Why State Registration Of Security-Based Swaps Is Non-Existent


The regulation of “swaps” lies at the intersection of the commodities and securities regulation.  In the parlance of commodity regulation, a “swap” is a contract or transaction that provides for a payment dependent on an event or contingency “associated with” a financial, economic or commercial consequence.  7 U.S.C. § 1a(47).  A “security-based swap” is a “swap” based on a single security or the value of that security.  15 U.S.C. § 78c(a)(68) (Exchange Act Section 3(a)(68)).  The Dodd-Frank Act amended Section 5 of the Securities Act to make offers and sales of security-based swaps unlawful without an effective registration statement covering the offering.  It further sought to limit sales to persons who are not “eligible contract participants” as defined in 7 U.S.C. § 1a(18).

Yesterday, the Securities and Exchange Commission announced that it had settled an action against a company that allegedly offered security-based swaps without registration.  According to the SEC’s order,

Forcerank LLC ran mobile phone games where players predicted the order in which 10 securities would perform relative to each other. In each week-long game, players won points for each instrument based on the accuracy of their prediction, and players with the most aggregate points received cash prizes at the end of the competition. Forcerank LLC kept 10% of the entry fees and obtained a data set about market expectations that it hoped to sell to hedge funds and other investors.

The SEC’s action caused me to revisit this post from six years ago in which I noted that Section 28(a) of the Securities Exchange Act preempts state bucket shop laws as to security-based swaps as well as the question of whether security-based swaps are securities under the California Corporate Securities Law:

Because the qualification requirements of the Corporate Securities Law of 1968 (“CSL”) are laws regarding the offer, sale or distribution of securities, those requirements may not be applied to any transactions in either security futures products or security-based swaps.  Further, it is not entirely clear whether a security futures product or a security-based swap is a security under the CSL.   Corporations Code § 25019 mentions neither term in defining a “security”.   The amendments to the definitions of “security” under the Exchange Act and Securities Act suggest that these financial products did not come within the existing definitions.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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