SEC Proposes Reaffirmation of Existing Treatment of Security-Based Swaps

James Morphy is a partner at Sullivan & Cromwell LLP specializing in mergers & acquisitions and corporate governance. This post is based on a Sullivan & Cromwell client memorandum.

As anticipated, the U.S. Securities and Exchange Commission has proposed to readopt certain of its current rules, with no changes, in order to confirm that the Dodd-Frank Wall Street Reform and Consumer Protection Act did not alter the treatment of “security-based swaps” for purposes of determining “beneficial ownership” of equity securities under Sections 13 and 16 of the Securities Exchange Act of 1934. Comments on the proposal are due by April 15, 2011.

Section 766 of the Dodd-Frank Act, enacted in July 2010, added a new subsection (o) to Section 13 of the Exchange Act providing that, for purposes of Section 13 (which relates to reporting requirements for greater-than-five-percent holders of a class of registered, voting equity securities) and Section 16 (which relates to disclosure and short-swing profit recovery with respect to directors, officers and greater-than- 10-percent holders), a person shall be deemed to acquire beneficial ownership of the security underlying a “security-based swap” only if the SEC, by rule, determines after consultation with the prudential regulators and the U.S. Treasury Secretary that the purchase or sale of the security-based swap provides incidents of ownership comparable to direct ownership and that it is necessary to achieve the purposes of Section 13 that the purchase or sale of the security-based swap be deemed the acquisition of beneficial ownership of the underlying equity security. The Dodd-Frank Act defines the term “security-based swap” to encompass a swap on a single security, a narrow-based index, a loan or interest in a loan or the occurrence or non-occurrence of an event relating to a single security or narrow-based index that directly affects an issuer’s financial statements, financial condition or financial obligations. [1]

Existing SEC rules under Sections 13 and 16 already include in the calculation of beneficial ownership a security that may be received upon exercise or conversion of an option, warrant or other right within 60 days, and a security-based swap to the extent it provides voting or investment discretion over a registered, voting equity security or constitutes an arrangement to divest a person of beneficial ownership or prevent the vesting of beneficial ownership. The SEC’s proposing release notes that new Section 13(o) could be interpreted to render those provisions inapplicable to a holder of a “security-based swap,” absent SEC action. The stated purpose of the SEC’s proposal, which was made after consultation with the prudential regulators and the U.S. Treasury Secretary, is to maintain the status quo as to treatment of security-based swaps under Sections 13 and 16. In particular, for determining whether a holder of a security-based swap is a “beneficial owner” for purposes of Section 13(d) and (g) reporting or for determining whether the person is a greater-than-10-percent holder under Section 16, the analysis will continue to be whether the person has or shares (or has the right to acquire within 60 days) direct or indirect voting or investment power over a registered, voting equity security. For purposes of Section 16 reporting and short-swing liability, the analysis will continue to be whether the person has a “pecuniary interest” in the equity securities. In both cases, existing law (including SEC guidance) would continue to govern.

The SEC notes in the proposing release that, while this particular proposal is intended to maintain the status quo in this regard, the SEC is engaged in a separate project to develop proposals to modernize reporting under Sections 13(d) and 13(g).


[1] The term “security-based swap” does not include, among other things, an agreement to purchase or sell a security on a fixed basis or any put, call, straddle, option or privilege on any security. See footnote 54 in the proposing release, Beneficial Ownership Reporting Requirements and Security-Based Swaps, Rel. No. 34-64087 (Mar. 17, 2011), available at, and the definition of “swap” in Section 1a(47) of the Commodities Exchange Act.
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