Prohibition Against Fraud, Manipulation, and Deception in Connection With Security-Based Swaps, 68560-68568 [2010-28136]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 75, Number 215 (Monday, November 8, 2010)]
[Proposed Rules]
[Pages 68560-68568]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-28136]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-63236; File No. S7-32-10]
RIN 3235-AK77


Prohibition Against Fraud, Manipulation, and Deception in 
Connection With Security-Based Swaps

Agency: Securities and Exchange Commission.

Action: Proposed rule.

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Summary: The Securities and Exchange Commission (``Commission'') is 
proposing for comment a new rule under the Securities Exchange Act of 
1934 (``Exchange Act'') that is intended to prevent fraud, 
manipulation, and deception in connection with the offer, purchase or 
sale of any security-based swap, the exercise of any right or 
performance of any obligation under a security-based swap, or the 
avoidance of such exercise or performance.

DATES: Comments should be received on or before December 23, 2010.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (https://www.sec.gov/rules/proposed.shtml); or

[[Page 68561]]

     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-32-10 on the subject line; or
     Use the Federal eRulemaking Portal (https://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Securities and Exchange Commission, 100 F Street, NE., Washington, DC 
20549.

All submissions should refer to File Number S7-32-10. This file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
Internet Web site (https://www.sec.gov/rules/proposed.shtml). Comments 
are also available for Web site viewing and printing in the 
Commission's Public Reference Room, 100 F Street, NE., Washington, DC 
20549. All comments received will be posted without change; we do not 
edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: Josephine Tao, Assistant Director, 
Elizabeth Sandoe, Senior Special Counsel, or Joan Collopy, Special 
Counsel, Office of Trading Practices and Processing, Division of 
Trading and Markets, at (202) 551-5720, at the Securities and Exchange 
Commission, 100 F Street, NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission is requesting public comment 
on proposed Rule 9j-1 under the Exchange Act.

I. Introduction

    The Commission is proposing Exchange Act Rule 9j-1, which is 
intended to prohibit fraud, manipulation, and deception in connection 
with the offer, purchase or sale of any security-based swap, as well as 
in connection with the exercise of any right or performance of any 
obligation under a security-based swap, including the avoidance of such 
exercise or performance. Section 761(a) of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (the ``Dodd-Frank Act'') \1\ adds 
new Section 3(a)(68) of the Exchange Act to define a ``security-based 
swap'' as any agreement, contract, or transaction that is a swap, as 
defined in Section 1(a) of the Commodity Exchange Act,\2\ that is based 
on a narrow-based security index, or a single security or loan, or any 
interest therein or on the value thereof, or the occurrence or non-
occurrence of an event relating to a single issuer of a security or the 
issuers of securities in a narrow-based security index, provided that 
such event directly affects the financial statements, financial 
condition, or financial obligations of the issuer.\3\
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    \1\ Public Law 111-203 (July 21, 2010).
    \2\ 7 U.S.C. 1a. Section 721(b) of the Dodd-Frank Act amends 
Section 1(a) of the Commodity Exchange Act to add paragraph (47) 
defining swap, subject to enumerated exceptions, as ``any agreement, 
contract, or transaction: (i) That is a put, call, cap, floor, 
collar, or similar option of any kind that is for the purchase or 
sale, or based on the value, of 1 or more interest or other rates, 
currencies, commodities, securities, instruments of indebtedness, 
indices, quantitative measures, or other financial or economic 
interests or property of any kind; (ii) that provides for any 
purchase, sale, payment, or delivery (other than a dividend on an 
equity security) that is dependent on the occurrence, nonoccurrence, 
or the extent of the occurrence of an event or contingency 
associated with a potential financial, economic, or commercial 
consequence; (iii) that provides on an executory basis for the 
exchange, on a fixed or contingent basis, of 1 or more payments 
based on the value or level of 1 or more interest or other rates, 
currencies, commodities, securities, instruments of indebtedness, 
indices, quantitative measures, or other financial or economic 
interests or property of any kind, or any interest therein or based 
on the value thereof, and that transfers, as between the parties to 
the transaction, in whole or in part, the financial risk associated 
with a future change in any such value or level * * * including any 
agreement, contract, or transaction commonly known as (I) an 
interest rate swap; (II) a rate floor; (III) a rate cap; (IV) a rate 
collar; (V) a cross-currency rate swap; (VI) a basis swap; (VII) a 
currency swap; (VIII) a foreign exchange swap; (IX) a total return 
swap; (X) an equity index swap; (XI) an equity swap; (XII) a debt 
index swap; (XIII) a debt swap; (XIV) a credit spread; (XV) a credit 
default swap; (XVI) a credit swap; * * * (iv) that is an agreement, 
contract, or transaction that is, or in the future becomes commonly 
known to the trade as a swap * * * or (vi) that is any combination 
or permutation of, or option on, any agreement, contract, or 
transaction described in any of clauses (i) through (v).''
    \3\ See Section 761(a)(6) of the Dodd-Frank Act. See also 15 
U.S.C. 78c(a)(68).
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    Security-based swaps, as securities,\4\ will be subject to the 
general antifraud and anti-manipulation provisions of the federal 
securities laws (e.g., Section 10(b) of the Exchange Act and Rule 10b-5 
thereunder, and Section 17(a) of the Securities Act of 1933 
(``Securities Act'')) \5\ once the relevant provisions of the Dodd-
Frank Act take effect.\6\ Most security-based swaps are characterized 
by ongoing payments or deliveries between the parties throughout the 
life of the security-based swap pursuant to their rights and 
obligations. Because such payments or deliveries occur after the 
purchase of a security-based swap but before the sale or termination of 
the security-based swap,\7\ we believe a rule making explicit the 
liability of persons that engage in misconduct to trigger, avoid, or 
affect the value of such ongoing payments or deliveries is a measured 
and reasonable means to prevent fraud, manipulation, and deception in 
connection with security-based swaps.
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    \4\ See Section 761(a)(2) of the Dodd-Frank Act, which amends 
the definition of ``security'' in Section 3(a)(10) of the Exchange 
Act to include security-based swaps. See also Section 768(a)(1) of 
the Dodd-Frank Act, which amends the definition of ``security'' in 
Section 2(a)(1) of the Securities Act to include security-based 
swaps.
    \5\ Exchange Act Section 10(b) provides that ``[i]t shall be 
unlawful for any person, directly or indirectly * * * (b) to use or 
employ, in connection with the purchase or sale of any security * * 
* any manipulative or deceptive device or contrivance in 
contravention of such rules and regulations as the Commission may 
prescribe as necessary or appropriate in the public interest or for 
the protection of investors.'' 15 U.S.C. 78j.
    Rule 10b-5 under the Exchange Act provides that ``[i]t shall be 
unlawful for any person, directly or indirectly * * * (a) to employ 
any device, scheme, or artifice to defraud, (b) to make any untrue 
statement of a material fact or to omit to state a material fact 
necessary in order to make the statements made, in light of the 
circumstances under which they are made, not misleading, or (c) to 
engage in any act, practice, or course of business which operates or 
would operate as a fraud or deceit upon any person, in connection 
with the purchase or sale of any security.'' 17 CFR 240.10b-5.
     Securities Act Section 17(a) provides that ``[i]t shall be 
unlawful for any person in the offer or sale of securities * * * 
directly or indirectly--(1) to employ any device, scheme, or 
artifice to defraud, or (2) to obtain money or property by means of 
any untrue statement of a material fact or any omission to state a 
material fact necessary in order to make the statements made, in 
light of the circumstances under which they are made, not 
misleading, or (3) to engage in any transaction, practice, or course 
of business which operates or would operate as a fraud or deceit 
upon the purchaser.'' 15 U.S.C. 77q(a).
    \6\ See Section 774 of the Dodd-Frank Act. Security-based swap 
agreements, as defined in Section 206B of the Gramm-Leach-Bliley 
Act, 15 U.S.C. 78c note, are currently subject to the general 
antifraud and anti-manipulation provisions of the federal securities 
laws (e.g., Section 10(b) of the Exchange Act and Rule 10b-5 
thereunder).
    \7\ The Dodd-Frank Act amended the definitions of ``purchase'' 
or ``sale'' in the Securities Act and Exchange Act to include, in 
the context of security-based swaps, execution, termination, 
assignment, exchange, transfer, or extinguishment of rights. See 
Sections 761(a)(3) and (a)(4) of the Dodd-Frank Act (amending 
Sections 3(a)(13) and (a)(14) of the Exchange Act). See also Section 
768(a)(3) of the Dodd-Frank Act (amending Section 2(a)(18) of the 
Securities Act). Therefore, misconduct in connection with these 
actions will also be prohibited under Exchange Act Section 10(b) and 
Rule 10b-5 thereunder, and Securities Act Section 17(a).
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    Proposed Rule 9j-1 would prohibit the same misconduct as Exchange 
Act Section 10(b) and Rule 10b-5 thereunder, and Securities Act Section 
17(a), but would also explicitly reach misconduct that is in connection 
with the ``exercise of any right or performance of any obligation 
under'' a security-based swap. In other words, proposed Rule 9j-1 would 
apply to offers,

[[Page 68562]]

purchases and sales of security-based swaps in the same way that the 
general antifraud provisions apply to all securities but would also 
explicitly apply to the cash flows, payments, deliveries, and other 
ongoing obligations and rights that are specific to security-based 
swaps.

II. Background

    On July 21, 2010, the President signed into law the Dodd-Frank Act. 
Title VII of the Dodd-Frank Act, referred to as the Wall Street 
Transparency and Accountability Act of 2010, establishes a regulatory 
framework for the regulation of over-the-counter (``OTC'') swaps 
market. Under this framework, in general, swaps are regulated primarily 
by the Commodity Futures Trading Commission (``CFTC''), and security-
based swaps are regulated primarily by the Commission.
    Section 763(g) of the Dodd-Frank Act expands the anti-manipulation 
provisions of Section 9 of the Exchange Act \8\ and authorizes the 
Commission to adopt rules to prevent fraud, manipulation, and deception 
in connection with security-based swaps. Specifically, Section 763(g) 
adds new subparagraph (j) to Section 9 to make it unlawful for ``any 
person, directly or indirectly, by the use of any means or 
instrumentality of interstate commerce or of the mails, or of any 
facility of any national securities exchange, to effect any transaction 
in, or to induce or attempt to induce the purchase or sale of, any 
security-based swap, in connection with which such person engages in 
any fraudulent, deceptive, or manipulative act or practice, makes any 
fictitious quotation, or engages in any transaction, practice, or 
course of business which operates as a fraud or deceit upon any 
person.'' \9\
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    \8\ See Exchange Act Section 9, 15 U.S.C. 78i.
    \9\ See Exchange Act Section 9(j), 15 U.S.C. 78i(j).
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    Because Exchange Act Section 9(j) applies to ``any person,'' \10\ 
it would encompass issuers, broker-dealers, security-based swap 
dealers,\11\ major security-based swap participants,\12\ persons 
associated with a security-based swap dealer or major security-based 
swap participant, security-based swap counterparties, and any 
customers, clients or other persons that use or employ or effect 
transactions in security-based swaps, including security-based swaps to 
hedge or mitigate commercial risk or exposure.\13\ Section 763(g) does 
not include any specific exceptions. In addition, Exchange Act Section 
9(j) directs the Commission to ``by rules and regulations define, and 
prescribe means reasonably designed to prevent, such transactions, 
acts, practices, and courses of business as are fraudulent, deceptive, 
or manipulative, and such quotations as are fictitious.'' \14\
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    \10\ Exchange Act Section 3(a)(9) defines ``person'' as ``a 
natural person, company, government or, political subdivision, 
agency, or instrumentality of a government.'' 15 U.S.C. 78c(a)(9).
    \11\ Section 761 of the Dodd-Frank Act adds new definitions to 
Exchange Act Section 3(a). Subject to certain exceptions, Exchange 
Act Section 3(a)(71)(A) defines ``security-based swap dealer'' to 
mean any person who: (i) Holds themself out as a dealer in security-
based swaps; (ii) makes a market in security-based swaps; (iii) 
regularly enters into security-based swaps with counterparties as an 
ordinary course of business for its own account; or (iv) engages in 
any activity causing it to be commonly known in the trade as a 
dealer or market maker in security-based swaps. 15 U.S.C. 
78c(a)(71)(A).
    \12\ ``Major security-based swap participant'' is defined in 
Section 3(a)(67)(A) of the Exchange Act as any person: (i) Who is 
not a security-based swap dealer; and (ii)(I) who maintains a 
substantial position in security-based swaps for any of the major 
security-based swap categories, as such categories are determined by 
the Commission, excluding both positions held for hedging or 
mitigating commercial risk and positions maintained by any employee 
benefit plan (or any contract held by such a plan) as defined in 
paragraphs (3) and (32) of Section 3 of the Employee Retirement 
Income Security Act of 1974 (29 U.S.C. 1002) for the primary purpose 
of hedging or mitigating any risk directly associated with the 
operation of the plan; (II) whose outstanding security-based swaps 
create substantial counterparty exposure that could have serious 
adverse effects on the financial stability of the United States 
banking system or financial markets; or (III) that is a financial 
entity that (aa) is highly leveraged relative to the amount of 
capital such entity holds and that is not subject to capital 
requirements established by an appropriate Federal banking 
regulator; and (bb) maintains a substantial position in outstanding 
security-based swaps in any major security-based swap category, as 
such categories are determined by the Commission. 15 U.S.C. 
78c(a)(67)(A).
    The terms ``security-based swap dealer,'' ``major security-based 
swap participant,'' as well as ``security-based swap,'' and other 
terms will be the subject of joint rulemaking by the Commission and 
the CFTC. The Commission has issued an advance notice of proposed 
rulemaking seeking comment on the definitions of key terms relating 
to the regulation of swaps and security-based swaps. See Securities 
Exchange Act Release No. 62717 (Aug. 13, 2010), 75 FR 51429 (Aug. 
20, 2010).
    \13\ In other words, in contrast to certain other provisions of 
Title VII of the Dodd-Frank Act, Section 763(g) does not make an 
exception for end-users.
    \14\ See supra note 9.
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III. Proposed Rule 9j-1

    As noted above, unlike many other securities, a key characteristic 
of most security-based swaps is the obligation for and rights to 
ongoing payments or deliveries between the parties throughout the life 
of the security-based swap pursuant to the rights and obligations under 
the security-based swap. For example, a total return swap (``TRS'') 
that is a security-based swap may obligate one of the parties (i.e., 
the total return payer) to transfer the total economic performance 
(e.g., income from interest and fees, gains or losses from market 
movements, and credit losses) of a reference asset (e.g., a debt 
security) (the ``reference underlying''),\15\ in exchange for a 
specified or fixed or floating cash flow (including payments for any 
principal losses on the reference asset) from the other party (i.e., 
the total return receiver). This stream of payments, deliveries, or 
other ongoing obligations or rights between parties to a security-based 
swap can pose significant risk if, for example, the reference 
underlying of such security-based swap declines in value or the 
economic condition of the issuer changes (e.g., defaults or goes into 
bankruptcy).
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    \15\ As used in this release, the term ``reference underlying'' 
of a security-based swap would include any reference asset 
underlying a security-based swap, including any security underlying 
a security-based swap, any deliverable obligation under the terms of 
a security-based swap, any reference obligation, or reference entity 
under a security-based swap. This could include, for example, 
securities, instruments of indebtedness, indices, interest rates, 
quantitative measures, or other financial or economic interests 
underlying a security-based swap.
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    The exercise of rights or performance of obligations under a 
security-based swap can present opportunities and incentives for 
fraudulent, deceptive, or manipulative conduct. Parties to a security-
based swap may engage in misconduct in connection with the security-
based swap (including in the reference underlying of such security-
based swap) \16\ to trigger, avoid, or affect the value of such ongoing 
payments or deliveries. For instance, a party faced with significant 
risk exposure may attempt to engage in manipulative or deceptive 
conduct that increases or decreases the value of payments or cash flow 
under a security-based swap relative to the value of the reference 
underlying, including the price or value of a deliverable obligation 
under a security-based swap. However, because such payments (and the 
avoidance of such payments) occur after the purchase of a security-
based swap but before the sale or termination of the security-based 
swap, we believe a rule making explicit the illegality of misconduct in 
connection with such payments is appropriate.
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    \16\ See id.
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    Proposed Rule 9j-1 therefore prohibits the same categories of 
misconduct as Exchange Act Section 10(b) and Rule 10b-5 thereunder, and 
Securities Act Section 17(a) \17\ in the context of security-based 
swaps, and

[[Page 68563]]

explicitly reaches misconduct in connection with these ongoing payments 
or deliveries. In particular, proposed Rule 9j-1 would specify that it 
is unlawful for any person, directly or indirectly, in connection with 
the offer, purchase or sale of any security-based swap, the exercise of 
any right or performance of any obligation under a security-based swap, 
or the avoidance of such exercise or performance: (a) To employ any 
device, scheme, or artifice to defraud or manipulate; (b) to knowingly 
or recklessly make any untrue statement of a material fact, or to 
knowingly or recklessly omit to state a material fact necessary in 
order to make the statements made, in the light of the circumstances 
under which they were made, not misleading; (c) to obtain money or 
property by means of any untrue statement of a material fact or any 
omission to state a material fact necessary in order to make the 
statements made, in light of the circumstances under which they were 
made, not misleading; or (d) to engage in any act, practice, or course 
of business which operates or would operate as a fraud or deceit upon 
any person.\18\
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    \17\ See supra note 5.
    \18\ Proposed Rule 9j-1.
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    The language in paragraph (a) of the proposed rule, which is based 
on Rule 10b-5(a), differs from Rule 10b-5(a) in that it explicitly 
prohibits employing any device, scheme or artifice to defraud or 
manipulate. While the term ``manipulate'' does not appear in the text 
of Rule 10b-5, Rule 10b-5 has been interpreted to reach manipulative 
activities. In light of that interpretation, we have added language to 
clarify that manipulation in connection with security-based swaps is 
unlawful. We do not anticipate or intend this clarification to 
represent a departure from the past interpretation or scope of Rule 
10b-5(a). In addition, the language in paragraph (b) of the proposed 
rule, which is based on Rule 10b-5(b), differs from Rule 10b-5(b) in 
that it explicitly prohibits knowingly or recklessly making any untrue 
statement of a material fact, or knowingly or recklessly omitting to 
state a material fact necessary in order to make the statements made, 
in light of the circumstances under which they were made, not 
misleading. This is intended to make clear, consistent with Rule 10b-5 
case law, that paragraph (b), in contrast to paragraph (c), would 
require scienter. We do not anticipate or intend this clarification to 
represent a departure from the past interpretation or scope of Rule 
10b-5(b).
    The proposed rule would prohibit a person from engaging in 
fraudulent and deceptive schemes in order to increase or decrease the 
price or value of a security-based swap, or disseminating false or 
misleading statements that affect or otherwise manipulate the price or 
value of the reference underlying of a security-based swap for the 
purpose of benefiting such person's position in the security-based 
swap. The proposed rule would also prevent, for example, disseminating 
false financial information or data in connection with the sale of a 
security-based swap or insider trading in a security-based swap.\19\
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    \19\ See also supra note 5.
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    In addition, the proposed rule would explicitly prohibit misconduct 
that is in connection with the ``exercise of any right or performance 
of any obligation under'' a security-based swap. This would include, 
for example, misconduct that affects the market value of the security-
based swap for purposes of posting collateral or making payments or 
deliveries under such security-based swap. Thus, the proposed rule 
would, among other things, prohibit fraudulent conduct (e.g., knowingly 
or recklessly making a false or misleading statement) in connection 
with a security-based swap that affects the value of such cash flow, 
payments, or deliveries, such as by triggering the obligation of a 
counterparty to make a large payment or to post additional collateral. 
It would also prohibit a person from taking fraudulent or manipulative 
action with respect to the reference underlying of the security-based 
swap that triggers the exercise of a right or performance of an 
obligation or affects the payments to be made.
    The proposed rule also would explicitly prohibit misconduct that 
avoids the exercise of rights or the performance of obligations under 
the security-based swap. Thus, it would prohibit a person from making 
false or misleading statements in order to avoid having to make a large 
payment, post additional collateral, or perform another obligation 
under the security-based swap. It would also prohibit a person from 
taking fraudulent or manipulative action with respect to the reference 
underlying of the security-based swap that avoids triggering the 
exercise of a right or performance of an obligation or affects the 
payments to be made.
    Paragraphs (a) and (b) of proposed Rule 9j-1 are modeled after 
Exchange Act Section 10(b) and Rule 10b-5,\20\ and Securities Act 
Section 17(a)(1),\21\ and therefore would require scienter. In 
contrast, paragraphs (c) and (d) of the proposed rule would not require 
scienter like Sections 17(a)(2) and (a)(3) of the Securities Act \22\ 
and Section 206(2) of the Investment Advisers Act of 1940 (``Advisers 
Act'').\23\ These paragraphs are proposed to prevent conduct that 
operates as a fraud, manipulation, or deception.
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    \20\ To state a claim under Exchange Act Section 10(b) and Rule 
10b-5, the Commission must establish that the misstatements or 
omissions were made with scienter. See, e.g., Ernst & Ernst v. 
Hochfelder, 425 U.S. 185, 193 (1976). The Supreme Court has defined 
scienter as ``a mental state embracing intent to deceive, manipulate 
or defraud.'' Id. Recklessness will generally satisfy the scienter 
requirement. See, e.g., Greebel v. FTP Software, Inc., 194 F.3d 185, 
198 (1st Cir. 1999); SEC v. Environmental, Inc., 155 F.3d 107, 111 
(2d Cir. 1998).
    \21\ Establishing violations of Securities Act Section 17(a)(1) 
requires a showing of scienter. See, e.g., Aaron v. SEC, 446 U.S. 
680, 701-02 (1980). Scienter is the ``mental state embracing intent 
to deceive, manipulate or defraud.'' Ernst & Ernst v. Hochfelder, 
425 U.S. 185, 193 (1976). The Fifth Circuit Court of Appeals has 
held that scienter is established by a showing that the defendants 
acted intentionally or with severe recklessness. See Broad v. 
Rockwell International Corp., 642 F.2d 929 (5th Cir.) (en banc), 
cert. denied, 454 U.S. 965 (1981).
    \22\ Actions pursuant to Securities Act Sections 17(a)(2) and 
17(a)(3) do not require a showing of scienter. See, e.g., Aaron, 446 
U.S. at 701-02. In Aaron, the Supreme Court sought to determine 
whether scienter was required in a Commission injunctive proceeding 
pursuant to the antifraud provisions of Exchange Act Section 10(b) 
and Securities Act Section 17(a). The Court examined the language of 
both sections and determined that scienter was required under 
Section 10(b) because the words ``manipulative,'' ``device,'' and 
``contrivance,'' which are used in the statute, evidenced a 
Congressional intent to proscribe only knowing or intentional 
misconduct. Similarly, the Court concluded that subsection (1) of 
Section 17(a) required proof of scienter because Congress used such 
words as ``device,'' ``scheme,'' and ``artifice to defraud.'' Aaron, 
446 U.S. at 696. In contrast, the Court concluded that the absence 
of such words under subsections (2) and (3) of Section 17(a) 
demonstrated that no scienter was required. Section 17(a)(2) 
prohibits any person from obtaining money or property ``by means of 
any untrue statement of a material fact or omission to state a 
material fact,'' which the Court found to be ``devoid of any 
suggestion whatsoever of a scienter requirement.'' Aaron, 446 U.S. 
at 696. Similarly, the Court found, in construing Section 17(a)(3), 
under which it is unlawful for any person ``to engage in any 
transaction, practice, or course of business which operates or would 
operate as a fraud or deceit,'' that scienter was not required 
because it ``quite plainly focuses upon the effect of particular 
conduct on members of the investing public, rather than upon the 
culpability of the person responsible.'' Aaron, 446 U.S. at 697.
    \23\ See, e.g., Section 206(2) of the Advisers Act, which 
prohibits an investment adviser from engaging in ``any transaction, 
practice or course of business which operates as a fraud or deceit 
upon any client or prospective client.'' The Commission is not 
required to demonstrate that an adviser acted with scienter in order 
to prove a Section 206(2) violation. SEC v. Steadman, 967 F.2d 636, 
643 (D.C. Cir. 1992) (citing SEC v. Capital Gains Research Bureau, 
Inc., 375 U.S. 180, 191-92 (1963)).
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    While both paragraphs (b) and (c) of the proposed rule would 
prohibit

[[Page 68564]]

material misstatements and omissions,\24\ they would address different 
levels of culpability. Paragraph (b) would apply when there is evidence 
of scienter (e.g., when a party to a security-based swap knowingly or 
recklessly makes a false statement even though it may not receive any 
money or property as a result). In contrast, paragraph (c) would extend 
to conduct that is at least negligent (e.g., when a party to a 
security-based swap knows or reasonably should know that a statement 
was false or misleading and directly or indirectly obtains money or 
property from such statement).
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    \24\ Consistent with Exchange Act Section 10(b), such 
misstatements and omissions must be material to be actionable. See, 
e.g., Basic v. Levinson, 485 U.S. 224, 233 (1988). Statements and 
omissions are material if there is a substantial likelihood that a 
reasonable investor would consider the information important in 
making an investment decision. See id. at 231-32; TSC Indus., Inc. 
v. Northway, Inc., 426 U.S. 438, 449 (1976).
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    Because the proposed rule would apply to conduct ``in connection 
with * * * a security-based swap'' it would apply to fraud, 
manipulation, or deception involving the reference underlying \25\ of 
such security-based swap to the extent that such misconduct is in 
connection with the offer, purchase or sale of any security-based swap, 
the exercise of any right or performance of any obligation under a 
security-based swap, or the avoidance of such exercise or performance 
(e.g., manipulative activity in the reference underlying that affects 
the price of the security-based swap, including misconduct in the 
reference underlying of a security-based swap that triggers, avoids, or 
affects the value of ongoing payments or other delivery obligations 
under such security-based swap).\26\ Depending on the facts and 
circumstances, misconduct involving a security that is also a reference 
underlying of any security-based swap may not necessarily be ``in 
connection with'' the offer, purchase or sale of any security-based 
swap, the exercise of any right or performance of any obligation under 
a security-based swap, or the avoidance of such exercise or 
performance, and therefore a violation of Rule 9j-1. The Commission, in 
determining whether to bring an enforcement action under Rule 9j-1 for 
misconduct involving such a security, would consider the facts and 
circumstances associated with the misconduct, including, among other 
things, the extent to which the effect of the misconduct on one or more 
security-based swaps is foreseeable to the party engaging in the 
misconduct or the purpose or the interest of that party.
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    \25\ See supra note 15 (defining ``reference underlying'' of a 
security-based swap to include, for example, any reference asset, 
reference security, reference entity, or reference obligation 
underlying a security-based swap).
    \26\ See Superintendent of Insurance v. Bankers Life and 
Casualty Co., 404 U.S. 6, 12-13 (1971) (to satisfy the ``in 
connection with'' requirement, the fraud need only ``touch'' on the 
purchase or sale of a security). See also SEC v. Texas Gulf Sulphur 
Co., 401 F.2d 833, 860 (2d Cir. 1968) (en banc) (concluding that 
``Congress when it used the phrase ``in connection with the purchase 
or sale of any security'' intended only that the device employed, 
whatever it might be, be of a sort that would cause reasonable 
investors to rely thereon, and, in connection therewith, so relying, 
cause them to purchase or sell a corporation's securities'').
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    Consistent with Section 9(j) of the Exchange Act, the proposed rule 
would apply to ``any person.'' \27\ In addition, the proposed rule 
would also apply to misconduct ``directly or indirectly'' engaged in by 
such person (i.e., whether the person engages in the misconduct alone 
or through others).\28\
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    \27\ See text supra at notes 10-13.
    \28\ The terms ``directly and indirectly'' are intended to 
describe the level of involvement necessary to establish liability 
under the proposed rule. See also id.
---------------------------------------------------------------------------

    The Commission preliminarily believes that Proposed Rule 9j-1 is 
reasonably designed to prevent fraud and manipulation in transactions 
in security-based swaps and inducements to purchase or sell security-
based swaps. Because fraud and manipulation that affect the value of 
the payments or deliveries pursuant to a security-based swap are likely 
to distort the price and market for such security-based swaps, they can 
undermine investor confidence in the integrity of the market for 
security-based swaps, as well as the market for the reference 
underlying of such security-based swap. The proposed rule is intended 
to parallel the general antifraud provisions applicable to all 
securities, while also explicitly addressing the characteristics of 
cash flows, payments, deliveries, and other obligations and rights that 
are specific to security-based swaps. By targeting misconduct that is 
specific to the ways in which security-based swaps are structured and 
used, the proposed rule should help to prevent such fraudulent and 
manipulative conduct--without interfering with or otherwise unduly 
inhibiting legitimate market or business activity.
    While the proposed rule is modeled on existing securities laws 
prohibiting fraud, manipulation, and deception in connection with 
security-based swaps, it is not intended to limit or extend liability 
in connection with non-swap securities to ``rights or obligations'' 
that do not involve purchases or sales. In other words, the scope of 
the proposed rule is not intended to affect the application or 
interpretation of the other antifraud provisions under the federal 
securities laws.
    Finally, as noted above, the Dodd-Frank Act included security-based 
swaps in the definition of ``security'' under the Securities Act and 
the Exchange Act.\29\ Thus, once the relevant provisions of the Dodd-
Frank Act take effect,\30\ persons effecting transactions in, or 
engaged in acts, practices, and courses of business involving security-
based swaps will be subject to the Commission's rules and regulations 
that define and proscribe acts and practices involving securities that 
are deemed manipulative, deceptive, fraudulent, or otherwise unlawful 
for purposes of the general antifraud and anti-manipulation provisions 
of the federal securities laws, including Exchange Act Section 10(b), 
Rule 10b-5 (and the prohibitions against insider trading), and 
Securities Act Section 17(a).\31\
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    \29\ See supra note 4 (defining ``security'' under the 
Securities Act and Exchange Act to include ``security-based 
swaps'').
    \30\ See supra note 6.
    \31\ See, e.g., Exchange Act Rules 10b-1 through 10b-21; 17 CFR 
240.10-1 through 240.10b-21.
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IV. Request for Comment

    The Commission seeks comment generally on all aspects of proposed 
Rule 9j-1. We encourage commenters to present data on our proposals and 
any suggested alternative approaches.
    In addition, we seek specific comment on the following:
    Does the reference in the proposed rule to ``in connection with the 
offer, purchase or sale of a security-based swap, the exercise of any 
right or performance of any obligation under a security-based swap, or 
the avoidance of such exercise or performance'' address the full scope 
of potentially fraudulent, manipulative, or deceptive conduct that 
pertains to security-based swaps? If not, how should the scope of these 
provisions be modified? Are there types of conduct not otherwise 
discussed above that should be addressed by the proposed rule? 
Commenters are invited to provide specific examples of such conduct.
    Please discuss how and to what extent the proposed rule may affect 
issuers, broker-dealers, security-based swap dealers, major security-
based swap participants, and other swap market participants. Are there 
other alternatives or additional, or different, approaches that the 
Commission should consider as means reasonably designed to prevent 
``such transactions, acts, practices, and courses of business as are 
fraudulent, deceptive, or manipulative''? In addition, are there 
specific practices that the Commission should explicitly

[[Page 68565]]

restrict or permit as part of the proposed rule? Comments are invited 
regarding any prophylactic rules that would further enhance the 
integrity of the security-based swap markets.
    Although much of the activity that would be prohibited by the 
proposed rule is already prohibited by the general antifraud and anti-
manipulation provisions of the Federal securities laws (e.g., Exchange 
Act Section 10(b) and Rule 10b-5 thereunder, and Securities Act Section 
17(a)), to what extent, if any, would the proposed rule affect the 
nature of the security-based swap market in general, including the 
extent or nature of information shared between market participants? If 
so, in what ways and to what degree?
    Are there any legitimate market activities that the proposed rule 
could have the effect of discouraging? Commenters are invited to 
provide specific examples of any such activities and any such potential 
effect.
    Are there any specific issues with respect to the application of 
the proposed rule to fraudulent, manipulative, or deceptive activity 
involving security-based swaps (including the reference underlying of 
such security-based swaps) that are or will be effected on or through 
security-based swap execution facilities or national securities 
exchanges, or over-the-counter? Please explain.
    To what extent are transactions in security-based swaps used as a 
functional or economic substitute or equivalent transaction for 
transactions or practices that are otherwise prohibited by the 
antifraud and anti-manipulation provisions of the Exchange Act? Should 
the proposed rule impose any restrictions on such transactions? 
Commenters are invited to provide specific examples.
    What, if any, costs or burdens would be imposed by the proposed 
rule? Would the proposed rule create any costs associated with changes 
to business operations or supervisory practices or systems? How much 
would the proposed rule affect compliance costs for issuers, broker-
dealers, security-based swap dealers, major security-based swap 
participants, and other swap market participants (e.g., personnel or 
procedural changes)? We seek comment on the costs of compliance that 
may arise.

V. General Request for Comment

    The Commission seeks comment generally on all aspects of proposed 
Rule 9j-1. Commenters are requested to provide empirical data or 
economic studies to support their views and arguments related to 
proposed rule. In addition to the questions above, commenters are 
welcome to offer their views on any other matter raised by the proposed 
rule. With respect to any comments, we note that they are of greatest 
assistance to our rulemaking initiative if accompanied by supporting 
data and analysis of the issues addressed in those comments and if 
accompanied by alternative suggestions to our proposal where 
appropriate.

VI. Paperwork Reduction Act

    Proposed Rule 9j-1 does not contain a ``collection of information'' 
requirement within the meaning of the Paperwork Reduction Act of 
1995.\32\ An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid OMB control number.
---------------------------------------------------------------------------

    \32\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

VII. Consideration of Costs and Benefits

    The Commission is considering the costs and benefits of proposed 
Rule 9j-1. The Commission is sensitive to these costs and benefits, and 
encourages commenters to discuss any additional costs or benefits 
beyond those discussed here, as well as any reductions in costs. In 
particular, the Commission requests comment on the potential costs for 
any modification market participants' business operations or 
supervisory practices or systems, as well as any potential benefits 
resulting from the proposed rule for issuers, investors, broker-
dealers, security-based swap dealers, major security-based swap 
participants, persons associated with a security-based swap dealer or a 
major security-based swap participant, other security-based swap 
industry professionals, regulators, and other market participants. The 
Commission also seeks comments on the accuracy of any of the benefits 
identified and also welcomes comments on any of the costs identified 
here. Finally, the Commission encourages commenters to identify, 
discuss, analyze, and supply relevant data, information, or statistics 
regarding any such costs or benefits.

A. Benefits

    Proposed Rule 9j-1 would specify that it is unlawful for any 
person, directly or indirectly, in connection with the offer, purchase 
or sale of any security-based swap, the exercise of any right or 
performance of any obligation under a security based swap, or the 
avoidance of such exercise or performance, to: (a) To employ any 
device, scheme, or artifice to defraud or manipulate; (b) to knowingly 
or recklessly make any untrue statement of a material fact, or to 
knowingly or recklessly omit to state a material fact necessary in 
order to make the statements made, in the light of the circumstances 
under which they were made, not misleading; (c) to obtain money or 
property by means of any untrue statement of a material fact or any 
omission to state a material fact necessary in order to make the 
statements made, in light of the circumstances under which they were 
made, not misleading; or (d) to engage in any act, practice, or course 
of business which operates or would operate as a fraud or deceit upon 
any person.\33\
---------------------------------------------------------------------------

    \33\ See Proposed Rule 9j-1.
---------------------------------------------------------------------------

    Thus, proposed Rule 9j-1 would prohibit the same misconduct as 
Exchange Act Section 10(b) and Rule 10b-5 thereunder, and Securities 
Act Section 17(a) \34\ but would also explicitly reach misconduct that 
is in connection with the ``exercise of any right or performance of any 
obligation under'' a security-based swap. In other words, proposed Rule 
9j-1 would apply to offers, purchases and sales of security-based swaps 
in the same way that the general antifraud provisions apply to all 
securities but would also explicitly apply to the cash flows, payments, 
deliveries, and other ongoing obligations and rights that are specific 
to security-based swaps. This would include, for example, misconduct 
that affects the market value of the security-based swap for purposes 
of posting collateral or making payments or deliveries under a 
security-based swap. Thus, the proposed rule would, among other things, 
prohibit a person who is a party to a security-based swap from later 
engaging in fraudulent conduct (e.g., knowingly making a false or 
misleading statement) that affects the value of cash flow, payments, or 
deliveries, such as triggering the obligation of a counterparty to make 
a large payment or to post additional collateral.
---------------------------------------------------------------------------

    \34\ See supra note 5.
---------------------------------------------------------------------------

    By prohibiting fraud, manipulation, and deception in connection 
with the exercise of any rights or performance of any obligations under 
a security-based swap, including actions taken to avoid the triggering 
of such exercise or performance, the proposed rule would help to 
prevent such misconduct from distorting the price and market for such 
security-based swap, as well as for the reference underlying, and 
improperly interfering with the independent and proper functioning of 
the markets. We therefore believe that the proposed rule would benefit 
market participants and

[[Page 68566]]

investors by promoting investor confidence in the integrity of the 
market for security-based swaps, as well as for the reference 
underlying \35\ of such security-based swaps.
---------------------------------------------------------------------------

    \35\ See supra note 15.
---------------------------------------------------------------------------

    The proposed rule should prevent fraud, manipulation, and deception 
from causing prices of security-based swaps to deviate from their 
fundamental values. This would allow the Commission to guard against 
misconduct that improperly interferes with the independent and proper 
functioning of the markets and help to promote price efficiency, the 
integrity of the price discovery process, and fair dealing between 
market participants in connection with security-based swaps.
    We solicit comment on any additional short-term and long-term 
benefits that could be realized with the proposed rule. Specifically, 
we solicit comment regarding benefits to the efficient operation of 
security-based swap markets, price efficiency, market integrity, and 
investor protection.

B. Costs

    As an aid in evaluating costs and reductions in costs associated 
with proposed Rule 9j-1, the Commission requests the public's views and 
any supporting information.
    By targeting misconduct that is specific to how security-based 
swaps are structured and used, the proposed rule is intended to be a 
measured and reasonable means to prevent fraudulent, deceptive, or 
manipulative acts or practices in connection with the exercise of any 
right or performance of any obligation under a security-based swap 
without interfering with or otherwise inhibiting legitimate market 
activity.
    Because proposed Rule 9j-1 is intended to parallel the general 
antifraud provisions already applicable to all securities, while also 
explicitly addressing the characteristics of cash flows, payments, 
deliveries, and other obligations and rights that are specific to 
security-based swaps, we do not believe that the proposed rule would 
impose any significant costs on persons effecting transactions or 
otherwise trading in security-based swaps. As noted above, the 
Commission seeks comment on whether the proposed rule could discourage 
certain legitimate market activities because of concern that such 
activities might be viewed as a violation of the rule.
    In addition, persons effecting transactions or otherwise trading in 
security-based swaps may incur costs associated with changes to 
business operations or supervisory practices or systems. However, we 
believe that, because most issuers, broker-dealers, security-based swap 
dealers, major security-based swap participants, and other swap market 
participants involved with security-based swaps are already subject to 
the general antifraud and anti-manipulation provisions, much of these 
practices and systems would already be in place. Thus, we believe that 
any costs associated with the proposed rule for such changes (e.g., 
business or procedural changes) would be minimal.
    The Commission believes that the proposed rule would not compromise 
investor protection. We seek data, however, supporting any potential 
costs associated with the proposed rule. In addition, we request 
specific comment on any changes to business operations or supervisory 
practices or systems that might be necessary to implement the proposed 
rule.

VIII. Consideration of Burden on Competition and Promotion of 
Efficiency, Competition and Capital Formation

    Section 3(f) of the Exchange Act \36\ requires the Commission, 
whenever it engages in rulemaking and is required to consider or 
determine whether an action is necessary or appropriate in the public 
interest, to consider whether the action would promote efficiency, 
competition, and capital formation. In addition, Section 23(a)(2) of 
the Exchange Act \37\ requires the Commission, when making rules under 
the Exchange Act, to consider the impact of such rules on competition. 
Section 23(a)(2) also prohibits the Commission from adopting any rule 
that would impose a burden on competition not necessary or appropriate 
in furtherance of the purposes of the Exchange Act.
---------------------------------------------------------------------------

    \36\ 15 U.S.C. 78c(f).
    \37\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    Proposed Rule 9j-1 is intended to prevent fraud, manipulation, and 
deception in connection with the offer, purchase or sale of any 
security-based swap, the exercise of any right or performance of any 
obligation under a security-based swap, or the avoidance of such 
exercise or performance. Proposed Rule 9j-1 would prohibit the same 
misconduct as Exchange Act Section 10(b) and Rule 10b-5 thereunder, and 
Securities Act Section 17(a) \38\ but would also explicitly reach 
misconduct that is in connection with the ``exercise of any right or 
performance of any obligation under'' a security-based swap. In other 
words, proposed Rule 9j-1 would apply to offers, purchases and sales of 
security-based swaps in the same way that the general antifraud 
provisions apply to all securities but would also explicitly apply to 
the cash flows, payments, deliveries, and other ongoing obligations and 
rights that are specific to security-based swaps.
---------------------------------------------------------------------------

    \38\ See supra note 5.
---------------------------------------------------------------------------

    By targeting specific misconduct that is specific to how security-
based swaps are structured and used, the proposed rule is intended to 
be a measured and reasonable means to prevent misconduct that is ``in 
connection with the exercise of any right or performance of any 
obligation under'' a security-based swap without interfering with or 
otherwise unduly inhibiting legitimate market activity. Also, because 
the proposed rule would prohibit the same misconduct as Exchange Act 
Section 10(b) and Rule 10b-5 thereunder, and Securities Act Section 
17(a),\39\ except to explicitly reach misconduct that is ``in 
connection with the exercise of any right or performance of any 
obligation under'' a security-based swap, we believe that the proposed 
rule would not have an adverse effect on price efficiency. If the 
proposed rule mitigates fraudulent behavior, price efficiency should 
improve.
---------------------------------------------------------------------------

    \39\ See id.
---------------------------------------------------------------------------

    By prohibiting fraud, manipulation, and deception in connection 
with security-based swaps (including the exercise of any right or 
performance of any obligation under a security-based swap or the 
avoidance thereof), the proposed rule would help to prevent such 
conduct from distorting the market and artificially increasing or 
decreasing prices for security-based swaps. Thus, we believe the 
proposed rule would help to ensure price accuracy and fairness for the 
parties, which are elements of efficiency.
    We also believe a rule highlighting the illegality of these 
activities would focus the attention of swap market participants on 
such activities and would reduce regulatory uncertainty for swap market 
participants and investors and would not impose significant costs on 
customers. We seek comment regarding whether proposed Rule 9j-1 may 
have any adverse effects on liquidity, market operations, or risks or 
costs to customers.
    In addition, as discussed above, because the proposed rule would 
prohibit the same misconduct as Exchange Act Section 10(b) and Rule 
10b-5 thereunder, and Securities Act Section 17(a),\40\ except to 
explicitly reach misconduct that is ``in connection with the exercise 
of any right or performance of any obligation (or the

[[Page 68567]]

avoidance of such exercise or performance) under'' a security-based 
swap, we believe that the proposed rule would have minimal impact on 
the promotion of capital formation. Fraudulent and manipulative conduct 
in connection with security-based swaps can undermine the confidence of 
investors, not only in the market for the security-based swaps but also 
in the market for the reference underlying of such security-based 
swaps. For the same reasons, the proposed rule should promote capital 
formation by discouraging misconduct in connection with the performance 
of security-based swaps that could otherwise undermine investor 
confidence or the ability of investors to make investment decisions 
that are congruent to their investment objectives.
---------------------------------------------------------------------------

    \40\ See id.
---------------------------------------------------------------------------

    Thus, we believe that the proposed rule would promote capital 
formation by helping to eliminate abuses in connection with security-
based swaps. We seek specific comment and empirical data, if available, 
on the potential impact of the proposed rule on capital formation, 
including whether the proposed rule would promote or inhibit capital 
formation, and if so, how.
    In addition, the prohibitions of the proposed rule would apply 
uniformly to all persons (e.g., issuers, broker-dealers, security-based 
swap dealers, major security-based swap participants, and all other 
swap market participants and investors) effecting transactions or 
otherwise trading in security-based swaps and, therefore, should not 
impose a burden on competition. Also, the proposed rule would prohibit 
the same misconduct as Exchange Act 10(b) and Rule 10b-5 thereunder, 
and Securities Act Section 17(a),\41\ except to explicitly reach 
misconduct that is in connection with the exercise of any rights or 
performance of any obligations under a security-based swap and, 
therefore, the proposed rule should not impose a burden on competition. 
By applying uniformly to all persons and by discouraging swap market 
participants from engaging in unfair fraudulent, manipulative, and 
deceptive conduct in connection with security-based swaps, we 
preliminarily do not believe that the proposed rule will pose a burden 
on competition and would also promote competition.
---------------------------------------------------------------------------

    \41\ See id.
---------------------------------------------------------------------------

    We request comment on whether the proposed rule would promote 
efficiency, competition, and capital formation or have an impact or 
burden on competition. Commenters are requested to provide empirical 
data and other factual support for their view to the extent possible.

IX. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, or ``SBREFA,'' \42\ the Commission must advise the OMB as 
to whether the proposed regulation constitutes a ``major'' rule. Under 
SBREFA, a rule is considered ``major'' where, if adopted, it results or 
is likely to result in: (1) An annual effect on the economy of $100 
million or more (either in the form of an increase or a decrease); (2) 
a major increase in costs or prices for consumers or individual 
industries; or (3) significant adverse effect on competition, 
investment or innovation. If a rule is ``major,'' its effectiveness 
will generally be delayed for 60 days pending Congressional review.
---------------------------------------------------------------------------

    \42\ Public Law 104-121, Title II, 110 Stat. 857 (1996) 
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note 
to 5 U.S.C. 601).
---------------------------------------------------------------------------

    The Commission requests comment on the potential impact of proposed 
Rule 9j-1 on the economy on an annual basis, any potential increase in 
costs or prices for consumers or individual industries, and any 
potential effect on competition, investment or innovation. Commenters 
are requested to provide empirical data and other factual support for 
their view to the extent possible.

X. Regulatory Flexibility Certification

    The Regulatory Flexibility Act (``RFA'') \43\ requires Federal 
agencies, in promulgating rules, to consider the impact of those rules 
on small entities. Section 603(a) \44\ of the Administrative Procedure 
Act,\45\ as amended by the RFA, generally requires the Commission to 
undertake a regulatory flexibility analysis of all proposed rules, or 
proposed rule amendments, to determine the impact of such rulemaking on 
``small entities.'' \46\ Section 605(b) of the RFA states that this 
requirement shall not apply to any proposed rule or proposed rule 
amendment, which if adopted, would not have a significant economic 
impact on a substantial number of small entities.\47\
---------------------------------------------------------------------------

    \43\ 5 U.S.C. 601 et seq.
    \44\ 5 U.S.C. 603(a).
    \45\ 5 U.S.C. 551 et seq.
    \46\ Although Section 601(b) of the RFA defines the term ``small 
entity,'' the statute permits agencies to formulate their own 
definitions. The Commission has adopted definitions for the term 
small entity for the purposes of Commission rulemaking in accordance 
with the RFA. Those definitions, as relevant to this proposed 
rulemaking, are set forth in Rule 0-10, 17 CFR 240.0-10. See 
Securities Exchange Act Release No. 18451 (January 28, 1982), 47 FR 
5215 (February 4, 1982) (File No. AS-305).
    \47\ See 5 U.S.C. 605(b).
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    For purposes of Commission rulemaking in connection with the RFA, a 
small entity includes: (i) When used with reference to an ``issuer'' or 
a ``person,'' other than an investment company, an ``issuer'' or 
``person'' that, on the last day of its most recent fiscal year, had 
total assets of $5 million or less,\48\ or (ii) a broker-dealer with 
total capital (net worth plus subordinated liabilities) of less than 
$500,000 on the date in the prior fiscal year as of which its audited 
financial statements were prepared pursuant to Rule 17a-5(d) under the 
Exchange Act,\49\ or, if not required to file such statements, a 
broker-dealer with total capital (net worth plus subordinated 
liabilities) of less than $500,000 on the last day of the preceding 
fiscal year (or in the time that it has been in business, if shorter); 
and is not affiliated with any person (other than a natural person) 
that is not a small business or small organization.\50\ Under the 
standards adopted by the Small Business Administration, small entities 
in the finance and insurance industry include the following: (i) For 
entities in credit intermediation and related activities, entities with 
$175 million or less in assets or, for non-depository credit 
intermediation and certain other activities, $7 million or less in 
annual receipts; (ii) for entities in financial investments and related 
activities, entities with $7 million or less in annual receipts; (iii) 
for insurance carriers and entities in related activities, entities 
with $7 million or less in annual receipts; and (iv) for funds, trusts, 
and other financial vehicles, entities with $7 million or less in 
annual receipts.\51\
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    \48\ See 17 CFR 240.0-10(a).
    \49\ See 17 CFR 240.17a-5(d).
    \50\ See 17 CFR 240.0-10(c).
    \51\ See 13 CFR 121.201 (Jan. 1, 2010).
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    Based on the Commission's existing information about the security-
based swap market, the Commission preliminarily believes that the 
security-based swap market, while broad in scope, is largely dominated 
by entities such as those that would be covered by the ``security-based 
swap dealer'' and ``major security-based swap market participant'' 
definitions.\52\ The Commission preliminarily believes that entities 
that will qualify as security-based swap dealers and major security-
based swap market participants, whether registered broker-dealers or 
not, exceed the thresholds defining ``small entities'' set out above. 
Moreover, while it is possible that other parties may engage in 
security-based swap transactions, the Commission

[[Page 68568]]

preliminarily does not believe that any such entities would be ``small 
entities'' as defined in Exchange Act Rule 0-10.\53\ Feedback from 
industry participants about the security-based swap markets indicates 
that only persons or entities with assets significantly in excess of $5 
million (or with annual receipts significantly in excess of $7 million) 
participate in the security-based swap market. Even to the extent that 
a handful of transactions did have a counterparty that was defined as a 
``small entity'' under the Commission Rule 0-10, we believe it is 
unlikely that proposed Rule 9j-1 would have a significant economic 
impact on such entity, as the rule prohibits fraudulent and 
manipulative acts, activities which are in most cases already 
prohibited. Finally, because the proposed rule applies to any person, 
the proposed rule applies equally to large and small entities and 
therefore would not have a disproportionate impact on small entities. 
Therefore, the Commission preliminarily does not believe that proposed 
Rule 9j-1 will have an impact on ``small entities'' in terms of the 
prohibitions included in the proposed rule.
---------------------------------------------------------------------------

    \52\ See supra notes 11 and 12.
    \53\ See 17 CFR 240.0-10(a).
---------------------------------------------------------------------------

    For the foregoing reasons, the Commission certifies that proposed 
Rule 9j-1 would not have a significant economic impact on a substantial 
number of small entities for purposes of the RFA. The Commission 
encourages written comments regarding this certification. The 
Commission requests that commenters describe the nature of any impact 
on small entities and provide empirical data to support the extent of 
the impact.

XI. Statutory Authority

    Pursuant to Exchange Act and, particularly, Sections 2, 3(b), 9(i), 
9(j), 10, 15, 15F, and 23(a) thereof, 15 U.S.C. 78b, 78c(b), 78i(i), 
78i(j), 78j, 78o, 78o-8, and 78w(a), the Commission is proposing a new 
antifraud rule, Rule 9j-1, to address fraud, manipulation, and 
deception in connection with security-based swaps.

Lis