On May 4, 2009, U.S. Senators Carl Levin and Susan Collins introduced a bill entitled “Authorizing the Regulation of Swaps Act” (the “Proposed Act”) relating to the regulation of derivatives transactions. The Proposed Act is another effort to increase regulatory oversight of the over-the-counter (“OTC”) derivatives market. (Another such attempt was the Derivatives Markets Transparency and Accountability Act, which was summarized in an Orrick Client Alert on February 19, 2009.) The lack of oversight of the derivatives market has been perceived by some as one of the underlying causes of the current financial crisis, primarily as a result of the losses that American International Group and other major financial institutions have attributed to their portfolios of credit default swaps.

The most significant aspect of the Proposed Act is the removal of significant exclusions and exemptions relating to OTC derivatives transactions that were introduced by the Commodity Futures Modernization Act of 2000 (the “CFMA”) to the Commodity Exchange Act, as amended (the “CEA”). The enactment of the CFMA almost a decade ago was a threshold moment in the development of the OTC derivatives market, as it provided comfort and legal certainty to market participants regarding the regulation of these financial instruments. In particular, prior to the enactment of the CFMA, confusion existed over whether OTC derivatives transactions constituted (i) “futures contracts” and “commodity options contracts” subject to regulation under the CEA or (ii) “securities” subject to regulation under the federal securities acts. Market participants relied-at least for certain transaction types-on administrative exemptions from regulation under the CEA, most notably the “Part 35 Swap Exemption” promulgated by the Commodity Futures Trading Commission in 1993. Among other things, the CFMA was intended to provide statutory exclusions and exemptions for OTC derivatives transactions that would replace this patchwork of administrative exemptions and policy statements. The CFMA also clarified that OTC derivatives transactions meeting a broad definition of “swap agreements” did not constitute “securities” subject to regulation under either the Securities Act of 1933, as amended (the “Securities Act”), or the Securities Exchange Act of 1934, as amended (the “Exchange Act”), although such transactions based on securities may subject the contracting parties to liability under the anti-fraud and anti-manipulation provisions of the Securities Act, as well as the insider trading and material nonpublic information provisions of the Exchange Act. The Proposed Act effectively calls for the repeal of numerous CFMA provisions, which could result in certain OTC derivatives transactions being characterized as securities under the Securities Act and the Exchange Act.

The Proposed Act is meant as a stop-gap of sorts, as the Obama Administration has announced its intention to provide a comprehensive financial reform bill that would cover the regulation of OTC derivatives transactions. Nevertheless, enactment of the Proposed Act in its current form would have a significant and immediate impact on the OTC derivatives market, effectively upending the current regulatory framework for OTC derivatives transactions established by the CFMA.