March 23, 2022 - Last week the LSTA submitted a comment letter to the Securities and Exchange Commission in response to its proposed Rule 9j-1 covering security-based swaps.  We previously highlighted the proposed rule here, noting that 9j-1 is designed to prevent fraud, manipulation, and deception in connection with security-based swap transactions.  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 used loan-based total return swaps (“LTRS”) as well as credit default swaps (both loan-related (LCDS) and traditional CDS).  But, in our view, the rule is unnecessary and goes too far for the reasons described in our letter and summarized below.

There is no need for the rule in light of existing anti-fraud rules.  Security-based swaps are already subject to a series of rules that pursue fraud, manipulation and deception, including Rule 10b-5 under the Exchange Act and Rule 17(a) of the Securities Act of 1933 and provide the Commission with broad powers.

The proposed rule would create considerable uncertainty with respect to the legitimate business decisions of lenders.  Even the most basic decisions, like whether to agree to credit agreement amendments or waivers, could be subject to hindsight SEC scrutiny if they implicate a related security-based swap

The proposed safe harbors are insufficient to capture common legitimate business activities of lenders who engage in security-based swap transactions.  The safe harbors crafted by the SEC do not go nearly far enough in protecting lenders from the hindsight risk described above. 

The proposed rule imposes significant compliance costs on lenders and security-based swap market participants.  The rule would require the design and implementation of extensive compliance programs to adhere to its broad prohibitions; such costs are only marginally alleviated by the narrow safe harbors, which present resource challenges of their own in ensuring that each activity falls within a designated safe harbor. The costs of compliance with the Proposed Rule would be unreasonably burdensome to lenders, and would have a significant, negative impact on the loan markets.

Conclusion.  While the LSTA supports the Commission’s ongoing effort to combat fraud, manipulation and deception in connection with security-based swaps and the securities markets more broadly, we strongly believe that the approach taken by the proposed rule would result in significant adverse impact on the markets for security-based swaps and their underlying instruments.

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