Thank you, Chair Gensler.  The final rules under consideration are in regard to prohibitions against fraud, manipulation, or deception in connection with security-based swaps and also include a prohibition against undue influence over chief compliance officers.  The Adopting Release proclaims that the final rule “is designed to prevent fraud, manipulation, and deception in connection with effecting any transaction in, or attempting to effect any transaction in, or purchasing or selling, or inducing or attempting to induce the purchase or sale of, any security-based swap.”[1]  The Adopting Release further states that “[t]he rule takes into account the features fundamental to a security-based swap.”[2] 

The problem with the rule is that it does not sufficiently take into account and address the special features of various types of security-based swaps. One key concern is that existing anti-fraud rules already cover security-based swaps and thus the entire purpose and reason for this rulemaking becomes questionable.  

This final rule should constructively fulfill the mandate of Section 763(g) of the Dodd-Frank Act.[3] The statute mandates that “the Commission shall . . . 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.”

Thus, two things are needed.  First, the regulations should “define” “such transactions, acts, practices, and courses of business” that are deemed “fraudulent, deceptive, or manipulative” in the context of security-based swaps.  But the final rule does not do much of that.  To be sure, the Adopting Release discusses some problematic conduct, such as manufactured credit events, but it does not effectively relate those events to the language of the rule.  The Adopting Release often notes that a violation of the new rule depends on the “facts and circumstances”—a phrase upon which the release heavily relies, using it 20 times.  This phrase is treated as if it constitutes a standard or test, whereas, in fact, it appears simply to constitute a linguistic dissimulation for the failure to provide sufficient specifics for the security-based swaps market as well as appropriate guidance and forewarning about what constitutes fraudulent practices in that market place, and what does not.    

Second, the statutory language should “prescribe,” by rule or regulation, “means reasonably designed to prevent” the “fraudulent, deceptive or manipulative” transactions.  Note that this language does not require or call for a rule that largely repeats the language contained in the existing anti-fraud rules that already cover security-based swaps.  Rather, it calls for rules that provide “means reasonably designed to prevent” certain bad conduct.  There are a variety of potential approaches that could be used to effectively tailor a rule to the special circumstances of security-based swap markets.  Unfortunately, this rule instead largely regurgitates language from existing antifraud rules that already apply to these products.  Indeed, the net effect of adoption of this rule would seem to be only greater uncertainty as to precisely how the antifraud provisions do apply to this market, rendering compliance more difficult and potentially undermining this market place and its potential to provide superior risk allocation.   

Contrary to the approach taken, this Adopting Release should be crystal clear about what is covered by this new rule that is not already covered by existing antifraud and anti-manipulation provisions.  And, yet, that is hardly discussed and certainly not with any precision.  Moreover, any discussion of why this rule is appropriate for adoption should focus on what is new and being introduced to the markets by this rule.  Specifically, the cost-benefit analysis should not focus on what the existing anti-fraud provisions accomplish, but only on what this rule adds to the mix.  As it stands, the Adopting Release makes it appear as if the Commission has not done the hard work of fully studying, analyzing and comprehending the security-based swaps market practices themselves to see what might be specifically or uniquely required. 

Security-based swap markets are markets in risk.  The exchange of certain well-defined risks can mutually benefit market participants.  Legal ambiguity can undermine these mutually beneficial trades.  In turn, this might undermine the efficacy of other closely related markets.  Greater clarity on the particular circumstances under which trading is deemed lawful or not would be very valuable.  To the extent this final rule—by virtue of being vague and too abstract in its language—creates uncertainty regarding what is, or is not, lawful conduct, it will serve to suppress otherwise healthy activity in the security-based swaps market.  

To be sure, these markets can also facilitate excess and hidden risk taking, if there is not sufficient transparency.  But if these markets are rendered uneconomic by regulatory ambiguity, the result could increase systemic risk.  In particular, if financial institutions making loans find it creates potential legal vulnerabilities to hedge their loan risks through these instruments, then that could increase systemic risk, as those with a comparative advantage in holding the risk are denied.  Such market preclusion could also reduce the flow of economically beneficial loans and result in lower economic growth rates. 

Notably, the final rule does not contain any safe harbor for hedging activities arising out of lending activities.  Given the acknowledged importance of the operational benefits and market efficiencies related to security-based swap portfolio compression, the decision to exclude any safe harbor for transactions effected in connection with certain types of bilateral or multilateral portfolio compression exercises seems ill advised—and modifying it to address concerns would have been more constructive.

Finally, the Adopting Release does not give a sense of the continuing prevalence of the problems in the security-based swaps market that Title VII of the Dodd-Frank Act was intended to address.  Both regulators and the market participants learned from those experiences, and many regulatory changes as well as private ordering have already occurred.  Pertinent to the efficacy, or lack thereof, of the final rule is the extent and prevalence of those problems, if any, that may continue to be encountered.  

For the foregoing reasons, I cannot support these rules.  I thank the staff in the Divisions of Trading and Markets and Economic and Risk Analysis as well as the Office of General Counsel for their efforts.