Last week the US Securities and Exchange Commission (the "SEC") proposed to maintain--for now, at least--the current reporting rules under Sections 13(d) and 16 of the Securities Exchange Act of 1934 (the "Exchange Act") as they apply to security-based swap transactions. The SEC issued the proposal to preempt any uncertainty that may arise when Section 13(o)--which was added to the Exchange Act by Section 766 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act")--becomes effective on July 16, 2011. Specifically, because new Section 13(o) may require the SEC to adopt new rules to regulate security-based swaps, the SEC has proposed readopting the portions of Rules 13d-3 and 16a-1 that apply to security-based swaps to maintain the regulatory status quo. The SEC's proposed rules are the same as the existing rules in all respects.

Under the proposed rules, as is currently the case, a party to a security-based swap transaction would be deemed the beneficial owner of the underlying securities if that party has or shares the power to direct the voting and/or disposition of the securities. Those security-based swaps that are settled in securities or otherwise entail voting or investment control may impute beneficial ownership of the underlying securities to the swap-holder, and thus reporting obligations for 5% beneficial owners under Section 13(d) and reporting obligations and the disgorgement of short-swing profits for 10% beneficial owners under Section 16. However, security-based swaps that are settled exclusively in cash (such as total return swaps) typically fall outside the definition of beneficial ownership because they entail only a pecuniary interest in the underlying securities--and not voting or investment power. The proposed rules would not change the definition of beneficial ownership to apply to those swaps that only convey a pecuniary interest in the underlying securities.

Although this rule proposal does not alter the existing rules, the SEC has indicated that a separate project is underway to develop a proposal to "modernize" the beneficial ownership rules, which may affect the reporting of security-based swaps. Such a proposal would have a far greater impact than the rules proposed to be adopted in this release. Nevertheless, in this release the SEC has asked the public, including market participants, to comment on the following issues:

  • Should the SEC provide guidance on how to disclose security-based swaps in Schedules 13D or 13G? If so, what guidance would be appropriate?
  • How common is the use of security-based swaps to obtain incidents of beneficial ownership, such as voting and/or investment power?
  • Should the rules be amended to specifically reference security-based swaps? If so, in what manner?
  • Should the SEC adopt rules specifically delineating when the purchase or sale of securities-based swaps gives rise to beneficial ownership for purposes of Sections 13(d) and 13(g)?

The Proposing Release is available at http://www.sec.gov/rules/proposed/2011/34-64087.pdf. Comments are due by April 15, 2011.