Security-Based Swaps, Insider Trading and More

Betty Q. Hixson

SEC Approves Proposal to Apply FINRA Rules to Security-Based Swaps

The SEC approved a FINRA proposal to address the application of FINRA rules to security-based swaps (“SBS”).

As previously covered, the proposal amends FINRA Rules 0180 (“Application of Rules to Security-Based Swaps”), 4120 (“Regulatory Notification and Business Curtailment”), 4210 (“Margin Requirements”), 4220 (“Daily Record of Required Margin”), 4240 (“Margin Requirements for Credit Default Swaps”) and 9610 (“Application”) to account for its members’ SBS activities. As modified by Amendment No. 1 and approved by the SEC, the changes include:

  • the replacement of expiring FINRA Rule 0180 with new FINRA Rule 0180, which makes FINRA rules applicable to members’ SBS activities and positions while providing exceptions where FINRA determined them to be appropriate; and

  • requiring that FINRA members that enter into swaps comply with the SEC’s amendments to its capital, margin and segregation requirements.

The SEC approval contains a fulsome discussion of the manner in which the SBS regulations apply to FINRA members that may enter into SBS, but that may not be registered security-based swap dealers (“SBSDs”). Amendment No. 1 extended the effective date of the proposed amendments for FINRA Rules 0180, 4120, 9610 until February 6, 2022, and extended 4210, 4220, and 4240 until April 6, 2022.

The FINRA rules should be closely reviewed and built into policies and procedures by (1) broker-dealers that engage in SBS as principal (including those registered as SBSDs), (2) broker-dealers that agent SBS for others (including for affiliates), and (3) broker-dealers that have employees that agent SBS for others (so-called “dual-hatted” personnel).

The proposal is most significant for the first category, as the FINRA rules provide an additional layer of regulation beyond the SEC SBS requirements. Non-SBSD broker-dealers are subject to most FINRA rules on their SBS, including suitability and new margin requirements. Broker-dealers and SBSDs are subject to a more limited subset of FINRA rules for their SBS activities, but must still abide by a number of FINRA requirements in addition to the SEC SBSD rules, including amended FINRA capital (and related financial responsibility) requirements.

Broker-dealers that agent SBS are distinguished by whether they act for a registered SBSD or an entity relying on the de minimis exception in Rule 3a71-3(d), in each case with the ability to rely on some exceptions from FINRA conduct rules given similar SEC SBSD requirements.

Finally, firms that employ “dual-hatted” structures should ensure that personnel are appropriately categorized and the activities are addressed under FINRA Rule 3270 on outside business activities. (In the original proposal, FINRA included a caution as to the “facts and circumstances” nature of a determination of whether a broker-dealer-employed person is acting solely on behalf of an SBSD.) said Nihal Patel of Cadwalader.

SEC Charges Emoji User with Insider Trading

The SEC charged two individuals with trading on material nonpublic information taken from a company’s confidential earnings preview meeting.

In a Complaint filed in the Northern District Court of Illinois, the SEC alleged that a company employee learned confidential information – that earnings were substantially above the company’s forecast – by attending a nonpublic, internal company meeting. He then shared the information with a second individual who was a close friend and former colleague. The friend profited by buying call options based on the information and then liquidating the options when the earnings were announced. The SEC’s Complaint highlighted the use of an emoji in communications between the alleged miscreants.

The SEC charged the two individuals with violations of Exchange Act Section 10(b) (“Regulation of the Use of Manipulative and Deceptive Devices”) and SEA Rule 10b-5 (“Employment of Manipulative and Deceptive Devices”), and sought civil penalties and a permanent injunction to prevent further violations.

The two individuals also face criminal charges from the U.S. Attorney’s Office in the Northern District of Illinois.

GAO Finds Inconsistencies in Implementation of FISMA Cyber Requirements

GAO found that federal agencies were inconsistent in implementing cybersecurity requirements under the Federal Information Security Modernization Act (“FISMA”).

GAO evaluated (i) the effectiveness of federal agencies’ implementation of cybersecurity policies and practices, and (ii) the extent to which relevant officials at federal agencies consider FISMA to be effective at improving the security of agency information systems.

In its report covering fiscal year 2020, GAO found that 23 civilian Chief Financial Officers Act (“CFO”) agencies reported progress toward meeting federal cybersecurity targets. A majority of those, however, said they were not fully meeting the requirements. GAO stated that Inspectors General found uneven implementation and concluded that only seven CFO agencies had effective agency-wide information security programs.

Agencies that implemented FISMA cybersecurity requirements into their security programs benefited from, among other things, (i) the standardization of security program requirements, (ii) the improvement of cybersecurity posture, (iii) more effective communication within the agencies, (iv) the ability to track the performance of security programs over time, and (v) the ability to establish responsibilities and authorities with respect to cybersecurity programs.

GAO noted that since 2010, it has made approximately 3,700 recommendations related to the nation’s cybersecurity efforts, of which about 900 have not yet been fully implemented as of November 2021.

SEC Solicits Comment on Nasdaq-Amended Proposal on Direct Listings of Primary Offerings

The SEC requested comment on a Nasdaq Stock Market LLC amended proposed rule to adjust pricing limitations on direct listings of primary offerings.

Nasdaq’s proposal would establish new pricing limitations on direct listings of public offerings (see Notice at 86 FR 34815). The execution of direct listings of primary offerings currently require price calculations by Nasdaq to fall between the highest and lowest prices stated on an issuer’s effective registration statement. The proposed rule would expand this pricing window for release and execution, expanding both the upper and lower bounds of the range by 20 percent.

Following the SEC’s institution of proceedings (see Order here), Nasdaq made numerous amendments to its proposal as to matters that included the setting of the projected pricing range, trading procedures and disclosure requirements.

Comments on the proposed rule change should be submitted to the SEC on or before February 2, 2022.

FDIC and FinCEN Launch “Tech Sprint” to Address Digital Identity Challenges

The FDIC and FinCEN will open registration for interested individuals to participate in a “Tech Sprint Program” to focus on developing solutions “for financial institutions and regulators to help measure the effectiveness of digital identity proofing.”

Through the “Tech Sprint,” FDIC’s tech lab (FDITECH) and FinCEN seek to increase efficiency and account security; reduce fraud and other forms of identity-related crime, money laundering, and terrorist financing; and foster customer confidence in the digital banking environment. The Tech Sprint is intended to address the challenges associated with compromised personally identifiable information (or “PII”), false identities, and multiple methods of digitally authenticating identity.

Participants in the Tech Sprint are asked to answer the following question: “What is a scalable, cost-efficient, risk-based solution to measure the effectiveness of digital identity proofing to ensure that individuals who remotely (i.e., not in person) present themselves for financial activities are who they claim to be?”

Interested persons may register online before mid-February 2022. The FDIC and FinCEN will select individuals to work in teams for approximately three weeks before presenting their findings to a panel of expert judges

Primary Sources

  1. Federal Register: Order Approving a Proposed Rule Change, as Modified by Amendment No. 1, Relating to Security Based Swaps

  2. Federal Register: Notice of Filing of Amendment No.1 and Order Institution Proceedings to Determine Whether to Approve or Disapprove the Proposed Rule Change, as Modified by Amendment No. 1, Relating to Security-Based Swaps

  3. SEC Complaint: David S. Sargent and Christopher M. Klundt

  4. SEC Release: SEC Charges Two Friends and Former Business Associates with Insider Trading

  5. GAO Report: Cybersecurity Preliminary Results Show That Agencies’ Implementation of FISMA Requirements Was Inconsistent

  6. Federal Register: Self-Regulatory Organizations; the Nasdaq Stock Market LLC; Notice of Filing of Proposed Rule Change, as Modified by Amendment No. 2, to Modify Certain Pricing Limitations for Companies Listing in Connection with a Direct Listing

  7. FDIC Press Release: FDIC and FinCEN Launch Digital Identity Tech Sprint

  8. FinCEN News Release: FDIC and FinCEN Launch Digital Identity Tech Sprint

  9. FDITECH Tech Sprint Webpage: Measuring the Effectiveness of Digital Identity Proofing for Digital Financial Services

© Copyright 2022 Cadwalader, Wickersham & Taft LLP
National Law Review, Volume XII, Number 14

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