SEC Proposes Expansive and Complex Reporting Regime for Security-Based Swap Users

General Background

The Proposal is structured to require persons (and related entities) who are owners or sellers of SBS positions that exceed certain specified thresholds to report these SBS positions and related information to the SEC on new Schedule 10B using the SEC’s Electronic Data Gathering, Analysis, and Retrieval (EDGAR) database system. The reported information would be made publicly available immediately upon filing.

Who Must Report

Proposed Rule 10B-1(a)(1) would require reporting by any person (and any entity controlling, controlled by, or under common control with such person), or group of persons, who through any contract, arrangement, understanding, or relationship, after acquiring or selling, directly or indirectly, any SBS is directly or indirectly the owner or seller of an “SBS Position” (described below) that exceeds an applicable “Reporting Threshold Amount” (described below).

In total, Rule 10B-1 would create the multipart reporting test described below in which users of SBS would have to monitor the size of their SBS Positions on an ongoing basis, measure those SBS Positions against the relevant Reporting Threshold Amounts, and determine whether the related SBS are reportable or whether ownership of certain underlying reference securities might also give rise to an SBS Position that would be required to be reported.

What SBS Are in Scope 

All SBS that meet the definition of a “security-based swap position” (“SBS Position”) that meet the applicability requirements in Rule 10B-1(d) and that meet or exceed the applicable Reporting Threshold Amount would be reportable.

SBS Position — This term would include all SBS based on

(a) a single security or loan, or a narrow-based security index,² or any interest therein or based on the value thereof;

(b) any securities issued by the same issuer (each, an “issuing entity”) of the securities, loans, or securities included in the narrow-based index (including any interest therein or based on the value thereof) described in (a); or

(c) any narrow-based security index that includes any of those issuing entities or their securities (including any interest therein or based on the value thereof), in each case as applicable.³

Applicability — The reporting requirements would apply to any SBS Position for which

1. any of the transactions that comprise the SBS Position would be required to be reported under Rule 908(a) of SEC Regulation SBSR⁴
   or
2. the reporting person holds any amount of reference securities underlying the SBS position (or would be deemed to be the beneficial owner of such reference securities, pursuant to Section 13(d) of the Exchange Act and the rules and regulations thereunder) and the issuer of such reference security is a partnership, corporation, trust, investment vehicle, or other legal person organized, incorporated, or established under the laws of the U.S. or having its principal place of business in the U.S.
   or
3. the reporting person holds any amount of reference securities underlying the SBS position (or would be deemed to be the beneficial owner of such reference securities, pursuant to Section 13(d) of the Exchange Act and the rules and regulations thereunder) and such reference security is part of a class of securities registered under Exchange Act Sections 12 or 15(d).

Any such SBS Positions meeting the SBS Position and applicability requirements would have to be measured against the Reporting Threshold Amounts below depending on whether the SBS Position is with respect to credit-default swaps (CDS) or is based on “debt securities”⁵ or equity securities.

REPORTING THRESHOLD AMOUNTS

SBS Positions in CDS

The lesser of a

• long notional amount of $150 million,⁶
• short notional amount of $150 million, or
• gross notional amount of $300 million⁷

SBS Positions Based on Debt Securities That Are Not CDS

• gross notional amount of $300 million

SBS Positions Based on Equity Securities

The lesser of the following two thresholds:

• Notional Threshold. The SBS Position meets or exceeds $300 million (calculated on a gross basis) or exceeds $150 million in certain circumstances.⁸
• Percentage Threshold. The SBS Position represents more than 5% of a class of equity securities or 2.5% in certain circumstances.⁹

The Proposal also contains a provision intended to prevent evasion of the reporting requirement, similar to that in the determination of “beneficial owner” in Rule 13d-3 under the Exchange Act. Any person who, directly or indirectly, creates or uses a trust, proxy, power of attorney, pooling arrangement, or any other contract, arrangement, or device as part of a plan or scheme to evade the reporting requirements with respect to an SBS Position would be deemed to be the owner of such SBS Position.¹⁰

What Information Must Be Reported

Schedule 10B would require certain general information about the identity of the reporting person (or persons if the filing is made as a group) and details about the SBS Position, such as the notional amount of the SBS Position, the Financial Instrument Global Identifier (FIGI) of the underlying reference security, and summary information about the composition of the position as it relates to the direction (i.e., long/short) and the tenor/expiration of the underlying SBS transactions.

Notably, Schedule 10B would also require disclosure of any other “instrument” related to the reportable SBS Position, and any SBSs based on securities of the same issuer — evidently, even if such related SBSs on other securities of the same issuer are below the applicable Reporting Threshold Amounts.¹¹ For example, if a reporting person has a reportable SBS Position based on equity securities, Schedule 10B would also require, among other things, disclosure of (i) all equity securities underlying an SBS included in the SBS position; (ii) all SBS based on debt securities issued by the same issuer; (iii) all CDS based on debt securities issued by the same issuer; and (iv) ownership of any other instrument relating to the SBS Position and/or any underlying security or loan or group or index of securities or loans, the price, yield, value, or volatility of which (or of which any interest therein) is the basis for a material term of a SBS included in the SBS Position.

Key Observations and Issues

• Affiliates — The reporting obligation would have vast reach in that it would extend to affiliates, parents, and subsidiaries of an entity that crosses an applicable Reporting Threshold Amount. If an entity in a corporate family triggers a reporting obligation, all other entities under common control would also have a reporting obligation.
  
  This scope departs substantially from reporting of “beneficial ownership” of long equity positions under Section 13(d) of the Exchange Act, which flows only up the chain of control (barring “group” status). The rules under Section 13(d) clearly distinguish between joint filings under Rule 13d-1(k) (e.g., where reporting persons simply agree to file together) versus a “group,” which is defined in Rule 13d-5 as two or more persons who “agree to act together for the purpose of acquiring, holding, voting or disposing of” the subject securities. Accordingly, under Section 13(d), affiliated persons are not necessarily members of a “group”; in contrast, the Proposal appears to contemplate that merely being affiliates or otherwise having a “relationship” makes such persons a “group.”¹²
• Extraterritorial Application — Reportable SBS Positions would include positions resulting from SBS transactions that must be reported pursuant to Rule 908(a) of Reg SBSR.¹³ Rule 908(a) generally requires reporting of any SBS transaction that involves a direct or indirect counterparty on either side of the SBS who is a U.S. person or that occurs in the U.S.¹⁴ SBS transactions that involve only non-U.S. counterparties and intermediaries (and occur outside of the U.S.) are generally outside of the scope of Rule 908(a). This means that proposed Rule 10B-1 would apply to SBS on reference securities of foreign issuers where there is a U.S. counterparty, directly or indirectly, on either side of the SBS transaction.
  
  Proposed Rule 10B-1, however, could also apply to SBS that do not involve a direct or indirect counterparty who is a U.S. person (and that may occur outside of the U.S.). This is because proposed Rule 10B-1(d)(2) would also apply to a person who holds any amount of the reference security where such reference security is issued by a legal person organized under U.S. law or registered under Section 12 of 15(d) of the Exchange Act. So rather than examining the nature of the counterparty and where the SBS transaction occurs (as applies under Rule 908(a) of Reg SBSR), the SEC proposes under these provisions in proposed Rule 10B-1(d)(2) to instead look to whether the reporting person owns any of the underlying reference securities that are U.S. securities. It is not immediately clear how the SEC would plan to enforce compliance in the case that none of the counterparties to the SBS, directly or indirectly, is a U.S. person. However, the SEC estimates in the Proposal that there would be only 79 U.S. reporting persons and as many as 283 foreign reporting persons captured by the  application of the Proposal.¹⁵
• Ownership of Reference Equity Securities or Other Derivatives on the Reference Security in a Control Group — As noted, the extension of the reporting obligation to entities under common control makes each such entity a reporting person. However, it is unclear under the Proposal whether holdings of the underlying reference securities (or related derivatives) by entities under common control should be imputed to all other members in the control group and how reporting should be effected.
  
  For example, assume that Firm A has an SBS Position based on equity securities with a gross notional amount that exceeds $150 million, but Firm A does not own any of the underlying reference securities. Assume further than Firm B (an affiliate under common control) does own shares of underlying reference securities. In this scenario, it is unclear whether Firm A would have to (pursuant to proposed Rule 10B-1(b)(iii)(A)) include all of Firm B’s holdings in the underlying reference security as part of its report. It would appear that Firm B would have an obligation to include these for its report, notwithstanding that Firm B does not hold any SBS Position at all (rather Firm A does).
  
  This same issue can arise in other circumstances, such as under proposed Rule 10B-1(d)(2). Assume that Firm A holds an SBS Position that crosses the Reporting Threshold Amount but that the underlying SBS transactions giving rise to the SBS Position are not reportable under Reg SBSR. As a result, Firm A would have to report the SBS Position only if it owns any amount of the reference securities underlying the SBS Position and such reference securities are either issued by a U.S. issuer or registered under the Exchange Act. Assume that Firm A does not own any of the underlying reference securities, but Firm B (an affiliate under common control) does, and such securities are issued by a U.S. issuer. Under this circumstance, it is unclear whether Firm B’s holdings in the underlying reference security should be imputed to Firm A, thus requiring Firm A to report when it otherwise would not have had such an obligation. It would also appear that because Firm A’s SBS Position is imputed to Firm B and because Firm B holds underlying reference securities, Firm B may have a reporting obligation notwithstanding that it does not itself own any SBS Position.
• Eclipsing Reg SBSR for U.S. Persons — As noted, SBS Positions resulting from SBS transactions reported pursuant to Rule 908(a) under Reg SBSR would be captured. However, under Reg SBSR, not all counterparties have a transaction reporting obligation because the rule instead allocates it to another party. For example, where the SBS transaction occurs on a platform, the platform assumes the transaction reporting obligation. Where a SBS transaction involves a “SBS dealer” or “major SBS participant,” those entities assume the SBS transaction reporting obligation.¹⁶ Market participants who do not meet these definitions but transact in SBSs may never have a reporting obligation under Reg SBSR (e.g., if they transact SBS only on a platform or with a SBS dealer). Under the Proposal, SBS Position reporting would extend to all persons with a reportable SBS Position, even if such person does not have a reporting obligation under Reg SBSR.
• Timing of Reporting Obligation — All reports on Schedule 10B (and amendments thereto) would be required to be filed “promptly,” which the SEC describes as in no event later than the end of the first business day following the day of execution of the SBS transaction that results in the SBS Position’s first exceeding the Reporting Threshold Amount.¹⁷
  
  This stands in stark contrast to the 10-calendar-day reporting deadlines for initial Schedules 13D and 13G, with only certain amendments required to be filed promptly.¹⁸ The Proposal thus would require substantially more information (i.e., reporting on behalf of all affiliates under common control) in a small fraction of the time allowed for initial long equity position reports on Schedule 13D and 13G.

¹ Securities Exchange Act Release No. 93784 (December 15, 2021), https://www.sec.gov/rules/proposed/2021/34-93784.pdf. As part of the Proposal, the SEC also proposed rules designed to prevent fraud, manipulation, and deception in connection with SBS as well as rules to prevent undue influence over the chief compliance officer of SBS dealers and major SBS participants.

² The SEC noted that a SBS based on a narrow-based security index could trigger a reporting obligation under proposed Rule 10B-1 in two ways: (i) if a person had a SBS Position composed of SBS based on a narrow-based security index that itself exceeds the relevant Reporting Threshold Amount; and (ii) if a person had a SBS Position composed of SBS based on a single security or loan, in which case that person would need to include in the calculation of that position all SBS based on the applicable single security or loan in an amount proportionate to the weighting of the security or loan in the narrow-based security index. For example, the SEC states that if a person had a SBS on a narrow-based security index with a notional amount of $100 million, the SBS Position would be $100 million. However, if one security makes up 40% of the that index by weight, that person would also be considered to have a SBS Position of $40 million attributable to that single security — and any other SBS related to that single security would need to be considered for reporting purposes. See Proposal at 69.

³ See proposed Rule 10B-1(b)(3).

⁴ 17 CFR 242.908(a). This generally covers any of the following SBS: (i) There is a direct or indirect counterparty that is a U.S. person on either or both sides of the transaction; (ii) the SBS is accepted for clearing by a clearing agency having its principal place of business in the U.S.; (iii) the SBS is executed on a platform having its principal place of business in the U.S.; (iv) the SBS is effected by or through a registered broker-dealer (including a registered SBS execution facility); (v) the transaction is connected with a non-U.S. person’s SBS dealing activity and is arranged, negotiated, or executed by personnel of such non-U.S. person located in a U.S. branch or office or by personnel of an agent of such non-U.S. person located in a U.S. branch or office; or (vi) the SBS does not satisfy any of (i) through (v), but there is a direct or indirect counterparty on either or both sides of the transaction that is a registered SBS dealer or a registered major SBS participant.

⁵ Unhelpfully, the Proposal does not define the term “debt security” (and such term is not otherwise defined in the Exchange Act), leaving ambiguity in how certain SBS may need to be aggregated and reported under the Reporting Threshold Amounts. For example, it would be unclear whether a debt security convertible into equity would be considered a SBS based on debt securities or based on equity securities, particularly as the definition of an “equity security” under the Exchange Act includes convertible securities. 17 CFR 240.3a11-1.

⁶ This long notional amount would be calculated by subtracting the notional amount of any long positions in a deliverable debt security underlying a SBS included in the SBS Position from the long notional amount of the SBS Position.

⁷ Gross positions are the sum of the absolute values of the notational amounts outstanding of all of the SBSs included in a SBS Position. Even if two SBSs offset each other (e.g., $75 million long CDS position and a $75 million short CDS position), the gross position would be $150 million. See Proposal at n.123. 

⁸ If the gross notional amount of the SBS position exceeds $150 million, the calculation of the SBS Position shall also include (pursuant to proposed Rule 10B-1(b)(i)(iii)(A)) the value of all of the underlying equity securities owned by the holder of the SBS Position (based on the most recent closing price of shares) as well as the delta-adjusted notional amount of any options, security futures, or any other derivative instruments based on the same class of equity securities.

⁹ Specifically, if the “security-based swap equivalent position” represents more than 2.5% of a class of equity securities, the calculation of the SBS Position must also include in the numerator all of the underlying equity securities owned by the holder of the SBS position as well as the number of shares attributable to any options, security futures, or any other derivative instruments based on the same class of equity securities. See proposed Rule 10B-1(b)(iii)(B). The term “security-based swap equivalent position” would mean the number of shares attributable to all of the SBS comprising the SBS Position. The SEC declined to provide clear examples of how this complicated provision is intended to operate, noting only that the purpose of this defined term and the 2.5% threshold is intended to help prevent evasion of the reporting requirements of Rule 10B-1. See Proposal at 79-80. 

¹⁰ See proposed Rule 10B-1(a)(4).

¹¹ See proposed Schedule 10B, items 7-9.

¹² See proposed Rule 10B-1(a)(3).

¹³ 17 CFR 242.908.

¹⁴ 17 CFR 242.908.

¹⁵ Proposal at n.252.

¹⁶ See 17 CFR 242.900(a)(2).

¹⁷ Note that this may suggest the SEC also expects amendments to Schedules 13D and 13G that are required to be filed “promptly” to similarly be filed within one business day.

¹⁸ See 17 CFR 240.13d-1 and 17 CFR 240.13d-2.