proposed Rule 9j-1 and proposed 
Rule 15Fh-4(c). The Commission has considered and responded to these 
comments in the sections that follow.

B. Broad Economic Considerations

    This section discusses certain aspects of the security-based swap 
market that may raise concerns or may be associated with concerns that 
would be addressed by final Rule 9j-1. The discussion is illustrative 
and is not intended to exhaust all types of conduct that may implicate 
final Rule 9j-1.
Opportunistic Strategies
    Opportunistic strategies often involve CDS buyers or sellers taking 
steps, either with or without the participation of the underlying 
entity, to avoid, trigger, delay, accelerate, decrease, and/or increase 
payouts on CDS.\272\ When market participants employ one of these 
strategies, they intend to obtain gains from the positions they hold 
that go beyond those corresponding to the initial profit and loss 
expectation (the initial payoff function) at trade execution. This 
additional gain would be obtained to the direct detriment of a 
counterparty that is unaware of that additional loss potential.\273\ 
One commenter pointed out that while CDS have many privately and 
socially valuable uses, such instruments could lend themselves to 
abuses such as opportunistic strategies.\274\
---------------------------------------------------------------------------

    \272\ See supra note 35 and accompanying text for a discussion 
of the settlement process that determines payout on a CDS contract 
that relies on the ISDA standard documentation.
    \273\ The market participant's gain from the transaction is 
inversely proportional to the gain of the counterparty, so the 
larger the market participant's position (and gain), the larger the 
counterparty's loss.
    \274\ Letter from Henry T.C. Hu, dated Mar. 21, 2022, at 6.
---------------------------------------------------------------------------

    To the extent that market participants anticipate opportunistic 
strategies, the CDS spread or price becomes a reflection of the 
likelihood of an opportunistic strategy being announced (or, if already 
announced, of succeeding) and decouples from the credit fundamentals of 
the reference entity.\275\ This effect reduces the utility of the CDS 
market as a venue to offload or take on the credit risk of a company 
because prices no longer reflect credit risk; bona fide hedgers or 
speculators in this market would be more likely to exit, as they cannot 
readily ``trade'' the credit of a company.\276\ In addition to their 
adverse impact on price efficiency, opportunistic strategies may impair 
the liquidity of the CDS markets. The fact that a counterparty might 
manufacture or delay a credit event in the future can deter others from 
entering into such contracts. If fewer parties enter into CDS 
contracts, the overall value of CDS as a risk-transferring instrument 
for the market will be reduced.\277\ Two commenters suggested that 
lenders may demand a higher rate of return (cost of debt) on new debt 
issuances by a reference entity that was involved in a manufactured 
credit event to compensate for the risk that such manufactured events 
may recur in the future.\278\
---------------------------------------------------------------------------

    \275\ Two commenters noted that opportunistic strategies impede 
price efficiency in the CDS market, particularly the CDS of 
distressed issuers because such strategies can be more profitable 
when implemented on distressed issuers. See AFRED Letter at 4-5; 
Fletcher Letter at 3.
    \276\ See Gina-Gail S. Fletcher, Engineered Credit Default 
Swaps: Innovative or Manipulative?, 94 N.Y.U. L. Rev. 1073 (2019) 
(explaining that ``engineered'' or ``manufactured'' transactions 
distort the information reflected in CDS spreads, to the point where 
the default risk expressed in CDS spreads is no longer connected to 
the financial condition of the underlying entity).
    \277\ See Fletcher Letter at 3.
    \278\ See AFRED Letter at 4; Fletcher Letter at 3.
---------------------------------------------------------------------------

C. Baseline

1. Existing Regulatory Frameworks
    As discussed in section I.A, because security-based swaps are 
included in the Exchange Act's definition of ``security,'' participants 
in the security-based swap market are currently 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 Rule 
10b-5 thereunder, and section 17(a) of the Securities Act. In 
particular, Rule 10b5-1 provides that a person trades ``on the basis 
of'' material nonpublic information when the person purchases or sells 
securities while aware of the information. However, the rule also sets 
forth several affirmative defenses to permit persons to trade in 
certain circumstances where it is clear that the information was not a 
factor in the decision to trade.\279\ Several commenters pointed out 
that most security-based market participants have organized their 
business activities and implemented policies and procedures to allow 
them to rely on the affirmative defense provided by Rule 10b5-1(c)(2) 
from liability under Rule 10b-5.\280\
---------------------------------------------------------------------------

    \279\ See Selective Disclosure and Insider Trading, Exchange Act 
Release No. 43154 (Aug. 15, 2000), 65 FR 51716 (Aug. 24, 2000).
    \280\ See IACPM Letter at 4; IIB-ISDA-SIFMA Letter at 4-5; MFA 
Letter at 13; SIFMA AMG Letter at 11. See also supra section II.E.2. 
EBF supports the arguments in the IIB-ISDA-SIFMA Letter regarding 
proposed Rule 9j-1. See Letter from EBF at 1; supra note 124.

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[[Page 42571]]

    In addition, the Dodd-Frank Act expanded the anti-manipulation 
provisions of section 9 of the Exchange Act to encompass security-based 
swap transactions and required the Commission to adopt rules to prevent 
fraud, manipulation, and deception in connection with security-based 
swaps.\281\ The Commission has now finalized a majority of its Title 
VII rules related to SBS Entities, including rules that allow such 
persons to manage the market, counterparty, operational, and legal 
risks associated with their security-based swap business. These include 
the Risk Mitigation Rules; \282\ rules relating to capital, margin, and 
segregation requirements for SBSDs, MSBSPs, and broker-dealers; \283\ 
and rules relating to recordkeeping and reporting requirements for 
SBSDs, MSBSPs, and broker-dealers.\284\ These rules are discussed in 
the 2021 Proposing Release.\285\ As discussed earlier, the CFTC has 
largely completed its Title VII rulemakings related to swaps, including 
the adoption of antifraud and anti-manipulation rules.\286\
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    \281\ See supra note 4 and accompanying text.
    \282\ See supra section III.B and note 262.
    \283\ See Capital, Margin, and Segregation Requirements for 
Security-Based Swap Dealers and Major Security-Based Swap 
Participants and Capital and Segregation Requirements for Broker-
Dealers, Exchange Act Release No. 86175 (June 21, 2019), 84 FR 43872 
(Aug. 22, 2019).
    \284\ See Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and 
Broker-Dealers, Exchange Act Release No. 87005 (Sep. 19, 2019), 84 
FR 68550 (Dec. 16, 2019).
    \285\ See 2021 Proposing Release, 87 FR at 6681-82.
    \286\ See supra note 16.
---------------------------------------------------------------------------

    Finally, Rule 15Fk-1 requires an SBS Entity to designate a CCO and 
imposes certain duties and responsibilities on that CCO.\287\ 
Additionally, the rule requires that a majority of the board approve 
the compensation and removal of the CCO.\288\ Rule 15Fh-4(a) makes it 
unlawful for an SBS Entity to: (1) employ any device, scheme, or 
artifice to defraud any special entity or prospective customer who is a 
special entity; (2) engage in any transaction, practice, or course of 
business that operates as a fraud or deceit on any special entity or 
prospective customer who is a special entity; or (3) engage in any act, 
practice, or course of business that is fraudulent, deceptive, or 
manipulative.\289\ Further, existing Rule 15Fh-3(h) requires an SBS 
Entity to establish and maintain a system to supervise its business and 
the activities of its associated persons; the system must be reasonably 
designed to prevent violations of the provisions of applicable Federal 
securities laws and the rules and regulations thereunder.\290\
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    \287\ See 17 CFR 240.15Fk-1(a) through (c).
    \288\ See 17 CFR 240.15Fk-1(d).
    \289\ See 17 CFR 240.15Fh-4(a).
    \290\ See 17 CFR 240.15Fh-3(h).
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2. Security-Based Swap Data, Market Participants, Dealing Structures, 
and Levels of Security-Based Swap Trading Activity
    As of January 4, 2023, there were 50 entities registered with the 
Commission as SBSDs, and no entities registered as MSBSPs.\291\ Market 
participants such as SBSDs and MSBSPs were required to report security-
based swap transactions to registered security-based swap data 
repositories (``SBSDRs'') pursuant to Regulation SBSR beginning on 
November 8, 2021.
---------------------------------------------------------------------------

    \291\ See List of Registered Security-Based Swap Dealers and 
Major Security-Based Swap Participants, available at https://www.sec.gov/files/list_of_sbsds_msbsps_1_4_2023locked_final.xlsx 
(providing the list of registered SBSDs and MSBSPs that was updated 
as of Jan. 4, 2023).
---------------------------------------------------------------------------

    The Commission uses information reported pursuant to Regulation 
SBSR to two registered SBSDRs--Depository Trust & Clearing Corporation 
Data Repository (``DDR'') and the ICE Trade Vault (``ITV'')--to 
describe the baseline.\292\ Table 1 shows that U.S. security-based swap 
market activity is split across three asset classes: credit, equity, 
and interest rate. Based on information reported to DDR, as of November 
25, 2022, there were approximately 523,000, 3.4 million, and 5,700 
active security-based swaps in the credit, equity, and interest rate 
asset classes, respectively. The gross notional amounts outstanding in 
the credit, equity, and interest rate asset classes were respectively, 
approximately $2.8, $3.6, and $0.18 trillion.\293\ Based on information 
reported to ITV, as of November 25, 2022, there were approximately 
155,000 active credit security-based swaps with gross notional amount 
outstanding of approximately $1.9 trillion.
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    \292\ DDR operates as a registered SBSDR for security-based swap 
transactions in the credit, equity, and interest rate derivatives 
asset classes. ITV operates as a registered SBSDR for security-based 
swap transactions in the credit derivatives asset class. See 
Security-Based Swap Data Repositories; DTCC Data Repository (U.S.) 
LLC; Order Approving Application for Registration as a Security-
Based Swap Data Repository, Exchange Act Release No. 91798 (May 7, 
2021), 86 FR 26115 (May 12, 2021); Security-Based Swap Data 
Repositories; ICE Trade Vault, LLC; Order Approving Application for 
Registration as a Security-Based Swap Data Repository, Exchange Act 
Release No. 92189 (June 16, 2021), 86 FR 32703 (June 22, 2021). The 
statistics presented herein are based on the SBS Report. See supra 
note 42.
    \293\ Active security-based swaps are those that have been 
neither terminated nor reached their scheduled maturity and are 
therefore open positions as of Nov. 25, 2022. Gross notional amount 
outstanding represents the total outstanding notional value of 
active, market-facing security-based swaps on Nov. 25, 2022. 
Security-based swaps are considered to be ``market-facing'' when 
they are executed at arms-length between third parties. While a 
reporting party is only required to report a transaction to one 
SBSDR--either DDR or ITV--some uncleared security-based swaps in DDR 
also appear in ITV. This overlap is very limited in scope. As of 
Nov. 25, 2022, there were 605 active credit security-based swaps in 
ITV that were reported as uncleared (0.4% of the 154,903 active 
credit security-based swaps in ITV). The 605 active credit security-
based swaps had a gross notional outstanding of $4.73 billion (0.3% 
of the approximately $1,900 billion gross notional outstanding of 
all active credit security-based swaps in ITV). These statistics 
provide an upper bound of the overlap between ITV and DDR and 
indicate that the overlap is very limited in scope. See SBS Report 
at 4 and 10.
---------------------------------------------------------------------------

    Table 1 also shows that U.S. security-based swap market 
participants trade a variety of security-based swaps in each of the 
three asset classes. Based on information reported to DDR, as of 
November 25, 2022, active credit security-based swaps fall into five 
product types. Single-name corporate CDS constitute the largest product 
type, with approximately 364,000 active CDS and $1.6 trillion gross 
notional amount outstanding. The second largest active credit security-
based swaps product type consists of single-name sovereign CDS, with 
approximately 94,000 active CDS and $0.9 trillion gross notional amount 
outstanding. For active equity security-based swaps, equity portfolio 
swaps constitute the largest product type, with approximately 2.3 
million active equity portfolio swaps and $1.7 trillion gross notional 
amount outstanding. The second largest active equity security-based 
swaps product type consists of equity swaps, with approximately 492,000 
active equity swaps and $1.2 trillion gross notional amount 
outstanding. Equity portfolio swaps and equity swaps can be further 
divided into sub-products that include, among other things, equity 
TRS.\294\ In the interest rate asset class, exotics constitute the 
largest product type, with approximately $0.1 trillion gross notional 
amount and 4,400 active exotic swaps outstanding. Based on information 
reported to ITV, as of November 25, 2022, active credit security-based 
swaps fall into two

[[Page 42572]]

product types. Single-name corporate CDS constitute the largest product 
type, with approximately 135,000 active CDS and $1.3 trillion gross 
notional amount outstanding. The second largest active credit security-
based swaps product type consists of single-name sovereign CDS, with 
approximately 20,000 active CDS and $0.5 trillion gross notional amount 
outstanding.
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    \294\ An equity swap references a single underlier while an 
equity portfolio swap involves a portfolio wrapper under which 
multiple swaps can be traded with operational efficiency. See 
Central Clearing in the Equity Derivatives Market: An ISDA Study, 
ISDA.org (June 2014) at 10, available at https://www.isda.org/a/6PDDE/central-clearing-in-the-eqd-market-final.pdf. See ISDA, ISDA 
Taxonomy 2.0_Finalized, ISDA.org (Sep. 4, 2019), available at 
https://www.isda.org/a/o1MTE/ISDA-Taxonomy_EQ-CR-FX-IR_v2.0__3-_September_2019-FINAL.xls (indicating that equity portfolio swaps 
and equity swaps can be further divided into sub-products that 
include, among other things, equity TRS).

   Table 1--Gross Notional Amount and Active Security-Based Swaps Outstanding on Nov. 25, 2022, Categorized by
                                    Asset Class and Product Classification a
----------------------------------------------------------------------------------------------------------------
                                                                              Gross notional
                                                                                  amount        Active security-
           SBSDR                  Asset class            Product type          outstanding      based swap count
                                                                            (millions of USD)
----------------------------------------------------------------------------------------------------------------
DDR.......................  Credit................  Index.................             44,407              2,992
                                                    Single-Name: Corporate          1,556,315            364,465
                                                    Single-Name: Sovereign            900,072             93,807
                                                    TRS \b\...............            156,849             49,867
                                                    Other \c\.............            122,970             12,081
                                                                           -------------------------------------
                                                    Total.................          2,780,613            523,212
                            Equity................  Portfolio Swap........          1,688,672          2,266,706
                                                    Swap..................          1,183,279            491,508
                                                    Contract For                      398,952            642,965
                                                     Difference.
                                                    Option................              6,915              1,281
                                                    Forward...............              5,663              1,393
                                                    Other \d\.............            330,136             41,115
                                                                           -------------------------------------
                                                    Total.................          3,613,617          3,444,968
                            Interest Rate.........  Exotic................            153,306              4,419
                                                    Forward...............             23,818              1,164
                                                    Other \e\.............                868                122
                                                                           -------------------------------------
                                                    Total.................            177,992              5,705
ITV.......................  Credit................  Single-Name: Corporate          1,348,002            134,741
                                                    Single-Name: Sovereign            544,414             20,162
                                                                           -------------------------------------
                                                    Total.................          1,892,416            154,903
----------------------------------------------------------------------------------------------------------------
\a\ For cleared security-based swaps in DDR, this table incorporates only one of the two security-based swaps
  that result from the clearing process. For ITV, this table incorporates all of the cleared security-based
  swaps.
\b\ As a general matter, TRS include non-CDS debt-based security swaps, equity-based security swaps, and mixed
  swaps. Counterparties in the TRS market use the contracts to obtain exposure, usually leveraged, to the total
  economic performance of a security or index and benefit from not having to own the security itself. Market
  participants, such as mutual funds, hedge funds, and endowments, use TRS to obtain exposure in markets where
  they would face difficulties purchasing or selling the underlying security (e.g., a market participant may
  find it difficult to buy a foreign company's security or locate a security to sell short) while taking
  advantage of the capital efficiencies of not holding the security in their inventories. See also supra section
  I.B.1, which discusses the ongoing payment stream of TRS, among other things.
\c\ Includes the following products reported to SBSDRs: exotic, index tranche, swaptions, and other single-name
  (e.g., asset-backed, loan, and municipal security-based swaps).
\d\ ``Other'' is a category in the DDR Equity Product ID field. All Product ID categories are listed in the
  table.
\e\ Includes the following products reported to SBSDRs: inflation, debt option, and cross-currency.

    Table 2 shows that both SBS Entities and non-SBS Entities 
participate in all three asset classes in the U.S. security-based swap 
market. Based on information reported to DDR, as of November 25, 2022, 
SBS Entities and non-SBS Entities had, respectively, entered into 
approximately 813,000 and 234,000 active credit security-based 
swaps.\295\ The gross notional amounts outstanding of the active credit 
security-based swaps held by SBS Entities and non-SBS Entities were, 
respectively, approximately $4.4 and $1.2 trillion. In the equity asset 
class, SBS Entities and non-SBS Entities had, respectively, entered 
into approximately 4.0 million and 2.9 million active equity security-
based swaps. The gross notional amounts outstanding of the active 
equity security-based swaps held by SBS Entities and non-SBS Entities 
were, respectively, approximately $4.5 and $2.7 trillion. In the 
interest rate asset class, SBS Entities and non-SBS Entities had, 
respectively, entered into approximately 6,200 and 5,200 active 
interest rate security-based swaps. The gross notional amounts 
outstanding of the active interest rate security-based swaps held by 
SBS Entities and non-SBS Entities were, respectively, approximately 
$0.2 and $0.1 trillion. Based on information reported to ITV, as of 
November 25, 2022, SBS Entities and non-SBS Entities had, respectively, 
entered into approximately 123,000 and 33,000 active credit security-
based swaps. The gross notional amounts outstanding of the active 
credit security-based swaps held by SBS Entities and non-SBS Entities 
were, respectively, approximately $1.6 and $0.3 trillion.
---------------------------------------------------------------------------

    \295\ For cleared security-based swaps where at least one 
counterparty is an SBS Entity, Table 2 reflects the security-based 
swaps entered into by each of the original counterparties, but does 
not include the positions of the clearing organizations themselves. 
For uncleared security-based swaps, Table 2 reflects the security-
based swaps entered into by each of the original counterparties. See 
SBS Report at 5.

[[Page 42573]]



   Table 2--Gross Notional Amount and Active Security-Based Swaps Outstanding on Nov. 25, 2022, Categorized by
                                        Asset Class and Registrant Type a
----------------------------------------------------------------------------------------------------------------
                                                                              Gross notional
                                                                                  amount        Active security-
           SBSDR                  Asset class           Registrant type        outstanding      based swap count
                                                                            (millions of USD)
----------------------------------------------------------------------------------------------------------------
DDR.......................  Credit................  Total.................          5,561,226          1,046,424
                                                    SBS Entities..........          4,403,130            812,647
                                                    Other.................          1,158,096            233,777
                            Equity................  Total.................          7,227,234          6,889,936
                                                    SBS Entities..........          4,490,592          4,013,393
                                                    Other.................          2,736,642          2,876,543
                            Interest Rate.........  Total.................            355,984             11,410
                                                    SBS Entities..........            210,663              6,214
                                                    Other.................            145,321              5,196
ITV.......................  Credit................  Total.................          1,897,249            155,578
                                                    SBS Entities..........          1,632,251            122,831
                                                    Other.................            264,998             32,747
----------------------------------------------------------------------------------------------------------------
\a\ For cleared security-based swaps where at least one counterparty is an SBS Entity, Table 2 reflects the
  security-based swaps entered into by each of the original counterparties, but does not include the positions
  of the clearing organizations themselves. For uncleared security-based swaps, Table 2 reflects the security-
  based swaps entered into by each of the original counterparties.

    In addition to information reported to registered SBSDRs, the 
Commission also uses data from the DTCC Derivatives Repository Limited 
Trade Information Warehouse (``DTCC-TIW'') to describe the baseline. 
DTCC-TIW provides data regarding the activity of market participants in 
the single-name CDS market during the period from 2006 to the end of 
2021.\296\ The Commission acknowledges that limitations in the data 
constrain the extent to which it is possible to quantitatively 
characterize the security-based swap market.\297\ Based on an analysis 
of DTCC-TIW data, staff concluded that there are 2,326 transacting 
agents that engaged directly in trading between November 2006 and 
December 2021 with 15,721 accounts.\298\
---------------------------------------------------------------------------

    \296\ DTCC-TIW provides weekly positions and monthly transaction 
files on a voluntary basis for single-name and index-based CDS. 
These data cover all positions and transactions where one of the 
counterparties is a U.S. entity or the reference entity is a U.S. 
entity, with status as a U.S. entity determined by DTCC-TIW. In 
DTCC-TIW, the Commission observes end of week CDS positions for all 
U.S. entities, foreign counterparties to a U.S. entity, or foreign 
counterparties trading a CDS referencing a U.S. underlying entity. 
The DTCC-TIW data have limitations. The data do not address two 
foreign counterparties with CDS referencing foreign underlying 
entities. In addition, the DTCC-TIW data do not provide any intra-
weekly CDS position information, nor any information on the 
underlying security holdings of reference entities. Further, DTCC-
TIW is a voluntary database where market participants on a voluntary 
basis submit transactions and end of week holdings.
    \297\ The Commission also relies on qualitative information 
regarding market structure and evolving market practices provided by 
commenters and the knowledge and expertise of Commission staff.
    \298\ These 2,326 entities, which are presented in more detail 
in Table 3, below, include all DTCC-TIW-defined ``firms'' shown in 
DTCC-TIW as transaction counterparties that report at least one 
transaction to DTCC-TIW as of Dec. 2021. The staff in the Division 
of Economic and Risk Analysis classified these firms by machine-
matching names to known third-party databases and by manual 
classification. See, e.g., Security-Based Swap Transactions 
Connected with a Non-U.S. Person's Dealing Activity That Are 
Arranged, Negotiated, or Executed By Personnel Located in a U.S. 
Branch or Office or in a U.S. Branch or Office of an Agent; 
Security-Based Swap Dealer De Minimis Exception, Exchange Act 
Release No. 77104 (Feb. 10, 2016), 81 FR 8598, 8602 n.43 (Feb. 19, 
2016). Manual classification was based in part on searches of the 
EDGAR and Bloomberg databases, the SEC's Investment Adviser Public 
Disclosure database, and a firm's public website or the public 
website of the account represented by a firm. As mentioned above, 
data on CDS market participants come from DTCC-TIW. Principal 
holders of CDS risk exposure are represented by ``accounts'' in the 
DTCC-TIW. ``Accounts'' as defined in the DTCC-TIW context are not 
equivalent to ``accounts'' in the definition of ``U.S. person'' 
provided by Exchange Act Rule 3a71-3(a)(4)(i)(C). 17 CFR 3a71-
3(a)(4)(i)(C). One entity or legal person (known as ``transacting 
agent'' in the terminology of DTCC-TIW) may have multiple accounts. 
For example, a bank that is a transacting agent may have one DTCC-
TIW account for its U.S. headquarters and one DTCC-TIW account for 
one of its foreign branches.
---------------------------------------------------------------------------

    Data from the DTCC-TIW show that activity in the single-name CDS 
market is concentrated among a relatively small number of entities, 
predominantly registered SBSDs.\299\ The top two SBSDs (when accounts 
are sorted by number of counterparties) each transacted with over a 
thousand counterparty accounts, consisting of both other SBSDs and non-
SBSDs. The next 13 percent of SBSDs each transacted with 500 to 1,000 
counterparty accounts; the following 21 percent of SBSDs each 
transacted with 100 to 500 counterparty accounts; and 62 percent of 
SBSDs each transacted security-based swaps with fewer than 100 
counterparty accounts in 2021. The median number of counterparty 
accounts across SBSDs is 16 (the mean is approximately 191). SBSD-
intermediated transactions reached a gross notional amount of 
approximately $1.5 trillion, approximately 66 percent of which was 
intermediated by the top five SBSD accounts. The median non-dealer 
counterparty transacted with only one SBSD account (with an average of 
approximately 1.9 SBSD accounts) in 2021.
---------------------------------------------------------------------------

    \299\ Dealers are generally persons engaged in the business of 
buying and selling securities for their own account, through a 
broker or otherwise. 15 U.S.C. 78c(a)(5). SBSDs are generally 
defined as persons who hold themselves out as dealers in security-
based swaps; make markets in security-based swaps; regularly enter 
into security-based swaps as an ordinary course of business for 
their own account; or engage in any activity causing them to be 
commonly known in the trade as a dealer or market maker in security-
based swaps. 17 CFR 240.3a71-1.
---------------------------------------------------------------------------

    Non-dealer single-name CDS market participants include, but are not 
limited to, investment companies, pension funds, private funds, 
sovereign entities, and industrial companies. We observe that most non-
dealer market participants of single-name CDS do not engage directly in 
the trading of security-based swaps, but trade through banks, 
investment advisers or funds, or other types of firms, which we refer 
to as transacting agents, consistent with DTCC-TIW terminology.\300\ As 
shown in Table 3, close to 79 percent of transacting agents are 
identified as investment advisers or funds.\301\ Although investment 
advisers and funds are the vast majority of transacting

[[Page 42574]]

agents, the transactions they executed account for only about 15 
percent of all single-name CDS trading activity reported to the DTCC-
TIW, measured by the number of transaction sides.\302\ The vast 
majority of transactions, approximately 82 percent, measured by number 
of transaction-sides were executed by ISDA-recognized dealers.
---------------------------------------------------------------------------

    \300\ Transacting agents participate directly in the security-
based swap market, without relying on an intermediary, on behalf of 
their principals, investment companies, pension funds, private 
funds, sovereign entities, and industrial companies. For example, a 
university endowment may hold a position in a security-based swap 
that is established by an investment adviser that transacts on the 
endowment's behalf. In this case, the university endowment is a 
principal that uses the investment adviser as its transacting agent.
    \301\ DTCC-defined ``firms'' shown in DTCC-TIW, which we refer 
to here as ``transacting agents.''
    \302\ Each transaction has two transaction sides, i.e., two 
transaction counterparties.

 Table 3--The Number of Transacting Agents by Counterparty Type and the Fraction of Total Trading Activity, From
                       Nov. 2006 Through Dec. 2021, Represented by Each Counterparty Type
----------------------------------------------------------------------------------------------------------------
                                                                                                    Transaction
                       Transacting agents                             Number          Percent       share  (%)
----------------------------------------------------------------------------------------------------------------
Investment Advisers/Funds \a\...................................           1,858            78.7            14.6
Banks (excluding G16) \b\.......................................             278            11.8             3.3
Pension Funds...................................................              30             1.3             0.1
Insurance Companies.............................................              49             2.1             0.2
ISDA-Recognized Dealers \c\.....................................              17             0.7            81.6
Other...........................................................             130             5.5             0.2
                                                                 -----------------------------------------------
    Total.......................................................           2,362           100.0             100
----------------------------------------------------------------------------------------------------------------
\a\ Investment Adviser/Funds--For purposes of this table, these entities have the following characteristics:
  clients are predominantly individuals, institutions, and investment companies that take public and
  institutional money. Some also manage pooled investment vehicles (e.g., hedge funds), private equity and
  venture capital.
\b\ Banks (excluding G16)--The primary characteristic is the entity is trading for its own account and not just
  on behalf of its clients. This includes depository institutions, swap dealers (market makers), and classically-
  defined investment banks.
\c\ ISDA recognized dealer--Market makers (dealers) identified by ISDA as belonging to the G14 or G16 dealer
  group during the period. See, e.g., 2010 ISDA Operations Benchmarking Survey (2010), available at https://www.isda.org/a/5eiDE/isda-operations-survey-2010.pdf.

    Figure 1 describes the percentage of global, notional transaction 
volume in North American corporate single-name CDS reported to the 
DTCC-TIW from January 2011 through December 2021, separated by whether 
transactions are between two ISDA-recognized dealers (interdealer 
transactions) or whether a transaction has at least one non-dealer 
counterparty. Figure 1 also depicts the notional trading volume of all 
North American corporate single-name CDS. As Figure 1 shows, all types 
of exposures have declined approximately proportionally since 2011.
BILLING CODE 8011-01-P

[[Page 42575]]

[GRAPHIC] [TIFF OMITTED] TR30JN23.049

BILLING CODE 8011-01-C

D. Benefits and Costs of Rule 9j-1

1. Benefits
    Rule 9j-1 would decrease fraudulent activity and litigation costs, 
and could decrease compliance costs. In addition, Rule 9j-1 may 
indirectly increase price efficiency and decrease capital costs of 
underlying entities. The Commission discusses each of these individual 
benefits in more detail below.
    Rule 9j-1 would reduce the risk of fraud in the security-based swap 
market, including the risk of opportunistic trading strategies to the 
extent that such strategies occur in connection with 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 (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 additional specificity offered by Rule 9j-1 may 
enhance Commission oversight of the security-based swap market, which 
may ultimately benefit market participants through reducing the risk of 
fraud. Any reduction in the risk of fraud as a result of Rule 9j-1 
would be limited to the extent that the fraudulent, manipulative, and 
deceptive conduct by security-based swap market participants is 
currently subject to the general antifraud and anti-manipulation 
provisions of the Federal securities laws, including but not limited to 
sections 9(a) and 10(b) of the Exchange Act, and Rule 10b-5 thereunder, 
and section 17(a) of the Securities Act. To the extent that Rule 9j-1 
reduces the risk of fraud, the rule could encourage participation in 
the security-based market, which may result in increased 
competition.\303\ More security-based swap entities would be willing to 
supply (issue) and/or demand (buy) security-based swaps, with increased 
confidence that their counterparties would have limited abilities to 
impact the market through fraudulent conduct.
---------------------------------------------------------------------------

    \303\ See 2019 Joint Statement, supra note 53.
---------------------------------------------------------------------------

    Rule 9j-1 may provide additional precision and specificity 
regarding the application of existing antifraud and anti-manipulation 
laws to misconduct in the security-based swap market, which could 
prompt some market participants to devote greater resources to ensure 
that they are compliant with their obligations under antifraud and 
anti-manipulation laws, which could also decrease the risk of fraud in 
the security-based swap market. Because of this decreased risk of 
fraud, market participants may have fewer disputes

[[Page 42576]]

with their counterparties regarding security-based swap contracts, 
which in turn, could lower litigation costs for security-based swap 
participants and underlying entities. Lower litigation costs could 
contribute to reducing the cost of CDS and, to the extent that the cost 
of CDS is reduced, lower costs of borrowing to the underlying entity. 
Rule 9j-1 may also decrease compliance costs for some market 
participants who may, as a result of the additional specificity of the 
rule, need to spend fewer resources determining appropriate compliance 
under section 9(j).
    Decreased risk of fraud in the security-based swap market may also 
lead to increased price efficiency, as more trading could lead to a 
greater exchange of market expectations from buyers and sellers 
transacting in the market. Further, by providing specificity, Rule 9j-1 
would help prevent prohibited conduct from distorting the market and 
artificially increasing or decreasing security-based swap prices, which 
also would help to ensure more efficient pricing. Increased price 
efficiency would consequently lead to greater security-based swap 
market efficiency, as security-based swap prices would provide greater 
confidence that their prices more likely reflect fundamental values and 
risk in more liquid markets. For example, the prices of single-name CDS 
contracts would more likely reflect the fundamental credit risk of the 
underlying entity, as opposed to counterparty credit risk, or the 
probability that fraudulent activity prohibited by Rule 9j-1 is being 
perpetrated in connection with the CDS contracts.\304\
---------------------------------------------------------------------------

    \304\ See generally Fletcher Letter at 3 (discussing the effects 
of engineered CDS transactions).
---------------------------------------------------------------------------

    Increased participation and price efficiency in the security-based 
swap market as a result of Rule 9j-1 could encourage lenders to make 
greater use of security-based swaps for hedging their loans, which in 
turn could increase lending activity and capital formation.\305\
---------------------------------------------------------------------------

    \305\ See generally LSTA Letter at 2 (stating that security-
based swaps ``play an important in risk management and hedging in 
the loan markets . . . [and] facilitate lending activity by 
transferring some or all of the risks associated with lending . . . 
.'').
---------------------------------------------------------------------------

    In addition, improvements in the security-based swap market as a 
result of Rule 9j-1 may in turn have a positive impact on capital 
formation and the cost of capital for the underlying entities. The 
market participation increases in security-based swaps may enhance 
liquidity in the underlying market and related swap indices, and, in 
general, lower the cost of capital for entities referenced by security-
based swaps.\306\ If single-name CDS prices are more reflective of the 
fundamental credit risk of the underlying entity, as a second order 
effect, participants in the market for the underlying security would be 
better informed about the underlying security's attributes through the 
CDS price signal, likely increasing their willingness to re-enter or 
engage in the underlying security's market. Specifically, the 
underlying security market uses the derivative market to assess its 
quality, as the derivative market in some circumstances is forward 
looking, liquid, and more informative than the underlying market.\307\ 
Greater activity in the underlying security market due to increased 
price efficiency and greater availability to hedge these securities in 
the security-based swap market could lead to lower capital costs and 
increase capital formation for the underlying entities. To the extent 
that increased capital formation for the underlying entities is 
associated with the issuance of a greater variety of securities, 
investors could benefit because they will have a larger set of 
investment opportunities with which to meet their investment goals.
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    \306\ See Martin Oehmke & Adam Zawadowski, Synthetic or Real? 
The Equilibrium Effects of Credit Default Swaps on Bond Markets, 28 
Rev. of Fin. Stud. 3303-3337 (2015) and Ilhyock Shim & Haibin Zhu, 
The Impact of CDS trading on the Bond Market: Evidence from Asia, 40 
J. of Banking & Finance 460-475 (2014).
    \307\ See Haibin Zhu, An Empirical Comparison of Credit Spreads 
Between the Bond Market and the Credit Default Swap Market, 29 J. of 
Fin. Serv. Rsch. 211-235 (2006) and Jongsub Lee, et al., When do CDS 
Spreads Lead? Rating Events, Private Entities, and Firm-Specific 
Information Flows, 130 J. of Fin. Econ. 556-578 (2018).
---------------------------------------------------------------------------

Comments Received
    In the 2021 Proposing Release, the Commission solicited feedback 
on, among other things, the benefits of the proposed rules, including 
re-proposed Rule 9j-1.\308\ One commenter strongly agreed with the 
Commission's discussion regarding the beneficial effects of greater 
participation in the security-based swap markets on liquidity in the 
underlying market and related swap indices, and the cost of capital for 
security-based swap referenced entities. The commenter also strongly 
agreed with the Commission's discussion regarding the value of the 
derivative market to the underlying security market for assessing the 
security market's quality.\309\
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    \308\ 2021 Proposing Release, 87 FR at 6701-02.
    \309\ Milbank Letter at 10, n.17.
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    Three commenters believed that re-proposed Rule 9j-1's anticipated 
benefit of reduced fraudulent and manipulative activity in the 
security-based swap market would not materialize.\310\ Three commenters 
stated that the adoption of the ISDA Amendments has reduced the use of 
opportunistic strategies, such as manufactured credit events,\311\ 
while two of these commenters stated that the use of anti-net short 
provisions in the syndicated bank loan market has also had this 
effect.\312\ One commenter observed that opportunistic strategies have 
been, on the whole, extremely infrequent and doubted that re-proposed 
Rule 9j-1 will result in any market-wide benefit from addressing these 
strategies or significantly reduce manipulative activity in the 
security-based swap markets.\313\ One commenter provided CDS pricing 
data (in the form of the difference between the CDS spread and 
underlying cash bond implied credit spread (``CDS-cash basis'') and 
interpreted those data to suggest that CDS protection buyers perceived 
the risk of certain opportunistic strategies to be low. The commenter 
then reasoned that because CDS protection buyers perceived the risk of 
such strategies to be low, re-proposed Rule 9j-1 would not generate the 
anticipated benefit of reducing fraudulent activity in the security-
based swap market as well as encouraging market participation.\314\
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    \310\ See LSTA Letter at 4; July 2022 MFA Letter at 4-10; 
Milbank Letter at 8-9.
    \311\ Id.
    \312\ See LSTA Letter at 4; July 2022 MFA Letter at 4-10.
    \313\ Milbank Letter at 9.
    \314\ July 2022 MFA Letter at 2-4. The commenter referred to 
opportunistic strategies undertaken by CDS sellers to affect the 
likelihood of a credit event and the cost of CDS through actions 
such as changing the supply of deliverable obligations and offering 
financing to restructure a reference entity. See 2021 Proposing 
Release, 87 FR at 6655.
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    The Commission has considered feedback from the commenters who 
argued that the proposed rule would not have the benefit of reducing 
fraudulent and manipulative activity in the security-based swap market. 
The provisions in Rule 9j-1 are designed generally to prohibit a range 
of fraudulent, manipulative, and deceptive conduct in the security-
based swap market. The rule is not solely intended to address 
opportunistic strategies in the CDS market.\315\ Further, anti-net 
short

[[Page 42577]]

provisions and ISDA Amendments are narrowly focused and have limited 
ability to reduce fraudulent and manipulative activity in the security-
based swap market. As discussed in the 2021 Proposing Release, the ISDA 
Amendments would 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.\316\ 
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.
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    \315\ As discussed earlier in this section, Rule 9j-1 would, 
among other things, reduce the risk of opportunistic trading 
strategies to the extent that such strategies occur in connection 
with 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 (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).
    \316\ See 2021 Proposing Release, 87 FR at 6655 n.31; supra note 
52.
---------------------------------------------------------------------------

    In response to the comment that opportunistic strategies have been, 
on the whole, extremely infrequent so that re-proposed Rule 9j-1 will 
not result in any market-wide benefit, the Commission reiterates that 
the provisions in Rule 9j-1 are designed generally to prohibit a range 
of fraudulent, manipulative, and deceptive conduct in the security-
based swap market. The rule is not solely intended to address 
opportunistic strategies in the CDS market.\317\ Thus, even if 
opportunistic strategies were no longer implemented, final Rule 9j-1 
would benefit the security-based swap market by prohibiting all other 
types of fraudulent, manipulative, and deceptive conduct in the market. 
That said, this benefit likely would be limited to the extent that the 
fraudulent, manipulative, and deceptive conduct by security-based swap 
market participants is currently subject to the general antifraud and 
anti-manipulation provisions of the Federal securities laws, including 
but not limited to sections 9(a) and 10(b) of the Exchange Act, and 
Rule 10b-5 thereunder, and section 17(a) of the Securities Act.
---------------------------------------------------------------------------

    \317\ See supra note 315.
---------------------------------------------------------------------------

    The Commission is not persuaded that the CDS-cash basis data 
provided by one of the commenters necessarily indicate that CDS 
protection buyers perceived the risk of certain opportunistic 
strategies to be low.\318\ Apart from such perceived risk, the academic 
literature suggests a number of factors that affect the CDS-cash basis 
such as funding cost, counterparty risk, collateral quality, and the 
CDS reference entity's financial characteristics.\319\ Without 
accounting for the influence of these other factors, it is not clear if 
the CDS-cash basis reflects that CDS protection buyers perceive the 
risk of certain opportunistic strategies to be low. Even if the CDS-
cash basis data reflect CDS protection buyers' perceived risk of 
certain opportunistic strategies, the data's limited scope provides no 
information on the perceived risk of other types of fraudulent and 
manipulative activity in the security-based swap market. Accordingly, 
the commenters have not offered convincing evidence that Rule 9j-1 will 
be without benefits. The Commission continues to believe that Rule 9j-
1, by addressing the security-based swap market more broadly, would 
reduce fraudulent and manipulative activity in this market.
---------------------------------------------------------------------------

    \318\ See July 2022 MFA Letter at 2-4.
    \319\ See, e.g., Jennie Bai & Pierre Collin-Dufresne, The CDS-
Bond Basis, 48 Fin. Mgmt., 417-439 (2019) and Amrut Nashikkar, et 
al., Liquidity and Arbitrage in the Market for Credit Risk, 46 J. of 
Fin. Quantitative Analysis 627-656 (2011).
---------------------------------------------------------------------------

    One commenter asserted that proposed Rule 9j-1(b) (adopted as Rule 
9j-1(a)(6)) would introduce substantial uncertainty in the application 
of the antifraud and anti-manipulation provisions of the Federal 
securities laws, and therefore questioned whether the benefits of 
``additional precision and specificity'' that the Commission identified 
would materialize.\320\ Final Rule 9j-1(a)(6)'s scienter requirements, 
the practical utility of the rule's objective facts-and-circumstances 
requirement, and the applicability of familiar case law help mitigate 
any uncertainty that market participants may have regarding the 
application of the final rule.
---------------------------------------------------------------------------

    \320\ See Milbank Letter at 5, 9.
---------------------------------------------------------------------------

2. Costs
    Some security-based swap market participants may incur costs 
associated with taking actions to update existing compliance systems 
for compliance with Rule 9j-1. The Commission estimates that security-
based swap market participants may incur one-time aggregate costs 
ranging between $1,225,360 and $2,450,720 to update their existing 
compliance systems.\321\ These additional costs could be limited to the 
extent that many of these practices and systems are already in place to 
ensure compliance with section 9(j) of the Exchange Act and the other 
general antifraud and anti-manipulation statutory and regulatory 
provisions.
---------------------------------------------------------------------------

    \321\ The Commission estimates that a security-based swap market 
participant that updates its existing compliance system likely will 
do so by having a compliance attorney make a one-time update to its 
policies and procedures. Costs per entity = 1 hour x $424/hour 
national hourly rate for a compliance attorney = $424. The per-hour 
figure for a compliance attorney is from SIFMA's Management and 
Professional Earnings in the Securities Industry--2013, as modified 
by Commission staff to adjust for inflation (through Dec. 2022) and 
to account for an 1,800-hour work-year, and multiplied by 5.35 to 
account for bonuses, firm size, employee benefits, and overhead. 
Based on an analysis of information reported pursuant to Regulation 
SBSR to DDR and ITV, the Commission estimates that there are 11,559 
security-based swap market participants (including SBS Entities) as 
of Nov. 25, 2022. There is uncertainty as to how many security-based 
swap market participants will choose to update their existing 
compliance systems to comply with Rule 9j-1. A lower bound estimate 
is 25% x 11,559 = 2,889.75, or approximately 2,890 security-based 
swap market participants. An upper bound estimate is 50% x 11,559 = 
5,779.50 or approximately 5,780 security-based swap market 
participants. The lower bound estimate of one-time aggregate costs = 
2,890 x $424 = $1,225,360. The upper bound estimate of one-time 
aggregate costs = 5,780 x $424 = $2,450,720. There is also 
uncertainty regarding the specific changes that security-based swap 
market participants may make to their existing compliance systems to 
comply with Rule 9j-1. Two commenters believed that re-proposed Rule 
9j-1 would require market participants to incur costs to design and 
implement extensive compliance programs and reconcile the scope of 
the new rule with existing practices. See LSTA Letter at 9-10; IACPM 
Letter at 4. However, these commenters did not provide quantified 
estimates of such costs. To the extent that security-based market 
participants choose to comply with final Rule 9j-1 in the manner 
described by these commenters, the costs of complying with the final 
rule could be higher than the Commission's estimate. To the extent 
that market participants incur compliance costs as a result of Rule 
9j-1, these costs represent a reasonable trade-off in light of the 
benefits discussed in section V.D.1. See also discussion later in 
this section.
---------------------------------------------------------------------------

    In addition, the rule could discourage some legitimate market 
activities, including some hedging activity, because of concerns that 
such activities might be viewed as rule violations. As a result, 
compliance costs related to evaluating whether or not certain 
activities are permissible may increase for some market participants.
    Market participants might incur costs associated with the 
affirmative defenses in Rule 9j-1(e). However, such costs likely would 
be very limited. As a general matter, the affirmative defenses in Rule 
9j-1(e) are voluntary and do not impose requirements on market 
participants. Market participants choose to incur costs related to the 
affirmative defenses if they anticipate the associated benefits to 
exceed the associated costs. Market participants for whom the 
anticipated benefits of the affirmative defenses do not exceed the 
associated costs likely would not incur those costs. However, market 
participants that choose not to rely on the affirmative defenses may 
incur other costs (e.g., additional cost of counsel or other experts to 
evaluate whether actions taken without relying on the affirmative 
defenses are compliant with the Exchange Act and Commission 
regulations, and a potential increase in legal liability risk).

[[Page 42578]]

    Market participants that seek to rely on the affirmative defense in 
paragraph (e)(1) of Rule 9j-1 likely would do so by creating and 
retaining the written security-based swap documentation governing such 
transaction or any amendment thereto. As discussed in the 2021 
Proposing Release, such documentation is already created and retained 
as a result of SBS Entities' compliance with existing 17 CFR 240.15Fi-5 
and the Commission's recordkeeping requirements in 17 CFR 240.17a-4 or 
17 CFR 240.18a-6, as applicable.\322\ Thus, the costs that may be 
incurred by those market participants that wish to rely on the 
affirmative defense likely would be very limited, if any.
---------------------------------------------------------------------------

    \322\ See 2021 Proposing Release 87 FR at 6662 n.88.
---------------------------------------------------------------------------

    Market participants that seek to rely on the affirmative defense in 
paragraph (e)(2) of Rule 9j-1 would be required to comply with the 
specific provisions of that paragraph, including implementing 
reasonable policies and procedures to prevent insider trading. For most 
market participants to whom this affirmative defense would be relevant, 
the costs associated with policies and procedures likely would be very 
limited. As discussed above, most security-based swap market 
participants have spent considerable resources to avail themselves of 
the affirmative defense of Rule 10b5-1(c)(2).\323\ Because the 
affirmative defense of Rule 9j-1(e)(2) is modeled on that of Rule 10b5-
1(c)(2), most security-based swap market participants likely would 
employ their existing policies and procedures to avail themselves of 
the affirmative defenses of both Rules 10b5-1(c)(2) and 9j-1(e)(2).
---------------------------------------------------------------------------

    \323\ See supra sections II.E.2 and V.C.1.
---------------------------------------------------------------------------

Comments Received
    One commenter believed that the proposed rules would help to reduce 
costs for all investors by removing fraud and manipulation from the 
security-based swap market and the market for underlying 
securities.\324\ However, several commenters were concerned that re-
proposed Rule 9j-1 would significantly increase compliance costs for 
security-based swap market participants in various ways.
---------------------------------------------------------------------------

    \324\ Michael Comments at 1.
---------------------------------------------------------------------------

    One commenter believed that re-proposed Rule 9j-1 would require 
market participants to incur costs to design and implement extensive 
compliance programs to adhere to the rule's broad prohibitions; and 
that such costs are only marginally alleviated by the narrow proposed 
safe harbors, since ensuring that each activity falls within a 
designated safe harbor presents resource challenges of its own. The 
commenter stated that such compliance costs would be unreasonably 
burdensome to lenders and would have a significant, negative impact on 
the loan markets. The commenter also stated that, absent an affirmative 
defense similar to Rule 10b5-1(c)(2), market participants may have to 
incur cost and effort to identify all security-based swaps and related 
reference underlying entities held by the organization and to track and 
coordinate all activity that could affect the purchase, sale, payments, 
deliveries, and other ongoing obligations or rights with respect to the 
security-based swaps and the related reference underlying 
entities.\325\ Another commenter stated that re-proposed Rule 9j-1 
would entail further significant costs and challenges because market 
participants would need to reconcile the scope of the new rule with 
existing practices.\326\
---------------------------------------------------------------------------

    \325\ LSTA Letter at 9-10.
    \326\ IACPM Letter at 4.
---------------------------------------------------------------------------

    The Commission has considered the above comments in finalizing Rule 
9j-1. As discussed above and in the 2021 Proposing Release, some 
security-based swap market participants may incur costs associated with 
taking actions to update existing compliance systems for compliance 
with Rule 9j-1. These additional costs could be limited to the extent 
that many of these practices and systems are already in place to ensure 
compliance with section 9(j) and the other general antifraud and anti-
manipulation statutory and regulatory provisions. To the extent that 
market participants incur compliance costs as a result of Rule 9j-1, 
these costs represent a reasonable trade-off in light of the benefits 
discussed in section V.D.1. With respect to the identification, 
tracking, and coordination activities that might be necessary absent an 
information barrier safe harbor, final Rule 9j-1(e)(2) provides an 
affirmative defense modeled on the affirmative defense in Rule 10b5-
1(c)(2). Final Rule 9j-1(e)(2) will help mitigate the cost and effort 
that market participants may incur to identify, track, and coordinate 
activities involving security-based swaps and related reference 
underlying entities held by the organization.
    Several commenters were concerned that re-proposed Rule 9j-1's 
liability standards are vague and that such vagueness would foster 
significant uncertainty among security-based swap market participants, 
resulting in reduced market participation, liquidity, capital 
formation, and investor choice.\327\ In response to these concerns, the 
Commission clarifies the liability standards of Rule 9j-1 in section II 
of this release. Specifically, the liability standards in the rule 
follow the well-settled standards in section 10(b) of the Exchange Act, 
and Rule 10b-5 thereunder, section 17(a) of the Securities Act, and 
applicable case law. The Commission also explains why a non-scienter-
based standard is appropriate for paragraphs (a)(3) and (a)(4) of final 
Rule 9j-1 and is consistent with sections 17(a)(2) and (3) of the 
Securities Act, on which they are based.
---------------------------------------------------------------------------

    \327\ See IACPM Letter at 4-5; IIB-ISDA-SIFMA Letter at 1-3, 5, 
13-14; LSTA Letter at 3, 5, 7; Milbank Letter at 1-5, 7, 9-10; July 
2022 MFA Letter at 1, 6, 7.
---------------------------------------------------------------------------

    Where commenters noted a discrepancy in the Commission's proposed 
rule and the legal standard for certain attempted offenses, the 
Commission revised the rule to conform to the legal standard in new 
Rule 9j-1(a)(5). These revisions should address any uncertainty that 
security-based swap market participants may have regarding the rule's 
liability standards. In addition, the Commission is adopting Rule 9j-
1(e), which includes two affirmative defenses for violations of the 
provisions in paragraphs (a)(1) through (a)(5) of Rule 9j-1.\328\ The 
final rule conforms the affirmative defenses in Rule 9j-1(e) to those 
in existing Rule 10b5-1(c). The revisions regarding the liability 
standards of Rule 9j-1 coupled with the affirmative defenses of Rule 
9j-1(e) should mitigate any potential adverse effects on market 
participation, liquidity, capital formation, and investor choice. 
Moreover, by reducing the risk of fraudulent and manipulative activity 
in the security-based swap market, Rule 9j-1 would increase market 
participation, liquidity, capital formation, and investor choice 
thereby further mitigating the potential adverse effects that 
commenters identified.\329\
---------------------------------------------------------------------------

    \328\ See final Rule 9j-1(e).
    \329\ See supra section V.D.1.
---------------------------------------------------------------------------

    One commenter was concerned that the inclusion of interim actions 
in the performance of contractual obligations within the scope of re-
proposed Rule 9j-1 will discourage market participants from transacting 
in security-based swaps, reduce liquidity in the security-based swap 
markets, increase the cost of capital, and reduce the availability of 
capital.\330\ The Commission does not believe the final rule will 
adversely affect market participation, liquidity, cost of capital, and 
availability of capital in the manner described by the commenter. Final 
Rule 9j-1 applies to fraudulent, deceptive, or manipulative

[[Page 42579]]

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. Moreover, the rule addresses actions 
taken outside the ordinary course of a typical lender-borrower 
relationship (or a prospective lender-borrower relationship). 
Accordingly, by reducing the risk of fraudulent and manipulative 
activity in the security-based swap market, Rule 9j-1 will increase 
liquidity in the markets for security-based swaps and underlying cash 
instruments, and lower capital costs and increase capital formation for 
reference underlying entities.\331\
---------------------------------------------------------------------------

    \330\ MFA Letter at 2, 8-9.
    \331\ See supra section V.D.1.
---------------------------------------------------------------------------

    Some commenters were concerned that the Commission's choice of a 
negligence standard for re-proposed Rules 9j-1(a)(3) and (4), coupled 
with the omission of Rule 10b5-1(c)(2) affirmative defenses, would 
discourage market participants from entering into security-based swaps 
and would, as a result, reduce liquidity in security-based swap 
markets, exacerbate risks for market participants, and increase 
issuers' cost of capital. These commenters were concerned that lenders 
may also reduce their lending activities, which would reduce financing 
to private companies.\332\ In response to comments received on the 2021 
Proposing Release, paragraphs (a)(3) and (a)(4) of new Rule 9j-1 
describe conduct for which a non-scienter based standard would apply, 
while paragraph (a)(5) of new Rule 9j-1 describes attempts of that 
conduct for which scienter is the proper standard. In addition, Rule 
9j-1(e)(2) provides for an affirmative defense that is modeled on the 
affirmative defense in Rule 10b5-1(c)(2). These changes from re-
proposed Rule 9j-1 should address the commenters' concerns and mitigate 
any potential adverse effects on liquidity, risks, cost of capital, and 
financing to private companies.
---------------------------------------------------------------------------

    \332\ See ACLI Letter at 5-6; MFA Letter at 2, 13-16.
---------------------------------------------------------------------------

    Some commenters stated that proposed Rule 9j-1(b) would create 
uncertainty and implicate a wide range of innocuous and ordinary course 
activities that are essential to markets in both security-based swaps 
and underlying cash instruments. The commenters stated that this would 
materially increase compliance costs for security-based swap market 
participants, reduce participation in security-based swap and 
securities markets, reduce lending activity and capital formation, and 
raise issuers' cost of capital.\333\ As discussed above, final Rule 9j-
1(a)(6), as revised from proposed Rule 9j-1(b), 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). 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. The final rule strikes an 
appropriate balance between preventing manipulation and attempted 
manipulation in the security-based swap market and addressing 
commenters' concern. A narrowing in the scope of final Rule 9j-1(a)(6) 
would create a gap in the prohibition against manipulation and 
attempted manipulation in the security-based swap market and reduce the 
benefits of the rule.
---------------------------------------------------------------------------

    \333\ See MFA Letter at 16-19; Milbank Letter at 9-10.
---------------------------------------------------------------------------

    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. Further, a scienter standard will be used to determine 
whether conduct is in violation of the rule. With respect to the loan 
market, final 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. 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. The foregoing discussion should help address concerns 
related to uncertainty that the rule may create and the proposed rule's 
scope.
    However, to the extent that market participants continue to have 
such concerns, final Rule 9j-1(a)(6) could increase compliance costs, 
reduce market participation, reduce lending activity and capital 
formation, and raise issuers' cost of capital. That said, by reducing 
the risk of fraudulent and manipulative activity in the security-based 
swap market, Rule 9j-1 would increase market participation, increase 
lending activity and capital formation, and lower issuers' cost of 
capital thereby mitigating the potential adverse effects that 
commenters identified. Further, to the degree that Rule 9j-1 provides 
additional precision and specificity regarding the application of 
existing antifraud and anti-manipulation laws to misconduct in the 
security-based swap market, some market participants may need to spend 
fewer resources determining appropriate compliance under section 9(j) 
of the Exchange Act and reduce their compliance costs.\334\
---------------------------------------------------------------------------

    \334\ See supra section V.D.1.
---------------------------------------------------------------------------

E. Benefits and Costs of Rule 15fh-4(c)

1. Benefits
    Rule 15fh-4(c) 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 take, directly or indirectly, any 
action to coerce, mislead, or otherwise interfere with the SBS Entity's 
CCO. This prohibition would support the ability of the CCO to meet the 
CCO's important obligations to foster compliance in its role of 
overseeing compliance within the SBS Entity. Rule 15fh-4(c) will make 
it more likely that a CCO is able to more efficiently and effectively 
execute the CCO's responsibilities to foster compliance, including for 
example, by ensuring that the SBS Entity maintains and reviews written 
policies and procedures reasonably designed to achieve compliance with 
the rules and regulations relating to the business of the SBS Entity. 
Ultimately, these effects will likely also reduce the risk of fraud, 
market manipulation, or other fraudulent activities in the security-
based swap market, providing additional protection for both 
counterparties in the security-based swap transaction and the 
underlying entity.

[[Page 42580]]

    Rule 15fh-4(c) will encourage officers, directors, supervised 
persons, and employees of SBS Entities to exercise reasonable attention 
and care in their dealings with CCOs, as discussed in section III.B. To 
the extent that such exercise of reasonable attention and care 
increases the quantity and quality of information exchanged between 
CCOs, officers, directors, supervised persons, and employees of SBS 
Entities, CCOs may more efficiently and effectively foster compliance 
in SBS Entities. Any resulting improvement in compliance in turn could 
reduce the risk of fraud, market manipulation, or other fraudulent 
activities in the security-based swap market. More broadly, improved 
communication between CCOs, officers, directors, supervised persons, 
and employees of SBS Entities also could facilitate decision making 
within the SBS Entities.
    Rule 15fh-4(c) would likely have minor indirect positive impacts on 
competition, price efficiency, and capital formation, as discussed in 
section V.F.
Comments Received
    Two commenters believed that proposed Rule 15Fh-4(c) would deter 
the types of actions that prevent CCOs from performing their duties and 
that deterring such actions would in turn help protect the CCOs' 
independence and objectivity in the fulfillment of their duties.\335\ 
The Commission agrees with the commenters that Rule 15fh-4(c)'s benefit 
could derive in part from deterring actions that are prohibited by the 
rule.
---------------------------------------------------------------------------

    \335\ See Better Markets Letter at 14; NYC Bar Letter at 4-5.
---------------------------------------------------------------------------

2. Costs
    Rule 15fh-4(c)'s prohibition on taking actions to coerce, mislead, 
or otherwise interfere with the SBS Entity's CCO, may create additional 
costs for SBS Entities. For example, to the extent that any current 
practices of an SBS Entity include activities that are explicitly 
prohibited under Rule 15fh-4(c), applicable policies and procedures 
will need to be updated. In addition, it is possible that the rule 
could cause officers, directors, supervised persons, or employees of an 
SBS Entity to be overly cautious when consulting with a CCO. The 
Commission does not, however, believe that any such effects will be 
significant, given the specificity of the rule's prohibition on certain 
interferences with the SBS Entity's CCO.
Comments Received
    One commenter was concerned that the scope of the proposed rule is 
unclear and could lead to confusion and uncertainty as to what 
communications between the CCO and the officers, directors, supervised 
persons, and employees of the SBS Entity might violate the rule. The 
commenter states that such confusion and uncertainty could have a 
chilling effect on dialog about compliance, budget, and resource 
matters, which, by implication, could impede decision making within the 
SBS Entity.\336\ In response to this comment, the Commission has 
clarified the scope of final Rule 15fh-4(c) in section III.B. Further, 
the Commission clarified that the acts to ``coerce, manipulate, mislead 
or fraudulently influence'' that would be prohibited by Rule 15fh-4(c) 
imply compelling the CCO to act in a certain way through pressure, 
threats, trickery, intimidation, misrepresentation, or some other form 
of purposeful action not limited to untrue statements or omissions of 
material facts. As discussed in section V.E.1, to the extent that the 
rule encourages officers, directors, supervised persons, and employees 
of SBS Entities to exercise reasonable attention and care in their 
dealings with CCOs, communication and decision making could improve 
within the SBS Entities and mitigate any potential adverse impact on 
decision making suggested by the commenter.
---------------------------------------------------------------------------

    \336\ IIB-ISDA-SIFMA CCO Letter at 1-2.
---------------------------------------------------------------------------

F. Effects on Efficiency, Competition, and Capital Formation

    The final rules would likely affect capital formation, competition, 
and efficiency in various ways, as discussed below.
1. Competition
    As discussed earlier, by reducing the risk of fraud, Rule 9j-1 
could encourage participation in the market, which may result in 
increased competition in the security-based swap market.\337\
---------------------------------------------------------------------------

    \337\ See supra section V.D.1.
---------------------------------------------------------------------------

    Rule 15fh-4(c) would likely have a minor indirect positive impact 
on competition in the security-based swap market. Because Rule 15fh-
4(c) would support the ability of the CCO to oversee compliance with 
the Federal securities laws within the SBS Entity and likely reduce the 
risk of fraud, security-based swaps would more likely reflect the 
fundamental credit risk of the underlying entity. This in turn could 
encourage greater participation in the security-based swap market and 
therefore, increase competition among the market participants.
2. Efficiency
    By decreasing the risk of fraud and preventing price manipulation 
in the security-based swap market, Rule 9j-1 may increase price 
efficiency. This would consequently lead to greater security-based swap 
market efficiency, as security-based swap prices would provide greater 
confidence that their prices more likely reflect fundamental values and 
risk in more liquid markets.\338\
---------------------------------------------------------------------------

    \338\ Id.
---------------------------------------------------------------------------

    Rule 15fh-4(c) would likely have a minor indirect positive impact 
on price efficiency. To the extent that the rule increases 
participation in the security-based swap market as discussed in section 
V.F.1, price efficiency may increase because increased trading by 
market participants could incorporate more information into security-
based swap prices.
3. Capital Formation
    Final Rule 9j-1 likely would have a positive impact on capital 
formation. As discussed earlier, greater activity in the underlying 
security market due to increased price efficiency and greater 
availability to hedge these securities in the security-based swap 
market could lead to lower capital costs and increase capital formation 
for the underlying entities. Increased participation and price 
efficiency in the security-based swap market as a result of Rule 9j-1 
could encourage lenders to make greater use of security-based swaps for 
hedging their loans, which in turn could increase lending activity and 
capital formation.\339\ To the extent that the rule lowers litigation 
costs and compliance costs for market participants and underlying 
entities, these market participants and entities could in turn use the 
resources that are freed up to invest in projects.
---------------------------------------------------------------------------

    \339\ Id.
---------------------------------------------------------------------------

    As discussed in section V.D.2, a number of commenters were 
concerned that re-proposed Rule 9j-1's compliance costs, scope, and 
liability standards would reduce capital formation (including financing 
to private companies) and increase the cost of capital, among other 
potential effects. As discussed in that section, compliance costs could 
be limited by existing practices and systems that are in place to 
comply with section 9(j) and the other antifraud and anti-manipulation 
provisions; that the rule's use of clear, consistent, and familiar 
liability standards reduces uncertainty; and that the rule's beneficial 
effects on capital formation and the cost of capital

[[Page 42581]]

would mitigate any potential adverse effects that commenters 
identified.
    Rule 15fh-4(c) would likely have a minor indirect positive impact 
on capital formation. To the extent that the rule increases price 
efficiency and competition in the security-based swap market, as 
discussed in sections V.F.1 and V.F.2, capital formation could, as a 
result, further indirectly increase, as greater price efficiency and 
competition among market participants could lead to a decrease in 
security-based swaps prices, and in turn, lower costs of borrowing (as 
a result of lowering the cost of CDS).

G. Reasonable Alternatives

    The Commission considered a number of alternatives when finalizing 
Rules 9j-1 and 15fh-4(c).
1. Narrow the Scope of Rule 9j-1
    Commenters recommended narrowing the scope of re-proposed Rule 9j-1 
in various ways: (1) exclude valuation, payment, and delivery from the 
scope of proposed Rule 9j-1(b); \340\ (2) exclude certain credit market 
conduct from the scope of proposed Rule 9j-1(b); \341\ and (3) exclude 
security-based swaps referencing sovereign debt from the scope of re-
proposed Rule 9j-1.\342\
---------------------------------------------------------------------------

    \340\ Milbank Letter at 5.
    \341\ See IACPM Letter at 4; IIB-ISDA-SIFMA Letter at 18-19; 
Milbank Letter at 4-5.
    \342\ ACLI Letter at 3, 13-14.
---------------------------------------------------------------------------

    The Commission has considered these alternatives but determined 
that the adopted approach is preferable to them. With respect to the 
exclusion of valuation, payment, and delivery from the scope of 
proposed Rule 9j-1(b), the Commission declines to adopt this 
alternative. The Commission is concerned that the alternative would 
create a gap in the prohibition against the manipulation and attempted 
manipulation of prices in the security-based swap market and reduce the 
benefits of final Rule 9j-1(a)(6), as revised from proposed Rule 9j-
1(b). The exclusion of valuation, payment, and delivery from the scope 
of final Rule 9j-1(a)(6) could increase the occurrence of manipulation 
and attempted manipulation of security-based swap prices in connection 
with such activities.
    With respect to the exclusion of certain credit market conduct, the 
Commission believes it cannot specify all possible types of misconduct 
that may prevail in the future. Hence, provisions designed to exclude 
certain legitimate credit market conduct could unintentionally apply to 
activities that final Rule 9j-1(a)(6), as revised from proposed Rule 
9j-1(b), is designed to prohibit, reducing the benefits of the rule. 
Further, an exclusion of certain credit market conduct would need to be 
balanced against the risk that market participants undertake 
transactions for which their counterparties should have the protections 
of final Rule 9j-1(a)(6). In addition, as discussed in section II.C.2, 
the fact that the Commission intends to apply a scienter standard in 
connection with final Rule 9j-1(a)(6), and that the rule does not 
impose liability for actions taken in the ordinary course of a typical 
lender-borrower relationship (or a prospective lender-borrower 
relationship), should help mitigate concerns regarding any ``chilling 
effects'' of the rule.
    With respect to the exclusion of sovereign debt security-based 
swaps, as a general matter, the Commission does not see a compelling 
reason to treat security-based swaps referencing sovereign underliers 
differently than security-based swaps referencing other underliers. As 
discussed in section II.E.2.d, while security-based swaps related to 
sovereign debt may have lesser opportunity for manufactured credit 
events or opportunistic strategies by regulated and non-regulated 
market participants alike, such instruments are not without risk of 
fraudulent and manipulative conduct and should remain within the scope 
of Rule 9j-1.\343\ Further, the Commission is concerned that the 
alternative would create a gap in the prohibition against fraudulent 
and manipulative activity in the security-based swap market. Even if, 
as the commenter asserted, manufactured credit events related to a 
country's sovereign debt are unlikely, other types of fraudulent and 
manipulative activities could be perpetrated in connection with 
sovereign debt security-based swaps.\344\ The alternative would not 
prohibit these activities and could increase their occurrence. In light 
of the above, the adopted approach is preferable to this alternative.
---------------------------------------------------------------------------

    \343\ See supra note 244 and related discussion.
    \344\ See ACLI Letter at 13 (stating that it seems unlikely that 
any holders of security-based swaps on sovereign debt would possess 
the leverage necessary to manufacture credit events related to a 
country's sovereign debt).
---------------------------------------------------------------------------

2. Safe Harbors
    Commenters suggested that the Commission add various safe harbors 
to Rule 9j-1. The Commission discusses these alternatives below.
a. Safe Harbor for Hedging Exposure Arising Out of Lending Activities
    One commenter urged the Commission to consider creating a safe 
harbor to re-proposed Rule 9j-1 for entering into security-based swap 
transactions for purposes of hedging some or all exposure arising out 
of lending activities with a reference entity or the syndication of 
such lending activities.\345\ Such a safe harbor could minimize the 
effects of the rule on risk-reducing hedging activity, which is one of 
the central purposes of CDS contracts and which provides important 
benefits to the lending market. Identifying legitimate, risk-reducing 
hedging activity--undertaken with the intent of covering potential 
losses in a position--and distinguishing such activity from other types 
of speculative transactions would likely be difficult. Hence, even a 
safe harbor designed to apply solely to legitimate hedging transactions 
could unintentionally apply to activities that Rule 9j-1 is designed to 
prohibit, reducing the benefits of the rule. Further, such a safe 
harbor would need to be balanced against the risk that market 
participants undertake transactions for which their counterparties 
should have the protections of Rule 9j-1, including in circumstances 
involving potentially opportunistic trading strategies. In light of the 
above, the adopted approach is preferable to this alternative.
---------------------------------------------------------------------------

    \345\ LSTA Letter at 8.
---------------------------------------------------------------------------

b. Safe Harbors for Lender Disclosure, Centralized Market Activities, 
and Legitimate Restructurings
    One commenter urged the Commission to consider allowing the lender 
to avoid liability under re-proposed Rule 9j-1 by disclosing to the 
counterparty that it is a lender to the borrower and may have material 
nonpublic information from the borrower.\346\ Another commenter urged 
the Commission to provide safe harbors for certain centralized market 
activities: (1) multilateral amendment exercises (including ISDA 
protocols) or bilateral equivalents; and (2) participation in 
determination committees in accordance with the determination 
committees' rules and any applicable codes of conduct.\347\ A third 
commenter suggested that the Commission provide a safe harbor or 
exception for legitimate restructurings to avoid limiting the supply of 
funds to issuers during a restructuring.\348\ The affirmative defenses 
in Rule 9j-1(e) will serve the same purpose as these alternatives by 
permitting persons to enter into certain types of activity, pursuant to 
the requirements of the affirmative

[[Page 42582]]

defenses, while also addressing concerns about fraud and manipulation 
for the entire security-based swap market. With respect to the 
suggested safe harbor for legitimate restructurings, identifying 
legitimate restructurings and distinguishing such activities from other 
types of speculative transactions would likely be difficult. Hence, 
even a safe harbor designed to apply solely to legitimate 
restructurings could unintentionally apply to activities that Rule 9j-1 
is designed to prohibit, reducing the benefits of the rule. Further, 
such a safe harbor would need to be balanced against the risk that 
market participants undertake transactions for which their 
counterparties should have the protections of Rule 9j-1, including in 
circumstances involving potentially opportunistic trading strategies. 
Accordingly, the adopted approach is preferable to these alternatives.
---------------------------------------------------------------------------

    \346\ Id. at 9.
    \347\ IIB-ISDA-SIFMA Letter at 11-12.
    \348\ Fletcher Letter at 4.
---------------------------------------------------------------------------

c. Safe Harbor for Publicly Executed Strategies
    One commenter requested a safe harbor from liability under proposed 
Rule 9j-1(b) for publicly executed strategies, where multiple parties 
or an independent body (such as a court or regulator) are involved. The 
commenter distinguished publicly executed strategies from privately 
executed strategies, such as a single market participant entering into 
an agreement with a reference entity. The commenter argued that 
publicly executed strategies are more difficult for a single 
participant to manipulate than privately executed strategies because 
publicly executed strategies are driven by the incentives of a broader 
group of participants than privately executed strategies.\349\ The 
Commission declines to adopt this alternative. While publicly executed 
strategies may be difficult for a single participant to manipulate as 
the commenter argued, it is not clear that such strategies would remain 
difficult to manipulate when a group of market participants are acting 
in concert to manipulate such strategies. The Commission is concerned 
that providing a safe harbor for publicly executed strategies would 
encourage manipulative activity involving a coalition of market 
participants. That said, the Commission appreciates that there are 
legitimate publicly executed strategies that are not involved in 
manipulative activity. In section II.C.2, the Commission discusses at 
length the application of final Rule 9j-1(a)(6) and believes the 
discussion should alleviate concerns that legitimate publicly executed 
strategies may violate the rule.
---------------------------------------------------------------------------

    \349\ IIB-ISDA-SIFMA Letter at 17.
---------------------------------------------------------------------------

d. Elimination of All Safe Harbors and Affirmative Defenses
    Four commenters urged for the elimination of all safe harbors and 
affirmative defenses from proposed Rule 9j-1(a) liability.\350\ The 
adopted approach, which among other things, provides two affirmative 
defenses in final Rule 9j-1(e), is preferable to the alternative. As 
discussed in section V.D.2, the two affirmative defenses will help 
mitigate various adverse effects (e.g., reduced market participation) 
that certain commenters believed may arise as a result of Rule 9j-1. 
Final Rule 9j-1(e)(2) will help mitigate the cost and effort that 
market participants may incur to identify, track, and coordinate 
activities involving security-based swaps and related reference 
underlying entities held by the organization. At the same time, the 
costs that market participants may incur in connection with these 
affirmative defenses likely would be very limited.\351\
---------------------------------------------------------------------------

    \350\ Better Markets Letter at 2, 9-12; Anonymous Penguin 
Comments at 1; J.T. Comments at 1; Michael Comments at 1.
    \351\ See supra section V.D.2.
---------------------------------------------------------------------------

3. Implementing a More Prescriptive Approach in Rule 9j-1
    One commenter urged the Commission to consider the alternative 
approach of identifying and prohibiting within Rule 9j-1 specific types 
of events (for example, market behavior around certain events and fact 
patterns) and opportunistic trading behavior that have been observed. 
According to the commenter, this alternative approach could provide 
even more certainty and precision with respect to the particular types 
of activities that are prohibited in the security-based swap market. 
The commenter believed that the greater certainty of outcome with 
respect to Rule 9j-1 would benefit lenders when they need to exercise 
rights or remedies under a loan or credit agreement.\352\ However, this 
approach could lead to greater uncertainty with respect to 
circumstances not explicitly contemplated in the rule, which could 
increase litigation costs for market participants involved in such 
transactions. This approach may also decrease the integrity of the 
market for security-based swaps, and in addition, could cause market 
participants to bear greater compliance costs in connection with the 
evaluation of circumstances not explicitly contemplated in the rule. As 
a result, the more prescriptive alternative approach would have limited 
benefits and greater costs as compared to the adopted approach in the 
market for security-based swaps, as well as the market for the 
reference underlying of such security-based swaps.
---------------------------------------------------------------------------

    \352\ LSTA Letter at 7.
---------------------------------------------------------------------------

    The Commission acknowledges the commenter's concern that not 
adopting the more prescriptive alternative approach could prevent 
lenders or security-based swap participants from exercising legitimate 
rights and remedies and impose costs that would be greater than those 
discussed in the 2021 Proposing Release in connection with re-proposed 
Rule 9j-1.\353\ Final Rule 9j-1 would enable lenders or security-based 
swap participants to exercise legitimate rights and remedies, thereby 
addressing the commenter's concern. In particular, paragraphs (a)(3) 
and (a)(4) of final Rule 9j-1 describe conduct for which a non-scienter 
based standard would apply, while paragraph (a)(5) of final Rule 9j-1 
describes attempted aspects of that conduct for which scienter is the 
proper standard. In addition, final Rule 9j-1(e) provides for 
affirmative defenses similar to the affirmative defenses in Rule 10b5-
1(c). The clarification regarding the liability standards of Rule 9j-1 
coupled with the affirmative defenses of Rule 9j-1(e) should mitigate 
any potential adverse effects on market participation, liquidity, 
capital formation, and investor choice. Moreover, by reducing the risk 
of fraudulent and manipulative activity in the security-based swap 
market, Rule 9j-1 would increase market participation, liquidity, 
capital formation, and investor choice thereby further mitigating the 
potential adverse effects that commenters identified.
---------------------------------------------------------------------------

    \353\ Id.
---------------------------------------------------------------------------

4. Separate Rules for CDS and Equity Security-Based Swaps
    One commenter asserted that opportunistic strategies work best with 
CDS and that equity SBS are less susceptible to such strategies. The 
commenter suggested that the Commission propose separate rules for each 
type of instrument.\354\ The Commission has considered the commenter's 
suggested alternative, but believes that the adopted approach is 
preferable to the alternative. The aim of Rule 9j-1 is to address fraud 
and manipulation in the security-based swap market and is not limited 
to addressing fraud and manipulation in connection with certain 
opportunistic strategies that historically have been implemented with 
CDS. As discussed in section II, fraudulent and manipulative

[[Page 42583]]

conduct 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. Rule 9j-1 is appropriately tailored 
to address fraud and manipulation for the entire security-based swap 
market. As such the Commission does not see the need to adopt separate 
rules for CDS and equity security-based swaps.
---------------------------------------------------------------------------

    \354\ Fletcher Letter at 4.
---------------------------------------------------------------------------

5. Exclude Underlying Securities
    One commenter urged the Commission to modify re-proposed Rule 9j-1 
by providing that its prohibitions do not extend to the purchase or 
sale of underlying securities.\355\ The Commission declines to adopt 
this alternative. Because security-based swaps by their nature are tied 
intrinsically to activity in other securities markets, persons that 
intend to perpetrate fraudulent or manipulative activity with respect 
to a security-based swap may choose to do so by purchasing or selling 
the underlying security. The alternative would create a gap in the 
prohibition against fraudulent and manipulative activity in connection 
with security-based swaps and increase the risk of such activity to the 
detriment of investors. In contrast, final Rule 9j-1(c) is designed so 
that a person cannot escape liability under section 9(j) of the 
Exchange Act 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 or 
narrow-based security index underlying that security-based swap.
---------------------------------------------------------------------------

    \355\ MFA Letter at 2, 8-9.
---------------------------------------------------------------------------

6. Limit Activities Prohibited Under Rule 15fh-4(c)
    One commenter suggested that final Rule 15fh-4(c) should limit the 
prohibited interference to knowingly making untrue statements or 
omitting material facts.\356\ As discussed in section III.B, Rule 15fh-
4(c) protects the independence and objectivity of an SBS Entity's CCO 
by prohibiting undue influence by other personnel. Such influence could 
take many forms and is not limited to material misstatements or 
omissions. The Commission is concerned that limiting prohibited 
activities to material misstatements and omissions, as suggested by the 
commenter, would fail to adequately protect the CCO from undue 
influence and consequently reduce the rule's benefit. As discussed in 
section V.E.1, by encouraging officers, directors, supervised persons, 
and employees of SBS Entities to exercise reasonable attention and care 
in their dealings with CCOs, final Rule 15fh-4(c) would foster 
compliance in SBS Entities, reduce the risk of fraudulent and 
manipulative conduct, and facilitate decision making in SBS Entities. 
The suggested alternative, by its limited nature, may be less likely to 
encourage such exercise of reasonable attention and care in dealings 
with CCOs. Accordingly, the adopted approach is preferable to the 
alternative.
---------------------------------------------------------------------------

    \356\ ISDA-IIB-SIFMA CCO Letter at 2.
---------------------------------------------------------------------------

VI. Regulatory Flexibility Act Certification

    The Regulatory Flexibility Act (``RFA'') \357\ requires Federal 
agencies, in promulgating rules, to consider the impact of those rules 
on small entities. Section 603(a) of the Administrative Procedure 
Act,\358\ as amended by the RFA, generally requires the Commission to 
undertake a regulatory flexibility analysis of all proposed rules, or 
proposed rule amendments, to determine the impact of such rulemaking on 
``small entities.'' \359\ Section 605(b) of the RFA states that this 
requirement shall not apply to any proposed rule or proposed rule 
amendment which, if adopted, would not have a significant economic 
impact on a substantial number of small entities.\360\ The Commission 
certified in the 2021 Proposing Release that new Rules 9j-1 and 15fh-
4(c) would not have a significant economic impact on any ``small 
entity'' for purposes of the RFA.\361\ The Commission received no 
comments on its certification.
---------------------------------------------------------------------------

    \357\ 5 U.S.C. 601 et seq.
    \358\ 5 U.S.C. 603(a).
    \359\ Although section 601(b) of the RFA defines the term 
``small entity,'' the statute permits agencies to formulate their 
own definitions. The Commission has adopted definitions for the term 
``small entity'' for the purposes of Commission rulemaking in 
accordance with the RFA. Those definitions, as relevant to this 
rulemaking, are set forth in 17 CFR 240.0-10 (``Rule 0-10'') under 
the Exchange Act. See Final Definitions of ``Small Business'' and 
``Small Organization'' for Purposes of the Regulatory Flexibility 
Act, Exchange Act Release No. 18452 (Jan. 28, 1982), 47 FR 5215 
(Feb. 4, 1982) (File No. S7-879).
    \360\ See 5 U.S.C. 605(b).
    \361\ See 2021 Proposing Release, 87 FR at 6702-03.
---------------------------------------------------------------------------

    For purposes of Commission rulemaking in connection with the RFA, a 
small entity includes: (1) when used with reference to an ``issuer'' or 
a ``person,'' other than an investment company, an ``issuer'' or 
``person'' that, on the last day of its most recent fiscal year, had 
total assets of $5 million or less; \362\ or (2) a broker-dealer with 
total capital (net worth plus subordinated liabilities) of less than 
$500,000 on the date in the prior fiscal year as of which its audited 
financial statements were prepared pursuant to 17 CFR 240.17a-5(d) 
under the Exchange Act,\363\ or, if not required to file such 
statements, a broker-dealer with total capital (net worth plus 
subordinated liabilities) of less than $500,000 on the last business 
day of the preceding fiscal year (or in the time that it has been in 
business, if shorter); and is not affiliated with any person (other 
than a natural person) that is not a small business or small 
organization.\364\
---------------------------------------------------------------------------

    \362\ See 17 CFR 240.0-10(a).
    \363\ 17 CFR 240.17a-5(d).
    \364\ See 17 CFR 240.0-10(c).
---------------------------------------------------------------------------

    Based on available information about the security-based swap 
market, the market, while broad in scope, is largely dominated by 
entities such as those that will be covered by the SBSD and MSBSP 
definitions. Based on feedback from industry participants about the 
security-based swap market, the Commission continues to believe that: 
(1) the types of entities that are and will continue to register with 
the Commission as SBSDs (i.e., because they engage in more than a de 
minimis amount of dealing activity involving security-based swaps)--
which generally would be large financial institutions--would not be 
``small entities'' for purposes of the RFA; and (2) the types of 
entities that may have security-based swap positions above the level 
required to register as MSBSPs would not be ``small entities'' for 
purposes of the RFA.
    Although Rule 15fh-4(c) applies only to SBS Entities, Rule 9j-1 is 
not on its face limited to SBS Entities. However, while it is possible 
that other parties may engage in security-based swap transactions, the 
Commission does not believe that any such entities would be ``small 
entities'' as defined in Exchange Act Rule 0-10.\365\ Feedback from 
industry participants about the security-based swap market indicates 
that only persons or entities with assets significantly in excess of $5 
million (or with annual receipts significantly in excess of $7 million) 
participate in the security-based swap market. With respect to Rule 9j-
1, even to the extent that a small number of transactions did have a 
counterparty that was defined as a ``small entity'' under Rule 0-10, 
the Commission believes it unlikely that the rule would have a 
significant economic impact on such entities, as the rule prohibits 
fraudulent and manipulative acts, activities which are in most cases 
already prohibited.
---------------------------------------------------------------------------

    \365\ See 17 CFR 240.0-10(a).
---------------------------------------------------------------------------

    For the foregoing reasons, the Commission certifies that Rules 9j-1 
and 15fh-4(c) will not have a significant

[[Page 42584]]

economic impact on a substantial number of small entities for purposes 
of the RFA.

VII. Other Matters

    Pursuant to the Congressional Review Act,\366\ the Office of 
Information and Regulatory Affairs has designated these rules as not a 
``major rule,'' as defined by 5 U.S.C. 804(2).
---------------------------------------------------------------------------

    \366\ 5 U.S.C. 801 et seq.
---------------------------------------------------------------------------

    If any of the provisions of these final rules, or the application 
thereof to any person or circumstance, is held to be invalid, such 
invalidity shall not affect other provisions or application of such 
provisions to other persons or circumstances that can be given effect 
without the invalid provision or application.

Statutory Authority

    The Commission is adopting the new rules and rule amendment 
contained in this release under the authority set forth in the Exchange 
Act, 15 U.S.C. 78a et seq., as amended, and, particularly sections 2, 
3(b), 9(i), 9(j), 10, 15, 15F, and 23(a) thereof (15 U.S.C. 78b, 
78c(b), 78i(i), 78i(j), 78j, 78o, 78o-10, and 78w(a)).

List of Subjects in 17 CFR Part 240

    Administrative practice and procedure, Brokers, Confidential 
business information, Fraud, Reporting and recordkeeping requirements, 
Securities, Swaps.

Text of the Final Rule

    For the reasons set forth in the preamble, title 17, chapter II of 
the Code of Federal Regulations is amended as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

0
1. The general authority citation for part 240 continues to read, and 
the sectional authority for Sec.  240.15fh-1 is revised to read, as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f, 
78g, 78i, 78j, 78j-1, 78j-4, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 
78o-4, 78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78dd, 78ll, 
78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, and 7201 
et seq., and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 
U.S.C. 1350; Pub. L. 111-203, 939A, 124 Stat. 1376 (2010); and Pub. 
L. 112-106, sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise 
noted.

    Sections 240.15fh-1 through 240.15Fh-6 and 240.15Fk-1 are also 
issued under sec. 943, Pub. L. 111-203, 124 Stat. 1376.
* * * * *


Sec. Sec.  240.10a-1 and 240.10a-2  [Amended]

0
2. Move reserved Sec. Sec.  240.10a-1 and 240.10a-2 from undesignated 
center heading ``Hypothecation of Customers' Securities'' to 
undesignated center heading ``Manipulative and Deceptive Devices and 
Contrivances'' in numerical order.

0
3. Add Sec.  240.9j-1 under the undesignated center heading 
``Manipulative and Deceptive Devices and Contrivances'' to read as 
follows:


Sec.  240.9j-1  Prohibition against fraud, manipulation, or deception 
in connection with security-based swaps.

    (a) It shall be 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:
    (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 omits 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 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;
    (4) Engages in any act, practice, or course of business which 
operates or would operate as a fraud or deceit upon any person;
    (5) 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 attempts 
to engage in any act, practice, or course of business which operates or 
would operate as a fraud or deceit upon any person; or
    (6) Manipulates or attempts to manipulate the price or valuation of 
any security-based swap, or any payment or delivery related thereto.
    (b) 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 Act or the 
Securities Act of 1933, 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.
    (c) Wherever taking any of the actions set forth in paragraph (a) 
of this section involving a security-based swap would violate, or 
result in liability under, Section 9(j) of the Act or this section, 
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) of the Act or paragraph (a) of this section.
    (d) For 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.
    (e) A person shall not be liable under paragraphs (a)(1) through 
(a)(5) of this section solely for being aware of material nonpublic 
information while taking the following actions:
    (1) Actions taken by a person in accordance with binding 
contractual rights and obligations under a security-based swap (as 
reflected in the written documentation governing such security-based 
swap or any amendment thereto) so long as the person demonstrates that:
    (i) The security-based swap was entered into, or the amendment was 
made, before the person became aware of such material nonpublic 
information, and
    (ii) The security-based swap was entered into in good faith and not 
as part of a plan or scheme to evade the prohibitions of this section.
    (2) Actions taken by a person other than a natural person if the 
person demonstrates that:
    (i) The individual making the investment decision on behalf of the 
person taking the action was not aware of the material nonpublic 
information, and

[[Page 42585]]

    (ii) The person had implemented reasonable policies and procedures, 
taking into consideration the nature of the person's business, to 
ensure that individuals making investment decisions would not be in 
violation of paragraphs (a)(1) through (a)(5) of this section. These 
policies and procedures may include those that restrict effecting a 
transaction in, or purchasing or selling, any security, including any 
security-based swap, as to which the person has material nonpublic 
information, or those that prevent such individuals from becoming aware 
of such information.

0
4. Redesignate Sec.  240.15Fh-4 as Sec.  240.15fh-4 and amend newly 
redesignated Sec.  240.15fh-4 by:
0
a. Revising the section heading; and
0
b. Adding paragraph (c).
    The revisions read as follows:


Sec.  240.15fh-4  (Rule 15fh-4) Antifraud provisions for security-based 
swap dealers and major security-based swap participants; special 
requirements for security-based swap dealers acting as advisors to 
special entities.

* * * * *
    (c) No undue influence over chief compliance officer. It shall be 
unlawful for any officer, director, supervised person, or employee of a 
security-based swap dealer or major security-based swap participant, or 
any person acting under such person's direction, to directly or 
indirectly take any action to coerce, manipulate, mislead, or 
fraudulently influence the security-based swap dealer's or major 
security-based swap participant's chief compliance officer in the 
performance of their duties under the Federal securities laws or the 
rules and regulations thereunder.

    By the Commission.

    Dated: June 7, 2023.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2023-12592 Filed 6-29-23; 8:45 am]
BILLING CODE 8011-01-P