January 19, 2022 - On December 15, 2021, the Securities and Exchange Commission (SEC) approved a reproposal Rule 9j-1, a long dormant proposal originally promulgated in 2010 under the Dodd-Frank Act. Ostensibly, 9j-1 is designed to prevent fraud, manipulation, and deception in connection with security-based swap transactions. Importantly, the proposal specifically attempts to address “manufactured credit events” or other opportunistic strategies that involve fraudulent, deceptive, or manipulative activity, or that involve fictitious quotations. Since loan-based swaps are statutorily defined as security-based swaps, the proposal is very relevant to the institutional leveraged loan market that has taken advantage of loan-based total return swaps (“LTRS”) as well as credit default swaps (both loan-related (LCDS) and traditional CDS).
As noted in a recent memo from Sullivan & Cromwell, the proposed rule expands on the scope of existing language in Section 10(b) of the Exchange Act, Rule 10b-5 thereunder and in Section 17(a) of the Securities Act, beyond the scope of those analogous rules in potentially significant ways. “The prohibitions reach beyond activity around the entry into a security-based swap transaction (the “purchase” or “sale”), or the novation or termination of a security-based swap, to actions taken in connection with obligations or rights under a security-based swap, including margin payments or early termination of the transaction. In addition, the proposed rule potentially reaches attempted fraud, deceit and manipulation, which may create uncertainty for market participants (emphasis added).” Notably, the LSTA commented on the original proposal back in 2010, identifying several serious issues associated with the proposal’s implementation and asking the SEC 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. While the SEC acknowledged the LSTA’s position in its recent proposal, many of the risks identified by the LSTA remain.
The SEC has requested comments on the reproposal of Rule 9j-1 within 45 days of its publication in the Federal Register and the LSTA intends to do so.