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New Compliance And Disclosure Interpretation Regulates Forward Contracts On Restricted Securities – Securities

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On June 9, 2022, the staff (“Staff”) of the US
Securities and Exchange Commission (“SEC”) added Question
101.01 to its Compliance and Disclosure Interpretations
(“C&DI”), addressing forward contracts on restricted
securities. The new CD&I clarifies that forward contracts on
restricted securities would not be considered “intended to be
physically settled” under certain circumstances as discussed

Typically, forward contracts benefit from an exclusion from the
definition of “swap” and “security-based swap;”
this is because the definitions of “swap” and
“security-based swap” exclude “any sale of a
nonfinancial commodity or security for deferred shipment or
delivery, so long as the transaction is intended to be
physically settled
.” Forward contracts are typically
“intended to be physically settled.” To the extent
forward contracts are excluded from the definition of
“swap” and “security-based swap,” they are not
subject to Title VII under the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (the “Dodd-Frank

CD&I Question 101.01 clarifies that while a determination of
whether an instrument is a “swap” or a
“security-based swap” is based on facts and
circumstances, the SEC Staff would not consider a forward contract
as “intended to be physically settled” if, at the time
the parties enter into the contract, the underlying securities (i)
cannot be legally transferred, or (ii) are subject to contractual
restrictions on transfer. In order for the contract to be
considered “intended to be physically settled,” the
following conditions must both be met: (i) the offer and sale of
the underlying securities must be registered in compliance with
Section 5 of the Securities Act or otherwise exempt from
registration; and (ii) any contractual restrictions on the transfer
of the underlying securities must be satisfied or otherwise

This means that employees and stockholders of private companies
that are subject to employment or charter restrictions on transfers
may be prevented from using forward contracts to obtain liquidity
in the absence of the company’s express cooperation. Although
some private companies sponsor liquidity programs for employees and
stockholders, typically, these are sponsored through organized
platforms and are structured as outright sales.

If the contractual restrictions are not waived, the forward
contract would not be considered “intended to be physically
settled” and would be subject to regulation under Section 5 of
the Securities Act of 1933 (the “Securities Act”), which
was amended by the Dodd-Frank Act to make it unlawful for any
person to offer to sell, offer to buy, or purchase or sell a
security-based swap to any person or entity that is not an eligible
contract participant (“ECP”) without first registering
with the SEC. As a result, these transactions would no longer be
practically viable.

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article provides information and comments on legal
issues and developments of interest. The foregoing is not a
comprehensive treatment of the subject matter covered and is not
intended to provide legal advice. Readers should seek specific
legal advice before taking any action with respect to the matters
discussed herein.

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