Gary DeWaal and Associates LLC

Last week, the Securities and Exchange Commission issued its first rules governing cross-border transactions involving security-based swaps. Overall these rules are parallel to guidance previously adopted by the Commodity Futures Trading Commission, but differ in some important respects. Also last week, the Financial Industry Regulatory Authority issued a red flag to a broker-dealer and its CEO for engaging in fraud against many current and former US professional football and basketball players. Talk about unsportsmanlike conduct!

As a result, the following matters are covered in this week’s Bridging the Week:

• SEC Adopts First Rules and Guidance Related to Cross-Border Security-Based Swap Activity; Describes When Registration Is Required and the Scope of the Agency’s Cross-Border Anti-Fraud Authority;
• Barclays Charged by New York State in Connection With the Marketing and Operation of Its Dark Pool; SEC Orders Study on the Impact of Tick Size on Market Quality;
• Broker-Dealer Success Trade Securities and Its President Expelled From FINRA for Ripping Off Many Former NFL and NBA Players Through a Ponzi Scheme;
• ESMA Publishes Revised EMIR Q&As; Adds New Matters Related to Reporting to Trade Repositories and of Exchange-Traded Derivatives; and more.

Video Version:

Article Version

SEC Adopts First Rules and Guidance Related to Cross-Border Security-Based Swap Activity; Describes When Registration Is Required and the Scope of the Agency’s Cross-Border Anti-Fraud Authority

The Securities and Exchange Commission last week adopted its first in a series of rules aimed at cross-border security-based swap transactions. The rules establish when a cross-border transaction must be counted to determine if a non-US person has to register as a security-based swap dealer or a major security-based swap participant, as well as the scope of the agency’s anti-fraud authority.

The SEC also adopted a rule establishing the procedure for submitting substituted compliance requests, pursuant to which, if granted, a non-US security-based swap dealer or security-based major swap participant can rely on certain of its home jurisdiction’s rules to satisfy comparable SEC obligations. The actual nature of substituted compliance will be addressed in a future SEC rule-making.

In the US, security-based swaps are swaps based on a single entity’s security or a narrow-based security index (e.g., credit default swaps based on a single entity’s security or total return swaps based on a narrow-based security index). Jurisdiction over swaps and certain persons engaging in swaps activity (except for security-based swaps) lies with the Commodity Futures Trading Commission. Jurisdiction over security-based swaps and certain persons engaging in security-based swaps activity resides with the SEC. The CFTC and SEC share jurisdiction over certain mixed swaps.

Previously, the CFTC issued interpretive guidance and an exemptive order to govern cross-border swaps transactions.  A lawsuit is pending against the CFTC for its issuance of requirements as guidance as opposed to as rules. (For details regarding the CFTC’s interpretive guidance, click here to see the July 16, 2013 article on this website, “CFTC Enacts Interpretive Guidance and Passes Exemptive Order Regarding Cross Border Swaps Transactions.” For details regarding the lawsuit against the CFTC, click here to see the article “Three Industry Organizations File Lawsuit Against the CFTC Over Its Cross Border Guidance” in the December 2 to 6 and 9, 2013 edition of Bridging the Week.) 

Under the SEC’s new rules, for purposes of assessing its obligation to register as a security-based swap dealer, a non-US person must count towards a de minimis threshold all security-based swaps transactions with counterparties that (1) are US persons (including foreign branches or offices of US banks that are not registered as security-based swap dealers); (2) have rights of recourse against a US person affiliate for a non-US person’s obligations under a security-based swap transaction; and (3) are so-called “conduit affiliates” (e.g., where through internal group transactions, the risks and benefits of a security-based swap with a non-US person are transferred to a US person).

These requirements are parallel to but different from CFTC requirements in some respects. For example, whereas the CFTC’s guidance takes the view that a non-US person which receives any express guarantee from a US affiliate should count all its dealing activity against the de minimis threshold, the SEC requires inclusion only where a counterparty has recourse against a US person that is affiliated with the non-US person. The SEC says it has adopted a “more targeted” approach.

The de minimis threshold, however, is similar under both the CFTC’s and SEC’s methodologies for potential swap dealers and security-based swap dealers (i.e., for a potential security-based swap dealer, $8 billion of gross notional CDS activity over the prior 12 months decreased to $3 billion after a phase-in period will trigger a registration obligation).

Likewise, the definition of US person includes (1) natural persons who reside in the US; (2) any legal entity or vehicle that is established under US laws or has its principal place of business in the US; (3) any discretionary or non-discretionary account of a US person; and (4) any estate of a decedent who was a US person at the time of death. The SEC’s final rules define place of business as “the location from which the officers, partners or managers of the legal person primarily direct, control and coordinate the activities of the legal person.” This definition of place of business will capture many externally managed investment vehicles organized outside the US that are active participants in the security-based swap markets, acknowledges the SEC.

The SEC definition of US person differs from the CFTC's definition, particularly as it relates to investment vehicles.  The SEC, for example, expressly declined to include within its definition of US person the CFTC’s inclusion of any investment vehicle that is majority-owned by US persons.

The SEC believes its definition captures the universe of persons whose security-based swaps activity could have a significant impact within the US no matter where or with whom their activities occur:

“[T]he definition of “U.S. person” in the final rule is intended, in part, to identify those persons for whom it is reasonable to infer that a significant portion of their financial and legal relationships are likely to exist within the United States and that it is therefore reasonable to conclude that risk arising from their security-based swap activities could manifest itself within the United States, regardless of the location of their counterparties, given the ongoing nature of the obligations that result from security-based swap transactions.”

In commentary regarding its new rules, the SEC said it will later solicit comment on how it should address security-based swap transactions between two non-US persons when activity related to such swaps occurs at least partially in the US.

As part of its rulemaking, the SEC also indicated that a request for substituted compliance may be submitted by any party that potentially must comply with SEC requirements, or by a relevant foreign regulator. A request must include documentation regarding methods used by a relevant foreign regulator to enforce its applicable rules.

Finally the SEC’s final rule states that its anti-fraud authority is applicable wherever there is sufficient conduct in furtherance of an alleged fraud or sufficient effects of the alleged fraud within the US.

In enacting its rules, the SEC emphasized the global interconnectedness of security-based swap dealers. According to the Commission,

“Because dealers facilitate the great majority of security-based swap transactions, with bilateral relationships that extend to potentially hundreds of counterparties, liquidity problems or other forms of financial distress that begin in one entity or one corner of the globe can potentially spread throughout the network, with dealers as a central conduit.”

The effective date of the SEC’s new rules will be 60 days after they are published in the Federal Register.

And briefly:

• Barclays Charged by New York State in Connection With the Marketing and Operation of Its Dark Pool; Separately SEC Orders Study on the Impact of Tick Size on Market Quality: Barclays Capital, Inc. and Barclays PLC were both charged last week with violations of New York State law regarding the bank’s marketing and operation of its dark pool known as Barclays LX. The NYS attorney general alleged that Barclays may not have been fully forthcoming with its insitutional investors regarding the activity of high-frequency traders in its dark pool. According to a Barclays press statement published on its website, “[w]e take these allegations very seriously. Barclays has been cooperating with the New York Attorney General and the SEC and has been examining this matter internally. The integrity of the markets is a top priority of Barclays.” In a separate but related development aimed at enhancing market structure, the SEC instructed US national securities exchanges and the Financial Industry Regulatory Authority to develop and implement a 12-month pilot program to widen tick sizes for certain small capitalization stocks and to assess how this impacts market quality for US investors, issuers and other market participants.
   
• Broker-Dealer Success Trade Securities and Its President Expelled From FINRA for Ripping Off Many Former NFL and NBA Players Through a Ponzi Scheme: An SEC-registered broker-dealer and its chief executive officer were barred from the business and ordered to make restitution to 59 investors, the majority of whom were unnamed current and former professional US football and basketball players. This was as a result of a Financial Industry Regulatory Authority hearing panel finding that the broker, Success Trade Securities, Inc., and its CEO and founder, Fuad Ahmend, engaged in a fraudulent sale of promissory notes and marketed a Ponzi scheme. FINRA has charged that the promissory notes (which were issued by Success’ parent company – also owned by Mr. Ahmend) were described in their offering documentation as being available to accredited (i.e., very wealthy) investors, when in fact they were largely sold to recent college graduates with no significant assets or income who had just begun playing professional sports or were waiting to be drafted. The promissory notes, says the hearing panel, were represented as being used for legitimate purposes by the parent company, but in fact were used for non-legitimate purposes, including to pay interest to earlier investors. As a result, the respondents were ordered to pay almost US $14 million in restitution to the 59 customers, and were barred as FINRA members, which precludes them from dealing with the public.

And even more briefly:

• ESMA Publishes Revised EMIR Q&As; Adds New Matters Related to Reporting to Trade Repositories and of Exchange-Traded Derivatives: Last week, the European Securities and Markets Authority published another update to its Questions and Answers on OTC derivatives, central counterparties and trade repositories under the European Market Infrastructure Regulation. New questions asked and answered dealt with how collateral and information regarding position valuation should be reported to trade repositories, in addition to the reporting of exchange-traded derivatives.
   
• CFTC Extends Dates of Prior No-Action Relief Related to Receipt and Recording of Customer Funds as Well as the Reporting of Certain Identifying Information Regarding Certain OTC Swaps: The CFTC extended the expiration dates of two previously issued no-action letters. First, the CFTC’s Division of Swap Dealer and Intermediary Oversight extended until October 31, 2014, no-action relief initially granted on January 10, 2014, that extended the time futures commission merchants have to comply with the requirement to immediately book entry credit to a customer’s so-called “Part 30 secured funds account” or “cleared swaps funds account” funds received in the customer’s so-called “Section 4d(a)(2) account.” No-action relief is subject to an FCM maintaining sufficient funds in each of the three customer protection environments to meet the net liquidating equities of all of the FCM’s customers in each environment at all times. Second, the Commission’s Division of Market Oversight extended until no later than January 16, 2015, no-action relief previously granted on June 20, 2013, that waived trade repository reporting obligations regarding certain identifying information related to certain OTC swaps, where the reporting of such information would be subject to statutory or regulatory prohibition (e.g., under privacy, secrecy or blocking laws) in specifically enumerated non-US jurisdictions. The Commission indicated it is also considering extending the scope of this relief.
   
• NFA Highlights Changes to CPO Form PQR and CTA Form PR That Are Effective for the Period Ending June 30: The National Futures Association issued a reminder to all commodity pool operators and commodity trading advisors that there are changes to the forms that they are required to file with NFA for the quarter ending June 30 related to their operations. These forms are Form PQR for CPOs and Form PR for CTAs. Previously the NFA issued a notice to members regarding these changes (to see this notice, click here). 
   
• NFA Proposes to Prohibit Credit Card Use to Meet Margin Calls for Retail FX Accounts: Retail forex and futures customers no longer will be permitted to use their credit cards to fund their accounts according to a rule proposal submitted by the National Futures Association to the CFTC. "Forex and futures markets are both high-risk and volatile, and individuals who wish to participate should use only risk capital to fund their accounts,” says Dan Roth, NFA’s President and CEO. “Allowing customers to fund accounts with credit cards encourages them to trade with borrowed money." The NFA’s proposed prohibition will not impact the permitted use of debit cards.

For more information, see:

CFTC Extends Date of Prior No-Action Relief Related to the Receipt and Recording of Customer Funds:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-88.pdf

CFTC Extends Date of Prior Relief for Reporting Certain Identifying Information Regarding Certain OTC Swaps:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-89.pdf

ESMA Publishes Revised EMIR Q&As; Adds New Matters Related to the Reporting to Trade Repositories and of Exchange-Traded Derivatives: 
http://www.esma.europa.eu/system/files/2014-682.pdf

Broker-Dealer Success Trade Securities and Its President Expelled From FINRA for Ripping Off Many Former NFL and NBA Players Through a Ponzi Scheme:
http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p537675.pdf

Barclays Charged by New York State in Connection With the Marketing and Operation of Its Dark Pool:
http://www.ag.ny.gov/pdfs/Barclays_complaint_as_filed_June_25_2014.pdf

NFA Highlights Changes to CPO Form PQR and CTA Form PR That Are Effective for the Period Ending June 30: http://www.nfa.futures.org/news/documents/Changes_to_PQR.pdf

NFA Proposes to Prohibit Credit Card Use to Meet Margin Calls for Retail FX Accounts:
http://www.nfa.futures.org/news/PDF/CFTC/InterpNotice_CR2-4_2-36_Prohibit_Use_of_Certain_Funding.pdf

SEC Adopts First Rules and Guidance Related to Cross-Border Security-Based Swap Activity:
http://www.sec.gov/rules/final/2014/34-72472.pdf

SEC Orders Widened Tick Size for Certain Small Capitalization Stocks and Market Quality Impact Study:
http://www.sec.gov/rules/other/2014/34-72460.pdf

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of June 28, 2014. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP and/or Gary DeWaal may represent one or more entities mentioned in this article.

---

© 2024 Gary DeWaal and Associates LLC | 1 (212) 382-4615 | 1180 Avenue of the Americas, Suite 809, New York, NY 10036