SEC Provides More Guidance and Exemptions for Security-Based Swaps

Title VII of the Dodd-Frank Act created a new regulatory framework for over-the-counter derivatives, authorizing the SEC to regulate security-based swaps and the Commodity Futures Trading Commission to regulate other swaps.  Under Dodd-Frank, starting July 16, 2011, security-based swaps are defined as “securities” subject to existing federal securities laws, including the Securities Act of 1933 and the Securities Exchange Act of 1934.  

The SEC provided additional guidance on July 1 to clarify which U.S. securities laws will apply to security-based swaps starting July 16.  Interim final rules provide certain conditional exemptions under the Securities Act (Rule 240), the Exchange Act (Rule 12a-11 and Rule 12h-1(i)), the Trust Indenture Act (Rule 4d-12) and other provisions of the federal securities laws to allow certain security-based swaps to continue to trade and be cleared as they have pre-Dodd-Frank.  This interim relief will remain in effect until the compliance date for final rules that the SEC may adopt further defining the terms “security-based swap” and “eligible contract participant.”  

By Exemptive Order effective on July 1, the SEC granted temporary relief clarifying that a substantial number of the requirements of the Exchange Act applicable to securities will not apply to security-based swaps when the revised definition of security goes into effect on July 16.  The prohibitions on fraud and manipulation will continue to apply to security-based swaps after that date.  To enhance legal certainty for market participants, the SEC also provided temporary relief from provisions of U.S. securities laws that allow the voiding of contracts made in violation of those laws.  

The purpose of the exemptions is to allow market participants to continue to enter into those security-based swaps that under current law are defined as security-based swap agreements as they do today, and to minimize disruptions and costs to the security-based swap markets that could otherwise occur on July 16.  The SEC intends to monitor closely the transition of the derivatives markets to regulated markets and to determine to what extent, if any, additional regulatory action may be necessary.  Public comments on the exemptions are due July 15.