
[Federal Register: October 9, 2009 (Volume 74, Number 195)]
[Proposed Rules]               
[Page 52374-52381]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr09oc09-24]                         



[[Page 52374]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 229, 230, 239, 240, 242, 249, 270 and 275

[Release Nos. 33-9069; 34-60790; IA-2932; IC-28940; File Nos. S7-17-08, 
S7-18-08, S7-19-08]
RIN 3235-AK17, 3235-AK18, 3235-AK19

 
References to Ratings of Nationally Recognized Statistical Rating 
Organizations

AGENCY: Securities and Exchange Commission (``Commission'').

ACTION: Proposed rule; re-opening of comment period; request for 
additional comments.

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SUMMARY: The Securities and Exchange Commission is re-opening the 
comment period on certain of the proposed rule amendments to remove 
references to ratings of Nationally Recognized Statistical Rating 
Organizations proposed in Release Nos. 33-8940 [73 FR 40106 (July 11, 
2008)], 34-58070 [73 FR 40088 (July 11, 2008)], and IC-28327 [73 FR 
40124 (July 11, 2008)] ``Proposing Releases''). Today, in a companion 
release, the Commission is taking action on some of the amendments in 
the Proposing Releases. In view of the continuing public interest in 
the Proposing Releases and the Commission's desire to receive 
additional comment, we believe that it is appropriate to re-open the 
comment period before we take further action on certain proposals made 
in the Proposing Releases.

DATES: Comments should be received on or before December 8, 2009.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-17-08, S7-18-08, and/or S7-19-08 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number S7-17-08, S7-18-08, and/or 
S7-19-08. The file number(s) should be included on the subject line if 
e-mail is used. To help us process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/proposed.shtml). Comments are also available for public 
inspection and copying in the Commission's Public Reference Room, 100 F 
Street, NE., Washington, DC 20549 on official business days between the 
hours of 10 a.m. and 3 p.m. All comments received will be posted 
without change; we do not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
publicly available.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate 
Director, Thomas K. McGowan, Deputy Associate Director, Randall W. Roy, 
Assistant Director, Joseph I. Levinson, Special Counsel (Net Capital 
Requirements and Customer Protection) at (202) 551-5510; Paula Jenson, 
Deputy Chief Counsel, Ignacio Sandoval, Special Counsel (Confirmation 
of Transactions) at (202) 551-5550; Josephine J. Tao, Assistant 
Director, Elizabeth A. Sandoe, Branch Chief, and Bradley Gude, Special 
Counsel (Regulation M) at (202) 551-5720; Marlon Quintanilla Paz, 
Senior Counsel to the Director at (202) 551-5756, in the Division of 
Trading and Markets; Hunter Jones, Assistant Director, Penelope W. 
Saltzman, Assistant Director, or Daniel K. Chang, Attorney at (202) 
551-6792, in the Division of Investment Management; or Katherine Hsu, 
Special Counsel (Asset-Backed Securities), Blair Petrillo, Special 
Counsel at (202) 551-3430, in the Division of Corporation Finance, U.S. 
Securities and Exchange Commission, 100 F Street, NE., Washington, DC 
20549.

SUPPLEMENTARY INFORMATION: 

I. Introduction

    On July 1, 2008, the Commission proposed to eliminate references to 
ratings issued by nationally recognized statistical rating 
organizations (``NRSROs'') in certain rules and forms under the 
Securities Exchange Act of 1934 (``Exchange Act''), the Investment 
Company Act of 1940 (``Investment Company Act''), the Investment 
Advisers Act of 1940 (``Investment Advisers Act''), and the Securities 
Act of 1933 (``Securities Act'').\1\ The Commission proposed these 
amendments, among other reasons, to address the risk that the reference 
to and use of NRSRO ratings in Commission rules could be interpreted by 
investors as an endorsement of the quality of the credit ratings issued 
by NRSROs, and may encourage investors to place undue reliance on NRSRO 
ratings.\2\ The comment period for the Proposing Releases ended on 
September 5, 2008. Today, in a companion release, the Commission is 
adopting proposed amendments to remove references to ratings issued by 
NRSROs in certain rules.\3\ Given regulatory developments,\4\ comments 
received on the proposals, and the continuing public interest in the 
Proposing Releases, particularly in light of recent economic events, 
the Commission is requesting additional public comment on certain 
proposed rule changes relating to the use of references to ratings 
issued by NRSROs, as detailed below.
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    \1\ See References to Ratings of Nationally Recognized 
Statistical Rating Organizations, Exchange Act Release No. 58070 
(July 1, 2008) [73 FR 40088 (July 11, 2008)] (proposing amendments 
to rules and forms under the Securities Exchange Act) (``Exchange 
Act Proposing Release''); References to Ratings of Nationally 
Recognized Statistical Ratings Organizations, Investment Company Act 
Release No. 28327 (July 1, 2008) [73 FR 40124 (July 11, 2008)] 
(proposing amendments to rules under the Investment Company Act and 
the Investment Advisers Act) (``Investment Company Act Proposing 
Release''); Security Ratings, Securities Act Release No. 8940 (July 
1, 2008) [73 FR 40106 (July 11, 2008)] (proposing amendments to 
rules and forms under the Securities Act and the Securities Exchange 
Act) (``Securities Act Proposing Release'').
    \2\ See Exchange Act Proposing Release, supra note 1, at Section 
I; Investment Company Act Proposing Release, supra note 1, at 
Section I; and Securities Act Proposing Release, supra note 1.
    \3\ See References to Ratings of Nationally Recognized 
Statistical Rating Organizations, Exchange Act Release No. 34-60789 
(October 5, 2009) (``NRSRO References Adopting Release'').
    \4\ See, e.g., Money Market Fund Reform, Investment Company Act 
Release No. 28807 (June 30, 2009) [74 FR 32688 (July 8, 2009)] 
(``Money Market Fund Proposing Release'') (proposing amendments 
designed to improve the regulatory framework governing money market 
funds and requesting comment on, among other things, whether the 
Commission should eliminate Rule 2a-7's use of ratings by NRSROs, or 
whether the Commission should adopt other alternatives to encourage 
more independent credit risk analysis, including whether the 
Commission should reformulate the rule's use of ratings by requiring 
the fund's directors to designate specific NRSROs that the board of 
directors determines issue credit ratings that are sufficiently 
reliable.).
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II. References to Ratings of NRSROs in Exchange Act Rules

    As discussed below, the Commission is deferring consideration of 
action and soliciting comment on certain of its proposals relating to 
the use of NRSRO credit ratings in the rules and forms proposed in the 
Exchange Act Proposing Release.\5\ The Commission is seeking

[[Page 52375]]

additional comment on specific issues as well as general comments on 
the proposals.
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    \5\ For a detailed discussion of each of these proposals, see 
Exchange Act Proposing Release, supra note 1.
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A. Regulation M

    Regulation M is intended to preclude manipulative conduct by 
persons with an interest in the outcome of an offering. It governs the 
activities of underwriters, issuers, selling security holders, and 
others in connection with offerings of securities. In particular, Rules 
101 and 102 of Regulation M prohibit, in connection with a distribution 
of securities, issuers, selling shareholders, distribution 
participants, or any affiliated persons of such persons from directly 
or indirectly bidding for, purchasing, or attempting to induce a person 
to bid for or purchase a covered security during certain defined 
periods. Certain securities are excepted from Rules 101 and 102, 
including investment grade non-convertible debt securities, investment 
grade non-convertible preferred securities, and investment grade asset-
backed securities.
    In the Exchange Act Proposing Release, the Commission proposed to 
change the exceptions in Rules 101(c)(2) and 102(d)(2) of Regulation M 
for investment-grade non-convertible debt securities, investment grade 
non-convertible preferred securities, and investment grade asset-backed 
securities (``Regulation M Proposals'').\6\ The Regulation M Proposals 
would have removed references to NRSRO ratings from the determination 
of whether such securities would be eligible for the exceptions, and 
instead would have excepted non-convertible debt securities and non-
convertible preferred securities based on the ``well-known seasoned 
issuer'' (``WKSI'') concept of Securities Act Rule 405.\7\ The 
Regulation M Proposals would have also excepted asset-backed securities 
that are registered on Form S-3.\8\
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    \6\ See Exchange Act Proposing Release, supra note 1.
    \7\ Id.
    \8\ Id.
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    Commenters that specifically addressed the Regulation M Proposals 
expressed uniform opposition.\9\ Many of these commenters stated their 
view that the proposal would fail to address the issue of investors' 
undue reliance on NRSRO ratings.\10\ Commenters that specifically 
addressed the Regulation M Proposal also stated that, because the 
Regulation M Proposals would have altered the scope of the exception 
for investment-grade non-convertible debt securities, investment-grade 
non-convertible preferred securities, and asset-backed securities, the 
Regulation M Proposals would have placed new burdens on issuers and 
underwriters by imposing the restrictions of Regulation M on currently 
excepted investment-grade securities.\11\ Additionally, commenters that 
specifically addressed the Regulation M Proposal expressed the view 
that certain issuers of high yield securities that are currently 
subject to Regulation M, but are arguably more vulnerable to 
manipulation than securities currently excepted from Regulation M, 
would have been excepted from Rules 101 and 102 of Regulation M by the 
Regulation M Proposals.\12\ These commenters suggested retaining the 
NRSRO references in Regulation M and did not generally suggest 
alternatives to the Regulation M Proposals that would achieve our goals 
while addressing these concerns.\13\
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    \9\ We received five comment letters that specifically addressed 
the Regulation M proposals and each opposed the proposals. Letter 
from Keith F. Higgins, Chair, Committee on Federal Regulation of 
Securities, American Bar Association (``ABA''), to Florence E. 
Harmon, Acting Secretary, dated October 10, 2008 (``ABA Letter 1''); 
Letter from Robert Dobilas, CEO and President, Realpoint LLC, to 
Secretary, dated September 8, 2008; Letter from Jeremy Reifsnyder 
and Richard Johns, Co-chairs, ASF Credit Rating Agency Task Force, 
to Florence E. Harmon, Acting Secretary, dated September 5, 2008 
(``ASF Letter''); Letter from Deborah A. Cunningham and Boyce I. 
Greer, Co-chairs, SIFMA Credit Rating Agency Task Force, to Florence 
E. Harmon, Acting Secretary, dated September 4, 2008 (``SIFMA 
Letter''); and Letter from Mayer Brown LLP, to Florence E. Harmon, 
Acting Secretary, dated September 4, 2008 (``Mayer Brown Letter''). 
There were comment letters supportive of the Commission's effort to 
minimize undue reliance on NRSRO ratings by market participants, 
however, these commenters did not discuss Regulation M. See, e.g., 
Letter from Suzanne C. Hutchinson, Executive Vice President, 
Mortgage Insurance Companies of America, to Florence E. Harmon, 
Acting Secretary, dated September 5, 2008.
    \10\ See, e.g., SIFMA Letter (``Regulation M is primarily 
directed at the actions of the issuers of securities and the 
investment banks who underwrite them; in contrast, the investors 
that the Commission is concerned with are not users of Regulation 
M'').
    \11\ ABA Letter 1, SIFMA Letter.
    \12\ ABA Letter 1, SIFMA Letter.
    \13\ The ABA did, however, suggest that should the Commission 
insist on using the WKSI standard for investment-grade non-
convertible debt and investment-grade non-convertible preferred 
securities, it do so only as an alternative to the current 
exceptions at Rules 101(c)(2) and 102(d)(2). ABA Letter 1. However, 
the ABA expressed its ``strong[] belie[f] that the Commission should 
retain the current exceptions.'' Id.
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    The Commission is deferring consideration of action on the 
Regulation M Proposals. In light of the uniform opposition in the 
comment letters and the Commission's remaining concern regarding the 
undue influence of NRSRO ratings, the Commission is seeking additional 
comment. The Commission is continuing to consider its proposed 
amendments as well as other changes to Rules 101(c)(2) and 102(d)(2) of 
Regulation M to address concerns with regard to references to NRSRO 
ratings, and it continues to invite comments suggesting alternative 
proposals to achieve the Commission's goals, as well as comments on the 
Regulation M Proposals generally.\14\ In assessing the Commission's 
proposals and alternatives to these proposals, the Commission would 
consider a number of factors, including: \15\
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    \14\ The Commission specifically invited commenters to suggest 
alternatives to the Regulation M Proposals in the Proposing Release, 
see Exchange Act Proposing Release, supra note 1, at 40096, but none 
were received at that time.
    \15\ While the Commission asked similar questions in the 
Exchange Act Proposing Release relating to the specific Regulation M 
Proposals, the Commission will consider these factors in connection 
with any alternative proposal suggested by commenters.
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     Is the alternative comparable in scope to the existing 
exceptions? Does the alternative except roughly the same type and 
quantity of securities as the current exceptions for non-convertible 
debt, non-convertible preferred, and asset-backed securities?
     Does the alternative capture securities that are traded on 
basis of their yields, are largely fungible and less likely to be 
subject to manipulation? Are there factors in addition to yield and 
fungible nature that effect the trading of nonconvertible and asset 
backed securities?
     What effect(s) of the alternative, if any, would you 
anticipate in the investment-grade debt market and high-yield debt 
market?
     To the extent the alternative excepts non-convertible 
debt, non-convertible preferred, and asset-backed securities that are 
not currently excepted, how are those newly excepted securities less 
likely to be subject to manipulation?
     Will the alternative remove the exception for certain non-
convertible debt, non-convertible preferred, and asset-backed 
securities that fall within the current exceptions?
     Does the alternative provide an equally bright-line 
demarcation that is not unduly reliant on NRSRO ratings?
     Is the alternative easy for all persons subject to Rules 
101 and 102 of Regulation M to determine (i.e., can it be determined by 
publicly available sources of information)?
    Please provide empirical data, when possible, and cite to economic 
studies to support alternative approaches. Please suggest additional 
factors that you believe should be considered in assessing 
alternatives. Please discuss whether and to what extent investors rely 
upon the current Rule 101 and 102

[[Page 52376]]

exceptions for investment-grade non-convertible and asset-backed 
securities when making a decision to invest in such securities. Please 
also discuss whether, given that Rules 101 and 102 of Regulation M are 
directed at distribution participants, issuers and selling security 
holders, Rules 101 and 102 of Regulation M pose any danger of undue 
reliance on NRSRO ratings by investors.

B. Rule 10b-10

    Exchange Act Rule 10b-10,\16\ the Commission's transaction 
confirmation rule for broker-dealers, generally requires broker-dealers 
that effect transactions for customers in securities, other than U.S. 
savings bonds or municipal securities,\17\ to provide those customers 
with written notification, at or before completion of a securities 
transaction, disclosing certain information about the terms of the 
transaction. Specifically, Rule 10b-10 requires the disclosure of the 
date, time, identity, and number of securities bought or sold; the 
capacity in which the broker-dealer acted (e.g., as agent or 
principal); yields on debt securities; and under specified 
circumstances, the amount of compensation the broker-dealer will 
receive from the customer and any other parties. In doing so, the rule 
serves a basic investor protection function by conveying information 
that: (1) Allows customers to verify the terms of their transactions; 
(2) alerts customers to potential conflicts of interest; (3) acts as a 
safeguard against fraud; and (4) allows customers a means of evaluating 
the costs of their transactions and the quality of the broker-dealer's 
execution and order-handling.
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    \16\ 17 CFR 240.10b-10.
    \17\ Municipal securities are covered by Municipal Securities 
Rulemaking Board rule G-15, which applies to all municipal 
securities brokers and dealers.
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    Paragraph (a)(8) of Rule 10b-10, which the Commission adopted in 
1994, requires a broker-dealer to inform the customer in the 
transaction confirmation if a debt security, other than a government 
security, is unrated by an NRSRO.\18\ While paragraph (a)(8) was 
intended to alert customers to the potential need to obtain more 
information about a security from a broker-dealer, it was not intended 
to suggest that an unrated security is inherently riskier than a rated 
security.\19\ The Commission proposed to delete paragraph (a)(8) of the 
Rule in light of present concerns regarding undue reliance on NRSRO 
ratings and confusion about the significance of those ratings.\20\ The 
Commission also stated that, in the absence of this requirement, 
broker-dealers could voluntarily include this information in 
confirmations they send to customers.\21\
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    \18\ See Exchange Act Release No. 34962 (November 10, 1994) [59 
FR 59612 (November 17, 1994)] (File No. S7-6-94) (``1994 Adopting 
Release'').
    \19\ Id. The Commission stated in the 1994 Adopting Release that 
``[i]n most cases, this disclosure should verify information that 
was disclosed to the investor prior to the transaction. If a 
customer was not previously informed of the security's unrated 
status, the confirmation disclosure may prompt a dialogue between 
the customer and the broker-dealer.''
    \20\ Exchange Act Proposing Release, supra note 1, 73 FR at 
40092.
    \21\ Id.
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    Four commenters expressed views regarding the proposed deletion of 
paragraph (a)(8) from Rule 10b-10.\22\ One commenter maintained that 
deleting the requirement could be confusing and misleading to 
customers, who might presume that the security was rated because the 
non-rated status would no longer appear on the confirmation.\23\ This 
commenter also noted that customers could be confused by a lack of 
uniformity in confirmations, if some broker-dealers chose to continue 
including the non-rated status on confirmations while others did 
not.\24\ Another commenter stated that investors benefit from, and 
broker-dealers are not materially burdened by, the disclosure 
requirement in paragraph (a)(8).\25\ One commenter expressed the view 
that deleting paragraph (a)(8) would be appropriate, and noted that a 
proposed FINRA rule would, among other things, require brokers-dealers 
to provide investors with the lowest credit rating on a security.\26\ 
Finally, one commenter suggested that if paragraph (a)(8) were deleted, 
it could be replaced with the use of a credit spread as a credit risk 
measure.\27\
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    \22\ See Realpoint Letter; SIFMA Letter; Letter from Cate Long, 
Multiple-Markets to Secretary, Securities and Exchange Commission, 
dated September 5, 2008 (``Multiple-Markets Letter''); Tom McNerney, 
Managing Director, Data and Analytics and Marcus Schuler, Managing 
Director, Regulatory Affairs, Markit to Securities and Exchange 
Commission, dated September 5, 2008 (``Markit Letter'').
    \23\ See SIFMA Letter.
    \24\ Id.
    \25\ See Realpoint Letter. This commenter also urged the 
Commission to ``at a minimum, retain the existing requirement * * * 
[and] strongly consider requiring that the confirmation disclose 
whether the security is rated by an NRSRO who was not and is not 
being compensated'' directly or indirectly by the issuer. Id.
    \26\ See Multiple-Markets Letter. This commenter stated that a 
proposed FINRA rule ``serves to protect investors but could be 
enhanced by the addition of an alternative method of showing credit 
quality'' by requiring broker-dealers to ``provide the investor with 
the `average' rating across NRSROs.'' Id. The Commission is 
considering the FINRA proposed rule change separately. See Exchange 
Act Release No. 56661 (October 15, 2007) [72 FR 59321 (October 19, 
2007)] (File No. SR-NASD-2005-100).
    \27\ See Markit Letter. ``The usage of credit spreads for this 
purpose would be much more accurate, and would be capable of 
revealing that many unrated securities are actually less risky than 
rated ones.'' Id.
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    After considering the comments, the Commission has determined to 
seek further comment on this proposal before considering action. The 
Commission is continuing to consider the relative benefits of retaining 
this information in the transaction confirmation against the benefits 
of removing the reference to whether a security is unrated. The 
Commission notes in this regard that the current requirement to 
disclose when a debt security is unrated by an NRSRO provides investors 
with an item of factual information that is conveyed together with 
additional factual information about the terms of the trade. Moreover, 
we are still evaluating the impact that eliminating this disclosure 
requirement would have against the possibility of permitting broker-
dealers to continue providing, on a voluntary basis, information on the 
confirmation that a debt security is not rated. In addition, we are 
concerned that customers may potentially be confused by the lack of a 
disclosure that they may be accustomed to receiving.
    At the same time, the Commission remains concerned that customers 
may place undue reliance on NRSRO ratings and that there may continue 
to be confusion about the significance of those ratings. Therefore, the 
Commission will continue to consider whether to delete paragraph (a)(8) 
of Rule 10b-10, particularly in light of comments received to date, and 
invites further comment on the proposed deletion of Rule 10b-10(a)(8), 
including comments that suggest alternative proposals to achieve the 
Commission's stated goals. In continuing to assess these issues, the 
Commission requests comments on the following:
     Would the investor protection function of Rule 10b-10 be, 
in any way, undercut by deleting paragraph (a)(8) from the Rule? Are 
there any other alternatives for providing customers with this 
information?
     What types of securities would typically be unrated by an 
NRSRO? What types of issuers would typically not have their securities 
rated by an NRSRO?
     Could the disclosure that a security is unrated be removed 
from the confirmation without creating customer confusion? If so, given 
the historical use and investor expectations related to this 
disclosure, could it be removed without implying that a security is in 
fact rated?

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Would the suggested approach vary if certain broker-dealers continued 
to voluntarily disclose that securities were unrated? Should broker-
dealers be required to alert customers that the unrated status of a 
security is no longer being disclosed? If so, for how long?
     The preliminary note to Rule 10b-10 provides: ``This 
section requires broker-dealers to disclose specified information in 
writing to customers at or before completion of a transaction. The 
requirements under this section that particular information be 
disclosed is not determinative of a broker-dealer's obligation under 
the general antifraud provisions of the federal securities laws to 
disclose additional information to a customer at the time of the 
customer's investment decision.'' If paragraph (a)(8) were deleted, 
would the preliminary note to Rule 10b-10 affect a broker-dealer's 
decision to nonetheless continue to voluntarily disclose whether a 
security is unrated?
     One approach for addressing possible customer confusion if 
some broker-dealers continue to disclose that a security is unrated, 
while others do not, could be to prohibit broker-dealers from making 
this disclosure on the confirmation. Such an approach, however, could 
be viewed as inconsistent with broker-dealers' obligations under the 
general antifraud provisions of the federal securities laws, as 
highlighted in the preliminary note to Rule 10b-10, to disclose 
material information to their customers. We invite comment on this 
approach, and particularly on how a broker-dealer, if it considered the 
fact that a security was unrated to be material, could disclose this 
information to customers other than on the confirmation.
     If paragraph (a)(8) were deleted, is there a disclosure 
that should be required in the confirmation on a transitional or 
permanent basis that would help prevent customer confusion? For 
example, should the Commission require broker-dealers, either 
permanently or temporarily for a transition period, to disclose that 
broker-dealers are no longer required to include on the confirmation 
the fact that a security is unrated? Should such a disclosure be made 
on the confirmation, the account statement, or in a separate document 
accompanying the confirmation or account statement? What are the costs 
associated with providing this disclosure on the confirmation, the 
account statement or in a separate document?
     If the requirement to disclose that a security is unrated 
were deleted from Rule 10b-10, would broker-dealers nevertheless feel 
compelled to include the disclosure in order to satisfy their 
suitability or other sales practice obligations?
     Should the requirement to disclose that a security is 
unrated be replaced by a requirement to provide a general statement 
regarding the importance of considering an issuer's creditworthiness?
     If the requirement to disclose that a security is unrated 
were deleted from the rule, are there alternative external or objective 
measures of credit risk that could be substituted for ratings by an 
NRSRO? Is it practicable to replace it with a requirement to disclose 
specific information regarding an issuer's creditworthiness? If so, 
what specific information should the Commission consider including?
     Are credit spreads \28\ a viable method of addressing an 
issuer's creditworthiness? For example, is there a consistent, 
reliable, and generally agreed upon method for determining credit 
spread? How could information about credit spread be presented so that 
it could be readily understood by customers, particularly retail 
customers?
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    \28\ ``Credit spread'' has been defined to mean the 
``differences in yield resulting from different levels of credit 
risk.'' See Oxford Dictionary of Finance and Banking 100 (3rd ed. 
2005). See also Barron's Dictionary of Finance and Investment Terms 
152 (6th ed. 2003) (defining ``credit spread'' as the ``difference 
in value of two options, when the value of the one sold exceeds the 
value of the one bought. The opposite of a debt spread.'').
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C. Net Capital Rule

    The Commission proposed to remove, with limited exceptions, all 
references to NRSROs from the net capital rule for broker-dealers, Rule 
15c3-1 under the Exchange Act (``Net Capital Rule'').\29\ Under the Net 
Capital Rule, broker-dealers are required to maintain, at all times, a 
minimum amount of net capital, generally defined as a broker-dealer's 
net worth (assets minus liabilities), plus certain subordinated 
liabilities, less certain assets that are not readily convertible into 
cash (e.g., fixed assets), and less a percentage of certain other 
liquid assets (e.g., securities). When calculating net capital, broker-
dealers are permitted to take a lower capital charge, called a 
``haircut,'' for certain types of securities that are rated investment 
grade by an NRSRO.
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    \29\ 17 CFR 240.15c3-1; see Exchange Act Proposing Release, 
supra note 1, 73 FR at 40092.
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    As the Commission stated in proposing to remove references to 
NRSROs from the Net Capital Rule, broker-dealers are sophisticated 
market participants regulated by at least one self-regulatory 
organization. Accordingly, the Commission expressed its preliminary 
belief that broker-dealers would be able to assess the creditworthiness 
of the securities they own without undue hardship.\30\ In lieu of the 
references to NRSROs in the Net Capital Rule, the Commission proposed 
substituting two subjective standards for credit risk and liquidity 
risk. For the purposes of determining haircuts on commercial paper, the 
Commission proposed to replace the current NRSRO ratings-based 
criterion with a requirement that the instrument be subject to a 
minimal amount of credit risk and have sufficient liquidity such that 
it can be sold at or near its carrying value almost immediately.\31\ 
For the purposes of determining haircuts on nonconvertible debt 
securities as well as on preferred stock, the Commission proposed to 
replace the current NRSRO ratings-based criterion with a requirement 
that the instrument be subject to no greater than moderate credit risk 
and have sufficient liquidity such that it can be sold at or near its 
carrying value within a reasonably short period of time.\32\ The 
proposed standards were intended to advance the purpose the NRSRO 
ratings-based standards were designed to advance, which is to enable 
broker-dealers to make net capital computations that reflect the market 
risk inherent in the positioning of those particular types of 
securities. Notwithstanding the Commission's belief that broker-dealers 
have the financial sophistication and resources to make these 
determinations,\33\ the Commission stated that it would be appropriate, 
as one means of complying with the proposed amendments, for broker-
dealers that wished to continue to rely on credit ratings of NRSROs to 
do so.\34\
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    \30\ See Exchange Act Proposing Release, supra note 1, 73 FR at 
40092.
    \31\ Id.
    \32\ Id.
    \33\ See Exchange Act Proposing Release, supra note 1, 73 FR at 
40093.
    \34\ See Exchange Act Proposing Release, supra note 1, 73 FR at 
40092.
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    The majority of the commenters to the Commission's proposal to 
remove references to NRSROs from the Net Capital Rule were opposed to 
the change.\35\ Generally, commenters stated

[[Page 52378]]

that they preferred the existing rule because it is a bright line 
objective test that is relatively inexpensive to utilize.\36\ 
Commenters asserted that the new subjective standards that rely on the 
discretion of an interested decision-maker (i.e., the broker-dealer 
itself) would increase uncertainty, decrease transparency, and decrease 
market confidence in the financial strength of broker-dealers.\37\ 
Commenters expressed their belief that the direct conflict of interest 
that would exist for broker-dealers to overestimate the 
creditworthiness of a security to minimize the amount of required net 
capital would lead broker-dealers to maintain too little net capital 
and would have the effect of increasing systemic risk.\38\ Commenters 
also stated that the proposed changes would require increased oversight 
by Commission staff to enforce the use of internal processes in capital 
charge calculations.\39\ In this regard, commenters noted that 
Commission staff would need to review procedures at each broker-dealer, 
and each review would need to include the algorithms of broker-dealer 
internal processes, requiring intensive scrutiny at both large and 
small broker-dealers.\40\ Further, commenters argued that not all 
broker-dealers are ``sophisticated'' and have sufficient resources or 
expertise to develop their own internal processes for rating 
securities.\41\ A minority of commenters supported the proposal to 
remove references to NRSROs from the net capital rule.\42\ One 
commenter argued that NRSROs have too much influence on the ``quality 
assessments of securities that the SEC's regulated financial 
institutions have been required to make.'' \43\
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    \35\ See, e.g., SIFMA Letter; Markit Letter; Letter from Jeffrey 
T. Brown, Senior Vice President, Charles Schwab Co., Inc., 
Washington, District of Columbia to Florence E. Harmon, Acting 
Secretary, Commission dated September 5, 2008 (``Schwab Letter''); 
Letter from Kent Wideman, Group Managing Director, Policy and Rating 
Committee, DBRS and Mary Keogh, Managing Director, Policy and 
Regulatory Affairs, DBRS dated September 8, 2008; Letter from Robert 
Dobilas, CEO and President, Realpoint LLC dated Sept. 8, 2008; 
Gregory W. Smith, General Counsel, Colorado Public Employees' 
Retirement Association to Nancy M. Morris, Secretary, Commission 
dated September 5, 2008.
    \36\ See, e.g., SIFMA Letter.
    \37\ Letter from Keith F. Higgins, Chair, Committee on Federal 
Regulation of Securities, and Vicki O. Tucker, Chair, Committee on 
Securitization and Structured Finance, Business Law Section, 
American Bar Association to Florence E. Harmon, Acting Secretary, 
Commission dated September 12, 2008 (``ABA Letter 2''); SIFMA 
letter.
    \38\ ABA Letter 2.
    \39\ Schwab Letter.
    \40\ Schwab Letter.
    \41\ ABA Letter 2; Schwab Letter.
    \42\ See Letter from Suzanne C. Hutchinson, Executive Vice 
President, Mortgage Insurance Companies of America; Letter from 
Lawrence J. White, Professor of Economics, Stern School of Business, 
New York University, New York, New York to Commission dated 
September 5, 2008 (``White Letter'').
    \43\ White Letter.
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    After considering these comments, the Commission has determined to 
solicit further comment before considering action on the proposed rule 
amendments to remove references to NRSROs from the Net Capital Rule. In 
evaluating whether to take action in the future, the Commission would 
consider, among other things, whether the haircut for the position 
would be appropriate given the risks inherent in the position. The 
relevant risks would include the price volatility, creditworthiness, 
and liquidity of the position. Additionally, in evaluating whether to 
adopt any amendments, the Commission would consider, among other 
things, the costs of an objective approach versus a subjective test; 
whether any alternative objective approaches exist; whether the 
proposed rule would create conflicts of interest that may result in 
undesirable consequences, such as increasing systemic risk; and whether 
broker-dealers have sufficient resources and expertise to implement the 
proposed rule.
    The Commission generally requests comments on whether it should 
retain the NRSRO reference in the Net Capital Rule, as well as all 
aspects of the proposed rule and reiterates its request for comment in 
the Exchange Act Proposing Release. Further, the Commission seeks 
comments on the factors it would consider in determining whether to 
amend the requirements for determining haircuts for proprietary 
securities positions. The Commission also requests comments on the 
following specific questions:
     Are there factors other than creditworthiness and 
liquidity that should be required to be considered in determining the 
appropriate haircut for a proprietary securities position?
     What would be the cost to broker-dealers to develop, 
document, and enforce internal procedures to evaluating the 
creditworthiness and liquidity of proprietary securities positions?
     Do certain broker-dealers lack sufficient resources or 
expertise to independently assess the creditworthiness of securities?
     How could the concern that a broker-dealer would have an 
incentive to downplay the credit risk associated with a particular 
security to minimize capital charges be addressed? Would reviews of 
internal procedures by examiners be sufficient to address this concern? 
Are there other methods, such as reviews by internal or external 
auditors, that could effectively address this concern? Do other 
objective measures of credit risk exist, and could they be used in 
place of NRSRO ratings to address this concern?
     If the Commission decides to adopt the proposal to replace 
the current NRSRO ratings-based criterion with a requirement that the 
instrument be subject to a minimal amount of credit risk and have 
sufficient liquidity, and permits broker-dealers to continue to rely on 
credit ratings of NRSROs as one mean of complying with the proposed 
amendments, should the Commission nevertheless require that the 
standard that results in a higher determination of credit risk be used 
for each individual instrument?
     If the Commission replaces the current NRSRO ratings-based 
criterion with a requirement that the instrument be subject to a 
minimal amount of credit risk and have sufficient liquidity such that 
it can be sold at or near its carrying value within a reasonably short 
period of time, should the Commission also require that broker-dealers 
consult credit ratings of NRSROs for that instrument, comparing which 
method requires the higher capital charge, and require that the broker-
dealer take the higher capital charge?
     Conversely, if broker-dealers continue to rely on credit 
ratings of NRSROs, either because the Commission does not remove the 
reference to NRSROs from the Net Capital Rule or as one means of 
complying with the proposed amendments, should the Commission require 
an analysis of the debt instrument that is independent of the NRSRO 
credit rating (e.g., an internal risk assessment or one performed by a 
third-party vendor) to support the use of the credit rating of NRSROs, 
and if the analysis does not support the credit rating, require that 
the broker-dealer take the higher capital charge?

III. References to Ratings of NRSROs in Securities Act Rules

    In the Securities Act Proposing release, the Commission proposed 
changes to certain eligibility criteria for issuers to conduct primary 
offerings ``off the shelf'' under Securities Act Rule 415 \44\ and 
Forms S-3 and F-3 \45\ and changes to other rules that refer to that 
eligibility.\46\ In addition, the Commission proposed changes to Rule 
436(g) under the Securities Act.\47\ Today, in a companion release, the 
Commission is proposing amendments to our rules to require disclosure 
of information regarding credit ratings used by registrants in 
connection with a registered offering of securities so that investors 
will better understand the credit rating and its limitations and, in 
another companion release, the

[[Page 52379]]

Commission is soliciting comment on whether it should propose 
rescinding Rule 436(g) under the Securities Act.\48\ The Commission is 
deferring consideration of action at this time on the other proposals 
in the Securities Act Proposing Release. However, in view of the 
continuing public interest in the Proposing Releases and the 
Commission's desire to receive additional comment, the Commission is 
re-opening the comment period for the Securities Act Proposing Release. 
As the Commission continues to evaluate and consider the proposed rule 
revisions outlined in this section, the Commission will review whether 
there are appropriate alternatives to references to credit ratings by 
NRSROs in those rules and forms.
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    \44\ 17 CFR 230.415.
    \45\ 17 CFR 239.13 and 17 CFR 239.33.
    \46\ For a more detailed discussion of each of these proposals, 
see Securities Act Proposing Release, supra note 1.
    \47\ 17 CFR 230.436(g).
    \48\ See the releases considered by the Commission on September 
17, 2009 regarding proposed amendments to require disclosure of 
information about credit ratings used by registrants in connection 
with registered offerings, and soliciting comment on whether the 
Commission should propose to rescind Rule 436(g) under the 
Securities Act.
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    Under existing requirements, an issuer's ability to conduct shelf 
offerings of non-convertible debt or asset-backed securities (ABS) may 
depend on, among other things, the securities' credit ratings. In 
particular, a primary offering of non-convertible debt securities is 
eligible for registration on Form S-3 or Form F-3, regardless of the 
issuer's public float or reporting history, if the securities are 
investment grade rated.\49\ Securities registered on Form S-3 or Form 
F-3 may be offered on a delayed, or ``shelf,'' basis.\50\ An offering 
of asset-backed securities is eligible for shelf registration on Form 
S-3 or Form F-3 if the securities are investment grade rated and the 
offering meets certain other conditions.\51\ In addition, a subset of 
asset-backed securities, ``mortgage-related securities,'' that, among 
other things, are rated in one of the two highest rating categories by 
an NRSRO,\52\ may be offered on a delayed basis, regardless of the form 
on which the offering is registered.\53\
---------------------------------------------------------------------------

    \49\ See General Instruction I.B.2 of Form S-3 and General 
Instruction I.B.2 of Form F-3.
    \50\ See 17 CFR 230.415(a)(1)(x).
    \51\ See General Instruction I.B.5. of Form S-3.
    \52\ The term ``mortgage related securities'' is defined by 
Section 3(a)(41) of the Exchange Act [15 U.S.C. 78c(a)(41)].
    \53\ See 17 CFR 230.415(a)(1)(vii).
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    In the Securities Act Proposing Release, the Commission proposed to 
replace the shelf eligibility requirements that rely on investment 
grade ratings with alternate requirements.\54\ For the registration of 
a non-convertible debt offering on Form S-3 or Form F-3, the Commission 
proposed to require that, instead of having investment grade rated 
securities, a registrant must have issued $1 billion of non-convertible 
securities in registered primary offerings over the prior three years. 
For shelf eligibility of ABS offerings, including offerings of mortgage 
related securities, the Commission proposed to replace the investment 
grade ratings requirement with requirements that initial and subsequent 
resales of ABS offerings be made in minimum denominations of $250,000 
and that initial sales of the securities be made only to ``qualified 
institutional buyers,'' as that term is defined in Securities Act Rule 
144A.\55\ We also proposed revisions to related rules and form 
requirements. We received letters from 35 commenters on these 
proposals. Most commenters opposed the proposed amendments that would 
replace the investment grade ratings component of the shelf eligibility 
requirements.\56\
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    \54\ See Securities Act Proposing Release, supra note 1.
    \55\ 17 CFR 230.144A.
    \56\ See ABA Letter 1; ABA Letter 2; SIFMA Letter; Letter from 
Thomas G. Berkmeyer, Associate General Counsel, American Electric 
Power Service Corporation to Secretary, Commission dated September 
4, 2008; ASF Letter; Letter from Shirley Baum, Senior Attorney, 
Pinnacle West Capital Corporation to Secretary, Commission dated 
September 5, 2008; Letter from Walter E. Skrowronski, President, 
Boeing Capital Corporation to Secretary, Commission dated September 
26, 2008; Schwab Letter; Letter from Constance Curnow to Christopher 
Cox, Chairman, Commission dated August 28, 2008; Letter from Davis 
Polk & Wardwell to Florence E. Harmon, Acting Secretary, Commission 
dated September 4, 2008; Letter from Debevoise & Plimpton LLP to 
Florence E. Harmon, Acting Secretary, Commission dated September 3, 
2008 (``Debevoise Letter''); Letter from Dewey & LeBoeuf LLP to 
Florence Harmon, Acting Secretary, Commission dated September 5, 
2008; Letter from James P. Carney, Vice President and Assistant 
Treasurer, Dominion Resources, Inc. to Florence E. Harmon, Acting 
Secretary, Commission dated September 5, 2008; Letter from David K. 
Owens, Executive Vice President, Business Operations Group, Edison 
Electric Institute to Commission dated September 5, 2008; Letter 
from Joseph J. Novak, General Counsel, Incapital, LLC to Florence E. 
Harmon, Acting Secretary, Commission dated September 5, 2008; Letter 
from Richard A. Lococo, Senior Vice President & Deputy General 
Counsel, Manulife Financial Corporation to Commission dated 
September 5, 2008; Mayer Brown Letter; Letter from John A. Courson, 
Chief Operating Officer, Mortgage Bankers Association to Jill M. 
Peterson, Assistant Secretary, Commission dated September 5, 2008; 
Letter from Michael W. Rico, Assistant Treasurer, PNM Resources, 
Inc. to Office of the Secretary, Commission dated September 5, 2008; 
Letter from W. Paul Bowers, Executive Vice President and Chief 
Financial Officer, Southern Company to Florence Harmon, Acting 
Secretary, Commission dated September 5, 2008; Letter from Vincent 
L. Ammann, Jr., Vice President and Chief Financial Officer, WGL 
Holdings, Inc. and Washington Gas Light Company to Florence Harmon, 
Acting Secretary, Commission dated September 10, 2008; Letter from 
James C. Fleming, Wisconsin Energy Corporation to Secretary, 
Commission, dated September 5, 2008.
---------------------------------------------------------------------------

    At this time, the Commission is deferring consideration of action 
on the proposals to amend the investment grade ratings component of the 
Form S-3 or Form F-3 eligibility requirements and, as noted above, we 
are soliciting further comment on the proposals. With respect to the 
ABS shelf eligibility requirements, the staff of the Division of 
Corporation Finance is currently engaged in a broad review of the 
Commission's regulation of asset-backed securities including 
disclosure, offering process, and reporting of asset-backed issuers. In 
connection with that review, the staff is evaluating alternatives to 
the investment grade rating requirements, including alternatives other 
than the type of purchaser or the denomination of the security. The 
Commission believes that any proposal for an alternative to investment 
grade ratings for the purpose of ABS shelf eligibility will be better 
considered together with other possible proposals to the regulations 
governing the offer and sale of asset-backed securities.

IV. References to Ratings of NRSROs in Investment Company Act and 
Investment Advisers Act Rules

    In the Investment Company Act Proposing Release, the Commission 
proposed to amend four of the Commission's rules under the Investment 
Company Act \57\ (Rules 2a-7, 3a-7, 5b-3, and 10f-3) and one rule under 
the Investment Advisers Act \58\ (Rule 206(3)-3T) that refer to credit 
ratings by NRSROs.\59\ These rules use the credit ratings issued by 
NRSROs in different contexts, and for different purposes, to 
distinguish among various grades of debt and other rated securities.
---------------------------------------------------------------------------

    \57\ 15 U.S.C. 80a. Unless otherwise noted, all references to 
rules under the Investment Company Act will be to Title 17, Part 270 
of the Code of Federal Regulations [17 CFR 270].
    \58\ 15 U.S.C. 80b. Unless otherwise noted, all references to 
rules under the Investment Advisers Act will be to Title 17, Part 
275 of the Code of Federal Regulations [17 CFR 275].
    \59\ Investment Company Act Proposing Release, supra note 1.
---------------------------------------------------------------------------

    The Commission proposed to amend each rule to omit references to 
NRSRO ratings and, except with respect to one of the rules, substitute 
alternative provisions that were designed to achieve the same purpose 
as the ratings.\60\ The Commission received 66

[[Page 52380]]

comment letters on the proposal, most of which opposed the 
proposals.\61\ Commenters expressed a variety of concerns regarding the 
proposed amendments. For example, some commenters expressed concern 
that the proposed amendments would replace an objective standard of an 
NRSRO rating with a riskier, subjective determination by the board of 
directors, which would be difficult to apply and would increase the 
burden on the fund's board.\62\ Several commenters also asserted it was 
premature for the Commission to consider eliminating NRSRO ratings from 
Commission rules given the Commission's ongoing initiatives to address 
issues such as improving the accuracy of NRSRO ratings and eliminating 
NRSRO conflicts of interest.\63\
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    \60\ See Investment Company Act Proposing Release, supra note 1, 
at Section III. As discussed in the Investment Company Act Proposing 
Release, we did not propose an alternative provision for one of the 
NRSRO references in Rule 3a-7, which excludes structured finance 
vehicles from the definition of ``investment company'' subject to 
certain conditions. We did not provide an alternative for the 
requirement that structured financings offered to the general public 
have an investment grade rating because we believed that these 
offerings generally were not made to retail investors. See id. 73 FR 
at nn. 41-42 and accompanying and following text.
    \61\ See, e.g., Letter from Ronald W. Forbes and Rodney D. 
Johnson, Independent Directors of the Blackrock money market funds 
to Florence Harmon, Acting Secretary, dated September 10, 2008; 
Letter from Robert G. Zack, Executive Vice President and General 
Counsel, OppenheimerFunds, Inc. to Florence Harmon, Acting 
Secretary, dated September 4, 2008. The comment letters are 
available for public inspection and copying in the Commission's 
Public Reference Room, 100 F Street, NE, Washington, DC 20549 on 
official business days between the hours of 10 am and 3 pm (File No. 
S7-19-08), and also are available on the Commission's Internet Web 
site (http://www.sec.gov/comments/s7-19-08/s71908.shtml).
    \62\ See, e.g., Letter from David Oestreicher, Chief Legal 
Counsel, T. Rowe Price Associates, Inc. to Florence Harmon, Acting 
Secretary, dated September 5, 2008.
    \63\ See, e.g., ABA Letter 2; SIFMA Letter. A few commenters 
also stated that removing the references may lead to a significant 
risk of unintended adverse consequences to capital markets, 
regulatory community and other industries that have regulatory 
requirements involving NRSRO ratings and may not address concerns 
about undue investor reliance on NRSRO ratings. See, e.g., SIFMA 
Letter; Debevoise Letter; Letter from Nathan Douglas, Secretariat, 
Institutional Money Market Funds Association to Florence Harmon, 
Acting Secretary, dated September 5, 2008).
---------------------------------------------------------------------------

    In a companion release the Commission is issuing today, the 
Commission is adopting certain of the proposed amendments to Rules 5b-3 
and 10f-3 under the Investment Company Act.\64\ The Commission is 
deferring consideration of action on the remaining proposed amendments 
to Rules 2a-7, 3a-7, and 5b-3 under the Investment Company Act and Rule 
206(3)-3T under the Investment Advisers Act in light of the comments 
received on the proposed amendments and further actions the Commission 
is considering in separate rulemakings.
---------------------------------------------------------------------------

    \64\ See NRSRO References Adopting Release, supra note 3.
---------------------------------------------------------------------------

    Rule 2a-7 under the Investment Company Act governs the operation of 
money market funds, which rely on the rule to use different valuation 
and pricing methods than other investment companies (``funds'') are 
permitted to use, to help maintain a stable share price. The rule 
contains conditions that restrict money market funds' portfolio 
investments to securities that have received certain minimum credit 
ratings from NRSROs or comparable unrated securities.\65\ This past 
June, the Commission proposed amendments to Rule 2a-7 and related rules 
designed to improve the regulatory framework governing money market 
funds.\66\ In that release, the Commission requested further comment on 
whether we should eliminate the use of NRSRO ratings in Rule 2a-7, 
including whether we should consider establishing a roadmap for phasing 
in the eventual removal of NRSRO references from the rule. We also 
asked whether we should adopt other alternatives to encourage more 
independent credit risk analysis, including whether we should 
reformulate the rule's use of ratings by requiring a money market 
fund's directors to designate specific NRSROs that the board determines 
issue ratings that are sufficiently reliable.\67\
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    \65\ For example, Rule 2a-7 limits a money market fund's 
portfolio investments to securities that have received credit 
ratings from at least one NRSRO in one of the two highest short-term 
rating categories or, if unrated, be of comparable quality. Rule 2a-
7(a)(10) (definition of ``Eligible Security'').
    \66\ See Money Market Fund Reform, Investment Company Act 
Release No. 28807 (June 30, 2009) [74 FR 32688 (July 8, 2009)].
    \67\ See id. at Section II.A.2.a.
---------------------------------------------------------------------------

    Rule 3a-7 under the Investment Company Act excludes structured 
finance vehicles from the Act's definition of ``investment company'' 
subject to certain conditions.\68\ The conditions include the 
requirement that structured financings offered to the general public be 
rated by at least one NRSRO in one of the four highest ratings 
categories, with certain exceptions.\69\ As discussed above, Commission 
staff is developing proposals regarding the offer and sale of asset-
backed securities, which may affect the exemptive relief provided by 
Rule 3a-7.\70\ In considering those changes, the Commission may revisit 
the use of NRSRO ratings in the offer and sale of asset-backed 
securities.
---------------------------------------------------------------------------

    \68\ Structured financings meet the definition of investment 
company under Section 3(a) of the Act because they issue securities 
and invest in, own, hold, or trade securities. Almost none of the 
structured financings, however, are able to operate under the Act's 
requirements. See Exclusion from the Definition of Investment 
Company for Structured Financings, Investment Company Act Release 
No. 19105 (Nov. 19, 1992) [57 FR 56248 (Nov. 27, 1992)].
    \69\ Rule 3a-7(a)(2).
    \70\ See supra Section III.
---------------------------------------------------------------------------

    Rule 5b-3 under the Investment Company Act permits a fund, subject 
to certain conditions, to treat a repurchase agreement as an 
acquisition of the securities collateralizing the repurchase agreement 
in determining whether the fund is in compliance with two provisions of 
the Act that may affect a fund's ability to invest in repurchase 
agreements.\71\ The rule permits a fund to treat a repurchase agreement 
as an investment in the underlying collateral if the agreement is 
``collateralized fully,'' and some types of collateral must have 
received certain credit ratings in order to meet this standard.\72\ 
This reference to credit ratings is used to determine credit risk and 
liquidity of collateral securities that the fund may look to in meeting 
the diversification requirements of the Investment Company Act.\73\ 
Fourteen commenters opposed the proposed amendment to eliminate NRSRO 
ratings references from this definition because, among other reasons, 
it would replace an objective standard with a subjective standard that 
would be difficult to apply.
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    \71\ Section 5(b)(1) of the Act limits the amount that a fund 
that holds itself out as being a diversified investment company may 
invest in the securities of any one issuer (other than the U.S. 
Government). Section 12(d)(3) of the Investment Company Act 
generally prohibits a fund from acquiring an interest in a broker, 
dealer, or underwriter. Because a repurchase agreement may be 
considered to be the acquisition of an interest in the counterparty, 
Section 12(d)(3) may limit a fund's ability to enter into repurchase 
agreements with many of the firms that act as repurchase agreement 
counterparties.
    \72\ See Rule 5b-3(c)(1)(iv).
    \73\ See Rule 5b-3(c)(1)(iv)(C)-(D).
---------------------------------------------------------------------------

    Rule 5b-3 includes a second reference to NRSRO ratings, in the 
definition of ``refunded security.'' \74\ The rule allows a fund for 
purposes of the Investment Company Act's diversification requirements 
to treat the acquisition of a refunded security as the acquisition of 
U.S. government securities that are pledged to make payments to 
investors if, among other conditions, an independent certified public 
accountant has certified to the escrow agent that the government 
securities will satisfy all scheduled payments on the refunded 
security.\75\ Three commenters opposed

[[Page 52381]]

eliminating this NRSRO reference on the grounds it could increase fund 
expenses and decrease liquidity if funds chose not to bid on refunded 
securities for which certifications are not available. As discussed in 
the NRSRO References Adopting Release, because we understand that bond 
indentures or resolutions authorizing the issuance of the refunded 
bonds typically require that the escrow agent receive the requisite 
certification, we do not share these commenters' concerns and are 
amending Rule 5b-3 to eliminate this reference to NRSRO ratings.\76\
---------------------------------------------------------------------------

    \74\ A ``refunded security'' is a debt security whose principal 
and interest are to be paid by U.S. government securities that have 
been irrevocably placed in an escrow account and pledged only to 
payment of the principal and interest on the debt security. See Rule 
5b-3(c)(4).
    \75\ See Rule 5b-3(c)(4)(iii) (requiring at the time the 
deposited securities are placed in the escrow account that an 
independent accountant has certified to the escrow agent that the 
deposited securities will satisfy all scheduled payments of 
principal, interest, and applicable premiums in the refunded 
securities).
    \76\ See NRSRO References Adopting Release, supra note 3, at 
Section II.B.1.
---------------------------------------------------------------------------

    Finally, Rule 206(3)-3T under the Investment Advisers Act 
establishes a temporary alternative means for investment advisers who 
are registered with the Commission as broker-dealers to meet the 
requirements of Section 206(3) of the Advisers Act when they act in a 
principal capacity in transactions with certain of their advisory 
clients.\77\ The rule contains a condition that excludes securities 
from coverage under the rule if the adviser or its close affiliate is 
the issuer or an underwriter of the security, unless it is an 
underwriter of non-convertible debt securities rated in one of the four 
highest rating categories of at least two NRSROs.\78\ The Commission 
intends to consider taking separate, broader, action on Rule 206(3)-3T, 
which is set to expire at the end of this year.\79\
---------------------------------------------------------------------------

    \77\ Rule 206(3)-3T [17 CFR 275.206(3)-3T]. See also Temporary 
Rule Regarding Principal Trades with Certain Advisory Clients, 
Investment Advisers Act Release No. 2653 (September 24, 2007) [72 FR 
55022 (September 28, 2007)] (``Principal Trade Rule Release''). 
Section 206(3) of the Investment Advisers Act makes it unlawful for 
any investment adviser, directly or indirectly ``acting as principal 
for his own account, knowingly to sell any security to or purchase 
any security from a client * * * without disclosing to such client 
in writing before the completion of such transaction the capacity in 
which he is acting and obtaining the consent of the client to such 
transaction.'' 15 U.S.C. 80b-6(3).
    \78\ Rule 206(3)-3T(c).
    \79\ See Principal Trade Rule Release, supra note 77.
---------------------------------------------------------------------------

    As previously mentioned, the Commission is deferring consideration 
of action on the proposals to remove NRSRO references from the rules 
described above under the Investment Company Act and Investment 
Advisers Act. Our broader consideration of each of these rules will 
afford us the opportunity to re-evaluate credit rating references in 
those rules.
    The Commission generally requests further comment on the proposed 
amendments described above to Rules 3a-7 and 5b-3 under the Investment 
Company Act and Rule 206(3)-3T under the Investment Advisers Act. We 
also request specific comment on whether the rules should require, in 
place of existing references to credit ratings, alternate standards 
that would use (i) credit ratings as a minimum standard, and (ii) 
additional criteria that must be met with regard to evaluating the 
securities, such as determinations of credit quality, liquidity, or 
appropriateness of the security as an investment for the particular 
purchaser. This approach, if applied to Rules 3a-7 and 5b-3 under the 
Investment Company Act and Rule 206(3)-3T under the Investment Advisers 
Act, would be designed to help reduce undue reliance on ratings by 
requiring an additional evaluation of credit quality, while retaining 
the external or objective measure of the NRSRO rating. Under Rule 2a-7 
in its current form, for example, a determination that a security is an 
``eligible security'' as a result of its NRSRO ratings is a necessary 
but not sufficient finding in order for a money market fund to acquire 
the security. The rule also currently requires a determination that the 
security presents minimal credit risks, and specifically requires that 
the determination ``be based on factors pertaining to credit quality in 
addition to any ratings assigned to such securities by an NRSRO.'' \80\ 
Although the Commission, as noted above, is continuing to consider 
whether to remove references to credit ratings from Rule 2a-7 
altogether, we request comment on whether we should consider the two-
step approach of existing Rule 2a-7 for the other rules (i.e., Rules 
3a-7, 5b-3, and 206(3)-3T) that contain references to NRSRO credit 
ratings. Alternatively, are there other objective measures of credit 
risk, and should they be used in place of NRSRO ratings to address the 
concerns addressed by the rules?
---------------------------------------------------------------------------

    \80\ Rule 2a-7(c)(3)(i).
---------------------------------------------------------------------------

V. Request for Comment

    The Commission generally requests comment on the Proposing Releases 
as indicated above, including whether the Commission should remove 
references to credit ratings by NRSROs in Commission rules and the 
appropriate factors to consider in making this determination. The 
Commission asks that commenters provide specific reasons and 
information to support alternative recommendations. Please provide 
empirical data, when possible, and cite to economic studies, if any, to 
support alternative approaches.

    By the Commission.

    Dated: October 5, 2009.
Elizabeth M. Murphy,
Secretary.
[FR Doc. E9-24365 Filed 10-8-09; 8:45 am]

BILLING CODE 8011-01-P
