August 2, 2021 - by Elliot Ganz. In late July, SEC Chair Gary Gensler signaled that the SEC would once again turn its attention to “security-based swaps”.  Why is this important?  Under the Dodd-Frank Act of 2010, loan total return swaps (LTRS) and loan credit default swaps (LCDS) were categorized as security-based swaps subject to all of the rules and regulations promulgated under Dodd-Frank.

In November 2010, the SEC proposed Rule 9j-1 (the “Proposed Rule) in connection with security-based swaps.  The rule was meant to be a swaps-equivalent of the anti-fraud rules that pertain to regular securities, such as Rule 10b-5.  However, those rules relate to the purchase and sale of securities, but the Proposed Rule goes much further and explicitly reaches activity in connection with the “exercise of any right or performance of any obligation under” a security-based swap, which the SEC states would include conduct involving the “reference underlying” of the security-based swap.  Stated differently, actions taken in the normal course of managing credit agreements could, theoretically, trigger anti-fraud liability under Rule 9J-1 thereby requiring analysis of any such actions from that point of view.

The LSTA commented on this rule in December 2010.  We asked the SEC to consider the differences between the security-based swaps market and the traditional securities market and to the complexities of the security-based swaps market, before adopting an anti-manipulation and antifraud rule regarding security-based swaps. Specifically, we asked that the SEC construct a rule that avoids triggering significant adverse effects on the market for security-based swaps and on the ability of banks and other lenders to make and maintain syndicated loans. Most importantly, we urged the Commission to craft any final rule to permit lenders to exercise their rights and remedies and to modify, forebear and waive provisions under credit agreements without regard to the effect that those actions may have on existing LCDS, LTRS or CDS positions.

Interestingly, after proposing Rule 9j-1 and receiving many comments, the SEC never followed up and no further action was taken.  Until now.  Chair Gensler’s recent comments suggest that the staff might, in the near future, repropose a rule that has sat dormant for 11 years. 

Because this rule could profoundly impact the viability of LTRS, we will continue to follow this issue very closely.

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