The Securities and Exchange Commission (SEC) and its Democratic majority ushered in a slew of rulemaking proposals Wednesday that include new disclosure requirements for the security-based swaps market, mutual funds, and share buyback arrangements.
The rules are meant to curb existing practices that skate on the edge of insider trading violations as well as provide transparency within corners of the market that have been the source of dramatic economic meltdowns.
While some of the proposals are simply extensions of previous disclosure requirements established by Dodd-Frank, SEC Chair Gary Gensler & Co. put forward a new rule that would prohibit personnel at a security-based swap entity from “taking any action to coerce, mislead, or otherwise interfere with” the entity’s chief compliance officer. Dodd-Frank requires such entities hire a CCO, and this new layer of protection, Gensler said in a statement, “gets to our mission to protect investors and safeguard market integrity.”
Critics of the new disclosure rules—most prominently, the SEC’s two Republican commissioners—said the additional requirements would curb the formation of capital; potentially squelch legitimate market activity; and for security-based swaps at least, force firms to provide nearly continuous disclosures that offer little informative value. Undoubtedly, the new rules would drive up the cost of compliance, they said.
Here’s a breakdown of the SEC’s policy announcements, along with commissioner reaction:
Security-based swap disclosure rules
In proposing the new disclosure rules for security-based swaps, Gensler invoked the recent economic meltdowns caused by total return swaps used by Archegos Capital Management and the 2008 collapse of AIG in explaining his position. He also alluded to the much more distant collapse of Long-Term Capital Management in 1998.
“Thus, the jitters and lack of transparency in 1998, 2008, and 2021 inform how I think about the security-based swaps market,” he said in his statement.
Before Dodd-Frank passed, there was little transparency regarding the security-based swaps market. Under Dodd-Frank, security-based swap dealers are compelled to register with the SEC, and, as of November 2021, are required to report security-based swaps transactions to a registry controlled by the agency. Transactions in the registry will be accessible to the public in February 2022.
The proposed rules for security-based swaps would do three things:
- A rule proposed by Dodd-Frank prohibited “misconduct that is in connection with the exercise of any right or performance of any obligation under a security-based swap,” extending the anti-fraud rules already laid out in established securities laws to cover actions unique to security-based swaps. Despite Dodd-Frank passing into law in 2010, the SEC never implemented this mandate. In reproposing it, the agency has added an anti-manipulation provision that states a person with material nonpublic information about a security “cannot avoid liability under the securities laws by making purchases or sales in the security-based swap (as opposed to purchasing or selling the underlying security)” as well as participating in the opposite fraudulent scheme, which would be to purchase the underlying security as opposed to making purchases or sales in the security-based swap.
- As noted above, a new rule would prohibit personnel of a security-based swaps entity from taking any action to coerce, mislead, or otherwise interfere with that entity’s CCO.
- Another new rule would require anyone who owns a security-based swap position that exceeds a certain threshold amount to file a statement containing the information required by Schedule 10B on the SEC’s EDGAR system. The filings would be publicly available. “Such transparency could provide relevant parties with advance notice that certain market participants are building large positions and could facilitate risk management and inform pricing of security-based swaps,” the SEC said in a press release.
Republican SEC Commissioner Hester Peirce argued in her dissent that not only does the proposal attempt to tighten the rules around fraud, deceit, and manipulation that are already covered in existing securities law, but, for the first time, addresses potential attempted fraud, deceit, or manipulation.
Peirce said the rule “may create additional uncertainty for market participants who may be concerned about how the Commission or counterparties will assess even innocuous conduct in retrospect.” She also said the security-based swaps data repository, only just put in effect, should be allowed to operate for several years before the SEC requires additional transparency measures.
Money market fund rules
The SEC proposed rules aimed at improving the transparency and resiliency of money market funds, particularly in times of economic stress like the onset of the COVID-19 pandemic. As currently designed, mutual funds provide an advantage to investors who recognize an economic downturn and withdraw their funds before the greater market recognizes it, something Gensler called a “first-mover advantage.”
“This is about systemic risk. Those of us at the SEC have an obligation to the public to once again come back and see if we can shore up this system a bit more,” Gensler said in a statement.
The rules would increase liquidity requirements to guard against rapid redemptions, according to an SEC press release. They also would “remove provisions in the current rule permitting or requiring a money market fund to impose liquidity fees or to suspend redemptions through a gate when a fund’s liquidity drops below an identified threshold,” which addresses one of the issues highlighted in the economic meltdown in 2008 that led to the Great Recession.
Compliance departments would be tasked with implementing policies and procedures that “would require institutional prime and institutional tax-exempt money market funds to implement swing pricing policies and procedures that would require redeeming investors, under certain circumstances, to bear the liquidity costs of their redemptions,” the SEC said. There would also be additional reporting requirements the agency said would help it monitor the sector.
Republican Commissioner Elad Roisman criticized the liquidity requirements as onerous. “It is concerning that we would introduce such drastic changes without a clear reason to do so, especially when other aspects of this proposal would already bring dramatic changes to the operation (and possibly the desirability) of non-government funds,” he said in his dissent.
Share repurchase (buyback) rules
The proposed rules would require an issuer to file a disclosure with the SEC before the end of the first business day following the day the issuer executes a share repurchase. The rule currently states these disclosures should be made on a quarterly basis, with aggregated monthly data.
The disclosure would list the class of securities purchased, the total amount purchased, the average price paid, and the aggregate total amount purchased on the open market, according to an SEC press release.
Existing periodic disclosure requirements would be enhanced, with new mandates to disclose “the objective or rationale for the share repurchases and the process or criteria used to determine the repurchase amounts; any policies and procedures relating to purchases and sales of the issuer’s securities by its officers and directors during a repurchase program, including any restriction on such transactions; and whether the issuer is making its repurchases” in compliance with the Exchange Act Rule.
“I think investors would benefit from the timeliness and granularity that today’s proposal would provide,” Gensler said in a statement. “The amendments also would enhance existing buyback disclosure requirements.”
Republican opposition to the proposal was vocal and biting.
“Both dividends and share repurchases are ways companies return cash to shareholders. Yet, say ‘dividend,’ and nobody gets angry, but say ‘share buyback,’ and the rage boils over,” Peirce said in her dissent. “Today’s proposal channels some of that rage against repurchases in a way that only a regulator can—through painfully granular, unnecessarily frequent disclosure obligations.”
Insider trading rules
The SEC voted to offer amendments to Rule 10b5-1 under the Securities Exchange Act to enhance disclosure requirements and investor protections against insider trading, according to a press release.
Gensler said investors have pointed out several gaps in the existing requirements for an affirmative defense for insider trading allegations. The new rules would impose a cooling off period of 120 days for officers and directors and 30 days for issuers before trading could commence under a plan, prohibit overlapping trading plans, and limit single trade plans to one trading plan per 12-month period. Directors and officers would be required to furnish written certifications that they are not aware of any material nonpublic information when they enter the plans.
The rule would require more comprehensive disclosure about issuers’ policies and procedures related to insider trading, the SEC said, as well as their practices around the timing of options grants and the release of material nonpublic information.
“Today’s proposal addresses the means by which companies and company insiders—chief executive officers, chief financial officers, other executives, directors, and senior officers—trade in company shares,” Gensler said in a statement. “The core issue is that these insiders regularly have material information that the public doesn’t have. So, how can they sell and buy stock in a way that’s fair to the marketplace?”
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