The US Securities and Exchange Commission (“SEC”) has adopted final rules (the “CrossBorder Rules”) regarding the cross-border application of certain security-based swap (“SBS”) provisions of Title VII of the DoddFrank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). 1 The Cross-Border Rules: (i) define the term “US person” and indicate which SBS transactions a non-US SBS participant should include in its SBS dealer (“SBSD”) and major SBS participant (“MSBSP”) registration threshold calculations; (ii) establish the procedural rules for market participants and non-US regulators to request that the SEC determine that another jurisdiction’s SBS rules are comparable to the SEC’s rules and permit market participants in that jurisdiction to rely on that jurisdiction’s SBS rules via substituted compliance when acting in the jurisdiction; and (iii) generally define the scope of the SEC and US Department of Justice’s (“DOJ”) cross-border enforcement authority with respect to the antifraud provisions of the US federal securities laws. Because it intends to request further public comment, the SEC declined to adopt a rule defining the circumstances under which an SBS between two non-US persons constitutes dealing activity within the United States. 2 It also declined to adopt rules defining the cross-border application of the entity-level and transactionlevel requirements for SBSDs or requirements specific to clearing, trade execution, regulatory reporting and public disclosure; the SEC intends to address those items in subsequent rulemakings and guidance regarding the relevant substantive requirements. 3 The Cross-Border Rules were issued in the form of legally binding regulations, and were styled as such, in contrast to the US Commodity Futures Trading Commission’s (“CFTC’s”) approach of denominating its principles for applying the cross-border provisions of its swaps rules as agency “guidance.” Also, while the Cross-Border Rules state, and SEC Commissioners indicated at the time of adoption, that the SEC consulted with the CFTC and sought to minimize differences between the SBS and swaps regulatory regimes, significant differences are evident when comparing the two regimes. 4 The SEC, however, did move markedly toward the CFTC position with regard to the treatment of guaranteed affiliates and conduit affiliates. It will be important to monitor and understand, in particular, how dealers subject to both CFTC and SEC jurisdiction adapt over time to the challenge of emerging differences in analogous rules. Timing. The SEC stated that these rules become effective September 8, 2014, but that compliance generally will not be required until after the SEC adopts related substantive SBS2 Mayer Brown | US Securities and Exchange Commission Issues Final Rules Regarding the Application of SecurityBased Swap Intermediary Definitions to Cross-Border Security Based Swap Activity rules (e.g., rules for registration of SBSDs and MSBSPs). 5 Definition of “US Person” US Person. The Cross-Border Rules define a US person as: i. a natural person resident in the United States; ii. a partnership, corporation, trust, investment vehicle, or other legal person organized, incorporated, or established under the laws of the United States or having its principal place of business in the United States; iii. an account (whether discretionary or non-discretionary) of a US person; or iv. an estate of a decedent who was a resident of the United States at the time of death. 6 The Cross-Border Rules provide that a person may treat a counterparty as a non-US person if the person receives a representation to that effect from the counterparty and does not know or have reason to know that the representation is inaccurate. 7 This provision roughly mirrors the CFTC’s guidance with respect to reasonable reliance on representations. 8 In contrast to the CFTC, the Cross-Border Rules expressly exclude from the definition of a US person the International Monetary Fund, InterAmerican Development Bank, and other similar international organizations, their constituent agencies, and their pension plans. 9 Like the CFTC, the SEC treats foreign branches and offices of a US person as part of that US person, stating that dealing counterparties will look to the entire US person, and not just its foreign branch, for performance on the transaction. 10 That said, foreign branches of US banks receive distinct treatment in certain parts of the Cross-Border Rules. As for US branches of foreign banks, the preamble suggests, but does not make express, that they will be treated as non-US persons. 11 The SEC and CFTC definitions of a US person diverge in that the SEC’s omits any requirement to “look-through” the ownership structure of a collective investment vehicle or unlimited liability entity and determine the US person status of the owners or investors. The treatment of investment vehicles also differs as a result of the way that each agency has articulated a principal place of business test. The CFTC focuses on where the vehicle is (i) formed and promoted and (ii) where its investment strategy and risk management are implemented. 12 The SEC requires that one look to the location of the office from which an investment vehicle’s investment adviser primarily directs, controls, and coordinates the vehicle’s investment activities to determine the US person status of the vehicle. 13 The SEC, however, in line with the CFTC’s guidance, indicates that the mere retention of a US person asset manager will not make the investment vehicle a US person. 14 SBSD and MSBSP Registration Threshold Calculations SBSD De Minimis Calculation for US Persons and Conduit Affiliates. The CrossBorder Rules require US persons and non-US persons who are “conduit affiliates” of a US person to include on an aggregate basis all of their SBSD transactions, whether with US or non-US counterparties, in their de minimis threshold calculations, 15 subject to the exclusion, previously adopted as part of the SBS entity definitions, of SBS transactions with majorityowned affiliates. 16 Conduit affiliates are defined as non-US persons that: (i) are directly or indirectly majority-owned by one or more US persons; (ii) in the regular course of business enter into SBS with other non-US persons or non-US branches of US banks that are registered as SBSDs to hedge or mitigate risks on behalf of their US person affiliates (other than affiliates registered as3 Mayer Brown | US Securities and Exchange Commission Issues Final Rules Regarding the Application of SecurityBased Swap Intermediary Definitions to Cross-Border Security Based Swap Activity SBSDs or MSBSPs); and (iii) enter into offsetting SBS or other arrangements with such US person affiliates to transfer the risks and benefits of the SBS described in (ii). 17 While closely patterned after the CFTC definition, the SEC’s definition appears to be self-contained and exhaustive, rather than indicating a non-exhaustive list of “relevant factors,” as the CFTC has done. 18 As defined by the SEC, the term potentially could include affiliates of an SBSD if those affiliates act as conduits on behalf of US person affiliates that are not registered as SBSDs or MSBSPs. In this respect, the CFTC’s exclusion from its “conduit affiliate” concept for affiliates of a registered swap dealer appears to be broader than the SEC’s, as the CFTC does not “intend that the term ‘conduit affiliate’ would include affiliates of swap dealers.” 19 SBSD De Minimis Calculation for Non-US Persons. The Cross-Border Rules provide that a non-US person that is not a conduit affiliate must include in its de minimis threshold calculation all of its SBS transactions connected with dealing activity of the following types: SBS transactions entered into with US persons (other than SBS transactions “conducted through” a foreign branch of a registered US SBSD [or, prior to 60 days following the earliest date on which the registration of SBSDs is required, a foreign branch of its counterparty]) and SBS transactions in which the counterparty has “rights of recourse” against a US person affiliate 20 of the non-US person that is calculating its de minimis threshold. 21 However, SBS transactions entered into anonymously on an execution facility or national securities exchange that are cleared through a clearing agency 22 and SBS transactions with majority-owned affiliates 23 are excluded from the de minimis threshold calculation of a nonUS person that is not a conduit affiliate. As used in the Cross-Border Rules, a right of recourse is a “conditional or unconditional legally enforceable right, in whole or in part, to receive payments from, or otherwise collect from, the US person in connection with the [SBS].” The SEC’s definition of a right of recourse is more narrowly targeted than the CFTC’s definition of the term “guarantee.” In the CFTC’s in its cross-border release, “guarantee” encompasses not only traditional guarantees of payment or performance, but also includes “other formal arrangements that, in view of all the facts and circumstances, support the non-US person’s ability to pay or perform its swap obligations with respect to its swaps.” 24 An SBS transaction is “conducted through” a foreign branch of a counterparty if the foreign branch is the counterparty to the SBS transaction and the SBS transaction is arranged, negotiated and executed on behalf of the foreign branch solely by persons located outside the United States. 25 A person may treat an SBS transaction as conducted through a foreign branch of a counterparty if the person receives a representation to that effect from the counterparty and does not know or have reason to know that the representation is inaccurate. 26 The SEC’s two “conducted through” criteria are more straightforward than with the CFTC’s “all facts and circumstances” test, backed with five criteria, for when a swap transaction is considered to be “with” a foreign branch. 27 Affiliate Aggregation. Under the CrossBorder Rules, a US or non-US person, if it engages in SBS transactions required to be counted toward its SBSD de minimis threshold under the rules described above, will be required to include in its de minimis calculation the SBS dealing activities of all US affiliates and conduit affiliates and the portion of SBS dealing activities of other non-US affiliates that count toward those non-US affiliates’ de minimis thresholds. 28 US and non-US persons may exclude from their de minimis calculation the4 Mayer Brown | US Securities and Exchange Commission Issues Final Rules Regarding the Application of SecurityBased Swap Intermediary Definitions to Cross-Border Security Based Swap Activity SBS dealing activity of affiliates registered as SBSDs (or phasing into registration). 29 MSBSP Threshold Calculations. The CrossBorder Rules define the MSBSP threshold calculation for US persons, conduit affiliates, and non-US persons that are not conduit affiliates, respectively, as generally including SBS positions of the same types as must be included in the SBSD de minimis threshold calculation. 30 That is, US persons and conduit affiliates must include all SBS positions that they enter into, and non-US persons that are not conduit affiliates must include: SBS positions entered into with US persons (other than SBS positions that arise from transactions conducted through a foreign branch of a registered US SBSD [or, prior to 60 days following the earliest date on which the registration of SBSDs is required, a foreign branch of its counterparty]) and SBS positions in which the counterparty has rights of recourse against a US person. 31 Consistent with the rules previously adopted as part of the SBS entity definitions, SBS positions between majority-owned affiliates are disregarded for purposes of the MSBSP threshold calculation. 32 Unlike the SBSD de minimis calculation, no exclusion applies for anonymously executed, cleared SBS positions. The Cross-Border Rules also provide for the attribution of guaranteed SBS positions to the guarantor (i.e., the person against whom there are “rights of recourse”) for MSBSP threshold calculation purposes. 33 A US person guarantor must include in its MSBSP threshold calculation all SBS positions of a non-US person for which that non-US person’s counterparty has a right of recourse against the US person guarantor. 34 A non-US person guarantor must include in its MSBSP threshold calculation (i) any SBS position of a US person for which that US person’s counterparty has rights of recourse against the non-US person guarantor and (ii) any SBS position of another non-US person entered into with a US person (other than positions arising from “foreign branch” transactions, as described above) for which the US person has rights of recourse against the non-US person guarantor. Inclusion by a US or non-US guarantor is not required with respect to SBS positions if the person whose performance is being guaranteed is (i) subject to capital regulation by the SEC or the CFTC, (ii) regulated as a bank in the United States, (iii) subject to capital standards adopted by such person’s home country supervisor that are consistent in all respects with the Capital Accord of the Basel Committee on Banking Supervision, or (iv) is phasing into MSBSP registration. Substituted Compliance Request Procedure Overview. “Substituted compliance” means that a non-US SBS market participant may satisfy certain of its SBS obligations under the Dodd-Frank Act through compliance with comparable non-US requirements. The SEC’s Cross-Border Proposal addressed which obligations might be satisfied via substituted compliance, the evidence required by the SEC to issue a substituted compliance order and the procedures the SEC would use to receive and process substituted compliance requests. 35 The Cross-Border Rules defer determination of the substantive issues eligible for substituted compliance and substituted compliance orders, but implement the procedure by which the SEC will receive and process substituted compliance requests. Requests. The Cross-Border Rules provide that a non-US market participant (including a nonUS branch of a US bank) or a non-US financial regulatory authority may submit a request for a substituted compliance order. Because a non-US financial regulatory authority may submit potentially sensitive information regarding its5 Mayer Brown | US Securities and Exchange Commission Issues Final Rules Regarding the Application of SecurityBased Swap Intermediary Definitions to Cross-Border Security Based Swap Activity compliance and enforcement capabilities and practices, the Cross-Border Rules provide for broader confidentiality requests than were envisioned in the Cross-Border Proposal. Processing. The Cross-Border Rules provide that the SEC will publish notice in the Federal Register when reviewing a completed request for a substituted compliance order to permit public comment on the request. 36 This approach differs greatly from the approach taken by the CFTC, which does not use notice and comment in its review of comparability determination requests. 37 Antifraud Authority Overview. The SEC adopted a new antifraud rule at 17 C.F.R. § 250.1 of the Cross-Border Rules to clarify the scope of its antifraud enforcement authority in the cross-border context with respect to all securities transactions, including SBS transactions. 38 Under Rule 250.1, the SEC’s antifraud authority extends to: i. Conduct within the United States that constitutes significant steps in furtherance of the violation; a. Even if the violation relates to a securities transaction or securities transactions occurring outside the United States that involves only foreign investors; or b. The violation is committed by a foreign adviser and involves only foreign investors. ii. Conduct occurring outside the United States that has a foreseeable substantial effect within the United States. 39 Rule 250.1 implements the antifraud provisions of the US federal securities laws in accordance with Section 929P of the Dodd-Frank Act, which restored the “conduct and effects” test for SEC and DOJ actions. This antifraud rule represents the SEC’s interpretation of the statutory language of Section 929P, and is intended to clarify and confirm that the SEC and the DOJ have enforcement authority for violations that involve significant conduct within the United States or extraterritorial conduct that has a foreseeable substantial effect within the United States. Further, in adopting Rule 250.1, the SEC stated that it interprets the scope of the grant of subject-matter jurisdiction in Section 929P to be coextensive with the cross-border reach of the antifraud provisions. 40 Conduct and Effects Test. In applying the conduct and effects test, courts used a range of approaches to define when the level of conduct in the United States was sufficient to support a claim. 41 Courts generally found “significant conduct” where: (i) the mastermind of the fraud operated from the United States in a scheme to sell shares in a foreign entity to overseas investors; (ii) much of the important work (such as the underwriting, drafting of prospectuses, and accounting) that led to the fraudulent offering of a US issuer’s securities to overseas investors occurred in the United States; or (iii) the United States was used as a base of operations for meetings, phone calls and bank accounts to receive overseas investors’ funds. 42 The “foreseeable substantial effects” threshold generally applied where either overseas fraudulent conduct or a predominantly foreign transaction resulted in a direct injury to: (i) investors resident in the United States (even a relatively small number); (ii) securities traded on a US exchange or issued by a US entity; or (iii) US domestic markets, at least where a reasonably particularized harm occurred. 43 Conclusion The SEC must still adopt rules for the domestic and cross-border application of the majority of SBS provisions of the Dodd-Frank Act. The Cross-Border Rules are the first final SBS rules adopted by the SEC since October 2012. The Cross-Border Rules finalize an important portion of the Proposing Release and lay the6 Mayer Brown | US Securities and Exchange Commission Issues Final Rules Regarding the Application of SecurityBased Swap Intermediary Definitions to Cross-Border Security Based Swap Activity foundation for the long-awaited rollout of the SEC’s domestic and cross-border SBS rules, which we believe will take place over the coming year. The Cross-Border Rules nevertheless leave many questions unanswered that will need to be addressed as the final elements of the SEC's SBS regulatory framework are implemented.