
[Federal Register: October 9, 2009 (Volume 74, Number 195)]
[Rules and Regulations]               
[Page 52357-52373]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr09oc09-18]                         


[[Page 52357]]

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Part IV





Securities and Exchange Commission





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17 CFR Parts 229, 230, 239 et al.



References to Ratings of Nationally Recognized Statistical Rating 
Organizations; Final Rule and Proposed Rule


[[Page 52358]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240, 242, 249 and 270

[Release Nos. 34-60789, IC-28939; File Nos. S7-17-08, S7-19-08]
RIN 3235-AK17, 3235-AK19

 
References to Ratings of Nationally Recognized Statistical Rating 
Organizations

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
adopting amendments to certain of its rules and forms to remove 
references to securities credit ratings. The Commission is eliminating 
certain references to credit ratings issued by nationally recognized 
statistical rating organizations (``NRSROs'') in rules and forms under 
the Securities Exchange Act of 1934 related to the regulation of self-
regulatory organizations and alternative trading systems, and in rules 
under the Investment Company Act of 1940 that affect an investment 
company's ability to purchase refunded securities and securities in 
underwritings in which an affiliate is participating. The Commission 
believes that the references to credit ratings in these rules and forms 
are no longer warranted as serving their intended purposes. The 
amendments are designed to address concerns that references to NRSRO 
ratings in Commission rules may have contributed to an undue reliance 
on those ratings by market participants. In a companion release, the 
Commission is re-opening the comment period for certain other proposed 
rule and form amendments that would eliminate additional references to 
NRSRO ratings.

DATES: Effective Date: November 12, 2009.

FOR FURTHER INFORMATION CONTACT: For the rule and form amendments under 
the Securities Exchange Act of 1934, Michael Gaw, Assistant Director, 
at (202) 551-5602, Brian Trackman, Special Counsel, at (202) 551-5616, 
and Sarah Albertson, Special Counsel, at (202) 551-5647, in the 
Division of Trading and Markets; for rules under the Investment Company 
Act of 1940, Penelope W. Saltzman, Assistant Director, and Daniel K. 
Chang, Attorney, at (202) 551-6792, in the Division of Investment 
Management, at the Securities and Exchange Commission, 100 F Street, 
NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to 
Rule 3a1- 1\1\ under the Securities Exchange Act of 1934 (the 
``Exchange Act''),\2\ Rules 300, 301(b)(5) and 301(b)(6) of Regulation 
ATS,\3\ Form ATS-R \4\ and Form PILOT.\5\ The Commission also is 
adopting amendments to Rules 5b-3 \6\ and 10f-3 \7\ under the 
Investment Company Act of 1940 (``Investment Company Act'').\8\
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    \1\ 17 CFR 240.3a1-1.
    \2\ 15 U.S.C. 78a. Unless otherwise noted, all references to 
rules under the Exchange Act will be to Title 17, Part 240 or Part 
242 of the Code of Federal Regulations [17 CFR 240 or 17 CFR 242].
    \3\ 17 CFR 242.300, 242.301(b)(5), and 242.301(b)(6).
    \4\ 17 CFR 249.638.
    \5\ 17 CFR 249.821.
    \6\ 17 CFR 270.5b-3.
    \7\ 17 CFR 270.10f-3.
    \8\ 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].
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Table of Contents

I. Introduction
II. Discussion
    A. Amendments to Rules Under the Exchange Act
    1. Rule 3a1-1
    2. Rules 300, 301(b)(5) and 301(b)(6) of Regulation ATS
    3. Form ATS-R and Form PILOT
    4. Discussion
    B. Amendments to Rules Under the Investment Company Act
    1. Refunded Securities (Rule 5b-3)
    2. Affiliated Underwritings (Rule 10f-3)
III. Paperwork Reduction Act
IV. Cost-Benefit Analysis
V. Consideration of Burden on Competition and Promotion of 
Efficiency, Competition and Capital Formation
VI. Final Regulatory Flexibility Certification and Analysis
VII. Statutory Authority
Text of Rule Amendments

I. Introduction

    Last year the Commission issued rulemaking initiatives in 
furtherance of the Credit Rating Agency Reform Act of 2006.\9\ The 
Commission also proposed to eliminate from certain Commission rules and 
forms references to credit ratings.\10\ The Commission proposed to 
amend these rules and forms to address concerns that the inclusion of 
requirements relating to credit ratings could create the appearance 
that the Commission had, in effect, given its ``official seal of 
approval'' on ratings, which could adversely affect the quality of due 
diligence and investment analysis and lead to undue reliance on NRSRO 
ratings.\11\
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    \9\ Public Law 109-291, 120 Stat. 1327 (2006). See, e.g., 
Proposed Rules for Nationally Recognized Statistical Rating 
Organizations, Exchange Act Release No. 57967 (June 16, 2008) [73 FR 
36212 (June 25, 2008)].
    \10\ See References to Ratings of Nationally Recognized 
Statistical Rating Organizations, Exchange Act Release No. 58070 
(July 1, 2008) [73 FR 40088 (July 11, 2008 (``Exchange Act Proposing 
Release'')] (proposing amendments to rules and forms under the 
Exchange Act); References to Ratings of Nationally Recognized 
Statistical Rating Organizations, Investment Company Act Release No. 
28327 (July 1, 2008) [73 FR 40124 (July 11, 2008)] (``Investment 
Company Act Proposing Release'') (proposing amendments to rules 
under the Investment Company Act and Investment Advisers Act of 1940 
(``Investment Advisers Act'')). See also 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 of 1933 (``Securities Act'') and the Exchange Act).
    \11\ See Exchange Act Proposing Release, supra note 10, at 
Section I; Investment Company Act Proposing Release, supra note 10, 
at Section I. We note that the Department of the Treasury similarly 
has expressed concern that investors were overly reliant on credit 
rating agencies, and that credit ratings often failed to accurately 
describe the risk of rated products. The Department of the Treasury 
recommended that regulators reduce the use of credit ratings in 
regulations and supervisory practices wherever possible. See U.S. 
Department of the Treasury, Financial Regulatory Reform--A New 
Foundation: Rebuilding Financial Supervision and Regulation 6, 46 
(July 2009).
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    Today the Commission is adopting several of the amendments that we 
proposed last year to rules and forms under the Exchange Act and rules 
under the Investment Company Act.\12\ The Commission believes that the 
references to credit ratings in these rules are no longer warranted as 
serving their intended purposes. These amendments would reduce reliance 
on credit ratings in our rules under the Exchange Act and the 
Investment Company Act, consistent with the protection of investors.
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    \12\ The Commission is deferring consideration of action and 
reopening the comment period on other proposed amendments to remove 
NRSRO ratings references to rules under the Securities Act, Exchange 
Act, Investment Company Act, and Investment Advisers Act. See 
References to Ratings of Nationally Recognized Statistical Rating 
Organizations, Securities Act Release No. 9069, Exchange Act Release 
No. 60790, Investment Advisers Act Release No. 2932, Investment 
Company Act Release No. 28940 (Oct 5, 2009) (``NRSRO Comment Re-
Opening Release'').
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II. Discussion

A. Amendments to Rules Under the Exchange Act

    The Commission today is revising Rule 3a1-1 under the Exchange Act; 
\13\ Rules 300, 301(b)(5) and 301(b)(6) of Regulation ATS; \14\ Form 
ATS-R; \15\ and Form PILOT \16\ to remove references to NRSRO ratings. 
Each of these rules and forms was adopted in 1998 as part of the 
Commission's new framework for the regulation of exchanges and 
alternative

[[Page 52359]]

trading systems (``ATSs'').\17\ That framework provides the operator of 
a securities market the choice whether to register as a national 
securities exchange or to register as a broker-dealer and comply with 
the requirements of Regulation ATS.
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    \13\ 17 CFR 240.3a1-1.
    \14\ 17 CFR 242.300, 242.301(b)(5), and 242.301(b)(6).
    \15\ 17 CFR 249.638.
    \16\ 17 CFR 249.821.
    \17\ See Exchange Act Release No. 40760 (Dec. 8, 1998) [63 FR 
70844 (Dec. 22, 1998)] (``Regulation ATS Adopting Release'').
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1. Rule 3a1-1
    The amendments to Rule 3a1-1 are being adopted as proposed. Rule 
3a1-1(a) provides an exemption from the Exchange Act definition of 
``exchange''--and thus the requirement to register as an exchange--for 
a trading system that, among other things, is in compliance with 
Regulation ATS.\18\ Rule 3a1-1(b) contains an exception to the 
exemption from the exchange definition. Under this exception, the 
Commission may require a trading system that is a ``substantial 
market'' to register as a national securities exchange if it finds that 
such action is necessary or appropriate in the public interest or 
consistent with the protection of investors.\19\ Thus, pursuant to Rule 
3a1-1, the Commission may require a ``dominant'' ATS to register as an 
exchange.\20\
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    \18\ See 17 CFR 240.3a1-1(a)(2).
    \19\ See 17 CFR 240.3a1-1(b); Regulation ATS Adopting Release, 
63 FR at 70857.
    \20\ Specifically, the Commission may--after notice to an ATS 
and an opportunity for it to respond--require the ATS to register as 
an exchange if, during three of the preceding four calendar 
quarters, the ATS had: (1) 50% or more of the average daily dollar 
trading volume in any security and 5% or more of the average daily 
dollar trading volume in any class of securities; or (2) 40% or more 
of the average daily dollar volume in any class of securities. See 
17 CFR 240.3a1-1(b)(1).
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    Prior to the amendments being adopted today, Rule 3a1-1 set forth 
eight classes of securities in any one of which an ATS might achieve 
``dominant'' status: (1) Equity securities; (2) listed options; (3) 
unlisted options; (4) municipal securities; (5) investment grade 
corporate debt securities; (6) non-investment grade corporate debt 
securities; (7) foreign corporate debt securities; and (8) foreign 
sovereign debt securities.\21\ Under the definitions that were provided 
in Rule 3a1-1, investment grade and non-investment grade corporate debt 
securities have three elements in common. They are securities that: (1) 
Evidence a liability of the issuer of such security; (2) have a fixed 
maturity date that is at least one year following the date of issuance; 
and (3) are not exempted securities, as defined in Section 3(a)(12) of 
the Exchange Act.\22\ The distinguishing characteristic of an 
investment grade corporate debt security was that it has been rated in 
one of the four highest categories by at least one NRSRO.\23\ A non-
investment grade corporate debt security under our rules was a 
corporate debt security that has not received such a rating.\24\
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    \21\ See 17 CFR 240.3a1-1(b)(3).
    \22\ Compare 17 CFR 240.3a1-1(b)(3)(v) with 17 CFR 240.3a1-
1(b)(3)(vi).
    \23\ See 17 CFR 240.3a1-1(b)(3)(v).
    \24\ See 17 CFR 240.3a1-1(b)(3)(vi).
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    The Commission is revising Rule 3a1-1 by replacing paragraphs 
(b)(3)(v) and (b)(3)(vi), which define investment grade corporate debt 
securities and non-investment grade corporate debt securities, 
respectively, with a single category ``corporate debt securities'' in 
paragraph (b)(3)(v).\25\ This new definition retains verbatim the three 
elements common to the existing definitions of investment grade and 
non-investment grade debt securities. The 5% and 40% thresholds beyond 
which the Commission could require an ATS to register as an exchange 
also remain unchanged.\26\ Under amended Rule 3a1-1, the Commission 
can, for example, determine that an ATS must register as an exchange if 
the system had--during three of the preceding four calendar quarters--
50% or more of the average daily dollar trading volume in any security 
and 5% or more of the average daily dollar trading volume in corporate 
debt securities, or 40% of the average daily dollar trading volume in 
corporate debt securities.\27\
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    \25\ Existing paragraphs (b)(3)(vii) and (b)(3)(viii) are 
unchanged but redesignated as paragraphs (b)(3)(vi) and (b)(3)(vii), 
respectively.
    \26\ See supra note 19. While the percentage thresholds remain 
unchanged, the dollar volume needed to reach these thresholds has 
increased. For example, under Rule 3a1-1 as it existed prior to 
today's action, an ATS that had 40% of the average daily dollar 
trading volume in non-investment grade corporate debt securities and 
0% of the average daily dollar trading volume in investment grade 
corporate debt securities for three consecutive months could have 
been required by the Commission to register as an exchange. Under 
the amended Rule 3a1-1, the Commission will not be able to require 
the ATS to register as an exchange because the ATS's combined 
average daily dollar trading volume in corporate debt securities 
would be less than 40%.
    \27\ The other six classes of securities--equity securities, 
listed options, unlisted options, municipal securities, foreign 
corporate debt securities, and foreign sovereign debt securities--
remain unchanged. Therefore, as under Rule 3a1-1 prior to today's 
amendments, the Commission may also determine that an ATS must 
register as an exchange if the system exceeds the volume thresholds 
in any of these other classes of securities.
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2. Rules 300, 301(b)(5) and 301(b)(6) of Regulation ATS
    As proposed, the Commission is making similar changes to Rules 300, 
301(b)(5) and 301(b)(6) of Regulation ATS. Rule 300 sets forth 
definitions used in Regulation ATS, including of ``investment grade 
corporate debt security'' and ``non-investment grade corporate debt 
security.'' \28\
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    \28\ See 17 CFR 242.300(i) and (j).
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    Rule 301(b)(5) of Regulation ATS imposes a ``fair access'' 
requirement, whereby an ATS that exceeds certain volume thresholds in 
any class of securities must establish written standards for granting 
access to trading on its system and not unreasonably prohibit or limit 
any person in respect to access to the services it offers.\29\ Prior to 
today's amendments, the fair access standard applied if an ATS had 5% 
or more of the average daily volume during at least four of the 
preceding six calendar months in any of the following: (1) Any 
individual National Market System stock (``NMS stock''); \30\ (2) any 
individual equity security that is not an NMS stock and for which 
transactions are reported to a self-regulatory organization (``SRO''); 
(3) municipal securities; (4) investment grade corporate debt 
securities; or (5) non-investment grade corporate debt securities.
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    \29\ See 17 CFR 242.301(b)(5).
    \30\ See 17 CFR 240.600(a)(47) (defining ``NMS stock'').
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    Rule 301(b)(6) of Regulation ATS \31\ requires an ATS that exceeds 
certain volume thresholds in any class of securities to comply with 
standards regarding the capacity, integrity and security of its 
automated systems. Five classes of securities were identified in Rule 
301(b)(6): (1) NMS stocks; (2) equity securities that are not NMS 
stocks and for which transactions are reported to a SRO; (3) municipal 
securities; (4) investment grade corporate debt securities; and (5) 
non-investment grade corporate debt securities.\32\
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    \31\ 17 CFR 242.301(b)(6).
    \32\ 17 CFR 242.301(b)(6)(i).
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    The Commission is amending Rules 300, 301(b)(5) and 301(b)(6) as 
proposed to establish a single class of ``corporate debt securities'' 
and to eliminate the existing separate classes of investment grade and 
non-investment grade corporate debt securities. Accordingly, paragraphs 
(i) and (j) of Rule 300 are replaced with a new paragraph (i) defining 
``corporate debt security'' to mean any security that: (1) Evidences a 
liability of the issuer of such security; (2) has a fixed maturity date 
that is at least one year following the date of issuance; and (3) is 
not an exempted security, as defined in Section 3(a)(12)

[[Page 52360]]

of the Exchange Act.\33\ Former paragraphs (i)(D) and (i)(E) of Rule 
301(b)(5) are replaced with a new paragraph (i)(D) providing that an 
ATS must comply with the access requirements set out in Rule 301(b)(5) 
if, with respect to corporate debt securities, such system accounts for 
5% or more of the average daily volume traded in the United States for 
the requisite number of months. The 5% threshold at which an ATS would 
have to grant fair access to its system also remains unchanged.\34\ 
Former paragraphs (i)(D) and (i)(E) of Rule 301(b)(6) are replaced with 
a new paragraph (i)(D) providing that an ATS must comply with the 
capacity, integrity and security requirements of Rule 301(b)(6) if, 
with respect to corporate debt securities, such system accounts for 20% 
or more of the average daily volume traded in the United States for the 
requisite number of months. The 20% threshold and the other three 
classes of securities remain unchanged. As with the changes to Rule 
3a1-1, the other classes of securities referenced in these rules remain 
unchanged.
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    \33\ 15 U.S.C. 78c(a)(12).
    \34\ When the Commission originally adopted Regulation ATS, it 
set the fair access threshold at 20%. It later lowered the threshold 
to 5% in connection with the adoption of Regulation NMS. See 
Exchange Act Release No. 51808 (June 9, 2005) [70 FR 37496, 37550 
(June 29, 2005)].
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3. Form ATS-R and Form PILOT
    The Commission is making corresponding amendments as proposed to 
Form ATS-R and Form PILOT. Form ATS-R is used by ATSs to report certain 
information about their activities to the Commission on a quarterly 
basis.\35\ Form ATS-R requires each ATS to report the total unit volume 
and total dollar volume in the previous quarter for various categories 
of securities, including--prior to today's amendments--investment grade 
and non-investment grade corporate debt securities. Consistent with the 
amendments to Regulation ATS described above, we are revising Form ATS-
R to eliminate the separate categories for investment grade and non-
investment grade corporate debt securities, and instead creating a 
single category for ``corporate debt securities.''
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    \35\ Each ATS must file a Form ATS-R within 30 days of the end 
of each calendar quarter, and within ten days of a cessation of 
operations. See 17 CFR 242.301(b)(9).
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    As with the changes to Regulation ATS, ``corporate debt 
securities'' is defined in the instructions to Form ATS-R to mean any 
security that: (1) Evidences a liability of the issuer of such 
security; (2) has a fixed maturity date that is at least one year 
following the date of issuance; and (3) is not an exempted security, as 
defined in Section 3(a)(12) of the Exchange Act. Because separate 
classes for investment grade and non-investment grade corporate debt 
securities are eliminated for purposes of the thresholds in Rule 3a1-1 
and Rules 301(b)(5) and 301(b)(6) of Regulation ATS, no purpose is 
served by requiring ATSs to separately report their trading volumes for 
investment grade and non-investment grade debt securities on Form ATS-
R. The figures for the separate classes will be added together and 
reported as a single item on the amended form. The Commission is not 
making any other changes to Form ATS-R.
    Ordinarily, Section 19 of the Exchange Act \36\ and Rule 19-4 
thereunder \37\ require a SRO to file with the Commission proposed rule 
changes on Form 19b-4 regarding any changes to any material aspect of 
its operations, including any trading system. Rule 19b-5 under the 
Exchange Act \38\ sets forth a limited exception to that requirement by 
permitting an SRO to operate a pilot trading system without filing 
proposed rule changes with respect to that system if certain criteria 
are met. One of those criteria is that the SRO files a Form PILOT in 
accordance with the instructions on that form. Like Form ATS-R, Form 
PILOT--prior to today's amendments--required quarterly reporting of 
trading activity by classes of securities, including investment grade 
and non-investment grade corporate debt securities. For the same 
reasons we are amending Rule 3a1-1 and Regulation ATS, we are also 
revising Form PILOT to eliminate these two categories, replacing them 
with a single category of ``corporate debt securities.'' Corporate debt 
securities are defined identically in Form PILOT and Form ATS-R. The 
Commission believes that it is appropriate to obtain trading volumes 
from pilot trading systems for the combined class of corporate debt 
securities, and that separate reporting of the two classes is not 
necessary to adequately monitor the development of pilot trading 
systems. The Commission notes that, in over nine years since Rule 19b-5 
and Form PILOT were adopted, no SRO has ever established a pilot 
trading system pursuant to Rule 19b-5 to trade corporate debt 
securities.
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    \36\ 15 U.S.C. 78s.
    \37\ 17 CFR 240.19b-4.
    \38\ 17 CFR 240.19b-5.
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4. Discussion
    In the Exchange Act Proposing Release, the Commission sought 
comment on proposed changes to certain Exchange Act rules and forms, 
including the changes to Rule 3a1-1, Regulation ATS, Form ATS-R and 
Form PILOT that the Commission is adopting today. With respect to Rule 
3a1-1 under the Exchange Act and Rules 300, 301(b)(5) and 301(b)(6) of 
Regulation ATS, the Commission sought comment on whether, in light of 
the proposed combination of investment grade and non-investment grade 
corporate debt securities into a single class, it should adopt lower 
thresholds at which an ATS that trades corporate debt securities should 
be required to register as an exchange. The Commission also solicited 
comment on whether the proposed amendments to Rule 3a1-1, Regulation 
ATS, Form ATS-R and Form PILOT would significantly affect investors, 
market participants, the national market system or the public interest.
    The Commission received many comments broadly arguing that the 
elimination of references to NRSRO ratings would not reduce undue 
reliance on the NRSROs and could have a potentially destabilizing 
effect, but these comments focused on NRSRO references in rules where 
the NRSRO credit rating was relied upon to determine the credit risk or 
liquidity of a particular security in order to achieve the rules' 
regulatory purpose. \39\ For

[[Page 52361]]

example, one commenter suggested that credit ratings are a necessary 
part of an effective risk measurement, along with each participant's 
independent analysis of credit risk, and questioned the availability 
and quality of substitutes for such ratings.\40\
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    \39\ 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 a.m. and 3 p.m. (File No. S7-17-08), and also are 
available on the Commission's Internet Web site (http://www.sec.gov/
comments/s7-17-08/s71708.shtml). The Commission received 20 comments 
in response to the Exchange Act Proposing Release. Many of the 
comments commended the Commission's efforts to reform the credit 
rating process, but opposed the proposals outlined in the proposed 
rulemakings. See, e.g., Comment Letter of Charles Schwab (Sept. 5, 
2008) (labeling the Commission's proposed amendments to remove NRSRO 
rating from its rules as premature and ultimately destabilizing) 
(``Schwab Comment Letter''); Comment Letter of the Securities 
Industry and Financial Markets Ass'n. (Sept. 4, 2008) (``SIFMA 
Comment Letter'') (noting that SIFMA has not found that the 
possibility of undue reliance on credit ratings supports the 
deletion of references to, and the use of, credit ratings in 
regulations while stating that the appropriate degree of use of 
credit ratings by market participants is less of a regulatory issue 
and more one of best practices within the marketplace). One 
commenter also encouraged the Commission to analyze the potential 
consequences of removing particular references to ratings, as 
opposed to a wholesale abandonment of NRSRO-ratings based criteria. 
See Comment Letter of Moody's Investor Services (Sept. 5, 2008). 
Another commenter encouraged the Commission to withdraw the 
proposals from active consideration until the Commission has 
coordinated with other regulatory agencies to prevent the proposals 
from conflicting with existing or proposed regulation of other 
financial services industries. See Comment Letter of Mortgage 
Bankers Ass'n. (Sept. 5, 2008). In addition, the majority of 
commenters specifically opposed the other proposed amendments in the 
Exchange Act Proposing Release. The Commission is deferring action 
and seeking additional comments on those other proposed amendments. 
See NRSRO Comment Re-Opening Release, supra note 12.
    \40\ See Schwab Comment Letter (specifically commenting on Rule 
15c3-1 under the Exchange Act (the ``Net Capital Rule''), Rule 2a-7 
under the Investment Company Act and Rule 206(3)-3T under the 
Investment Advisers Act).
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    In contrast, the amendments to Regulation ATS and the related 
Exchange Act rules discussed herein simply use NRSRO ratings to 
categorize trading activity into market segments for purposes of these 
rules' reporting and other requirements. The two commenters who 
expressly addressed the specific changes that the Commission is 
adopting in this release raised no objection to the elimination of 
references to NRSRO ratings in Rule 3a1-1, Regulation ATS, Form ATS-R 
and Form PILOT.\41\ One commenter, an NRSRO, was generally supportive 
of these proposed changes, stating that the current distinction between 
investment grade and non-investment grade corporate debt securities in 
these rules and forms was ``superfluous and can be eliminated without 
any untoward consequences for investors.'' \42\ The other commenter was 
also generally supportive of the proposals, and advocated various 
additional rule changes that, in its view, would enhance transparency 
for investors in fixed income securities.\43\
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    \41\ See Comment Letter of DBRS (Sept. 8, 2008) (``DBRS Comment 
Letter''); Comment Letter of Multiple-Markets (Sept. 5, 2008) 
(``Multiple-Markets Comment Letter'').
    \42\ See DBRS Comment Letter.
    \43\ See Multiple-Markets Comment Letter. The commenter also 
suggested reducing the volume threshold in Rule 3a1-1 for the 
determination of a ``substantial market'' and distinguishing market 
centers based on client and product types, and a corresponding 
reduction of the threshold in Rule 301(b)(6) for determining the 
applicability of capacity, integrity, and security requirements. The 
commenter also advocated that the Commission undertake a review of 
electronic trading platforms to evaluate fair access under Rule 
301(b)(5). In addition, the commenter encouraged the Commission to 
make public the data filed on both Forms ATS and ATS-R. Although 
these comments go beyond the scope of the initial proposal, the 
Commission will consider them in connection with any future 
proposals in this area.
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    Consistent with the reasons set forth in the Exchange Act Proposing 
Release and based on the Commission's experience since the adoption of 
Regulation ATS in 1998, the Commission believes that distinguishing 
investment grade corporate debt securities and non-investment grade 
corporate debt securities as separate classes of securities under Rule 
3a1-1, Regulation ATS, Form ATS-R and Form PILOT is no longer 
necessary. In each case, as discussed, we believe that combining all 
corporate debt securities into a single class is appropriate. 
Consolidated reporting is adequate for Commission purposes and removal 
of NRSRO references in these rules may help marginally reduce any undue 
reliance on credit ratings.
    With regard to Rule 3a1-1, the Commission believes that exceeding a 
volume threshold for a combined class of all corporate debt securities 
is a sufficient indication of significant trading activity that could 
warrant requiring an ATS to register as an exchange, and that it is not 
necessary to assess trading volumes in the narrower segments of 
investment grade and non-investment grade corporate debt securities. 
While the amendment to Rule 3a1-1 adopted today increases the dollar 
volume of trading in corporate debt securities that an ATS must execute 
before it is required to register as an exchange, which could 
potentially reduce the likelihood that an ATS would be required to 
register as an exchange,\44\ we believe that this change is 
nevertheless appropriate. As noted above, the Commission believes that 
these NRSRO references are no longer necessary and thus there is no 
need to analyze ``dominance'' in separate classes of investment grade 
and non-investment grade corporate debt securities. We specifically 
asked in the Exchange Act Proposing Release whether the Commission 
should lower the threshold in Rule 3a1-1 for the combined class of 
corporate debt securities. The Commission received no comments in 
response to this question and no suggestion for an alternate threshold. 
Following the amendment adopted today, we will continue to analyze for 
dominance in six other classes of securities (in addition to the new 
single class for corporate debt securities).\45\
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    \44\ See supra note 25.
    \45\ In over ten years since adopting Rule 3a1-1, the Commission 
has never determined to require an ATS to register as an exchange 
because it has become ``dominant.''
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    For the same reasons we are amending Rule 3a1-1, we believe that 
amending Rules 300, 301(b)(5) and 301(b)(6) of Regulation ATS is 
appropriate because these NRSRO references are no longer necessary to 
serve their regulatory purpose and such removal may help reduce any 
undue reliance on credit ratings. The Commission believes that a volume 
threshold for a combined class of all corporate debt securities is 
sufficient for the fair access requirement and the capacity, integrity 
and security requirements. The Commission believes that the purposes of 
Regulation ATS will be fulfilled if investment grade and non-investment 
grade corporate debt securities are combined into a single class. ATSs 
will continue to be subject to the existing fair access requirement and 
capacity, integrity and security requirements with respect to the other 
existing classes of securities set forth in Rules 301(b)(5) and 
301(b)(6) of Regulation ATS.
    For the reasons described above, the Commission believes that the 
changes to Rule 3a1-1, Regulation ATS, Form ATS-R and Form PILOT that 
we are adopting today to remove references to NRSRO ratings are 
necessary and appropriate in the public interest and consistent with 
the protection of investors. While the removal of the distinction 
between investment grade and non-investment grade corporate debt in the 
context of ATS reporting may marginally reduce the information 
immediately available to the Commission regarding corporate debt 
traded, the Commission believes that these specific references are not 
necessary.\46\ Eliminating these references may help marginally reduce 
undue reliance on credit ratings and the removal of these requirements 
relating to credit ratings could marginally reduce compliance costs for 
ATSs. Moreover, as discussed above, the Commission does not believe 
that the broad concerns raised by many commenters regarding the risks 
inherent in removing NRSRO ratings and replacing them with a substitute 
in response to the Exchange Act Proposing Release are applicable to the 
specific changes being adopted in today's amendments. Finally, the 
Commission notes that the two commenters who specifically commented on 
these changes supported them.
---------------------------------------------------------------------------

    \46\ The Commission retains the authority to request more 
specific information regarding the securities traded by ATSs. See 17 
CFR 242.302-303.
---------------------------------------------------------------------------

B. Amendments to Rules Under the Investment Company Act

    Four of the Commission's rules under the Investment Company Act 
(Rules 2a-7, 3a-7, 5b-3 and 10f-3) and one rule under the Investment 
Advisers Act of 1940 \47\ (``Investment Advisers Act'') (Rule 206(3)-
3T) reference credit ratings by NRSROs. These rules use the credit 
ratings issued by NRSROs in different

[[Page 52362]]

contexts, and for different purposes, to distinguish among various 
grades of debt and other rated securities.
---------------------------------------------------------------------------

    \47\ 15 U.S.C. 80b.
---------------------------------------------------------------------------

    In July 2008, we 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.\48\ We received 66 comments on the proposal.\49\ Six 
commenters generally advocated eliminating references to NRSRO ratings 
in Commission rules.\50\ However, most commenters opposed the 
amendments. Many of those commenters supported the Commission's 
reevaluation of the use of NRSRO ratings in its rules, but suggested 
that the Commission continue its evaluation pending implementation of 
the additional requirements for NRSROs that we recently adopted under 
the Credit Rating Agency Reform Act.\51\ Most commenters also addressed 
specific proposed rule amendments, which we discuss in more detail 
below.
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    \48\ See Investment Company Act Proposing Release, supra note 
10, at Section III.
    \49\ 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 a.m. and 3 p.m. (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).
    \50\ Comment Letter of Professor Frank Partnoy (received Sept. 
5, 2008) (``I am submitting comments to applaud the Commission's 
proposed rules, to indicate that there is strong academic support 
for its proposal * * *.'') (``Partnoy Comment Letter''); Comment 
Letter of Lawrence J. White, Professor of Economics, Stern School of 
Business (Sept. 5, 2008) (``White Comment Letter'') (``I endorse 
[the] general spirit of the SEC's proposed rules and urge the SEC to 
go even further and to eliminate the NRSRO category entirely.''); 
Comment Letter of the Government Finance Officers Ass'n. (Sept. 5, 
2008) (``GFOA Comment Letter'') (``We also generally support the 
Commission's proposals to deemphasize the reliance on ratings 
throughout its Rules.''); Comment Letter of The Reserve (Sept. 5, 
2008) (advocating removal of the designation of any entities as 
NRSROs); Comment Letter of Financial Economists Roundtable (Dec. 1, 
2008) (``FER Comment Letter'') (``strongly endors[ing] eliminating 
from SEC regulations every prescriptive mandate that is or would be 
based solely on credit ratings set by NRSROs'' but acknowledging a 
division of opinion with regard to assessing the net benefits of 
``quasi-safe-harbors (offered mainly to officers and directors of 
money market mutual funds) based on credit ratings''); Comment 
Letter of CFA Institute (Mar. 26, 2009) (``CFA Institute Comment 
Letter'') (``agree[ing] with the objectives * * * to eliminate, 
modify or substitute references to ratings assigned by an NRSRO in 
an effort to reduce reliance on ratings that may have inadvertently 
conveyed an `official seal of approval' '' but questioning the 
breadth of certain proposed changes and urging retention of current 
regulation for certain rules).
    \51\ See, e.g., Comment Letter of the Investment Company 
Institute (``ICI Comment Letter'') (Sept. 5, 2008); Comment Letter 
of the American Securitization Forum (Sept. 5, 2008) (``ASF Comment 
Letter''); Comment Letter of the Vanguard Group (Aug. 1, 2008) 
(``Vanguard Comment Letter''). We proposed and adopted rules under 
the Credit Rating Agency Reform Act in 2007. See Oversight of Credit 
Rating Agencies Registered as Nationally Recognized Statistical 
Rating Organizations, Exchange Act Release No. 55231 (Feb. 2, 2007) 
[72 FR 6378 (Feb. 9, 2007)] (proposing release); Oversight of Credit 
Rating Agencies Registered as Nationally Recognized Statistical 
Rating Organizations, Exchange Act Release No. 55857 (June 5, 2007) 
[72 FR 33564 (June 18, 2007)] (adopting release). We also have, 
among other things, adopted amendments to those rules this year to 
impose additional requirements on NRSROs to address concerns about 
the integrity of their rating procedures and methodologies. See, 
e.g., Amendments to Rules for Nationally Recognized Statistical 
Rating Organizations, Exchange Act Release No. 59342 (Feb. 2, 2009) 
[74 FR 6456 (Feb. 9, 2009)]. We believe, however, that the 
amendments eliminating the references to NRSRO ratings in certain 
rules would address our separate concerns discussed above. See supra 
text accompanying note 11.
---------------------------------------------------------------------------

    Today we are amending Rules 5b-3 and 10f-3 under the Investment 
Company Act.\52\ As discussed further below, we believe that these 
amendments eliminate unnecessary references to credit ratings. The 
amendments may marginally reduce any undue reliance on credit ratings 
and may advance the goal of promoting better analysis of underlying 
investment decisions. In addition, because the references are no longer 
necessary and an adequate substitute exists for the reference in Rule 
10f-3, reliance on credit ratings in these contexts is no longer 
justified. We believe the amendments to Rule 5b-3 are necessary and 
appropriate in the public interest and consistent with the protection 
of investors and the purposes fairly intended by the policy and 
provisions of the Investment Company Act.\53\ We also believe that the 
amendments to Rule 10f-3 are consistent with the protection of 
investors.\54\
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    \52\ As discussed below and in a companion release, we are 
adopting amendments to Rule 5b-3 with respect to investments in 
refunded securities, and are deferring consideration of action on 
and requesting further comment on, amendments to Rule 5b-3 with 
respect to investments in repurchase agreements. See NRSRO Comment 
Re-Opening Release, supra note 12. We are also requesting further 
comment on the proposed amendments to Rule 3a-7 under the Investment 
Company Act and Rule 206(3)-3T under the Investment Advisers Act. 
See id. In June 2009, as part of our proposal on money market fund 
reform, we requested further comment on whether we should eliminate 
the use of NRSRO ratings in Rule 2a-7. See Money Market Fund Reform, 
Investment Company Act Release No. 28807 at Section II.A.a (June 30, 
2009) [74 FR 32688 (July 8, 2009)] (``Money Market Fund Proposing 
Release''). We also sought comment on what other alternatives we 
could adopt to encourage more independent credit risk analysis and 
meet the regulatory objectives of the requirement in Rule 2a-7 
regarding NRSRO ratings. We asked whether we should consider a 
roadmap for phasing in the eventual removal of NRSRO references from 
the rule. We specifically noted that we were considering an approach 
under which a money market fund's board would designate three (or 
more) NRSROs that the fund would look to for all purposes under Rule 
2a-7 in monitoring whether a security held by a fund continues to be 
an ``eligible security'' for purposes of the rule. We are not 
pursuing this approach with regard to the rules we are amending 
today because Rules 5b-3 and 10f-3 require that certain standards be 
met when the fund acquires those securities, and do not require 
subsequent monitoring of credit ratings by various NRSROs. See Rule 
5b-3(c)(iv); Rule 10f-3(a)(3).
    \53\ See Section 6(c) of the Investment Company Act.
    \54\ See Section 10(f) of the Investment Company Act.
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1. Refunded Securities (Rule 5b-3)
    Under Rule 5b-3, a ``refunded security'' is a debt security whose 
principal and interest payments are to be paid by U.S. government 
securities that have been irrevocably placed in an escrow account and 
are pledged only to the payment of the debt security.\55\ Section 
5(b)(1) of the Investment Company Act limits the amount that a fund 
that holds itself out as being ``diversified'' may invest in the 
securities of any one issuer (other than the U.S. Government). Rule 5b-
3 permits a fund that acquires a refunded security to treat it as an 
acquisition of the escrowed government securities for purposes of the 
diversification requirements of Section 5(b)(1) of the Act, if certain 
conditions are met.\56\
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    \55\ Rule 5b-3(c)(4).
    \56\ Rule 5b-3(b). Similarly under Rule 2a-7, a money market 
fund may treat the acquisition of a refunded security, as defined in 
Rule 5b-3(c)(4), as the acquisition of the escrowed government 
securities for purposes of Rule 2a-7's diversification requirements. 
Rule 2a-7(c)(4)(ii)(A), (B), 2a-7(a)(20) (definition of ``refunded 
security'').
---------------------------------------------------------------------------

    One of the conditions of Rule 5b-3 is that an independent certified 
public accountant (``independent accountant'') must have certified to 
the escrow agent that the escrowed securities will satisfy all 
scheduled payments of principal, interest, and applicable premiums on 
the refunded securities.\57\ The rule requires the certification by an 
independent accountant (together with the other conditions) to ensure 
that the bankruptcy of the issuer of the pre-refunded securities would 
not affect payments on the securities from the escrow account.\58\ This 
condition is not required, however, if the refunded

[[Page 52363]]

security has received a debt rating in the highest rating category from 
an NRSRO.\59\ The Commission included this exception because in rating 
refunded securities, NRSROs typically require the same 
determination.\60\
---------------------------------------------------------------------------

    \57\ Rule 5b-3(c)(4)(iii).
    \58\ See Treatment of Repurchase Agreements and Refunded 
Securities as an Acquisition of the Underlying Securities, 
Investment Company Act Release No. 25058 (July 5, 2001) [66 FR 36156 
(July 11, 2001)] (``Rule 5b-3 Adopting Release''), at text 
accompanying n. 25 (explaining that the conditions required in the 
definition of refunded security correspond to those in the 
definition of the term in Rule 2a-7); Revisions to Rules Regulating 
Money Market Funds, Investment Company Act Release No. 21837 (Mar. 
21, 1996) [61 FR 13956 (Mar. 28, 1996)] (``Rule 2a-7 1996 Amending 
Release''), at Section II.D.2.
    \59\ Rule 5b-3(c)(4)(iii).
    \60\ See Technical Revisions to the Rules and Forms Regulating 
Money Market Funds, Investment Company Act Release No. 22921 (Dec. 
2, 1997) [62 FR 64968 (Dec. 9, 1997)], at Section I.B.2.c.
---------------------------------------------------------------------------

    Last year the Commission proposed to eliminate the exception to the 
certification requirement for securities that have received the highest 
credit rating from an NRSRO. Under the proposed amendment, the 
accountant certification condition would apply uniformly to all 
refunded securities, regardless of the securities' credit rating.
    We are amending Rule 5b-3, as proposed, to eliminate the exception 
for refunded securities with certain credit ratings.\61\ Under the 
amended rule, an independent accountant must have certified to the 
escrow agent that the deposited securities will satisfy all scheduled 
payments of principal, interest and applicable premiums on the refunded 
securities.\62\ Thus, the same standard will apply for securities with 
the highest NRSRO debt rating as currently apply to those that have 
received lower or no ratings.
---------------------------------------------------------------------------

    \61\ Amended Rule 5b-3(c)(4)(iii).
    \62\ Id.
---------------------------------------------------------------------------

    Three commenters objected to the proposed amendment, asserting that 
requiring funds to obtain independent accountants' certifications for 
refunded securities is inefficient, could increase fund expenses and 
could decrease liquidity if funds choose not to bid on refunded 
securities for which certificates are not readily available.\63\ The 
amended rule, however, does not require that funds obtain such a 
certification. Rather, it requires that an independent accountant 
certify to the escrow agent that the escrowed securities will satisfy 
all scheduled payments. This requirement may be met, for example, by 
the fund manager confirming that a certification meeting the 
requirements of the rule was provided to the escrow agent.
---------------------------------------------------------------------------

    \63\ See Calvert Comment Letter (Sept. 5, 2008); Letter of 
Connecticut Treasurer (Sept. 4, 2008) (``Connecticut Treasurer's 
Comment Letter''); Oppenheimer Comment Letter (Sept. 4, 2008).
---------------------------------------------------------------------------

    Bond indentures or resolutions authorizing the issuance of the 
refunded bonds typically require that the escrow agent receive a 
certificate from an independent accountant that the escrowed securities 
will satisfy all scheduled payments on the refunded securities. Fund 
managers could confirm that the escrow agent has received such a 
certification, and this confirmation could come from any of multiple 
sources at little expense, such as the issuer's Web site, a municipal 
dealer's Web site or the escrow agent's Web site.\64\ Moreover, and as 
explained in the Proposing Release, a fund could satisfy the 
certification requirement of Rule 5b-3 by determining that a third 
party such as an NRSRO, in the course of evaluating an offering of 
refunded securities, already has determined that an independent 
accountant provided the required certification to the escrow agent.\65\
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    \64\ Although such information may not be readily available from 
all of these sources today, issuers, dealers, escrow agents or 
NRSROs are likely to provide such information to meet the needs of 
fund managers.
    \65\ See Investment Company Act Proposing Release, supra note 
10, at text accompanying n.59. Some rating agencies require 
certifications that we understand meet the requirements of Rule 5b-
3. See, e.g., Moody's Investors Services, Ratings Methodology: 
Refunded Bonds (June 2007) (available at http://www.moodys.com/
moodys/cust/research/MDCdocs/29/2006700000441141.pdf?doc_
id=2006700000441141&frameOfRef=municipal) (``The initial 
verification reports should be prepared by an individual Certified 
Public Accountant (CPA), a CPA firm, a Public Accounting Firm, or by 
another entity with nationally recognized proficiency in providing 
verification reports. Importantly, the verification should be 
provided by an entity independent of the issuer and refunding 
transaction.''); Fitch Ratings, Guidelines for Rating Prerefunded 
Municipal Bonds (Apr. 2, 2009) available at http://
www.fitchratings.com/creditdeskreports/report_frame.cfm?rpt_
id=431370; Standard & Poor's, Criteria/Governments/U.S. Public 
Finance: Defeasance (June 26, 2007) available at http://
www2.standardandpoors.com/portal/site/sp/en/us/page.article/
2,1,1,0,1204836565946.html#ID199.
---------------------------------------------------------------------------

    Because we understand that accountant certifications are typically 
provided during the course of a refunding transaction, we believe that 
it will not be difficult or expensive for fund managers to confirm that 
the certification has been provided to the escrow agent. Thus, we do 
not believe that eliminating the ratings requirement exception in Rule 
5b-3 is likely to result in significant additional costs to purchasers. 
Fund managers' ability to confirm without significant difficulty or 
expense that the requisite certification has been provided to the 
escrow agent should address concerns that the amendment could decrease 
the liquidity of refunded securities as a result of funds choosing not 
to bid on refunded securities for which certificates are unavailable.
2. Affiliated Underwritings (Rule 10f-3)
    Section 10(f) of the Investment Company Act prohibits a registered 
fund from knowingly purchasing any security for which an underwriter 
having certain relationships with the fund or its investment adviser 
(``affiliated underwriter'') is acting as a principal underwriter \66\ 
during the existence of an underwriting or selling syndicate for that 
security.\67\ The prohibition was designed to prevent the ``dumping'' 
of unmarketable securities on affiliated funds, either by forcing the 
fund to purchase unmarketable securities from the underwriting 
affiliate itself or by forcing or encouraging the fund to purchase the 
securities from another member of the syndicate.\68\
---------------------------------------------------------------------------

    \66\ The term ``principal underwriter'' means (in relevant part) 
an underwriter who, in connection with a primary distribution for 
securities: (1) Is in privity of contract with the issuer or an 
affiliated person of the issuer; (2) acting alone or in concert with 
one or more other persons, initiates or directs the formation of an 
underwriting syndicate; or (3) is allowed a rate of gross 
commission, spread, or other profit greater than the rate allowed 
another underwriter participating in the distribution. 15 U.S.C. 
80a-2(a)(29).
    \67\ Section 10(f) prohibits a registered fund from knowingly 
purchasing a security during the existence of an underwriting or 
selling syndicate if a principal underwriter of the security is an 
officer, director, member of an advisory board, investment adviser, 
or employee of the fund or is a person of which any such officer, 
director, member of an advisory board, investment adviser, or 
employee is an affiliated person. An affiliated person of a fund 
includes, among others: (1) Any person directly or indirectly 
owning, controlling, or holding with power to vote, five percent or 
more of the outstanding voting securities of the fund; (2) any 
person five percent or more of whose outstanding voting securities 
are directly or indirectly owned, controlled, or held with power to 
vote by the fund; and (3) any person directly or indirectly 
controlling, controlled by, or under common control with the fund. 
15 U.S.C. 80a-2(a)(3)(A), (B) and (C).
    \68\ See Report of the SEC, Investment Trusts and Investment 
Companies, H.R. Doc. No. 279, 76th Cong., 2d Sess., pt. 3, at 2581, 
2589 (1939). The sales were also used to alleviate certain of an 
affiliated underwriter's financial difficulties. For example, an 
underwriter could benefit by rapidly turning over its securities 
inventory to produce working capital and to reduce the related 
expenses of carrying the inventory. Congress also expressed concern 
regarding the amount of underwriting fees earned by the sponsors and 
affiliated persons who placed the securities with the fund. See 
Hearings on S.3580 Before a Subcommittee of the Commission on 
Banking and Currency, 76th Cong., 3d Sess. 209, 212-23 (1940).
---------------------------------------------------------------------------

    The Commission adopted Rule 10f-3 in 1958 to permit a fund that is 
affiliated with a member of an underwriting syndicate to purchase 
securities from the syndicate if certain conditions are met.\69\ The 
conditions are designed to address the risks raised by purchases that 
could benefit fund affiliates. For example, one condition of the rule 
requires that securities be purchased before the end of the first day 
on which any sales are made, at a price that is not more than the price 
paid by each other

[[Page 52364]]

purchaser of securities in that offering or in any concurrent offering 
of the securities.\70\ In addition, the commission, spread or profit 
received or to be received by the principal underwriters must be 
reasonable and fair compared to the commission, spread or profit 
received by other such persons in connection with the underwriting of 
similar securities being sold during a comparable time period.\71\ The 
rule also requires public reporting of securities purchases made in 
reliance on the rule. A fund must report the existence of any such 
purchases on Form N-SAR, and provide a written record of each 
transaction, setting forth from whom the securities were acquired, the 
identity of the underwriting syndicate's members, the terms of the 
transaction, and the information or materials on which the board has 
made a determination that the transaction complied with the procedures 
approved by the board.\72\
---------------------------------------------------------------------------

    \69\ Exemption of Acquisition of Securities During Existence of 
Underwriting Syndicate, Investment Company Act Release No. 2797 
(Dec. 1, 1958) [23 FR 9548 (Dec. 10, 1958)]. The rule codified the 
conditions of orders that the Commission had granted prior to 1958 
exempting certain funds from Section 10(f) to permit them to 
purchase specific securities.
    \70\ See Rule 10f-3(c)(2) (also providing an exception from the 
pricing provision for rights offerings required by law in certain 
foreign offerings).
    \71\ See Rule 10f-3(c)(6).
    \72\ See Rule 10f-3(c)(9).
---------------------------------------------------------------------------

    We amended Rule 10f-3 in 1979 to add municipal securities to the 
class of securities that funds could purchase under the rule.\73\ The 
rule defines municipal securities that may be purchased during an 
underwriting in reliance on the rule (``eligible municipal 
securities'') to include securities that have an investment grade 
rating from at least one NRSRO or, if the issuer or the entity 
supplying the revenues or other payments from which the issue is to be 
paid has been in continuous operation for less than three years (i.e., 
the security is a less seasoned security), one of the three highest 
ratings from an NRSRO.\74\ The rating requirement was designed to 
prevent the purchase of less seasoned and lower quality securities, and 
thereby reduce the risk of unloading unmarketable securities on the 
fund.\75\
---------------------------------------------------------------------------

    \73\ Rule 10f-3(c)(1)(iii). See Exemption of Acquisition of 
Securities During the Existence of Underwriting Syndicate, 
Investment Company Act Release No. 10736 (June 14, 1979) [44 FR 
36152 (June 20, 1979)] (``Rule 10f-3 1979 Adopting Release'').
    \74\ Rule 10f-3(a)(3). As noted above, an investment grade debt 
security is a security that has been rated in one of the four 
highest categories by at least one NRSRO. See supra text following 
note 22.
    \75\ See Rule 10f-3 1979 Adopting Release, supra note 73; 
Exemption of Acquisition of Securities During the Existence of 
Underwriting Syndicate, Investment Company Act Release No. 10592 
(Feb. 13, 1979) [44 FR 10580 (Feb. 21, 1979)], at Section B.2.
---------------------------------------------------------------------------

    In July 2008, we proposed to eliminate the references to NRSRO 
ratings in Rule 10f-3 and substitute alternate provisions that require 
the assessment of liquidity and credit risk.\76\ Those alternate 
provisions were designed to achieve the same purpose as that served by 
the references to credit ratings, in addressing concerns that funds 
might purchase less seasoned, unmarketable securities in affiliated 
underwritings.\77\
---------------------------------------------------------------------------

    \76\ See Investment Company Act Proposing Release, supra note 
10, at Section III.D.
    \77\ See id. at Section III.
---------------------------------------------------------------------------

    Most commenters on the proposed amendments did not specifically 
address the amendments to Rule 10f-3. As noted above, some of those 
commenters agreed generally with eliminating references to NRSRO 
ratings from Commission rules, while other commenters did not.\78\ One 
commenter specifically supported the proposed amendments to Rule 10f-
3.\79\ It noted that, although the duty to make credit determinations 
``may appear to require expertise beyond typical board experience, 
boards would be allowed to rely on information and assessments provided 
by other sources.'' \80\ Seven commenters specifically opposed the 
amendments to Rule 10f-3.\81\ Some expressed concerns that the proposed 
standards would likely increase the time and costs of the board of 
directors' oversight and could result in a lack of consistency among 
funds as to what is an eligible municipal security, and a lack of 
transparency in the board's subjective determinations.\82\
---------------------------------------------------------------------------

    \78\ See supra note 50 and accompanying text; Schwab Comment 
Letter; Calvert Comment Letter; SIFMA Comment Letter.
    \79\ See CFA Institute Comment Letter.
    \80\ Id.
    \81\ See, e.g., Independent Trustees of Fidelity Fixed-Income 
Funds Comment Letter (Oct. 3, 2008) (``Fidelity Independent Trustees 
Comment Letter''); SIFMA Comment Letter; Realpoint Comment Letter 
(Aug. 14, 2008).
    \82\ See Fidelity Independent Trustees Comment Letter; SIFMA 
Comment Letter. SIFMA also asserted that the proposed amendment 
would provide ``little added benefit while creating substantial 
market uncertainty.''
---------------------------------------------------------------------------

    Today we are adopting the amendments as proposed, and we address 
the concerns of commenters below. The amended rule eliminates the 
references to ratings and revises the rule's definition of ``eligible 
municipal security'' to mean securities that are sufficiently liquid 
that they can be sold at or near their carrying value within a 
reasonably short period of time.\83\ In addition, the securities would 
have to be either: (1) Subject to no greater than moderate credit risk; 
or (2) if they are less seasoned securities, subject to a minimal or 
low amount of credit risk.\84\
---------------------------------------------------------------------------

    \83\ For a discussion of the proposed amendments to Rule 10f-3, 
see Investment Company Act Proposing Release, supra note 10, at 
Section III.D.
    \84\ The amended rule defines ``eligible municipal securities'' 
to mean `` `municipal securities' as defined in Section 3(a)(29) of 
the [Exchange Act], that are sufficiently liquid such that they can 
be sold at or near their carrying value within a reasonably short 
period of time and either (i) [a]re subject to no greater than 
moderate credit risk; or (ii) [i]f the issuer of the municipal 
securities, or the entity supplying the revenues or other payments 
from which the issue is to be paid, has been in continuous operation 
for less than three years, including the operation of any 
predecessors, the securities are subject to a minimal or low amount 
of credit risk.'' Amended Rule 10f-3(a)(3).
---------------------------------------------------------------------------

    The standards we are adopting require a level of liquidity and 
credit quality that is very similar to that of the current rule, but 
without the reference to NRSRO ratings.\85\ These standards are 
designed to address the investor protection concerns that a fund and 
its investors might be harmed by the fund's purchase of unmarketable 
securities in an affiliated underwriting. A fund that purchases 
municipal securities that are sufficiently liquid should, by the terms 
of the amended rule, be able to sell the securities at or near their 
carrying value within a reasonably short period of time. Thus, the fund 
should be able to sell the securities, and thereby unwind its position 
and reduce its exposure, relatively quickly. Furthermore, securities 
that are subject to no greater than moderate credit risk or, if less 
seasoned, are subject to minimal or low credit risk, are similarly less 
likely to be unmarketable securities that have been ``dumped'' on the 
fund.\86\ Securities that meet these quality standards are likely to be 
more liquid, and thus able to be sold relatively quickly by the 
fund.\87\
---------------------------------------------------------------------------

    \85\ As discussed above, some commenters expressed concerns 
about a possible lack of consistency among funds as to what 
constitutes an ``eligible municipal security'' under the amended 
rule. See supra note 82 and accompanying text. Those commenters did 
not specify whether such lack of consistency might directly affect 
funds or investors, or might affect the municipal securities markets 
in an indirect way. We believe that funds' determinations as to 
whether particular securities meet the amended rule's standards of 
credit quality and liquidity will be sufficiently consistent for the 
purposes that Rule 10f-3 was adopted to promote, i.e., the 
protection of funds and their investors from the purchase of 
unmarketable securities.
    \86\ A municipal security (or its issuer) subject to a moderate 
level of credit risk would present average creditworthiness relative 
to other municipal or tax exempt issues or issuers. Moderate credit 
risk also would denote current low expectations of default risk, 
with an adequate capacity for payment of principal and interest. 
Municipal securities subject to minimal or low credit risk would be 
less susceptible to default risk (i.e., have a low risk of default) 
than those with moderate credit risk. These securities (or their 
issuers) also would demonstrate a strong capacity for principal and 
interest payments and present above-average creditworthiness 
relative to other municipal or tax exempt issues (or issuers).
    \87\ See M. David Gelfand, State and Local Government Debt 
Financing Sec.  8:72 (2nd. ed. 2007) (noting that municipal 
securities trade largely on the basis of creditworthiness).

---------------------------------------------------------------------------

[[Page 52365]]

    Protection of the fund is further provided by other existing 
provisions in the rule that require the fund's board of directors, 
including a majority of disinterested directors, to (1) approve 
procedures under which the fund purchases securities under the rule, 
(2) approve any needed changes to those procedures and (3) review 
purchases quarterly to assure that they conformed to the fund's 
procedures.\88\ Those provisions will continue to apply to affiliated 
underwritings under the amended rule,\89\ and the board's 
responsibilities with regard to fund procedures will apply to the new 
standards in the rule regarding liquidity and credit quality.\90\
---------------------------------------------------------------------------

    \88\ See Rule 10f-3(c)(10)(i)-(iii). See also Rule 10f-3 1979 
Adopting Release, supra note 73 (``[T]he Commission expects that 
investment company directors, in establishing procedures under the 
rule and determining compliance with such procedures, will address 
the concerns embodied in section 10(f) of the Act against 
overreaching and the placing of otherwise unmarketable securities 
with an investment company.''); Exemption for the Acquisition of 
Securities During the Existence of an Underwriting or Selling 
Syndicate, Investment Company Act Release No. 22775 (July 31, 1997) 
[62 FR 42401 (Aug. 7, 1997)] (``1997 Rule 10f-3 Adopting Release''), 
at text following n.51 (``A fund's board should be vigilant in 
reviewing the procedures and transactions as required by rule 10f-3 
as well as in conducting any additional reviews that it determines 
are needed to protect the interests of investors, particularly if 
the fund purchases significant amounts of securities in reliance on 
rule 10f-3.'').
    \89\ Rule 10f-3(c)(10); Investment Company Act Proposing 
Release, supra note 10, at n.69 and accompanying text.
    \90\ See amended Rule 10f-3(a)(3), (c)(10)(i).
---------------------------------------------------------------------------

    We believe that the standards provided in the amended rule--that an 
``eligible security'' must be sufficiently liquid that it can be sold 
at or near its carrying value within a reasonably short period of time, 
and either subject to no greater than moderate credit risk, or, if less 
seasoned, subject to a minimal or low amount of credit risk--are 
sufficiently clear to permit a fund board or fund investment adviser to 
understand the risks acceptable under the amended rule without 
significantly increasing the time and costs of board oversight. In 
addition, as we pointed out when we proposed the amendments to Rule 
10f-3, the amendments may emphasize for funds the need to independently 
evaluate the credit risks associated with the underwritten security, 
and may possibly benefit funds by enabling them to acquire a wider 
range of securities, including unrated securities, that present 
attractive investment opportunities and the requisite level of credit 
quality, even though they do not meet the current rule's ratings 
requirement.\91\ In exercising caution to ensure compliance with the 
revised standards, funds also might limit their acquisitions of 
municipal securities in reliance on the amended rule to securities of 
higher credit quality than required under the current rule.
---------------------------------------------------------------------------

    \91\ See Investment Company Act Proposing Release, supra note 
10, at Section VI.A.
---------------------------------------------------------------------------

    In developing procedures under the rule, the board of directors may 
incorporate ratings, reports, analyses, opinions and other assessments 
issued by third-parties, including NRSROs, although an NRSRO rating, by 
itself could not substitute for the evaluation performed by the board. 
We would expect the board to evaluate assessments it intends to 
incorporate and the third-party sources that provide those 
assessments.\92\ The board could then incorporate in its procedures 
those third party assessments that it determines are reliable. The 
ability to incorporate outside assessments may mitigate the potential 
increased burdens about which some commenters expressed concern.\93\
---------------------------------------------------------------------------

    \92\ When a fund's determination with regard to a security 
departs from ratings provided by NRSROs (including ratings by 
``unsolicited'' NRSROs), the board may choose to require in its 
policies and procedures that the fund document the rationale 
underlying the determination. See Realpoint Comment Letter 
(recommending that the Commission require that a fund document when 
its determinations differ from those of ``unsolicited'' NRSROs). We 
are not adopting such a requirement because we believe the board 
should make the determination regarding the extent to which it will 
rely on the rating of any NRSRO as an appropriate indication of 
credit quality or liquidity.
    \93\ See supra note 82 and accompanying text. The ability to 
rely on outside assessments also addresses to some extent the 
concerns expressed by one commenter about market uncertainties. See 
SIFMA Comment Letter. Any remaining increase in uncertainty (for 
funds and their shareholders) that results from the exercise of 
discretion by funds and their advisers in determining which 
municipal securities to purchase under the amended rule, is an 
inherent corollary of the flexibility added by the rule amendments. 
We also note, with regard to concerns about transparency, that 
investors and fund analysts will continue to have access to 
information about the securities that funds hold and have purchased 
in reliance on rule 10f-3. See Form N-SAR [17 CFR 274.101], Item 770 
(reporting of transactions effected in reliance on rule 10f-3); Form 
N-CSR [17 CFR 274.128], Item 6(a) (disclosure in shareholder reports 
of portfolio holdings); Form N-Q [17 CFR 274.130], Item 1 (quarterly 
schedule of portfolio holdings).
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III. Paperwork Reduction Act

A. Rule and Form Amendments Under the Exchange Act

    Certain provisions of the amendments to the forms contain 
``collection of information'' requirements within the meaning of the 
Paperwork Reduction Act of 1995 (``PRA'').\94\ The hours and costs 
associated with preparing and filing the disclosure, filing the forms 
and schedules and retaining records required by these regulations 
constitute reporting and cost burdens imposed by each collection of 
information. An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid control number. The titles of the affected 
information forms are ``Form ATS-R'' (OMB Control Number 3235-0509) and 
``Form PILOT'' (OMB Control Number 3235-0507). Responses to this 
collection are mandatory for broker-dealers that comply Regulation ATS 
(in the case of Form ATS-R) and for SROs that operate pilot trading 
systems (in the case of Form PILOT). For the reasons discussed below, 
we do not believe the amendments will result in a material or 
substantive revision to these collections of information.\95\
---------------------------------------------------------------------------

    \94\ 44 U.S.C. 3501 et seq.
    \95\ 5 CFR 1320.5(g).
---------------------------------------------------------------------------

    The amendments to Form ATS-R and Form PILOT revise the forms to 
require that information which had been reported as separate items 
(i.e., investment grade debt corporate debt securities and non-
investment grade corporate debt securities) now will be combined and 
reported as a single item (i.e., corporate debt securities). In all 
other respects, as discussed in the Exchange Act Proposing Release, the 
information collected on these forms remains unchanged.\96\ 
Accordingly, the Commission does not believe the amendments will result 
in a substantive or material revision to those collections of 
information\97\ within the meaning of the PRA.\98\ The Commission 
received no comments on the PRA analysis in the Exchange Act Proposing 
Release applicable to Forms ATS-R and PILOT.
---------------------------------------------------------------------------

    \96\ See Exchange Act Proposing Release, 73 FR at 40097.
    \97\ 5 CFR 1320.5(g).
    \98\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

B. Rule Amendments Under the Investment Company Act

    Certain provisions of the amendments to Rule 10f-3 contain 
``collection of information'' requirements within the meaning of the 
PRA.\99\ The title for the collection of information is ``Rule 10f-3 
under the Investment Company Act of 1940, Exemption for the Acquisition 
of Securities During the Existence of an Underwriting and Selling 
Syndicate'' (OMB Control No. 3235-0226). Responses to this collection 
are mandatory for funds that intend to rely on Rule 10f-3. Records of 
information made in connection with this requirement are required to be

[[Page 52366]]

maintained for inspection by Commission staff, but the collection will 
not otherwise be submitted to the Commission. There are currently no 
approved collections of information for Rule 5b-3, and the amendments 
we are adopting today would not create any new collections.
---------------------------------------------------------------------------

    \99\ 44 U.S.C. 3501-3520.
---------------------------------------------------------------------------

    We requested comment on the collection of information requirements 
in the Investment Company Act Proposing Release and submitted the 
revisions to the collections of information to OMB for review and 
approval in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. We 
received no comments that specifically addressed the collection of 
information requirements. An agency may not conduct or sponsor, and a 
person is not required to respond to, a collection of information 
unless it displays a currently valid control number.
    Rule 10f-3 permits a fund that is affiliated with a member of an 
underwriting syndicate to purchase securities from the syndicate if 
certain conditions are met. In the case of a municipal security, the 
security generally must have received an investment grade rating by at 
least one NRSRO, or if it is a less seasoned security, one of the three 
highest ratings by an NRSRO. The amended rule eliminates this condition 
and includes a substitute therefor.\100\ Under the amendment an 
``eligible municipal security'' means a security that is sufficiently 
liquid that it can be sold at or near its carrying value within a 
reasonably short period of time, and is either: (1) Subject to no 
greater than moderate credit risk; or (2) if it is a less seasoned 
security, subject to a minimal or low amount of credit risk.
---------------------------------------------------------------------------

    \100\ See supra notes 83-84 and accompanying text.
---------------------------------------------------------------------------

    Rule 10f-3 also requires fund boards to (1) approve procedures 
under which the fund purchases securities in reliance on the rule, (2) 
approve needed changes to the procedures and (3) review purchases 
quarterly to ensure they were effected in compliance with the 
procedures.\101\ Accordingly, fund boards currently review purchases of 
municipal securities made in reliance on Rule 10f-3, and should 
continue to do so under the amended rule.
---------------------------------------------------------------------------

    \101\ Rule 10f-3(c)(10).
---------------------------------------------------------------------------

    In our most recent PRA submission, Commission staff estimated that 
each year, approximately 350 funds engage in transactions in reliance 
on Rule 10f-3.\102\ Staff further estimated that each fund would, on 
average, take two hours to review and revise, as needed, written 
procedures for these transactions. In the Investment Company Act 
Proposing Release, we stated that we believed that any revisions funds 
would have to make to comply with the proposed amendment would be 
incorporated in the two hours of review.\103\ Some commenters asserted 
that the proposed amendment would likely increase the time and costs of 
the board of directors' oversight.\104\
---------------------------------------------------------------------------

    \102\ See Submission for OMB Review, Comment Request, Rule 10f-3 
[73 FR 13263 (Mar. 12, 2008)].
    \103\ See Investment Company Act Proposing Release, supra note 
10, at Section V.B.
    \104\ See supra note 82 and accompanying text.
---------------------------------------------------------------------------

    We continue to believe that the specific changes a board might make 
to the procedures that are designed to comply with the amendments would 
not be significant. As noted above, we are adopting a standard 
regarding liquidity and credit quality that is very similar to that of 
the current rule.\105\ In addition, directors may incorporate 
securities quality assessments by third party sources that the 
directors determine are reliable in the procedures they approve and 
their review of municipal securities purchases made in reliance on Rule 
10f-3, which may mitigate the potential increased burdens on fund 
boards.\106\ Nevertheless, in consideration of the comments, we 
recognize that there may be an additional one-time burden for fund 
boards to review and approve revised procedures designed to ensure 
compliance with the amendment to Rule 10f-3.\107\ Commission staff 
estimates that each fund board would incur a one-time burden of two 
hours for a total burden for all fund boards of 700 hours at a cost of 
$2.8 million.\108\ Amortized over three years, this would be an annual 
burden of 0.67 hours per fund and 235 hours for all funds.\109\
---------------------------------------------------------------------------

    \105\ See supra text accompanying note 85.
    \106\ See supra note 93 and accompanying text. These concerns 
were expressed with respect to the proposed amendments generally, 
and commenters did not provide any estimates of the increased burden 
that boards might incur under the proposed amendments.
    \107\ We do not anticipate the revised procedures would require 
an increase in the current estimated time the board spends each 
quarter to review acquisitions of securities for compliance with 
Rule 10f-3.
    \108\ These estimates are based on the following calculations: 
350 fund boards x 2 hours = 700 hours; 700 hours x $4000 = 
$2,800,000. The estimate for the hourly cost for a fund board is 
based on an average board size of 8 directors and a cost of $500 per 
hour for each director.
    \109\ This estimate is based on the following calculation: 350 
fund boards x 0.67 hours = 234.5 hours.
---------------------------------------------------------------------------

    IV. Cost-Benefit Analysis

A. Rule and Form Amendments Under the Exchange Act

    The Commission is sensitive to the costs and benefits imposed by 
its rules. The Commission notes that no comments addressed the 
Commission's analysis of the costs and benefits associated with the 
proposed amendments to Rule 3a1-1, Regulation ATS, Form ATS-R and Form 
PILOT contained in the Exchange Act Proposing Release.
1. Benefits
    The amendments to Rule 3a1-1, Regulation ATS, Form ATS-R and Form 
PILOT eliminate the separate definitions of and references to 
investment grade corporate debt securities and non-investment grade 
corporate debt securities and replace them with a single category, 
``corporate debt securities.'' The Commission believes that the 
inclusion of requirements relating to securities credit ratings are no 
longer necessary to achieve the regulatory purpose of these rules, and 
may help marginally reduce any undue reliance on credit ratings.
    For reasons discussed above, the Commission believes that it is no 
longer necessary to assess trading volumes in the narrower segments of 
investment grade and non-investment grade corporate debt securities to 
fulfill the purposes of those rules and forms. Broker-dealers that are 
subject to Regulation ATS will no longer have to purchase and keep 
track of credit ratings solely for the purpose of Regulation ATS. The 
other classes of securities and the threshold levels themselves remain 
unchanged. With respect to the changes to Form ATS-R and Form PILOT, we 
believe that combining investment grade and non-investment grade 
corporate debt securities into a single class for purposes of those two 
forms will benefit market participants by making reporting slightly 
more streamlined and may reduce undue reliance on references to ratings 
issued by credit rating agencies. At the same time, the Commission does 
not believe that the amendments to these rules and forms will 
significantly affect market participants because the total units and 
total dollar volume of corporate debt securities transacted will still 
be reported. In addition, the removal of these requirements relating to 
credit ratings reduces compliance costs for ATSs.
2. Costs
    The amendments to Rule 3a1-1, Regulation ATS, Form ATS-R and Form 
PILOT eliminate the separate definitions of and references to 
investment grade corporate debt securities and non-investment grade 
debt securities and replace them with a single category, ``corporate 
debt securities.'' We believe

[[Page 52367]]

that these changes will not impose any significant costs on market 
participants.
    The amendments to Rule 3a1-1 and Regulation ATS will marginally 
reduce the likelihood of an ATS meeting the thresholds in those rules. 
For example, under Rule 3a1-1 as it existed prior to today's action, an 
ATS that had 40% of the average daily dollar trading volume in non-
investment grade corporate debt securities and 0% of the average daily 
dollar trading volume in investment grade corporate debt securities for 
at least four of the preceding six calendar months could have been 
required to register as an exchange. Under amended Rule 3a1-1, the 
Commission can no longer require the ATS to register as an exchange, 
because its average daily dollar trading volume in corporate debt 
securities combined is less than 40%. A potential cost of the 
amendments to Rule 3a1-1 and Regulation ATS is that an ATS that 
exceeded one of the thresholds that existed prior to today and thus 
would have become subject to additional regulatory requirements (in the 
case of Regulation ATS) or must register as an exchange (in the case of 
Rule 3a1-1) will no longer exceed the threshold and will not have to 
meet the attendant requirements. However, the Commission believes that 
this possibility is remote, and that the amendments are unlikely to 
impose any costs on investors, market participants or the national 
market system generally.
    We believe that any costs associated with the changes to Form ATS-R 
and Form PILOT will be minimal. Respondents already determine and 
report the total units and total trading volume for investment grade 
and non-investment grade corporate debt securities separately. On the 
revised forms, respondents will report them together as a single item 
for ``corporate debt securities.'' Combining the categories of 
investment grade and non-investment grade debt on these forms will not 
significantly affect the level of information available to the 
Commission in monitoring ATSs. We expect that any programming costs to 
market participants to implement the reporting changes to these forms 
will be minimal and involve adding two previously reported items 
together and reporting the combined amount.
    In addition, broker-dealers that are subject to Regulation ATS will 
no longer be required to purchase and keep track of credit ratings 
solely for the purpose of Regulation ATS. If broker-dealers subject to 
Regulation ATS no longer purchase credit rating data from NRSROs, the 
amendments may marginally reduce the revenues of NRSROs that charge 
subscriber fees. However, we believe that the number of broker-dealers 
subject to Regulation ATS is small and these broker-dealers represent a 
very small portion of NRSRO customers. Further, these broker-dealers 
may subscribe to NRSRO ratings for other purposes. Therefore, we 
believe that any impact on the revenues of the NRSROs will likely be 
small.
    Also, combining the categories of investment grade and non-
investment grade debt on these forms also will marginally reduce the 
level of information available to the Commission in monitoring ATSs. 
This may marginally reduce the ability of the Commission to stay 
abreast of changes to the trading of corporate debt securities. 
However, the Commission believes that the elimination of this detailed 
information will not significantly affect monitoring of ATSs because 
the Commission will still be able to monitor the volume of corporate 
debt traded by an ATS.

B. Rule Amendments Under the Investment Company Act

    As discussed above, the rule amendments we are adopting today 
eliminate certain references to NRSRO ratings in Rules 5b-3 and 10f-3. 
The amendments to Rule 5b-3 remove an exception based on credit 
ratings. The amendments to Rule 10f-3 substitute references to 
alternative credit quality and liquidity criteria that are similar to 
that of the current rule. We prepared a cost-benefit analysis in the 
Investment Company Act Proposing Release, and received comments 
relating to that analysis.
1. Benefits
    The amendments to Rules 5b-3 and 10f-3 are part of our larger 
initiative to eliminate references to NRSRO ratings from Commission 
rules where possible. This initiative is designed to address the 
concern that the inclusion in the Commission's rules and forms of 
requirements relating to security ratings could create the appearance 
that the Commission had, in effect, given its ``official seal of 
approval'' on ratings, which could adversely affect the quality of due 
diligence and investment analysis performed and lead to undue reliance 
on ratings. We noted that the proposed amendments to eliminate ratings 
as a whole might result in increased market efficiency by affording 
funds access to securities that do not meet the rating requirements in 
the current rules, but that would satisfy the credit risk and liquidity 
standards in the proposed amendments.\110\ It is difficult to estimate 
specifically the benefits of the amendments to Rules 5b-3 and 10f-3 in 
isolation. We believe that the amendments to these rules remove 
unnecessary references to credit ratings, which may reduce undue 
reliance on credit ratings. Because these references are no longer 
necessary, and an appropriate substitute exists for the reference in 
Rule 10f-3, reliance in these contexts is no longer justified. In 
addition, the amendment to Rule 10f-3 could emphasize the importance to 
funds that acquire municipal securities in an affiliated underwriting 
of making an independent evaluation of the credit risks associated with 
the underwritten security. Finally, by moving away from a required 
reliance on credit ratings in our rules, funds may possibly benefit by 
acquiring a wider range of securities that present attractive 
investment opportunities and the requisite level of credit quality, 
even though they do not meet the current rule's ratings requirement.
---------------------------------------------------------------------------

    \110\ See Investment Company Act Proposing Release, supra note 
10, at Section VII.
---------------------------------------------------------------------------

2. Costs
    We anticipate that funds and investment advisers may incur certain 
costs as a result of the amendments we are adopting today. These costs 
will principally relate to the replacement of the NRSRO ratings 
standard with the new credit quality and liquidity criteria. Commenters 
asserted that elimination of a bright-line standard could create 
additional costs and uncertainty in the application of, compliance 
with, and enforcement of the rule.\111\ They also asserted that the 
subjective judgment-based standard in the proposed amendments might 
cause funds to acquire securities that do not meet the particular 
ratings requirement and that could result in the concerns that the 
rating requirements were designed to address (e.g., poor liquidity or 
credit quality). We understand these concerns. However, we believe that 
the alternative credit quality and liquidity criteria we are 
substituting for NRSRO ratings will achieve the same purpose the 
ratings were designed to meet, and that they are sufficiently clear to 
permit a fund board and adviser to understand the risks acceptable 
under the rules. In determining a security's credit quality and 
liquidity, fund boards and advisers will, of course, be free to 
incorporate ratings, reports and analyses issued by, third parties, 
including NRSROs. We

[[Page 52368]]

believe that most fund advisers, in the ordinary course of managing 
portfolios, already evaluate third party opinions, including those of 
ratings agencies, that provide assessments of the credit quality and 
liquidity of debt instruments. We also believe that the boards and 
advisers of funds that rely on Rule 10f-3 are likely to look to those 
third parties in which they have confidence when incorporating third 
party assessments in making their determinations. For these reasons, we 
do not anticipate that the amendments will result in significant costs 
or compromise investor protection.
---------------------------------------------------------------------------

    \111\ See, e.g., Oppenheimer Comment Letter (``a subjective 
standard is difficult to apply, difficult to test for compliance, 
and causes uncertainty regarding enforcement'').
---------------------------------------------------------------------------

    We are making changes today to two rules under the Investment 
Company Act, which are limited in scope. As noted above, we believe 
that the standards in the Rule 10f-3 amendments are similar to the 
NRSRO ratings they replace. Thus, we believe it is unlikely that the 
amendments will result in unintended adverse consequences or involve 
conflicts with other regulations, as some commenters have 
suggested.\112\ Those comments appeared to address the consequences of 
eliminating references to other rules, such as Rule 2a-7 or the entire 
group of rules we proposed to amend, the consequences of which could be 
more substantial.
---------------------------------------------------------------------------

    \112\ See, e.g., SIFMA Comment Letter; Comment Letter of 
Institutional Money Market Funds Ass'n (Sept. 5, 2008).
---------------------------------------------------------------------------

    Rule 5b-3. The amendments we are adopting today eliminate 
references to NRSRO ratings in the definition of ``refunded security'' 
in Rule 5b-3. We anticipate that our elimination of references to NRSRO 
ratings in the definition of ``refunded security'' in Rule 5b-3 is 
unlikely to result in significant additional costs for funds that rely 
on the rule.\113\ Under the amendment, in order to meet the definition 
of a ``refunded security'' for purposes of the rule, an independent 
accountant must have certified to the escrow agent that the deposited 
securities will satisfy all scheduled payments of principal, interest 
and applicable premiums on the refunded securities.\114\ This standard 
will apply to all securities regardless of their rating.
---------------------------------------------------------------------------

    \113\ See supra Section II.A.2.
    \114\ Amended Rule 5b-3(c)(4).
---------------------------------------------------------------------------

    Without providing specific estimates, some commenters stated this 
amendment could create higher costs for funds and adversely affect the 
liquidity of refunded securities by requiring them to obtain an 
independent accountant's certification.\115\ The amended rule, however, 
does not require funds to obtain accountants' certificates, but 
requires the escrow agent to have received an accountant's 
certification. Commenters also indicated that it may not always be 
clear whether the escrow agent for a refunded security has received the 
necessary certification, thus requiring funds to incur costs related to 
determining the certification status of each refunded security.\116\ As 
noted above, we understand that an independent accountant typically 
provides the escrow agent a certification during the course of a 
refunding transaction.\117\ We believe that fund managers could consult 
any of multiple sources at little expense to confirm the escrow agent's 
receipt of this certification, including, for example, the issuer's Web 
site, a municipal dealer's Web site or the escrow agent's Web 
site.\118\ In addition, funds may be able to satisfy the certification 
requirement of Rule 5b-3 by confirming that an NRSRO determined that an 
independent accountant has provided the required certification to the 
escrow agent.\119\ For these reasons, we believe that eliminating the 
ratings requirement exception in Rule 5b-3 is unlikely to result in 
additional costs to purchasers. Based on our belief that the amendment 
to Rule 5b-3 would not result in additional costs or pose compliance 
difficulties for fund managers, we do not share commenters' concerns 
that the rule amendment could decrease the liquidity of refunded 
securities.
---------------------------------------------------------------------------

    \115\ See, e.g., Calvert Comment Letter.
    \116\ See, e.g., Connecticut Treasurer's Comment Letter.
    \117\ See supra text preceding note 64.
    \118\ See supra note 64 and accompanying text.
    \119\ See supra note 65 and accompanying text.
---------------------------------------------------------------------------

    Rule 10f-3. In the Investment Company Act Proposing Release, we 
stated that our belief that the proposed amendment to Rule 10f-3 would 
not impose costs on funds that rely on Rule 10f-3 to purchase municipal 
securities.\120\ Some commenters asserted that the proposed amendments 
might increase the costs and time devoted to board oversight of these 
transactions and could result in a lack of consistency among funds as 
to what is an eligible municipal security, and a lack of transparency 
in the board's subjective determinations.\121\ Rule 10f-3 requires the 
fund's board to determine that the fund has procedures reasonably 
designed to ensure that purchases are made in compliance with the rule 
and to determine each quarter that purchases made have been effected in 
compliance with the procedures.\122\ As noted above in our PRA 
analysis, we currently estimate that boards spend, on average, two 
hours each year revising procedures designed to ensure compliance with 
the rule and reviewing transactions to determine whether they have been 
effected in compliance with the procedures.\123\ We anticipate that the 
specific changes a board might make to the procedures that are designed 
to comply with the amendments would not be significant because, as 
noted above, we are adopting a level of credit quality and liquidity 
that is very similar to that of the current rule. In addition, 
directors may use securities quality assessments by outside sources 
that they determine are reliable in the procedures they approve and 
their review of municipal securities purchases made in reliance on Rule 
10f-3. We anticipate this ability to use assessments of third parties 
may mitigate the potential increased oversight burdens on fund 
boards.\124\ After consideration of the comments, however, we recognize 
that fund boards may incur one-time costs to approve revised policies 
and procedures as a result of the amendment to Rule 10f-3. Staff 
estimates that a board may take two hours to review and approve revised 
procedures designed to ensure that transactions entered into in 
reliance on the rule comply with the amendment to Rule 10f-3. Staff 
further estimates that approximately 350 funds engage in transactions 
in reliance on Rule 10f-3. Staff estimates that boards of these funds 
would incur one-time costs of $8000 to review and approve revised 
procedures for a total cost to all funds of $2.8 million.\125\
---------------------------------------------------------------------------

    \120\ See Investment Company Act Proposing Release, supra note 
10, at text preceding n.107.
    \121\ See, e.g., Fidelity Independent Trustees Comment Letter 
(``The proposed standards, given their emphasis on judgment, would 
likely increase the time and costs devoted to that oversight.'').
    \122\ Rule 10f-3(c)(10)(i), (iii).
    \123\ See supra text following note 102.
    \124\ See supra text accompanying note 106. These commenters did 
not provide any estimates of the increased burden that boards might 
incur under the proposed amendments.
    \125\ This is based on the following calculation: 350 funds x 2 
hours x $4,000 per hour of board time = $2,800,000.
---------------------------------------------------------------------------

    We do not believe that the amendments would significantly change 
the amount of time the board would spend to review transactions each 
quarter. We believe that a fund adviser, rather than the board, 
determines whether a security meets the definition of an eligible 
municipal security for purposes of Rule 10f-3. We also believe that the 
standards in the amended definition are sufficiently clear to allow a 
fund adviser to understand the risks and level of liquidity acceptable 
under

[[Page 52369]]

the rule.\126\ Fund advisers may use securities quality assessments by 
third parties, including NRSROs, that the board or adviser determines 
are reliable in its review of municipal securities purchases made in 
reliance on Rule 10f-3, which may offset concerns about additional 
costs that may result from the amendment. We do not believe that the 
proposed amendments would result in increased costs for advisers in 
determining whether securities are ``eligible municipal securities'' 
under the amended rule. When the board performs its quarterly review of 
transactions, we believe that the board would focus on reviewing 
whether the purchase was effected in compliance with the procedures the 
board has established.\127\ For these reasons, we continue to believe 
that the standards we are substituting with respect to eligible 
municipal securities will not require significantly greater 
consideration of these transactions on the part of the board than we 
have previously estimated.
---------------------------------------------------------------------------

    \126\ As discussed above, we believe that funds' determinations 
as to whether particular securities meet the amended rule's 
standards of credit quality and liquidity will be sufficiently 
consistent for the purposes that Rule 10f-3 was adopted to promote, 
i.e., the protection of funds and their investors from the purchase 
of unmarketable securities. See supra note 85. With regard to 
concerns about transparency, we note that investors and fund 
analysts will continue to have access to information about the 
securities that funds hold and have purchased in reliance on Rule 
10f-3. See supra note 93.
    \127\ See 1997 Rule 10f-3 Adopting Release, supra note 88, at 
text following n.51.
---------------------------------------------------------------------------

V. Consideration of Burden on Competition and Promotion of Efficiency, 
Competition and Capital Formation

A. Rule and Form Amendments Under the Exchange Act

    Section 3(f) of the Exchange Act \128\ requires the Commission, 
whenever it engages in rulemaking and is required to consider or to 
determine whether an action is necessary or appropriate in the public 
interest, to consider whether the action will promote efficiency, 
competition and capital formation. In addition, Section 23(a)(2) of the 
Exchange Act \129\ requires the Commission, when promulgating rules 
under the Exchange Act, to consider the impact any such rules would 
have on competition. Section 23(a)(2) further provides that the 
Commission may not adopt a rule that would impose a burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Exchange Act. The Commission notes that no commenters addressed 
the effect that the proposed changes to Rule 3a1-1, Regulation ATS, 
Form ATS-R and Form PILOT would have on efficiency, competition and 
capital formation.
---------------------------------------------------------------------------

    \128\ 15 U.S.C. 78c(f).
    \129\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    We believe that the amendments to Rule 3a1-1 under the Exchange Act 
and Rules 300 and 301 of Regulation ATS will not create any adverse 
impact on efficiency, competition or capital formation. The Commission 
believes that the inclusion of requirements relating to credit ratings 
are no longer necessary to achieve the regulatory purpose of these 
rules, and may help marginally reduce any undue reliance on credit 
ratings. Broker-dealers that are subject to Regulation ATS will no 
longer be required to purchase and keep track of credit ratings solely 
for the purpose of Regulation ATS. This reduces the cost to comply with 
Regulation ATS. However, we believe that any impact on the revenues of 
the NRSROs will be inconsequential. Therefore, these changes should not 
impose any additional burdens on competition.
    The Commission believes that combining investment grade and non-
investment grade corporate debt securities into a single class of 
securities for purposes of the thresholds in those rules is unlikely to 
affect whether an ATS crosses one of those thresholds. Moreover, the 
other classes of securities for which the thresholds are applied--and 
the levels of the thresholds themselves--remain unchanged. Therefore, 
these changes should not affect the development of ATSs or capital 
formation.
    The amendments being adopted today also will increase the effective 
thresholds for Rule 3a1-1(a) under the Exchange Act and Rules 301(b)(5) 
and 301(b)(6) of Regulation ATS for systems that trade corporate debt 
securities. The Commission believes that these changes will not impact 
whether any ATS crosses one of these thresholds. However, as outlined 
above,\130\ the changes could have the effect of reducing the 
regulatory requirements for some ATSs at some time in the future by 
potentially reducing the likelihood that an ATS would be required to 
register as an exchange. The Commission believes that the efficiency 
gains from combining the two categories of investment-grade and non-
investment grade corporate debt into the single category of corporate 
debt justifies these risks.
---------------------------------------------------------------------------

    \130\ See supra Section II.A.4.
---------------------------------------------------------------------------

    The changes to Form ATS-R and Form PILOT will simplify reporting 
for ATSs and SROs that operate pilot trading systems. Form ATS-R and 
Form PILOT respondents are already required to determine and report the 
volumes of corporate debt securities. A single reporting item for 
``corporate debt securities'' will replace the existing separate 
entries for ``investment grade corporate debt securities'' and ``non-
investment grade corporate debt securities.'' Since respondents will no 
longer have to keep track of ratings, the calculation of these items 
does not force the respondent to purchase credit ratings solely for the 
purpose of Form ATS-R or Form PILOT.
    For the reasons discussed above, we believe that the changes to 
Form ATS-R and Form PILOT are unlikely to have any significant impact 
on efficiency, competition or capital formation.

B. Rule Amendments Under the Investment Company Act

    Investment Company Act Section 2(c) requires us, when engaging in 
rulemaking where we are required to consider or determine whether an 
action is necessary or appropriate in the public interest, to consider, 
in addition to the protection of investors, whether the action will 
promote efficiency, competition and capital formation.\131\
---------------------------------------------------------------------------

    \131\ 15 U.S.C. 80a-2(c).
---------------------------------------------------------------------------

    In the Investment Company Act Proposing Release, we indicated our 
belief that that the amendments to Rules 5b-3 and 10f-3 would not 
significantly affect competition or have an adverse affect on capital 
formation. We noted that the proposed amendments to eliminate ratings 
as a whole might have some negative effect on efficiency by eliminating 
an objective standard in credit quality determinations, or might result 
in increased market efficiency by affording funds access to securities 
that do not meet the rating requirements in the current rules, but that 
they would satisfy the credit risk and liquidity standards in the 
proposed amendments.\132\ We also stated that we did not believe that 
the amendments to Rules 5b-3 and 10f-3 would result in significant 
costs to investment companies, advisers or investors. We did not 
receive any comments that specifically addressed the effect of the 
proposed amendments to Rules 5b-3 and 10f-3 on efficiency, competition 
and capital formation.
---------------------------------------------------------------------------

    \132\ See Investment Company Act Proposing Release, supra note 
10, at Section VII.
---------------------------------------------------------------------------

    As discussed above, the amendments we are adopting today to Rules 
5b-3 and 10f-3 are part of a larger initiative to eliminate certain 
references to NRSRO ratings from Commission rules. The amendments to 
Rule 5b-3 remove an

[[Page 52370]]

exception based on credit ratings, and do not require an analysis of 
liquidity or credit quality. In the amendment to Rule 10f-3, we have 
substituted standards that require a level of credit quality and 
liquidity that is similar to the standards in the current rule, but 
without references to NRSRO ratings. These standards are designed to 
achieve the same purpose as ratings references were designed to meet, 
with minimal costs and consistent with the protection of investors. We 
believe that the amendments eliminate unwarranted references to credit 
ratings, which may reduce undue reliance on credit ratings and advance 
the goal of promoting better analysis of underlying investment 
decisions. Because these references are no longer necessary and an 
adequate substitute exists for the reference in Rule 10f-3, reliance on 
credit ratings in these contexts is no longer justified. With respect 
to the standards in amended Rule 10f-3, in developing procedures under 
the rule, boards may incorporate ratings reports, analyses and other 
assessments issued by third parties, including NRSROs, although an 
NRSRO rating, by itself, could not substitute for the evaluation 
required to be performed under the amendments to the rules. For these 
reasons, we continue to believe that the amendments to Rules 5b-3 and 
10f-3 are unlikely to result in any significant impact on competition 
or capital formation. We also believe that the amendment to Rule 10f-3 
which is limited in scope, is unlikely to have a significant effect on 
efficiency by eliminating an objective standard in credit quality 
determinations, or to result in significant market efficiency by 
affording funds access to securities that do not meet the rating 
requirement in the current rule but that would satisfy the revised 
standards. Similarly, because we believe that fund managers will not 
have significant difficulty or incur significant expense to confirm 
that an escrow agent has received the requisite certification from an 
independent accountant, we do not believe that the amendment to Rule 
5b-3 eliminating the exception to this requirement for highly rated 
securities is likely to have a significant effect on efficiency.

VI. Final Regulatory Flexibility Certification and Analysis

A. Rule and Form Amendments Under the Exchange Act

    Section 3(a) of the Regulatory Flexibility Act of 1980 \133\ 
(``RFA'') requires the Commission to undertake an initial regulatory 
flexibility analysis of proposed rule amendments on small entities 
unless the Commission certifies that the rule, if adopted, would not 
have a significant economic impact on a substantial number of small 
entities.\134\ The Commission notes that no comments addressed the 
effect that the proposed changes to Rule 3a1-1, Regulation ATS, Form 
ATS-R and Form PILOT would have on small entities.
---------------------------------------------------------------------------

    \133\ 5 U.S.C. 603(a).
    \134\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------

    For purposes of Commission rulemaking in connection with the RFA, 
small entities include broker-dealers with total capital (net worth 
plus subordinated liabilities) of less than $500,000 on the date in the 
prior fiscal year as of which its audited financial statements were 
prepared pursuant to Rule 17a-5(d) under the Exchange Act,\135\ or, if 
not required to file such statements, a broker or dealer that had total 
capital (net worth plus subordinated liabilities) of less than $500,000 
on the last day of the preceding fiscal year (or in the time that it 
has been in business, if shorter); and is not affiliated with any 
person (other than a natural person) that is not a small business or 
small organization.\136\
---------------------------------------------------------------------------

    \135\ 17 CFR 240.17a-5(d).
    \136\ See 17 CFR 240.0-10(c).
---------------------------------------------------------------------------

    An ATS that complies with Regulation ATS must, among other things, 
register as a broker-dealer.\137\ Thus, the Commission's definition of 
small entity as it relates to broker-dealers also will apply to ATSs. 
An ATS that approaches the volume thresholds for investment grade or 
non-investment grade corporate debt securities in Rule 3a1-1 or 
Regulation ATS would be very large and thus unlikely to be a small 
entity or small organization. With respect to the proposed changes to 
Form ATS-R, even if an ATS is a ``small entity'' or ``small 
organization'' for purposes of the RFA, the only change being proposed 
to the form is to eliminate the distinction between investment grade 
and non-investment grade corporate debt securities and to require 
reporting for the combined class of corporate debt securities. We 
believe this will impose only negligible costs on ATSs, even if they 
were small entities or small organizations.
---------------------------------------------------------------------------

    \137\ See 17 CFR 242.301(b)(1).
---------------------------------------------------------------------------

    Similarly, SROs are the only respondents to Form PILOT and are not 
``small entities'' for purposes of the RFA. Accordingly, no small 
entities would be affected by the proposed amendments to Form PILOT.
    Under Section 605(b) of the RFA,\138\ we certified that, when 
adopted, the rule amendments would not have a significant economic 
impact on a substantial number of small entities. We included this 
certification in Part VIII of the Exchange Act Proposing Release. While 
we encouraged written comments regarding this certification, no 
commenters responded to this request as it pertains to the action taken 
in this release.
---------------------------------------------------------------------------

    \138\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------

B. Rule Amendments Under the Investment Company Act

    This Final Regulatory Flexibility Analysis (``FRFA'') has been 
prepared in accordance with 5 U.S.C. 604. We published in the 
Investment Company Act Proposing Release an Initial Regulatory 
Flexibility Analysis (``IRFA''), which we prepared in accordance with 
the RFA. It relates to amendments to Rules 5b-3 and 10f-3 under the 
Investment Company Act. The amendments remove references to, and the 
required use of, NRSRO ratings from these rules.
1. Need for and Objectives of the Rule Amendments
    The rule amendments are designed to address the concern that the 
inclusion in the Commission's rules and forms of requirements relating 
to security ratings could create the appearance that the Commission 
had, in effect, given its ``official seal of approval'' on ratings, 
which could adversely affect the quality of due diligence and 
investment analysis and lead to undue reliance on ratings.
2. Significant Issues Raised by Public Comment
    When the Commission proposed amendments to Rules 5b-3 and 10f-3, we 
requested comment on the proposal and the accompanying IRFA. In 
particular, we sought comments regarding:
     The number of small entities that might be affected by the 
amendments;
     The existence or nature of the potential impact of the 
amendments on small entities; and
     How to quantify the impact of the amendments, including 
any empirical data supporting the extent of the impact.
    We received no comments that addressed the proposed amendments' 
impact on small entities.
3. Small Entities Subject to the Rule Amendments
    The amendments to Rules 5b-3 and 10f-3 will affect funds, including

[[Page 52371]]

entities that are considered to be small businesses or small 
organizations (collectively, ``small entities'') for purposes of the 
RFA. Under the Investment Company Act, for purposes of the RFA, a fund 
is considered a small entity if it, together with other funds in the 
same group of related funds, has net assets of $50 million or less as 
of the end of its most recent fiscal year.\139\ Based on Commission 
filings, we estimate that 122 investment companies may be considered 
small entities. The Commission staff estimates that all of these 
investment companies may potentially rely on Rules 5b-3 and 10f-3.
---------------------------------------------------------------------------

    \139\ 17 CFR 270.0-10.
---------------------------------------------------------------------------

4. Reporting, Recordkeeping and Other Compliance Requirements
    The amendments to Rule 5b-3 eliminate the exception for 
certification requirements in conditions relating to the treatment of 
refunded securities, by removing the exception for rated debt in the 
definition of ``refunded security.'' \140\ Under the amended rule, in 
order to meet the definition of ``refunded security,'' an independent 
accountant must have certified to the escrow agent that the deposited 
securities will satisfy all scheduled payments of principal, interest 
and applicable premiums on any refunded securities.\141\ The amendment 
eliminates the current exception that does not require the 
certification if the refunded security is rated in the highest category 
by an NRSRO.
---------------------------------------------------------------------------

    \140\ See supra Section II.A.1.
    \141\ Amended Rule 5b-3(c)(4)(iii).
---------------------------------------------------------------------------

    The amendments to Rule 10f-3 eliminate references to NRSRO ratings 
in the rule's definition of ``eligible municipal security'' and 
substitute alternative provisions that require securities to be 
sufficiently liquid that they can be sold at or near their carrying 
value within a reasonably short period of time. In addition, the 
securities must be either:
     Subject to no greater than moderate credit risk; or
     If they are less seasoned securities, subject to a minimal 
or low amount of credit risk.\142\
---------------------------------------------------------------------------

    \142\ Amended Rule 10f-3(a)(3).
---------------------------------------------------------------------------

    Small entities registered with the Commission as investment 
companies seeking to rely on each of the rules will be subject to the 
same requirements as larger entities. As discussed in the IRFA and in 
this FRFA, in developing the amendments to Rules 5b-3 and 10f-3, we 
considered the extent to which the amendments will have a significant 
impact on a substantial number of small entities.
5. Commission Action To Minimize Effect on Small Entities
    The RFA directs us to consider significant alternatives that may 
accomplish our stated objective, while minimizing any significant 
adverse impact on small entities. In connection with the amendments, we 
considered several alternatives, including the following:
    (a) Different reporting or compliance standards or timetables. We 
believe that the credit quality and liquidity considerations required 
by the amendments to Rule 10f-3 should apply to all funds relying on 
the rules, including small entities. We believe that special compliance 
requirements or timetables for small entities are unnecessary because 
the substituted standards require a level of credit quality and 
liquidity that is similar to the standards in the current rule, but 
without reference to NRSRO ratings. Thus, these standards are designed 
to achieve the same purpose that the ratings were designed to achieve 
without resulting in significant costs for funds, including small 
entities. In addition, funds that rely on Rule 10f-3 may continue to 
use or rely on NRSRO ratings in making determinations under the amended 
rule. Moreover, different or special compliance requirements for small 
entities consistent with the Commission's goal of removing references 
to NRSRO ratings in the rule may create a risk that those entities 
could purchase securities with insufficient liquidity and credit 
quality, to the detriment of the fund and its investors. As discussed 
above, we do not believe that the requirement that the escrow agent for 
all refunded securities (not just those that are not top-rated) have 
received an independent accountant's certification would result in 
significant cost burdens for funds. We believe that fund managers may 
be able to obtain this information from multiple sources at little 
expense, including, for example, the issuer's Web site, a municipal 
dealer's Web site or the escrow agent's Web site.\143\ In addition, 
funds can satisfy the certification requirement of Rule 5b-3 by 
determining that an NRSRO required an independent accountant to make 
the same determination.\144\ Because we understand that these 
certifications are typically provided during the course of refunding 
transactions, we believe that it will not be difficult or expensive for 
fund managers to confirm that the certification has been provided to 
the escrow agent.
---------------------------------------------------------------------------

    \143\ See supra note 64 and accompanying text.
    \144\ See supra note 65 and accompanying text.
---------------------------------------------------------------------------

    (b) Clarification, consolidation or simplification of reporting and 
compliance requirements. Where we have substituted alternative credit 
quality and liquidity criteria for ratings references in the amended 
rules, we have endeavored to make the criteria as clear and 
straightforward as possible. We believe that the standards provided by 
the amended rule are sufficiently clear to permit a fund (or a fund 
adviser conducting the analysis on behalf of the fund board) to 
understand the risks acceptable under the rule. The amended rules are 
designed to minimize the regulatory burden, consistent with the 
Commission's objectives, on all entities eligible to rely on the 
respective rules, including small entities.
    (c) Performance rather than design standards. Rules 5b-3 and 10f-3, 
as amended, do not dictate any particular design standards that must be 
employed to meet the objectives of the rules. In fact, the amendments 
to the rules substitute a performance standard for references to NRSRO 
ratings.
    (d) Exempting small entities. Continuing to require small entities 
to rely exclusively on NRSRO ratings for the credit quality and 
liquidity determinations required by the amendments to Rule 10f-3 would 
not be consistent with the goals underlying our amendments. Moreover, 
fund boards may incorporate ratings reports, analyses and other 
assessments issued by third parties, including NRSROs, in making their 
determinations, although an NRSRO rating, by itself, could not 
substitute for the evaluation required to be performed under the 
amendments.

VII. Statutory Authority

    The Commission is adopting amendments to Rule 3a1-1, Rules 300 and 
301 of Regulation ATS and Forms ATS-R and PILOT under the Exchange Act 
under the authority set forth in Sections 3, 11A(c), 15, 17, 23(a) and 
36(a)(1) of the Exchange Act [15 U.S.C. 78c, 78k-1(c), 78o, 78q, 78w(a) 
and 78mm(a)(1)]. The Commission is adopting amendments to Rule 5b-3 
under the Investment Company Act under the authority set forth in 
Sections 6(c) and 38(a) of the Investment Company Act [15 U.S.C. 80a-
6(c) and 80a-37(a)]. The Commission is adopting amendments to Rule 10f-
3 under the Investment Company Act under the authority set forth in 
Sections 10(f), 31(a) and 38(a) of the Investment Company Act [15 
U.S.C. 80a-10(f), 80a-30(a) and 80a-37(a)].

[[Page 52372]]

List of Subjects

17 CFR Parts 240, 242 and 249

    Broker, Reporting and recordkeeping requirements, Securities.

17 CFR Part 270

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of Rule Amendments

0
For reasons set out in the preamble, Title 17, Chapter II of the Code 
of Federal Regulations is amended as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

0
1. The authority citation for Part 240 continues to read in part as 
follows:

    Authority:  15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 
80b-11 and 7201 et seq.; and 18 U.S.C. 1350, unless otherwise noted.
* * * * *

0
2. Amend Sec.  240.3a1-1 by revising paragraphs (b)(3)(v), (b)(3)(vi) 
and (b)(3)(vii) and by removing (b)(3)(viii) to read as follows:


Sec.  240.3a1-1  Exemption from the definition of ``Exchange'' under 
Section 3(a)(1) of the Act.

* * * * *
    (b) * * *
    (3) * * *
    (v) Corporate debt securities, which shall mean any securities 
that:
    (A) Evidence a liability of the issuer of such securities;
    (B) Have a fixed maturity date that is at least one year following 
the date of issuance; and
    (C) Are not exempted securities, as defined in section 3(a)(12) of 
the Act, (15 U.S.C. 78c(a)(12));
    (vi) Foreign corporate debt securities, which shall mean any 
securities that:
    (A) Evidence a liability of the issuer of such debt securities;
    (B) Are issued by a corporation or other organization incorporated 
or organized under the laws of any foreign country; and
    (C) Have a fixed maturity date that is at least one year following 
the date of issuance; and
    (vii) Foreign sovereign debt securities, which shall mean any 
securities that:
    (A) Evidence a liability of the issuer of such debt securities;
    (B) Are issued or guaranteed by the government of a foreign 
country, any political subdivision of a foreign country or any 
supranational entity; and
    (C) Do not have a maturity date of a year or less following the 
date of issuance.

PART 242--REGULATIONS M, SHO, ATS, AC AND NMS AND CUSTOMER MARGIN 
REQUIREMENTS FOR SECURITY FUTURES

0
3. The authority citation for Part 242 continues to read as follows:

    Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2), 
78i(a), 78j, 78k-l(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g), 
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29 and 
80a-37.


0
4. Section 242.300 is amended by revising paragraph (i), removing 
paragraph (j) and redesignating paragraph (k) as paragraph (j).
    The revision reads as follows:


Sec.  242.300  Definitions.

* * * * *
    (i) Corporate debt security shall mean any security that:
    (1) Evidences a liability of the issuer of such security;
    (2) Has a fixed maturity date that is at least one year following 
the date of issuance; and
    (3) Is not an exempted security, as defined in section 3(a)(12) of 
the Act (15 U.S.C. 78c(a)(12)).
* * * * *
    5. Section 242.301 is amended by:
    a. Adding the word ``or'' to the end of paragraph (b)(5)(i)(C);
    b. Revising paragraph (b)(5)(i)(D);
    c. Removing paragraph (b)(5)(i)(E);
    d. Adding the word ``or'' to the end of paragraph (b)(6)(i)(C);
    e. Revising paragraph (b)(6)(i)(D); and
    f. Removing paragraph (b)(6)(i)(E).
    The revisions read as follows:


Sec.  242.301  Requirements for alternative trading systems.

* * * * *
    (b) * * *
    (5) * * *
    (i) * * *
    (D) With respect to corporate debt securities, 5 percent or more of 
the average daily volume traded in the United States.
* * * * *
    (6) * * *
    (i) * * *
    (D) With respect to corporate debt securities, 20 percent or more 
of the average daily volume traded in the United States.
* * * * *

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

0
6. The authority citation for Part 249 continues to read, in part, as 
follows:

    Authority: 15 U.S.C. 78a et seq. and 7201 et seq.; and 18 U.S.C. 
1350, unless otherwise noted.
* * * * *


0
7. Form ATS-R (referenced in Sec.  249.638) is amended by:
0
a. In the instructions to the form, Section B, revising the second 
term, ``Investment Grade Corporate Debt Securities,'' and removing the 
third term, ``Non-Investment Grade Corporate Debt Securities''; and
0
b. In Section 4 of the form, revising Line L, to read ``Corporate debt 
securities,'' removing Line M and redesignating Lines N and O as Lines 
M and N.
    The revision reads as follows:

    Note: The text of Form ATS-R does not and this amendment will 
not appear in the Code of Federal Regulations.

Form ATS-R, Quarterly Report of Alternative Trading System Activities

Form ATS-R Instructions

    B. * * *
* * * * *
    CORPORATE DEBT SECURITIES--Shall mean any securities that (1) 
evidence a liability of the issuer of such securities; (2) have a fixed 
maturity date that is at least one year following the date of issuance; 
and (3) are not exempted securities, as defined in Section 3(a)(12) of 
the Exchange Act, (15 U.S.C. 78c(a)(12)).
* * * * *

0
8. Form PILOT (referenced in Sec.  249.821) is amended by:
0
a. In the instructions to the form, Section B, revising the second 
term, ``Investment Grade Corporate Debt Securities,'' and removing the 
third term, ``Non-Investment Grade Corporate Debt Securities''; and
0
b. In Section 9 of the form, revising Line J, to read ``Corporate debt 
securities,'' removing Line K and redesignating Lines L, M, N and O as 
Lines K, L, M and N.
    The revision reads as follows:

    Note:  The text of Form PILOT does not and this amendment will 
not appear in the Code of Federal Regulations.


[[Page 52373]]



Form PILOT, Initial Operation Report, Amendment to Initial Operation 
Report and Quarterly Report for Pilot Trading Systems Operated by Self-
Regulatory Organizations

Form PILOT Instructions

    B. * * *
* * * * *
    CORPORATE DEBT SECURITIES--Shall mean any securities that (1) 
evidence a liability of the issuer of such securities; (2) have a fixed 
maturity date that is at least one year following the date of issuance; 
and (3) are not exempted securities, as defined in Section 3(a)(12) of 
the Exchange Act, (15 U.S.C. 78c(a)(12)).
* * * * *

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

0
9. The authority citation for Part 270 continues to read in part as 
follows:

    Authority:  15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37 and 80a-
39, unless otherwise noted.
* * * * *

0
10. Section 270.5b-3 is amended by revising paragraph (c)(4)(iii) to 
read as follows:


Sec.  270.5b-3  Acquisition of repurchase agreement or refunded 
security treated as acquisition of underlying securities.

* * * * *
    (c) * * *
    (4) * * *
    (iii) At the time the deposited securities are placed in the escrow 
account, or at the time a substitution of the deposited securities is 
made, an independent certified public accountant has certified to the 
escrow agent that the deposited securities will satisfy all scheduled 
payments of principal, interest and applicable premiums on the Refunded 
Securities.
* * * * *

0
11. Section 270.10f-3 is amended by:
0
a. Revising paragraph (a)(3);
0
b. Removing paragraph (a)(5); and
0
c. Redesignating paragraphs (a)(6), (a)(7) and (a)(8) as paragraphs 
(a)(5), (a)(6) and (a)(7).
    The revision reads as follows:


Sec.  270.10f-3  Exemption for the acquisition of securities during the 
existence of an underwriting or selling syndicate.

    (a) * * *
    (3) Eligible Municipal Securities means ``municipal securities,'' 
as defined in section 3(a)(29) of the Securities Exchange Act of 1934 
(15 U.S.C. 78c(a)(29)), that are sufficiently liquid that they can be 
sold at or near their carrying value within a reasonably short period 
of time and either:
    (i) Are subject to no greater than moderate credit risk; or
    (ii) If the issuer of the municipal securities, or the entity 
supplying the revenues or other payments from which the issue is to be 
paid, has been in continuous operation for less than three years, 
including the operation of any predecessors, the securities are subject 
to a minimal or low amount of credit risk.
* * * * *

    By the Commission.

    Dated October 5, 2009.
Elizabeth M. Murphy,
Secretary.
[FR Doc. E9-24364 Filed 10-8-09; 8:45 am]

BILLING CODE 8011-01-P
